Russia economy feels sting of Ukraine crisis

Moscow (Apr 25)  Russia’s economy felt the sting of the Ukrainian crisis Friday as a ratings agency cut its credit rating to near junk and Moscow hiked interest rates to keep its sliding ruble from fueling inflation.

The impact could get harder as the West threatens additional sanctions. Still, Russia is showing no signs of backing down, saying Friday that pro-Russian insurgents in Ukraine’s southeast will lay down their arms only if the Ukrainian government clears out nationalist protesters in Kiev, the capital.

The soaring prosperity that has been a cornerstone of President Vladimir Putin’s popularity already had been heading for a slowdown before the Ukraine crisis hit, as Russian oil and gas exports slowed and the country’s reliance on extractive industries remained high. But the uncertainty ignited by the Ukraine crisis and Western sanctions against Russia worsened the problem.

Ratings agency Standard & Poor’s cut its credit grade for Russia on Friday for the first time in five years, saying the tensions over Ukraine were causing investors to pull money out of the country. Capital flight from Russia in the first three months of this year totaled about $70 billion — more than all of 2013.

The United States and the European Union imposed sanctions on Russia after it annexed Ukraine’s Crimean Peninsula in March. Despite the sanctions and international denunciation, the annexation appears to be a done deal. Now the focus is on eastern Ukraine, where armed pro-Russia insurgents have seized police stations and government buildings in at least 10 cities and towns, allegedly with Russian participation or connivance

President Barack Obama told four European leaders that the United States was prepared to impose new targeted sanctions on Russia. The White House says the allies on Friday agreed that Russia has not abided by an agreement to ease tensions with Ukraine and has escalated strains in the eastern parts of the former Soviet state.

New measures may not dissuade Russia.

“On the one hand, there appears to be a very gung-ho (Russian) attitude toward east Ukraine,” said Chris Weafer, an analyst at Macro Advisory in Moscow. “On the other hand, they are showing they are very concerned about the impact this is having on the economy and the currency and trying to limit the damage.”

A resolution to the unrest in eastern Ukraine is appearing elusive. The agreement reached last week in Geneva between Russia, Ukraine, the U.S. and the European Union called for all illegal armed groups to lay down their weapons and leave illegally seized buildings and public spaces.

But Russian Foreign Minister Sergey Lavrov declared Friday that the pro-Russia insurgents in eastern Ukraine will only lay down their arms if the Ukrainian government clears out the Maidan protest camp in Kiev and vacates buildings occupied by activists there.

The Maidan tent camp and the building occupations in Kiev are rooted in the massive protests that broke out in late November and culminated in pro-Russia president Viktor Yanukovych fleeing the country for Russia in February. The hundreds of demonstrators and activists who remain say they want to pressure the new government to enact promised reforms and they want to protect the buildings from attack by pro-Russia forces.

“We are defending and helping them, but at the same time they feel threatened by us, we keep them in check,” activist Oleksandr Zhak said Friday.

The occupiers in Kiev consist largely of nationalist sympathizers, including the far-right group Right Sector, who were a core element of the anti-Yanukovych protests. Although more-moderate elements of the new government are uncomfortable with them, forcing them out would be risky.

Yulia Torhovets, a spokeswoman for the Kiev city government, said nationalists have promised to leave Kiev’s occupied city hall by the end of the week.

The West, meanwhile, has accused Russia of fueling the unrest in Ukraine’s east and failing to use its influence on the pro-Russia insurgents.

“For seven days, Russia has refused to take a single concrete step in the right direction,” U.S. Secretary of State John Kerry said Thursday. “Not a single Russian official, not one, has publicly gone on television in Ukraine and called on the separatists to support the Geneva agreement, to support the stand-down, to give up their weapons and get out of the Ukrainian buildings.”

As each side blames the other for inaction and bad faith, the turmoil in eastern Ukraine continues.

There were scattered reports of violence Friday. Ukraine’s Defense Ministry said a grenade fired from a launcher caused an explosion in a helicopter at an airfield outside the eastern city of Kramatorsk, wounding a pilot.

In southern Ukraine, seven people were wounded by a blast at a checkpoint set up by local authorities and pro-Ukraine activists outside the Black Sea port of Odessa. Police spokesman Volodymyr Shablienko said unknown men had thrown a grenade at the checkpoint.

The drop in Russia’s credit rating means it will be more expensive for Russia to borrow on international markets and eventually will determine how much Russian consumers pay for their loans.

As Russia does not borrow much on international bond markets, the impact on its public financing costs is likely to be limited. Russia had 4.4 trillion rubles, or $123 billion, in outstanding government bonds as of April 1. The downgrade amounts to a warning on the risks of investing in the country and the low grade is surprising for a government that has very low levels of public debt.

But Russia’s economic growth slowed to 0.8 percent during 2014’s first quarter, sharply worse than earlier forecast.

And its ruble currency slumped, hitting record lows against the dollar. On Friday, it was down 0.7 percent at 36.03 rubles per dollar. The ruble’s weakness, in turn, has been pushing inflation up in Russia, as a lower currency makes imports more expensive.

The Russian Central Bank sought to fight that trend by increasing its main interest rate, the one-week auction rate, by 0.5 percentage points to 7.5 percent on Friday.

The bank, which had already hiked its rate sharply in March from 5.5 percent, said in a statement it aimed to keep the inflation rate under 6 percent this year and does not expect to cut the rate back in the coming months.

The interest rate increase is a double-edged sword — it could help stabilize the ruble by attracting foreign investors in search of higher returns but will also tend to hurt economic growth by making loans more expensive.