Major banks across Europe, as well as the UK, US, and Japan, are at risk should the Russian economy default, according to a study by Capital Economics published on 17th December 2014 (Russia Today, 2014).
Many Russian companies borrow money from European and American banks, but now the value of their domestic currency has decreased by more than 50 percent against the dollar, so the cost of the loans has doubled in rouble terms, but, according to Macro Advisory in Moscow the Russian Central Bank, flush with foreign cash reserves, can help these companies out. It believes that the Russian economy is nowhere near default as the Central Bank has more than $400 billion in foreign currency reserves, unlike the last time when they defaulted in 1998, when they only had $16 billion.
Russian banks have warned against hysterically jumping to the conclusion that the current rouble crisis will follow the trajectory of 1998, when the country was forced to default.
The ruble’s 22 percent plunge on the 15th and 16th of December has prompted investors to liken the crisis to 1998, when the ruble lost 27 percent on August 17, 1998. On the 16th of December, the ruble fell to 80 ruble to the US dollar benchmark, compared to its price of 32.9 to the dollar on January 1, 2014, it equated to a 58 percent loss in value.
In 1998, over a six month period, the currency lost more than 70 percent of its value. Inflation sky rocketed, banks and enterprises across the country collapsed, and Russians were left jobless and Russia’s GDP took 7 quarters to recover to pre-crisis levels after 1998.
At the start of December 2014, Russia’s foreign exchange reserves stood at $418 billion, which far exceeds the $16 billion Russia had saved up ahead of the 1998 default.
In 1998, the Central Bank performed currency interventions to prop up the ruble, but eventually exhausted them to a point they couldn’t meet its key debt obligations.
Currently the Central Bank is working on a new strategy to stabilize the financial market including measures to increase foreign exchange refinancing and selling off foreign currency if necessary.
It also has the option to make funds available to Russian companies, possibly $20-30 billion of credit, so they can meet their financial obligations. This move would act as a temporary internal ‘bailout’. The Central Bank outlined these options in their strategy, but didn’t list specific figures. The Bank will also continue to exercise its REPO option which allows it to balance the Russian ruble, but will not use reserve currencies. The first attempt to quell the ruble crisis by increasing interest rates backfired, causing more panic, forcing the currency to drop 20 percent.
The appearance of President Putin at his annual press conference on December 18th has appeared to calm the FX markets somewhat as the Ruble has recovered to under 60 to the US$ on the 19th December.
The 1998 ruble crisis, like today, was driven by falling oil prices, which went as low as $18 in August 1998 Brent crude is now trading at $60 per barrel, a more than 50 percent decrease since June 2014.
The Russian government originally based its budget plan on $100 barrel oil, and later revised it to $80. As of late, the ruble has been falling faster than oil, signalling Russia is facing more serious economic challenges ahead besides oil. In the last six months, the ruble has been in rapid descent congruent with falling oil prices, which accelerated in November and December. Investors have been pulling capital out of Russia over geopolitics, and the US and EU sanctions have made it difficult for Russia to borrow from Western capital markets.
The ING Group in the Netherlands, Raiffeisen Bank in Austria, Societe General in France, UniCredit in Italy, and Commerzbank in Germany, have significant exposure to the ruble crisis.
In April 2014 Societe Generale, France’s second-largest bank, increased its stake in Russian subsidiary Rosbank, which it said was part of a long-term commitment to Russia. The deal comes as Russia’s economy is under pressure partly as a result of sanctions imposed by the United States and Europe to protest against Moscow’s annexation of Crimea. Societe Generale said it bought 7 percent of Rosbank’s share capital from Interros group, controlled by Russian billionaire Vladimir Potanin, increasing the stake to 99.4 percent. “Societe Generale’s commitment to Russia is part of a long-term vision,” the bank said in a statement.
Russia and Eastern Europe are key planks of SocGen Chief Executive Frederic Oudea’s strategy, which aims to increase exposure to economies beyond the euro zone. SocGen bought into Rosbank in 2006 and had built up an 82 percent stake by 2012. SocGen then bought 10 percent of Rosbank from Russia’s second-largest bank, state-controlled VTB in 2013, increasing the stake to more than 90 percent.
SocGen had exposure of 22.4 billion euros to Russia at the end of June, according to the European Banking Authority’s (EBA) data. That equated to 15.7 billion euros in risk-weighted assets. The bank said the transaction had a limited impact of a few basis points on the group’s Common Equity Tier 1 ratio, which stood at 10 percent at the end of 2013.
SG Russia, which includes Rosbank and other insurance and financial operations, made operating income of 239 million euros ($331.91 million) last year, almost double 2012 despite a 41 percent jump in losses from bad debts.
According to Citigroup Inc. analysts Societe General, through Rosbank, currently has US$31 billion, or €25 billion, exposure. This is equivalent to 62 percent of the bank’s tangible equity. Capital conomics
Because of its Russian exposure the shares in Soc Gen are down about 15% since December began and its Credit default swap price has fallen against its peers.
Britain has limited direct exposure to economic turmoil in Russia, but BoE Deputy Governor Jon Cunliffe said on the 17th of December in an interview with the BBC that it is important to weigh up risks to the financial system resulting from the market strife. The sharp fall in oil prices was good overall for the global economy and Britain, although policy-makers should look beyond one-off effects from energy and food prices. What one needs to watch really carefully in a situation like this is whether that change in investor sentiment towards Russia and the volatility that’s going on around Russia, starts to transmit to other markets, he added that the core of the financial system was better equipped than it used to be to handle situations like this.
Undoubtedly the weakness of the oil price and the subsequent fall in the Ruble will severely impact on profits at companies that deal with Russia and at banks that have outstanding loans to those companies. The difference between today’s crisis and that of 1998 is the amount of foreign reserves that the Russian central bank has amassed from the good times in the last decade. This combined Political posturing from Mr Putin has restored some calm to the markets and Ruble has steadied without the need for FX intervention from Russia in the last 3 trading days. The reluctance of OPEC to reduce production despite the falling oil price will mean that oil prices will remain weak for the foreseeable future which has significant benefits for the world economy with its need for growth. Political and economic forces appear to be combining to curb the power of the Russian bear.