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By HaleStewart December 26, 2014 11:46 am
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Potential 2015 Flashpoint #1: Russia

          At the beginning of this year, Russia wasn’t on anybody’s economic radar.  While their growth had slowed, the general consensus was this was due to a BRIC economy that was heavily dependent on oil revenue facing the need to diversify its sources of growth.  Other raw material exporters such as South Africa and Australia are facing the same problem.  Oil’s price collapse, however, was a serious blow to Russia’s economic growth potential.  Compounding their troubles are the sanctions imposed as a result of their invasion of Ukraine.  The sum total of these fact is that, by year end, Russia is now seen as the economy most likely to create problems for the world at large going into 2015.

          After the imposition of sanctions, oil’s half year long price drop from a high of 107 mid-summer to its current readings in the lower 50s made overall matters worse:

Numerous reasons have been offered for Saudi Arabia’s desire to keep gas prices low.  The most prominent are they are either trying to force marginal US frackers out of the business, thereby lowering supply and driving up cost, or that this is a political move where the Saudis are trying to punish the Iranians and the Russians.  Regardless of the motive, they have signaled they are more than willing to continue sending prices lower for an extended period of time.

          The Russian economy was doing poorly when all this started.  Overall growth was slowing due to weak business investment, dropping consumer demand and a weakening currency.   But the drop in oil prices exacerbated this problem due to several factors.  First, oil is responsible for over 50% of Russia’s exports and government funding.  A near 50% drop in oil’s price greatly lowers both of these key economic statistics.

          And the predictable fallout occurred, starting with a massive drop in the ruble. 

The dollar/ruble pair started the year trading around the 35 level.  Now they’re trading in the lower 50s.

     In response, the Russian central bank sharply increased interest rates to their current level of 17%. 

This was seen as a panic move after it occurred.  This was a big reason for the rubles major sell-off earlier next month.

          The drop in oil will exacerbate the other major problem facing the Russian economy, spiking inflation:

As the chart above shows, inflation has increased from 6.1% at the beginning of the year to 9.1% in its latest reading. 

     While the interest rate increase will obviously help to alleviate this problem, there is a very nasty side-effect: an incredibly high probability of recession.  In fact, with interest rates this high, a recession is pretty much baked into the economic cake, as it were.  The only question now is its overall severity and length.

     The biggest concern regarding this stems from the Russian government.  Putin is a classic Russian strongman with an iron grip on power.  But economic trouble has ways of increasing domestic tensions, which could increase the possibility of internal conflicts.  And the worse the overall economic situation, the more likely this will occur.    

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

 

         

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