ON MONDAY, as financial markets began trading in Asia, the value of the Russian rouble collapsed. The cause was harsh Western sanctions introduced over the weekend. In effect these freeze Russia’s foreign currency reserves and begin to lock Russian banks out of the SWIFT network for arranging international transactions. The US dollar rose by as much as 40% against the rouble, taking the Russian currency from its Friday closing level of around 84 to the dollar to as high as 118, a new record.
The move will be one of the largest one-day slumps in the Russian currency’s modern history, similar in scale to the one-day declines recorded during the worst moments of the country’s financial crisis in 1998, when Russia defaulted on its debt. In mid-morning in Moscow, the Russian central bank raised its key interest rate from 9.5% to 20% in an effort to stem the rouble’s slump, and the country’s finance ministry ordered companies with foreign currency revenues to convert 80% of their income into roubles.
The rouble’s collapse shows how isolated the government has become. Its functional exclusion from international financial markets could do the economy grave harm. A plunging currency makes imports of everything from cars to medical products dramatically more expensive. External debts, much of which are denominated in dollars, will be more difficult to service. The rouble’s decline will further reduce the falling quality of life for the Russian middle class, and it will harm any company that has to pay for overseas goods and services.
The country’s central bank has ordered financial institutions to reject the instructions of foreign clients attempting to sell Russian securities, a move that may be the beginning of controls to prevent massive outflows of capital. Any ban on foreign investors from getting out their money could sour what little is left of the country’s reputation as an investment destination. Over the weekend, Russian citizens queued outside banks to withdraw their money. Panic about the stability of Russia’s financial system could yet lead to bank runs.
Oil prices climbed higher, on worries about disruptions to supply, possibly because of embargoes. On Monday-morning trading in Asia, they rose to just short of $100 per barrel, up by around 5% compared with their levels at the end of last week. As a huge exporter of oil and gas, Russia would usually gain from higher energy prices. But the plunge of the rouble suggests that the extra revenue from commodity sales is expected to pale in comparison to the damage done by sanctions.
The spillover in other markets was muted in early trading on Monday, with benchmark equity indexes in Hong Kong, Shanghai and Tokyo not far from their levels at the close on Friday. But as investors scramble to work through the knock-on effects of the conflict for assets around the world, more frenetic trading activity may yet be to come.
The threat of more severe sanctions has become increasingly real since financial markets closed for the weekend on February 26th. The announcement that America, Britain and the European Union would target the Russian central bank and its ability to sell its $630bn in foreign-exchange reserves, much of which are held in overseas custody, could frustrate Russia’s ability to defend the value of its currency. On Monday morning, the EU prohibited all transactions with the Central Bank of Russia.
Russian banks’ bid-and-ask quotes for US dollars—the prices at which a dealer will buy or sell—widened dramatically during the weekend, demonstrating both uncertainty about what lies ahead and also how keen holders of dollars are to hang onto hard currency. Sberbank, Russia’s largest bank, quoted a spread of around 22% between purchases and sales of dollars even before Monday’s enormous move in the exchange rate. One week ago, the spread was just 5%.
The Russian government has made efforts in recent years to protect itself from the full impact of any further international sanctions. In 2014 the central bank established an alternative financial messaging system to SWIFT, called SPFS. Last year it boasted that the system’s message volume exceeded 20% of SWIFT’s levels in 2020, with around 400 institutions connected to the system, including several foreign companies.
But recent international sanctions mean that banks overseas will hesitate to participate in any workarounds that could violate incoming sanctions. In 2020, when the American Treasury Department imposed sanctions on political and security figures in Hong Kong, even Chinese banks in the territory would not hold accounts for those who had been targeted. The reason is that they were fearful of losing access to dollar-denominated payment and settlement.
Direct exposure between the Russian financial system and the rest of the world is slim, but not non-existent. Banks based in Russia record $134bn in liabilities owed to institutions abroad, according to data from the Bank for International Settlements, around 0.4% of the global total. Four-fifths of the country’s 15.5trn-rouble government bond market is held domestically. That means there is less risk of direct financial contagion from a Russian financial crisis.
A handful of European banks—Hungary’s OTP, Austria’s Raiffeisen, France’s Société Générale and Italy’s UniCredit—have meaningful exposure to Russia or Ukraine, according to S&P global ratings, a credit-rating agency. But there is no obvious current equivalent to Long-Term Capital Management, the American hedge fund which collapsed in 1998 as a result of highly leveraged bets on Russian government bonds, threatening to take much of Wall Street with it.
Instead, the most important effects of Russia’s financial distress could flow through real economic channels. The rising price of oil will exacerbate inflation which has already surged in most of the Western world. And Chicago wheat futures for delivery in May rose by around 6% during overnight trading, to a little over $9 per bushel. As a staple foodstuff across much of the world, more supply disruptions will mean higher food prices, too. According to Rabobank, a Dutch bank, Russia and Ukraine account together for 30% of global wheat exports.
The reaction of the Federal Reserve to the market ructions adds another element of uncertainty. Until the conflict erupted, expectations that the Fed might signal its intention to whip inflation with a 0.5 percentage point interest-rate increase were growing. Based on market pricing, investors still expect the American central bank to raise rates at its mid-March meeting, but by a more restrained 0.25 percentage points.
If the weakness of the rouble endures and efforts to prevent capital from leaving the country continue, the financial damage to Russian businesses and livelihoods could be lasting. The diversification of Russia’s economy away from commodities would have been set back by years. Just as Vladimir Putin, Russia’s president, has made himself a pariah by invading the country next door, so the Russian economy could end up being isolated, too.