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Kremlin Oligarchs to Take Control in Norilsk Nickel

Russia auctioned its biggest mining company a decade ago when it was strapped for cash. It’s using the global credit crisis to regain control of OAO GMK Norilsk Nickel as economic turmoil forces U.S. and European governments to bail out their own corporations.

Without buying a single share, the government is to appoint its own man as Norilsk chairman this month, replacing the company’s largest owner, Vladimir Potanin. The move comes as the economic crisis saps oligarch funds and Kremlin bailouts help Prime Minister Vladimir Putin secure control of industries where Russia can compete globally, such as energy and arms. Norilsk is the Kremlin’s candidate in mining.

Potanin, 47, is handing over the keys after ending a feud with Oleg Deripaska, the billionaire owner of United Co. Rusal, that turned the world’s biggest nickel producer into a battleground of ambitions. The dispute “irritated” government officials, Potanin said Nov. 26 at a briefing with Deripaska, 40, in Moscow to mark the truce.

“The Kremlin wants to see global champions in the industries most important to the country and the feud lost track of that goal,” said Chris Weafer, chief strategist with Moscow- based investment bank UralSib Financial Corp.

Presiding over the only Russian metals maker among the top 200 companies in the MSCI Emerging Markets Index gives the Kremlin a close handle on the supplier of half the world’s palladium and a fifth of its nickel, key to the global auto and steel industries. It has also alienated investors.

Shares Fall

“From an investor standpoint, it’s basically a big mess,” said Kevin Dougherty, fund manager with Pharos Financial Group in Moscow, which doesn’t own Norilsk. A weak metals price outlook and the battle with Deripaska, coupled with “deteriorating corporate governance make investing in Norilsk like stepping into a casino.”

Norilsk shares are down 40 percent since Nov. 5, when the government approved a $4.5 billion loan to help refinance Rusal, Norilsk’s second-largest shareholder. The Micex Index, a measure of 30 large Russian companies, has dropped 17 percent.

The state took a 25 percent stake in Norilsk as collateral for that loan. When Norilsk shareholders meet Dec. 26 to elect a new board, the remaining intrigue is how many of the 13 seats the Kremlin will win. The bailout also means two government officials will join Norilsk as managers.

Putin, in a Dec. 4 address, said Russia’s role in Norilsk is about providing stability and isn’t much different from assistance other countries have provided to their troubled financial institutions. Without state aid Norilsk may be unable to support its production, company officials have said.

Yeltsin Era

“There’s no direct policy to de-privatize” Norilsk, said Dmitry Peskov, a spokesman for Putin, who opposed the state’s auctions of the country’s major industries and spent the last eight years reasserting government control. “How this situation will play out, only time will tell,” Peskov said.

Russia is “willing” to buy stakes in companies where owners request aid with the aim of later selling out on fair terms, Putin said on Dec. 4. “This is not a way to nationalize the economy,” he said.

The state sold Norilsk to Potanin’s bank in 1997. Putin’s predecessor as Russian president, Boris Yeltsin, auctioned stakes in the country’s biggest enterprises to help his cash-strapped administration. As then deputy prime minister, Potanin became a Norilsk board director in 1996 and helped organize the auctions.

Reasserting state control at Norilsk revives the potential for it to become a platform for mergers in Russia’s metals industry, with the aim of creating a rival to Melbourne-based BHP Billiton Ltd., the world’s largest miner. It would also assert state influence in an industry that lags behind only oil and gas in terms of export volumes and budget contributions.

Cuba, Venezuela

A state-run Norilsk may help Russia’s government expand ties with anti-U.S. states such as Venezuela and Cuba, which has one of the biggest nickel resources. Norilsk is ready to develop a nickel mine in Cuba should Russia lend the Caribbean island $1.5 billion for the project, Chief Executive Officer Vladimir Strzhalkovsky, a former officer in the KGB Soviet-era security agency, said Nov. 20.

Norilsk could operate the Cuban mine without taking an equity stake in the project, the CEO said. The company currently only manages mines it controls.

Stock Downgraded

“If Norilsk has aspirations of being in the same league as the likes of BHP Billiton, it should start behaving as such and show the necessary respect to capital markets,” UralSib metals analyst Michael Kavanagh said in a report today. UralSib cut the company’s 12-month price target to $58 from $285 per share on a lack of strategy, poor disclosure and weak metal demand. Norilsk traded in Moscow today at $64.

Uralkali, a potash miner controlled by billionaire Dmitry Rybolovlev, might also be folded into a state mining giant based on Norilsk after Putin’s deputy, Igor Sechin, reopened a probe into a 2006 flood at the company’s mine. Potanin said Aug. 8 that the arrival of Strzhalkovsky at Norilsk was likely to spur mergers with iron ore, potash, coal and copper assets.

Deripaska had opposed Norilsk combinations with companies other than Rusal. After Rusal acquired its Norilsk stake in April, the nickel company’s merger talks with billionaire Alisher Usmanov’s iron ore producer OAO Metalloinvest stopped.

‘Invisible Hand’

At the “truce” briefing with Potanin, Deripaska only shook his head when asked if he would block a Norilsk merger with Metalloinvest.

“The invisible hand of the state could have seriously contributed to such an idyllic agreement,” Mikhail Stiskin, an analyst at Troika Dialog, Russia’s oldest investment bank, said of the settlement between the billionaires. “The state is playing first violin” and will support Norilsk mergers, he said.

Russia’s upper hand, with $437 billion in international reserves built up during Putin’s presidency from high commodity prices, is reinforced by the global market turmoil. Deripaska, the country’s richest man according to Forbes magazine, ceded stakes in Canadian auto-parts maker Magna International Inc. and German builder Hochtief AG to banks in October after shares used as collateral to finance the acquisitions lost value.

When Rusal’s 25 percent stake in Norilsk, pledged against a $4.5 billion loan from foreign lenders, faced the same risk in October, Russia stepped in. Norilsk CEO Strzhalkovsky, 54, formerly the country’s tourism chief with no experience in the metals industry, said that he asked the state to buy Rusal’s shares. The Kremlin chose to refinance Rusal’s loan for one year and took Norilsk shares as collateral.

Loan Conditions

Among the loan conditions, the state has the right to at least one Norilsk board seat. One of two government nominees is Sergei Chemezov, who like Putin and Strzhalkovsky is a former KGB officer. Chemezov is now CEO of state holding company Russian Technologies Corp., which controls OAO VSMPO-Avisma, the world’s biggest producer of titanium, and has 49 percent of Erdenet, Mongolia’s largest copper miner.

Chemezov said Dec. 12 that he has already asked Potanin and Deripaska to consider a combination with the copper assets of Russian Technologies, which are jointly held with Metalloinvest. Meanwhile, Usmanov of Metalloinvest has acquired about 5 percent of Norilsk as a prelude to consolidation.

“Norilsk Nickel is creeping toward becoming a state-run entity, in practice if not formally so,” Stratfor, a U.S.-based risk advisory group, wrote clients last month.

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Market downgrades Evraz on cashflow concerns

Evraz shares fall 6.4 percent in London as it announces shareholders can receive part of div in new shares.

Shares in Evraz Group fell on Wednesday after the company said stockholders could receive part of their interim dividend in discounted shares to enable the Russian steel maker to preserve cash.

At 1453 GMT the London-listed GDRs were off 6.4 percent at $10.2 having earlier fallen as much as 18.9 percent as analysts voiced concerns about Evraz’s cash flow.

The new shares will be issued at $22.50 each, or $7.50 per GDR, about 31.2 percent below the closing prices on Dec. 16.

Michael Kavanagh, a metals and mining analyst with Uralsib, calculated that if all investors accept the shares the total number of GDRs could increase by 10 percent.

“On one hand, the part shares offer, saving $276 million in cash could imply that cash is in short supply and raise some concerns,” Kavanagh said.

“On the other, the fact that the company is paying a $750 million cash dividend in this environment is a very positive sign regarding the health of the balance sheet and cash position of the company.”

The original first half dividend, announced on Aug. 26, proposed a cash payout of $8.25 per share or $2.25 per GDR.

Under the new proposal, shareholders will still receive $6.00 per share or $2.00 per GDR in cash by Dec. 18 with the remaining $2.25 per share or $0.75 per global depository receipt (GDR) available in the new shares.

“The board believes that the proposal offers shareholders an attractive partial scrip dividend alternative,” Evraz said in a statement on Wednesday.

“Any resultant cash saving will further strengthen the company’s financial position in the current challenging economic and market environment.”

All shareholders of record as of Sept. 18 are eligible for the dividend. They will be asked to vote on the proposal at a Jan. 30, 2009 extraordinary general meeting (EGM).

The company did not say when shareholders will receive the remaining portion of the payout.

Evraz built up considerable debt in recent years through acquisitions in Africa, Europe and North America. Its $2.3 billion purchase of Canadian steel pipe maker IPSCO earlier this year has saddled the company with a sizeable short term debt load.

The group in November obtained $1.8 billion in credits from state-owned VEB to refinance debt.

VEB, or Vnesheconombank, has been entrusted by the Kremlin to distribute a $50 billion rescue package to help Russian companies refinance a total of $120 billion in Western loans by the end of 2009. (Reporting by Alfred Kueppers; Editing by David Cowell and Elaine Hardcastle)

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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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Russia Pharmaceuticals and Healthcare in Q4 2008

Despite a bruising a few months for the Russian economy as a whole, BMI broadly maintains an optimistic growth outlook for the Russian pharmaceutical market for the period 2008 to 2012. We have lowered our US dollar growth rate estimates based on updated exchange-rate forecasts. With the precipitous fall in oil and gas prices in recent months and foreign-investment outflows, both the ruble short- and longer-term position has weakened. Nonetheless, we see strong average annual US dollar growth of 10.6% for the period and 10.3% for the ruble. Market growth is forecast at 22.0% for 2008, in line with 2007 levels, with the market cooling from 2009.

We expect 2012 market value to reach US$23.6bn. It would be going too far to describe the pharmaceutical industry as immune to the current instability, in particular the lack of access to capital for expansion and worries about a weakening currency are substantial worries. Anecdotal evidence suggests that the damage to date from the broader crisis has been limited. Domestic producer Valenta (formerly Otechestvennye Lekarstva) has reportedly had problems refinancing existing debt. It has halted investment projects and has moved to sell its Krasfarma production subsidiary in Krasnodar Region.

Leading wholesaler Protek has announced and then shelved its latest initial public offering (IPO) plans in the face of tumbling stock markets. Unlike the banking or retail sectors, however, there have been no high-profile company defaults . yet. Arguably, the local sector is mired in a longer-term crisis.

Local research group Pharmexpert estimates that around 50% of the country.s 525 registered producers are unprofitable.

In July, Prime Minister Vladimir Putin described the sector as only capable of producing “last century’s drugs”. Hence the industry is closely watching the development of the Conception for the Development of the Russian Pharmaceutical Industry to 2020, a draft of which was submitted to the government in August 2008. Unsurprisingly the plan calls for the development of both modern generics and innovative drugs by the domestic industry in order to lead five-fold growth in the sector as whole by 2020. Like Brazil, Russia sees import substitution of vaccines “a traditional strength of the Soviet-era industry” and insulin as a vital first step. With the exception of a long-rumoured plant project by Nycomed, the bulk of new investments in recent months have come from domestic players, including new players intent on raising capital from domestic and foreign markets.

One example is Gerofarm, which is building a contract-research focused factory in Moscow Region using both Danish and UK expertise for a EUR15mn. Meanwhile, some attractive production assets are reportedly in play. A powerful shareholder in local market leader Pharmstandart is reportedly pursuing Verofarm, controlled by Pharmacy Chain 36.6 and a modern player in oncology generics.

The belated collapse of a 2007 deal by Gedeon Richter for Polpharma and its Russian subsidiary Akrikhin could see bids for the latter firm. The prices paid will be indicative, a study by PriceWaterhouseCoopers suggests that asset prices for mid-sized Russian companies may be off by between 10 and 20% from their peak.

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Russian Mining Sector in Q4 2008

The global credit crunch is having a significant impact on the Russian mining industry, particularly among the oligarchs who control many Russian miners. In late October 2008, Russia’s richest man, Oleg Deripaska, was the recipient of a US$4.5bn loan from state-owned Vnesheconombank, which enabled his company United Company RUSAL (UC RUSAL) to maintain its 25% stake in Norilsk Nickel. The money will be used to repay the syndicated loan from foreign lenders used by Deripaska to buy the Norilsk stake in April 2008, it was reported on Reuters.

The motivation behind the loan was arguably political, with Russia keen to maintain control of strategic mining assets. Deripaska has already lost control of other non-mining assets around the world as a result of the credit crunch and Russia would not have wanted to see the 25% stake in Norilsk fall into Western hands. Russia has already stated that is ready to lend up to US$50bn to any domestic company having trouble refinancing existing loans with the West.

Where this leaves the recent trend towards consolidation among Russian mining players remains unclear.

Earlier in 2008, there was a spate of M&A activity among Russian miners. This was tacitly encouraged by the Kremlin as it would strengthen the position of Russian companies on world markets. An asset swap deal in late May 2008 between Alisher Usmanov and Vladimir Potanin allowed Usmanov to acquire 10% of Russian palladium and nickel giant MMC Norilsk Nickel, while Vladimir Potanin gained a 25% stake plus one share of Russian iron ore and steel producer Metalloinvest. In April, Mikhail Prokhorov’s ONEXIM Group bought a 14% stake in aluminium local UC RUSAL, as part of a deal in which UC RUSAL, controlled by Oleg Deripaska, acquired 25% plus one share of Norilsk Nickel. A three-way merger of Norilsk Nickel, Metalloinvest and UC RUSAL had been seen as a possibility earlier in 2008, although short-term economic difficulties may now preclude this.

Looking at foreign players active in the Russian mining sector, Canadian miner High River Gold’s future was in severe jeopardy as this report went to press. The company has said that its Berezitovy Rudnik subsidiary does not currently have enough funding to make a scheduled US$15.2mn payment to Nomos Bank due on November 21.

In terms of both area as well as the sheer variety of endowments, Russia figures as a major mining nation of the world. It is home to an array of minerals and metals including nickel, platinum, bauxite, cobalt, coal and tin. Siberia hosts the bulk of Russia’s nickel, platinum and diamond deposits, and despite the harsh geography and weather conditions, it remains an attractive destination for mining players from around the world. Russia-based Norilsk Nickel, ALROSA, UC RUSAL and Polyus Gold are some of the major local mining players that have established a strong presence.

However, in order to leverage these opportunities fully, Russia needs to improve its stance on certain parameters. Topping the list are bureaucratic delays and instances of corruption that substantially escalate the costs of doing business. On the mining front, safety issues and environmental standards continue to challenge the industry, in spite of the government’s efforts to review mines for compliance with technological documentation, estimated project capacity and safety regulations.

The Russian state holds rights over all mineral endowments. Historically, mineral resources have been auctioned to mining companies for development. However, a new methodology is on the anvil, whereby the decision to grant licences will be based on the applicant’s processing capacity. As mentioned above, the government also plans to stiffen regulations concerning foreign participation in the mining industry.

Industry forecast owing to its large metal and mineral base, Russia can continue to derive benefits from the boom in the global metal prices. Diamond mining augers a healthy outlook for the Russian mining industry.

The domestic mining industry is forecast to register an average growth of 7.7% a year over 2008-2012, reaching a total value of US$216.1bn.

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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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Evraz seeks funding from VEB

Russian steel maker Evraz Group has requested a $1.8 billion loan from state bank VEB to refinance debt incurred to acquire Canadian steel pipe maker IPSCO, Vedomosti business daily reported on Tuesday.

The newspaper said another Russian steel maker, Mechel , had also prepared a request to VEB for a loan and that Severstal, the country’s largest steel maker, was considering a similar plan. It did not specify the amounts.

Vedomosti quoted several unnamed sources in the banking sector and close to the steel companies. Evraz and VEB declined to comment, it said. Evraz was not immediately available for comment when contacted by Reuters.

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

The first payouts were approved last month. United Company RUSAL, controlled by billionaire Oleg Deripaska, secured a $4.5 billion loan to repay debt incurred to help buy a one-quarter stake in Norilsk Nickel.

Alfa Group, controlled by another billionaire, Mikhail Fridman, secured a $2 billion loan to help it pay back a loan to Deutsche Bank and rescue its stake in mobile phone firm Vimpelcom , which was used as collateral with the bank.

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