The Wall Street Journal reports,''markets experienced a classic flight to safety Monday, with stocks down, bonds up and emerging markets falling further from favor. But the harshest judgment was reserved for Russian assets: The RTS stock index plunged 12%, Russian dollar-denominated sovereign bonds fell and the ruble dropped sharply against the dollar".
Russia hasn't faced quite the same pressures as other emerging markets that have been grappling with the impact of U.S. monetary policy this year. But the country already had problems even before the Ukrainian crisis hit. Russia's current account risks moving into deficit and the central bank is forecasting growth of just 1.5%-1.8% this year. January's data showed a sharp drop in fixed investment, a contraction in industrial production and slowing retail sales growth, Royal Bank of Scotland notes. Russia's actions in Ukraine will only be a further red flag for foreign investors.
The ruble in particular looks like a weak point, despite the country's stock pile of $493 billion in foreign-exchange reserves. The currency has already come under severe pressure this year, falling more than 9% against the U.S. dollar. The Central Bank of Russia responded to the volatility Monday with an emergency rate hike of 1.5 percentage points to 7%, a move that it described as "temporary."
But Russia's central bank is caught in a tricky spot: rates rises threaten to push the economy into recession, but failing to tighten policy could lead to a rout in the ruble and higher inflation. For the moment, further ruble weakness seems unavoidable, particularly since the central bank is in the midst of moving to a more flexible exchange-rate regime.
Economic sanctions from Western countries look more likely than military intervention. But Mr. Putin may be gambling that Europe will stop short of measures that could seriously destabilize the Russian economy, such as major restrictions on trade. Russia is clearly reliant on revenues from trading in oil and gas. But by the same token, Europe needs Russian energy supplies: Russia accounts for 31% of European Union natural gas imports and 27% of crude oil imports, Citigroup notes. Asset freezes and travel restrictions might be less dramatic, but could yet cause problems for Mr. Putin, as Russia's political and business elite have increasingly become global players.
Geopolitical risk is always hard for investors to assess: it is impossible to predict how the crisis in Ukraine will play out. Ultimately, it remains to be seen whether Mr. Putin's apparent political ambitions to keep a grip on Ukraine are a stronger force than the undoubted costs his tactics could inflict on Russia's economy. Until that becomes clearer, investors have good reason to shun Russia.
