Bloomberg warns of global financial instability as low oil price and sanctions back Putin into a corner

Russia's sovereign debt has been downgraded to "junk" status for the first time in a decade by ratings agency Standard & Poor as economists anticipate a "painful recession" for the country, which is suffering from the effects of the low oil price and international sanctions.

S&P said the downgrade was caused by Russia's reduced flexibility to cut interest rates and a weakening of its financial system.

The economy is battling currency depreciation, collapsing oil export revenues and Western sanctions over Ukraine. The rouble tumbled further on the news of the downgrade, dropping to 68.76Rb to the dollar.

It is possible that other ratings companies will follow S&P's lead and that Russian corporate bonds and banks may also face downgrades.

The lower the debt rating, the more expensive it becomes to borrow and some investors are ruled out from holding the debt at all.

The Russian economy contracted for the first time in five years in November, with economists "anticipating a painful recession in Russia this year", says the Financial Times. Russia is heavily dependent on oil exports, and with global oil prices having halved since June last year its economy has struggled to maintain momentum.

Last night, Russian finance minister Anton Siluanov said the downgrade showed "pessimism" and failed to take into account stronger aspects of the Russian economy. "There's no reason to dramatise the situation," he said.

But Mohamed El-Erian at Bloomberg warns that the downgrade will "worsen the country's economic and financial implosion" and is likely to lead to "further currency depreciation, capital flight, and could advance the timetable for import and capital controls".

The broader economic implications will depend on the reaction of Vladimir Putin, says El-Erian. There is hope that Putin will draw back from Ukraine and open a better dialogue with the West, but others fear he will continue his "regional adventures" to distract the Russian public from the imploding economy, prompting further sanctions from the West and then countersanctions from Moscow.

"The result would be deeper economic and financial turmoil in Russia, and a return to recession for Europe – both of which would contribute to a higher risk of global financial instability," says El-Erian.

The oil price steadied this morning at $48 per barrel after a volatile day of trading yesterday. Nevertheless, it remains close to the lowest it has been for six years.

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