With plunging oil and a tumbling rouble on the one hand, and rocketing bond yields and inflation on the other, Moscow is clearly worried, but is a perfect storm gathering over Putin?

On 1 December, Russian president Vladimir Putin announced during a visit to Turkey that Russia was abandoning its South Stream project, a pipeline envisioned to bring gas to south-eastern Europe bypassing Ukraine by going through the Black Sea.

The official explanation for halting the project are EU regulations, which prohibit one company controlling the full cycle of extraction, transportation and sale of energy resources. Simply put, the same company cannot own both the gas and the pipeline it goes through.

In reality, alongside EU pressure on member states supportive of the deal, the main reason for Russia’s change of heart is money. The $40bn project was always driven more by a political rationale than a business case. The influence that would have flowed through the pipeline was more important than the gas it would have carried.

Earlier this month, Russia’s economy ministry announced that it expects the country to enter recession next year. The ministry also lowered its assumptions for 2015 oil prices to $80 per barrel. Just over a month ago, Russia was forecasting $100 oil and 1.2% growth for next year.

Capital outflows from Russia are expected to exceed $100bn this year, a nearly 65% increase on last year, prompting renewed reports of temporary capital controls.

On Thursday, Russia’s central bank lifted its benchmark interest rate by 1 percentage point to 10.5%.

Moscow is clearly worried, but is a perfect storm gathering over Russia?

On Wednesday the price of a barrel of brent dropped below $65 for the first time in five years. Prices continue to be pushed downwards by weak demand (primarily from China and Europe), OPEC inaction, and higher output. The US now produces 65% more oil than it did five years ago following the boom in shale production, and output in Iraq and Libya has picked up after turmoil in both countries.

Recent calculations show that Russia needs oil to stick to around $105 a barrel for its budget to break-even. This is far from the case at the moment, even though a weaker rouble will have nudged down the break-even point.

According to different studies, the country would lose about $12-14bn a year in revenue for every loss of $10 per barrel (here and here). Since Oil and gas make up around half of government income, and more than 60% of the country’s exports, the impact can be substantial.

Russia’s attempts at hedging falling oil prices and sanctions have so far included increasing energy exports to Asia, a plan to ship gas through Turkey, which has been dubbed as unrealistic, and a gold buying spree. In the bigger scheme of things, these measures, at least in the short-term, have limited impact and are at best speculative.

Falling oil prices have led the rouble to tumble, losing nearly 50% against the dollar this year. The currency also recently hit a five-year low against the dollar.

While bond yields have rocketed in the other direction:

Robin Wigglesworth (@RobinWigg) Russian bond yield rockets to five-year high as analysts talk about another financial crisis. http://t.co/DPGo4xylhP pic.twitter.com/et2WKV2m0M

The currency meltdown weighs significantly on foreign debt repayments

At 13% of GDP, government debt is pretty low. Private debt is a different matter, especially given the flexible nature of Russia’s private sector.

Russia’s external debt amounted to $731bn in June 2014. 74% of this is denominated in foreign currency, meaning that the depreciation of the rouble makes it more expensive to repay.

$35bn of debts are due in December alone.

The largest component of debt is attributable to banks and other non-government sectors, which together owe more than $650bn to foreign lenders, 17% of which is short-term, and much of which (46%) is attributable to state-owned banks and enterprises.

Sanctions too are starting to bite

Companies directly under western sanctions account for about 60% of the total debt due by the end of 2015 (£).

While most of these companies are (for now) relatively cash rich, the fact that many are sanctioned from raising finance means that they cannot simply roll over debt by borrowing externally, and need to instead buy dollars in the market. There also appears to be growing evidence (£) of concerned western banks and financial institutions refusing to finance even those Russian companies that are not on the blacklist.



It is worth keeping in mind at this point that while not being state-run, private companies are often merely quasi-sovereign in Russia, and ownership structures are rather fluid and can change quite rapidly - the potential weight of debt on government finances goes beyond only state-run companies.

Finding alternative funding sources will not be easy.

Following the imposition of sanctions, Russian companies and banks - traditionally reliant on dollar-denominated syndicated loans – started to look to China for a financial escape route. The rouble-yuan currency pair reached records in trading volumes over the summer. Russian companies are not new to the renminbi market, nor to the issuance of so-called “Dim Sum bonds” - bonds denominated in Chinese yuan and largely issued by entities based in China or Hong Kong - in the past these options represented a cheaper source of funding. But, yields on Russian corporate bonds denominated in yuan have been increasing recently as the list of sanctions started mounting up.

The one parallel with the 1998 crash is that some of the Russian economy’s greatest vulnerabilities to a weaker currency lie in the banking sector. Capital Economics calculates that banks alone have $192bn external debt (about 10% of GDP), up from $170bn in 2008, and from $18bn in 1998.

The key point here is that Russia’s banks have few dollar assets to set against their dollar debts.

All this directly impacts governments finances in at least three ways:

1. Russia’s Central Bank needs to support the rouble. Since the beginning of the year it has spent more than $70bn to do so. Russia has $420bn in reserves, and a significant portion of these are in dollars. While still vast, nearly $100bn have been burnt through the past 12 months.



2. Directly support companies’ debt repayments. Companies like Rosneft and VTB Bank may well require funds far greater than the $90 billion held by the National Welfare Fund, a sovereign wealth fund designed to support companies in moments of difficulties. Rosneft alone, struggling under the debt pile it took on to acquire TNK-BP, has sought $48bn (£).

3. The imposition of sanctions from both the US and the EU is making Russia increasingly look east, but especially in terms of its relation with China, Russia is not strongest of the two in this partnership.

Despite all this, figures at hand, while it won’t be pretty, Russia can cope with the current context through next year. Should today’s scenario remain unchanged over the next two years or more though, then even the country’s hefty reserves may begin to struggle. In terms of external debt, credit rating agency Moody’s even gives this potential challenge a number: $112bn over the next four years.

The weight of falling oil prices goes beyond the holes it leaves in Russia’s budget

Russian wealth is disproportionately dependant on natural resources. According to World Bank calculations, natural capital is 43% of overall wealth in Russia. In Australia, Canada, Norway, and New Zealand the ratio is between 8-13%.

Back in November, Russia was predicting 5% inflation next year. The rate will end the year above 9%, and many analysts predict it will hit double figures in the first three months of 2015. Nowhere near the levels of 1998’s financial implosion which ended with the country defaulting, but already enough to cause unease on the streets of Moscow.

According to a recent poll by Levada, 71% of Russians are worried about inflation - more than 30 points ahead of the two next most frequently mentioned concerns, poverty and inequality.

Inflationary pressure on many food items is even greater. The price increases for meat and fish are in the double figures. The price of cucumbers increased by 7.6% in the first week of October, and tomatoes saw a +5.7% spike the following week.

Inflation is hitting all areas of society. Brothels in the Arctic port of Murmansk have hiked their prices by 30-40%, and may in future even peg their services to the dollar.

Public sector employees account for more than 25% of Russia’s workforce, and are Putin’s core electorate. When the Russian president returned to the office in 2012, he promised hefty pay increases for public sector workers (in some cases doubling salaries). The government is now attempting to back peddle and bring these increases in line with inflation.

Despite a relatively austere budget, Russia’s budget also foresees a 20% increase in military spending, which together with law enforcement, and state security sectors makes up about a third of the federal budget.

President Putin remains remarkably popular, and his grip on the country firm.

At the end of 1985, the Soviet Union started losing about $20bn a year because of increased Saudi production and plunging oil prices. That’s about $44bn in today’s money. In pure number terms, today’s figures are relatively speaking still some way away from the levels of the Soviet crash.

The political context and markets were so different then compared to today’s that any comparison isn’t straightforward. The story though matters for a different reason.

When the Soviet Union collapsed, Putin was a KGB agent stationed in East Germany. He will have experienced the USSR’s fall, and the regime change that followed, first hand.

He will want to avoid a rerun.

It may not be 1991 or 1998 all over again for Russia, but today’s financial misfortune means that several of Putin’s tools of economic control and influence will now be less sharp - and over time, if sustained, the political implications of this may come to matter just as much. Despite the president’s necessary ramblings against the west during his latest state of the nation speech, there are already hints of greater caution and prudence. Maybe even concern.

Silvia Merler contributed to this article. She is an affiliate fellow at Bruegel.