New rouble crisis unlikely, but we cannot relax
Date Released: Mon, 8 December 2014 12:00 +0200
THE Russian rouble has plummeted against the dollar since the middle of the year. The sharp decline of the oil price in recent months has added to the woes of an economy already struggling under the combined pressures of poor economic management and western sanctions implemented after Russia's annexation of Crimea and its support for separatists in Ukraine.
Even before the fall in the oil price, the International Monetary Fund had predicted Russia would grow only 0.2% this year and 0.5% next year. This makes the country by far the slowest-growing of the Brics (Brazil, Russia, India, China and SA) economies. Economic growth next year is now likely to be even lower than forecast.
Oil and gas sales make up 68% of Russia's exports and more than half its tax revenue. Export earnings have plummeted in dollar terms and, because of the weaker rouble, the costs of imports have soared. The Financial Times reports that in response to deteriorating foreign exchange earnings some Russian banks are limiting the daily amounts of dollars and euros individual clients may buy. Russia's central bank also raised interest rates last month to encourage Russians to keep their savings in roubles.
The effect of the rouble's decline is especially severe for companies that borrowed in foreign currency at the stronger exchange rate. The value of this debt has risen dramatically in roubles. According to the Financial Times, Russia owes more than $600bn in foreign debt. One-fifth of this falls due for repayment in the next 12 months.
In 1998, Russia defaulted on its debt, setting off a chain reaction that became a crisis for all emerging markets. It had begun the previous year in East Asia, when foreigners started withdrawing their investments from Thailand and Korea when it became clear these countries could not repay their foreign borrowings. When Russia defaulted on its debt, investors began treating all emerging markets as equally risky, regardless of their differing economic circumstances or levels of foreign debt. "Emerging markets," the quip went, "are markets from which you cannot emerge in an emergency".
SA was hard hit by the negative sentiment and the rand fell more than 28% in the ensuing panic. Foolishly, our Reserve Bank attempted to halt the rand's decline by raising interest rates. The prime overdraft rate leapt to 25.5% and as a result economic growth in 1998 fell to less than 1%.
The Bank also borrowed $10bn in the forward market and sold at spot to arrest the rand's decline. It did not succeed and later had to buy back the then much more expensive dollars at a far weaker exchange rate than it had sold them. The Treasury had to repay the resultant large losses from the country's budget. The overhang of dollar demand of this costly reaction by the Reserve Bank also helped to set the scene for the renewed plunge of the rand in 2001.
Fortunately, few commentators are predicting that recent events in Russia will precipitate a similar global crisis. Important lessons were learnt in 1998, including the need to let exchange rates adjust in response to large capital outflows. Hopefully, in similar circumstances the mistakes which in 1998 led to localised problems escalating globally should be avoided.
But there is no room for complacency. Even before the fall in the oil price, there was considerable uneasiness about the fallout for emerging markets when US interest rates start to rise to more normal levels. This is because emerging markets have attracted huge inflows of foreign money in recent years. Much of this has been invested in developing countries' bonds offering foreign savers higher interest rates than in the US and Europe. This attractiveness will weaken when interest rates in the developed world begin to rise. Investors may then choose to move their funds for the better returns in developed economies, with negative consequence for asset prices and exchange rates in developing countries. As a warning of what may be to come, emerging market exchange rates fell sharply last year, when the US Federal Reserve just hinted that the era of ultracheap money may be coming to an end.
An additional worry for developing countries is the pressure under which their exports are now. Lower oil prices are accompanied by simultaneous falls in other commodity prices exported by many developing countries, such as iron ore, coal and gold. For oil importers such as SA, lower commodity export receipts will be partially offset by the lower cost of oil. But for major oil exporters such as Russia, Venezuela and Angola, the falling oil price is very negative.
Oil and other commodity prices could stay at their lower levels for some time. Policy makers need cool heads while global economies come to terms with these new realities. Markets remain jittery as we see in the falling value of the rand at present.
Things may get worse before they get better for SA on the global front and our leaders need to do all they can to affirm and support the long-term resilience and competitiveness of our economy.
By Gavin Keeton
Source: Business Day
Keeton is with the economics department at Rhodes University