by Giovanni Verra de Fonseca Russian President Vladimir Putin emerged defiant on Thursday, telling journalists at his annual news conference in Moscow that he would work hard to revive Russia’s broken economy, which he said could take around two years to fix. It was the first time we had heard from Putin since the Russian Central Bank was forced to raise interest rates on Tuesday by an enormous 6.5% to stem a free fall in the value of Russia’s currency, the ruble. Putin acknowledged that Western sanctions, which were levied earlier this year in response to Russia’s annexation of Crimea, were around 25% to 30% to blame as well. By September, the U.S. had barred several major Russian companies—most notably Rosneft, the Russian state-controlled energy giant—from accessing the U.S. debt markets. This set the stage for the ruble’s massive drop in value this week. Since oil is traded in dollars on the international markets, Rosneft has accumulated a great deal of debt denominated in dollars. It is able to service that debt each quarter by borrowing dollars via the U.S. debt markets. The sanctions brought an abrupt end to this dollar-debt merry-go-round, forcing Rosneft to hoard dollars to make its $10 billion debt payment due at the end of the month. By forcing Rosneft and other major Russian companies to hoard dollars to service its debt, the Western sanctions managed to remove one of the largest buyers of Russian rubles from the foreign exchange markets. This created an imbalance in the supply and demand for the ruble, leading to the currency’s drop in value. There were simply too many people wanting to sell rubles and not enough buyers. The ruble’s collapse has hit the Russian people hard, as 80% of Russian savings are locked up in assets denominated in rubles. But they aren’t the only ones suffering. Western companies that do business in Russia are also feeling the pain. Foreign companies are naturally some of the biggest sellers of rubles, as they are constantly converting rubles into their home currencies. Clearly, Russia’s economy has turned into a hot mess. Much of it was its own doing. We all agree that Kremlin failed to diversify the nation’s economy, leaving it a slave to the gyrations of the consistently volatile oil markets. But, don’t get me wrong, it’s not the first time that the price of black gold drops without obvious reason. In the 80s, Saudi Arabia had already opened the oil valves to flood the market. The price per barrel fell in 1986 from $27 to below $10. Does the Saudi kingdom has gained by the change? Not really, as its revenues have completely melted, which was forced to borrow to cover its budget deficit while it is normally in surplus. In fact, the maneuver had no other purpose than to economically asphyxiate Iran in tackling its oil revenues. The strategy simmered by Washington failed to topple the ruling mullahs in Tehran, but has helped to temper their revolutionary ardor, while giving air to Saddam Hussein, whose army faced with massive defeats inflicted by iranian forces. The current goal seems eerily similar. This is to neutralize Putin and make Moscow bend. Because the oil sector is the backbone of the Russian economy. With the decline of oil, it is the foreign exchange earnings of the country that are melting at sight of eye. For many investors, bankruptcy seemed inevitable as in 1998. But Moscow’s position is it as brittle as some want to believe? Kremlin has other allies than Pyongyang and Caracas. China, whose economy slows down since some time should probably be concerned about the recent US initiatives such as the Trans-Pacific Partnership Agreement which threats Russia of insolation on the economic and diplomatic front. Therefore, it wouldn’t pleased for China to see Russia collapse to make way for a regime aligned with the American positions as in the case of Ukraine, for example. We can bet that China won’t remain insensitive to the Russia’s financial difficulties. Its foreign exchange reserves are huge as they already exceeded 3,820 billion at the end of last year. Whereof perfectly cover the reimbursement of all Russian maturing loans. However, this will not be necessary. The fact that Beijing is ready to fly to the rescue of Moscow will be enough to deter speculators to sell the overdrawn Ruble by betting on a default. Also, the ruble has recovered 30% of its value against the Euro so far (and its upwards was almost identical vis-à-vis the US dollar). However, what’s made the Ruble to enable a such recovery as speculative as attack that pushed the ruble into the abyss? As we all know, the central banks of Russia and China have signed a contract (swap) to exchange their values directly without using the intermediary of the dollar. The exchange rate provided for in the contract is 5.67 rubles for 1 yuan renminbi. Since the Yuan exchange with other values (including the dollar) swing between +/- 2% compared to the average rate established by the Chinese central bank, Russia may sell yuan – at the exchange rate established by contract – in exchange for dollars, and then with these dollars, acquire rubles. Therefore, buying rubles increases immediately its value against the dollar, and makes incur losses those who would have sold rubles “short” (without owning them) in the hope of acquiring them later, with the certainty of a decline and thus to pocket the difference. With the discreet support of its neighbor China, it is unlikely that Russia has real trouble to do. The Saudis have no interests in maintaining the price of a barrel artificially low even though their production costs are the lowest in the world. One can thus think that the calm will eventually come back very soon. If so, the episode will have served only reinforce the suspicion that Moscow and Beijing maintain towards the West in general, and Washington in particular. As for the boss of the Kremlin, his position seems to be stronger than ever. Nothing like a crisis to sit a popularity that already exceeds 85%. In a recent article published in Finance commentary section of “Fortune Magazine” Cyrus Sanati wrote that the West should not let Russia fall apart. He added that Russia’s economy is much larger and richer than it was in 1998, making a potential default much scarier. According to him, Russian corporate and government debt is held by a number of financial institutions around the world, from banks in Italy and France, to asset managers in London and New York. Pimco’s $3.3 billion Emerging Market Bond Fund is made up of 21% Russian bonds, for example. So far, the fund is down 8% on the month and set to go further south. There is little the West can do to boost oil prices, but it could help things by allowing Russian companies to access the dollar markets, at least temporarily until the panic subsides, he wrote. After all, the sanctions were designed to punish Russia for its actions in the Ukraine, not kill it. No one, at least no one sane, wants to see Russia default and descend into economic chaos. That’s bad for German auto exporters, bad for U.S. energy companies, bad for Italian banks, and bad for Wall Street. Sure, Russia’s economy isn’t as large as the U.S. or EU in terms of GDP, but its meltdown wouldn’t be an isolated incident. It won’t take long before the contagion spreads to CIS member states and Eastern Europe, both of which maintain strong trade relations with Russia, said Cyrus Sanati. http://stateofmindaristierpartners.com/