Sometimes words can hurt more than actions. Last week, the president of the European Central Bank, Mario Draghi said that capital flight from Russia might be four times as high as reported by Russia’s government. So far, the finance ministry reported $ 51 billion in the first qurter, while, according to Draghi, ECB estimates total outflows to have reached $ 222 billion this year. At the same time, there is significant suspicion that not only the official numbers on capital flight but also the ones on Russia’s currency reserves ($ 477 billion) are bogus, following the Russian Central Bank’s efforts in the past weeks to protect the rouble. Regardless of whether these assumptions are right, the mere fact that it is just plausible to assume that Russia is lying about its important economic indicators may soon lead to serious consequences. By all accounts, Russia may be headed towards a 1998-type crisis.

Taking a closer look at the two situations, despite the obvious differences, one can observe a whole range of similarities:

–       An illusion is lost: in 1998, the illusion that the Russian economy, following the reforms carried out in the early 90s, was strong enough to withstand external shocks was brought down by the Asian economic crisis of 1997. In 2014, the illusion that Russia had been fully integrated into a rules-based international economic system is shattered by its non-conventional intervention in Ukraine; especially the sanctions that followed as well as Russia’s answers to them. Some may argue that the rules-based international system essentially means playing by Western rules, but given Russia’s weight in the global economy compared to the West’s, this seems only rational. Investors – in this case, overwhelmingly Westerners – prefer known and universal rules and they will avoid bringing money into a country with increasingly high institutional risks. Just as the 1997 Asian crisis showcased one major structural weakness of the Russian economy – overdependence on commodities exports – the Ukrainian campaign showcased another: its non-integration into the existing set of rules governing the global economy and global politics. In fact, a poll published by Bloomberg last week cited Russia as the worst place to invest among the world’s biggest economies.

–       Costs of a war: right before in 1998, the costs of the First Chechen War – both the actual costs of the war and the costs of reconstruction – burdened the Russian economy, making the economic situation all the more delicate. In 2014, the situation appears to be similar, if not even more severe. The annexation of Crimea will cost the Russian federal budget 160-200 billion rouble each year, according to the Ministry of Economic Development, and may as well wipe out the budget’s reserves this year. Not only will this keep the government from investing in other regions of Russia (including those that are already affected by chronic underinvestment), but it will also require regions, some of them already on the verge of bankruptcy, to take up further tasks.

–       Devaluation of the Russian currency: in 1998 the currency market caved in as a result of fears for devaluation of the rouble. In 2014, the Russian currency has already lost 9% of its value, despite increasingly desperate attempts of the Central Bank to remedy the situation. Yes, we all know the official explanation of how a weak rouble is, in fact, beneficial to export, but the unexpected rate hike announced by the Central Bank at the end of April and the sheer amount of money the bank has spent to protect the rouble both raise some doubts about the veracity of this argument. If Russia’s currency reserves actually turn out to be lower than officially declared, that may be the tipping point.

–       Nervous bond markets: In 1998, similar to the currency market, the stock and bond markets collapsed following increasing fears of default on domestic debt. Government bond yields reached 47% in the early stages of the crisis, further worsened by reduced liquidity. We’re not here yet. Nonetheless, in 2014, there has been a steady increase in Russia’s 10Y bond yield, from below 7% at the beginning of the year to around 9%. At the end of April, Standard & Poor’s downgraded Russia’s bonds to one level above junk. Today, Russia’s is the fifth most expensive government debt to insure. Put in context, Russia is in a basket with Argentina, Ukraine, Venezuela and Croatia. With weakening investor and depositor trust, a similar liquidity crisis may as well reproduce once government bonds become too risky. It should also be added that as state ownership in the Russian economy got considerably stronger in the past decade, in case the Russian state gets riskier, state-owned companies will get riskier too. This will considerably impact their investment opportunities, even if no direct sanctions are adopted against them. Rosneft, Gazprom and a range of other companies should gear up for rating cuts! Ironically, offshore companies are less likely to be affected, which, on the other hand, contradicts Vladimir Putin’s de-offshorisation campaign.

Certainly, not every foreign investor will flee Russia. Companies like BP, for example, have already indicated that they will stay in the country. Obviously, for some firms with considerable history in Russia, especially in the energy industry, sunk costs would be too high to abandon investments altogether (even though, like many companies have publicly announced in the past weeks, they will think twice before they bring additional money to Russia). And if Mario Draghi’s numbers are right, they constitute a minority.

And then, there is China, together with the rest of East Asia. Both the Russian government and state-owned companies have been engaged in enormous efforts to show that Russia has options: it can, if it has to, redirect its exports to Asia. However, this needs further investment – and, as mentioned above, money is on increasingly short supply. Even the most optimistic estimates do not foresee a considerable redirection of Russian exports to Asia before 2017. If Gazprom and China finally agree on pricing, that is. Cold comfort for an economy that has probably already entered recession.

25 May and its immediate aftermath will be a turning point. According to credible sources, debates within the Russian political elite on how to proceed have gotten increasingly fierce, regardless of which officials have been affected by Western sanctions. The question that remains is: does Vladimir Putin listen to them? If yes, he will know that finding an end game for Russia is getting increasingly urgent. The Ukrainian election will determine the political costs of this end game. Whether they believe it or not, Ukrainians may as well hold the key for the next chapter of the crisis.

One additional thing – to follow up on my latest blog entry: the second phase of the 1998 crisis began with the dismissal of the Prime Minister. We shall see what happens now.