The Wall Street Journal
Heard on the Street
Russian Controls Would Risk Capital Chaos
Results of Such a Move Could Be Disaster
By Richard Barley
Dec. 17, 2014 1:47 p.m. ET
In Russia’s dire situation, imposing capital controls could be the best way to lose control of its economy.
The ruble’s dramatic dive has sparked warnings that Moscow, having already jacked up interest rates to an eye-watering 17% this week, may be forced to introduce capital controls to stabilize the currency by curbing flows of money out of the country.
Russian officials have denied any such plans. They are right to do so; such a move could be disastrous, both in terms of unraveling confidence in the country’s banks and spreading fear through bond markets for other developing economies.
Capital controls of any kind would stoke concerns about domestic bank accounts potentially facing restrictions and risk the recreation of a black market for dollars—something Russians will remember from the dark days of the 1990s.
The history of the relationship between Russians and their banks isn’t a happy one. Fear of capital controls, alongside rising inflation, could spark bank runs. Central-bank data for September and October show ruble deposits of individuals falling modestly, suggesting no crisis of confidence yet. Still, that was before the Russian currency’s slide accelerated in November.
For now, it isn’t clear that capital controls are needed. True, the risks involved have increased due to the poor handling of the ruble crisis by the authorities, with central-bank intervention having been relatively piecemeal so far. Dollar sales settled Monday and Tuesday totaled just $4.3 billion—tiny given that practice has shown overpowering force is needed to stem a potential currency collapse. Meanwhile, the belated rise in interest rates meant the final increase, by a huge 6.5 percentage points, caused new concerns about the economy. Wednesday’s rally in the currency, taking it back to about 60 rubles to the dollar ahead of a major speech by President Vladimir Putin on Thursday, may only be a temporary respite.
So far, the Russian central bank has relied on orthodox tools to face up to its problems. And Russia still had $361 billion in foreign-exchange reserves, excluding gold and items related to the International Monetary Fund, as of end-November. True, the country isn’t as strong as it was during the 2008 financial crisis. Back then, reserves peaked at $582 billion and roughly covered the full stock of external sovereign and corporate debt; now they cover just more than half of the $678 billion outstanding, notes BNP Paribas. Short-term cover looks decent, though, at around 2.8 times the amount falling due by end-2015.
Still, if intervention is ramped up, capital flight continues and Russian companies remain cut off from international capital markets, in part due to sanctions over the Ukraine crisis, some form of rationing of access to foreign currency is imaginable.
Yet capital controls could have very severe and immediate consequences. Already, MSCI has said it may exclude Russia from its emerging-market benchmark equity index as a result. That could cause turmoil as investors who track indexes redeploy cash. The repercussions of such shifts can be powerful; one of the factors that exacerbated the Eurozone sovereign-debt crisis was the ejection of countries from widely followed bond indexes. Further, capital controls would be likely to lead to credit-rating downgrades for Russia and its companies. That could potentially cause further selling in emerging-market bonds, spreading Russia’s pain to other developing economies.
Domestically, the introduction of capital controls—even if only for companies, such as a proposal to force exporters to sell some of their foreign-exchange earnings—could yet lead to the perverse outcome of generating more demand for dollars from Russians. There are reports already of panic buying of goods and foreign-exchange. It isn’t hard to imagine that snowballing to the point at which Russia’s ordinary savers lose confidence in the ruble—and the safety of their bank deposits. While in 2008 Russians retained faith in banks and didn’t rush for the doors, the collapse of 1998 is still a vivid memory for many.
On top of all that, the lesson from other countries that have introduced capital controls, such as Iceland, is that they cause fresh economic distortions and prove difficult to remove. If Russia’s authorities reach the point they have to implement such measures, they will effectively have lost the battle already. For investors in emerging markets, though, the carnage would likely be just beginning.