Russia is in a heck of a fix right now. Hurt by lower oil prices and U.S.-backed sanctions, the sprawling Eurasian country is on the precipice of a steep economic downturn thanks in no small part to the foreign borrowings of its largest companies.
Problems in Russia surfaced last year when OPEC decided to drive oil prices lower by maintaining a high level of supply relative to demand. The decision has been interpreted as a shot across the bow of higher-cost producers in the United States, but Russia has emerged as the top victim due to its inordinate reliance on energy exports.
The extent of the damage to Russia's economy can be seen by the sharp decline in its currency. Since the beginning of last year, the ruble has lost half its value versus the dollar. In January 2014 it took 33 rubles to buy a dollar. Today it takes 65.
The steep fall in the ruble roughly doubles the cost of imports, but a more pressing concern for the Russian government stems from the foreign borrowings of its companies. Like the cost of imports, the burden of interest and principal payments has effectively doubled on non-ruble-denominated debts.
As a recent Wells Fargo report notes, "Any Russian company or bank that needs to service foreign currency debt would have a more difficult time making foreign currency debt servicing payments if it does not generate revenue that is denominated in foreign currency."
A large swath of principal payments on foreign-denominated debt comes due this year, making the issue even more pressing. According to The Wall Street Journal, "about $40 billion of dollar-denominated debt needs to be rolled over by Russian entities in the first half of 2015, and $77 billion in the full year."
This very problem led to the 1997 Asian financial crisis -- which, coincidentally, went on to spark a Russian default the following year. As in Russia, companies in nations such as South Korea and Thailand had financed their growth with dollar-denominated debt. The situation reached a breaking point when a drop in Asian currency values led to a debilitating rise in debt-servicing costs.
It's too early to say, of course, whether Russia will follow the same path. Things certainly don't look promising. But it's important for investors to be psychologically prepared in the event that it happens.
