Understanding Russia’s currency troubles

How do we understand the sudden collapse of the Russian ruble? The trigger, explained by Leonid Bershidsky, appears to have been a massive bond issue on 12 December 2014.

Russia’s state-owned oil company, Rosneft, raised 625 billion rubles ($10.8 billion at that day’s exchange rate) with a bond issue that had a lower yield than Russian government bonds of similar maturity.

Russia’s Central Bank agreed to accept the bonds as collateral, so any banks buying these bonds could borrow against them. (Rosneft denies any role in the crisis.)

But why is Russia so vulnerable? One answer came from Paul Krugman, who has studied currency crises since 1979:

[Russia] has, after all, run large current surpluses over time; overall, it’s a creditor, not a debtor nation. But there are a lot of external debts all the same, reflecting private sector borrowing — and foreign currency reserves are dropping fast in part thanks to private capital flight.

What this reminds me of was one of the corners of the 1980s Latin American debt crisis, which preoccupied me during my year in Washington back in 1982-3. Venezuela then, like Russia now, was a petro-economy which had consistently run external surpluses. But it was nonetheless a vulnerable debtor, because all those external surpluses and more had in effect been recycled into overseas assets…

Krugman sees this as a classic emerging market currency crisis:

When you have big balance-sheet problems involving foreign-currency debt, an interest-rate hike that tries to discourage capital flight damages the economy, and hence those same balance sheets, from another direction, and it’s common, even standard, for the effort to fail.

For those arguing that the collapse in the oil price is broadly beneficial, Russia’s plight is a counterpoint. As Gavyn Davies writes in the FT:

If there is a really dark side to this oil shock, it is likely to stem not from the developed economies, but from its destabilising effects on Russia…and some other oil producers in the emerging world. That is what transpired, eventually, in the oil shock of 1997/98.

A collapse of the Russian economy, with its dangerous political consequences, is the most important reason to worry that the “idiotic optimists” will be wrong about the beneficial market impact of the 2014 oil shock.