Texas Tech University

"Russia's Economic Outlook" - Franco Parisi, Amanda McIntire and Jacob Armitage

Trevor Bell

November 24, 2014

Visiting International Scholar Franco Parisi partnered with Amanda McIntire and Jacob Armitage to discuss Russia's economic outlook. This semester, Parisi has worked with students in the Rawls Business Leadership Program and his Finance course to discuss current international issues.

Amanda McIntire is a sophomore Pre-Energy Commerce major from Houston, Texas. She hopes to pursue a career in the oil and gas industry upon graduation in May 2017. Currently, she works as a student intern in the Office of the Vice President for Research at Texas Tech University. Amanda has been rewarded The President's Volunteer Service Award for her efforts in community service, has a paper published in the Congressional Record, and has been involved in multiple leadership programs including the Rawls Business Leadership Program, the Hugh O'Brien Youth Leadership Program, the Fort Bend Leadership Program, and Congressman Pete Olsen's Congressional Youth Advisory Council.

Jacob Armitage is a senior Finance and Accounting dual major. He is also minoring in Economics and has a Certificate in Wind Energy. Jacob has excelled in the classroom, where he has achieved Dean's List each semester since Fall 2012. Jacob has been actively involved in many student organizations throughout his time at Texas Tech, including Beta Gamma Sigma Honor Society, the Tech Economic Association, Golden Key Honor Society, the Association of Fundraising Professionals, the Wind Energy Student Association, the National Society of Collegiate Scholars, and Lambda Chi Alpha Fraternity.

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Russia's Economic Outlook

ForbesMagazine named Russian President Vladimir Putin as "The Most Powerful Man in the World," but the economy in his country is not doing so well and looks to perform worse in the near future. The Russian local currency, the Ruble (₽), was ₽32.47 per dollar a year ago and this week is at ₽46.54, a total depreciation of 43% and, in only a month, a deterioration of about 15% of its relative value. The depreciation of the Ruble was accompanied by an outflow of the Russian Central Bank Reserves. According to official information, the reserve level in the Russian Central Bank is about $457 billion, but only $220 are foreign currency stockpile; the rest are gold and others reserves.

The Russian Central Bank has burned approximately $70 billion in reserves this year, and it is expected to continue doing so, but up to a limit. This week, they announced that the Ruble "dirty flotation" strategy that will change the currency to a free flotation, so speculators will face high risk in their trade. Also, they are offering repurchase agreements from one week, to four weeks, or as long as year, in attempt to control expectations over the local currency and local interest rate. These measures are textbook oriented to diminish speculation and to segment the market; then the real sector that needs dollars in the near future can get repurchase agreements and not to rush in the spot market, increasing the interest rate for borrowers in all of the sectors, for both companies and consumers. The idea to increase interest rate is to attract short term U.S. dollars and to avoid capital outflows, but this action will damage the economy in the midterm and long term can turn the economy into a speculative economy rather than a productive one. This is not an easy outlook for Russians.

As long as the "drums of war" are still in place, the shadows on new economic sanctions feed the exodus of foreign exchange and increase the pressure on the Central Bank to sell dollars at a growing rate. So the question is, "When will Putin maintain this situation?" The Russian President is the only one that knows the answer to that; however, we can speculate different scenarios. First, the oil price is very low to support the currency attack over the Ruble, and the low oil price is expected to last for 4 to 8 months, depending on OPEC production decision. Second, after the big loss of the mid-term election, Barack Obama cannot afford to lose internal popularity more than that which has already been lost, so he and Angela Merkel will impose more economic sanctions over Russia, impacting the exchange rate to 50 Ruble per dollar with a significant loss of reserves. Inflation is also getting high in Russia; it is about 8% due to the high exchange rate and a high index price impact negatively in the president evaluation, Putin's main asset.

We expect that at a level of around 50 Rubles per dollar, Putin will change his strategy about Ukraine. Take into consideration, few years ago (2008), Putin was successful in annexing Kosovo with no pressure over his economy or over his international policy; but this time is different. With a Ruble at the level of ₽50 per dollar or more, we expect a change in Putin's behavior, moving toward the start of meetings about a peace zone in the conflict region with Germany. At that moment, capital market will decide if Putin's behavior is credible or not, and if the summit takes a long time, the Ruble should get higher and higher. It is clear that both ends will try to gain time, but it could be a cold winter for Russia and Europe. Time is in favor of Europe, as long as the oil price remains below $95 the barrel. Since they are having a bad economic performance, they do not need high energy costs.

But make no mistake; Putin has been working the international relationship in emerging markets. He went to the World Cup final in Brazil, visiting Argentina and other Latin American countries, and he has been strengthening ties with China. Europe needs Russian Oil and Gas, especially in a harsh winter like this one, due to the weather and the economic outlook of the European zone. Also President Putin can play "the good boy role" and change behavior at any time; he has the support of the Russian people, an advantage that neither Merkel nor Obama has.

So after Putin gives up the Ukraine, the Ruble should get strong, about ₽40, and we will see Russian bonds with a yield to maturity about 8% and the inflation below 6%, and capital inflow to Russia and a stock index renting 20% per month. But the capital market will take notes, any attempt to attach some region of the former Soviet bloc by Putin, and this will have a direct impact in the Russian capital market and Germany and the U.S. will have to take immediate action in the economic area, if not Putin will continue annexing new nations of the old Russian empire. It is only a matter of time to see who the winner will be, Putin or Occident, or maybe they will find a win-win situation for Putin, Merkel and Obama, but someone has to lose, so if you are thinking about going into the Russian capital market, now may not be the right time. Maybe in March 2015 we can see what is going on in Putin's land to see if the capital is heating back up in Russia's favor.

This supports the efforts outlined in the Rawls College of Business Strategic Plan. Learn more about the LEADER 2020 Strategic Plan and follow our progress on Twitter at #RawlsLeads.