A Bad Financial Week for Russia

Sources: Bloomberg, Ruble Suffers Biggest Weekly Plunge Against Euro Since 2000; Financial Times, Rouble Exodus Hits Russia Credit Rating; Financial Times, Minister Warns Russia Faces Recession; Bloomberg, Klepach Clarifies Statement on Russian Recession

Facing the shrinking of foreign reserves that until recently were some of the largest in the world, the Russian central bank widened the band within which the ruble can be traded for the fifth time in a month on Thursday. The ruble fell 3.2% against the euro this week as investors rapidly pulled money out of the country in fear of falling oil prices. Banks are also rushing to replace rubles with dollars or hoarding their rubles, which makes the $200 billion government bailout plan largely ineffective. Forecasts range from a fifteen to twenty-five percent fall of the ruble against the euro-dollar basket by the end of 2009, and at least one large investment bank is calling for major devaluation in January. The problem is that though Prime Minister Putin promised that Russia will let the exchange rate adjust gradually, using its reserves to avoid sharp movements, the current economic situation makes gradual depreciation very difficult.

This follows Monday's ratings downgrade, when Standard & Poor's reduced Russia's foreign currency credit rating from BBB+ to BBB due to depletion of foreign exchange reserves and troubles finding external financing due to the financial crisis. Standard & Poor's warned that Russia may have to spend all the money in its Reserve Fund and National Wealth Fund, two sovereign wealth funds that were supposed to guarantee prosperity for future generations, in re-capitalizing the banks and covering fiscal deficits over the next two years. Low oil prices will pressure the trade balance, and balancing the budget over the next few years will be a much tougher challenge for Russian legislators. This is the first downgrade of a G8 country's rating in the present crisis.

On Friday, the Russian Deputy Economic Minister admitted that Russia is facing a potential recession of more than two quarters, though he quickly clarified his statement to mean slowing economic growth rather than an economic contraction as the term is used in the United States. If there is a recession, it would be the first for Russia since August 1998, but the Deputy Minister did not provide specific forecasts for the slowed growth.

Also on Friday, Russia suspended trading on the MICEX exchange. Prices fell 5.6% before the suspension in reaction to another oil price drop, bringing the index's value down a total of more than seventy percent since May.

Questions:

1) Do you think Russia should adopt a more flexible exchange rate policy, rather than drying up its reserves defending the currency, or is Putin's avoidance of a sharp movement smart policy?
2) Do you think that the current slowing growth will compromise all of Russia's phenomenal growth over the past ten years, so that the cycle will have to restart again, or can smart policy decisions get it quickly back on the road to sustainable growth?