Russia's Moment of Crisis: Moscow Might Be Down, but Not Out

Sanctions, falling oil prices and a plummeting currency will put tremendous strain on the Russian government. But to assert that Russia is on the verge of collapse seems a bit premature.

Western commentators reporting on events in Russia have a tendency to swing from one extreme to the next. Seven months ago, when oil prices were high and the Kremlin had seemingly amputated Crimea off from Ukraine without firing a shot, the narrative was about an unstoppable Vladimir Putin who would soon be overrunning all Eastern and Central Europe. Today, he is being placed on deathwatch, with prognosticators speculating about precisely when the Russian economy will collapse and Putin will be overthrown. With the precipitous fall in the value of the ruble—something a major interest-rate hike by the Russian Central Bank seemed unable to reverse—some pundits are even crowing that the Ukrainian hryvnia is doing better than the Russian currency.

It helps to step back and put the larger picture in perspective. The hryvnia is the currency of a country facing a major contraction in its GDP and on the verge of bankruptcy; investors are gambling that beyond the $27 billion aid package from the International Monetary Fund, the European Union and the United States will fund an additional $15 billion bailout. Ukraine's energy supply is also quite tenuous, depending on a fragile agreement brokered with the Kremlin and conditional upon prepayment for supplies. Take out any of these factors from the equation and the hryvnia looks much less attractive as a bet.

The collapse in global energy prices, the impact of Western sanctions and the free fall in the ruble's value are all quite serious economic problems for Russia. They will put tremendous strain on the Russian government and may even force radical revisions in some policies. But to assert that Russia is on the verge of collapse seems a bit premature. Moreover, Putin believes that he can ride out the short-term turbulence without having to make serious concessions to the West.

The ruble is losing value because both investors, as well as ordinary Russians are looking to lock in whatever they can salvage from the value of their savings. A seventy-year-old Russian will have lived through a series of currency devaluations in his or her lifetime (the introduction of "new rubles" in the Khrushchev era or the massive inflationary wave that came as a result of "shock therapy" in 1992). The current ruble is not backed by gold or oil and it freely floats, so, given worries about whether one's 2013 rubles will be worth less than half of that value in 2015, it is not surprising that the run has accelerated as people seek safer storehouses of value for their currency holdings—which even a major interest-rate hike on the part of the Russian Central Bank is not sufficient as an incentive for keeping rubles. As the ruble loses value, imports become much more expensive—meaning that not only luxury goods, but a wide range of daily consumer products, including many foodstuffs, will become pricier. People will either have to do without—something that can fuel popular discontent over time—or the Kremlin will push for wage increases, creating the possibility of a destabilizing inflationary spiral. More ominously, Russian companies who borrowed funds for corporate expansion denominated in dollars or euros, but whose businesses are largely paid in rubles for their goods and services, are witnessing their debt burdens nearly double at an instant.

The collapse in energy prices is also problematic. It directly impacts the amounts available to the Russian treasury for what might be termed "safety spending"—massive developmental projects, the transfer of welfare payments to restive areas of the country like the North Caucasus, the equalizing of pensions and salaries in the newly-acquired Crimea. It also forces cutbacks in social spending, and we have already seen protests of potential cutbacks and changes in health-care policy. When oil and gas prices were high, the Kremlin could propose a massive new spending spree for defense without having to jeopardize the "butter" side of the equation—one of the trade-offs that helped doom the USSR. Now, with diminished revenues, the fight begins over what part of the rearmament program or which set of welfare payments will be cut to try and balance the books.

Finally, sanctions are having an impact because Western investment in Russia has been put on indefinite hold. Indeed, companies are postponing transactions that right now would still be legal for fear that they may be negatively impacted by future sanctions decisions. Deals that were grandfathered in (such as contracts for drilling in the Arctic ocean) or arrangements such as prepaying for future oil deliveries have been cancelled or suspended—depriving Russian firms of needed investment cash.

But while the Russian economy has been battered and is certainly down, it is by no means out. A number of major Russian exports—starting with energy, but also encompassing nuclear power equipment and arms—are paid for in dollars or euros. Even with lower global prices for oil and natural gas, the depreciation of the ruble has meant that the expenses of such companies—wages, payments for domestic goods and services and so on—counterbalance the fall in prices, because Western exchange now buys many more rubles.