According to a report from the Wall Street Journal, "Russia hasn't escaped the recent emerging-market turmoil. The ruble has been a poor performer, falling some 7% against the dollar this year. And with investors wondering whether the turmoil in countries such as Turkey could lead to wider systemic problems, Russia presents a potential cause for concern, both because of its size and turbulent history".
Russia has come a long way since 1998, however, when its default led to the implosion of U.S.-based hedge fund Long Term Capital Management, which reverberated through Wall Street. Russia ran a current-account surplus of 1.5% of gross domestic product in 2013 and a budget deficit of just 0.5% of GDP.
Reserves are solid at $497 billion. And the country hasn't been a magnet for hot-money inflows. From mid-2009 to the end of 2012, when emerging markets were a favorite destination for investors, portfolio inflows were just 1% of GDP, according to Morgan Stanley, versus 10% of GDP for Turkey.
Not that Russia is without issues. Two loom large: its relatively lackluster economic prospects and unfortunately timed push to liberalize its foreign-exchange system.
The current-account surplus has shrunk and may yet turn into a deficit. Growth has slowed since the global financial crisis and was just 1.5% in 2013. Despite that, inflation is proving tricky to bring down to target. Some Russian officials warn the country faces stagflation. Russia remains reliant on oil and gas revenues and it still hasn't done enough to attract investment that might help diversify its economy.
Russia also is unlucky in that it has chosen now to increase exchange-rate flexibility, with the aim of moving to a floating-rate system by 2015. In the long term, this is likely to be a positive development. But changes to the relatively complex system, which couples a moving currency band with interventions at preset thresholds, may be adding to the pressure on the ruble and increasing volatility.
Moreover, if the ruble continues to fall steeply, it could cause tensions in a country that has seen repeated painful currency crises. In 1998, when Russia defaulted, the ruble lost 70% of its value against the dollar; in 2008-2009, it lost 55% against the dollar, according to RBS.
The move this year in the Russian central bank's ruble band against the euro and dollar is the fastest since 2009 and may evoke memories of those previous devaluations for the population, notes RBS. A big threat to the ruble could yet lie in a surge in demand by Russians for foreign currency.
Russia's central bank,has a tricky task. Slow growth means it is unlikely to want to raise rates, but currency weakness could prove inflationary. One option is for the central bank to pause in its progress toward a free-floating ruble. If the pressure increases, that might be a handy safety valve.
Investors mindful of Russia's importance to emerging markets are right to keep a sharp eye
on its currency
