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Russia’s Economy Contracts By 7% In Q1 2009

Edward Hugh — Tue, 07 Apr 2009 15:58:00 +0000

by Edward Hugh: Barcelonabr /br /According to Deputy Economic Development Minister Andrei Klepach last week, Russia's economy shrank by 7 percent year on year in the first quarter of 2009, a staggering turnaround for an economy which has just enjoyed eight years of solid oil-fueled growth.br /br /"These figures are worse than we expected," Klepach said at a press conference in Kiev,citing preliminary figures. Klepach also stated that net capital outflows reached $33 billion in the first quarter of 2009, following record outflows of $130 billion in the second half of last year.br /br /pa href="http://1.bp.blogspot.com/_ngczZkrw340/SdsTJmo57XI/AAAAAAAANbI/gYR1beR2NiI/s1600-h/russia+gdp.png"img id="BLOGGER_PHOTO_ID_5321868440380239218" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 229px; TEXT-ALIGN: center" alt="" src="http://1.bp.blogspot.com/_ngczZkrw340/SdsTJmo57XI/AAAAAAAANbI/gYR1beR2NiI/s400/russia+gdp.png" border="0" //abr /br /The Russian State Statistics Service have also released official gross domestic product figures for the fourth quarter of 2008. GDP was up 1.2 percent year on year, the worst reading for any quarter since the first quarter of 1999, and down from a revised 6 percent in the previous three months. The World bank are now suggesting that the present slump may be deeper than the one that followed the government debt default and ruble devaluation in 1998.br /br /Certainly the data are bleak. Industrial production contracted for a fourth consecutive month in February - falling by 13.2% year on year - as the credit squeeze and falling incomes eroded demand for metals, cars and consumer goods. Retail sales contracted in February for the first time since February 1999. Unemployment was also up, at 8.5 percent in February, the highest level since January 2005.br /br /Manufacturing output plunged with the collapse in demand in the last two months of 2008, and it is likely to contract further in 2009. According to Rosstat five of 14 major manufacturing industries reported outright output declines in 2008, with electronics, electrical, and optical equipment hardest hit (-7.9 percent), followed by textile and sewing (-4.5 percent) and by chemicals (-4.2 percent). Most of the dislocation took place in November and December 2008, when total manufacturing output respectively fell 10.3 and 13.2 percent (year-on-year). As credit continues to tighten and demand to fall, manufacturing is likely to contract further in 2009. According to recent statistics, manufacturing output dropped 24.1 percent in January 2009, compared with January 2008, and 18.3 percent in February 2009, compared with February 2008. In February 2009 the most significant declines were registered in the production of electro-technical and optical equipment (-46.6%), other non-metal products (-33.3%), and transport and transportation equipment (-31%).br /br /a href="http://1.bp.blogspot.com/_ngczZkrw340/Sds9EueFlGI/AAAAAAAANcQ/rDbqskKq2ds/s1600-h/russia+IP.png"img id="BLOGGER_PHOTO_ID_5321914536071369826" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 239px; TEXT-ALIGN: center" alt="" src="http://1.bp.blogspot.com/_ngczZkrw340/Sds9EueFlGI/AAAAAAAANcQ/rDbqskKq2ds/s400/russia+IP.png" border="0" //abr / br /blockquoteTighter credit, collapsing global demand, huge global uncertainty, and rising unemployment have hurt both investment and consumption growth in Russia. According to Rosstat, total fixed capital investment grew 9.8 percent in 2008, compared with 21.1 percent growth in 2007. More worrisome is the investment decline by 2.3 percent in the fourth quarter of 2008 (year-on-year), largely reflecting escalating liquidity problems in the banking sector and the resulting credit crunch and a deceleration in consumption growth due to rising unemployment and lower growth. (World Bank Report, April 2009)/blockquotebr /br /strongGDP Indicator Shows 5.4% Contraction in March/strongbr /br /br /The latest data we have to hand confirm the ongoing character of the contraction. The Russian economy is thought to have declined by 5.4 percent in March compared with March 2008, according to the latest GDP indicator estimate provided by VTB Capital. The VTB GDP indicator also registered an average 4.4 percent contraction for the first three months of 2009, which would be the worst decline since the economy shrank 5.1 percent in the fourth quarter of 1998. The difference between the VTB estimate and the 7% estimate put forward by Klepach would lie in the fact that the VTB indicator does not include contstruction, and construction activity has declined sharply in recent months, so the two pieces of data are consistent with one another.br /br /a href="http://1.bp.blogspot.com/_ngczZkrw340/SdsTrdB-cKI/AAAAAAAANbQ/4XowM_UWDYM/s1600-h/RUSSIA+gdp+inic.png"img id="BLOGGER_PHOTO_ID_5321869021916590242" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 244px; TEXT-ALIGN: center" alt="" src="http://1.bp.blogspot.com/_ngczZkrw340/SdsTrdB-cKI/AAAAAAAANbQ/4XowM_UWDYM/s400/RUSSIA+gdp+inic.png" border="0" //abr /br /Purchasing power has been reduced by lower wages and less access to credit, togther with rising unemployment rates. 6.4 million Russians, or 8.5 percent of the economically active population, were unemployed in February, a 5 percent increase over January and a 20 percent increase on February 2008. The World Bank forecast recently that unemployment would rise to 12% in 2009. /ppThe weakening in retail sales and other consumption indicators is not that surprising given the strength of the contraction, and especially since there is now growing evidence that Russia's employers, in order to make cost savings while maintaining staff levels during financial crisis, are more and more resorting to salary reductions or part-time working schedules. This approach is thought to be being used widely and appears to have much more legitimacy under Russian law than simply telling employees to go home and take unpaid leave. Employers are being advised to take special care when unilaterally modifying major terms and conditions in employment contracts, since although under the Labour Code, changing the terms and conditions of an employment contract is permitted only by mutual written agreement of both parties, there is an exemption from this rule – Article 74 of the Code - which specifies that in the event of a change in organizational or technical working conditions which make it impossible for the previously agreed terms of an employment contract to be maintained, an employer is entitled to unilaterally change such terms on his or her own initiative.br /br /As a result of this contraction in output and weakening in the labour market real incomes have declined substantially in Russia since the autumn of 2008. Rising unemployment and worsening enterprise finances (wage arrears have increased considerably) have meant that in the fourth quarter of 2008 alone, real disposable income dropped 5.8 percent year on year, and by 10.2 percent in January 2009 (again year-on-year). And unpaid wages as a share of total enterprise turnover tripled to 0.12 percent in December 2008, compared with August 2008. The stock of wage arrears as of March 1, 2009 (8 billion rubles or about USD 240 million) remains small but is likely to increase as the crisis grows. At the present time such arrears are thought to affect up to 450,000 people, significantly less than 1 percent of total employment. Growth in real wages came to a complete halt in January-February 2009, following double-digit increases in previous years.br /br /strongRussian Services Contract Less Slowly In March/strongbr /br /Activity in Russia’s service sector continued to contracted in March, although the seasonally adjusted headline VTB Services Purchasing Managers Index rose to 43.9 in March from 40.0 in February. Since any readings below 50.0 signals contraction, we can see that while Russia's services are still contracting, they are contracting somewhat less rapidly than in earlier months.br /br /a href="http://3.bp.blogspot.com/_ngczZkrw340/Sds7Do0jA9I/AAAAAAAANcI/HPO-jYq5PHo/s1600-h/russia+services.png"img id="BLOGGER_PHOTO_ID_5321912318351836114" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 241px; TEXT-ALIGN: center" alt="" src="http://3.bp.blogspot.com/_ngczZkrw340/Sds7Do0jA9I/AAAAAAAANcI/HPO-jYq5PHo/s400/russia+services.png" border="0" //abr /br /Activity and new business both declined for the sixth consecutive month, however the rate of decline in the volume of new business was at its lowest rate since last October. However a survey-record decline in employment was registered in March, with redundancies at their most severe in hotels and restaurants. Firms raised output prices at a weaker rate in March, as input price inflation moderated and pricing power remained weak due to falling demand for services./pblockquote“Surging price competition on the back of weak market demand has urged companiesto tighten their cost cutting programs. Among the measures that have been applied are further redundancies that resulted in the fastest rate of employment contraction in the history of the survey. The input price inflation eased slightly, however, the pressure of utilities charges remains significant,” Svetlana Aslanova, an analyst at VTB Capital, commented on the survey. /blockquotepbr /br /strongAs Does Manufacturing/strongbr /br /br /Russian manufacturing contracted at the slowest pace for five months in March as companies reduced their stocks of unsold goods and the decline in new business eased, according to the latest PMI report from VTB Capital. The VTB Purchasing Managers’ Index was at 42 last month after a 40.6 reading in February. A figure below 50 means a contraction and above 50 implies growth. Stockpiles of unsold goods fell at the fastest rate since December 2005, according to the survey of 300 purchasing executives.br /br /a href="http://1.bp.blogspot.com/_ngczZkrw340/SdN0vwccH1I/AAAAAAAANX4/-IfuXesro5A/s1600-h/russia+PMI.png"img id="BLOGGER_PHOTO_ID_5319723948661546834" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 244px; TEXT-ALIGN: center" alt="" src="http://1.bp.blogspot.com/_ngczZkrw340/SdN0vwccH1I/AAAAAAAANX4/-IfuXesro5A/s400/russia+PMI.png" border="0" //abr /br /strongInflation Rising Again/strongbr /br /Russia’s inflation rate rose to a five-month high in March as the weaker ruble boosted import prices. The rate rose to 14 percent from 13.9 percent in February, while consumer prices grew 1.3 percent month on month, compared with 1.7 percent in February.br /br /br /a href="http://4.bp.blogspot.com/_ngczZkrw340/SdsVp3DrWkI/AAAAAAAANbY/EpygPiGDpFI/s1600-h/russia+cpi.png"img id="BLOGGER_PHOTO_ID_5321871193566566978" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 238px; TEXT-ALIGN: center" alt="" src="http://4.bp.blogspot.com/_ngczZkrw340/SdsVp3DrWkI/AAAAAAAANbY/EpygPiGDpFI/s400/russia+cpi.png" border="0" //abr /br /Inflation was spurred at the start of the year by the weakening ruble, which pushed up import prices, helping the annual rate jump to 13.9 percent in February from 13.4 the month before. The ruble has now lost 29 percent against the dollar since August. The most recent spike in inflation is evidently producing quite a headache for the Central Bank, since chairman Sergei Ignatiev last week that if April's inflation is “significantly less” than it was a year ago, the central bank may consider cutting interest rates for the first time since 2007, giving some kind of monetary relief to an economy which is badly in need of it. Russia’s inflation rate went as high as 15.1 percent last June, and has since come down somewhat from that peak, but really the record of the central bank in containing inflation has been pretty abysmal.br /br /Bank Rossii has been forced to raise its refinancing rate twice since last November, to the current level of 13 percent, in an attempt to limit the amount of rubles available to banks and companies and to slow the decline of the ruble against the dollar. On the other hand the central bank may be in danger of excessive optimism at this point, with Ignatiev telling journalists that his expectation was that the economy may pick up within “several months,” thus trying to offer hope that Russia's banks won’t suffer that “second wave” of crisis that Finance Minister Alexei Kudrin said may hit as bad loans eat up capital. I am of the opinion that Kudrin is right to be cautious here.br /br /Rising delinquency “is a serious problem, but I don’t share the opinion that a second phase of the crisis is unavoidable,” is Ignatiev's view. Overdue retail loans rose to 4.4 percent as of 1 March from 3.2 percent on 1 September. “I believe the most serious phase of the economic crisis is over," Ignatiev told journalists. Would that he were right, unfortunately I think he is wrong, the worst is still ahead.br /br /Obviously the continuing inflation is a problem for Russia's central bank since they would obviously like to offer monetary easing to the economy, just as the U.S. Federal Reserve, the European Central Bank and the Bank of England are doing by bringing their benchmark rates close to zero to bolster banks and pull their economies out of recessions. Bank Rossii last cut the refinancing rate in June 2007, and it has now increased the repurchase rate charged on central bank loans four times since November.br /br /a href="http://2.bp.blogspot.com/_ngczZkrw340/SdssHaUndKI/AAAAAAAANbo/u91g5ZHoQjg/s1600-h/bank+rossii.png"img id="BLOGGER_PHOTO_ID_5321895890504873122" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 400px; CURSOR: hand; HEIGHT: 230px; TEXT-ALIGN: center" alt="" src="http://2.bp.blogspot.com/_ngczZkrw340/SdssHaUndKI/AAAAAAAANbo/u91g5ZHoQjg/s400/bank+rossii.png" border="0" //abr /The refinancing rate, seen as a ceiling for borrowing money and a benchmark for calculating tax payments, is currently at 13 percent after being raised in November and December. The central bank increased the repo rate charged on central bank loans twice in February.br /br /br /Ignatiev admitted that problems with dealing with non-performing loans “could arise", and that he did not "think this is just empty talk,” although he stressed Bank Rossii would seek a solution should the banks be forced to increase reserves to deal with possible losses on loans. Bad loans are still a very low proportion of total debt, nut they are rising. NPLs held by OAO Sberbank, Russia’s largest lender, now make up about 2.8 percent of the bank’s loan portfolio, Chief Executive Officer German Gref last week.br /br /br /Also, on the general economic front the pessimists more or less balance out the optimists. The latest in the pessimist camp, Vladimir Yakunin, head of OAO Russian Railways, said this week that the slowing in the decline of cargo shipments in March doesn’t seem to him to indicate that the country is pulling out of its economic crisis. /pblockquote“We are only at the beginning of the crisis and we should wait for better andbr /more solid indications,” Yakunin, chief executive officer at the Russian statebr /rail monopoly which operates the world’s longest rail network, said in abr /Bloomberg Television interview in his Moscow office today. “We didn’t yet passbr /the middle point of the crisis.”br //blockquotepbr /Railway cargo turnover fell by 15.8 percent in March from a year earlier, compared with a 32 percent fall in January and a 26 percent decline in February. The data is a “leading indicator of the trend in Russian industry,” according to VTB analysts in their GDP indicator. Yakunin said Russian Railways is “fighting” to limit this year’s cargo turnover drop to 19 percent as it is forced to slow down its development amid falling investment.br /br /We also learn this week that Siberian Services, an oil-drilling company among whose clients are to be found OAO Rosneft, has defaulted on $100 million of bonds, thus becoming the first Russian borrower to fail to repay its foreign debt this year. Siberian Services didn’t redeem the 13.75 percent notes due 2010 by an April 3 deadline after bond holders exercised a so- called put option, according to Bloomberg news, citing some of the investors involved.br /br /br /State-owned Finance Leasing skipped an interest payment on $250 million of securities in December, according to Bloomberg. Russian borrowers are struggling to refinance about $100 billion in foreign notes maturing this year as banks reduce lending following $1.3 trillion of losses and writedowns since the start of 2007. /ppstrongConflicting Futures?br //strongbr /While the Organization for Economic Cooperation and Development and the World Bank are forecasting that the Russian economy will decline by 5.6 percent and a 4.5 percent, respectively, in 2009, the Russian government is still stubbornly holding fast to its official forecast of a 2.2 percent fall. Publicly government officials are sticking to their view, and diiging in around the idea that they expect a recovery in the final quarter. Deputy Economic Development Minister Klepach said that the government forecast takes into account a package of anti-crisis measures currently being debated by lawmakers that should bolster domestic demand and help boost GDP. Without it, the economy could contract by 4 percent to 5 percent, Klepach noted. /ppThe Central Bank, on the other hand, continues to forecast a 4.5 percent contraction for the current year. /ppThe Russian Cabinet approved last month a revised budget containing the first deficit in 10 years. The budget anticipates a deficit of 7.4 percent of projected gross domestic product, but since the current forecast is for a GDP contraction of only 2.2%, the final deficit may be considerably larger. The Finance Ministry is now transfering money from the Reserve Fund to cover the deficit, and anticipates using some 2.7 trillion rubles this year to help fund the budget gap. br /br /The Ministry of Finance has released the main parameters of its revised federal budget for 2009 which is based on lower oil prices (USD 41 a barrel, Urals) and a drop in budget revenues from the original 21.2 percent of GDP (under the old assumption of USD 95 a barrel) to 16.6 percent, or RUB 6.72 trillion. At the same time, expenditures will be increased by RUB 667.3 billion to RUB 9.69 trillion, to produce a deficit of RUB 2.98 trillion (about 7.4 percent of GDP), a massive reversal of the fiscal position from the 4.1 percent surplus in 2008. br /br /The total consolidated general government deficit is expected to be around 8 percent in 2009 deficit and will be financed largely from the Reserve Fund (7 percent of GDP) with modest domestic borrowing (up to 1 percent of GDP). With a large fiscal deficit, however, and the need to preserve some reserve fund resources for the uncertainty likely to extend into 2010, the space for more fiscal stimulus this year appears limited.br /br /So the level of the contraction which the Russian economy undergoes in 2009 really is rather big beer, since it will condition the size of the eventual fiscal deficit, and the percentage of the Reserve Fund which will need to be used this year. If there is no rebound in oil prices in 2010 then Russia's position can complicate on a number of fronts, since the Central Bank Reserves will be significantly depleted, the Reserve fund also, and there may be less room for fiscal easing in the face of potential credit rating downgrades, while monetary easing may also prove difficult given the need to support the currency, and protect Central Bank Reserves. All in all, 2010 could be a very hard year for Russia and its citizens.div class="blogger-post-footer"img width='1' height='1' src='http://res1.blogblog.com/tracker/8991369883287712098-2651809959312061467?l=globaleconomydoesmatter.blogspot.com'//div

Russia’s Crisis Spreads Right Across The Domestic Credit Market

Edward Hugh — Fri, 03 Oct 2008 07:31:00 +0000

by Edward Hugh: Barcelona

Well the action in Russia this week has moved on slightly, and the damage has started to spread from pressure on the domestic stock market (accompanied by capital flight) to the real economy - via a very rapid tightening in credit conditions for Russian domestic users. We are also seeing a rapid slowdown in Russian manufacturing industry as internal demand slows while the inflation-driven decline in cost competitiveness continues to make imported products (where available) an attractive alternative to the home produced variant.

Emerging-market bonds have been generally falling this week as the U.S. Senate's approval of a $700 billion bank rescue package did little to revive demand for riskier debt, and Russia has, unsurprisingly, been among the worst affected. The extra yield investors demand to own developing-nation bonds rather than U.S. Treasuries rose 8 basis points yestreday to 4.14 percentage points after widening 12 basis points on Wednesday, according to the JPMorgan Chase EMBI+ index. At the same time the MSCI Emerging Markets Index of stocks fell 0.3 percent to 783.79, its lowest point in four days. While such data readouts do not of course exclusively define the outlook for the Russian economy, they do give us a good indication of the context within which economic activity occurs, and they also give us a very clear measure of the current level of global risk sentiment whose influence, as we will see below, lies right at the heart of the immediate shock that is hitting Russian households and businesses.

Central Bank Reserves Actually Rise

One indication of the slightly different panorama to be found in Russia this week - and of the way in which the recent government intervention is moving the focal point of the crisis away from the equity markets and into the credit ones - is to be found in the little detail that the dollar value of Russia's international reserves actually rose $3.4 billion last week, following consecutive declines during each of the three previous weeks, according to data released this week by Bank Rosii. The value of Russia's Forex reserves increased to $562.8 billion in the week to Sept. 26, after decreasing $900 million to $559.4 billion in the previous week. A significant decline in the value of the dollar (which only represents about 47% of the reserves basket) seems to have been behind what is really a technical revaluation - given that the effect is produced by the rest of the currencies in the basket rising in value against the dollar. But there is no doubting the fact that the capital flight has - for the time being - lost momentum, even though the central bank felt forced to sell an estimated $4.9 billion from the reserves last week to support the ruble, and an estimated $20.6 billion over the last four weeks.

About 47 percent of Russia's reserves are held in U.S. dollars, 42 percent in euros, 10 percent in pounds and 1 percent in yen, according to the most recent figures released by the central bank on June 30, 2007. The share of the reserves held in Swiss francs was reported as being "insignificant''.

Moody's Dowgrades Russian Banks

But while the bloodletting on the foreign exchange side seems to have abated for the time being - PNB Paribas estmated that some $57 billion were taken out of the country between Aug. 8 and Sept. 19, BNP Paribas - the outlook for Russia's banking system has deteriorated significantly after been downgraded to a "negative'' rating by Moody's Investors Services last week.

Slowing asset growth, higher inflation and a decline in equities may constitute as lethal cocktail which produce a sytematic deterioration in the undelying fundamental of Russian banks, is the conclusion many investors are drawing from Moody's latest "Banking System Outlook for Russia" report. Moody's main expressed concern was the way in which Russian banks hadn't cut back their lending in response to the recent change in risk sentiment, thus increasing their risk profile. The "structural weaknesses'' that surfaced this month in Russia's banking system and the possible impact of the global credit squeeze may hurt the ability of banks to repay debt and attract financing, Moody's said in the report. Both OAO Sberbank and VTB Group, Russia's biggest banks, declined following the issuing of the Moody's report. Indeed only this morning (Friday) VTB shares have fallen back one more time, after the bank announced it lost 9.31 billion rubles ($360 million) in September due to ``negative market dynamics.'' Nine-month net income for the bank (under Russian accounting standards) fell to 7.44 billion rubles from the 16.8 billion rubles in the first eight months of the year declared in August. The drop followed a "revaluation of the bank's securities portfolio,'' according to the accompanying statement.

And the other main credit rating agencies have not exactly been silent, with Fitch stating earlier this month that Russian real estate and construction companies are the most at risk as domestic and international banks curb lending, while Russia's credit outlook was cut to "stable'' from "positive'' by Standard & Poor's on Sept. 19. S&P's made the point that the Russian authorities face growing pressure to spend the country's oil generated reserve funds, undermining the country's longer term credit strength. They did however maintain Russia's rating of BBB+, the third- lowest investment grade ranking.

Lending Conditions Tighten

Of course the result of these downgrades (coming hard on the heels of the loss of confidence in the ability of the Russian institutional system to reform itself) wasn't hard to anticipate or slow in coming, and Russia's largest lender, the state-controlled, Sberbank reported on Wednesday that it was going to raise interest rates on retail loans due to the sharp rise in its own borrowing costs. This would seem to be the first major trickle-down from the global financial turmoil onto ordinary Russian citizens, who are already struggling to see the wood from the trees under the impact of double-digit inflation rates. The point about Russia's 15% inflation rate isn't simply the "Alice in Wonderland" quality it has given to Russia's recent growth spurt, what we need to think about is the way in which it distorts all those fundamental day to day decisions which the economy's principal actors (households, companies and the government) need to take. Thus, there is much more to think about in the Russian context than the evident fact that it is a "resource rich country": long term structural distortions which go unattended are never good news.

And with 32 percent of the retail lending market, Sberbank's move will have a rapid impact on millions of ordinary Russians - since interest rates on loans are set to rise by anything between 0.25-2.25 percentage points, depending on the type of loan, and the quality of the collateral offered as guarantee. And, of course, the other consumer banks are all set to follow Sberbank's lead in adjusting their lending conditions.

Sberbank is reported to be in the process of securing a $1.2 billion loan which will be 40 basis points more expensive than its last syndicated loan - a $750 million credit taken out in December 2007, before the impact of the credit crunch was really felt. Sberbank has said it will start passing these extra costs on to new customers immediately, while loan agreements that have already been signed will remain unchanged.

Hardest hit will be rates on mortgage loans taken out in roubles, which will increase by 1.25-2.25 percentage points, while rates for mortgages in foreign currencies will go up between 0.75-1.75 percentage points. Thus interest charged on these loans will rise to between 12.75 and 15.5 percent, depending on the type of collateral and other factors. Interest on other consumer loans - such as cash loans or for consumer durables - will be up by an estimated 1 percentage point on average.

Property Market Starts To Crash

And the trickle-down on loans is rapidly becoming a torrent on the mortgages front. One of the first casualties here would seem to be Moscow's decade-long building boom as the sharp rise in interest rates squeezes developers in what has suddenly become the world's third most expensive property market - bettered only by Monaco and London, according to Global Property Guide.

The case of the Mirax Group - the Moscow-based company that's building the Federation Tower, which will be Europe's tallest skyscraper when completed - is typical, since Mirax have just had to cancel plans to develop 10 million square meters (108 million square feet) of commercial and residential space after they found that interest rates on some loans had risen to as high as 25 percent.

Higher borrowing costs already are hitting demand for apartments, and Moscow-based Real Estate Market Indicators report that prices may fall in the fourth quarter of 2008 and continue falling in 2009. If this happens it will be the first decline in Moscow property prices in 11 years, they say. The property consultants suggest the drop may reach as much as 30 percent for some types of apartments by the end of 2009. This assertion is very hard to judge, but does give some indication of the kind of decline we may see.

Prices for homes in Moscow have risen more than sixfold since 2003. In the first six months of 2008 they were up 25 percent, reaching a record average price of 136,404 rubles ($5,318) per square meter, according to data from Metrinfo.ru, a market research company. Since June prices have climbed another 13 percent.

And it isn't just in Moscow that the credit crunch is tightening its grip, Russian developers are also cutting apartment prices in the regions as a decline in mortgage lending lowers demand for housing. According to Russia's regional press, sales of new apartments in Rostov-on-Don are down 40 percent this month from August, while sales in St. Petersburg have fallen by half since the spring. Prices are said to have declined as much as 24 percent as a result.

And the investment analysts are hitting Russian real estate hard. JPMorgan advised investors, in a research note this week, to "steer clear'' of Russian real-estate stocks since the Russian property sector is expected to be one of the "hardest hit'' in a global recession, while Unicredit analysts state that "The current situation in Moscow partly resembles Japan's real-estate crisis of the 1990s" - personally I think that this is altogether the wrong comparison, but it does give some idea of the seriousness of the situation.

Russia's builders have also started to take a beating. Shares of Sistema-Hals, the property company owned by billionaire Vladimir Yevtushenkov, dropped 25 percent to 75 cents at one point in London trading on Wednesday, touching their lowest level since shares began trading in November 2006, while PIK, the Russian developer with the highest market cap, has lost 78 percent of its value since going ahead with an initial public offering in June 2007. OAO Open Investment, Russia's second-largest publicly traded property company, has declined 52 percent this year. LSR Group, the Russian developer and building-materials maker controlled by billionaire Andrei Molchanov, has fallen 64 percent.

Oh, How Are The Mighty Fallen

"The Federation Tower, which is due to be completed by the company in 2010, will be 506 meters (1,660 feet) tall and will replace Commerzbank AG's headquarters in Frankfurt as Europe's tallest building". And this, we may like to ask ourselves, will be a monument to what, exactly?

Russia's Railways Delay Bond Issue

In another sign of the way in which the global credit strains are now biting, OAO Russian Railways, Russia's state owned rail monopoly, has said it is going to "hold off'' on selling $7 billion of 30-year bonds due to the turmoil in global financial markets. The company had planned to sell $600 million of Eurobonds by the end of 2008 to finance an upgrade in what is effectively the world's longest rail network. ING Groep NV, Barclays Capital and Morgan Stanley, the financial advisers on the loan, recommended waiting to sell the Eurobonds after they saw investor interest waning while the cost of borrowing surged. The impression that all this creates is that the global wholesale money markets are now firmly, but politely, closing their doors in Russia's face.

Back in July, Prime Minister Vladimir Putin was busying himself advocating a $525 billion overhaul of Russia's railway system, lauding the rail network as "one of the foundations of Russia's political, social, economic and cultural unity.'' Now, wasn't it Lenin who once said that Russian socialism was nationalisation plus electricity, well Vladimir Putin seems to be suggesting that the new Russian capitalism is lots of public money to support the price of Russian equities plus railways, or words to that effect.

In fact the sad reality is, after all those ambitious words have been spoken and forgotten, that the current credit crunch will probably lead OAO Russian railways to reduce spending both this year and next (and after that we'll see), both delaying and reducing the scope of the principal projected projects. Of course, the Russian govenment could fund some of the activity itself from the National Wealth Fund, but wouldn't that be just the kind of activity which S&P's are warning about? At the present time Russian Railways claim to have sufficient funds to pay off their current debt and state that they won't need to tap the state-run development bank VEB for refinancing. The rail operator does, however, have 128 billion rubles of loans and bonds outstanding, including 16 billion rubles worth due next year according to estimates, so the validity and realism of their recent statements looks like it is about to be tested.

Moody's Investors Service rates Russian Railways A3, the fourth-lowest investment grade level, while Standard & Poor's rates it one step lower at BBB+.

Russia's Manufacturing Output Falls

Obviously the credit crunch and construction slowdown is bound to work its way through to Russia's real economy one of these fine days (as we have already seen in places like Spain and the Baltics), and one early warning sign on this front could be considered to be the recent evolution in Russian industrial output. In fact Russian manufacturing shrank for a second month in September, and in so doing registered its first back-to-back contraction since November 1998, as companies cut jobs and growth in new orders slowed, according to the latest VTB Bank Europe Purchasing Managers Report. The PMI came in at a seasonally adjusted 49.8, compared with 49.4 in August. The August reading was the lowest figure in three and a half years, according to the bank statement. On such indexes a figure above 50 indicates growth while one below 50 indicates a contraction.

Russia's economic growth is obviously slowing quite quickly - and evidently far more rapidly than the government anticipated - largely due to the impact of the global credit crunch, the downward movement in oil prices and investor reaction to Russia's "go it alone" attitude in international disputes.

In the present environment inflation is likely to slow quite rapidly, and in September this easing in infaltion was noted in the prices that manufacturers pay and charge, as highlighted in the VTB report: "The rate of increase in prices charged by Russian manufacturers eased for the fifth straight month to its weakest' since at least January 2003".

Oil Output Down

And just to cap it all, Russia's oil production also fell in September as companies struggled with costs and maturing fields, effectively bringing the world's second-largest crude exporter closer to its first annual drop in output since 1998. Production fell to 9.83 million barrels of crude a day (40.2 million metric tons a month), 0.4 percent less than a year earlier, according to figures released by the Energy Ministry's CDU-TEK unit.

So What Can We Expect?

Well, in broad outline I don't think the outlook has changed that much from when I wrote my last analysis two weeks ago.

As I said at that point, Russia is hardly the Baltics, so we should not expect the economy to go into a complete nosedive. A lot depends on the view you take about the future of energy prices. While the global economy is now evidently set to slow considerably - in addition to the reduction in growth rates already seen so far this year -and especially in the aftermath of the most recent bout of financial turmoil. Cleary oil prices are set to drop even further - and this will only keep pushing Russian growth down - but at some point the market will find a floor, possibly in the region of $80 a barrel. More importantly when it comes to the future of oil prices, I would not be banking on some kind of long and deep global recession. Many of those developed economies who are significantly affected by the bursting of their construction booms (and the banking issues which have gone with it) will probably have weak domestic consumer demand for some time to come, but a solid core of emerging economies may well take off again quite rapidly as we move into 2009 -and especially if energy prices drop back, and the current near panic in the financial markets settles down (people do, after all, have to put their money somewhere). So the emergent (and numerous in population terms) emerging economies should give another strong shove to what may have become a rather listless global economy. As a knock on effect this should also serve to put some life back into export dependent economies like Germany and Japan (who by and large are not reeling under the impact of the construction bust, although their banks may have been lending to people who are).

So the bottom line here, I think, is be ready for a sharp slowdown in headline Russian GDP, but don't expect to see any imminent meltdown in the Russian financial system, one way or another they have the wherewithall at this point to keep limping forward. Of course, in the longer term, well, you know......

Russia’s Crisis Spreads Right Across The Domestic Credit Market

Edward Hugh — Fri, 03 Oct 2008 07:31:00 +0000

Well, in broad outline I don't think the outlook has changed that much from when I wrote my last analysis two weeks ago.