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Russia’s market capitalization is currently about $495 billion. It’s down about 68% from the peak in January 2008. But in local currency, it is down about only 13% in the same period (about 10% of the fall has been in the last quarter). This means that the entire country is valued at less than three quarters of Apple Inc. Russia has a gross domestic product (GDP) in excess of $2 trillion; foreign exchange reserves in excess of $355 billion; and 12.5% of world’s land mass along with abundant natural resources, especially related to energy. And yet it is valued lower than a company that makes iPhones and iPads.

This is surprising because the Russian economy has, in fact, done well over the years. It is the 10th largest economy in the world by nominal GDP and the seventh largest by purchasing power parity (PPP). It has enjoyed fiscal surplus for most of the past decade, except marginal deficits in past five years. Its fiscal deficit in 2014 was just 0.5% of GDP. Government debt to GDP ratio was one of the lowest in the world, at under 14%. Current account was in surplus at 1.5% of GDP. With a GDP per capita at $6,923 (in 2013), Russians are better off than many of their emerging market peers.

From the time when its economy had hit rock bottom in 1998, after the collapse of the USSR, unemployment and poverty have been reduced significantly. While oil and gas remain a substantial part of the country’s exports and its economy, the talent pool it has in the field of space and engineering remains enviable.

But still many aspects show weakness. From the third largest forex reserves globally in 2008, in excess of $590 billion then, there has been a decline of more than 40%. The Russian equity index saw a correction of about 53% between June and December of 2014. The Russian ruble went down from about 34 to a dollar in June 2014 to 67 per dollar in December 2014, before recovering to around 52 to a dollar currently. Russian credit spread expanded from 173 basis points (bps) to 590 bps in the same period, before recovering to 360 bps currently. (One basis point is one-hundredth of a percentage point.) Russian overnight implied forwards moved from 8.5% in June 2014 to 31% in December 2014 before recovering to 15% currently. The Russian overnight repo rate went from 8.5% to 18% during the same period before recovering to 15% at present.

The impact of the turmoil witnessed by the Russian economy can be seen when its equity markets are down by about 5% in local currency terms but 53% in dollar terms, forex reserves are down by 18% and overnight repo rate up by 211%.

This devastation has been caused by a combination of many factors—drop in crude prices, sanctions on Russia due to Ukraine engagement, raw material-heavy export basket in a period of falling commodity prices, and more. But the volatility witnessed in the markets was much more than what the fundamentals suggest. It was not as if Russian equities came from a bubble valuation to warrant such a large correction. The damage witnessed by Russia was nothing short of what a physical war could have caused.

Is this evidence of the world having moved from physical warfare to financial warfare? Do analysts and fund managers now do what soldiers used to do earlier? While in the long term fundamentals will prevail, can the markets be influenced in the short term with such devastating effect on fundamentals? Can the short-term trends be accentuated to cripple markets, and consequently, economies?

One doesn’t know the answers convincingly but it is possible that a short- to medium-term trend of falling crude oil and gas prices was accentuated to create a turmoil in Russian markets.

Integrated debt, currency and equity markets, and the presence of offshore markets allow fund managers to make the effect the cause for further adverse effects. Presence of offshore markets, which are beyond the regulatory oversight and reach of the target country, availability of leverage at near zero interest rates, ability to use the media to push one set of views, ability to influence independent opinion makers such as rating agencies, economists, columnists, policy advisers, and global watchdogs in terms of data interpretation and forecasting can magnify the effects of a small shift in fundamentals.

In addition, the adverse effect can be increased manifold if the opposite side does not have financially savvy decision makers; open and liberal markets that allow free flow of capital across debt, equity, commodity and currency markets; deep local markets; and large and nimble domestic institutions that can face the battle. If the perpetrators are able to get financial as well as non-financial support from sovereign organizations, then the target country becomes even more vulnerable. Malaysian leader Mahathir Mohamad hinted at such a scenario during the Asian crisis of 1997-98.

It is important for India to safeguard against a black swan event like this where the presence of offshore markets and open access to equity, fixed income and currency markets is used to destabilize Indian markets, and consequently, the Indian economy. Superior macros along with low inflation, balanced budget, manageable current account, adequate forex reserves and higher growth is the best way to keep a global investor’s interest. Development of large domestic institutional investors and increasing the depth of the domestic market is critical to maintain equilibrium. Most importantly, regulators and policymakers will have to be prepared with a deeper understanding of the market, quicker decision-making and having the ability to take unconventional steps such as the Hong Kong monetary authority’s intervention in equity during the Asian crisis. While the probability of such an event taking place is low, it is better to be safe than sorry.

Nilesh Shah is managing director, Kotak Mahindra Asset Management Co. Ltd.

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