The Ukrainian crisis has aroused great concern among investors and economists. It has brought back memories of the 1998 Russian financial crisis, when the ruble nosedived and Russia defaulted on its debt. Investors worry that another Russian debt crisis could have devastating consequences for the global economy. How could this be? The logic seems to be that because of the sanctions imposed by the West on Russia, the country is no longer able to borrow in the capital markets. But this is not the complete story. It is also because of other risks associated with investing in Russia. These risks are likely to increase during the next few years.
What Went Wrong in Ukraine?
In February 2014, the Ukrainian parliament endorsed the European Union’s Association Agreement with Kiev. This was considered a big step toward integration with the West. However, the Russian parliament denounced the agreement as a grave threat to Russia’s economy and national security. In response to the agreement, the Russian parliament voted to suspend the membership talks with Ukraine, and then in March, President Putin signed a law prohibiting the use of force or threat of force against Ukraine or neighboring countries.
These actions by the Russian parliament and president seemed to be a response to the situation in Ukraine. However, there was also a domestic political component to the crisis. At the same time, the Ukrainian government was moving ahead with the implementation of the EU agreement. What happened next is largely a result of the Russian political system.
The Current Situation in Russia
Since the Ukrainian crisis erupted, the Russian ruble has lost more than 40 percent of its value against the U.S. dollar. The Purchasing Power Parity exchange rate shows a decline of 40 percent against the dollar. The Russian Central Bank has had to intervene heavily in the currency markets to defend the ruble. This has raised concerns about the Central Bank’s ability to defend the currency and the integrity of the monetary system.
The Russian government has also been struggling with a falling oil price and a drop in the value of the rouble in international trade. The Financial Times newspaper reported in December 2017 that the rouble was in “free fall.” The newspaper also quoted one economist who estimated that the rouble was 30 percent overvalued in relation to the price of oil.
Risks for the Ev Future
Even though the country’s current account deficit is fairly modest, it is growing rapidly. The current account deficit reached 5.6% of GDP in 2017 and is expected to rise to 6.5% of GDP in 2018. This suggests that Russia’s currency reserves could be depleted in the next few years.
One of the biggest risks for the Russian economy is the price of oil. If the oil price drops, it will have a negative impact on the Russian economy because a large share of national income comes from the oil and gas sector.
The Ukrainian crisis has brought back memories of the 1998 Russian financial crisis. There are many similarities between the two crises. Both were triggered by political concerns over relations with Russia. Both resulted in a major fall in the price of Russian assets. And both resulted in a major devaluation of the ruble and a significant drop in Russia’s GDP.
In the case of the 1998 crisis, it took Russia more than a decade to recover from the economic damage caused by the financial crisis. Investors should be aware of the significant risks associated with investing in Russia. The ruble’s devaluation could have a major impact on the global economy.