The Russian economy was the eighth largest in the world in 2013 by nominal gross domestic product (GDP) valued at $2.3 trillion. The country's economy experienced rapid growth between 2000 and 2012, driven by higher energy prices and increased arms exports.
Investors around the world felt sure that Russia was turning a corner and that foreign direct investment was flowing into the country. But Russia’s economy was on the brink of a crisis just a year later when the ruble fell to record lows against the U.S. dollar. The Russian central bank hiked interest rates by a massive 6.5%, but it failed to stem the tide. Investors lost confidence in the currency, but it recovered to some extent in 2016.
- Russia's economy depends on crude oil and natural gas. It was weakened in 2014 when OPEC refused to cut production to boost prices.
- Russia was subject to sanctions after it invaded Ukraine in 2014 and allegedly interfered in other countries' elections in 2016 and 2017.
- Russia is working toward being less dependent on the dollar, but it would have to pay more in rubles to pay off its debt in U.S. dollars.
- Problems in Russia's economy could lead to another financial crisis or a recession in the future.
Falling Oil Prices
Russia’s economy has always depended on crude oil and natural gas. Commodities account for a big portion of its economy. Exports of crude oil and related products accounted for more than two-thirds of the country’s total exports in 2013. That was more than half the government’s total revenue.
But crude oil prices fell by about 50% in 2014 due to lower demand in Europe, Russia’s key market, and to increased production in the U.S. The largest source of Russia’s problems may have come when the Organization of the Petroleum Exporting Countries (OPEC) stated that it would not cut its production to boost prices in late 2014. OPEC did eventually cut production, but crude oil prices still haven't bounced back to their old highs.
Crude oil prices may remain depressed in the 2020s. OPEC compliance is less than 50% by many accounts if you exclude Kuwait and Saudi Arabia. These countries can't be responsible for maintaining cuts on their own. U.S. shale production has proven to be flexible in response to falling crude oil prices. Levels recovered in 2018.
Russia’s second problem relates to its foreign policy. The U.S. and the European Union imposed a number of financial sanctions that made it difficult for Russian firms to borrow abroad after the country invaded the Ukraine in February 2014. These sanctions grew with the country's alleged interference in the U.S. and European presidential elections in 2016 and 2017, and with its military interventions in Ukraine and Syria.
President Vladimir Putin admitted that these sanctions are harming the economy. There are signs that these sanctions may be discouraging families from having more children over the long term. This could have devastating long-term effects.
Russia reduced its U.S. Treasury holdings from $96 billion in March 2018 to $14 billion in May 2018 in response to fears that U.S. sanctions would freeze a large portion of the country’s international reserves.
The third problem deals with Russia’s U.S. dollar-denominated debt. The country went into 2017 with holdings of over $11.1 billion in ruble-denominated debt, and with $62.4 billion (rubles) in dollar-denominated debt. It would likely have to pay more in rubles to pay off its debt in U.S. dollars.
Russia is working on a plan to become less dependent on the dollar, such as by increasingly executing trade deals in rubles and other currencies.
The Bottom Line
The Russian ruble crisis had many causes. It contributed to a sudden crisis of confidence, including falling energy prices, heightened geopolitical risks, and increasing demand for the U.S. dollar. The country still suffers from the same problems that caused the crisis.
You may want to take caution if you're thinking about investing in Russia, given the ruble crisis and its aftermath. Dollar-denominated debt could become difficult to service in rubles. Equities could suffer due to deteriorating spending power among consumers and businesses. These trends could lead to a similar crisis or a recession down the road.