A Healthier Russia Is In The US’s Best Interest

America could be helped if reforms there follow the current crisis

It is a tragedy that a country as rich in resources as Russia begins 2015 with major economic hurdles. Not only are oil prices falling, but the country is plagued by corrupt politics, stultifying state control and lack of property rights, which have resulted in a bankrupt economy, substantial debt and a currency that is losing value by the day.

Contrast Russia with neighboring countries such as Latvia, Estonia and Lithuania, which have put in place sensible economic policies and low tax systems, and are now reaping the rewards. That could be happening to Russia today.

Instead, Russia's economy is projected to shrink by as much as 4.7%, the financial system is under pressure, and oil prices continue to fall. Those factors mean Russia may lose its investment-grade rating for the first time since 2005.

With Russia's belligerence toward Ukraine and Georgia, this economic fiasco might be good news for the United States. After all, under current conditions, Russia will have fewer resources with which to invade its neighbors. However, it would be better for the U.S. if Russia tried to reform its economy by selling its state-owned assets, moving to a market-based system and encouraging entrepreneurship. In that way, Russia and the U.S. could be close trading partners with joint goals.

But this is not to be. As a well-known Russian joke goes, there are two ways out of the economic crisis, the natural and the miraculous. In the natural way, the archangel Michael comes down to Earth and saves the Russian economy. The miracle is that the Russians themselves save their economy.

Last week Standard & Poor's said there is at least a 50% chance that it will lower Russia's debt to junk status within the next three months. It expects to complete its evaluation of the Russian economy by mid-January. Russian debt is now rated by S&P as BBB-, and the country was placed on a negative credit watch due to concern over the Russian banking system's exposure to the economic crisis.

Russia's weak economy has made it easier for sanctions over Russia's belligerence in Ukraine, combined with the falling price of oil, to cripple the economy to the verge of recession. These sanctions have excluded Russian corporate borrowers from international debt markets, leaving the Kremlin to take steps to aid struggling companies, especially financial institutions.

The Russian Deposit Insurance Agency was recently given the authority to keep the financial system stable by buying stakes in banks before they face bankruptcy. Last week the Russian central bank bailed out the National Bank Trust, one of the country's largest banks.

The ruble slid about 40% against the dollar in 2014, ending the year at nearly 60 rubles to the dollar. It has lost almost half of its value since March. According to Bloomberg, this is the second-worst performance among 175 currencies, after Ukraine's hryvnia.

On Dec. 16, the Russian central bank raised its interest rate from 10.5% to 17% in an attempt to support its currency. While this has the potential to encourage investors to continue holding rubles, this rapid rate increase carries the risk of further damage to the fragile Russian economy. Higher inflation coupled with low economic growth brings to mind the devastating “stagflation” faced by the U.S. and other countries in the 1970s. Stagflation will cause real incomes of Russians to fall, possibly lowering President Vladimir Putin's approval ratings, which now somehow hover around 85%.

Russian foreign exchange reserves are also falling. As the Kremlin runs low on foreign reserves to utilize in propping up the ruble, five of the country's most prominent state-controlled exporters were told to reduce their foreign currency assets to October levels, and to hold them at those levels until March. The five companies include the energy companies Gazprom, Rosneft and Zarubezhneft, as well as diamond conglomerates Alrosa and PO Kristall.

If Russia's situation continues to deteriorate, it is unlikely that aid will be coming from the International Monetary Fund. Russia has consistently ignored the foreign-policy demands of Western countries and has lost support from many countries that figure prominently in the IMF's decision-making framework. Russia has remained defiant in the face of sanctions and has not shown signs of withdrawing from Ukraine.

Russia's economic crisis does have the potential to strengthen its economic ties with China. Wang Yi, China's foreign minister, has promised to support Russia through its economic struggles. Wang said: “Russia has the capability and the wisdom to overcome the existing hardship in the economic situation. … If the Russian side needs it, we will provide necessary assistance within our capacity.” One way China could do this is by boosting trade with Russia in yuan.

It would be to America's advantage if Russia could take basic steps to repair its economy and its strained relationship with the West. Despite the falling price of oil, this is not impossible. Instead, Russia's Putin prefers to maintain his defiant stance, even as his economy hovers on the brink of collapse. Resolving Russia's problems requires much more than manipulated interest rates, limited foreign reserves and Chinese financial support: It needs the will to change the system.

This piece originally appeared in WSJ's Marketwatch

This piece originally appeared in WSJ's MarketWatch