The sweeping sanctions imposed by Russia after the invasion of Ukraine on February 24 ripped the country from the global financial system and sent its economy reeling.
One month later, Russia’s currency lost a significant amount of its value and its stocks and bonds were removed from the indexes. The country’s people are suffering economic pain that will likely last for many years.
According to the World Bank, Russia was the 11th-largest country in 2020. It may not rank higher than No. 15 based on the end February rouble exchange rate according to Jim O’Neill (an ex-Goldman Sachs economist) who created the acronym BRIC to refer to the four major emerging economies Brazil. India, China, Russia and India.
Recession looks inevitable. According to the central bank, economists expect a 8% contraction in this year’s economy and 20% inflation.
Economists outside Russia have worse forecasts. The Institute of International Finance forecasts a 15% contraction for 2022 and a 3% contraction for 2023.
The IIF stated in a note that “All things considered, our projections indicate that current developments will wipe out the economic gains of approximately fifteen years.”
INFLATION BUSTING CONVERTS TO DUST
Elvira Nabirullina, central bank governor, has been a great success since her election in 2013. She managed to reduce inflation from 17% in 2015 down to just over 2% in the early years of 2018. In the aftermath of the pandemic, prices rose and she defied industrialists to raise interest rates for eight consecutive months.
Nabiullina also refused to comply with calls for capital controls in 2014-2015 to stem outflows after the annexed Crimea.
These achievements were ripped to pieces in less than a month.
Annual price growth has increased to 14.5%. It should exceed 20%, five-times the target. The inflation expectations of households for the next year are higher than 18%, an 11-year record.
Panic-buying accounts may be used for some of these, but rouble weakness could keep price pressures high .
Nabiullina was forced by Russia’s frozen reserves warchest to increase interest rates and implement capital controls on February 28. The central bank expects that inflation will return to target in 2024.
Index providers are being forced to remove Russia from the benchmarks that investors use to funnel billions into emerging markets by sanctions.
JPMorgan (.JPMEGDR.) and MSCI have both announced that they will remove Russia from their stock and bond indexes (.MSCIEF.).
Russia’s position in these indexes was already affected by the Western sanctions of 2014 and 2018, which followed the poisoning of an ex-Russian spy in Britain, and investigations into Russian meddling in 2016 U.S. election.
Nearly all major index providers will dial Russia’s weighting to zero on March 31.
Russian troops invaded Ukraine in 2014, and Ukraine had an enviable “investment-grade” credit rating from the three major agencies S&P Global Moody’s, Fitch, and Moody’s.
This allowed it to borrow reasonably cheaply, and a default on sovereign debt seemed distant.
Russia has seen its sovereign credit score suffer the most severe cuts in the last four weeks. Russia is currently at the bottom of ratings, indicating an imminent risk to default.
The average exchange rate for the rouble over the past year was 74 dollars per dollar. Different platforms displayed the tight spreads and ample liquidity expected in a major emerging market currency.
All of that has changed. The central bank being without a significant amount of its hard currency reserves, the ruble plunged to new lows of over 120 dollars per dollar. It was as low as 160 against the greenback in offshore trade.
Pricing the rouble has become more difficult as liquidity declined and bid/ask spreads increased. The balance between on-shore and offshore is still to be found in the exchange rate.