Russia in crisis: Analysis of a meltdown

Russia faces what analysts are calling its gravest economic crisis since 1998, when the country defaulted on its debt following financial malaise in Asia.

The country's currency, the ruble, is plunging against international currencies, causing panic among domestic consumers and global investors to withdraw capital. For Russian President Vladimir Putin, the meltdown poses perhaps his sternest test of leadership.

He can expect little help from Washington. White House spokesman Josh Earnest said Tuesday that President Barack Obama will sign a measure by the end of the week applying new sanctions against Russia because of its actions earlier this year in Ukraine.

What is happening to Russia's economy? Russia's crisis has been triggered by a sharp plunge in oil prices since this summer and international sanctions over Russia's March annexation of Crimea. The ruble is collapsing. The currency lost 10 percent of its value and fell to a record low on Tuesday, dipping to more than 80 rubles to the dollar before rebounding to 68 rubles -- it is down more than 60 percent this year.

"The end is near for Russia's economic and financial stability," said Carl Weinberg, chief economist with High Frequency Economics, in a note. "This is an unrecoverable spiral. The combination of economic and financial sanctions by NATO governments and the crash of global oil prices has killed Russia's economy."

How is Russia responding to the crisis? The Central Bank of Russia (CBR) surprised financial markets overnight by abruptly jacking up interest rates from 10.5 percent to 17 percent. The goal is to shore up the ruble, including the exchange rate with other currencies; maintain fiscal stability; forestall inflation; and discourage global investors from pulling their capital out of Russia. Of particular concern for policymakers is whether Russia has enough money in reserve to weather the decline in oil prices and its growing isolation from global capital markets.

The CBR has made a number of moves in recent months to soften the blow from sanctions and the drop in energy prices, with limited effect. The ruble continued to fall Tuesday ever after the massive rate hike, while gauges of financial risk, such as the price of credit insurance on Russian debt, are flashing red.

"No one expected the ruble to hit 60 this year against the dollar, let alone 70 or 80 even," said Timothy Ash at Standard Bank in a research note. "And no one is positioned for this. This will impart huge short-term damage to Russia. There is now a huge credibility gap for Russian policymakers in the eyes of the market."

What are the risks for Russians? The spike in interest rates could slam the brakes on Russia's troubled economy, slowing growth and pushing up the country's already high rate of inflation, now around 9 percent, even higher. The Russian stock market has fallen more than 25 percent since yesterday.

Some Russians are panicking, with reports of people looking to put their money into other financial assets, or even big-ticket goods such as washing machines.

What happens next? Russian officials are meeting today to discuss the turmoil. Russian President Vladimir Putin is also scheduled Thursday to address the nation in an annual live TV call-in show, offering him a chance to discuss any plans for stabilizing the ruble and the economy. One key question for Russians and global investors: Would the Kremlin consider implementing controls to stem a flight of capital?

Yet even capital controls might not stem the crisis in Russia. IHS economist Chuck Movit says that monetary policy alone is unlikely to contain the damage, noting that the ruble's strength depends chiefly on oil prices and the impact of sanctions. Other analysts worry that Putin also could resort to other measures, such as escalating the conflict in Ukraine, to distract public attention from Russia's economic problems.

"Any further escalation would probably trigger further sanctions, from which Russia would again be the loser," said economist Andrew Kenningham of Capital Economics in a report.

How is the Russian crisis affecting the rest of the world? Russia, one of the world's largest oil exporters, has enormous currency reserves and is not in immediate danger of default. Alexander Moseley, a senior portfolio manager at asset management firm Schroders, notes that Russia has enough liquidity to repay its external debts.

Meanwhile, the country does not carry much public debt, and its credit profile is solid. The sanctions against Russia and instability in the region has also reduced its financial and trade links with the rest of the world. For now, that is expected to damp the global reverberations. Russia accounts for only 2.7 percent of world GDP, according to Capital Economics.

Still, financial crises are hard to contain, especially when they involve a large economy. Russia's economy is unbalanced -- nearly one-seventh of its GDP comes from oil -- and risks tumbling into recession. That would stunt global growth, with China also slowing down and Europe fighting its own deflationary spiral. Such a slowdown would almost certainly impede the U.S. economic recovery just as it is gaining strength.

Putin is also unpredictable. If Russia's economy continues to founder, he could even consider reneging on the country's foreign debts, High Frequency Economics suggests. That would put global lenders, including U.S. banks, investors, insurance companies and other major financial actors, on the hook for major losses.

"Russia is in a full-blown currency crisis, and currency crises end when either the central bank overreacts with overwhelming policy steps to support the currency or the underlying source of stress ends," Moseley said by email.