Russia has just lost the economic war with the West

The Guardian: 16. December 2014
by Larry Elliott

The freefalling rouble will cause Russians a bit of a headache.

The interest rate hike’s failure to halt a freefalling rouble means Russia is facing a perfect storm, only part of which is a full-blown currency crisis

A full-blown currency crisis. That’s one way to describe the situation in Russia, where even the attempted “shock and awe” of a 6.5 percentage point-hike in interest rates failed to halt the rouble’s slide on the foreign exchanges. The other is to say that Russia has been engaged in an economic war with the west – and has just lost.

Put simply, this was Moscow’s Norman Lamont moment. Back in September 1992, the then chancellor said he would defend the pound and keep Britain in the exchange rate mechanism by raising official borrowing costs to 15%, even though the economy was in deep trouble at the time.

Russia is in even worse shape than Britain was in 1992. With a clapped-out manufacturing sector, it is over-reliant on its massive stocks of oil and gas at a time when the price of oil is falling through the floor. A barrel of Brent crude was trading at below $60 a barrel on Tuesday, compared to a recent peak of $115 in the summer.

The west knows all about the vulnerability of Russia’s economy. When the introduction of sanctions over Russia’s support for the separatists in Ukraine failed to bring Vladimir Putin to heel, the US and the Saudi Arabians decided to hurt Russia by driving down oil prices. Both countries will face some collateral damage as a result – and this could be considerable in the case of the US shale sector – but both were prepared to take the risk on the grounds that Russia would suffer much more pain. This has proved to be true.

At some point, lower oil prices will lead to stronger global growth, because consumers will have more money to spend and businesses will have more spare cash to INVEST. At that point, the price of oil will rise. But we are not there yet; in the short term the oil price is likely to keep falling.

So where does that leave Russia? Like Lamont, it has reached the end of the road with interest-rate increases. If a 6.5-point rise proves insufficient to halt the collapse of the rouble, it is hard to know what would do the trick. What’s more, it’s clear that some members of the policy elite in Moscow are unhappy with the idea of further damaging an already weak economy through draconian increases in interest rates to defend the currency.

As a result, there are now only two options. 

The first is to allow the rouble to find its own level, in the hope that the decline in the oil price will prove temporary and that rising demand for energy as the global economy recovers will push up the rouble against the dollar.

The other is to introduce stringent capital controls. These are seen very much as a last resort by Moscow, but may prove necessary if the rouble rout continues.

The phrase “perfect storm” is much over-used, but in Russia’s case it is entirely apposite. The country has a collapsing currency, a collapsing economy and sky-high interest rates. The question now is how the Putin government responds. If Moscow softens its line over Ukraine, it will be a case of mission accomplished for the west. But if economic agony makes a wounded Russian bear even more belligerent, it could prove to be a hollow victory.