Crime and punishment

Russian markets have paid a heavy price for Wall Street’s excesses – but also for what many increasingly see as the state’s heavy-handedness. The troubles may only just have begun

  • By Simon Pirani
  • 12 Oct 2008
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The tremors from Wall Street’s mid-September earthquake shook Russia’s financial markets harder than most. The US investment banking collapse tightened still further a liquidity squeeze already aggravated by western investors’ adverse reaction to Moscow’s war with Georgia and prime minister Vladimir Putin’s perceived anti-business antics.

Between May and September 22, nearly $800 billion was wiped off Russian stocks. Russia’s market was down 43% since the start of the year – outdone in Europe only by Ukraine, which was down 70%. The mid-September crisis hit already falling markets in Moscow, and the authorities moved swiftly to stabilize them. On Tuesday, September 16 Russian stock exchanges – the largest of which, the MTS, fell 17.75% on the day – were shut down. The next day president Dmitry Medvedev pledged to inject liquidity into the system.

By Friday, September 19, $130 billion of funding had been made available. On Sunday, September 21, the finance ministry announced the provision of a further $24.2 billion in three-month credit – not only for the big three state-owned banks but also to another 20 smaller institutions. Oil export duty was cut by 25% in a bid to increase the amount of ready cash in the corporate sector.

The crisis was Russia’s most serious since the 1998 crash that triggered a default on local debt and devaluation of the rouble. This time was different because of the “incredible growth of the volume of [banks’] debt by comparison to the level of their capital”, Boris Jordan, one of the founders of Renaissance Capital, the largest Russian investment bank, and president of a related insurance company, said in a newspaper interview on September 22.

The problem is “short money and long assets. And... liquidity on the market. These problems could very easily turn into macroeconomic ones,” Jordan told Kommersant newspaper. Twenty-four hours later, 49.9% of Renaissance Capital was snapped up by Mikhail Prokhorov, the metals billionaire who in April sold his 25% share of Norilsk Nickel after a bruising battle for control with his co-owner Vladimir Potanin. Renaissance insisted the $500 million deal with Prokhorov was a pre-emptive strike while asset prices were low – but it valued Renaissance at less than half the level sought last year.

State-controlled institutions were in talks to buy KIT Finance, a medium-sized bank that failed to meet obligations on September 17. Russian corporates – who have also had to deal with the effects of the rebounding oil price – were being stretched to meet margin calls.

Western banks, conscious of the commodity exporters’ underlying value, were anxious to help them. One of the biggest creditors, the aluminium producer Rusal, which in April took a $4.5 billion two-year bridge loan to finance the purchase of Prokhorov’s share of Norilsk Nickel – and had collateralized it with that company’s steeply-falling shares – was reported to have restructured the deal.

Capital outflow

On September 19, Standard & Poor’s revised Russia’s sovereign outlook to stable from positive – and underlined that this reflected not only “uncertainty regarding Russia’s economic policy response” to the liquidity crisis but also “rising downside risk to Russia’s terms of trade” as the world moves towards recession.

It also highlighted the outflow of foreign funds over the summer, which had already concerned commentators before the Wall Street meltdown. These were caused firstly by fears of renewed attacks on business by the hardline statists in government – reflected in Putin’s clash with Mechel, the steel producer – and the increase of political risk caused by the war in Georgia.

In the week up to August 15 – that is, the first week of fighting in South Ossetia – Russia’s foreign exchange reserves fell by $16.4 billion. The main cause was capital flight, triggered by the war, analysts believed, although depreciation of both the rouble and the euro against the dollar, in which the reserves are measured, also played a part.

The forex reserves dip to $581.1 billion on August 15 was the second-biggest fall since 1998, when the central bank began weekly reporting of its reserves position. The only greater fall was in the week to August 18, 2006, reflecting Russia’s repayment of the final $22.5 billion it owed the Paris Club of sovereign creditors.

Even at that stage analysts were warning that the capital outflow would cause a liquidity problem for Russian banks. Aleksandr Morozov, chief economist at HSBC Russia, told Emerging Markets that the central bank had been expecting the current account to move into deficit in 2010, but that now it will happen this year.

“The banking sector’s situation has deteriorated quite considerably, and I don’t think it will improve in the coming months,” he says. “Firstly, interest rates will rise, and there will be an impact on the credit portfolios. Secondly, the difficulties Russian banks have had borrowing on international markets will return... I don’t see markets responding to IPOs [initial public offerings] or Eurobonds [from Russian borrowers]. Some money may be available through the syndicated bond market.”

Second-tier Russian banks found it almost impossible to borrow internationally for several months after the credit crisis of August 1997, and the improvements in market conditions earlier this year have been wiped out again.

In early September, Russian corporates, which had abandoned hopes of raising either equity or debt in the capital markets, were crowding the syndicated loan market, where liquidity is tight – and interest rates are up about 1% since this time last year.

Chris Green, senior economist at VTB Europe, the capital markets arm of Russia’s second-largest bank, said in an interview that the rouble was pushed to its lowest level this year in mid August by “a rise in investor risk aversion and Russia’s political risk premium”. Not only will Russian corporates find borrowing pricier, but also foreign direct investment (FDI) will suffer, he believes. Firms will not pull out of Russia, but those thinking of moving in are putting investment decisions on hold, Green added. The Wall Street storm broke upon this already struggling market.

The bigger picture

The Georgia conflict and the subsequent political standoff between Russia and the West was not the first or only cause of the sell-off in Russian markets. Political risk concerns have been growing over the summer, driven in particular by three incidents.

First, the bitter battle for control of the TNK-BP oil company [see box] has heightened worries. Many observers believe that the campaign by the company’s Russian owners against executives seconded to it by BP is symptomatic of a darkening environment for big strategic investors.

The collapse of the share price of Mechel, the steel, iron ore and coal company, in response to remarks by Prime Minister Putin accusing its owners of price gouging and tax evasion, has also taken a toll. Mechel’s value sank from $15.2 billion to $10.5 billion in a day, and the Russian stock market as a whole lost nearly $60 billion in the following week. It recovered subsequently, as fears of a repeat of the Yukos debacle receded.

The government’s decision to put grain exports – mainly handled by commodity traders and agriculture holdings – in the hands of a state agency has raised concerns and led to a flurry of exaggerated claims that Russia was planning to add the “food weapon” to the “energy weapon” already allegedly in its armoury.

Ed Parker, head of emerging Europe sovereign ratings at Fitch Ratings, says the Russian private sector’s dependence on external borrowing means it is “not immune” from poor international investor sentiment. “Even before the war with Georgia, Fitch had expected private-sector net capital inflows to fall to around $40 billion this year, from a record $81 billion in 2007,” he says. The war, and the Mechel and TNK-BP incidents “have brought political and corporate governance risks back to the fore and added to the country’s risk premium and cost of capital.”

Green at VTB Europe points out: “Russia largely weathered the fallout from the markets crisis last year, but things changed in the last two or three months. There was a sharp decline on the equity market before the Georgia war. The weakness in the price of oil and other commodities, and the sense among investors that the Japanese and eurozone economies were softening, along with the US, all fed through. And there were fears of Yukos Mark 2 as a result of the incident with Mechel.”

Those studying the bigger picture have a greater fear: that the steam has gone out of the Russian government’s reform plans. Badly needed reshaping of government bureaucracy and the legal system – expected from, and promised by, Medvedev – will be pushed back, pessimists fear. The ex-security services faction in government (the siloviki or power people), who are economically conservative by nature, have the wind in their sails after Georgia, the argument runs.

The Georgia conflict will delay the reform agenda, Chris Weafer, chief strategist at Ural-Sib, believes. “Investors came in specifically because Putin appointed Medvedev, and thereby signalled a drive for more substantive and faster reform, to rebuild and diversify the economy. That is just not happening as expected.”

Matthew Partridge at Lombard Street Research, which is forecasting below-trend Russian output growth in the medium term, says that falling commodity prices had signalled an end to the Russian boom even before the Georgia conflict.

The Purchasing Managers Index, a longstanding indicator of the strength of Russia’s real sector, is the lowest it has been this decade, Partridge cautions. “Oil and gas still accounted for 64% of exports last year. This fundamental structural weakness is going to hit home in the next year or two. There is substantial empirical evidence that the manufacturing and service sectors will not be able to make up for any slack created by falls in commodity prices.”

And any hopes that Putin is a reformer have been scotched, he adds. “Corruption, bureaucracy and the undue influence of state-owned companies will produce a torrid next five years, even if commodity prices do not fall. But we believe they will.”

  • By Simon Pirani
  • 12 Oct 2008

All International Bonds

Rank Lead Manager Amount $bn No of issues Share %
  • Last updated
  • Today
1 JPMorgan 164.80 545 9.83%
2 BofA Securities 139.54 459 8.33%
3 Citi 128.00 437 7.64%
4 Goldman Sachs 99.84 283 5.96%
5 Barclays 92.11 342 5.50%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $bn No of issues Share %
  • Last updated
  • Today
1 Deutsche Bank 9.11 38 6.62%
2 UniCredit 7.52 36 5.46%
3 BofA Securities 7.39 29 5.37%
4 BNP Paribas 7.38 42 5.36%
5 Credit Agricole CIB 6.01 35 4.37%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $bn No of issues Share %
  • Last updated
  • Today
1 Credit Suisse 3.10 7 9.18%
2 JPMorgan 3.10 21 9.18%
3 Citi 2.87 19 8.51%
4 Morgan Stanley 2.81 15 8.33%
5 Goldman Sachs 2.43 15 7.19%