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Russia is edging closer to a crisis, with the Central Bank of Russia (CBR) starting to spend money to prop up the ruble, which has clearly started to devalue.

The CBR reported that reserves declined by $6bn in September, ending the month with $526bn. At the same time, the ruble has continued to slide against the dollar and lost about 4% over the week, having lost about 14% since the start of the year.

This is very bad news, as Russia has been enjoying a trade surplus this year, posting a $117.6bn surplus in the first seven months. This helped rebuild the country's reserves to peak around $540bn (up from crisis low of $320bn, but still down from pre-crisis high of $600bn) and also to replenish the reserve fund, which is (or rather "was" earlier last week) expected to end the year at $145bn.

The fall is driven almost exclusively by fear and the danger now is that talk of a crisis will become a self-fulfilling prophesy. CBR Chairman Sergei Ignatiev (who hates talking to the media) was forced to go on record at the end of September to promise that the ruble corridor would not be abandoned and confirmed the band at 32.50-37.50. That press conference came a day after Finance Minister Alexei Kudrin was sacked, which has only added to the uncertainty.

Ignatiev also said there was no need to provide uncollateralized loans as the bank did in the second half of 2008, "which also reflects his optimistic view on the Russian banking system," says Natalia Orlova, the chief economist at Alfa Bank.

"In the event of improvement on global markets, we believe the CBR's strategy will be shown to have been fully appropriate. However, if more negative news comes, further CBR interventions will reinforce the local liquidity squeeze," Orlova said in a note on September 30. "While yesterday the ruble managed to bounce off the border of the CBR's currency band to RUB36.9 to the basket, that move was driven by a global correction after a week-long market fall, and volatility is very likely to persist. Thus, even though uncollateralized loans are not required at the moment and the currency band appears sustainable, Russia will face more tension on the interbank and exchange rate markets if oil falls lower."

Capital flight

The CBR's spending also means that capital outflows have probably restarted after they slowed dramatically in the summer. Some $31bn left the country in the first eight months of the year, and the recent bought of nerves means that capital flight has resumed. Some people are now talking about a total outflow of $100bn for the full year - at this stage, probably an overstatement. Even if Greece doesn't blow up in two weeks time, such nervousness is doing an increasing amount of damage to the Russian economy, despite the fact that the basic economic fundamentals are unchanged.

Russia's reserves are amongst the highest in the world on both an import coverage and GDP per capita basis, while the inflation forecast for the year has been lowered to 7.3%, its lowest level since 1991. The current account remains in surplus and the Finance Ministry also ordered another $1.3bn pay-off on Russia's external Eurobond debt last week. And so on - almost all the macro indicators are good.

However, you can see the hysteria building outside Russia. The BBC ran a story over the weekend claiming that "investors are fleeing Russia" thanks to "falling oil prices", when in fact neither of these things are happening. Investment, especially foreign direct investment, continues to recover from the crisis lows and oil remains resolutely at about $100 per barrel. That said, the current equity valuations are pricing in an oil price of about $75, which is where oil could go if there is an economic meltdown in the Eurozone.

With a price/earnings ratio for Russian stocks at below five, the valuations on Russian equity are "absurdly low," according to Mattias Westman, founder of Prosperity Capital Management - but that has not stopped portfolio investors rushing for the exit.

The last week of September saw another heavy sell-off. "Fund flows showed continued flight from risk and no appetite for risk assets this past week. Some inflows were recorded into gold in what we view as a flight to safety, but EM bonds and equity funds continued to post outflows," says Ovanes Oganisian of Renaissance Capital. Russia equity-dedicated funds showed the biggest outflow among all developing countries, losing $443m, whilst Russian bond funds recorded a similar feat, losing $12m.

Confidence is clearly fading fast. "The September Manufacturing PMI reading indicates that the manufacturing sector is stagnating, dragged back by new orders and export orders," says Alexey Moiseev, chief economist at VTB Bank. "The combination of close to zero output growth, shrinking employment and abating inflation suggests that activity in the sector is indeed subdued. This is likely to feed into the official data on industrial production, which has recently been strong, with a 6.2% year-on-year increase in August."

Meanwhile, the banks are clearly anticipating trouble and have started to curb their personal lending - the engine of growth for Russia's economy today - to limit their exposure to non-performing loans should there be another crunch. "We are thinking how to scale down credit expansion and don't want to run risks once again. But we are unwilling to frighten customers by such statements and announce it in public. Why should we be the first?" a senior manager at a top-20 bank was quoted by Kommersant as saying last week.

Another banker was quoted as saying: "There are risks, of course. But we can scale down the granting of loans without any public statements. We don't have to explain reasons for a loan refusal."

Even more scary, it has emerged recently that Sberbank had the right to a margin call on the 50.1% stake in Novorossiysk Commercial Sea Port pledged against a loan as the company's share price declined in August. Whilst the share price threshold was not revealed, and Sberbank held back from utilizing its right, the news will alarm many who recall the carnage that margin calls inflicted on equity prices in the 2008 meltdown. It's also worth noting that this margin call is controlled by a Russian state-owned bank, which is bound to be a lot more forgiving, while the 2008 margin calls were controlled by foreign banks.

Will all this spin out of control? The liquidity in the financial sector is the key to the whole game and the CBR has already shown it is willing to provide it when necessary. Moreover, the CBR has also shown (despite what Ignatiev says) that it is willing to let the ruble slide if things get very bad, which should cushion the blow on the economy. And finally, the one bright spot in this otherwise gloomy picture is that one of the reasons why liquidity has been so tight is the annual tax collection season - which sucks up huge amounts of cash - and this came to an end on Friday, September 30.