Russian economy hammered by massive money drain

Vladimir Putin
Sasha Mordovets | Getty Images
Vladimir Putin

While Russian President Vladimir Putin plots his next move into Ukraine, capital is fleeing Russia.

Russia's central bank this week confirmed that some $64 billion in assets held by Russians headed for the exits in the first three months of this year—roughly matching the total for all of 2013. The estimate of the capital exodus amounts to roughly 12 percent of Russia's gross domestic product.

That hemorrhaging is expected to continue if the turmoil in the Ukraine continues. Officials at the World Bank have warned that Russia could watch another $150 billion in capital leave the country if the crisis deepens. Since 2008, nearly half a trillion dollars has fled the country.

As the money flowing out of Russia is surging, the upheaval in Ukraine has put a damper on investment coming into the country. The cash squeeze comes as Russia's economy is barely growing, inflation is rising fast and the central bank has been forced to raise interest rates to prop up a sagging ruble.

The U.S. and Western countries seeking to thwart Putin's Ukrainian ambitions have threatened economic sanctions if the Russian aggression continues. So far those have been limited to freezing the holdings of a handful of Putin's political allies.

"The Achilles' heel of the Russian economy remains the flow abroad of Russian capital following any shock," Goldman Sachs analysts Clemens Grafe and Andrew Matheny said in a recent note. "We would also think that any sanctions or even the threat of sanctions will be ultimately targeted at these flows."

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Expanding a freeze on Russian assets held outside the country could involve the cooperation of relatively few governments—including Cyprus and the British Virgin Islands—that have become tax havens for Russian oligarchs and other wealthy Russians. This list of assets stashed abroad includes real estate, stocks, bonds, bank deposits and private companies.

"These locations are relatively independent of Russian influence, keeping private capital out of the reach of Russian prosecution in case of legal investigations or seizure of assets at home," according to CEIC analyst Alexander Dembitski.

But Western leaders' tough talk of wider asset freezes and threats of broader economic sanctions are complicated by Europe's dependence on Russia for roughly 30 percent of its natural gas demand supplies, half of which flows through Ukraine.

Putin played that trump card again Thursday, warning European leaders that the Kremlin would cut natural gas supplies to Ukraine if it did not pay up on a $2.2 billion gas debt to its former Soviet master. In a letter to the leaders of 18 countries, Putin demanded payment after Kiev failed to meet a Monday deadline for its March gas bill.

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The gas shut-off notice was not an idle threat: State-controlled Gazprom stopped pumping gas to Ukraine during disputes in the winters of 2005-2006 and 2008-2009, crimping the flow to Europe.

Still, the Russian economy is already feeling the pain from Ukraine—even without economic sanctions.

Earlier this week, Russia's Economy Ministry predicted that GDP growth could slow to around 0.5 percent—from 1.3 percent last year. In February, Russia's gross domestic product eked out growth of just 0.3 percent year over year, up from a revised 0.1 percent in January, the ministry's Andrei Klepach told reporters.

If it continues, the Ukraine crisis could send Russia's economy into reverse, according to a report last month by the World Bank, which forecast a 1.8 percent contraction in its worst-case scenario. Russian officials have disputed that assessment.

"There won't be a recession, but there is a problem of stagnation: it's length and depth," Klepach said. "Unfortunately the investment slump is continuing. I'm not ready to say how long it will continue."

To add to the pain of the slowdown, the Ukrainian crisis has battered the value of the ruble, as foreigners scramble to get out of investments based in the currency. That's raised import prices, fueling a surge in inflation. The Economy Ministry predicted annual price inflation of 7.0 percent in March, up from 6.2 percent in February.

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To defend the ruble, Russia's central bank recently boosted interest rates by 1.5 percentage points, further tightening credit at a time when the local economy can ill afford it.

With roughly half a billion in gold and foreign reserves, the central bank still has some leeway in defending the ruble. But a deeper currency crisis can't be ruled out if the country continues to bleed capital.

Last month, citing the Ukraine crisis, falling investment and "persistent" capital outflows, Fitch Ratings cut the outlook on Russia's triple-B credit rating to negative and reduced its growth forecast to less than 1 percent for 2014.

By CNBC's John Schoen. Follow him on Twitter @johnwschoen or email him.