The financial crisis will spread to the economy with GDP contraction in 2022, according to financial circles, by 5-7%.
“I’ll drink to the death of the Russian stock exchange, I will work as Santa Claus.” On the Russian round-the-clock news channel RBC, economist and trader Alexei Butmatov made a splash. The market expert took out a bottle of live alcohol to drink a shot from the neck, leaving the presenter speechless for a moment.
This intervention reflects the plight of investors and the financial community in general, which in recent days have faced the collapse of their system.
“Causing the Collapse of the Russian Economy”. Bruno Le Maire’s formula, uttered on France Info on Tuesday, has toured the planet. As sanctions continue to hit the country of Vladimir Putin and his allies, the Russian economy is starting to shake in earnest.
The ruble, the first victim of an economic war unleashed by the Western powers, as well as Japan or South Korea, continues to go to hell, falling more than 10% on Thursday. The Russian currency fell to historical lows against the dollar and the euro after the decision of rating agencies Fitch and Moody’s to downgrade Russia’s sovereign rating to speculative category.
117 rubles per dollar
At 11:30 a.m. Thursday, more than 117 rubles were needed to make a dollar, compared to 75 on January 1. Less sharp fall against the euro, but the exchange rate is equivalent to the dollar on Thursday morning (1 euro for 117 rubles).
In an attempt to support its currency, the Central Bank of Russia introduced a 30% commission on the purchase of foreign currency by individuals and on foreign exchange transactions, which has not prevented the further fall of the ruble at the moment. Earlier this week, the institution unexpectedly raised its key rate by 10.5 points to 20%. This only temporarily slowed down the fall of the ruble and limited the medium-term creditworthiness of companies to invest in the country’s economy.
What will be the consequences of this historical fall of the national currency? First, of course, a strong inflationary surge. Russian companies will have to shell out more rubles to buy foreign products on which they depend, which they will pass on to prices. Thus, Godlman Sachs raised its inflation forecast to 17% year-on-year at the end of 2022 against the expected 5%. This estimate, however, does not take into account a possible further increase in the key rate by the central bank.
“The West destroyed Russian finances overnight,” notes Swedish economist Anders Åslund, a member of the Atlantic Council think tank and author of books on the Russian economy. “The situation is likely to get worse compared to 1998, because there is no more positive capital markets have been destroyed and are unlikely to come back with anything but deep reforms.”
The economist cites the 1998 financial crisis in Russia, which saw the country’s economy shrink by 6.8% that same year and inflation was 84%. A crisis that seriously undermined the purchasing power of Russians and led to the beginning of the government, which undertook economic reforms to make the country’s productive apparatus more competitive, promising stability to the population. The reforms were led, in particular, by a certain Vladimir Putin, the prime minister at the time.
GDP between -5 and -7%
But this year, the drop in activity could be even more dramatic. Goldman Sachs, which previously estimated GDP growth at 2%, now projects a 7% contraction in the Russian economy in 2022.
Russian oligarch Oleg Deripaska, founder of the aluminum giant Rusal, believes the consequences could be even worse.
“We have never faced such a problem. […] When they tell you: they will lower the iron curtain, they will not lower the iron curtain. It has already been lowered, this is already a fact … – he commented during the Russian Economic Forum, which is now taking place in Krasnoyarsk. We are facing a serious economic crisis. You can multiply the 1998 crisis by three to get the scale.”
The billionaire whose fortune has melted by nearly $2 billion in a year. Forbes calls for the elimination of Russian state capitalism. And while he may exaggerate the effects of the current sanctions, the financial crisis should quickly spread to the rest of the economy.
“Financial conditions have tightened to levels similar to 2014 (Russian annexation of Crimea), so we expect domestic demand to contract by 10% or more,” the statement said. CNBC Clemens Grafe, Chief Economist for Russia at Goldman Sachs.
Slightly less pessimistic are the forecasts of the analytical company Capital Economics, which nevertheless expects a fall of 5% (against an increase of 2.5% was originally expected) and inflation in the region of 15%.
According to economists, the sanction that slows down the Russian financial system the most is the inability to use its foreign exchange reserves, which reached $500 billion in 2021, to support its currency.
China to help Russia?
If the Russian financial system is on the brink of collapse, further sanctions could be considered to hasten the collapse of the economy. Starting with restrictions on Russian exports. Oil and gas flows account for almost half of Russian exports and more than 30% of state exports. While some banking institutions have been excluded from the Swift system, most other companies are not limited in their financial flows.
“Limiting them would also stifle a key source of dollar revenue for energy companies with foreign-currency debt, and possibly trigger a much larger financial crisis in Russia,” Liam Peach, an economist at Capital Economics, told CNBC.
The stubbornness of the Russian government in Ukraine could break the last taboos of the Western powers by taking on the costs for their populations through skyrocketing prices.
“The willingness of the G7 to bear the costs is growing, and ultimately this could mean that restricting Russian exports and accepting higher commodity prices could become politically feasible,” Clemens Grafe said.
Deprived of access to Western financial markets, deprived of foreign currency and limited in its exports, Russia then could only count on the help of China. The country has already started converting its foreign exchange reserves into Chinese currency and is moving its payment systems to Chinese banks with the integration of the Chinese equivalent of Swift.
If Russia is counting on China, Chinese diplomacy seems to be distancing itself from Vladimir Putin. Beijing has been calling for hours to respect the territorial integrity of Ukraine and the withdrawal of Russian troops. Russia seems increasingly isolated.