Investors shaken by Russian invasion

The people of Ukraine protesting Russian's intervention in Crimea
The people of Ukraine protesting Russian’s intervention in Crimea

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Merely  twenty-four  years on since Ukraine gained independence from the USSR and the conflict between the pro-European nationalists and the Party of Regions has warranted Russian military invasion in Ukraine’s Southeastern  peninsula –Crimea.

While speculations surrounding Russia’s intent behind the invasion are numerous, investors across the globe fear a war in the region could be imminent.

As a result key economic barometers like the Russian stock markets, MICEX & RTS indices, and the value of the ruble (Russia’s currency) have been moving in just one direction–downwards.

Mr Putin and his policies have shocked investors due to mounting fears of war and the possibility of international sanctions being slammed on Russia.

The MICEX index on March 3rd decreased by 10.79% since February 28th 2014. The RTS index fell by almost 13%, thus recording one of the highest one-day falls in Russian stock market history.

Investor wealth plunged by a whopping $58.7bn.

War and economic  sanctions would result in further declines in Russian companies’ value. Its companies’  profits  would  decline due to restrictions on exporting and credit from overseas would be prevented, thus stopping investment flows for expansion.

Currently foreign investors are pulling money out of all Russian assets causing the ruble’s value to plummet against the US Dollar due to falling demand for its use. Its value has fallen 5% over the past months.

Gennady Timchenko  and Leonid Mikhelson, two of Russia’s richest, together lost a total of $3.2 billion on the day of the stock market crash as their shares in gas company OAO Novatek’s  nose-dived  by  almost 18%.State-owned  oil  producer Gazprom also took a beating as its shares fell by 10.7%.

Key commodities like oil increased in price by $3 per barrel to $112 per barrel on March 3rd.

The  spillover effects that this could potentially have had on the European population intensified concerns. However, as worries  about supply shocks faded, Brent crude traded  at $109.30 per barrel.

While the GDP growth forecast for 2014 has considerably fallen, retail inflation has remained at mid-6% levels. The weakening of the ruble has caused  serious  concerns that  inflation will increase.

The Central Bank of Russia has stepped in by increasing interest rates from 5.5% to 7%.This will discourage borrowing  so that less money is active in the economy.

This is in the hope of preventing the ruble’s value declining  further. The downside is that the increase in interest rates  could  dampen  economic growth since taking out loans for investment becomes  more expensive.

JPMorgan now predicts Russia will grow at a mere 0.9%, a reduction from its initial growth forecast of 1.9%. The ruble did bounce back by a small margin and reached levels of around 36.05  rubles to the US Dollar (for 24-hour period ending March 4th).

This was achieved through heavy intervention by the Central Bank of Russia–a record $11.7 billion being spent by the Central Bank of Russia on buying the excess rubles on the foreign exchange market. This will all have to be paid back through Russian taxpayer money.

Stock markets have also recovered by 5.3% since March 5th however overall investor sentiment is still pessimistic.

“The lack of certainty over further developments of the situation in Ukraine would continue to inflict downside pressure on the markets,” said Olma Brokerage, a brokerage firm based in Moscow.

Even though Russian government bonds (Government IOU for a return of interest) might have seemed like safe investments, insurance companies believe otherwise.

The price of insuring these relatively risk-free debt securities hit a nine-month high.

The high investment insurance premiums could possibly deter investment in Russian assets and lead to investors channeling their money towards safe-haven investments like US assets that are cheaper to insure.

These transfers could also be due to increasing concerns that the Russian government defaulting on debt in addition to political uncertainty surrounding Crimea’s fate.

If Mr Putin goes ahead with a military invasion, the United States and Europe are expected to declare economic sanctions against Russia.

The USA is already threatening to impose economic sanctions on anyone who is, “threatening  the sovereignty and territorial integrity of Ukraine”.

An escalation of Russia’s interference  in Ukraine’s crisis could lead to the imposition of much stricter sanctions like restrictions against the importing of oil producing technology into Russia.

It could provide a test of unity between  the  US and Europe who can put themselves in a position of strength by acting together. To do this, the Obama administration must recognise that the EU has a lot more at stake than the US due to Europe’s reliance on Russia for a significant amount of its energy.

Sanctions could have major repercussions for Russia’s economy (since  Russia  is  a major exporter of oil) and the world economy as a whole, but it would successfully limit Russia’s military interference.

Since corrupt capitalism  is rife in Russia, the economic sanctions would have the most influence if they were targeted at the people who help keep Mr. Putin in power. These are the super-rich band of Russians that control the politics of Russia.

Sanctions such as Visa bans and  asset freeze limits would limit their ability to access the large quantities of property and assets that Russia’s wealthiest have  sprawled  across  Europe.

This would encourage Russia’s oligarchs to persuade Putin to stop the military invasion. The US  has  indicated  that it would also consider issuing banking sanctions if the conflict escalates  similar to what was done over Iran’s nuclear proliferation program.

The sanctions include cutting off any bank from the US financial system that does business with a Russian banks. The long-term economic consequences of the intensification of the conflict would be more severe than the impact over the last week.

Unlike a quarter of a century ago, when trade played a fairly minor role in the economy of the Soviet Union, Russia today is a major global interdependent player in the world economy.

Crimea, a small peninsula with a population of just about two million, might not be a significant addition to Russia in statistical terms, but if Russia continues it is highly likely that the country will go back to ‘Soviet Union lite’ and restart the Cold War.

Photograph: BO Freedom

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