The Russian imperial double-headed eagle coat of arms, the emblem of Russia’s central bank, sits on a five rouble coin, standing on it’s edge against piles of rouble coins
Markets have priced in substantial rouble depreciation and decline in the price of Russian debt © Andrey Rudakov/Bloomberg

The writer is professor of economics at Sciences Po, Paris 

It was Russia’s interior minister Vyacheslav von Plehve who, a century ago, infamously said: “What this country needs is a short, victorious war to stem the tide of revolution.” In 1904, in the midst of growing public dissatisfaction with the Czarist government, he viewed the forthcoming Russo-Japanese conflict as a welcome distraction from domestic unrest.

His doctrine spectacularly backfired, however. The Russian Empire did go to war with Japan, but suffered a catastrophic defeat; the resulting 1905 revolution forced the tsar to establish the first Russian constitution and parliament, the Duma. Von Plehve himself did not live to see this — he was killed in 1904 by the very same revolutionaries his war was intended to suppress.

Given Vladimir Putin’s historically low electoral ratings, and Russians’ pessimistic views of their country’s economic prospects, it is hard not to recall von Plehve’s dictum. Whether or not Moscow invades Ukraine, it is already distracting the world — and ordinary Russians — from growing problems such as stagnating incomes, corruption, and the catastrophic handling of the Covid-19 pandemic. Russian opposition leader Alexei Navalny strongly believes this is the motivation for Putin’s current foreign policy “spectacle”. 

But brinkmanship requires credible threats. If Putin’s bellicose discourse were not backed up by the necessary troop movements, it would not be taken seriously. And while we do not know whether the war will actually happen, the prospect of conflict has already damaged the Russian economy. On January 24 alone, the stock market fell by 7 per cent in rouble terms; this drop was accompanied by the weakening of the rouble and sovereign bonds. Since the beginning of the year, the dollar-denominated RTSI index lost almost 20 per cent. It is back to its pre-pandemic levels — even though oil, Russia’s main export commodity, is worth a third more than it was back then. The Russian market’s performance is especially striking given that global stock prices are now trading at 20 to 40 per cent above their pre-pandemic peaks.

January 24 was also unprecedented for Russia’s Central Bank move to support the rouble. Russia’s budget breaks even when the oil price is at $44 per barrel. When it is higher, the Russian Finance Ministry uses excess export revenues to fill up the sovereign wealth fund by taxing the oil firms and handing these revenues to the Central Bank to buy dollars. Since today’s oil price is almost double the break-even level, the Central Bank should be investing heavily in dollars. On January 24, it stopped buying any.

Why are the markets so nervous? Russia’s macro fundamentals are actually very good: its gross domestic product is already above pre-pandemic levels, and according to the IMF’s Fiscal Monitor, it is the only large economy to have balanced its 2022 budget, with a predicted fiscal surplus in 2023 and 2024. Russia’s sovereign wealth fund stands at 12 per cent of GDP. Its sovereign debt is very low, so the central bank can extinguish inflation by raising rates without substantial fiscal pain.

Yet, investors are still scared. Despite high oil prices, capital outflow is high and the rouble is weak. Forecast GDP growth rates are well below the global average. This is because markets believe that the worst is yet to come. The invasion has not yet happened, but neither has it been ruled out — and a war would mean new, severe sanctions. It is unlikely that the west will impose an oil and gas embargo on Russia, as it did on Iran. Russia is a top oil exporter (second only to Saudi Arabia) and an essential supplier of gas to Europe. However, Nato allies have the power greatly to harm Russia’s financial system.

This is why markets price in substantial rouble depreciation and decline in the price of Russian debt. In the event of an invasion, it is likely that Russia will be suspended from the Swift payment system, that its largest banks will be placed under full sanctions and the assets of its richest citizens frozen. While Russia has substantial reserves and its own national (albeit imperfect) Swift substitute, it will experience further financial problems, and bank failures, with an impact on the purchasing power of ordinary citizens.

Will this deter Putin? In 2015 he famously said: “Our sovereignty is not up for sale,” implying that financial costs will not prevent him claiming territory he considers to be his. Since then, he has indeed ramped up repression, ensuring that popular discontent does not translate into a tangible political challenge. On the other hand, this may be a mistake — just as von Plehve’s doctrine turned out to be. The markets’ reaction to Putin’s brinkmanship already suggests a real war may cost him much more than he is able to bear.

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