Ruble Rout and Financial Market Volatility - Pneumonia Ahead for Europe? (12/29)     Print

spellmanBy James David Spellman, Strategic Communications LLC

If Russia catches the flu, will Europe suffer pneumonia?

As the ruble plummeted in value just before Christmas, a new wave of volatility swept through Europe’s financial markets, underscoring the complex, deep interdependence of EU member-countries with Russia.


Abruptly, investors embraced the scenario that Russia’s recession will be deep and the impact on Europe and the global economy large enough to push the Eurozone into its third recession since 2008.   Yet, two days later, Europe’s stocks posted their biggest one-day rally in three years, following calm in Russia’s markets, a bounce in oil prices, and dovish Fed views toward an interest-rate hike.  Too many imponderable risks, though, promise continued high volatility in the months ahead.

Cauldrons of emotions, stock and bond markets over-react or under-react to events minute-by-minute, day-by-day until settling into a range of fluctuation, the trend line over time a reflection of the crowd’s wisdom.  The ruble rout showed that dynamic, as the currency suffered its worst drop in value since 1998, losing 17 percent over the first two days of the week and hitting an all-time low of 35 rubles against the U.S. dollar last Tuesday, roughly half the exchange rate this past summer. 

As Russia’s finance ministry reaffirmed its commitment to intervene and stop the “bacchanalia” --  having bought $10-billion-plus in rubles since December 1 from its $400-billion war chest of foreign currency reserves -- the ruble advanced as much as 12 percent the day after last Tuesday’s low to reach 62.1 rubles per dollar.[1] Relief from the central bank, which included easing regulation and promising recapitalization of banks when necessary, provided additional support for the ruble.  By Thursday, Russia’s markets had regained much of their lost ground, and by Friday the frenzy had dissipated.

Russia’s problems are long-simmering ones, a “slow motion” crisis in one analyst’s view.  Growth has been stagnant this year (0.8 percent for the first half) as business and consumer confidence deteriorated, capital investments dropped, and geopolitical tensions worsened.  The Olympics’ most expensive winter games in Sochi and the “annexation” of Crimea in March were temporary distractions from the troubling economic fundamentals.

As oil prices slid since June, Russia’s malaises were revealed.  “Oil and gas revenues make up more than 50 percent of the Russian government’s total revenue, most of it coming from Europe,” reports The New Republic.  “[T]he export of crude oil, petroleum products, and natural gas made up more than two-thirds of their total exports.”[2]  Russia’s average cost of oil production is roughly $40 per barrel, according to the consulting firm Energy Aspects.[3]  Each $1 fall in the oil price lops around $3 billion off export earnings,” Reuters reports.[4] Lubomir Mitov, of the Institute of International Finance, said, “Each $10 fall in the price of oil reduces export revenues by some 2 percent of GDP.”[5] Another economist, Ludovic Subran with the global credit insurer Euler Hermes, sees a 4.7-4.8 percent contraction next year for Russia.[6]

Sanctions against Russia for its role in Crimea and the Ukraine are biting too.  The U.S. ban prohibits banks from lending U.S. dollars to any company in Russia for more than 90 days. That forced Russia’s Rosneft to seek $10 billion in financing from Russia’s state-owned banks, which were allowed to use the notes to Rosneft as collateral to borrow from the country’s central bank. Rosneft has massive foreign debt: “around $115 billion in dollar-denominated debt falls due before the end of 2015,” according to the Economist.  These financial machinations played a key role in triggering the ruble’s tailspin.

What does this mean for Europe?

Overall, “Eastern European countries [that] have the closest links with Russia … could be seriously affected by a sharp slowdown of the Russian economy or a ratcheting up of sanctions and countersanctions,” according to the International Monetary Fund.  “Western European countries are relatively less linked but some could also see significant effects.”[7]

Energy:   Russia is the fourth largest market for EU exports, and the second largest for EU imports, energy the largest component. (About half of the EU's primary energy consumption is used for space and water heating.)  European countries account for 84 percent of Russia's oil exports and three-quarters of its natural gas exports (roughly 30 percent of the natural gas Europe consumes comes from Russia).[8]  Shutoffs in 2006 and 2009 show the potential economic impact that could occur.

Disruptions in Russia’s oil and natural gas supplies would be impossible to quickly offset from other sources. “Oil reserves, largely in the North Sea, are dwindling,” notes Slate.  “Europe has yet to embrace fracking to produce natural gas in large quantities. And some policies—a desire to move away from coal, Germany’s phasing out its nuclear fleet—are boosting demand for natural gas in the electricity sector.”

“Eliminating Europe’s dependence on Russian gas could require as much as $200 billion in investment, according to analysts at Sanford Bernstein,” Bloomberg reports. “Boosting LNG imports would force Europe to compete with Asia, where spot prices have been about a third higher over the past three years.”[9]


Source:   New York Times, “How Much Europe Depends on Russian Energy.” September 2, 2014.

Investment:  The EU is the most important investor in Russia with up to 75 percent of foreign direct investment in Russia coming from the EU, according to Eurostat.  The Netherlands and Ireland have significant FDI in Russia as do the financial centers in Cyprus and Luxembourg.

In June, FDI flows to Russia were already projected to drop to half the 2013 level, to 30 billion ($41 billion) from 59.7 billion, with the steepest decline in eastern Europe, according to the Vienna Institute for International Economic Studies.[10]

“The region is exposed to two main factors that drive FDI into opposing directions,” Gabor Hunya, a researcher at WIIW, said in the June report. “One is the acceleration of economic growth which spurs FDI. The other is the Ukraine–Russia conflict, which depresses economic growth and increases investment risk in the affected countries.”

“There are ripple effects,” Eric Chaney, chief economist at AXA SA in Paris, said. “If there is a deep recession in Russia it’s not good news for European banks, not good news for some luxury-goods makers who used to sell in Russia.”[11]

This is demonstrated by BP’s largest single investment in Russia, Rosneft.  BP’s 19.75-percent share is worth half the value a year ago, to about $7.7 billion.  Further, Rosneft’s net-income will be wiped out; that had added 13 percent to BP’s net income, Deutsche Bank AG estimates.[12]

Credit rating agencies have yet to downgrade Russia’s debt; reviews in January will determine if any will occur.


Source:  European Commission.



Source:  Aasim M. Husain, Anna Ilyina and Li Zeng, “Europe’s Russian Connections.”  IMF Direct, August 1, 2014.      

How investments will fare will depend largely, too, on whether political order is maintained. “We have to remember that Russia is an important part of the international system, and therefore useful in solving all sorts of other crises, for example in the agreement on nuclear proliferation with Iran or over Syria,” said Henry Kissinger, former U.S. Secretary of State, in a wide-ranging interview with Der Spiegel.[13]

[1]Jack Farchy, John Aglionby, and Stefan Wagstyl, “Russian rouble rises on government intervention,” Financial Times, December 17, 2014. 

[2]Danny Vinik, “Chart: Russia Is Insanely Dependent on Oil and Gas Money.” The New Republic, July 23, 2014.

[3] Bill Powell, “Cheap Oil Puts Russia's Economy in Tailspin.” Newsweek, December 16, 2014.

[4]“Russia puts losses from sanctions, cheaper oil at up to $140 billion per year.” Reuters, November 24, 2014.

[5]Ambrose Evans-Pritchard, “Russia risks Soviet-style collapse as rouble defence fails.” Daily Telegraph, December 16, 2014.

[6]Claire Guélaud, «La solution aux problèmes russes est largement politique. » Le, December 17, 2014.

[7]Aasim M. Husain, Anna Ilyina and Li Zeng, “Europe’s Russian Connections.” IMF Direct, August 1, 2014.

[8]“Russia's trade ties with Europe.” BBC, March 4, 2014.

[9]Anna Shiryaevskaya, “Russian Gas: Putin's Pipeline Politics.” Bloomberg, December 9 2014.  The EU published a “stress test” of gas supplies in October 2014 to estimate the impact of a Russian shutoff.

[10]Alexander Weber, “Russian FDI to Fall 50% in 2014 on Risk, Institute Says.” Bloomberg, June 5, 2014.

[11]Scott Hamilton, “Russian Crisis Creeps Into Europe on Ruble Rout, Economic Slump.” Bloomberg, December 18, 2014.


[13]Juliane von Mittelstaedt and Erich Follath, “Interview with Henry Kissinger: 'Do We Achieve World Order through Chaos or Insight?' “ Der Spiegel. November 13, 2014.