The recent turmoil in the Russian ruble has raised market risk aversion and caused fund outflows from emerging markets (EM). Brokers’ EM fund-flow data shows that dedicated EM funds sold a net US$7 billion in bonds and equities in the month to early December, the largest outflow since mid-2014. Many investors are also speculating as to whether China would lend Russia a helping hand, given their close “working relationship”.
Relative to the rest of Asia, China has the largest exposure to Russia in terms of both investment and trade. However, as a share of China’s GDP, this exposure is very small. Overall, Asia’s exposure to Russia is negligible. While the direct ruble risk is limited, Russian instability could cause further risk aversion and more fund outflows from EM, dragging Asia down along the way in the short term.
Asia’s financial links with Russia involve Russia’s total (direct, portfolio and others) investment in the region and Asia’s total investment in Russia. There are two risks here: The first is a Russian repatriation risk triggering capital outflows from Asia, and the second is a Russian default risk jeopardizing Asia’s investment in the country.
From a Russian outward-investment perspective, in money terms, China and Singapore are the largest recipients of Russian investment in Asia, amounting to US$7 billion and US$9 billion, respectively, since 2004. But as a share of their respective GDPs, these amounts are in fact small, amounting to 0.1 percent for China and 2.7 percent for Singapore. It is interesting to note that total Russian investment in Hong Kong amounts to 0.4 percent of Hong Kong’s GDP, the second highest in Asia after Singapore.
From an Asian investment perspective, in money terms, China has been the largest investor in Russia since 2003, investing US$26 billion, followed by South Korea’s US$9 billion. But as a percentage of GDP, South Korea’s exposure (0.6 percent of its GDP) is larger than China’s (0.3 percent). The investment exposure of other Asian countries to Russia has been small, averaging only 0.1 percent of their GDPs.
Trade links between Asia and Russia are also limited. South Korea and China are the largest trading partners with Russia, with annual total Russian trade amounting to 2.4 percent and 2.2 percent of their respective totals over the past year. The rest of Asia’s total trade with Russia averages less than 1 percent.
Hence, any potential economic contagion stemming from the ruble turmoil via the trade and financial channels is quite limited.
What if further Russian instability were to cause more sell-off in Asian markets? Which markets/economies would be vulnerable? Those economies that have current account deficits and low foreign-reserve coverage of their foreign debt would be more vulnerable to capital outflows than their healthier peers. From this perspective, India and Indonesia would potentially be hit hard, while Singapore, Taiwan, South Korea and Malaysia have the strongest defense due to their large current account surplus and foreign reserve coverage of their foreign debt.
It should be noted that China has recently allowed direct foreign exchange trading between the RMB and the ruble without going through the USD as a conduit. It has also signed a three-year 150 billion yuan currency swap agreement with Russia. While these moves were unrelated to the ruble turmoil, they are steps that can in fact implicitly help Russia get RMB financing now that USD financing has dried up in the current political and economic environment.
What can the Russian government do to diffuse the current crisis? Fundamentally there is not much it can do. Technically, it has a few options, including more foreign exchange intervention by either raising the already high (almost 20 percent per annum now) interest rates to even higher levels or selling more foreign exchange to protect the ruble, or doing both. There is also the possibility of capital controls, which is the last resort that investors do not want to see.
In the current situation of a confidence collapse, further interest rate hikes would not help much. There is also limited room for large-scale foreign exchange intervention. This is because Russia’s US$416 billion foreign reserves (as of 5 December) are equal to about four times the foreign debt repayments due next year, and the government would prefer to use them for debt servicing rather than fighting capital outflows. So this is not the move one can count on to stem the ruble’s downward spiral.
The last resort is capital controls. But this move does not necessarily mean that investors would not be allowed to enter or exit the Russian market. It may take a number of forms, including a tax on currency repatriation, a requirement for Russian exporters to sell their foreign currency revenues for rubles and partial physical capital controls.
At this point, it is likely that Russia would want to keep its market open for investors, and the ruble turmoil is still an idiosyncratic shock that has limited contagion effect on the global markets.
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