Russia's power play for Ukraine's Crimea region is putting to flight foreign stock and bond investors, who are rattled by the Kremlin's overruling of the country's economic interests in favor of its military ambitions.
Russia's half-trillion dollars in central bank reserves mean its creditworthiness is not in doubt, and political risk has always been part of the game while investing in Russia.
Yet the move on Crimea, which has earned Moscow global censure and the threat of Western sanctions, will deliver a blow to an already-faltering economy, with the U.S. Secretary of State threatening “very serious repercussions”.
And perhaps more crucially, it will further deepen investor mistrust of Russian institutions.
Gary Greenberg, head of emerging markets at Hermes Fund Managers, said a sell-off on Russian financial markets could spiral if uncertainty continues, especially in equities, where foreigners are estimated to hold 70 percent of the market.
“The market's assessment is that the Russian government is willing to sacrifice both the country's economy and its international standing in order to bolster its pretensions for a Eurasian union,” Greenberg said, referring to Moscow's desire for a customs union of ex-Soviet states.
“On the surface this looks like really bad news and it warns of the case for investing in Russia,” he said. “It also looks to me that the economy will worsen from here because of this, so some kind of sell-off is appropriate.”
Moscow stocks have endured the worst bloodbath so far, with a 12 percent plunge on Monday that has wiped almost $60 billion off the market's value.
The rouble has plunged to record lows, forcing the central bank to raise interest rates by 1.5 percentage points. Traders estimated it had sold $10 billion on foreign exchange markets.
Even Russian sovereign dollar bonds - the most heavily traded emerging debt instruments, according to industry body EMTA - have sold off, their average yield premium to U.S. Treasuries rising 2.6 percentage points on the day.
Losses will escalate if Western nations hit Moscow with economic sanctions. Kerry has named asset freezes, visa bans and trade isolation as possible measures.
Whatever the outcome of the crisis, Russia stands to lose the most, PIMCO fund manager Francesc Balcells said in a note.
Curbs on holding Russian financial assets for instance could make life hard for companies that rely on foreign money for debt and equity funding. Companies now face higher borrowing costs and delays on billions of dollars in loans as foreign banks become more wary of lending.
“Russian corporates are among the most active in international debt markets, and Russia has tried hard to open up its local currency debt market to foreign investors while making inroads in improving the investment climate,” Balcells said. “A confrontation with the West would erode many of these achievements, driving more foreign investors away.”
The moves are all the more damaging because of the timing.
First, Russia's economy is in trouble, with growth slowing to under 2 percent, inflation up and investment levels stagnant around 20 percent, well below necessary levels. The outlook for oil, accounting for half of budget revenues, is not optimistic.
Second, the past two years have seen investors overcome some of their Russia jitters and pile into rouble bonds, where they now own almost a quarter of the market. They had boosted holdings to 900 billion roubles ($25 billion) by end-2013, a nine-fold increase from early-2012, central bank data shows.
Despite emerging market ructions, they have held onto these positions, betting Russia's reserves will keep the rouble firm. Instead, the rouble is one of the worst performing emerging currencies this year, losing 10 percent against the dollar.
That unexpected currency weakness could fuel an exodus from foreigners who had not bargained on the losses but the exit may have started even before the latest developments.
JPMorgan's monthly investor survey showed funds had swung into an underweight on rouble and local bonds in February, while dollar debt positions were also cut sharply.
“My guess is that markets will look for more risk premium in Russia,” said Sam Finkelstein, a bond fund manager at Goldman Sachs Asset Management who is neutral on Russia.
It may be harder to convince equity investors to stay. Over $2 billion has fled Russian equity funds this year, Morgan Stanley estimates, after 2013 outflows of $4.2 billion.
Russian stocks trade around 4.7 times their estimated 2015 earnings, the cheapest across emerging markets, partly because of corporate governance fears and lack of faith in local institutions. In comparison, shares in another troubled emerging market Turkey, trade at more than 7 times earnings.
Some funds such as JPMorgan reckon shares are cheap enough to take a punt on, but others such as Greenberg are happy to wait, fearing an economic recession and even full-fledged war. Yet others may just prefer to cut and run.
The Kremlin will have to work hard to lure investors back, says Christopher Granville, a long-term Russia watcher and managing director of consultancy Trusted Sources.
He draws parallels with the Yukos Affair of 2003 when Putin seized Russia's biggest oil company and jailed its owner Mikhail Khodorkovsky on charges of embezzlement, events that sparked a mass exodus of foreign investors.
“At that time Putin decided he had an agenda he was going to pursue regardless of the cost to the economy and investment climate and there were certainly high costs,” Granville said.
“This time he's decided there is a paramount interest in Ukraine and he is going to take it on the chin. If there is some damage control, Russian assets may bounce back. Alternatively, Putin has stepped over a rubicon and in the latter case Russia will be uninvestable in the near future.”