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Monday, February 9, 2009

Russia Heading Towards The Abyss?

by Edward Hugh: Barcelona

“A significant amount, if not all, of the speculative attacks on the ruble are funded by the central bank itself,” said Vladimir Osakovsky, Moscow-based economist for UniCredit

The underlying dynamics of the current ruble devaluation are provoking more than a little consternation in Russia at the moment. In the forefront of the debate are data from Bank Rossii (the central bank) which show they lent 7.7 trillion rubles ($214 billion) in overnight and seven-day loans (secured with bonds or other collateral) in just 16 trading days last month - this was about double the 4.8 trillion rubles provided via so-called repurchase auctions in December. Over the same period the ruble lost 18 percent against the dollar. The question is, is there a connection here?

Russia's banking authorities now certainly seem to think there is and Kommersant reported (Friday) that policy makers planned to reduce bank loans in an attempt to limit bets on the ongoing ruble devaluation. As a result the ruble remained safely within the target band all day Friday, and there was no need for any kind of intervention.

The decision follows several days of severe criticism over the way in which Russian banks appeared to be using the loans being made available to them. Oleg Vyugin, former deputy central banker and currently chairman of MDM Bank has suggested that Russia's banks have now accumulated about $40bn in hard currency deposited for their clients on accounts with the central bank and another $40bn on accounts held with foreign banks.

Policy makers lifted the rate on overnight and seven-day loans obtained through the auctions by 1 percentage point to 11 percent this week, the highest since at least November 2007. Banks used “almost all” the money from loan auctions to bet against the ruble, Natalia Orlova chief economist at Alfa, Russia’s largest non-government bank, said. Policy makers “have basically fueled the speculation on the ruble themselves.....The market is intent on testing the central bank’s ability to spend reserves and they’re going to really have to tighten liquidity, or something, if they want to have a hope against that.”

“If they really wanted to stop speculation, they have to raise the rates significantly, say to 20 or 30 percent, for a short period of time,” said Evgeny Gavrilenkov, chief economist at Moscow-based brokerage Troika Dialog. “One day they have to say: Give me my money back, no more repo is available.” “They have to raise interest rates if they want to stop speculation.....But there is still a lot of concern among the authorities that the banking sector might collapse.”

According to Bloomberg, Russia's banks bid for 505 billion rubles in repo auctions on Thursday, more than the 402 billion rubles actually lent. Banks also requested 139 billion rubles in an auction of unsecured loans on 3 February, about six times the 23.5 billion rubles provided. The possibility of obtaining such loans was opened up to over 100 Russian banks in November as part of a plan to boost liquidity amid the seizure in global credit markets. The extra funding has helped lower the average interest rate banks charge each other for overnight loans, known as the MosPrime rate, to 10.83 percent on Wednesday from a record 25.17 percent on Jan. 27.
Bank Rossii may send representatives to individual banks to check on their foreign-currency holdings, said Stanislav Ponomarenko, chief economist in Moscow at ING Groep NV. President Dmitry Medvedev told the Federal Security Service, Russia’s spy agency, to monitor the allocation of state funds on Jan. 29, saying it is “doubly criminal” for investors to get rich off the crisis.

VTB GDP Indicator Shows Severe Contraction

In any event, while a lot of people in the Russian establishment seem busy trying to decide which side they are batting for in all this, a Russian economy which is basically being starved of liquidity is now spirally downwards and downwards. The most recent piece of evidence for this comes from the latest reading on VTB’s Russian GDP Indicator which showed that economic output contracted at a year on year rate of 4 percent in January, down from December’s 1.1 percent decline, and November's 2.1 percent expansion.

According to Russian economy Ministry estimates the economy will contract by only 0.2 percent this year after expanding 5.6 percent in 2008, so this estimate now seems hopelessly out of date. If we look at the monthly contraction rate as a reflection of the current quarter on quarter contraction, we find a rate of minus 1.6%, which means that the present rate is something like a 6.5% annualised shrinkage rate. At present this is stationary and not accelerating, but it is quite strong, especially for an economy which only six months ago was expanding at a 6.5% annualised rate.

Services Contract But Less Strongly Than Manufacturing

Russia's services industries are still not contracting as fast as the manufacturing sector (34.4), but with the Russian economy shedding 800,000 jobs in December the outlook for improvement is not exactly bright. The PMI reading was little changed - and close to December's all-time low rising to 36.8 in January from 36.4 the previous month. Since a reading over 50 indicates expansion, and below 50 a contraction, this is still a pretty hefty rate of shrinkage.

Meantime retail sales grew at the slowest annual pace in nine years in December while disposable incomes fell 11.6 percent.

“Business activity and incoming new business contracted further to record lows due to still weak demand,” said Svetlana Aslanova, senior corporate analyst at VTB Capital, in the report. “Low levels of workloads have forced companies to cut costs” resulting in jobs cuts, she added.

New Policies From The Administration?

With declining reserves in the background, and oil prices which may well not rebound very much this year to concentrate their minds, the Russia adminstration indicated on Wednesday that it was about to make a significant change in the policies it is deploying to fight the financial crisis. The move basically involves switching from bailing out individual companies to attempting to directly support the economy through the banking sector. At the same time Moscow is planning large budget cuts in an attempt to limit the fiscal deficit since letting it run too high threatens to eat up Reserve Fund resources far too quickly if oil prices remain low for any length of time. The general impression is that the administration has now lost hope it can avoid the crisis simply by increasing public spending and is instead digging in deep in an attempt to endure what might turn out to be a rather prolonged recession.

The policy change was announced by Igor Shuvalov, Russia's first deputy prime minister, who stressed the government was deliberately choosing to allow gross domestic product growth to fall to zero or below in 2009 to stabilise the economy and maintain foreign exchange reserves. He was thus explicitly rejecting the advice of those economists who had suggested using the reserves to finance a budget deficit of 10 per cent of GDP to promote growth. Of course the risk here is that this will produce a much stronger GDP contraction with unknown social consequences.

Shuvalov also indicated the government would invest “several percentage points of GDP” in strengthening the banking sector, covering “possible future losses” and supervising a consolidation plan that would see the number of banks cut from 1,100 to 500. Alexei Kudrin, the finance minister, confirmed during a visit to London that the state was preparing to inject $40bn (€31bn, £28bn) capital into banks provided that the money was channelled into the real economy. This would follow last year’s Rbs960bn package of subordinated loans.

Shuvalov indicated some key industrial companies would continue to get priority, headed by military enterprises, Gazprom, the gas monopoly, electricity groups and the state railways. This is a far more tightly focused target than the previously announced list of 295 industrial companies deemed worthy of financial support that included oligarch-led groups such as Rusal, the aluminium company, and Norilsk Nickel, the metal combine. Shuvalov suggested that the state should not have lent $4.5bn to Rusal, Oleg Deripaska’s aluminium group, on the security of its 25 per cent stake in Norilsk Nickel, the metals company, when it was clear these shares were worth only $1.5bn.

In line with the change in policy Vladimir Putin gave the go ahead on Thursday for a second wave of bank bail-outs to extend up to Rbs1,000bn ($28b) in order to refinance the banking sector with new capital and subordinated debt in an effort to transfer the burden for bailing out companies on to commercial banks. Of the three big state-controlled banks, VTB is to receive Rbs200bn in new capital, state-owned VEB is to receive Rbs100bn in capital and Rbs100bn in subordinated debt, and Sberbank, the huge savings bank, may receive funding in the region of Rbs500bn.

The moves will increase the state’s stakes in these three banks, boosting its role in the Russian economy. The state’s stake in the three banks are Sberbank 61 per cent, VTB 77.5 per cent and 100 per cent VEB. Vladimir Putin said Moscow could also inject up to 100bn roubles in subordinated loans – Tier 2 capital under international banking rules – into private banks but said the government would not seek stakes in return.

Andrei Sharonov, a former deputy economy minister, who now works as
managing director of Troika Dialog, the Moscow investment bank, said the second
bail-out of the banking system was part of an effort to switch the government
anti-crisis programme to the banking system instead of bailing out individual
companies, which must repay some $140bn in foreign debts this year.

Danske Bank A/S, which ranks itself among the five biggest traders of the ruble
through Finnish subsidiary Sampo Bank Plc, said yesterday the ruble will be
allowed to trade freely “within weeks,” because pressure on the currency won’t
abate after the decline in oil prices, according to Lars Christensen, Danske’s
head of emerging -markets strategy. Urals crude, Russia’s chief export blend,
has fallen 70 percent to $43.01 a barrel since reaching a record in July, below
the $70 average required to balance the government’s 2009 budget. Energy
accounts for more than 70 percent of Russia’s exports.