To Russia Without Love

To Russia with no love.

The economic assault on Russia is in full swing.

The Ruble has plunged by 17 percent leading to a fall in all Russian asset classes and the economy is bleeding capital badly. Recent data out from the Institute of International Finance (IIF), shows net outflow of investments in the second quarter of this year for the first time since 2008, during the global financial crisis. Outflows soared to 74.6 billion USD in the first half, compared with 61 billion USD in all of 2013, according to central bank data. Capital outflows could reach 120 billion USD this year, Interfax cited Deputy Economy Minister Alexey Vedev as saying in September. 22.

Capital flights from Russia have been triggered by Moscow's alleged involvement in attempting to destabilize the Ukraine and its suspected military backing of pro Russian separatists that country.

The Russian economy was already limping prior the capital outflows according to Charles Collyns, chief economist at the IIF, "Russia was already weakening" before the crisis, said Collyns "And then it worsened in March when the Ukraine situation began," he added, as sanctions have threatened to push Russia’s 2 trillion USD economy into a recession.

Even before all this trouble flared up in the Baltic and the US spurred on sanctions followed by the reluctant European Union, the Russian economy was starting to stall. Weakening global demand for commodities, particularly oil was starting to take its toll on the economy. Russia is too heavily reliant on the export of commodities and its industries are neglected and under capitalised. This leaves it vulnerable to volatile commodity price falls. Moreover, more than half of the workforce is suckling on the state's teat, totally dependant on the public-sector for their livelihood.

"The country was living on the high commodity prices," said Collyns. The decline in prices, along with the crisis, have "laid bare the fundamental issues" of the Russian economy.

What does Russia export other than oil, gas and arms? It is not a world player in terms of exporting say cars, trucks, precision tools, white goods, electronics or computer technology. The private sector is relatively small, under-capitalised and lacks dynamism.

To make matters more difficult for Russia the number of eurobond issuances from Russia has also plunged, which means that it is becoming more difficult for bond issuers to borrow.

So with oil prices on the decline and foreign investors pulling out, could the Russian “feel good factor” start to evaporate along with Putin's popular support? That is probably the West's game-plan; to get the people to turn on their leader with the aim that they will do the messy work and oust Putin from power.

Perhaps the powers to be in Washington think the Russian leader is just too ambitious and it’s time he goes. All that talk about a BRICS currency, to rival the US dollar as a reserve currency and for the BRICS nations to move away from US dollar hegemony has probably got the US hot under the collar. Maybe it is like that, a kingpin just doesn't like competition.

Russian investors are starting to feel the pinch.

The market is now on edge over talks about capital controls as the ruble continues to sink. Already holders of Russian ruble bonds are nursing some of the worst losses in emerging-market bonds, in the third quarter of 2014. Capital controls are more likely to compound losses for Russian Ruble bond investors.

“It would be very negative for your investments in the local currency”, said Peter Schottmueller, who helps manage 17 billion USD as head of emerging-market fixed income at Deka Investment GmbH in Frankfurt. Foreign ownership of ruble bonds has dropped and any curbs on capital flows would further “increase the investment risk” he said.

“Outflows should sharply increase now”, Stanislav Kopylov, who helps manage 45 billion rubles ($1.14 billion) at UralSib Asset Management in Moscow, said by phone yesterday. “When you’re threatened like that, you need to urgently pull out the cash.”

The currency slid 14 percent versus the dollar in the three months ended yesterday, the worst drop among 24 emerging markets tracked by Bloomberg. The yield on 10-year bonds increased 102 basis points, the most after Turkish debt in developing nations.

The ruble’s share of global trading dropped to 0.4 percent in August from 0.6 percent since 2012, falling five places to rank 18th most-traded in the world, according to the Society for Worldwide Interbank Financial Telecommunication, or SWIFT.

Russia’s central bank is studying all possible scenarios on how to implement capital controls, according to an employee, who asked not to be identified because no decision was made. They gave no timeline and said such measures would be preventative.

The country probably won’t take the step unless its currency reserves start dropping by more than 20 billion USD a month, Vladimir Osakovskiy, an economist at Bank of America Corp., said in e-mailed comments yesterday.

Nevertheless, what this indicates is that sanctions are now hurting the Russian economy, these discussions about making the central bank mull over policies it sought to avoid underscores that point.

How long is this going to go on? Be prepared for the long haul.

German Chancellor Angela Merkel said the EU and the US may be facing a long confrontation with Russia.