Monday, 6 of April of 2020

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Russian nationalizations pick up steam amid economic crisis: for better for worse

Nickel and potash mining are the latest key industries targeted by the nationalization efforts of the Russian government. Moscow has recently nationalized some private holdings that have put extreme levels of concentrated wealth in the hands of the country’s new oligarchs.

In the immediate aftermath of the socialist Soviet Union’s overthrow in 1991, there was a frenzy of unbridled privatization of all the former Soviet republics’ tremendous natural wealth, especially in the Russian republic.

Under socialism, the huge oil, natural gas, mineral, forest and other natural resources had been owned and shared in common by the people. But in capitalist Russia, modern-day robber barons have amassed huge fortunes while poverty has risen to record levels.

Much of the motivation for state intervention is the collapsing economy that has severely affected Russian companies. More than $74 billion worth of foreign investments has left the country since August, and the Russian stock market has lost more than 60 percent of its value since May.

The international capitalist financial collapse and plummeting prices for oil and other raw materials exports have pushed Moscow to act more forcefully to recapture some of the wealth stolen by the oligarchs. The government and state cannot function without sufficient income and resources.

From 2003 to 2006, the government took action against Yukos Oil, Russia’s largest private oil company, and its principal billionaire owner, Mikhail Khodorkovsky, because of massive tax evasion and siphoning of profits. Rosneft, Russia’s state-owned oil company, took over the assets. Last month, the government intervened in the nickel industry. Russia is the world’s largest producer of this strategic metal.

The government’s possible future takeovers are an attempt to keep vital industries operating by reclaiming them from the obscenely wealthy billionaires who have stolen resources that were once used for the benefit of all. So far, Dmitri Rybolovlev, the mining oligarch who owns almost all of Russia’s potash industry, has not resisted steps by the Kremlin to sanction and perhaps reclaim the industry.

In an online forum accompanying the New York Times article of Nov. 11, many Russians supported the nationalization, recognizing that “Mineral resources are a national wealth, and as such should belong to the state,” and that “[o]ligarchy sprang up thanks to the ‘liberal’ reforms imposed on us by Washington.”

One participant observed: “The financial crisis is an excellent way to review the results of the criminal privatization. … I can only praise it. And these measures will be very popular among people.”

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Rouble devaluation pressures continue

Russia’s Central bank has once again widened Rouble trading band this week. It’s the fifth time in the past month that the bank has allowed the local currency to devaluate - but not the last, say experts. Some investment firms are expecting a one-time devaluation of about 20% in January, following the New Year holidays.

Russians have started buying jewelry and hoarding foreign currency as the Rouble continues to lose value, falling 16 % against the dollar since August.

The Central Bank continues to weaken its defense of the Rouble, while the government assures it won’t allow sharp devaluation. Prime Minister Putin is adamant there will be no sharp Rouble fluctuations.

“With low prices for oil and metals - our traditional export products - we may face a deficit in our trade balance. This in turn has an impact on our national currency. But we will do everything to prevent sharp Rouble fluctuations. We have all the necessary financial reserves.”

The average forecast for the Rouble - Dollar rate at the beginning of 2009 is around 30 Roubles per Dollar. But some experts see signs that a larger devaluation may be on the way.

Investment firm Troika Dialog thinks the New Year holidays are a perfect time for a sharp drop of up to 20 percent in the Rouble’s value as demand for the currency rises.Chris Weafer of Uralsib agrees but says the government hasn’t taken a final decision so far.

“Despite Prime Minister Putin’s comments and statements that there would be no sharp moves in the Rouble, the fact is that the price of oil continues to go lower. Its increasing the cost of defending the Rouble, ie the reserves are going down at quite a big pace, and so the pressure is building. Despite the Prime Minister’s assurances they maybe in a situation where they’ll have no choice but to allow the Rouble to devalue by a higher level.”

Meanwhile Russian companies that borrowed massively in U.S. Dollars last year, have already started to lose money due to exchange rate movements. X5 retail group posted third quarter losses of $15 million, while Russian mobile operators, MTS and Vimpelcon lost $200 and $300 million dollars respectively - much of that blamed on exchange rate costs.

Experts say only state-owned firms are relatively safe now. The government has postponed sharp devaluation to allow them to convert their dollar debts into Roubles. Now it seems that there is not much holding the government back from letting the Rouble fall.

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The Real Estate Crunch Comes to Russia

By Jason Bush

The global economic crisis has hit Russia with full force, and property prices, especially in Moscow, are tumbling.

Shares of Russian companies have lost nearly three-quarters of their value in six months. The price of government bonds is down by almost a quarter. The ruble is sliding, losing 20% of its value against the U.S. dollar since August. The price of oil, Russia’s chief export, has fallen by 70% since the summer. But for a long time, there was one asset in Russia—real estate—that somehow seemed capable of defying gravity.

Even as property market bubbles burst all over the world, the value of Russian real estate just seemed to go up and up. According to Moscow real estate agency IRN, residential property prices in Moscow did not peak until mid-October, rising by some 50% from a year earlier. With apartments in central Moscow selling for $6,000 per square meter ($557 a square foot), the city regularly tops lists of the world’s most expensive cities. Elsewhere in Russia, too, property values have climbed dramatically over recent years.

It couldn’t last, and it hasn’t. Now that the global economic crisis has hit Russia with full force, real estate prices are finally tumbling. And if recent trends are any guide, the mother of all crashes may be in the offing. “The property market in Russia is on the brink of collapse,” says Vasily Koltashov, head of economic research at the Institute for Globalization & Social Movements, a Moscow think tank. “Property prices are very severely inflated, and demand is obviously slumping.”

Down 10% in Two Months
According to the widely cited IRN Index, the value of residential property in Moscow fell by 2% in the first week of December alone. That compares with a decline of 2.3% for the whole of November, and just 0.9% in October. Oleg Repchenko, IRN’s head of research, says that real estate prices in Russia have fallen on average by around 10% in the last two months. He estimates they’ll fall by a further 30% before next summer.

Others go further. Peter Aven, president of Alfa Bank, one of Russia’s leading commercial banks, has predicted that Moscow property values will fall “several times over.” In an October conference presentation, Aven pointed out that the value of Moscow property prices is some five times the European average. When it comes to choice property in the center of Moscow, the cost for a 100 square meter apartment is 155 times the income of the typical Russian. That compares with a multiple of just 5.9 in Germany.

Little wonder that Moscow property prices are now sinking rapidly. Indeed, some analysts say that the real market situation is way worse than the headline figures suggest. According to Inkom-Nedvizhimost, a Moscow real estate consultancy, the city’s major development companies sold an average of five new apartments in the city in November. That compares with around 40 to 50 apartments per month in the summer, and 90 to 100 in the first half of the year. The collapse in demand means that many developers are already offering deep discounts on new apartments, typically ranging between 25% and 40%.

Nor is it just residential property, the most overheated segment of the Russian market, that is now crashing. Commercial property also has taken a dramatic hit. Irina Florova, an analyst at real estate consultancy CB Richard Ellis (CBG) in Moscow, says that average office rents have fallen by 20% since October and are expected to decline by 25% more by early next year. The take-up of new office space has fallen by 50% since a year ago, while the volume of vacant office space has doubled. “Now it’s a tenant’s market,” says Florova. “Landlords were used to increasing prices, and now they are faced with a completely different situation. For them it was a bad surprise, which happened in the space of two or three weeks.”

No Mortgage Overhang
The sudden slump is bad news not just for landlords, but also for the wider Russian economy. True, Russia can take some comfort from the fact that the mortgage market, a major component of the economic crisis in the West, is still in its infancy. The value of outstanding mortgage loans represents just 3% of Russia’s gross domestic product, compared with shares of between 40% and 60% more typical in the West.

Nevertheless, mortgage lending has grown rapidly over recent years, doubling each year between 2002 and 2007. A collapse in apartment prices will spell misery for the most economically active part of the Russian population, young professionals who have recently taken out loans. Even for the majority of Russians who don’t have mortgages, a dramatic fall in apartment prices is likely to have a major psychological impact, affecting their confidence and consumption.

For one thing, it will wipe out the largest share of many households’ wealth. Unlike Westerners, few Russians invest in shares, pension plans, or mutual funds. Only a third have bank accounts. In contrast, most Russian families own at least one apartment, with many also owning country dachas. And over recent years, they have seen the value of this property rise dramatically—leading many to assume that the property market was a one-way bet.

As recently as October, a poll by Russia’s National Financial Research Agency showed that 51% of Russians regarded real estate as the safest form of investment. The next most popular form of savings, an account at the state savings bank Sberbank (SBER.RTS), was trusted by just 23% of respondents. Only a tiny fraction of the population felt confident about other savings vehicles, such as mutual funds and pension plans.

Developers Facing Ruin
That’s why, with property values now heading the same way as the Russian stock market, Russians will be in for a huge shock. The dismay will be greatest for the growing number of Russians who have acquired real estate not just as a place to live, but as an investment. “The real estate market in Russia was driven by investments by private individuals,” says Natalia Orlova, chief economist at Alfa Bank, who estimates that around 20% to 25% of Russians’ annual savings were put into real estate.

Spare a thought, too, for Russia’s construction and development companies, many of which now face ruin. Over recent years they have collectively plowed tens of billions of dollars into new construction projects, typically financed with the help of short-term loans. But even before property prices began tumbling, the sector was in a crisis brought on by a complete halt in financing. In comments to the RIA-Novosti news agency in November, Vladimir Ponomarev, vice-president of the Association of Russian Builders, described the situation facing the industry as “practically a catastrophe.”

As a result of the financial crunch, investment in the construction sector has already ground to a virtual standstill, with knock-on effects for other sectors of the Russian economy. “Of course, changes on the real estate market can significantly affect the rate of investment in the economy,” says Evgeny Nadorshin, chief economist at Trust Bank in Moscow.

The real estate crunch also will affect the wider economy through its impact on the banking sector. When it comes to the banks’ balance sheets, the fledgling mortgage market represents just the tip of iceberg. Alfa Bank’s Orlova estimates that around 14% of corporate loans are to construction companies, while an additional 30% of loans use some form of real estate as collateral. That means that the volume of bad loans—already estimated at around 10% of banks’ portfolios—is now set to rise sharply.

The combination of all these factors means that the wider economic impact of slumping real estate prices should not be underestimated. Little wonder economic forecasts for Russia are growing gloomier by the day, with signs that economic growth has already ground to a halt. “This is not just about 2009, but also about 2010 and 2011,” says Orlova. “It’s quite possible that GDP growth will stay around zero for this period.”

Bush is BusinessWeek’s Moscow bureau chief .

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Ruble exchange rate manipulation as key to weathering the crisis

During the nationwide broadcast by Prime Minister Vladimir Putin, he said that Russia would avoid “sharp jumps” in the ruble as it fell to the lowest level against the dollar in almost three years.

The ruble, which the central bank manages against a euro-dollar basket, on Monday had weakened to as much as 0.6 percent to 28.0908 per dollar, the lowest since March 2006, as the U.S. currency rose against the euro. The value of the ruble has declined by 16 percent since Aug. 1.

“We will not allow sharp jumps in the economy and in the exchange rate of the national currency,” Putin said in televised comments in Moscow on Thursday. “We will carefully use our currency reserves and other government funds, and if we carry out a balanced, considered and responsible economic policy, this money will be enough for us.”

The reserves have fallen 24 percent since reaching a peak of $598.1 billion in August as the central bank sold foreign currencies to prop up the ruble, Bloomberg reported.

Putin, who remains Russia’s most influential leader, fears that costs for the country’s economy as economic growth slows and the ruble weakens would be enormous.

Additional threats to the economy are falling profits in the energy, chemicals and metals export sector and the withdrawal of investment capital from the country, which has totaled about $190 billion since the start of August, according to BNP Paribas.

Experts say the government is taking unprecedented measures in the fiscal policy to reverse these negative trends.

“In 2008, the Russian central bank increased the refinancing rates six times. The last two changes of the refinancing rates amounted to one percent and were conducted on Nov. 12 and Dec 1, correspondingly. At the moment, the interest rate in Russia is 13 percent, among the highest in the developing countries,” said Anton Kozirev, general manager of Fibo St. Petersburg.

He added that from a Forex (foreign exchange) point of view, increasing loan rates could lead to a fall in consumer demand for goods, causing traders to sell the national currency resulting in further downward pressure on the ruble.

There are additional factors adding to this pressure.

“Among the most important are: monetary policy and macroeconomic factors such as the unemployment rate, retail sales and the level of inflation. Commodity price fluctuations (especially oil and gold prices), and the current political situation also have a big influence on exchange rates,” said Irina Kormilitsyna, senior analyst at Rosfinconsulting finance and analysis center.

Many investors are trying to sell the cheap currency they possess amid decreasing growth of the economy and the rise of the U.S. currency against the euro and ruble.

At the height of the 1998 crisis when Russia defaulted on debts of $40 billion and devalued the ruble, the mass selling of rubles for dollars became endemic. It wiped out the life savings of millions of people overnight and pushed the government to the edge of bankruptcy.

“Most likely people still haven’t forgotten those times when there was a ‘dollarization of the economy.’ Neither in Europe nor in other regions do people rush to throw out the euro, the pound or the franc in favor of the dollar, while here it’s a common reaction when a crisis appears, and it can only aggravate it,” said Yegor Susin, head of the analysis department at Alpari (Russia).

The Russian economy has expanded by seven percent a year since 1999 and may grow only one to two percent in 2009, Gary Dugan, Merrill Lynch & Co.’s chief investment officer, told Bloomberg.

While the ruble declined against the dollar, it appreciated 0.4 percent to 35.3450 against the euro. Those movements left it little changed at 31.3212 against the basket that the central bank uses to control its fluctuations. Hence, some experts have differing opinions about the ongoing decline of the ruble while agreeing that the destabilization of the ruble is out of question.

“Almost all current media reports talk about the ruble’s decline, but at the moment it is more honest to say that the U.S. dollar is rising. The central bank uses not only the U.S. currency, but a basket of dollars and euros to control ruble fluctuations, creating conditions for stabilizing it with such measures as intervening on the domestic currency market,” Susin said. He added that measures such as the expansion of the exchange-rate limits of the currency basket would limit the possibilities for speculation on the Forex market.

According to analysts, a weaker ruble may benefit Russian oil producers as they sell crude on a dollar basis and pay most expenses in rubles. Rosneft, Russia’s biggest oil producer, is cutting finance costs by paying back ruble debt with a cheaper currency.

“As crude oil prices are declining, the government cannot hold the ruble rate against the dollar at the current level, because it could be a blow to the economy and its competitiveness and could lead to the exhaustion of currency reserves,” said Susin.

However, the government plans further tax cuts from Jan. 1 for oil companies to help reduce domestic gasoline prices. Russian companies that fail to get funds through the banking system may be able to turn to the government for “a large scale” capital injection, Putin said.

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Russia and the deteriorating global economic outlook

Central banks around the world are trying to reboot the global financial system but keep getting, “Error! Total system crash.” What happens now? Who will be the winners and losers? How long will it take for growth to return? What will happen to commodity prices? How is the nature of the banking system going to change with all these governments taking stakes in private banks? Are emerging markets going to lead the recovery or be the laggards?

The papers are full of commentary and analysis, and the international financial institutions (IFIs) are busy issuing research notes and forecasts, but the depth of the confusion is clear from the fact the numbers keep changing on a weekly basis. In mid-November, the International Monetary Fund was confidently predicting Russian growth would be 3.3% in 2009, but only eight weeks earlier it was confidently predicting it would be 6.5%. No one has a clear idea of what is happening at the moment and that in itself is making the current crisis all the worse.

Unlike the crises that swept emerging markets in 1997 and 1998, this crisis is not a banking crisis per se, but a crisis of “questions” concerning the future of the global financial system to which no one can seemingly answer with any confidence. Although the meltdown began in the US where the crisis has developed into a full-blown banking crisis, in emerging markets a systemic collapse of the financial sector has largely been avoided.

Almost all the countries of Eastern Europe and Central Asia (with the notable exception of Ukraine) have prudently used the boom years to build up huge reserves that they have used to contain the damage. While the last two months have been extremely expensive - Russia alone spent $150bn of the $600bn it had in reserves in August – so far only half a dozen mid-sized banks have collapsed in Russia and Kazakhstan, whereas a dozen in Ukraine have gone to the wall. But importantly, all of these banks have been bailed out or taken over. Even in Ukraine, the financial sector is still standing, has money and is ready to work.

However, all business is on hold until some of the questions can be answered with any confidence. The pause in commerce is causing a massive amount of damage and the longer it goes on, the longer it will take for the recovery to start. However, none of the countries in the region are fundamentally “broken” in the same way the bankruptcies and defaults at the end of the 1990s smashed the fragile system that was emerging from the chaos of transformation.

The make-up of the global economy has been radically altered. Equity markets in even supposedly “healthy” countries have collapsed in a crisis of confidence. Nominally, they should not have been affected by the US’ problem, as few banks in emerging markets had any exposure at all to the “toxic” US sub-prime assets. But it has been the speed of the change rather than the massive destruction of wealth that has wreaked the most damage on emerging markets. In the fast-growing economies of New Europe, companies were borrowing heavily to finance rapid growth in the race to grab market share. The problem was not that they had, on aggregate, borrowed too much – in Russia the state has no debt and total corporate debt is about 30% of GDP equivalent – but the slowdown came so fast that companies had no chance to restructure their debts to cope with the changes. Russian companies had used their shares to back loans with margin calls that kick in when the shares fall 60-70% - a seeming impossibility when the deals were signed. But they were left gasping on the pier when share prices tanked this amount in only a few weeks.

How much has the crisis cost?

The first question to ask is how much this crisis has cost. New Europe’s countries were growing fast by tapping global capital markets for cheap and long-term money, which has all but disappeared now.

Russia has been amongst the worst hit and the government was spending about $3bn a day in September and October to prevent a wholesale collapse of the banking system. The government has since said it will spend another $200bn to replace the borrowing that companies had been assuming they could raise from banks next year.

In all, the World Bank estimates that $1 trillion worth of Russian wealth has been destroyed between the stock market peak in May and the start of November, equivalent to 87% of GDP in 2007. Of this amount, state-owned oil and gas companies make up $700bn and Russia’s leading businessmen lost another $300bn. This will take its toll on the entire region, as over the last five years or so Russia, Kazakhstan and Ukraine have emerged as the three investment “nodes” in the region: despite the ballooning levels of foreign direct investment into Russia, it has been a net export of capital for most of the last decade.

How deep will the recession be?

The amount of damage can be seen in the falling GDP estimates for this year and next. Before the crisis hit, Russia was expecting to end this year with 6.8% growth and next year with 6.2%. In light of the crisis, these numbers have fallen to 6% and 3% respectively, says the World Bank - or put another way, each week that passed during the worst of the sell-off between September 16 and the end of November saw 0.1% per day shaved off the growth forecast for next year.

“The world economy is entering a severe recession. Output is falling in the US, Japan, Germany, France and the UK, and prospects are for this contraction in activity to intensify over the next 12 months. For the major advanced economies in aggregate, Fitch Ratings is forecasting the steepest decline in GDP since the Second World War at –0.8%, in part reflecting the unusually synchronised downturn expected next year,” Fitch said in a report in November, adding that world GDP would grow by just 1% next year — the lowest rate since the early 1990s and compared with an average of 3.5% over the last five years.

Ukraine and Kazakhstan have also stumbled. Kazakhstan was the first CIS country to be hit by the crisis last September. Growth has already slowed from 5.7% in the first half of this year to 3.9% in the third quarter, and is on course to end the year at 3.1%. The IMF is now predicting that growth in 2009 will be a low, but still respectable, 5.3%. However, the bank said medium-term expectations remain positive and anticipates a return to form by the end of next year.

Ukraine is having a much harder time of it. From a growth rate of over 10% in the middle of this year, growth is expected to end this year at 4.5-4.8% and economic growth will fall to 2% next year, according to First Deputy Presidential Secretariat Chief Oleksandr Shlapak.

Further afield and the damage is probably even worse. The Baltics were already facing severe macroeconomic problems before the crisis hit, while Central Europe’s countries are much more closely tied to the economies of Western Europe where growth is expected to be about 0.5% next year. “[The effect of the global crisis on] countries in the region is very different,” says an Organisation for Economic Co-operation and Development (OECD) economist, who asked not to be named, as he isn’t authorised to speculate on the future of the region. “They are more or less vulnerable, with Russia being among the more protected ones. It is no secret to anybody that Ukraine is not only in a total political, but also a total economic, mess. I am not sure that the currency boards in the Baltics will hold, and if they didn’t, that may be really nasty (think Argentina). Also, if the first goes, they would probably all go - including Bulgaria’s currency board. All this probably doesn’t bode well for the CEE growth investment story. But that said, given current prices there’s probably a lot of value in many things if one takes a medium-term perspective and avoids the countries that are heading for a full fledged crash. Most things in Russia are a screaming buy at current valuations.”

How long will the recession last?

Everyone knows next year is going to be bad, but of greater interest is when the recovery will start? In 1998, it took only two years before Russia’s economy started to grow quickly again, but that was driven by a rebound in oil prices from $10 to $25. This time round, commodity prices will play a key role again. While economists all agree that long-term commodity prices will continue to climb, driven by the transformation of the emerging markets, the prospects for a rebound in the short term are dubious.

The growth forecasts of the banks and IFIs are all based on a variety of guesswork about the future of commodity prices, as well as domestic consumption and the availability of cost of credit - all of which are extremely uncertain at the moment. Indeed, IFIs have a very poor forecasting record in times of crisis: the World Bank said Russia was facing hyperinflation and years of low growth in the autumn of 1998 and completely miscalculated the beneficial effects of devaluation that fuelled a boom. The IFIs have a predilection towards pessimistic forecasts as a way to keep the pressure on reforming governments.

And there is some chance that the bounce back could come sooner than later. Fitch says the fast and coordinated action by central banks around the world and massive liquidity injections will, “head off the worst case scenario of widespread deflation.”

The consensus view is currently that growth will resume in 2010, but at rates well below those seen over the last five years. Troika Dialog’s Kingsmill Bond outlines the three dominant scenarios:

The IMF view: The IMF argument is that government action will be able to forestall the worst impacts of debt deflation, and that growth will therefore bounce back in the third quarter of 2009. The problem, however, is that the IMF seems to downgrade its forecasts each month, so it’s too soon to say if it will be right. If the market really believed this argument, then valuations would not be at current levels, or we would be on the verge of a huge rally as in 1974.

The Roubini view: Nouriel Roubini, the foremost economist to predict the crash, believes that growth won’t return until at least 2010, as the years of excess expansion on the back of a debt bubble will take time to unwind. This would put back a global market bottom to mid-2009.

The depression view: There remains a chance that global growth will follow the Japanese debt deflation route, meaning that we don’t see a return to global growth for several years. Thanks to policy action, this seems a tail risk, but can’t be ruled out.

What will happen to commodity prices?

Where commodity prices will settle will be a key determining factor for all three of the big economies in New Europe; Ukraine, Russia and Kazakhstan are all heavily dependant on commodity prices – either oil or steel prices or both - which have crashed in recent months.

The good news is that the IMF predicts commodity prices should settle early next year, which answers one of the most important questions facing investors, although prices will remain under pressure for most of 2009.

Macquarie, an Australian commodity and infrastructure financial group, said on November 17 that it had cut its 2009 forecasts for base metals, coal and iron ore by up to 60% to reflect the deteriorating global economic outlook. Those numbers include a cut to the 2009 contract prices of copper and zinc by 43% and 40%, respectively. For the coal sector, the thermal coal price forecast was lowered by 38%, while the bank slashed prices for the hard coking coal used in steel production by a huge 60%, citing drastic output reduction plans by global steel giants such as ArcelorMittal. Under its most pessimistic scenario, the Moscow-based investment bank Troika Dialog expects global consumption of steel to decline in 2009 by as much as 10%, bringing steel prices down by 25-45%.”Clearly we are in the midst of a global slowdown and have seen some major steelmakers warning about reducing output next year - we just don’t have any clarity on prices for next year at this point in time,” Marek Jelinek, the CFO of Central Europe’s largest coal mining group New World Resources, tells bne.

Oil prices will set the tone for the Russian and Kazakh economies, and at the time of writing had dipped below the $50-a-barrel mark, down from a high of just under $150 a barrel just a few months previously. The International Energy Agency (IEA) on November 13 slashed its 2009 oil price forecast to $80 from its previous forecast of $110, and the Russian government cut its forecast almost in half in November to $50 a barrel.

However, while $50 oil is bad news for the Russian government, it’s not actually a crisis unless the price stays at $50 for several years, thanks to the huge reserves in the stabilisation fund that were specifically built up to cover budget payments in case oil prices did slump. At the end of November, Russia’s Finance Minister Alexei Kudrin said there is enough money in the reserve fund to finance the budgetary shortfall at $50 for another five to 15 years, depending on the rates of growth.

One school of thought believes that the Organization of the Petroleum Exporting Countries will cut production to maintain the oil price at around $68 a barrel, as the Middle Eastern countries need this price to balance their own budgets. An expected fall of 2-5% in Russian oil production in 2009 will also support prices.

If oil does stay at $50, clearly Russia’s ruble and the Kazakh tenge will have to devalue further. The ruble has already lost 20% against the dollar in the last two months despite the Kremlin spending $57bn to support the currency. The threat of a sharp devaluation remains on the cards, and the fate of the currency remains pinned to what happens to the oil price.

What will happen to the financial sector?

The biggest changes in the global economy will be to the financial sector. Lower oil prices and a weaker currency will increase debt/GDP ratios and reduce the desire of foreigners to lend money and the capacity of Russian companies to pay it back. This will keep the domestic cost of money high. The foreign debt/GDP ratio would rise from around 30% to over 40%, which would take it up toward the higher end of the emerging market universe, say analysts at Troika.

In the short term, the willy-nilly lending that most banks had indulged in will come back to bite them: the ratio of non-performing loans was already rising by the start of November. “2009 will be a tough year for the sector, as banks will have to create a significant amount of new provisions for their loan books (which have demonstrated fast growth in the past),” say analysts at VTB Capital. “We doubt the sector will see any significant recovery in the next two or three quarters: a high degree of uncertainty over asset quality will remain while negative earnings surprises start to appear.”

The key to the health of the bank sector will depend on how fast credit quality deteriorates: estimates for the rising NPLs range from 3.5% to 16.3%.

Cut off from an emaciated global credit market, banks will have to look for new sources of capital, which will have a number of effects. First stop will be the state, which has stepped up to the plate not just in New Europe, but in the West as well. The Russian state is already heavily involved in its banking sector, while the Kazakh government bought blocking stakes in its leading banks in November to bolster their capitalization. State-directed lending is on the cards in both countries. “Following this crisis, it may well turn out the Belarusian bank model is the one that the rest of the world follows going forward,” Peter Donnelly, a former partner at Lehman Brothers and now a director of Banco Finantia that is a big investor in Eastern Europe, said at the first Belarus Investment conference in London in November.

Next, banks will turn to the surviving (but still reduced) pools of capital in Asia and the Middle East. By the end of November, the Kremlin had already hit the Chinese up for billions in loans for its biggest state-owned oil company Rosneft, and has been pushing its oligarchs and corporates to find money in places like Hong Kong and Singapore.

However, the biggest source of capital will be a switch to domestic resources. In Ukraine, leading consumer finance bank Delta Bank presciently saw the crisis coming and has replaced $450m of international wholesale financing by collecting domestic deposits. Russia is also well placed in this regard, as it enjoys the highest level of domestic saving in the world after China. The 30% of GDP equivalent is more than enough to cover its domestic investment needs and the Kremlin’s $1-trillion infrastructure investment plans.

At the same time, banks in the CIS will turn inward and borrow more from each other. As the bne Eurasia bank ranking shows (see PX), Russian banks no longer dominate in the region and between them the top 100 regional banks had assets of $891bn as of the end of the third quarter of this year. “But this will take time,” says Ian Hague, manager and founder of Firebird Capital, which has a large exposure to banks across the region. “They will have to introduce more transparency and get to the point where they trust each other more than they do now. It will take several years to develop this business, but it is the obvious way to go.”

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Russia’s Severstal seeks state funds for refinancing

Severstal, Russia’s largest steel maker, is in talks with state bank VEB to refinance 75 percent of a $325 million bond due in February, 2009, Chief Financial Officer Sergei Kuznetsov said.

Kuznetsov said on Tuesday the refinancing would provide ‘an extra cushion’, and stressed his company had sufficient liquidity to re-pay the amount.

State-owned VEB, or Vnesheconombank, has been entrusted by the Kremlin with distributing a $50 billion rescue package to help Russian companies refinance a total $120 billion of Western loans by the end of 2009.

Kuznetsov also said Severstal ’s worldwide production is 50 percent below normal capacity.

Last month Severstal slashed production by 25-30 percent at plants in Russia, Italy and the United States.

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Financial Crisis in Russia: the New Prospective

The global crisis is adding a new urgency to reforms towards political pluralism and competition in Russia.

When the financial crisis broke out in September, the Russian government quickly moved to reassure the business community that it had enough resources to prevent a meltdown. Announcing a multi-billion rescue package, Prime Minister Vladimir Putin remarked rather sarcastically: “We have been often asked in recent years: what do we need such large currency reserves for? To feel confident [in this crisis].”

Russia set up the so-called “stabilisation fund” in 2004 to sop up excessive oil-generated cash from the market and save it for a rainy day. As of August 1, the country had the world’s third biggest currency reserves — $595.9 billion. It is out of that pot that the government has promised to dish out more than $210 billion to support the banking sector and industry.

Many economists and industrialists agree that the injection of billions of dollars into the economy may ease the debt and liquidity crunch but they say the government strategy of building up such huge reserve funds instead of promoting growth was wrong and will aggravate the fallout of the current crisis on the economy. Deputy Prime Minister and Finance Minister Alexei Kudrin, the architect of the safety cushion policy, once compared himself to the biblical Joseph, who stocked up grain during seven fat years to feed his people over the next seven lean years.

Critics counter that while Joseph stored grain thereby encouraging production, Mr. Kudrin has been hoarding money taking it out of the economy and thereby slowing growth. As the government invested its currency reserves in the West in low-yield securities, Russian companies were forced to borrow from western lenders at a much higher rate. When the global crisis struck, Russian businesses owned close to $550 billion in foreign debts, which almost equalled the country’s hard currency reserves.

According to the critics, the government should have instead poured money into Russia’s still underdeveloped banking system to increase its capitalisation, which currently stands at just over 60 per cent of the country’s GDP, and enable banks to offer long-term credits at affordable interest. Had the oil windfall been used for investment to diversify away from over-dependence on oil and gas, it would have made the Russian economy more reliant on long-term Russian money, encouraged sustainable growth in non-oil industries and insulated the country from the U.S. contagion.

Penny wise and pound foolish

Mr. Kudrin’s penny wise and pound foolish policy meant Russia forfeiting a chance to build a robust manufacturing sector during the fat years and prepare the country better for the lean years ahead, independent economists say. Its 2009 budget will be in the red if oil prices dip below $70 a barrel as they did recently. The massive bailout effort now threatens to deplete the oil funds. This will jeopardise an ambitious programme of economic modernisation unveiled earlier this year when the government finally agreed to invest part of the oil money in infrastructure and high-tech sectors.

The crisis is bound to have a strong negative impact in the long term, the economists warn. Russian stocks have lost more than 70 per cent of their value since spring; the GDP growth plummeted from 7.6 per cent in January-August to 0.4 per cent in September. Net private capital outflows are expected to reach $20 billion this year, in stark contrast to the previous forecast of $40 billion in net inflow. Industries have started cutting jobs and people are spending less. The crisis threatens to wipe out the impressive economic gains of the past 10 years.

Russia’s leading economists and business lobby groups, including the Association of Russian Banks, the Russian Chamber of Trade and Industry and the Russian Union of Industrialists and Entrepreneurs, have been urging drastic changes in monetary strategies for years. But Mr. Kudrin successfully fended off all attacks. He is the longest serving Cabinet Minister who has not only survived three Prime Ministers — he was appointed Finance Minister in 2000 — but also exerted decisive influence on shaping the economic strategy in the last eight years.

Mr. Kudrin owes his fantastic survival, in the face of massive criticism, to one man, then President and now Prime Minister Putin, who firmly believes in the financial acumen of his long-time friend and ally. Mr. Kudrin’s story points to critical flaws in the system of “managed democracy” Mr. Putin set up during his eight-year presidency. He calls it “manual control.”

When Mr. Putin became President in 2000 after a decade of post-Soviet meltdown, he faced the Herculean task of pulling the country together, reasserting Central control and rebuilding the economy. The chaotic transition from the Soviet Communist system to a market democracy under his predecessor Boris Yeltsin had all but destroyed the institutional capacity of the state to govern. This convinced Mr. Putin that law and order must be restored before democracy was introduced step by step.

Mr. Putin brought the electronic media under the Kremlin’s control, cancelled elections of regional leaders, and marginalised opposition parties by tightening election laws and controlling financial contributions to parties from businesses. The Kremlin effectively removed political parties from the sphere of state governance. Centralisation of power helped Mr. Putin establish political stability and carry out painful reforms, and set the economy on the path of revival.

But as Russia moved from economic recovery to modernisation, the lack of political competition, absence of strong opposition parties and the presence of an obedient Parliament emerged as major hurdles to faster growth. The costs of “manual control” began to outweigh the gains. Corruption has grown to staggering proportions in recent years in the absence of effective parliamentary oversight and accountability of government officials.

Experts say Russians pay a 30-50 per cent “corruption tax” added to the price of all goods and services. President Dmitry Medvedev has just unveiled a new plan to combat corruption, but sceptics say the plan is likely to fail because its implementation has been entrusted to the law enforcement agencies, which are also deeply steeped in corruption. “These methods are useless when there are no external institutional checks and balances, such as a critical and independent media, independent courts, transparent government and fierce competition from political opponents,” said Georgy Satarov, a leading anti-corruption expert. Monopoly on power has stifled the contest of ideas and led to costly mistakes, analysts say. A sweeping reform of the Soviet-era social security net undertaken three years ago was necessary but was so badly prepared that it provoked large-scale protests, forcing the government to increase social expenditure, instead of trimming it. A pension reform launched in 2001 fell through and is being overhauled again.

Several years ago, the Moscow government decided to build a new ring road to cope with the growing traffic in the capital. Experts then warned that the road would not solve the problem of congested streets fanning out from the city centre to the outskirts in a star-like pattern, but the docile city legislature approved the project backed by Moscow’s powerful Mayor Yuri Luzhkov. The new road was laid at a cost of over $4 billion but it failed to unclog city streets. Notwithstanding this, the Moscow government is about to launch the construction of yet another ring road which, the experts predict, will be just as useless.

The Kremlin’s chief ideologist, Vladislav Surkov, compared Russia’s political system in which the main pro-government party, United Russia, dominates Parliament to a one-legged man and called for the establishment of another major party, “a second leg to which society can shift its weight when the first leg goes numb.”

Towards two-party system

Two years ago, the Kremlin started building a new two-party system with the establishment of a left-of-the-centre party, Fair Russia, to compete for power with the ruling right-of-the-centre United Russia. However, the effort to promote political competition suffered a setback when Mr. Putin threw his weight behind United Russia last year. This enhanced the monopolisation of power helping United Russia win a huge constitutional majority in the parliamentary elections in December 2007, while Fair Russia captured a mere 8 per cent of the vote, just enough to cross the 7-per cent threshold. In his first state-of-the-nation address this week, Mr. Medvedev called for liberalising political life, stating democracy “on orders from above” must give way to grass-roots democracy.

“I believe that the citizens of Russia today are far more ready for freedom in professional, social and political activity than they were at the start of the reforms,” Mr. Medvedev said proposing a raft of measures to encourage the “broad involvement of citizens, political parties and other civic institutions” in dealing with the challenges of “a new phase in the country’s development.”

The global crisis is indeed adding a new urgency to reforms towards political pluralism and competition in Russia, as the wasteful system of “managed democracy” becomes too costly to maintain when oil prices are falling.

A study commissioned by Mr. Medvedev’s think tank, the Institute of Contemporary Development, earlier this year showed that the Russian political and business elites think “managed democracy” no longer meets the challenges of modernisation and must be replaced with a full-fledged democratic system.

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Andrew Sommers on U.S.-Russian Business

Speaking to Business Today Mr. Andrew Sommers, President of the American Chamber of Commerce maintained that American companies continue to be very interested in Russia, but that the problems stemming from the global credit crisis are impacting on Russian operations.

AS: I’ve heard of no one who has written off the Russian market or feels that the Russian market is somehow a different animal. But the situation is different right now. Its true all around the world and there’s an amount of uncertainty, and when there’s uncertainty people tend to hesitate.
RT: Is there an indication that the U.S. companies operating in Russia are experiencing difficulties because of the effect the current crisis is having on the Russian market?
AS: Because of the difficulty of access to credit, not by these companies, but by their Russian distributors, their Russian retailers, the Russian companies who purchase equipment and resell them to the Russian consumer, those companies, and they are substantial companies, are having trouble getting credit. Either the interest rates are higher now, or they can’t get as much credit as they wanted. The result has been that a number of companies are selling less goods in volume to the distributors because the distributors can’t get enough credit to purchase the original amount that they would have bought.
RT: Many argue that the current crisis doesn’t have the far reaching consequences that many say it does. Do you agree with that?
AS: I tend to agree with it. I think that the analysis of the so called crisis in the States has over emphasized the role of banks because it was the investment banks – a certain type of bank – that is viewed as being he ones which kind of went too far. There has been an impact on credit though, but probably not as severe, if this study, I am sure this study is done professionally the impact on credit has been less. But, at the same time, the consumers in the States are getting much more conservative, and maybe that’s somewhat of a good thing, even though it slows growth down, because Americans don’t save.
RT: Do you expect the U.S. sanctions against the Russian state owned arms trader, Rosoboronexport, to hurt the two countries bilateral ties?
A.S.: The damper on the business relations. If you look at these regulations they are pointed only at U.S. Government agencies. It doesn’t forbid U.S. companies from dealing with Rosoboronexport. But, companies get nervous when they see this, so that they kind of hold off. So I think you will have a temporary decline in the business of several, what I would call strategic, American companies, with Rosoboronexport.

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Russia Can Escape the Financial Crisis in Real Economy

By: Former advisor to the Russian president, economist Andrei Illarionov

A Statement by the Liberal Charter alliance

The Liberal Charter alliance expresses its fundamental disagreement with the measures taken by Russian authorities in the financial crisis, and puts forth the principles of a fiscal policy that a government responsible to the citizens of Russia must take.

1. Today’s financial crisis in Russia has foreign and domestic causes. The most important external cause of this crisis is the world monetary system, which goes through cyclical phases of boom and bust. Such instability is created first of all by modern money, which governments can issue in any amount, combined with a wide range of government privileges and guarantees provided to commercial banks. Interest rates held at artificially low levels and government loan guarantees stimulate the growth of credit that is not backed by real savings, leading to less responsibility on the part of creditors and borrowers, and a collapse of confidence in financial assets.

The main culprits of the global financial crisis are the fiscal authorities in the U.S. and European countries, who have pursued a policy of so-called “cheap” money in recent years. The governments of other countries, including Russia, also carry their share of responsibility for spreading and worsening the crisis. Government encouragement of credit expansion has led to massive investments into overly risky, inefficient, and unsalable projects. The illusion of the accessibility of investment resources, created by governments, has led to a decline in the quality of issued loans and purchased securities. As result, many banks have been unable to meet their obligations before depositors.

2. The Russian authorities have contributed their share to the financial “bubble” in our country. Due to their privileged status, state-owned and partly state-owned banks and companies borrowed heavily on foreign and domestic markets. In doing so, short-term loans were used for long-term investments, and to finance expenditures growing out of control. The disappearance of cheap credit destroyed such financial “pyramids”. With a fall in equity prices, companies whose shares were put as collateral to private and partly state-owned companies to obtain credit were now under threat of handing ownership to those creditors, including foreign ones. The threat that companies would be punished for their irresponsible borrowing policies became an instrument of their pressure on authorities, and the basis for transferring their colossal accumulated debts to the federal budget.

3. Provoked by government intervention, the mistakes made by banks and businesses are at the present largely irreversible; serious problems can no longer be avoided. The economy must undergo a period to correct those mistakes.

4. Presently, the primary danger to the global and Russian economies are the so-called “anti-crisis programs” put on by governments, which are hidden behind demagogic statements that the “free market” is supposedly to blame for the current crisis. Government intervention, which hinders the culling of inefficient investment projects, blocks the review of mistaken decisions and puts off the bankruptcy of irresponsible businesses, only deepens and extends the financial crisis, turning an inevitable short-term economic decline into a long-term depression. In world history, it is precisely the interference with market mechanisms that has had such dire consequences, such as the US Great Depression from 1929-33, or the transformation of Great Britain into the “sick man of Europe” from 1961-79, or the Japanese stagnation from 1991-2004.

5. The Liberal Charter alliance expresses a fundamental disagreement with the actions already undertaken, as well as the stated intentions of the Russian authorities – the president, parliament, government, and the Bank of Russia. Their plans of uncontrolled intervention in the country’s economy are, among other things, a disregard for the rule of law and the existing legislation, the undoing of the separation of powers, and the dismantling of democratic institutions accountable to the people.

We believe that the proposed measures are wrong. [These include] the use of federal resources, administered by the Government and Bank of Russia, to finance irresponsible borrowers, to support banks and stock market speculators who risked their client’s money, as well as acquiring shares of those companies that the market has lost confidence in. These measures will squander the federal gold reserves, which guarantee the value and free convertibility of the Russian ruble. They will inevitably result in higher prices for the public, who will end up paying for benefits essentially doled out to businessmen and managers close with the authorities. The concentration of financial resources in the hands of bureaucrats and their “inner circle” is aimed at further monopolization of property and power in our country.

6. In this time of crisis, a government responsible before the Russian people must follow financial policies based upon the following principles:

-Maintaining the exchange rate of the ruble against the pre-determined dollar and euro currency basket. A guarantee of the sanctity of gold reserves in the Bank of Russia to back 100% of issued Russian rubles. Continuing a responsible monetary policy, dictated by the basic principles of respect for property rights and meeting ones obligations, even if these obligations were not explicitly formalized.

-Preserving a deficit-free budget, where expenditures do not exceed revenues, [and committing to] prohibit the growth of public debt. At a time of unavoidable economic stagnation, public expenditures must be lowered proportionately with the fall in government revenues.

-Establishing transparent mechanisms for distributing assistance from the state budget and special endowments. Excluding the possibility that these funds will head to privileged banks and companies. The main way to use the budget surplus, which has accumulated in special endowments, must either be the return of previously collected taxes, or a reduction in future taxes.

- Directing funds from the budget and special endowments to commercial banks only in exceptional cases, and only through the mechanism of returning money to depositors (the so-called “monetization of bank liabilities”). The banks subjected to this measure must undergo bankruptcy proceedings. This provides an effective countermeasure to owners stripping assets, and allows for an open and transparent sale of all assets, with revenues going to the state budget. The expansion of a government role in the banking system’s equity is impermissible.

-It is unacceptable to use budgetary funds to rescue bankrupt companies. It is unacceptable to increase the government’s direct or indirect control over the real sector of the economy. Irresponsible business owners and managers should be punished by having the encumbered shares of bankrupt Russian companies transferred to their creditors– independent from their citizenship or country of registration. Bankruptcy sales must be carried out in open and transparent auctions.

-Reducing government intervention in the financial sector. The reorganization of the financial regulatory system on the principles of competition and free enterprise.

-Reform of the monetary regulatory system. The Bank of Russia should maintain its aim of supporting the value of the ruble, even as it ceases the additional powers granted it under the “anti-crisis measures.” Regulation of banks should be transferred to a separate government body. [This would] eliminate the privileges given to commercial banks, which arise from the Bank of Russia’s joint function of “printing” rubles and regulating the banking system.

7. The Liberal Charter alliance marks that the result of the so-called “anti-crisis programs” proposed by authorities will be the deepening and widening of the financial crisis, and the transition of a short-term recession into an extended depression. Preserving mistakes made during an economic boom, continuing the policy of promoting risky loans, and the misuse of public resources for false purposes will inevitably lead to grave financial, economic and social consequences. Russia does not need to repeat mistakes made more than once by authorities in the US, the European Union and other countries.

The only guarantee of the Russian economy’s competitive edge and long-term success, and that of the whole Russian society– is the freedom of entrepreneurship by Russian citizens. [Further, the] government must respect property rights and carry out responsible, consistent and ethical economic policies.

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