The heavy toll of war on the Russian economy
Historically, currency crashes and bank runs do not usually end well for the economies that experience them. The currency crash and banking panic currently occurring in Russia will be no exception. As happened during the 1998 Russian financial market crisisRussians should prepare for a deep economic recession and high unemployment rates as a direct result of the invasion.
Over the weekend, the United States and Europe dramatically stepped up financial market sanctions against Russia as the price for its invasion of Ukraine. These sanctions included freezing the assets of the Russian central bank and excluding some Russian banks in the SWIFT banking system.
Anyone who doubts that these sanctions precipitated a Russian currency crisis and caused a bank run need only look at what happened on the ground in Russia.
With the Russian central bank now hampered in its ability to defend the currency through sales of international reserves from its Currency stock of $630 billion, the Russian ruble has plunged more than 40% in recent days. As a result, the ruble now buys only about 1 US cent. This represents one of the largest currency collapses on record and surpasses Russia’s currency collapse in 1998. This collapse in turn has helped cause the Russian stock market to lose about half of its value since the invasion.
At the same time, as public confidence in the safety of its bank deposits has evaporated, long lines people desperate to withdraw their deposits were seen at banks across the country. This forced the central bank to assure depositors that banks are sound and to more than double interest rates to 20 percent.
Normally, a country struggling with a very difficult financial market in Russia would approach the International Monetary Fund (IMF) for an economic adjustment program that could help restore lost credibility. In doing so, it hopes to receive the stamp of approval from the IMF for its policies and financial support. But with the country effectively at war with the West, this is hardly an option open to Russian economic policymakers.
One of the ways the Russian central bank could quell a bank run is to print all the rubles that depositors might demand to be withdrawn from banks. However, printing money on such a scale would be a sure recipe for further currency weakness and to put the country on the path to an economically destructive hyperinflation crisis.
Another way Russian economic policymakers may be responding to the crisis is how they now seem to be choosing to do so. They can let the currency find its own level and they can raise interest rates sharply. But it risks bankrupting many domestic businesses and households by dramatically increasing their debt servicing costs, especially dollar-denominated debt. A wave of bankruptcies is unlikely to restore confidence in banks or help stabilize the currency.
This leaves Russian policymakers with the less unpleasant but still costly option of imposing exchange rate controls and strict limits on the amount of money depositors can withdraw from banks. While such measures can stabilize the currency and quell bank runs, they will do so at the long-term economic cost of preventing a properly functioning financial system.
All of this suggests that whatever the foreign policy goals of the Russian president Vladimir PoutineVladimir Vladimirovich Putin Pentagon: Russia has lost partial control of the first captured Ukrainian city Ukraine, Taiwan, the Koreas: Is the world leaning towards major wars? Russian Ambassador Files Lawsuit Against Italian Newspaper Over Article Suggesting Putin’s Death could achieve by its invasion of Ukraine, they will come at a very heavy economic cost to the average Russian household. It is far from certain that Russian citizens will think that Putin’s war was worth their economic costs.
Desmond Lachman is a senior fellow at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department at the International Monetary Fund and Chief Emerging Markets Economic Strategist at Salomon Smith Barney.