When a central bank changes interest rates very early in the morning, its economy is almost certain to be in trouble. When it raises rates by 6.5 percentage points at one go, then it is not just dealing with trouble – it is crisis management. That is what the Russian central bank had to do on Tuesday, raising its benchmark interest rate from 10.5 per cent – already pretty high – to a startling 17 per cent. The bank’s urgency, and the magnitude of its action, are understandable. The rouble was in free fall; it seemed only something drastic could stop it in its tracks. This is the worst economic peril Russia has been in since the 1990s, when the country defaulted in 1998, and persistent hyperinflation rendered almost every pensioner destitute. The bedrock of Vladimir Putin’s power in his 15 years as Russia’s leader has been the promise that those days of instability will never return.
Ironically, high oil prices meant Russia was posting very healthy macroeconomic numbers. It has a solid current account surplus and a marginal fiscal deficit, and a credit rating two notches better than India’s. Normally, economies with these numbers should not stumble into sudden trouble. But this apparent solidity is built on weak foundations. Russia exports about six million barrels of crude oil a day. In the past half-year, the price of oil has fallen sharply to around $ 60 a barrel. The loss of $ 40 a barrel in revenue means a reduction in the value of exports of around $ 240 million a day – about $ 90 billion in a year, were oil prices to stay at $ 60. This is a staggeringly large number – about 4.5 per cent of its gross domestic product or GDP. And it doesn’t even take into account the knock-on effect on the price of gas. So the current account could have a deficit of five per cent of GDP or more. Still, this, in itself, need not necessarily provoke a crisis, if, for instance, the assessment is that oil prices have to rebound within a year. True, given much oil revenue goes to the government, the fiscal deficit would also go up – perhaps to as much as five per cent of GDP, if expenditure were cut to some degree. But again, this is not so high as to necessarily cause a crisis.
The real problem is that Russia is not as independent of the rest of the world as its foreign policy has pretended of late. Foreign debt (mostly non-government) is high, at around a third of GDP – in India, it is less than a quarter of GDP. The killer: the country has an open capital account. This means uncertainty about the value of the rouble and economic growth – below one per cent and dipping – could at any time lead to a sudden exit of foreign capital. Capital flight forces a higher interest rate, which then brings about a recession and serious trouble at a time when Western-dominated institutions like the International Monetary Fund may not be willing to help (given that the United States has just put yet more sanctions in place). The crisis then feeds on itself. The lesson for all emerging markets surely is that there are inherent risks associated with having an open capital account. As with East Asia in the late 1990s, the first hint of a crisis can cause the economy to quickly implode. And the geo-strategic implications of a foreign policy that does not nurture big powers as friends can come back to haunt the country then.