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Today in Russian Business – July 1, 2009

Robert Amsterdam — Wed, 01 Jul 2009 08:44:51 +0000

Norilsk Nickel shareholders have voted to invite a state representative, Vasily Titov, deputy chairman of state-run VTB Group, to their board, to give the company additional support during the crisis. Russian Railways chief Vladimir Yakunin has recommended the government consider...

Today in Russian Business – June 18, 2009

Robert Amsterdam — Thu, 18 Jun 2009 09:01:23 +0000

Deputy Finance Minister Sergei Shatalov says there will be no tax raises on individual incomes during the crisis, but the government plans to introduce an increase on gas extraction tax for businesses. The Moscow Times looks the construction firms of...

Russia’s Economic And Financial Meltdown Continues Apace

Edward Hugh — Tue, 16 Dec 2008 10:06:00 +0000

By Edward Hugh: Barcelonabr /br /Russia's foreign-exchange reserves have been now been declining very rapidly since mid August, and as the money goes so does the faith that the large stock of reserves the country built up during the boom times would be sufficient to see them through any downturn in energy prices. As the money leaves, so it seems does the decade of economic growth and stability which they symbolised. Indeed so rapid has been the decline that Russia's international reserves, which are the third-biggest after those of China and Japan, have now fallen $161 billion, or 27% percent, since 8 August last, and decreased by $17.9 billion to $437 billion in the week to 5 December. Investors have now pulled $211 billion out of the country since August, according to estimates by BNP Paribas.br /br /br /pa href="http://1.bp.blogspot.com/_ngczZkrw340/SUbQptNe4tI/AAAAAAAALyE/K0xlBOy3AlA/s1600-h/russia+GDP.png"img id="BLOGGER_PHOTO_ID_5280137028067844818" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 320px; CURSOR: hand; HEIGHT: 162px; TEXT-ALIGN: center" alt="" src="http://1.bp.blogspot.com/_ngczZkrw340/SUbQptNe4tI/AAAAAAAALyE/K0xlBOy3AlA/s320/russia+GDP.png" border="0" //abr /br /br /But just how difficult managing this process is proving to be was illustrated yet again this morning as Russia’s central bank found itself forced to accept a further devaluation in the ruble - for what is now the second time in a only a week - subsequent to which the ruble fell as much as 1.3 percent (to a four-year low of 37.5015 per euro) as Bank Rossii widened the trading band against the basket of dollars and euros used by the bank as the measure for attempting to manage the exchange rate.br /br /Russia has now used some 27 percent of its reserves in these attempts to stem what has now become a 16 percent decline in the ruble following a 69 percent drop in the price of oil and last weeks decision by credit ratings agency Standard amp; Poor’s to cut its Russian credit rating on for the first time in nine years.br /br /Thus over at Bank Rossii they have been having their work cut out "fexibilising" the trading band, and it this flexibilisation process that has now allowed the ruble to fall against its target exchange rate against a basket of currencies by 8.6 percent, down further from the 7.7 percent level facilitated last week and the 3.7 percent one of a month ago. Thus the currency has now fallen a net total of 5.9 percent against the basket in the series of six "adjustments" to the trading band implemented since 11 November. However this "slow and steady" approach to devaluation is creating uncertainty, as well as fomenting a loss of confidence with Russians withdrwaing a total of 6 percent from their ruble accounts in October alone, the fastest rate of withdrawal since Bank Rossii started collecting this data two years ago, while foreign currency deposits rose 11 percent. Thus instead of reinforcing confidence in the monetary regime, the slow, step-by-step adjustment of the nominal exchange rate may be perpetuating a steady stream of deposit withdrawals and dollar purchases, and some evidence for this can be found in November's 5.9 percent contraction in the money supply.br /br /Apart from the financial turmoil, Russia's economy is really reeling under the weight of the sharp drop in crude prices, and the price of Urals crude, Russia's main export blend, is currently trading at around $44.13 a barrel, down 69 percent from the July peak, and well below the $70 average required to balance the country's 2009 budget.br /br /strongGDP Growth Slowing Rapidlybr //strongbr /It is hard to get a fix at the present time on what Russia's growth rate will look like in 2009, and estimates vary widely. Deutsche Bank recently cut its Russian growth forecast to 1 percent for next year, down from an earlier 3.4 percent, while the World Bank last month forceast a slowdown to 3 percent from what has been an average expansion of 7 percent a year since 1999. At the bottom end of the forecast range we have Oleg Vyugin, chairman of MDM Bank and a former central banker, who suggests the economy may contract by as much as 4% if the prices of raw materials exports do not recover. My own feeling is that the final figure may well be much nearer to Vyugin's estimate than to the World Bank one, especially if we don't get a strong rebound in commodity prices and given the sharp contraction in non-energy industrial output.br /br /Analysts an OAO Sperbank have gone one step further and come up with two possible scenarios for possible impacts of the economic slump on property prices. For the first (or mild case) scenario they postulate a 2.5-3.5% growth in GDP, 11% inflation and a 30 ruble per dollar exchange rate in 2009. In this case, the bank anticipates a drop in Moscow real estate prices of 34.4% in ruble terms and 46.6% in dollars. On the second scenario GDP stagnates (or even contracts by up to 2.5%), there is higher inflation and an even larger devaluation of the ruble against the dollar. On this (worst) case scenario the Bank suggests that Moscow property prices would plummet by 38.1% in rubles and 59.6% in US dollars. You have been warned!br /br /br /strongThe Inflation Worm Is At The Heart Of The Problembr //strongbr /br /The real difficulty facing Russia's macroeconomic managers is that after two years of shocking inflation domestic industry is in no position to compete with its overseas competitors while the ruble remains at its present rate, while any sharp devaluation will have a serious impact on the balance sheets of those who took advantage of cheaper interest rates available abroad to do their borrowing using forex loans. This situation is not that different from that which is to be found in many other economies across the region, in Latvia, Hungary, Ukraine and Romania (for example), with the added rider that the IMF representatives who are in dialogue with policy makers in these very fragile economies would do well to bear in mind the potential knock-on effect of any coming downward adjustment in the ruble./ppIn annual terms inflation is now slowing, and was down to 13.8% in November, from 14.2% in October. Still, these are very - unacceptably - high numbers, and those who so willingly acquiesced in them earlier will now feel the downside of their negligence, although unfortunately it is - as ever - the poor old Russian in the street who will really pick up the bill.br /br /br /a href="http://2.bp.blogspot.com/_ngczZkrw340/SUZ6N5DK8cI/AAAAAAAALx8/T4TcZGW4WfE/s1600-h/russia+cpi.png"img id="BLOGGER_PHOTO_ID_5280041992209494466" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 320px; CURSOR: hand; HEIGHT: 194px; TEXT-ALIGN: center" alt="" src="http://2.bp.blogspot.com/_ngczZkrw340/SUZ6N5DK8cI/AAAAAAAALx8/T4TcZGW4WfE/s320/russia+cpi.png" border="0" //abr /Basically, the credit driven consumer boom which accompanied the commodities one severely distorted the always delicate balance between Russia's commodities and manufacturing sectors, leaving the manufacturing sector strongly uncompetitive. It is this lack of competitiveness which now exaccerbates the severity of the downturn, just as many commentators, a href="http://russiatooat.blogspot.com/2007/12/inflation-in-russia-two-much-money.html"including yours truly/a, where arguing it would do. Frank Gill from Standard and Poor's puts it like this.br /br //pblockquoteAccompanied by generous government spending, the credit boom also fueled inflation, which weighed on the competitiveness of Russia's noncommodity sector. As wage growth averaged nearly 30 percent over the last two years and the ruble-denominated cost of production rose, domestic manufacturers found it very difficult to compete with cheap high-quality imports. As a consequence, entrepreneurs logically avoided manufacturing and, instead, invested in much more profitable and more import-intensive sectors, such as banking, retail and construction.br /br /The resulting structural imbalances were well camouflaged by the extraordinary growth in energy and other commodity prices. For six straight years, the earnings from Russian oil and commodity exports on world markets have increased much faster than the cost of imports, offsetting the less flattering volume effects. From 2003 through this year, the cumulative difference between export and import price inflation in Russia was a fairly remarkable 74 percent. This put upward pressure on the ruble, encouraging borrowers to take loans in dollars or euros at negative real interest rates, under the assumption that the ruble would appreciate indefinitely. But it also provided an important source of financing.br /Frank Gill, director of European sovereign ratings at Standard amp; Poor's in London, a href="http://www.moscowtimes.ru/article/1016/42/373149.htm"writing in the Moscow Times/a /blockquotepThe critical part of the overheating process was to be found in the evolution of real wages which continuously outpaced productivity growth, thus undermining competitiveness. According to Rosstat, average real wage growth in the first nine months of 2008 was 12.8 percent, down from 16.2 percent during the same period in 2007 (see chart below). Meanwhile unemployment has continued to decline, and reached 5.3 percent in the third quarter, suggesting that at that point the economic slowdown had still not reached the labour market. But this is expected to change quite dramatically now, as the credit seize up and construction slump lead to lay offs in one enterprise after another./ppa href="http://1.bp.blogspot.com/_ngczZkrw340/SUZyF4GNiQI/AAAAAAAALx0/lrKzfnucyPY/s1600-h/rus+prod+1.png"img id="BLOGGER_PHOTO_ID_5280033058421836034" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 320px; CURSOR: hand; HEIGHT: 194px; TEXT-ALIGN: center" alt="" src="http://1.bp.blogspot.com/_ngczZkrw340/SUZyF4GNiQI/AAAAAAAALx0/lrKzfnucyPY/s320/rus+prod+1.png" border="0" //abr /The Russian government has implemented a programme - worth about $200 billion - involving a mixture of loans, tax cuts and other measures to boost liquidity and reduce borrowing costs as the 50-stock RTS Index heads for its worst year since 1998, while the ruble denominated Micex stock index is down 64 percent since 1 August. /pblockquote``It's a vortex of despair,'' said Julian Rimmer, head of sales trading at UralSib Financial Corp. Russian stocks are weighed down by ``an economy rendered sclerotic by the vanishing of credit, a market paralyzed by margin calls and illiquidity, the opacity of earnings through 2009 and the ruble quivering while speculators circle''.br //blockquotepFinance Minister Alexei Kudrin has said the government has already spent 90 billion rubles ($3.3 billion) out the available total of 175 billion rubles set aside for investing in domestic stocks and bonds. VTB Group (Vnesheconombank), Russia's second-biggest bank, lent 190 billion rubles ($6.9 billion) to companies in November alone as part of the plan following the supply of 120 billion rubles to what Finance Minister Alexei Kudrin termed the "real sector" (or non financial companies) in October./ppstrongFDI Drying Up?/strong/ppRussia's supply of foreign direct investment seems to be steadily drying up. During the first nine montsh of this year the country attracted 2.3 percent less foreign direct investment than it did in the same period in 2007 as the global credit squeeze reduced investor appetite for emerging market projects. Direct investment was running at $19.2 billion over the period, while total foreign investment, including credits and flows into securities markets, was $75.8 billion, a drop of almost 14 percent over 2007, according to the most recent data from the Federal Statistics Service. Foreign investment in stocks and bonds fell 16 percent to $1.3 billion. Foreign direct investment was at a record $27.8 billion in 2007, up 100% over 2006, and thus the fall has not been that dramatic, so far, but the numbers for the last quarter will undoubtedly be much worse than those for the earlier part of the year.br /br /strongSamp;P Downgradebr //strongbr /Russia’s long-term debt rating was lowered earlier this month - for the first time in nine years -by ratings agency Standard amp; Poor’s, who cited capital outflows and the “rapid depletion” of the foreign currency reserves as their justification. Russia's rating was cut one level to BBB, the second-lowest investment grade, and down from BBB+. The last time Samp;P downgraded Russia was in January 1999, when the country had a rating of SD (or ‘selective default’) following the government's decision to default on $40 billion of debt. Russia’s outlook remains “negative.” /pblockquote“The rapid depletion of reserves in order to resist a more substantive adjustment of the nominal exchange rate increases the chances of discontinuous exchange-rate movements later, at a lower level of international reserves, with even more severe consequences for the private sector,” said Frank Gill, Samp;P’s primary credit analyst in London, in the statement./blockquotebr /Samp;P said it expected Russia’s current-account surplus to swing into a deficit equivalent to 2.6 percent of gross domestic product next year, compared with a surplus of 5 percent in 2008 due to a “sharp deterioration in the country’s terms of trade”. Russia’s GDP growth is expected to decline “sharply” in 2009, according to the agency.br /br /Energy, including crude oil and natural gas, accounted for 73 percent of exports to countries outside of the former Soviet Union (not counting the three Baltic states), in the first 10 months of this year, according to data from the Federal Customs Service, while the federal budget is likely to “shift into deficit” as the government implements emergency tax cuts, commodities prices remain low, and a weaker economy generates less tax revenue, according to Samp;P. Russia’s budget surplus amounted to 7.8 percent of GDP in the first 10 months, according to Finance Ministry data, but so sharp is the turnaround that Russia may need to use most, or even all, of the money in its two oil funds to cover the budget deficit and recapitalize banks should oil prices stay at about current levels. These funds - the National Wellbeing Fund and the Reserve Fund - held a combined $209 billion as of 1 December.br /br /Moody’s Investors Service also changed Russia’s rating outlook at the end of November - to stable from positive - citing their opinion that the defense of the exchange rate has been "ineffective and extremely costly for official reserves".br /blockquote“Russia is now facing a perfect storm of falling commodity prices, weaker external demand, tighter credit conditions and slower real incomes growth for which no amount of currency adjustment can compensate,” Neil Shearing, an emerging-markets economist at Capital Economics Ltd. in London, said in a research note today. /blockquotebr /Russia's response to the crisis seems to be what might be termed a "process in development", with new measures being continuously announced. In one of the latest such "developments" Finance Minister Alexei Kudrin said the government is thinking of using some of the funding to buy bank mortgages and will also provide 300 billion rubles ($11 billion) to guarantee corporate loans in a bid to boost liquidity. “In order to strengthen guarantees for loans, including loans for two and three years, the state must be ready to provide 300 billion rubles,” Kudrin said in a televised broadcast on the Russian state channel Vesti-24. “If necessary we can increase this limit.” Thirty billion rubles in loans are also to be provided to large airlines like Aeroflot and Transaero, according to First Deputy Prime Minister Igor Shuvalov, while Vnesheconombank, Russia’s state-run development bank, has now requested a total of 950 billion rubles ($34 billion) in government funds. To put all this in perspective, the latest amount requested by VEB represents more than 7.5 percent of Russia’s foreign-currency reserves.br /br /br /strongServices And Manufacturing Contractionbr //strongbr /Russia's real economy is shrinking very rapidly under the weight of all this. Russian service industries shrank in November at the fastest rate on record, and the VTB Bank Europe Services Sector Purchasing Managers’ Index was in contraction mode for a second consecutive month (registering 37.2, a sharp acceleration in the rate of contraction from the 47.4 reading in October). On such indexes a reading of 50 is the dividing line between expansion and contraction. The contraction in service industries was “by far” the biggest since the survey began in October 2001, according to the VTB statement. “Activity, new business, employment and backlogs all registered much steeper contractions than in October.”br /br /pa href="http://3.bp.blogspot.com/_ngczZkrw340/ST5YzXONRqI/AAAAAAAALrk/-j4L4I5HHJ4/s1600-h/russia+services.png"img id="BLOGGER_PHOTO_ID_5277753452754978466" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 320px; CURSOR: hand; HEIGHT: 194px; TEXT-ALIGN: center" alt="" src="http://3.bp.blogspot.com/_ngczZkrw340/ST5YzXONRqI/AAAAAAAALrk/-j4L4I5HHJ4/s320/russia+services.png" border="0" //abr /br /br /VTB Group’s Manufacturing Purchasing Managers’ Index also showed a decline in November, this time for the fourth consecutive month, and the index registered a record low of 39.8, even lower than that of September 1998, when Russia defaulted on $40 billion of domestic debt and sharply devalued the ruble. /ppbr //pa href="http://4.bp.blogspot.com/_ngczZkrw340/ST5Z6pWljzI/AAAAAAAALrs/qaa9gk36xUs/s1600-h/russia+pmi.png"img id="BLOGGER_PHOTO_ID_5277754677392674610" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 320px; CURSOR: hand; HEIGHT: 195px; TEXT-ALIGN: center" alt="" src="http://4.bp.blogspot.com/_ngczZkrw340/ST5Z6pWljzI/AAAAAAAALrs/qaa9gk36xUs/s320/russia+pmi.png" border="0" //abr /The manufacturing reading is also confirmed to some extent by the November industrial output data from Rostat, since output contracted year on year by 8.7 percent after a 0.6 percent rise in October. Production shrank for the first time since new methodology was introduced in 2003 and, again, this was the biggest decline since 1998. Manufacturing fell an annual 10.3 percent compared with growth of 0.3 percent in October. Steel pipe production dropped an annual 36.9 percent and coking coal output fell 38.7 percent. Truck and car production dropped 58.1 percent and 7.2 percent respectively. Russia’s largest steelmaker, OAO Severstal, have announced they are cutting output by half and plan to reduce spending 20 percent in 2009, while Ford Motor announced on 8 December it was closing its St. Petersburg factory between 24 December and 21 January.br /br /strongIs Russia On The Brink Of Outright Recession?br //strongbr /Russia may well already be in its first recession since 1998, according to what may well have been a slip of the tongue by Deputy Economy Minister Andrei Klepach while Evgeny Gavrilenkov, chief economist at Troika Dialog, estimates that the word's largest energy exporter may already be running a current account deficit. blockquote“The recession has already begun and, I’m afraid, it won’t end in two quarters,” Klepach said in comments made in Moscow today that were confirmed by his press secretary.br //blockquotepbr /Klepach added that the economy would grow by less than the ministry’s current forecast of 6.8 percent for 2008, and that industrial output growth will slow to around 1.9 percent for the whole year.br /br /Gross domestic product growth dropped to 6.2 percent in the third quarter, and this was already the slowest pace in three years. Russia’s last economy fell into recession in the first quarter of 1998, and only returned to growth in the second quarter of 1999. Growth has averaged over 7 percent a year since 2000.br /br /As I said, Klepach's declaration may well have been a (Freudian?) slip of the tongue (or tongue twister) since he later qualified his statement, saying there had been some linguistic confusion given that the Russian words “retsessiya” (recession) and “spad” (decline, slump) “mean the same thing". "This isn’t a technical recession in the American sense.” he said - referring to the fact that a recession is often defined as two consecutive quarters of negative growth. Actually the sticklers among us will note that the two quarters negative growth rule of thumb is not in fact the US criterion (since the NBER business cycle dating committee use their own "in house" methodology, as I explain a href="http://spaineconomy.blogspot.com/2008/12/as-spanish-unemployment-rises-sharply.html"in applying this methodology to Spain here/a), but he may be right, and what we have on our hands may best be termed a "slump" rather than a recession, but which ever it is, of one thing I am sure: the contraction has already started./ppWhatever the confusion, what Klepach did make clear is that he expected Russia’s economy to grow by only 2.6 percent year-on-year in the fourth quarter (giving total growth for the year of 6 percent) and this does seem to suggest that the economy is already contracting on a quarter on quarter basis.br /br /Equally worrying is the evolution in the current account deficit. The full impact of the fall in oil prices will only be noted in the trade and external current account data in the fourth quarter, when export deliveries based on the new lower oil prices will be effectd. But to this evident oil price impact we need to add the fact that the non-oil external current account deteriorated significantly in 2008 as import volumes shot up considerably faster than non-oil exports (the competitiveness problem). In the second quarter of 2008, the non-oil external current account deficit reached almost US 60 billion, and this was followed by a further USD 62 billion in the third quarter, making Russia’s balance of payments position particularly vulnerable to a continuation in the low level of oil and gas prices.br /br /We also need to consider the problems Russia may now have in financing any such current account deficit (remember this one one of Samp;Ps concerns). The World Bank estimates Russia’s external debt maturing in the third and fourth quarters of 2008 at around USD 100 billion, of which about USD 45 billion is due in the last quarter of 2008. After including on-demand deposits held by the banking sector, the total debt that requires repayment or refinancing may well exceed USD 120 billion. The external debt maturing for the entire 2009 fiscal year is slightly less, at around USD 100 billion. It is clear, however, that some sectors, especially private financial corporations, are going to face challenges in rolling-over their external debt under current conditions. Further, higher prices for debt refinancing are inevitable, and to all of this you need to add-in the sharp drop in the stock values used as loan collateral which will have resulted in sizeable margin calls on lending facilities with 1-2 year maturities. /ppAll in all the World Bank reached the conclusion that the total debt due in the fourth quarter of 2008 could amount to about USD 60-65 billion. Even so, they concluded that systemic risk to the banking sector, while rising, remained limited due to the government’s resolve in supporting the systemically important banks and the sizable package of measures taken to date. It is hard to assess whether or not they are right in this evaluation, but in any event we are all just about to find out, so those of us who don't especially like mysteries won't have too long to wait.

As S&P Cut The Credit Rating, Russia’s Crisis Wends On Down Its Long Winding Road

Edward Hugh — Wed, 22 Oct 2008 11:38:00 +0000

Russia's long-term sovereign credit rating outlook was lowered yesterday (Thursday) - to negative - by Standard & Poor's Ratings Services due to their assessment that the cost of the government's "bank rescue operation'' may increase. S&P cut their outlook from stable, a move which reflects the increased probability of a downgrade at some point in the future. Russia has committed as much as 15 percent of gross domestic product in budgetary and reserve funds to maintain banking liquidity, according to calculations made by the rating agency. At the same time S&P affirmed Russia's BBB+ long-term foreign currency and the A- long-term local currency ratings and the short-term ratings of A-2.

``We expect Russian corporate and financial sector default rates to increase as
debtors' access to official funds will vary,'' S&P said in the statement.
``Other uncertainties remain regarding what the economic policy response will be
to weakening growth, and whether the ongoing concentration of the financial
system in state hands is permanent or temporary.''

Russia's reserves fell $14.9 billion last week to $515.7 billion according to the latest data from the central bank. This was the third straight week of decline, and the fall comes after the central bank sold foreign currency to prop up the ruble. Obviously there are plenty of reserves left, but this is down from around $550 billion in August, so it can't go on forever, either. The ruble weakened yesterday by as much as 0.5 percent to hit 27.0664 to the dollar at one point, the lowest since July 2006. It later rebounded and was 0.1 percent lower on the day at 26.9538 at the close in Moscow.

Russian government bonds fell, with the yield on the 7.5 percent bond due 2030 rising 8 basis points to 10.94 percent, the highest for more than six years. The 12.75 percent bond maturing 2028 yielded 10.56 percent, up 84 basis points to a six-year high. The yield on the 11 percent bond due 2018 jumped 93 points to 8 percent, the most since 2004.

Micex Closes Again

Russia's Micex Stock Exchange slid again today, and suspended trading at 2:10 p.m. until next week. The next session will start on October 28, but with the Russian bourses now closed almost as often as they are open, it is hard to be sure about anything at this point. The so-called technical index fell more than 10 percent, triggering the halt, according to information available on the stock exchange Web site.

Russian stocks dropped for a third day, led by banks, on concern the turmoil in the country's equity markets is spreading to bonds and the ruble. OAO Sperbank, Russia's largestest bank, slid 15 percent and VTB Group, the second-largest, dropped 3.9 percent following a decline in Asian financial stocks. OAO Rosneft tumbled 9.4 percent as oil fell.

Crude dropped 1.7 percent to $69.68 a barrel in New York trading yesterday, after slumping 4.5 percent on Wednesday. Urals crude, Russia's export blend, fell 4.3 percent to $66.16 a barrel. Urals needs to average $70 a barrel next year for the country's budget to balance, according to the Finance Ministry.

Aid For The Crisis Hit Property Sector

Russia's government will decide "within days'' on how to help developers and reassure banks on loans for the building industry during an economic slowdown, according to Arkady Dvorkovich, an economic aide to President Dmitry Medvedev. Construction, agriculture, machine-tools building and retail are the non-financial industries the government plans to boost, along with small businesses across the economy.

Dvorkovich told reporters that the Russian government is discussing two possible mechanisms to help reassure banks vis a vis their lending to construction companies.

The government may offer to buy unsold apartments at a fixed price in residential buildings that are still under construction, once the buildings are completed. Another possibility is that the OAO Agency for Housing Mortgage Lending, the state-run mortgage agency, will refinance loans once construction of a residential building is completed.

Finance Minister Alexei Kudrin said earlier in the week that Russia's "overheated'' construction industry is facing difficult times,. Bank loans to construction companies increased 80 percent last year, compared with a 64 percent increase in borrowing for real-estate purchases, a sign that developers are over-building, according to Kudrin.

Soyuzcement, an industry group, have reported that cement producers are reducing plans for new factories as the credit crunch derails construction projects, while companies in industrial and services sectors right across the Russian economy are cutting back on jobs and investments.

Russia plans to establish a margin of spare oil production capacity as an alternative to cutting output, in order to indirectly influence prices according to Deputy Prime Minister Igor Sechin. He said Russia would not be joining in the OPEC cut back and argued that maintaining extra output capacity may allow Russia to produce oil ``at a volume that would allow more effective price parameters to be reached, ". According to Sechin "Oil has become more of a financial instrument than a commodity.''

Russian state revenue will more than likely fall sharply as the price of oil, the country's biggest export, plunges and capital flight accelerates on concern the global economy will enter a recession.

Russian companies and banks have applied for almost $100 billion of loans from state development bank Vnesheconombank to refinance foreign debt after credit markets worldwide seized up, threatening economic growth. Banks have asked for $64 billion, while companies have requested $33 billion, according to bank Chairman Vladimir Dmitriev. The bank's supervisory board plans to review the first 10 projects, from commodities and manufacturing companies, "in the near future". Prime Minister Vladimir Putin is chairman of the bank board.

Russia's government allocated $50 billion to Vnesheconombank, or VEB, as part of a more than $200 billion package to stem the country's worst financial crisis since 1998. Companies can apply for loans of between $100 million and $2.5 billion, Dmitriev said Oct. 13. Vnesheconombank will receive rescue funds after reviewing applications, Dmitriev said today.

Russian companies may default on almost a third of local-currency bonds as soaring borrowing costs make it "impossible'' to refinance the debt, according to Denis Gaevski, head of capital markets at Bank of Moscow, which the third-biggest arranger of ruble bonds. Companies may default on between 20 and 30 percent of the bonds, with retailers particularly vulnerable, he said.

Russian companies are estimated to have sold 406 billion rubles ($15.2 billion) of bonds this year, with almost all of the sales taking place before August, when Russia's invasion of Georgia triggered an investor exodus during which around $63 billion have left the country, according to a UniCredit estimate.

The average price of ruble-denominated corporate debt dropped to an all-time low of 86 percent of face value on Wednesday, from more than 100 percent in June, according to the MICEXCBI index of bonds traded on Moscow's Micex Stock Exchange. Bonds payable in 2009 by Moscow-based property developer Mirax Group traded for as little as 30 percent earlier this month, and were priced at 54 percent of face value in the middle of this week.

The average interest rate Russian banks charge to lend money to each other overnight - the so called MosPrime rate - oreached a record 21 percent last week, but was back down to 7.67 percent yesterday.

Slumping commodities prices, the war with Georgia and the seizing up of global capital markets prompted investors to pull money out of Russia, despite the best efforst of the Russian government to restore confidence and to inject money into the system to brake the slowdown. Last month the Russian government has pledged more than $200 billion for banks and companies to stem the worst financial crisis since 1998.

Russia’s Crisis Gathers Momentum

Edward Hugh — Tue, 07 Oct 2008 06:45:00 +0000

Russia's government plans to lend the country's biggest banks 950 billion rubles ($36 billion) for at least five years in an attempt to unfreeze credit markets, according to a new plan announced by President Dmitry Medvedev this morning. State-run OAO Sberbank and VTB Group, will get 500 billion rubles and 200 billion rubles respectively.

Some 450 billion roubles ($17.19 billion) of the 950 billion rouble subordinate loans package for banks will come from one of the National Wealth Funds according to Finance Minister Alexei Kudrin said on Tuesday. Russia's two oil wealth funds totalled $189.7 billion as of Oct. 1.

The Russian authorities, who are currently grappling with the worst financial crisis since the government's debt default in 1998, have already pledged more than $150 billion for banks and companies through loans and tax benefits (see details in this post here).

Stocks rose following the announcement, and with OAO Sberbank and VTB Group leading the advance. OAO Rosneft, Russia's biggest oil producer, pared back some of yesterday's 24 percent decline after crude rose in New York. The Micex Index gained 5.7 percent to 794.48 at 2:12 p.m. in Moscow, after falling 19 percent yesterday. The dollar- denominated RTS Index climbed 4 percent to 900.60 after retreating 19 percent yesterday, the biggest slump since the index began in 1995.

Share trading on Russia's bourses had earlier been suspended for a second day first thing this morning following yesterday's massive sell off. Russia's stock markets have now been halted nine times since Sept. 16.

The price of oil, which has slipped 38 percent from a record $147.27 a barrel July 11, snapped a four-day decline this morning, rising 3 percent to $90.47 a barrel.

Fence Mending

Russia is urgently seeking to mend fences with the west after the damage done by the conflict in Georgia, amid fears that the country faces a suuden slowdwon followed by an extended period of stagflation.

According to Igor Yurgens - former vice-president and executive secretary of the Russian Union of Industrialists & Entrepreneurs, and currently an adviser to Dmitry Medvedev - the Russian administration are trying their best to send signals of an improved business climate as Russia battles to restore investor confidence, which he recognises have been badly shaken by the cold war style rhetoric of recent weeks .

According to Yurgens - as quoted by the Financial Times this morning - both Dmitry Medvedev and Vladimir Putin understand the government needs to improve the climate for foreign and, mainly, Russian investors “who are sort of scared”. “A big financial crunch outside and a crisis of confidence and cold-warish kind of attitude inside was too much.”

Mr Yurgens told the FT that a slowdown in growth because “credit lines are closed” was inevitable with a fall of as much as 4 percentage points in GDP growth from the current 8 percent level. This provisional estimate of the growth rate at the end of 2008 seems realistic to me.

The head of a think tank advising the president, Igor Yurgens was pretty much a lone voice criticising Vladimir Putin this summer for his attack on Mechel, a coal and steel group, and his comments at the time was one of the factors which helped trigger the investor exodus due to concern over political risks.

The government’s reining in of its rhetoric “is visible and is being substantiated by some megadeals in the pipeline and signed, such as Eon Ruhrgas”, he said, referring to last week’s deal between Eon and Gazprom.

“You could feel a little bit of discontent with the hawkish rhetoric and you see the adjustment,” he said, adding that Mr Medvedev hoped to push ahead with cutting back bureaucracy and stimulating growth in the oil sector via tax incentives. I guess we can consider this mornings reported decision of the Russian authorities to extend a 4 billion-euro ($5.43 billion) loan to Iceland to be the kind of pacificatory measure Yurgens has in mind.

Meanwhile Andrei Sharonov, managing director of Troika Dialog, the Russia's oldest investment bank, warned yesterday that the country was "quite vulnerable" to the global credit crisis and with retailers and developers being particularly at risk, while Bloomberg cite Gulzhan Moldazhanova, chief executive officer of Basic Element, the investment group of Russia's richest man, Oleg Deripaska, to the effect that Russian retailers are currently being offered credit with an interest rate of up to 35 percent.

``There are two main consequences for Russia, a lack of confidence and a lack of liquidity,'' Sharonov, a deputy economy minister until resigning in July last year, said in a Bloomberg Television interview in Moscow. ``This problem is not only for financial institutions, but for the whole of industry, for the whole economy. Many companies feel these problems with debt financing.''

Disclosure Statement: Edward Hugh is a macroeconomist who maintains a premier set of blogs at Global Economy Matters and is a featured analyst at Emerginvest. Edward Hugh provides non-partisan information about world stock markets, and does not have any holdings in foreign equities. The information stated above should not be construed as investment advice, and Edward Hugh is not liable for any actions taken on said materials.

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.

Moody’s Downgrade Russian Bank Outlook To Negative

Edward Hugh — Fri, 26 Sep 2008 20:38:00 +0000

The outlook rating for Russia's banking system was changed today from "stable" to "negative" by Moody's Investors Services. The Banking System Outlook Report (published today) clited slowing asset growth, higher inflation, the slump in equities and funds leaving the country, all of which could result in deteriorating fundamentals for banks, according to the credit rating agency.

Moody's thus joins the other two large credit rating agencies - Fitch Ratings and Standard and Poor's in downgrading at least a part of the Russian financial system. Fitch said in a report last week that Russian real estate and construction companies were the most at risk as domestic and international banks curb lending, while Russia's credit outlook was cut to ``stable'' from ``positive'' at Standard & Poor's on Sept. 19. S&P's cited the growing pressure on Russian authorities to spend resources from the National Wealth Fund, undermining the nation's long term credit strength. Despite the outlook change S&P's continued to maintain Russia's BBB+ rating, the third- lowest investment grade ranking. Any downward move on this will mean loss of investment grade status, and the consequence will be that credit to both companies and households will become more expensive.

PNB Paribas now estimates that foreign investors pulled $56.7 billion from Russia from Aug. 8 to Sept. 19, up from their $35 billion figure two weeks ago..

Russian stocks, led by financial shares, slumped on the news of Moody's downgrade.

OAO Sberbank, Russia's largest lender, dropped 4.7 percent to 43.85 rubles, the biggest decline since regulators halted stock trading last week. The cost to protect bonds sold by VTB Group, the second-biggest lender, rose 3 basis points to 740, close to a record of 750, according to credit-default swap prices from CMA Datavision.

The Micex Index was down 1.5 percent today, hitting 1,079.04 at the close in Moscow. The drop so far this year is now 43 percent. Russian government bonds fell, raising the yield on the benchmark 30-year dollar note by 8 basis points to 6.98 percent.

Russia's international reserves, the world's third-largest, fell another $900 million last week to $559.4 billion, the lowest level in three months following central bank currency sales to support the ruble.

Russia Stock Markets Reopen, Surge and Close Again (Temporarily)

Edward Hugh — Fri, 19 Sep 2008 12:20:00 +0000

Russian stock exchanges had to halted trading again today (Friday) for the fourth successive day running, but this time the explanation was a rather different one - since stocks rapidly surged higher, following President Medvedev's announcement yesterday that the government was going to inject funds into the purchase of Russian stocks. Exchanges suspended trading after just hours of trading Friday after shares on the benchmark RTS and MICEX indexes shot up by 20 percent and 26.3 percent, respectively. Trading was only temporarily suspended and was expected to resume later today.

Stocks bounced back after the government rushed through a series of emergency measures — amounting to some $120 billion worth of relief — in the shape of increased liquidity to the banking sector and share purchases on the domestic markets. In fact Russia's RTS Index, which had previously been the best global stock performer this decade, had turned into the world's cheapest, at least on the price to earnings ratio measure, since at the time of closure it was valued at only 5.6 times the earnings of its 48 component companies, the lowest of any among the larger markets internationally.

Among the shares which surged the most were Russia's banks, and VTB Group and OAO Sberbank, Russia's biggest banks, benefited considerably from the perceived impact of the central bank decision to cut reserve requirements and the government pledge of up to $44 billion to shore up their liquidity. VTB jumped 1.63 kopeks, or 60 percent, to 4.35 kopeks, the biggest gain since the bank went public in the world's largest initial public offering last year. Sberbank rose 14.2 rubles, or 49 percent, to 43.01 rubles, its steepest gain in 10 years. Trading in both stocks was suspended for one hour at 11:05 a.m. Moscow time after their exceptional gains. Sberbank was suspended a second time on the Micex Stock Exchange at 12:58 p.m.

For more details on the background to all of this please see yesterday's extensive review on this blog.

Russia Stock Markets Reopen, Surge and Close Again (Temporarily)

Edward Hugh — Fri, 19 Sep 2008 12:20:00 +0000

Is Russia Just Another Emerging Economy, Or Is There Something Special About The Present Bout Of Financial Turmoil?

Edward Hugh — Thu, 18 Sep 2008 18:43:00 +0000

Russia's President Dmitry Medvedev today pledged $20 billion in financial support for the Russian stock market and cut oil taxes in an attempt to bring a halt to what has now become Russia's worst financial crisis in a decade. Medvedev took this action in order to try to lay the basis for a reopening of Russia's bourses tomorrow, following three days of irregular operation on the back of a 25% drop in the Micex Index. Following the announcement Russian shares traded in London surged and the interbank lending rate plunged.

The announcement followed a meeting between Medvedev, the central bank Chairman Sergey Ignatiev and Russia's Finance Minister Alexei Kudrin. Ignatiev also announced that central bank reserve requirements for Russia's banks would be eased in an attempt to provide more liquidity.

The tax cut for oil exports will come into effect on Oct. 1 and save producers and refiners $5.5 billion, Kudrin said. OAO Rosneft, the country's biggest oil company, climbed 23 percent to $5.76 in London trading at 3:40 p.m., while smaller rival OAO Lukoil advanced 8 percent to $56.20. Moscow's stock exchanges will open tomorrow after being halted by the market regulator.

The central bank cut reserve requirements for banks by 4 percentage points with effect from today, and this should free up an estimated 300 billion rubles for all lenders. The move is in addition to a Finance Ministry decision yesterday to make $60 billion of funds available to banks, including a three month injection of $44 billion into Russia's three largest banks - OAO Sberbank, OAO Gazprombank, VTB Group. VTB, the only one of the three that trades in London, had jumped 15 percent to $3.40 by late afternoon trading.

Russian sovereign bonds also dropped to the lowest in four years today, with the yield on the government's 30-year dollar bonds 32 basis points higher this afternoon at 7.3 percent at 1:23 p.m. in Moscow. The cost to of protecting this debt against default jumped 17 basis points to 300, the highest since May 2004, according to BNP Paribas prices for credit-default swaps.

The crisis seems to have been sparked by the default of brokerage Kit Finance on a number of repurchase agreements. This rather small scale incident in and of itself seems to have produced something approaching panic across Russia's financial markets. Evidently investors have become increasingly nervous about holding Russian assets amid the mounting global financial turmoil. In fact Russia seems to be facing something of a "trifecta" at the moment, which the normal nervous about holding riskier emerging market assets adding to the perceived vulnerability of the Russia economy in the face offalling oil prices and (added to both of these) are the concerns that have been provoked by Moscow's decision to "go it alone" in recognising Georgia's two separatist regions. All of this has coalesced to produce an especially toxic cocktail which despite Russia's substantial oil fund safety net, and the very large quantity of foreign exchange reserves parked at the central bank, seems to be proving very hard for the Russian financial system to simply brush aside.

The real point I would like to stress right however, is that while Russia's financial markets are currently taking a pounding for relatively fortuitous reasons, the underlying macroeconomic issues were always going to raise their head, as I have tried to spell out in my two extensive recent reviews of the Russian economy, Russian Inflation, Too Much Money Chasing Too Few People? and Russia's Consumption-Driven Inflation: Will It All End In Tears?. Basically Russia is suffering from some sort of modern variant of "Dutch disease", whereby the revenue generated by the sharp oil boom has accelerated the rest of the economy way beyond its short term capacity level (especially given the underlying demographic issues Russia faces) and this has simply produced a very pronounced spike in short term inflation, coupled with deteriorating competitiveness in Russia's domestic industrial sector. So even though it is obvious that we are not about to witness meltdown or anything approaching it in Russia at the present time, what has happened over the last week is an early warning sign. Things are not all for the best in the best of all possible worlds here, and even if a resurgence in oil prices during 2009 will once more paper over the multitude of seismic cracks which are emerging, the deep and endemic problems will in fact only worsen if what we are treated to is simply more and more of the same on the policy front.

Industrial Output Weak Again In August

In many ways the achilles heel in Russia's current development process is not to be found in the financial system - $550 billion or so in foreign exchange reserves and another $160 billion in the SWF should certainly serve to protect the economy from all but the most severe of shocks - rather the achilles heel is Russia's nascent industrial sector, which is being steadily choked into quiesence by a combination of high domestic inflation and long term labour shortages produced by Russia rather special demographic profile. Russian industrial production expanded at a slower pace than most observers were hoping yet one more time in August according this week's data from the Federal Statistics Service. Industrial output was up 4.7 percent, compared with 3.2 percent in July and 0.9 percent in June. Even the apparent acceleration over July is really only a mirage based on base effect variations from 2007, since output actually fell 0.9 percent on the month, as foreseen in the VTB Manufacuring PMI survey.

I think it is important to bear in mind here that Russia's economy actually grew at an annual 7.5% in the second quarter, while manufacturing growth was nearer 5%. Which means that in a "newly industrialising country" the weight of industry in the economy is declining. This is obviously unsustainable, since however resource rich Russia maybe, you cannot live from oil alone, especially when your oil output has a ceiling. Basically the more living standards in Russia rise, the less important oil will become as a percentage of GDP, and the more dependent the Russian economy will become on other sectors. This is why the current consumer price and wage inflation levels are no mere trifle.

Obviously the Russian authorities have deperately needed to get a grip on the inflation problem, and this is just what the central bank has clearly failed to do, with the annual rate rising again to 15 percent in August, up from 14.7 percent in July. So one part of the present financial crisis is clearly an institutional crisis of confidence. With the benchmark interest rate at the central bank currently at 11%, Russia has negative interest rates of 4% which obviously make it very easy to fuel a lending driven consumer and construction boom, but very much more difficult to communicate to observers that you actually know what you are doing. So while the fx muscle that the central bank can put to work in the short term to stamp out the present will in all probability work, they are clearly not able to prevent such forest fires breaking out in the first place, and we should, of course, expect more. Brazil's central bank which currently has interest rates at 13.75% while inflation is just over 6% (ie 7.5% positive interest rates) is currently justifiably earning for itself a reputation as Latin America's new Bundesbank, a way in which it would never ocur to anyone to refer to the Russian equivalent. And the comparison I would make with Brazil is not meant idly, since Brazil is, of course, also an oil and resource rich emerging economy.

So it is clear that Russia has special problems, which set what is happening in Russia rather apart from what is currently happening in a lot of emerging market economies.

Rout On The Bourses

Both Russia's MICEX and RTS exchanges remained effectively closed first thing this morning following trading being suspended again yesterday (Wednesday) - they were in fact open for less than two hours - in order to prevent a further sell-off on top Monday's record-breaking falls. The ruble-denominated Micex Stock Exchange did resume some very limited trading at 11:00 this morning, but only limited operations were authorsied - the decision was effectively simply to allow participants to close repurchase deals still outstanding from Sept. 16 and Sept. 17.

Russian stocks have now plunged around 60 percent since their May peak, and while the Micex did initially gain 7.6 percent in initial trading yesterday, this gains were very rapidly erased and then turned negative, as the index plunged as much as 10 percent before a halt was called. Russia's dollar-denominated RTS index stood at 1,058 points when trading was halted, nearly 58 percent down from its peak of 2,498 points reached in May.

Emerging Market Woes

In part Russia's problems only reflect more general "risk aversion" issues which are facing all emerging market economies. Emerging-market stocks have fallen the most in 11 years this week, their currencies have been falling, and the cost of insuring emerging market bonds has rocketed as rising lending rates and tumbling commodities have prompted investors to sell riskier assets.

Every emerging stock market in MSCI indexes has been retreating this month, and the MSCI Emerging Markets Index fell 2 percent yesterday to 768.92 a time, its lowest level since October 2006. The index is now down 19.59% since the start of the month, and 29.27% over the past 3 months.

The Russian MSCI index, in comparison, is down 36.1% on the month, and 54.2% over the past three months.

Of course, to put the recent fall in perspective, this recent fall follows several years of rising stock values, and thus is to some extent cyclical, as can be seen from the 4 year MSCI index chart (below).

Falling Oil Prices

In the forefront of the fall in Russia share prices have been energy stocks, including Russian oil producers like OAO Gazprom and OAO Rosneft, who have declined substantially following the sharp drop in crude prices. Gazprom, the world's biggest natural-gas producer, lost 18 percent to 158.41 rubles in the latest turmoil, while Rosneft, Russia's largest oil company, sank 22 percent to 132.20 rubbles.

Oil prices were down again this morning, after bouncing back somewhat yesterday. Light, sweet crude for October delivery fell 97 cents to $96.19 a barrel in electronic trading on the New York Mercantile Exchange midafternoon in Singapore. Overnight, the contract rose $6.01 to settle at $97.16, after having dropped $10.03 the previous two trading sessions. But the trend is decidedly down, and crude has now fallen more than $50 — or over 35 percent — from its all-time trading record of $147.27 reached July 11.

Urals crude peaked at $140.80 a barrel on July 3, and has fallen about 36 percent to $90.01 since then. Still, the oil price averaged $108.65 a barrel so far this year, compared with $63.54 a barrel January 02 through Sept. 18 last year.

Foreign Exchange Reserves

Evidently the Russian economy is in no evident danger of short term default, and foreign exchange reserves, which stood at $560.3 billion on September 12 (according to data from the Russian central bank) - the third largest globally, after China and Japan - are evidently ample. In addition Russia has a $163 billion SWF (the National Welfare Fund), which is split into two parts, $130 billion in a reserve fund, and $33 billion in the National Wealth Fund (the SWF proper).

Nonetheless, the reserves have dropped quite sharply since early August, and are now down some $37 billion since their August 8 peak, and reserves declined by $13.3 billion to $560.30 billion in the week ended Sept. 12, after falling $8.9 billion in the previous week. 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 (June 30, 2007.

Part of this reduction in reserves is a result of central bank intervention in support of the ruble, since Russia operates a policy of trying to maintain the currency steady within a trading band set against a basket of euros and dollars. Evgeniy Nadorhsin, a senior economist at Trust Investment Bank in Moscow, estimates that the central bank sold approximately $3 billion in fx reserves last week.

So Where Do We Go Now?

This is very hard to say. Clearly we should expect the economy to slow substantially in the last quarter of 2008 and the first quarter of 2009, as credit conditions tighten for households, and the decline in oil prices restricts revenue flows. As just one indication of the worsening credit conditions we could note that Russian 5-year credit default swaps are trading with a spread of around 253-255 basis points, little changed this week but more than double the level seen before the start of the conflict with Georgia.

On the other hand Russia is hardly the Baltics, so we should not expect the economy to go into a nosedive. A lot depends on the view you take about the future of energy prices. Since my own view is that the global economy will slow down considerably - in addition to the reduction in growth rates we have seen so far this year -following the most recent bout of financial turmoil, and this will serve top bring oil prices down even further, but we should see a floor, at around $80 perhaps.

More importantly I am not expecting a 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, but a solid core of emerging economies may well take off again quite rapidly as we move into 2009.

As we can see in the JP Morgan EMBI+ index (see below), bonds from these economies have taken one hell of a battering in September. Looked at the other way round, the extra yield investors demand to own developing nations' bonds instead of U.S. Treasuries has been going up, and today rose 2 basis points to 4.24 percentage points, the widest spread since September 2004, according to the EMBI+ index. So EM bonds have been taking a battering but they have taken a battering because of nervousness about the implications of a financial crisis in the developed economies, rather that as the result of any inherent problems in their own ones. That is what sets this crisis apart from the 1998 one, and that is what means that the financial markets in these economies will in all probablilty bounce back again quite substantially once all the nervousness dies down. Basically most of these markets are neither "oversold" nor are they "maxed out".

What is interesting about the above chart is the way in which things seem to have really taken a decisive turn for the worst in late August, and it is curious to note on the chart below that the Russian MSCI index also started to deteriorate further starting on or around 2 September (see chart below which is from May 2008 to date). So while the Georgia factor may have made people nervous, other, deeper, structural factors are obviously at work.

And while I am on deep structural factors, and the MSCI Emerging Markets index, I would like to conclude by pointing out that the decline since mid May has been pretty generalised, and in some sense is obviously cyclical. The point is that this fall will at some point hit bottom, after which time we should be ready to see a rebound, as investors move in and snap up what will obviously be seen as very attractive buying opportunities.

Russia’s Politics of Isolation Leave it Economically Stranded in a Time of Crisis

Money Morning — Thu, 18 Sep 2008 00:13:01 +0000

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Fed Steps in and Bails Out AIG to the Tune of $85 Billion in Taxpayer Funds

Money Morning — Thu, 18 Sep 2008 00:07:52 +0000

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RTS Index Tumbles and Fitch Warn On Investor Sentiment

Edward Hugh — Tue, 26 Aug 2008 14:11:00 +0000

Russian President Dmitry Medvedev said on Tuesday he had signed a decree recognizing the Georgian rebel regions of South Ossetia and Abkhazia as independent states. In the aftermath to the diplomatic chaos this decision is causing Russia's RTS Stock Index fell more than 6 percent to hit its lowest level since 2006 and the ruble dropped significantly.

The RTS index of 48 companies posted the biggest decline among 89 global equity measures tracked by Bloomberg today, while Russia's currency slid to its lowest level in almost seven months against the dollar. Credit-default swaps on Russian debt climbed 7 basis points, according to CMA Datavision prices in London, as the U.K. Foreign Office ``categorically'' rejected President Dmitry Medvedev's move and Italy and France expressed regret.

Medvedev's statement today accelerated a decline sparked by a drop of more than 2 percent in crude and slumping metals prices. The dollar-denominated RTS Index fell 4.3 percent to 1,576.36 at 5:48 p.m. in Moscow, extending its third-quarter drop to 32 percent. The ruble-denominated Micex Index slumped 2.1 percent to 1,292.92, the lowest level since September 2006.

VTB Group, Russian's second-biggest bank, plunged 3.2 percent to 6.63 kopeks, the lowest level since its initial public offering last year.

Analysts Shocked By Gazprom Plans

OAO Gazprom, the country's biggest publicly traded company, sank for a third day today, losing 0.9 percent to 230.79 rubles. Today's Gazprom fall follows a 2.9 percent fall last Friday after analysts said they were ``shocked'' by the company's plans to raise its investment budget to more than $40 billion this year.

Russia's natural-gas exporter has indicated it may raise its investment budget for 2008 by about 25 percent. Gazprom last month already increased the budget for 2008 by 16 percent to a record 822 billion rubles ($33.8 billion).

``We're shocked by the magnitude of the numbers, especially given that the company revised its investment plans only a month ago,'' Troika Dialog analysts Oleg Maximov, Valery Nesterov and Alex Fak wrote in a note to investors today. ``This raises questions about whether the management actually intends to generate any meaningful free cash flow.''

JPMorgan Chase & Co.'s Moscow-based analysts said in a note on Friday that they ``doubted'' the ability of what is Russia's biggest company to invest that amount of money efficiently. The spending signals "potential value destruction" for the stock, the bank said in the note.

Yields on Russian Credit Default Swaps Rise

Credit-default swaps on Russian government debt rose 7 basis points from Aug. 22 to 135, according to CMA Datavision prices at 12 p.m. in London. Contracts on Gazprom rose 11 basis points to 267, CMA prices show. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates a deterioration in the perception of credit quality; a decline signals the opposite.

Fitch Warns On Investor Sentiment

Rising tension with the West could damage foreign investor sentiment towards Russia, according a statement from the credit ratings agency Fitch after the announcement, although they stressed that they do not immediately see Russia's sovereign rating coming under threat. Fitch head of emerging European sovereigns Edward Parker did however go out of his way to underline how conditions for Russian corporate and quasi-sovereign borrowers may become more difficult in the aftermath the decision to recognise Georgia's rebel regions.

He said the fallout of the conflict may also affect sentiment towards other Central European and ex-Soviet states but that the oil and gas-rich country's vast foreign reserves eased the risks to the Russian economy itself in the short term. Fitch rates Russia as "BBB+" with a stable outlook.

"In terms of the cost of the conflict, the impact on the economy is negligible," Parker told Reuters in a telephone interview. "We're not expecting to take a negative action with regards to Russia's rating. The main potential impact on Russia is through an impact

on capital flows into the country... affecting foreign investment."

Parker said Russian foreign exchange reserves saw a slight fall last week but that it was too soon to say if the trend would continue."It's still very early days to assess the impact," he said. "Given that Russia has $580 billion in foreign exchange reserves, it has the ability to ride out weekly changes." But he said some Russian corporate borrowers as well as quasi-sovereigns - firms seen almost indissolubly tied to the state - might face problems with foreign lenders.

"There are a significant number of corporates who are very dependent on international capital markets," he said. "There could be an impact on the Russian banking system as well."

Investor sentiment towards other regional economies was also being affected, he said. Ukraine is seen amongst the most exposed, with any fall in foreign direct investment potentially making it harder to cover their current account deficit. Parker said there was already some impact on investor sentiment towards the Baltic states as well as Central European countries such as Poland, which has angered Russia by agreeing to house a U.S. missile defence shield.

"We don't see any immediate impact -- it's more a potential impact if Russia decides to take more aggressive action in due course," Parker said. "But it is affecting investor sentiment."

He said Fitch was keeping a close eye on other "frozen conflicts" in the region such as Moldova's Transdniestria region - which like Abkhazia and South Ossetia is home to Russian peacekeepers - as well as in Azerbaijan and Armenia.

Some General International Comments

Carl Bildt, Foreign Minister, Sweden

"That the Russian government leadership now has chosen this route means they have chosen a policy of confrontation, not only with the rest of Europe, but also with the international community in general." "The decision represents a Russian choice of path that will have sweeping consequences for a long time to come." "The decision represents a breach of international law and basic principles of stability in Europe, which is as obvious as it is intentional."

Franco Frattini, Foreign Minister, Italy

"The Balkanization of the Caucasus on an ethnic basis is a serious danger for everyone."

British Foreign Ministry Spokesperson

"We reject this categorically and reaffirm Georgia's sovereignty and territorial integrity." "This is contrary to obligations that Russia has repeatedly taken on in (United Nations) Security Council resolutions."

French Foreign Ministry Spokesperson

"We consider this a regrettable decision and I recall our attachment to the territorial integrity of Georgia."

Uwe Halbach, Caucasus Expert, German Institute For International and Security Affairs

"There will scarcely be a neighbor of Russia's that won't judge this negatively." "Russia will face accusations of breaching international law by Europe and much of the rest of the world. Hardly any other state will follow this (recognition). Russia will stand relatively alone with this step, in contrast to the recognition of Kosovo."

"(Europe) is standing relatively helplessly ... as regards an effective response to this Russian statement."

"Russia knows that there are very different views among Europeans about sanctions, and that they have limited capacity to impose sanctions. Economic sanctions boomerang back on those who impose them, and diplomatically ... you can't break off all diplomatic contact if you still hope to exert some influence on Russia."

Ondrej Soukup, Association For International Affairs, Prague

"We could expect it because (the regions were) de facto independent, and especially in the last two, three years, Russia has invested large money into both republics. Especially after the conflict in South Ossetia, it was just a question of time before they would recognize them officially."

"The Russians are saying there is a Kosovo precedent, but this situation is completely different in each of the republics."

"I don't think (there could be a return to fighting) because basically they achieved all their goals, except maybe the removal of (Georgian President Mikheil) Saakashvili. On the other hand, his position is now quite weak."

Vladimir Osakovsky, Economist, Unicredit Aton

"It's likely capital outflow will continue and probably even intensify on the back of a possible escalation of the conflict and possible economic sanctions against Russia."

"Capital outflow is likely to add to the weakening of the rouble which we have been witnessing recently."

Erik Depoy, Strategist, Alfa-Bank

"The whirlwind crescendo of bad news seems never-ending. But the lower this market goes, the more attractive it becomes for fundamental-based investors who have a longer-term horizon."

"We're in a very, very thin market right now. The second half of August is the peak of the vacation season ... it's almost dysfunctional right now."

"This is one of the worst corrections we've seen in a decade ... it's bigger than the one in 2004, bigger than the one in 2006."

"Across the board the valuations speak for themselves but -- and it's a big 'but' -- no-one wants to be the first to stick their foot back into the market."

"It's self-fulfilling: the fewer people buy, the worse the prices get. What you need is an indisputable catalyst for the domestic market. At this point, the only thing we can think of is some kind of announcement on the oil tax regime. That would be indisputably linked to the major part of the market, have an immediate bottom-line impact and draw some people in."

David Aserkoff, Equity Strategist, Renaissance Capital

"If you look at the RTSI futures, they dropped about 25 points on the news Russia had recognized Abkhazia and South Ossetia. I think what investors have been hoping in the last couple of weeks is for the government to take active steps to minimize the conflict. And the recognition of these two entities is clearly a step in the wrong direction from the stock markets' point of view."

"This is a symptom of the poor sentiment toward Russia on the international public level, on the domestic political level, and oil prices are at a new low in recent days and weeks. It is very hard to see any positives for the Russian market at the current time."

"However, every single stock on MICEX at this point is in the red, and well in the red. You are seeing a host of technical indicators that are telling you this market is grossly oversold. It is hard for me to see how the news gets worse unless oil dips below $105."