Explained: How screwed really is the Russian economy after invasion of Ukraine?

in Deep Dives3 months ago

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Ever since Putin invaded Ukraine, the world has bombarded Russia with sanctions, restrictions, and limitations. In terms of transportation, Boeing, Airbus, Ford, Mercedes, Toyota, and Volkswagen have all suspended exports/and or stopped operations
in Russia.

In terms of tech, Apple has halted all product sales, Google has demonetized Russian state media, and Facebook and TikTok have blocked Russian state media altogether in Europe. In terms of energy, Exxon, Shell, BP, and Equinor have announced that they will be canceling investments in Russia and/or leaving Russia
completely. In terms of logistics, UPS and FedEx have halted shipments to Russia and Ukraine.

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just a small portion of companies that left russian market after invasion of ukraine, tech4gamers

In terms of finances, several Russian banks have been barred from the SWIFT system, and Switzerland has frozen Russian assets. And that doesn’t even include the countrywide bans on bonds, airspace restrictions, and limitations on Russian banks and oligarchs. Considering all this, there’s no question that once everything is said and done in Ukraine, Russia is screwed economically. In fact, in just the past 1 month, the USD to Ruble exchange rate has exploded from 75 rubles per dollar to over 120 rubles per dollar. This means that the Russian Ruble has lost nearly 40% of its value against the dollar.

Meanwhile, the Russian stock market crashed 33% the day after the invasion even with the Russian central bank closing the stock market. And at the time of making this article, Russia has refused to reopen the market in fear of even greater losses. So, how screwed really is the Russian economy?

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Moscow stock market index graph

We hear all this news about sanctions and restrictions on Russia, but what does this really do to the economy? Well, from a consumer’s perspective, it seems like you just can’t travel as much abroad, and you can’t buy certain foreign goods. But, the true consequences are much more deep-rooted and painful with the first being uncontrollable inflation.

Like any other product on the market, the Russian Ruble is subject to supply and demand constraints. And the value of the Ruble in relation to other currencies is dependent on how many people want the Ruble vs the other currency. When a country is exporting a bunch of goods like Russia, a lot of countries and companies will need the Ruble to purchase Russian goods. But, when basically every Russian good is blocked from being imported, the demand for the Ruble falls off a cliff.

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Russian imports, tradingeconomics

In the meantime, Russians are still dependent on a lot of foreign goods including basics like food, clothing, and medicine. And in order to obtain these essentials, Russians must give up rubles in exchange for dollars, euros, or whatever the case may be. Russia has tried to soften this demand by limiting imports into the country. But, with how interconnected the global economy is today, it’s nearly impossible to break away and become independent. This means that the supply of rubles from Russians hasn’t really changed all that much while the demand for the ruble from foreigners has evaporated. And basic economics would tell you that this screws over the Ruble, and** that’s why it has dropped nearly 40% in the past few weeks**. But uncontrollable inflation is not even that bad when you consider that the entire financial system is in danger of collapsing.

You see, not only do sanctions limit the demand for rubles, but it makes it extremely difficult to access rubles that are stored in foreign countries. Ever since 2014, Russia’s central bank has been building up massive positions in foreign currencies. It’s estimated that they hold $630 billion in foreign currencies. This was a strategic move to protect Russia against inflation, but this has kind of backfired. The $630 billion worth of foreign currency is worth significantly more than if they had just held that money in rubles. But, given all these sanctions, they don’t actually have access to this money.

Not only does this make it more difficult for Russia to fund their activities, but more importantly, they’re now facing a massive liquidity problem. And given that this is public knowledge, Russian banks are scrambling to prevent a bank run. One of these countermeasures was raising interest rates from 9.5% to 20%. This is truly quite amusing.

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Russian central bank interest rates graph, tradingeconomics

Over here in the US, the stock market is throwing a fit because Powell might increase interests rates by half a percent after months of heads up. But, Russia literally raised interest rates by 10.5% overnight. Russia is hoping that 20% interest rates will convince Russians to keep their money in the bank and** that they can avoid a bank run**. But, the situation is still extremely fragile, and one big catalyst could destroy the Russian financial system.

Even if Russia is able to avoid a full-on financial collapse, the next several years will still be quite painful anyway. You see, when a bunch of everyday goods rise in price by 40%, people will need to spend significantly more money on living expenses. For many everyday Russians, this means withdrawing from savings and/or going broke.

In the meantime, businesses will have to pay significantly more for their goods which means that they’ll have to raise prices on their products just to stay afloat. But, by raising prices, a lot of their customers would no longer be able to afford these goods which means that they’ll get less business and may end up going bankrupt anyway.

Businesses that do survive will have to pay their employees significantly higher salaries which means that they’ll probably be more conservative when it comes to hiring, and they might even let go of a few employees. Not only does this dramatically increase the workload for the remaining employees, but this will dramatically increase unemployment. And when more people are unemployed, consumers as a whole will spend less money which means **even less revenue for businesses which could lead to another round of layoffs and then the cycle starts over. **

Also, what about the well-off Russians? I’m not talking about the billionaire oligarchs, but the everyday millionaires that worked saved, and invested for 40 50 years just to attain some level of financial freedom. At this rate, these individuals will have to return to work very soon. Something else to consider is that the inflation that Russia has seen so far could just be the beginning.

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USD/RUB graph, tradingeconomics

About 25 years ago, in 1998, Russia experienced a similar financial fallout due to a different set of circumstances. Things got so bad that Russia ended up defaulting on domestic debt which led to the Ruble jumping off a cliff. Before the crisis, you could get 1 US dollar using 5-6 Rubles, but after the crisis, you needed 30 rubles to just get a single dollar. This means that by the time things stabilized,** the Ruble had lost 80 to 90% of its value**. If we see something similar right now, each US dollar could be equivalent to 400 rubles by the end of this crisis. And that’s if things end up stabilizing.

The 1998 financial crisis was not a result of the world powers trying to punish Russia. It was due to unsustainable economic and financial practices similar to the 2008 financial recession. So, for the most part, no one was trying to intentionally screw over Russia, but the same cannot be said about the current situation. So, if worse comes to worst, it’s possible that Russia enters hyperinflation on the scale of Venezuela, Zimbabwe, and Germany after WW1. And at that point, there’s really nothing left to do but start over. So, even if the Russian economy doesn’t implode due to sanctions, it’s possible that the economy bleeds out due to hyperinflation.

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inflation rates by countries, statistia 2020

The collateral damage of a financial crisis and inflation alone is horrendous, but we haven’t even discussed the future of the Russian stock market and its collateral damage. At the time of making this article, Russia is yet to reopen the stock market, but a lot of Russian stocks are available on different exchanges like the London Stock exchange. And so far, they have lost 33% of their value which correlates to a $200 billion loss in market cap.

That makes this crash the 5th worst crash in stock market history. And that’s with the London exchange suspending Russian stocks. If London hadn’t suspended these stocks, it’s quite possible that these stocks would be down over 50% by now. For a lot of you guys, it might be confusing as to how the stock market affects the average Russian given that the average Russian likely doesn’t own many stocks.

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Russian government owned oil and gas company Rosneft's stock price 1YR in London stock exchange

Well, even though the average Russian may not incur direct losses on stock holdings, they will likely face several indirect consequences. To understand this, we have to first take a look at why the stock market is even crashing in the first place. The answer, in this case, is obvious. With all these sanctions and restrictions, it’s unlikely that most Russian companies will be able to pull in the revenue and profits that they used to. Many of these companies will no longer be profitable and will be headed towards bankruptcy. And given that low investor trust in Russia, it’s gonna be nearly impossible for these companies to raise money by selling shares.

This leaves them with only two options. Either they can fight for profitability until they go bankrupt at which point they’ll have to shut down operations and lay off all their employees. Or, they’ll have to get a bailout from the government which would simply increase the odds of hyperinflation. Neither of these options is particularly favorable to the average person. Either they lose their job or they lose their savings.

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Russian pension fund portfolios, IPE

And what about retirees? Most retirees in Russia depend on various pension and retirement plans, and these plans have investments in the stock market. With the stock market halving in values and their foreign assets being frozen, it’s gonna be a lot harder for these funds to pay out their millions of beneficiaries. These funds may be forced to default or borrow money to pay out their beneficiaries. And given that Russian interest rates are as high as credit cards right now, you definitely don’t want to be borrowing money. As you can see, even though the average Russian may not directly have stock holdings, a stock market crash would be pretty painful for them as well.

At the end of the day, the west doesn’t agree with Putin’s invasion of Ukraine, and this has caused them to take severe action. 100 years ago, the west may have entered into war against Russia or entered into an arms race against Russia. But, today, governments are trying to address this situation diplomatically. Instead of fighting a deadly war or building up weapons of mass destruction, the west is trying to get Russia to back off by threatening their economy. And with the biggest countries and companies on board, it seems to be pretty effective in causing economic damage.

However, it’s unclear if this will actually lead to Russia backing down. Here’s the thing, even if they did back down, Putin has permanently burned a lot of bridges by deciding to invade. So, it’s unlikely that their economy will just return to normal if they leave Ukraine. Considering this, if the Russian economy is screwed either way, why not make a statement on your way out. And it looks like that’s what Putin has chosen to do.

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Looking forward, it’s unlikely that the Russian economy will completely collapse or enter hyperinflation, though those do have non-negligible probabilities. The more likely scenario is that Russia falls down another tier amongst world powers economically with the everyday Russian bearing most of the fallout. While that’s quite a shame, hopefully, all these efforts make it substantially harder for Putin to invade yet another country. But only time will tell.

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I suspect China will gladly jump in to help out. In the process they will embed themselves all over the place like they have the U.S.

 3 months ago Reveal Comment