Russia Crisis Worsens As Ruble Tumbles

George Friedman calls it the Russian Resurgence and his editorial was featured by John Mauldin in his Outside The Box Special.

• Russian power is in long-term decline. Compared to the Soviet Union in 1989, the Russian Federation has less than half the population, one-third the economic bulk, lower commodity production and vastly decreased industrial output. Demographically, Russia is both shrinking and aging at rates that have not been seen outside of wartime since the time of the Black Death. The educational system has stalled, so Russia is facing an impending slide in labor quantity and quality, which will make it difficult if not outright impossible for Russia to keep up with its advancing neighbors. The long-term prognosis is, at best, very poor.
  
  But "long-term" is the operative term. Russian power today must not be measured in the terms that will dominate its existence in the future. Instead, it must be assessed dispassionately in relative terms against its neighbors and competitors. Of those neighbors, only China can compare to Russia regarding military and economic capability, and the two states are bending over backward to avoid an adversarial relationship. True, in 2009 Russia faces the most dire economic challenges since the 1998 ruble crash and debt default, but so do all the states in Central Asia, the Caucasus, the Balkans, Central Europe and the Baltics. In fact, since Russia maintains more reserve funds and currency reserves than all the states in this arc combined, Russia even maintains a financial edge over the competition. And even with the global recession placing very real limits on what Moscow can achieve financially — both at home and abroad — Russia has myriad tools that place countries of interest to it at the Kremlin's mercy. The Kremlin (rightly) fears that Russia's days are numbered, but it has a simple plan: Re-establish as large of a buffer zone around the Russian core as possible while the balance of power remains in Russia's favor.
  
  For Russia, most of the post-Cold War era was a chronicle of retreat from previous prominence, culminating in the West's decision in 2008 to recognize the independence of the former Serbian province of Kosovo — a decision that Russia campaigned long and hard to prevent. But in August 2008, Russia invaded its former territory of Georgia and proved to the world that Russian power was far from spent, marking the inflection point on the question of Russia's resurgence. The year 2009 will be about Russia using its military, intelligence and energy might to extend its influence back into its periphery.
  
  Russia's primary target in 2009 is Ukraine, a country uniquely critical to Russia's geopolitical position and uniquely vulnerable to Russia's energy, intelligence and military tools — and then there is the influence Russia can wield over Ukraine's large Russian-speaking population. Russia has many other regions that it wants to bring into its fold while it can still act decisively — the Caucasus, Central Asia, the Balkans, the Baltics and Poland — but Ukraine is at the top of the list.
  
  Ukraine occupies a piece of territory that is completely integrated into Russia's agricultural, industrial, energy and transport networks. Its physical position makes it crucial to Russia's ability to project power. A Ukraine at odds with Russia constrains Russia's position in the Caucasus, limits Russian power in Europe, threatens the entire Russian core and puts Moscow within spitting distance of a hostile border. A defiant Ukraine not only forces Russia to be purely defensive, but actually makes Russian territory indefensible from the west and south, as there are no natural boundaries to hide behind. In contrast, an acquiescent Ukraine allows Russia to project power outward into Central Europe and gives Russia greater access to the Black Sea and thus the Mediterranean and outside world.
  
  Russia lost the territory in 1992 with the Soviet collapse, but managed to keep Ukraine a political no-mans-land. In 2004, however, the Orange Revolution brought to power a government not just oriented toward the West but downright hostile to Moscow. This sparked a panic in the Kremlin that prompted a foreign policy leading to Russia's resurgence. That resurgence is now stable enough that the Kremlin feels it can return Ukraine to the Russian orbit — forcibly, if necessary.
  
  Russia has no shortage of tools to use on Ukraine to mold it into a shape more amenable to Russian interests. Russia backs and bankrolls Viktor Yanukovich, Yulia Timoshenko and Rinat Akhmetov — three of Ukraine's four most powerful political forces. Russia supplies Ukraine with two-thirds of its natural gas and four-fifths of its energy needs, and is not shy about using that control to damage the government. Ukraine is integrated into the Russian industrial heartland, and Russian firms directly control large portions of the Ukrainian metals industries. Russian control over several of Ukraine's ports links several Ukrainian oligarchs — and some Ukrainian organized crime syndicates — directly to the Kremlin.
  
  Ukraine is not well equipped to resist Russia's efforts. The United States has been working with Ukrainian intelligence (which is currently under President Viktor Yushchenko), sparking a fierce battle within the Ukrainian intelligence services, which spun off from the KGB. Yushchenko is trying to purge ex-KGB forces and put in younger, American-trained staff members, but the Russian intelligence surge into the country since 2004 has been massive and is hard to counteract. Other Western intelligence agencies are simply too far behind to make much of a difference; only the Turks have made a notable effort. The rest of the "Western" moves are largely limited to bureaucratized American processes, largely financial and social, which simply are no match for the powerful, multi-vectored effort that Russia is making.
  
  Russia is perfectly capable of achieving its goals in Ukraine on its own. The natural gas crisis at the start of 2009 is a testament to Russian capability, but Moscow has shown that it is willing to accept a deal that will make Ukraine more malleable. Specifically, the United States is attempting to forge a means of supplying its growing troop commitment in Afghanistan without becoming more dependent upon Pakistan. Russia is willing to allow American supplies to transit Russia and Russian-influenced Central Asia. But the price is Yushchenko's ouster and an agreement that the United States will not parlay its transit routes across Central Asia into actual influence over the region. And just in case the United States decides to push for more, Russia has established a network of options in the Middle East to complicate American efforts there should the need arise (for more information, see the Middle East section of the Annual Forecast), and is even putting some flags in the ground in Latin America.
  
  Under the Obama administration, American foreign policy's initial focus is on fighting the Afghan war. So the question regarding the Russian resurgence is not what the Americans will give the Russians, but how much and how publicly. This will give the United States greater leverage in dealing with what it has identified as its prime concern, but at the cost of both creating a greater challenge in the future and undermining the strength of the Transatlantic alliance structure.

And Russia is currently much in the news. On Wednesday it was downgraded by Fitch.

Fitch Cuts Russia Debt Rating First Time Since 1998

• Feb. 4 (Bloomberg) -- Russia had its debt rating cut by Fitch Ratings for the first time in more than a decade as falling oil prices contributed to dwindling foreign currency reserves and record capital flight.
  
  The rating was lowered to BBB, the second-lowest investment grade, from BBB+, Fitch said in a statement today. Fitch maintained its negative outlook. Standard & Poor’s Ratings Services took the same action on Dec. 8. Russian stocks erased earlier gains, while bonds were little changed.
  
  Emerging markets are being battered by the global financial crisis as investors shun assets seen as being riskier. Russia, the world’s largest energy supplier, has spent $210 billion, or more than a third of its currency reserves, supporting the ruble since August, Fitch said.
  
  “The country made a mistake trying to defend the ruble when it was indefensible,” said Nouriel Roubini, the New York University professor who forecast a U.S. recession two years ago, in an interview in Moscow today.
  
  Foreign investors have pulled about $290 billion out of the country in the same period, according to BNP Paribas SA estimates. The flight of capital is putting pressure on government finances and makes it difficult for Russian companies to refinance debt, Fitch said.
  
  ‘Materially Weakened’
  
  “The scale of capital outflows and the pace of decline in Russia’s foreign exchange reserves have materially weakened the sovereign balance sheet,” said Edward Parker, head of emerging Europe at Fitch, in the statement. “The downgrade reflects the negative impact on Russia from the fall in commodity prices and the dislocation to global capital markets.”
  
  Russian companies and banks have $140 billion in foreign debt payments coming due in 2009, which will be a “drain” on reserves this year, Fitch said. Russian companies have not sold bonds on the international markets since July.
  
  “In this market, it’s going to be extremely difficult for a number of those corporates to roll over that debt,” said Kevin Daly, who helps oversee about $4 billion in emerging- markets bonds at Aberdeen Asset Management Plc.
  
  Available Cash
  
  The central bank “may be running out” of cash to bolster the ruble, with the amount of reserves available to support the currency expected to decline from $59.4 billion at the end of January to less than zero at the end of the year, JPMorgan Chase & Co. said in a report dated yesterday.
  
  Fitch last downgraded Russian debt in August 1998, when the government defaulted on domestic debt and devalued the ruble, wiping out the savings of millions of people overnight.
  
  The 30-stock Micex Index fell 0.1 percent to 625.26 at 3:30 p.m. in Moscow after earlier rising as much as 2.2 percent before the Fitch announcement. The yield on Russia’s benchmark dollar bond due 2030 was little changed at 8.89 percent.
  
  Russia’s credit risk dropped to the lowest in a week, credit-default swap prices show.
  
  Swaps Fall
  
  The cost to protect against a Russia default fell 11.3 basis points to 718.7 basis points, the lowest since Jan. 29, according prices from CMA Datavision in London. The swaps rise as perceptions of credit quality deteriorate.
  
  Credit-default swaps, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point is equivalent to $1,000 on a contract protecting $10 million of debt.
  
  Moody’s may “follow the trend” with a downgrade of Russian debt, Commerzbank AG said in a note today.
  
  Fitch also cut the credit rating of OAO RusHydro, Russia’s state-controlled hydropower producer, to BB+, or junk, from BBB-. OAO Gazprom’s and OAO Rosneft’s credit ratings were affirmed.

And in globalised world, one cannot expect no chain reactions. Dearest Kat had wrote some short notes on Why Did the Euro Fall on Russia’s Credit Downgrade?

• The reason why the Euro has been impacted by the developments in Russia is because the central bank manages the Ruble’s value against a basket of dollar and euros. When the basket was introduced in 2005, it was made up of 10% Euros and 90% dollars. The Euro’s share has gradually increased since then and the basket is now 45% Euros and 55% dollars.
  If the central bank intervenes to stop the Ruble from falling, they would have to sell Euros and US dollars to rebalance their currency basket.

And the ruble of course tumbles.

Even Jim Rogers appeared on a Bloomberg video saying that Russia May Break Up, Mulls Bet Against Ruble (do click on the link for the video clip)

And of course the ruble continues to tumble. It's even a larger mess when their banks are saying that Russia Fueling Ruble Tumble With Loans! (Rogers quoted below)

• Feb. 5 (Bloomberg) -- Russia’s central bank is exacerbating the ruble’s 35 percent plunge since August, even as it struggles to defend the exchange rate, by providing loans to banks that speculate on the currency, say Alfa Bank and UniCredit SpA.
  
  Bank Rossii lent 7.7 trillion rubles ($214 billion) in overnight and seven-day loans secured with bonds or other collateral in the 16 trading days last month, about double the 4.8 trillion rubles provided in so-called repurchase auctions in December, central bank data show. The ruble lost 18 percent against the dollar in January. It weakened today beyond the lower limit that the central bank said it will defend.
  
  “A significant amount, if not all, of the speculative attacks on the ruble are funded by the central bank itself,” said Vladimir Osakovsky, Moscow-based economist for UniCredit, Italy’s largest bank.
  
  Prime Minister Vladimir Putin praised the central bank’s “gradual devaluation” policy in a Bloomberg Television interview Jan. 25, saying it avoided a repeat of the financial crisis a decade ago when the ruble plunged as much as 29 percent in a day as the government defaulted on $40 billion of debt. Jim Rogers, chairman of Rogers Holdings, said today that Russia has become “unstable” and may break apart. He’s considering betting against the ruble because of central bank mismanagement.
  
  Policy makers are trying to stop speculators from driving down the currency, which makes it more expensive for borrowers to pay back debt and fuels inflation, at the same time it seeks to hold down interest rates to keep the economy from contracting for the first time since 1998. Russia’s inflation rate rose in January for the first time in five months to 13.4 percent as the weakening ruble pushed up the cost of imports.
  
  Spending Reserves
  
  The ruble slid to as low as 41.0181 against a target basket of dollars and euros today. Central bank Chairman Sergey Ignatiev pledged Jan. 22 to continue using reserves to hold the ruble at 41, and said he would limit the amount of refinancing offered and adjust interest rates.
  
  “Knowing that the central bank has drawn a line in the sand, it makes me sit up and take a little more notice about the ruble,” Rogers said in an interview in Moscow. “So I will start thinking more about” betting against the currency.
  
  The central bank spent $210 billion, more than a third of its foreign-currency reserves, to support the ruble since August, as the war with Georgia, falling oil prices and the worst global financial crisis since the Great Depression spurred a retreat by investors that BNP Paribas SA estimates pulled more than $290 billion from the country.
  
  ‘Spill Blood’
  
  Bank Rossii won’t need to “spill a lot of blood” to defend the exchange rate, Sergei Shvetsov, director of the bank’s financial operations department, said in Moscow today. Reserves rose by $1.6 billion last week, the first gain in three weeks.
  
  While the central bank raised borrowing costs on short-term financing for the third time since November on Feb. 2 and limited traders’ ability to bet on the exchange rate, the efforts aren’t enough to slow demand, said Natalia Orlova, chief economist at Alfa, Russia’s largest non-government bank. Policy makers lifted the rate on overnight and seven-day loans obtained through the auctions by 1 percentage point to 11 percent this week, the highest since at least November 2007, data on the central bank’s Web site show.
  
  Banks used “almost all” the money from loan auctions to bet against the ruble, Orlova said.
  
  Putin Defends
  
  “If they really wanted to stop speculation, they have to raise the rates significantly, say to 20 or 30 percent, for a short period of time,” said Evgeny Gavrilenkov, chief economist at Moscow-based brokerage Troika Dialog. “One day they have to say: Give me my money back, no more repo is available.”
  
  The largest banks in Russia have been speculating, said Anton Petkin, head of trading in Moscow for Zurich-based UBS AG, Switzerland’s biggest bank. Petkin said his bank has been doing the same thing.
  
  Banks bid for 505 billion rubles in repo auctions yesterday, more than the 402 billion rubles that was lent, according to data compiled by the central bank. Banks also requested 139 billion rubles in an auction of unsecured loans Feb. 3, about six times the 23.5 billion rubles provided. These loans were extended to more than 100 Russian banks in November as a way of boosting liquidity amid the seizure in global credit markets.
  
  Sberbank earned nothing from the ruble’s depreciation, Chief Executive officer German Gref said at a conference in Moscow yesterday. Troika Dialog hasn’t been betting on the ruble’s drop, Managing Director Andrei Sharanov said Feb. 3.
  
  “It’s a great opportunity, why not?” said Petkin at UBS.
  
  Credit Squeeze
  
  Policy makers “have basically fueled the speculation on the ruble themselves,” Alfa’s Orlova said in an interview. “The market is intent on testing the central bank’s ability to spend reserves and they’re going to really have to tighten liquidity, or something, if they want to have a hope against that.”
  
  Bank Rossii is stepping up lending to banks to ease the credit squeeze created by its ruble purchases in the foreign- exchange market, according to Alexei Moisseev, head of fixed- income research at Moscow investment bank Renaissance Capital. Banks also borrowed 533 billion rubles in auctions of unsecured loans in January, compared with the 1.3 trillion rubles lent in December.
  
  The extra funding helped lower the average interest rate banks charge each other for overnight loans, known as the MosPrime rate, to a one-month low of 9.25 percent today from a record 25.17 percent on Jan. 27. Central bankers are concerned that a jump in interest rates would starve banks of cash and deepen the economic slowdown, said Renaissance’s Moisseev, a former economist with Bank Rossii’s capital controls department.
  
  Slowdown
  
  Russia’s economy will probably contract by 0.2 percent this year, marking the start of the first recession since the 1998 crisis, according to the Economy Ministry. Prices for Urals crude, Russia’s chief export oil blend, have slumped 70 percent from a July 4 record of $142.94 a barrel. Urals is now at $43.01 a barrel, below the $70 average required to balance Russia’s current budget for 2009.
  
  Russia’s dollar-denominated RTS stock index slumped 15 percent in January, its eighth monthly decline. OAO Sberbank, the country’s largest bank, lost 41 percent in the past month, while VTB Group slumped 36 percent in January.
  
  Financial turmoil forced neighboring Ukraine to let the hryvnia slump 42 percent against the dollar since August and Kazakhstan let the tenge decline 22 percent in the past two days, as central banks struggle to control their currencies and maintain reserves. Belarus devalued its ruble by 20 percent to the dollar last month.
  
  Bank’s Next Move
  
  “They have to raise interest rates if they want to stop speculation,” said Troika’s Gavrilenkov. “But there is still a lot of concern among the authorities that the banking sector might collapse.”
  
  To deter the use of the state loans by speculators, Bank Rossii ordered banks last year not to increase holdings of foreign currency above the average level in November. The central bank has also re-imposed a limit of 5 billion rubles on currency swap agreements that allow traders to bet on an exchange rate without having to sell currency upfront.
  
  Bank Rossii’s next move may be to reduce the amount offered in the auctions, possibly withdrawing the unsecured loans altogether, according to Alfa’s Orlova.
  
  A tax of as much as 20 percent on purchases of foreign currency is also possible, Orlova said. “It just seems very strange that they didn’t start to control this two months ago when the devaluation first started,” she said.
  
  Currency Police
  
  Bank Rossii may send representatives to individual banks to check on their foreign-currency holdings, said Stanislav Ponomarenko, chief economist in Moscow at ING Groep NV. President Dmitry Medvedev told the Federal Security Service, Russia’s spy agency, to monitor the allocation of state funds on Jan. 29, saying it is “doubly criminal” for investors to get rich off the crisis.
  
  “They’ll be watching carefully how liquidity is used,” Ponomarenko said. “Leaning on the banks and letting them know they’re being watched. That may be the most effective way of stopping this.”

See also: Russia Crisis Worsens and Another Russian Crisis?

And the following is the chart of the Ruble against the US Dollar provided by exchange-rates.org ( http://www.exchange-rates.org/history/RUB/USD/G )