Russia’s president Vladimir Putin today enjoys approval ratings over 80 percent at home. That support, however, is more tenuous than it appears — much of it stems from locals feeling victimized by Western sanctions plus a general rallying around their leader. Putin has a lot of work ahead if he wants to keep his hero-like status. Russia hasn’t seen a national emergency like this since 2002.
Year to date, the ruble has already fallen more than 40 percent against the dollar. Meanwhile, Russia’s foreign exchange reserves have dropped nearly $100 billion. The nation’s capital stock has declined by more than $250 billion. Most of these declines have occurred since July 1.
Annualized inflation is at 9.1 percent as of November and may soon reach double digits. In a scene reminiscent of Russia’s currency collapse under Boris Yeltsin, Russian citizens are flooding the malls and markets hoping to purchase goods before prices increase. Shelves are going empty.
Last week’s surprise 650-basis point rate hike — from 10.5 percent to 17 percent — was an act of desperation by Russia’s central bank. It marked the second attempt in a 48-hour period to shore up the value of the ruble, on the heels of four other rate increases since March when interest rates were at 5.5 percent.
Yet even these hikes didn’t save the ruble.
Both Washington and Wall Street are watching, wondering what Putin’s government does next. But it now appears safe to say: The Ukraine crisis has become a grave threat to the Russian economy.
The European Union and the United States have imposed successive layers of economic sanctions on Russia as a penalty for the annexation of Crimea back on March 17 and for its support of pro-Russian separatist groups in eastern Ukraine. These groups want autonomy. Kiev hates the idea: The last region to be autonomous was Crimea, and Crimea is now part of the Russian Federation.
Washington, Brussels, and Kiev think Moscow is trying to redraw the Ukrainian map. Moscow thinks the West is trying to reshape NATO. Investors, meanwhile, are losing millions of dollars.
Ukraine’s new government is in no better shape. It has been sitting on top of a looming government default amid an economy in chaos. And it is locked in a civil war it cannot afford.
In the Western media’s eyes, Russia became a pariah state after annexing Crimea. But the big turning point came this summer after tensions worsened between Moscow and Kiev. On July 1, Ukrainian President Petro Poroshenko lifted a cease-fire on pro-Russian separatists in the East. Civil war returned. Following the downing of Malaysian passenger airliner MH17 on July 17, the EU and United States announced a new set of sanctions. Unlike previous sanctions, these targeted the most important economic sectors of Russia — energy and finance — and have been the most damaging.
Due to these sanctions, companies like BNP Paribas, fined $9 billion by US authorities earlier in the year for violating sanctions during the Bush administration, began to pull their horns in. The spigot of European and American capital to Russia quickly turned off. But the ramifications have spread much farther.
Europe’s economy first felt the effect of sanctions as tourist towns in Greece, Czech Republic, and elsewhere remained dormant this summer. Russian tourists and their capital stayed home. Russian investors in Europe also turned tail. But the end is not near. This trouble could soon spill over on to the European Central Bank, thanks to an estimated at $1.2 trillion in consumer loans tied to the Russian economy. If bankruptcies begin to rise, we can only imagine how non-performing loans underwritten by European banks will skyrocket.
For the global economy, such headwinds have likely been too much to keep oil prices around $80 per barrel. The increased economic drag for Russia and Europe due to Ukraine — combined with coincident slowdowns in China and Japan — have likely fed into the rapid decline in oil prices since June. A slowing global economy demands less oil.
Moscow now expects its economy to contract 5 percent so long as oil persists at or below $60 per barrel. Low oil will likely continue to weigh on the ruble.
But unless the ruble stabilizes and inflation is brought under control, the ground could quickly shift under Putin. Think of Indonesia in the late 1990s.
Indonesian strongman Suharto had won an uncontested election in March 1998, but the problem of rising inflation due to rupiah weakness was already evident, with mothers reportedly being imprisoned for protesting the rising price of staples such as milk. By the time Suharto stepped down on May 21, 1998, the rupiah lost 80 percent of its value against the dollar on a year-over-year basis. The same sort of populist anxiety will exist under Vladimir Putin, too, until inflation is brought under control.
For now, resumption of the Minsk peace talks, which could lead to a negotiated settlement and a rescission of sanctions, seems the most rational outcome. Both Russia and Ukraine are incentivized to see diplomacy work. Barring that, what comes next for Russia if Putin loses his battle with inflation remains to be seen, of course. But such a scenario is worth pondering and worrying about.
Vladimir Signorelli is president of the investment research firm Bretton Woods Research LLC in New Jersey.