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Russia: Economic Vulnerabilities

Marc To Market's picture




 

There is a common perception that Russia's move on Crimea shows its strength.  A closer examination suggests it is more complicated that it may seem.   Like the bully at the school yard, the aggressiveness conceals weaknesses. 

 

Simply put, Russia felt threatened and for good reason.  The democratic coup in the Ukraine threatened a potentially strategic loss for Russia.  For months, it had been using both carrot and stick to pressure Ukraine, Moldova and Georgia from shifting more to the EU.  Reports indicate that Putin had drawn his own line on Ukraine and made it clear to the EU and US that Russia would not accept a Ukraine in unfriendly hands.  

 

Yanukovych was brought to heel and at the last minute embarrassed and frustrated the EU (and by extension, the US) and struck a deal with Russia.   A democratic coup toppled Yanukovych, and there are reasons to suspect that Europe and/or the US may have help facilitate the political uprising.  Among the first acts, the new government abolished Russian as the second official language.  

 

There was a realistic fear (on the part of Russia) that the new government would more to retract the  2010 agreement that arguably was struck under duress, to renew and extend the Russia's lease on the Sevastopol naval base.  The lease, first struck by Yeltsin was to expire in 2017.   Fisticuffs broke out in the Ukrainian parliament over the issue that eventually led to a 25-year extension of the lease. 

 

The annexation of Crimea will make this issue moot, though at a cost.  Prior to the annexation, Putin claims the mantel of the status quo power and forces the US and Europe to be the revisionists.  Annexation puts the shoe on the other foot.  It is a less defendable position in legal and diplomatic terms.   

 

Leaving aside potential Western military options, such as resuming the ballistic missile defense programs, moving NATO troops to Ukraine's western border,  and even sending new weapons to Ukraine, there will likely be economic consequences. 

 

The consequences we have in mind are not sanctions by government, but punishment by impersonal market forces.  Ironically, despite some claims that the US military buildup under Reagan led to the bankruptcy of the Soviet Union, arguably more robust analysis would give a more decisive role to the collapse in oil prices in the mid-1980s (e.g., WTI fell below $10 a barrel). 

 

With the exception of Singapore and Hungary, Russia has the highest amount of foreign currency debt at about 12% of GDP.   Ruble depreciation boosts the cost of servicing the debt, some of which is in corporate, not government hands.  The dollar rose 8.25% against the  from rouble the start of the year through early February.  It has gained another 7% since then.  It is the second worse performing currency against the dollar this year, behind the Argentine peso. 

 

The currency depreciation, in the context of political and economic uncertainty, has seen Russian yields soar.  The rouble denominated 10-year yield has risen more than 100 bp, thus far this year, to 8.85%, eclipsing the yield of South Africa.   The dollar denominated bond yield has risen 55 bp to 5.11%. 

 

The cost of insuring  Russian (rouble) exposure via the credit default swap market has risen about 50% this year to more than 230 basis points.  This puts it within spitting distance of Turkey (233 bp), Hungary (242 bp) and Croatia (318 bp). 

 

Russian equities are among the worst performing equity markets in the world so far this year.  MICEX is off 13% so far this year, with a 17% slide since February 18.  

 

Even before the recent developments, capital outflows frustrated Russian officials.  Outflows have typically exceeded forecasts by the central bank and government.  Last year, central bank forecast $10 bln of outflows.  Figures released in mid-January showed that the capital outflows were six times greater.  At the same time, the current account surplus was more than halved to $33 bln. 

 

Putin, who claims to be a student of history, may be repeating some of the same mistakes of the Soviet Union with  an apparent disregard of market forces; poor domestic investment opportunities, high inflation and high cost of capital weigh on growth.  Last year, Russia recorded growth of a 1.3%, the lowest since 2009 and well below the government's target of 5%. 

 

Russia has accumulated a stockpile of foreign currency reserves.  However, after peaking in 2011, near $544 bln, they have been trending lower, especially since the end of 2012.  They stood just below $495 bln at the end of February.  Reports of recent intervention warn of a further drawdown in reserves.    At the same time, its current account surplus is trending lower, with last year's the smallest in a decade.   

 

Russia is more integrated into the world economy that the Soviet Union ever was.  This is a source of non-statist pressure on Russia.  A decline in oil prices would be particularly helpful in this regard.  There are calls for the US to relax export restrictions on crude oil and natural gas.   Such efforts may prove more important symbolically than substantively as it would take a few years to deliver LNG.  Despite the increase in US output, the world's largest economy is still importing some 5.5 mln barrel of oil a day. 

 

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Tue, 03/11/2014 - 16:52 | 4535699 ebworthen
ebworthen's picture

And if Russia and China join hands to break the petro-dollar hegemony of the hypocritical U.S.A. it will be bye-bye dollar and hello hyperinflation here in the 'ole U.S.S.A.

Does Russia have 200+ military bases around the world playing World Police?  Didn't think so.  "Team America" does.

And those EU Brussels bandits subjugating southern Europe can go to hell too.

Tue, 03/11/2014 - 16:34 | 4535641 TheFourthStooge-ing
TheFourthStooge-ing's picture

Marc to Drivel

Tue, 03/11/2014 - 16:23 | 4535611 Poofter Priest
Poofter Priest's picture

 

 

Russia feels threatened like the U.S. would feel threatened if China suddenly was in bed with Mexico.

Would we be 'weak' then?

Tue, 03/11/2014 - 16:21 | 4535601 SAT 800
SAT 800's picture

I'll be glad when we can get over this tail wagging the dog item and get back to watching Obama break the law and ruin the Constitution; but he won't. every news event has its uses.

Tue, 03/11/2014 - 16:19 | 4535595 geno-econ
geno-econ's picture

So what would be mpact of Putin's inaction ? Russia loses warm water port, pipeline from Saudi Arabia through Syria reduces price of natural gas and ability to earn export currency , eventual NATO troops and missiles at his doorstep in Ukraine, encouragement of other regions in Chechnya and elsewhere to rebel . Seems Ukraine where cultural ties to Russia are strong is a good place to draw a line in the sand , especially when EU is financially weak, bordering on default . Other than resign,Putin has no choice as leader of a Nation. His weakness is convincing oligarchs who have little national royalties to go along, which is reason US sanctions are directed towards oligarchs. Ultimately, in a global economic system of trading, multinationals and oligarchs will rule the world. The good news is that Big Business does not go to war, unless they control corrupt politicians---Big Business prefers to merge or take over another competitor.
One also has to conclude Putin is a Russian nationalist which cannot be said of many American leaders

Tue, 03/11/2014 - 16:21 | 4535593 Poofter Priest
Poofter Priest's picture

 

 

....a democratic coup?

LOL

 

Post Note: I posted this before I saw all the other posters questioning/mocking the same phrase. Like....wow.

 

Tue, 03/11/2014 - 17:52 | 4535883 Marc To Market
Marc To Market's picture

We can talk about a military coup, when the military throws out the existing leader.       We can talk about a palace coup, which in effect how Italy's Renzi became PM ( a vote of the party in which his the head).  What is the problem with the concept of a democratic coup, where people take to the streets and force an elected but corrupt government to flee?  It is used in a descriptive sense to convey that it was not a military coup or a palace coup.  Wasn't this the goal of parts of the Arab Spring ?    

Tue, 03/11/2014 - 18:26 | 4535969 TheFourthStooge-ing
TheFourthStooge-ing's picture

.

What is the problem with the concept of a democratic coup, where people take to the streets and force an elected but corrupt government to flee?

The problem lies in your deceptive use of language. You call the overthrow of a corrupt yet democratically elected government a "democratic coup". By your logic, in order to remain consistent, a military coup would then have to be where people take to the street and force a corrupt military to flee.

The rest of the article simply toes the line, parroting the Western media narrative of "Russia evil, America good." One question remains, though: dupe or shill? Are you just another victim who has drank too much of the kool-aid, or are you standing at the punch bowl dispensing it with a ladle?

Tue, 03/11/2014 - 20:57 | 4536589 Marc To Market
Marc To Market's picture

You project more than you read.  I never made moral claims of what Russia did.  In fact, in my work, even if not in this particular post, I compare it to the US invasion of Grenada.   I purpoesly sought to avoid normative claims.  Did I not recognize that the US and Europe may have played a role in the mass action ?  I think most analysis plays up Russia's strength.  I suggested it was weak, though some people here mocked it.   Do I not try to understand why Russia did what it did ? 

 

A military coup is when the military ends a government.  A democratic coup is when people do.  So I don't know where this logic you say I must have arises.   Coup is the action.  The who is the descriptive word, military palace, people... 

The question is not about me (why do the comments get so personal) and whether I am a dupe or a shill, or what I do for a living.  Stick to the text, man.  Show me how I said Russia is evil and America is good. Show me that the Western media is saying Russia is weak.  Most of it, like the comments here, think Russia is strong.  

 

Many commentary in this space uses the anonimity to be bullies and try to intimidate people.  Perhaps that is why many want to believe Putin is strong, because they want to be strong.   

Tue, 03/11/2014 - 16:01 | 4535533 TheMuppet
TheMuppet's picture

What people like Marc to Market don't realise, as they invoke non existant "free market forces" when its ideologically convenient, and bailouts for our own "strategically important" American oligarchs and kleptocrats when it isn't, is that we are going to have our own "democratic coup" right in his own back yard, cleansing the land our oligarchs and their political supporters.

Tue, 03/11/2014 - 16:01 | 4535532 TheMuppet
TheMuppet's picture

What people like Marc to Market don't realise, as they invoke non existant "free market forces" when its ideologically convenient, and bailouts for our own "strategically important" American oligarchs and kleptocrats when it isn't, is that we are going to have our own "democratic coup" right in his own back yard, cleansing the land our oligarchs and their political supporters.

Tue, 03/11/2014 - 16:08 | 4535560 Mountainview
Mountainview's picture

Look at the Chinese attitude. Inspite of their Tibet question they are far from condemning Russia. The China-Russia link will gain in importance and balance Russias external comerce dependencies.

Tue, 03/11/2014 - 15:45 | 4535456 Panafrican Funk...
Panafrican Funktron Robot's picture

The only way crude drops in price is if there is a net reduction in total debt outstanding.  The only way this would functionally occur would be a financial crash from one of the big 4: China, US, UK, or Germany.  I see a papering over solution to any shadow banking deleveraging, which is nominal price supportive of crude.  A CDS/IR swap issue might be the only thing that would break the price of crude.  Also keep in mind that most of our extraction methodologies currently booming become uneconomic in a crude price drop.  

Tue, 03/11/2014 - 15:43 | 4535428 rwe2late
rwe2late's picture

Marc, are you for real?

Yanukovych was brought to heel and at the last minute embarrassed and frustrated the EU (and by extension, the US) and struck a deal with Russia.   A democratic coup toppled Yanukovych, and there are reasons to suspect that Europe and/or the US may have help facilitate the political uprising.

 

Yanukovch struck a deal to step down and have new elections, brokered by the EU, with the protestors (not "Russia") ... a deal the coup leaders broke forthwith.

A "democratic" coup did not topple the elected president Yanukovych, but an undemocratic coup carried out by a violent minority which was not supported in all regions of Ukraine.

Reasons to "suspect" that "Europe"(who is "Europe"? the EU? NATO?) and /or the US "may have" ...?

Apparently you have been asleep Mr. Marc Van Winkle. It is much more certain than "may have".

Nuland has admitted so. And then there is McCain ...etc.

Tue, 03/11/2014 - 17:13 | 4535769 ILLILLILLI
ILLILLILLI's picture

According to Marc's profile, he is employed by Brown Brothers Harriman...

"I am the global head of currency strategy at Brown Brothers Harriman..."

Plenty of good information about this bank and Nazi involvement in the links:

http://www.theguardian.com/world/2004/sep/25/usa.secondworldwar

http://www.tetrahedron.org/articles/new_world_order/bush_nazis.html


Tue, 03/11/2014 - 19:01 | 4536028 MrPalladium
MrPalladium's picture

Mark's article is a fraud.

Russia has one of the lowest debt to gdp ratios on the planet. Russia has foreign currency reserves and foreign bond holdings that needed to be hedged by incurring foreign debt to balance the risk of the toilet paper dollar and the can of piss euro. The Ruble is backed by oil while the dollar is backed by a vastly bloated defense bureaucracy and working age welfare costs that will sink the country and the Euro by the cost of maintaining the PIGS. Plus Russia's gold is held by banks inside Russia.

In the long run I will bet on the RSX and RSXJ when they bottom along with the rest of the BRICs.

In the meantime mark, keep driving them lower for me!!

Tue, 03/11/2014 - 17:45 | 4535859 Marc To Market
Marc To Market's picture

Have you no shame, man?  What my employer did or did not do before I was born, let alone an employee, is hardly relevant here and in this context.  You can hide here, but you are still a jerk.  

Tue, 03/11/2014 - 15:48 | 4535469 DeadFred
DeadFred's picture

A new oxymoron to add to the list, "democratic coup". Who thinks up such things? Well I was bummed out from a bad headache and I needed the laugh so thanks Marc.

Tue, 03/11/2014 - 21:11 | 4536639 Marc To Market
Marc To Market's picture

Long DeadFred, you both insult me and give me too much credit.  If you just take you time and not be in a hurry to prove your own ignorance, google the concept, you'll find that I did not make it up, but utilized a relatively new concept.  

Tue, 03/11/2014 - 16:38 | 4535653 TheFourthStooge-ing
TheFourthStooge-ing's picture

Didn't you know? A "democratic coup" is the only way to impose authoritarian freedom.

Makes you wonder what other gems Marc will be pulling out of his comic book collection.

Tue, 03/11/2014 - 17:05 | 4535741 Kayman
Kayman's picture

I like the "out of weakness" part.  Russia has near unlimited energy, has plenty of nukes, and knows that Europe isn't going to participate in another Cold War, even if the Kerry and Obama MIC puppets want to.

And Putin isn't afraid of being droned by some X-box kids in Nevada.

Tue, 03/11/2014 - 15:39 | 4535426 Fix-ItSilly
Fix-ItSilly's picture

What is a "democratic" coup?  Can Russia initiate a "democratic" coup or is it only the provenance of the EU or USA?

 

And what's with the canard of debt denominated in USD?  After all, Russia is a raw commodities exporter with a sizeable current account surplus.  This article exudes a John Kerry view of the world - one shaped by huge current account deficits warfare tools like fiat currency.  We should separate talking head politics from power play reality.

Tue, 03/11/2014 - 15:34 | 4535398 zhanglini
zhanglini's picture

what's a "democratic coup", a mob funded by "foreign government" pushing out a democratically elected (altho corrupt" government)?

Tue, 03/11/2014 - 15:50 | 4535478 WhyDoesItHurtWh...
WhyDoesItHurtWhen iPee's picture

You know, like "Jumbo Shrimp".

Tue, 03/11/2014 - 15:55 | 4535499 WhyDoesItHurtWh...
WhyDoesItHurtWhen iPee's picture

So hard to tell anymore a "democratic coup" from a "totalitarian coup" or a "communist coup" or a "corporate coup".

Tue, 03/11/2014 - 16:10 | 4535563 ZerOhead
ZerOhead's picture

It's beginning to look more like an "Oil and gas coup" to me...

"Before violent protests in Kiev overthrew pro-Moscow President Viktor Yanukovych and Russian troops occupied parts of Crimea, a group including Exxon and Royal Dutch Shell Plc planned to spend $735 million drilling two wells about 50 miles (80 kilometers) from the region’s southwest coast."

http://www.bloomberg.com/news/2014-03-10/ukraine-crisis-endangers-exxon-...

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