By Kenneth Rapoza
Billionaire investor George Soros warns of possible Russia default if peace deal is not reached and Putin’s power weakens. Oil prices remain the wildcard.
Everyone’s favorite target of conspiracy theory, the great mastermind of forex volatility and insider trading, George Soros himself, thinks Russia could default if the West prolongs sanctions.
Writing in the February edition of The New York Review of Books, the famed investor says the sanctions damaged Russia greater than anyone expected. In the article’s first paragraph, Soros brought up the specter of 1998. Known as the “Russian flu”, the financial crisis of 1998 packed a wallop on the economy and the nation’s politics. It led to the downfall of Boris Yeltsin and short term interest rates of more than 100%.
Of course, Russia is very much a different country now. The only similarity is the fact that, despite nearly 20 years difference, the economy is deeply dependent on oil and gas exports. Revenues from energy exports fill the government’s coffers. When oil prices and oil demand declines, Russian government accounts go into deficit.
Meanwhile, Russia’s economy is also better off than it was in 1998. Inflation, while high, is just 9% compared to around 40% in 1998. The ruble is allowed to float in the market, rather than face an unrealistic currency peg. The ruble was around six to 1 back then. And benchmark interest rates are 17% compared to triple digits back then.
Soros is no stranger to Russian economics. Back then, he was calling on Moscow to abandon its peg and stop supporting the ruble. Russia has spent around $40 billion of its roughly $338 billion in reserves trying to protect the ruble from declining too quickly. The ruble weakened to an all time low of 70 to 1 against the dollar in mid-December. It now trades in the low 60s to 1. In September, it was trading in the 30s to 1.
Soros notes that Russia ran out of its currency reserves in 1998 and defaulted on its debt, causing turmoil in the global financial system. He makes some comparisons.
Soros is of the mind that Russian president Vladimir Putin is out to rebuild the Soviet Union, on his terms. At first glance, this seems laughable. Putin’s latest economic move has been to create a customs union with minor economies on its border, a sort of alternative euro zone. It’s also been moving closer to China, though China’s closer to Europe and the U.S. economically — and closer to the U.S. culturally (thanks to the roughly 4 million Chinese living in the States) than it is to Russia. In other words, Putin may want to build a new Russian empire of sorts, but he most certainly has his work cut out for him.
Soros thinks Putin is on the ropes, despite the leverage he holds over Germany thanks to Gazprom . Germany is dependent on the Russian natural gas giant for its foreign gas deliveries. All told, Russia accounts for more than 30% of the E.U.’s foreign gas supply.
“Europe needs to wake up and recognize that it is under attack from Russia,” he says. “Assisting Ukraine should also be considered as a defense expenditure by the E.U. countries…. If the international authorities fail to come up with an impressive assistance program in response to an aggressive Ukrainian reform program, the new Ukraine will probably fail, Europe will be left on its own to defend itself against Russian aggression, and Europe will have abandoned the values and principles on which the European Union was founded. That would be an irreparable loss.”
Soros writes that sanctions on Russia should be maintained after they start expiring in April 2015. The E.U. is to take up discussion of extending sections on Jan. 19. Soros thinks the E.U. should not budge on them unless Putin agrees to “stop destabilizing Ukraine” in the four eastern provinces on its border.
Meanwhile, the financial crisis in Russia have made Putin politically vulnerable. It’s made investors who remain long Russian securities vulnerable too. This month’s peace talks, coupled with the E.U. meeting on sanctions and the International Monetary Fund’s meeting on Ukraine’s aid and reform deal will dictate where these markets go from here.