RUSSIA’S ECONOMIC CRISIS IS GETTING WORSE

The collapse of Ukraine’s ceasefire yesterday (7/01) has shattered hopes for a quick end to the crisis in the Donbass, setting off fresh capital flight from Russia and raising the specter of further Western sanctions against Russian companies.

Markets were caught off guard as Ukrainian leader Petro Poroshenko launched air strikes and an artillery barrage against rebels, pleading that he had no choice after they killed 27 Ukrainian servicemen. "We will attack and we will liberate our land. The end of the ceasefire is our response to terrorists, rebels, looters," he said.

The International Monetary Fund said the conflict risks deep damage to Russia’s economy, starving it of foreign funds and knowhow.

"Geopolitical tensions have brought the Russian economy to a standstill. Russia’s actions in Crimea have increased the uncertainty of doing business in Russia and are having a chilling effect on investment. Capital outflows could reach $100 billion in 2014. This comes at a crucial moment when the old growth model based on energy has been exhausted," the IMF said.

Russia never fully recovered from the 2008-09 crash and was in trouble before Ukraine’s crisis erupted. The IMF expects growth to fall to 0.2% this year, with risks "starkly to the downside."

Russia’s central bank chief Elvira Nabiullina said capital flight was playing havoc with exchange rate policy.

"Ruble stability is impossible unless we slow capital outflows," she said. The currency fell for the fourth session today (7/02), dropping 0.9% to 34.24 against the dollar.

The EU is holding the Kremlin accountable for the failed ceasefire. Its ambassadors agreed Monday (6/30) to "intensified preparations" for new sanctions, effectively cocking the gun.

German finance minister Wolfgang Schäuble said further measures would hurt Europe but insisted that violations of international law cannot stand.

A strategy paper from Angela Merkel’s Christian Democrat Party called for a complete change in policy, deeming it impossible to work with the Kremlin so long as Vladimir Putin is in charge.

Diplomats say the next round will see more "Stage 2" measures against companies rather than sectoral assaults on the energy industry or the financial system.

^{Source: IMF}

Tim Ash, from Standard Bank, said: "It’s very difficult for the US and the EU not to do anything: the Donbass can’t be mothballed like Northern Cyprus. It is Ukraine’s industrial heartland."

The mere threat of fresh action already risks blighting Russia’s efforts to develop oil and gas fields in the Arctic, and to explore for shale, because of the dependence of foreign capital and technology.

The IMF said Russia’s external debt has jumped from $467bn to $746bn in five years, reaching 30% of GDP. The Achilles’ Heel is corporate debt, with Rosneft, Gazprom, and Russian Railways facing large redemptions over the next two years. Aluminum giant Rusal has sought restructuring of $3.6bn of debt.

^{Source: IMF}

Firms must refinance $10bn a month in foreign debt, yet Russia’s bond market is mostly closed. "Even though many corporations appear to have enough buffers, close monitoring of systemic risks remains warranted," said the IMF.

Diplomats say the Kremlin is fully aware of the economic risks but the prospect of Ukraine slipping out of Russia’s orbit is a larger matter.

Mr, Putin is showing no sign of backing down, invoking Peter the Great’s push for a Black Sea coastline. "I want everyone to understand. Our country will continue to defend the rights of Russians abroad, and to use our entire arsenal," he said Monday (6/30).

The fresh violence is a reminder that the geo-strategic issues run deep, with Russia now fixed on a course likely to cause years of friction with the West. Russia has been shielded so far by high oil prices, with disruptions in Iraq and Libya pushing Brent crude to $112 a barrel. Energy makes up two-thirds of Russia’s exports and a third of budget revenues.

The IMF said the state’s "non-oil" budget balance has gone from a surplus to a deficit of 12% of GDP in barely a decade, while non-oil exports have collapsed from 22% to 8% of GDP. The country is a textbook case of the "Dutch disease."

^{Source: IMF}

After letting the rest of the economy atrophy, Mr. Putin’s Russia is acutely vulnerable to any future oil glut, a serious possibility as the US shale boom spreads abroad and Iran returns to the global economy. 

Which explains why the Kremlin is subsidizing European environmental groups to demonize fracking, as recently charged by NATO Secretary-General Anders Fogh Rasmussen.

Ambrose Evans-Pritchard is the International Business Editor of the London Telegraph.

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