Russian Capital Controls and Macho Interest Rates Policy

Unsurprisingly, since the Crimea crisis erupted, capital flight from Russia has increased and may reach around $70BN over Q1 of this year.

Bartosz Pawlowski from BNP Paribas is quoted by the Telegraph:

“It is shocking, markets have been extremely complacent, fooling themselves that Russia is invulnerable because it has almost half a trillion in foreign reserves. But reserves can become almost irrelevant in this sort of crisis.”

There is now a risk of capital controls being implemented, as per Lars Christensen from Danske Bank:

“Capital controls are a serious risk, and should not be discounted. Whatever now happens, there has been permanent damage to the Russian economy because investors are not going to forget this lightly.” 

Given that markets are driven by greed, fear and raw emotion, the very fact that capital controls have been flagged as a risk will now be the catalyst for ever larger movements of capital out of Russia. Thus the prediction will become a self fulfilling prophecy.

Additionally, as I noted in January, Russia is using interest rates to prop up the Rouble.This outdated macho policy of currency support has the effect of strangling the economy:

"A macho defence of one's currency is all very well in the short term, however in the medium to long term it will achieve nothing (as Britain's disastrous flirtation with the ERM in the 1990's showed). At some stage Russia will be forced to allow the rouble to float, or else face a recession caused by an excessively tight monetary policy.

Turkey’s “shock and awe” doubling of interest rates on Tuesday has failed to restore confidence in the lira, it too will have to allow the lira to go where the markets wish.

 

Suffice to say Russia, given its rigid mindset and macho self belief, will not in the near future allow the rouble to float. Instead it will continue to tighten monetary policy, and will impose capital controls to prevent currency flight.

 

This in turn will prompt other countries in East Europe to do the same, resulting in a general stagnation of the world economy as the flow of free moving capital dries up and people's confidence in the banking system is eroded."

Russia will learn, to its cost, that you cannot buck the market!