Russia faces 'perfect storm' as reserves vanish and derivatives flash default warnings
BNP Paribas says Russia no longer has enough reserves to cover external debt and enters this crisis 'twice as levered' as it was before the Lehman crash
9:02PM GMT 06 Jan 2015
Russia’s foreign reserves have dropped to the lowest level since the Lehman crisis and are vanishing at an unsustainable rate as the country struggles to defends the rouble against capital flight.
Central bank data show that a blitz of currency intervention depleted reserves by $26bn in the two weeks to December 26, the fastest pace of erosion since the crisis in Ukraine erupted early last year.
Credit defaults swaps (CDS) measuring bankruptcy risk for Russia spiked violently on Tuesday, surging by 100 basis points to 630, before falling back slightly.
Markit says this implies a 32pc expectation of a sovereign default over the next five years, the highest since Western sanctions and crumbling oil prices combined to cripple the Russian economy.
Total reserves have fallen from $511bn to $388bn in a year. The Kremlin has already committed a third of what remains to bolster the domestic economy in 2015, greatly reducing the amount that can be used to defend the rouble.
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The Institute for International Finance (IIF) says the danger line is $330bn, given the dollar liabilities of Russian companies and chronic capital flight.
Currency intervention did stabilise the exchange rate in late December after a spectacular crash threatened to spin out of control, but relief is proving short-lived.
The rouble weakened sharply to 64 against the dollar on Tuesday. It has slumped moe than 20pc since Christmas, with increasing contagion to Belarus, Georgia and other closely-linked economies.
There are signs that Russia’s crisis may undermine President Vladimir’s Putin’s Eurasian Economic Union before it has got off the ground. Belarus’s Alexander Lukashenko is already insisting that trade be carried out in US dollars, while Kazakhstan’s Nursultan Nazarbayev warned that the Russian crash poses a “major risk” to the new venture.
The rouble is trading in lockstep with Brent crude, which has continued its relentless slide this week, falling to a five-year low of $51.50 a barrel. “If oil drops to $45 or lower and stays there, Russia is going to face a big problem,” said Mikhail Liluashvili, from Oxford Economics. “The central bank will try to smooth volatility but they will have to let the rouble fall and this could push inflation to 20pc.”
Under the Russian central bank’s “emergency scenario”, GDP may contract by as much as 4.7pc this year if oil settles at $60. The damage could be worse following the bank’s contentious decision to raise rates from 9.5pc to 17pc in December. BNP Paribas says that each 1pc rise in rates cuts 0.8pc off GDP a year later.
BNP’s Tatiana Tchembarova said the situation is more serious than in 2008, when Russia had to spend $170bn to rescue its banks. This time it no longer has enough reserves to cover external debt, and it enters the crisis “twice as levered”.
Mr Putin has imposed partial capital controls by forcing companies to repatriate foreign currency. This has bought time and shored up the rouble for a few days, but it is a disguised form of reserve depletion since many of these companies will need dollars to repay debt.
Many of these companies are pillars of the Russian economy or energy champions. Their dollar debts are implicitly liabilities of the Russian state since these firms cannot be left to default. The oil giant Rosneft has requested $46bn in state aid to help meet repayments and cover investment.
Igor Sechin, Rosneft’s chairman, expects oil to recover in the second half of 2015 and fluctuate between $70 and $75 but warned that the group would have to retrench. “Some high-cost projects will be postponed,” he said. Analysts at Sberbank said the group faces a “very difficult year”.
The total foreign debt of Russian companies and state entities is $654bn. They have to repay roughly $10bn a month since they are shut out of international capital markets and cannot roll over loans.
The IIF’s Lubomir Mitov said the oil crash could leave Russia with a current account deficit of 3.5pc of GDP. Each $10 fall in crude cuts export revenue by 2pc of GDP. This comes on top chronic capital flight and the collapse of inward flows due to sanctions. The overall “financing gap” could soon reach 10pc of GDP, putting enormous strain on the rouble. “It’s a perfect storm,” he said.
The interest costs on hard-currency debt have suddenly doubled in rouble terms. While commodity exporters earn matching dollars, Russian property developers and domestic companies with dollar-debt have no such buffer.
Russia’s RTS index of stocks has fallen by 62pc since early 2011 but smaller companies have been hit far harder. Kingsmill Bond, Sberbank’s chief strategist, said Russian equities are among the cheapest in the world and are trading on fear, ignoring the country’s strategic depth. “People have been selling indiscriminately. Once the oil price stabilises, it will be a perfect time to buy illiquid domestic stocks, like the homebuilder ISR,” he said.
Mr Bond said brave investors who bought Russian stocks at the nadir of the crisis in 2008-2009 were rewarded with gains of up 1,000pc. “First we have to wait for oil to hit bottom,” he said.
