EMERGING MARKETS REPORT

As if tumbling oil and equity prices, capital flight, bank troubles and political risk weren't enough, the Russian markets now face the increasing risk of large ruble devaluation.

In Moscow on Wednesday, dollar-denominated equities extended their precipitous slide, falling 12.5% and forcing the RTS stock exchange to halt trading once again.

Over the last two days, the RTS index has plunged 22%. It is down a whopping 72% year-to-date, making it the worst performer among major global emerging markets.

The Micex stock exchange didn't open at all Wednesday after trading was halted in the previous session because of a 13% slide in share prices.

The latest plunge in equity prices comes as the Russian central bank allowed Tuesday the ruble to weaken 1% against its dual currency basket for the first time since September. Read more.

"We're observing what's going on with concern and we're hoping that it won't spiral out of control," said Jack Dzierwa, global strategist at U.S. Global Investors, commenting on the latest turmoil in Russian markets.

Fears of ruble devaluation "are currently adding to this uncertainty we're seeing," Dzierwa said. "This is having a dampening effect on equities. In order to understand Russia, you really have to look at the price of oil. It all really comes down to the falling price of oil."

Oil prices have tumbled from a record high above $140 a barrel to below $60 barrel currently, exposing the vulnerability of Russia's resource-dependent economy.

Ruble devaluation ahead?

Strategists at RBC Capital Markets said that Tuesday's ruble weakness will likely be followed by a further 1% to 2% devaluation over the next one to two months and an increasingly possible 20% plus maxi-devaluation at some point in 2009.

"We see little prospect of deepening negative capital and current account trends reversing anytime soon," said emerging-market strategists at RBC Capital Markets. "We question the CBR's [central bank of Russia] willingness to further materially run down its foreign exchange reserves trying to defend its currency."

Even though the country's international reserves are still relatively high at $485 billion, they have tumbled by $112 billion since their August peak.

Private capital outflows from Russia are estimated at between $110 billion and $140 billion since August, totaling a massive $50 billion in October alone, according to RBC Capital Markets.

In a move aimed at reducing inflation and stemming capital flight, Russia's central bank raised several key interest rates by 100 basis points late Tuesday, bringing the key overnight repo rate to 8% and the refinancing rate to 12%.

Referring to the rate hikes, currency strategists at Brown Brothers Harriman said that" the Russian policy response seems particularly obtuse."

The strategists noted that Russia is one of the few countries that are hiking interest rates as the global economy is projected to fall into a deep recession.

Lars Rasmussen, an analyst at Danske Bank, said that the high repo rates are unlikely to be very effective in stopping capital flight, but are a step in the right direction in terms of fighting inflation.

"All eyes will rather be focused on if/when the CBR [central bank of Russia] allows for another widening of the [ruble] trading band," Rasmussen said. "The crucial point will be fears of more devaluation and, even worse, fears over capital controls."

More ruble weakness in the short term could be "very toxic" for Russian markets, but it seems inevitable considering declining oil prices, he said.