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Claus Vistesen and I also have a number of country briefings and study papers available for download in PDF format. The latest are:

Bank Rossii Eases Further As Russia's Economy Contracts At A Record Rate

The ECB's Balance Sheet At A Glance.

Friday, December 19, 2008

Russia's Macro Data Starts To Confirm The Severity Of The Downturn

The Ruble Devaluation Continues

The ruble fell the most in nine years against the euro this week after the central bank widened its trading band twice and allowed the currency to fall by a further 3.8 percent, following last week's 1 percent devaluation. The currency retreated to a maximum of 5.8 percent over the week, although it recovered somewhat and was up 0.1 percent again today (Friday) over yesterday, trading at 39.1772 per euro at midday in Moscow. The currency has now fallen 16 percent against the dollar since the start of August, and added another 1.3 percent to its losses today, hitting 27.8412 per dollar and falling 1.1 percent (to 33.1020) against the currency basket which is targeted. The ruble thus lost 3.9 percent to the basket this week, in the process experiencing its sixth weekly drop.

Foreign Exchange Reserves Continue To Decline

Russia’s currency reserves fell $1.6 billion to $435.4 billion during the week to 12 December. When compared with the drop of $17.9 billion the week before you could reach the conclusion that the rate of outflow was steadying up, but this does not seem to be the case, since the size of the drop is largely a by-product of the valuation effect produced by the change in the USD-Euro cross, since we need to remember that euro, which constitutes around 44 percent of the reserves, was up 5.1 percent against the dollar during the week. The pound also gained 1.8 percent against the dollar. Hence the dollar value of the euro and pound sterling holdings (about another ten percent of the basket) were up. Vladimir Osakovsky, an economist in Moscow at UniCredit has done some calculations, and he estimates that Russia's central bank probably sold about $12.5 billion in foreign currency last week. Chris Weafer, chief strategist at Moscow bank UralSib, comes up with a similar estimate, and suggests the bank probably sold about $11.5 billion to counter the ruble’s slide, given that the euro component of the reserves increased in value by about $10 billion. (Actually, anyone interested in the somewhat ironic dimension of having so much analysis of Russia's crisis from economists at Unicredit Moscow, while back in Italy the bank's shares are currently falling mightily on a Merrill Lynch downgrade due to their Eastern Europe exposure, may be interested to read this post of mine).

Producer Prices Fall Sharply

So the ruble is falling and the reserves are flowing out at a rather fast rate, but this is not producing inflation in Russia - in fact quite the contrary, disinflation is very strong in Russia right now, and indeed if things continue at this rate (especially given the sharp contraction in internal demand) deflation and not inflation is going to be the big headache. Some evidence to indicate this danger can be found in the fact that Russian producer prices - which are widely regarded as an early indicator of forthcoming inflation - fell sharply again in November, pushing the annual rate to its slowest pace since March 2007 as demand for material for industrial production weakened rapidly. The cost of goods leaving Russian factories and mines fell 8.4 percent between October and November, while the year on year rate of increase dropped to 4.2 percent, according to data out today (Friday) from Rostat. This compares with 17.4 percent y-o-y rate in October, the Federal Statistics Service in Moscow said today.

The November fall follows a 6.6 percent monthly drop in October, and it is clear that the rate of disinflation in producer prices is extraordinarily rapid, and it may be that we will soon enter outright price deflation. The biggest difficulty is the almost complete lack of control by anyone in authority and the with tecnical expertise to adequately handle macro economic management, whether on the upside or the downside. This is quite simply all terribly dramatic.

Consumer price inflation is also slowing, and was down to 13.8% in November, from 14.2% in October. Russia's consumer price inflation rate was running at 0.1 percent in the week between December 9 and 15, according to the Federal State Statistics Service. Inflation was thus 0.3 percent for the month to date and 12.9 percent for the year to date, compared to 0.7 percent and 11.4 percent in the same periods in 2007. So disinflation is already well at work even in consumer prices. 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.

Rapid Economic Slowdown

More evidence for the rapid velocity of the economic slowdown is provided by the index of key economic activities, which has fallen back from a year on year high of 10.7% in April to a 2008 low of 2.6% year on year in October. This would seem to indicate that the economy may well have been contracting month on month between September and October, although as with much of the data which follows we do not have a lot of systematic access to direct month on month comparisons to be able to closely scrutinise what is happening.

Another short term measure we have - industrial production, which is responsible for about 40 percent of Russian GDP - contracted at a year on year rate of 8.7 percent in November, the fastest rate since the 1998 financial collapse. As a result Russia’s Economy Minstry now forecast that the eonomy may contract in the first two quarters of next year, and full year growth of 2.4 percent in 2009.

My feeling is that these estimates may well be too high, and that the economy may well already be contracting in Q4 2008 (in fact Deputy Economy Minister Kelpach more or less admitted that this was the case in his earlier slip of the tongue), so we could easily see an outright GDP contraction in 2009 both in real terms and, much more seriously, in nominal terms (if we hit price deflation, everything depends on how fast the authorities let the ruble devalue). A contraction in nominal GDP would be very hard for the Russian authorities to handle - since we would be into using unconventional tools in an economy where policy managers have not yet learnt to satisfactorily use conventional ones. Month on month industrial output was down 10.8%.

Unemployment is also rising, as are overdue wages, which were up 93% over the previous month. The unemployment rate rate rose to 6.6 percent in November, which is the highest since April, but still comparatively low by historic standards, although experts suggest we could easily see this number rise towards 10% to 11% in 2009.

The total number of unemployed reached 5 million people, compared with 4.624 million in October, or 6.1 percent, according data from Rostat. Wages, however, are still rising at this point, and the average monthly wage rose an annual 7.2 percent in November to 17,995 rubles, while real disposable income fell 6.2 percent.

Russian retail sales also slowed in November and sales increased at an annual 8 percent, still quite strong, but down considerably from a revised 12.4 percent in October. Still this is the slowest pace of expansion since November 2003 and more significantly sales fell 3.4 percent from October. Retail sales have increased at an average annual rate of about 13 percent since 1998. However these have to a large extent been fuelled by unsustainable wage rises, and large scale consumer borrowing. Loans to individuals rose 58 percent in 2007, reaching 2.97 trillion rubles ($110 billion) as of 1 January 2008.

Capital investment has also been slowing, and growth was down to an annual 3.9 percent in November, the lowest rate since January 2005, according to the statistics office. Investments grew 6.9 percent in the previous month.

Thus an incredible trifecta - a unilateral decision to recognise Georgia's two separatist regions, a 66 percent fall in oil prices and the worst global financial crisis since the Great Depression - has concocted itself, and has lead to a sharp spike in investor unease which has provoked the withdraw of around $211 billion from Russia (estimate by analysts at PNB Paribas) since that fateful day when the tanks went though roaring through the Roki tunnel, and we now await to see just how sharp "sharp" means when we are talking about the slowdown in Russian GDP in 2009.

Wednesday, November 19, 2008

Russia's Economic And Financial Meltdown Continues Apace

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.

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.

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 & Poor’s to cut its Russian credit rating on for the first time in nine years.

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.

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.

GDP Growth Slowing Rapidly

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.

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!

The Inflation Worm Is At The Heart Of The Problem

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.

In 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.

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, including yours truly, where arguing it would do. Frank Gill from Standard and Poor's puts it like this.

Accompanied 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.

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.
Frank Gill, director of European sovereign ratings at Standard & Poor's in London, writing in the Moscow Times

The 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.

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.

``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''.

Finance 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.

FDI Drying Up?

Russia'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.

S&P Downgrade

Russia’s long-term debt rating was lowered earlier this month - for the first time in nine years -by ratings agency Standard & 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 S&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.”

“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, S&P’s primary credit analyst in London, in the statement.

S&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.

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 S&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.

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".
“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.

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.

Services And Manufacturing Contraction

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.”

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.

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.

Is Russia On The Brink Of Outright Recession?

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.
“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.

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.

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.

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 in applying this methodology to Spain here), 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.

Whatever 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.

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.

We also need to consider the problems Russia may now have in financing any such current account deficit (remember this one one of S&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.

All 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.

Monday, November 10, 2008

Massive Foreign Reserves Outflow Puts Russia's Ruble Trading Band Under Threat

Russia's currency reserves, the third-biggest in the world, are falling steadily as tumbling oil prices and an exodus of capital are piling the pressure on the central bank and government policymakers to accept a devaluation in the ruble. Oil prices which are now down 60% from their july peak, slowing economic growth and increasing investor concern are steadily draining Russia's foreign exchange reserves, which fell 19 percent (to $484.6 billion) in the 12 weeks through Oct. 31. This is down from $598.1 billion in the week before the invasion of Southern Ossetia.

Russia had been using the reserves to try and contain the upward movement in the ruble was thought to present a threat to the competitiveness of exports. But resistance is now becoming increasingly difficult in the fact of a 13 percent drop against the dollar since August 1.

Bank Rossii began managing the ruble's exchange rate in February 2005 against a
currency basket comprised of about 55 percent dollars and 45 percent euros.
Policy makers let it trade within a fixed range in mid-May. Since then, it has
dropped 2.1 percent against the basket to 30.4020. Though the central bank
doesn't reveal the limits of the band, BNP Paribas considers 30.40 to be its
weaker end.
Evidently the main responsibility for the drop in the ruble has been a change in the relative values of the currencies in the basket, with the euro falling significantly against the dollar.

The central bank sold a record $40 billion in October, according to Moscow-based Trust Investment Bank, while Troika Dialog, the country's oldest investment bank, have warned that the currency may fall by as much as 30 percent in the event of a devaluation.

The logic behind any impending devaluation would not be too hard to find either. Try looking at the inflation bonfire which has been allowed to rage in Russia over the last eighteen months.

Inflation Drops Back In October, But Is Still At 14.2%

Russia's inflation rate fell to 14.2 percent, the lowest in seven months, in September as grain, legumes and gasoline prices all decreased. The rate dropped from 15 percent in September, according to data from the Moscow- based Federal Statistics Service. Prices were up 0.9 percent on the month, after rising 0.8 percent in September.

Bank Rossii, Russia's central bank, may have to increase the "flexibility'' of the ruble exchange rate, and this will involve a "certain tendency toward weakening'' according to bank Chairman Sergey Ignatiev speaking on state television Vesti-24 last week.

Russia may "gradually'' widen the trading band if the current account falls into a deficit next year, according to Arkady Dvorkovich, an economic adviser to President Dmitry Medvedev, recently.

And Russia's current account, the widest measure of flows in goods and services, seems now to be inexorably headed toward just thatdeficit. Russia's trade surplus narrowed to $16.4 billion in September, from $18.5 billion in August, according to the latest data from Bank Rossii .

Russia's benchmark 30-year government bond has fallen substantially in 2008, pushing the yield to an almost seven-year high of 12.55 percent as of Oct. 27. So far this year, the RTS Index has lost 64 percent, and is headed for its worst performance since 1998.

And Corporate Lending Piles Up And Up

VTB Group, Russia's second-biggest lender, has lent 377 billion rubles ($14 billion) to Russian companies since the beginning of September. The state-run bank provided 120 billion rubles worth of loans in September, 229 billion rubles in October and 28 billion rubles in the first week of November. Most of the money was leant by VTB (94 billion rubles) to metals companies. This was followed by 33 billion rubles for the power industry and 32 billion rubles for retail companies. The bank increased its corporate loan portfolio to 667 billion rubles in the first 10 months of 2008, from 363 billion rubles in the same period last year, according to the bank. The bank has also increased its retail loan portfolio by 183 billion rubles, a 97 percent increase from the first 10 months of 2007.

Russian Services Contract In October

Russia's service industries contracted in October for the first time in more than seven years as the effects of the financial crisis spread into the real economy. VTB Bank Europe's Purchasing Managers' Index of growth in services fell to 47.4 from 55.5 in September. A figure below 50 shows a contraction.

If we put this chart alongside the October manufacturing PMI one, it is clear that something significant happened in October. If things continue this way we are heading straight for recession I would say.

Update Tuesday 11 November 2008

The ruble fell this morning by the most in at least a month against the central bank's dollar-euro basket and stocks fell back as traders speculate policy makers are allowing the currency to weaken. The Micex Stock Exchange halted trading for an hour after the benchmark index sank almost 10 percent. The dollar-denominated RTS Index slipped 8.5 percent to 743.77. The ruble extended its 16 percent drop since August 1 following the statement by central bank Chairman Sergey Ignatiev (see above) that under current conditions the ruble may have a ``certain tendency toward weakening.''

The ruble declined 1 percent to 30.6879 versus the basket as of 1:30 p.m. in Moscow. Against the dollar, it was at 27.3040 having earlier slid by as much as 1.3 percent to 27.3975. It was 1 percent weaker against the euro at 34.8484 per euro.

In other news Fitch Ratings yesterday followed Standard & Poor's and lowered the outlook for Russia's credit rating to negative, while Bank Rossii today set a limit of 10 billion rubles ($366 million) on the amount of so-called currency swaps it offered. The swaps allow traders to bet on the exchange rate without having to sell rubles. The central bank started curbing swaps on Oct. 20 in theory to deter "speculators".

Among the falling stocks were those of OAO Sberbank, which dropped sharply after Vedomosti reported that Russia's largest savings bank had suffered a record $3 billion of withdrawals from retail accounts in October. Sberbank, which is the biggest holder of ruble deposits, fell 3.2 rubles, or 10 percent, to 27.63 rubles on the Micex Stock Exchange. Retail clients of Russia's biggest bank withdrew 80 billion rubles ($3 billion) in October, a record amount for a single month, Vedomosti reported, citing an unidentified person familiar with the bank's accounts. Central bank Chairman Sergey Ignatiev estimated yesterday said net private capital outflows reached $50 billion in October.

Update Wednesday 12 November

Russia's central bank lifted its key policy interest rate to 12 percent from 11 percent after the market closed yesterday. The move is widely interpreted as an attempt to stem the massive outflow of funds. The central bank also widened its trading band target by 30 kopeks (1 cent) yesterday, a move which "achieved almost nothing'' and cost the best part of $7 billion of the nation's foreign-currency reserves, according to analysts at Renaissance Capital. Russia has thus joined central banks in Hungary, Iceland and Pakistan in raising interest rates to stem currency losses while the rest of the world cuts benchmark levels to try to promote lending.

The cost of protecting against a default by Russia also soared after the decisions were announced. Credit-default swaps on Russian government bonds jumped to 7.17 percent of the amount insured from 6.14 percent yesterday, according to CMA Datavision prices. The yield on its 30-year dollar bonds increased to 10.77 percent from 9.1 percent.

The ruble fell back 1 percent yesterday, the biggest daily drop in two months.

Tuesday, November 4, 2008

Russian Manufacturing Contracts Again In October

Russian manufacturing contracted in October at the slowest pace in over two and a half years as the global financial crisis cut demand, according to the latest reading on VTB Bank Europe's Purchasing Managers' Index, which fell to 46.4 from 49.8 in September. This was the third consecutive month in which Russian industry has been contracting. A figure above 50 on these indexes indicates growth, while one below 50 means contraction.

Banks Lose $1.6 Billion In Assets

Sberbank, VTB Group and the other Russian banks lost a total of $1.6 billion from their stock and bond holdings in September, according to an estimate from UniCredit analysts who based their estimate on central bank data. Overdue loans held by banks rose rose in September to 1.45 percent (up from 1.33 percent tin August, according to Rustam Botashev, a Moscow-based analyst for UniCredit. The central bank said on November 1 that personal deposits in Russian banks fell 1.5 percent in September as people withdrew money amid global financial turmoil. Total deposits declined to 5.89 trillion rubles ($220 billion) on October 1 from 5.98 trillion rubles on September 1

National Wellbeing Fund Continues To Rise

The total assets of Russia's combined oil funds rose 4 percent - to $197.4 billion - in October after the transfer of taxes from oil revenue, according to data from the Finance Ministry. The National Wellbeing Fund held 1.7 trillion rubles as of November 1, equivalent to $62.8 billion, while the Reserve Fund held 3.6 trillion rubles, or $134.6 billion. Russia transfers a part of its oil and gas revenue to its two oil funds, which were created after the Stabilization Fund was split in two in February 2008.

Oil Stabilisation Fund

Reserve Fund
AUM: $134.6 Billion
The Reserve Fund may, by law, only invest in foreign government bonds.

National Welfare Fund
$62.8 Billion
Initially funded with just $32 Billion starting, this fund could increase dramatically in the future if oil prices start to rise again. The fund will mostly be managed by the Russian Ministry of Finance. The fund also has the ability to lend money to Russian banks. Furthermore the Fund is intended to serve as a tool for absorbing excess liquidity, in order to try to reduce inflationary pressure as well as insulate the economy from volatility in oil & gas export prices. The fund may invest in riskier assets, such as corporate bonds and possibly, at some point, equities.

The Russian state banks VEB and Sberbank are to get funds from the National Wealth Fund to place on deposit until 2020 as part of the recent plan to rescue the country's financial sector. The draft of the new law states that Sberbank will get a subordinated 500 billion rouble ($19.11 billion) loan at an annual interest of 8 percent and will issue a bonds to guarantee it. VEB will get the money from the National Wealth Fund at a rate of 7 percent a year and will provide loans to state bank VTB, and other banks and companies at 8 percent a year.

In line with this decision 170 billion rubles from the Wellbeing Fund ($6.3 billion) were last week deposited with the state development bank, Vnesheconombank. Russia has pledged a total of more than $200 billion to replenish liquidity and help companies overcome what is evidently now the worst financial crisis since the 1998 default on sovereign debt. The Russian government has said it will transfer 450 billion rubles from the Wellbeing Fund to Vnesheconombank, known as VEB, at an annual interest rate of 7 percent until 2019 for providing subordinate loans to banks. A further 175 billion rubles will be transferred from the fund at the same interest rate through 2013 to support local securities. Of the money deposited with Vnesheconombank, 125 billion rubles will go toward subordinate loans and 45 billion will be invested in Russian stocks and bonds.

Oil Production Down In October

Russia's oil production continued to fall in October - dropping for the 10th consecutive month - as producers struggled with rising costs and maturing fields, bringing the world's second-biggest crude exporter closer to its first annual drop in output since 1998. Output fell 0.7 percent compared with a year earlier to 9.87 million barrels of crude a day (41.7 million metric tons a month), according to figures released by the Energy Ministry. Output in Russia's oil heartland of western Siberia is sagging as older fields mature and producers are forced into remote regions to tap deposits. Oil companies need credit lines totaling $100 billion to make investments endangered by the global financial crisis, according to the Vedomosti newspaper, which cited a letter from Deputy Prime Minister Igor Sechin to President Dmitry Medvedev.

Ruble Falls The Most In Nearly A Decade In October

The ruble suffered its biggest monthly decline against the dollar in nine and a half years in October. Investors took $72 billion out of Russia during October, and have now taken around $140 billion since early August, according to estimates by BNP Paribas, while the Micex Index dropped 30 percent and pushed the yield on the 30-year government bond to a seven-year high.

The currency, which the central bank manages against a basket of dollars and euros, weakened 1 percent to 27.0955 per dollar last Friday, taking its decline on the month to 5.6 percent, the most since March 1999.

Bank Rossii, the central bank, buys and sells foreign- currency reserves to keep the ruble within a trading band against the basket. The mechanism comprises about 55 percent dollars and 45 percent euros and is used to protect the competitiveness of Russian exports from currency swings. The ruble fell 0.2 percent to 30.4036 versus the basket, from 30.3512 yesterday, and was little changed from 30.3675 at the end of September.

Bank Rossii - the Russian central bank - sold $40 billion in October, a record, to prevent the ruble from weakening beyond 30.40 to the basket. During the third week in October alone Russia's reserves dropped by $31 billion (another record) according to data from the central bank.

Monday, October 27, 2008

Moscow's Bourses Closed Again On Monday

Well, this is hardly news anymore, but Moscow's stock markets were closed again this morning. The news will obviously be in future when they are open. Russia's Micex Stock Exchange and RTS suspended trading this morning because their "technical indexes'' a measure of aggregate stock prices, fell more than 10 percent on opening.

Russian global depositary receipts plunged in London trading following the decision, led by steelmakers. The FTSE Russia IOB Index, a measure of Russian depositary receipts trading in London, sank 11 percent to 312.83 at 9:36 a.m. in London, the lowest in almost five years. OAO Severstal, Russia's biggest steelmaker, fell 23 percent to $2.50. Evraz Group SA, the second-largest steelmaker, dropped 15 percent to $10.60, or 92 percent below its May 16 high.

The Ruble Slides

The ruble fell to an 18-month low against the dollar this morning even while it strengthened for a second straight day versus an ever weaker euro.

The currency, which policy makers manage against a dollar- euro basket in an attempt to protect the competitiveness of exporters, fell as much as 0.6 percent to 27.3738 per dollar, the weakest since April 2006. It was at 27.3624 by 11:01 a.m. in Moscow, from 27.1991 late on Oct. 24. The ruble jumped 0.9 percent to 34.0292 per euro, the strongest in almost two years.

Bank Rossii, Russia's central bank, buys and sells foreign currency reserves to keep the ruble within a trading band against the basket. The basket rate is calculated by multiplying the ruble's rate to the dollar by 0.55, the euro rate by 0.45, then adding them together. Russia's currency was little changed at 30.3757 against the basket, from 30.4096 at the end of last week, when it strengthened just 0.1 percent. The 30.40 level is regarded by most analysts as the weakest end of the central bank's trading band. Bank Rossii sold almost $11 billion supporting the ruble against the basket last week, according to estimates by Moscow's MDM Bank.

Crude oil, Russia's biggest export earner, fell for a second day, extending its decline from a July 11 record of $142.27 to 57 percent. Urals crude, the nation's main export blend, slid 10 percent last week to $59.93, below the $70 average.

Wednesday, October 22, 2008

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

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.

Tuesday, October 7, 2008

Russia's Crisis Gathers Momentum

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 First Rise And Then Fall Back

Russian 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 initially 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.

However the good news was not to last long, and it seems the plan wasn't enough to convince investors the government can halt its worst financial crisis since 1998. On the day the Micex Index fell 4.5 percent to 717.83, after losing 19 percent yesterday, and closed at its lowest level since August 2005.

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. One indication of just how critical the situation is becoming is the fact that the MosPrime interbank rate - that is the rate that Russian banks charge to lend to each other - soared to 7.29 percent today from 4.75 percent at the end of last week.

Russia's oil and gas majors were all down, with Gazprom sinking 4.9 percent to 136.10 rubles. Rosneft falling 6.6 percent to 101.87 rubles, and Lukoil declining 5.3 percent to 1,047.90 rubles.

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, and all the majors seem to have applied to the government for help with loans. Lukoil is seeking between $2 billion and $5 billion to refinance loans, but many other companies are also reported to be seeking government loans, including OAO Gazprom, OAO Rosneft, and TNK-BP, BP Plc's 50 percent Russian venture.

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.''

Russia's ruble fell for the eighth consecutive day yesterday, and hit its weakest level in 18 months against the dollar at 26.2043. The extra yield investors demand to own developing-nation bonds instead of U.S. Treasuries swelled 48 basis points, or 0.48 percentage point, to a four-year high of 4.85 percentage points, according to the JPMorgan Chase & Co EMBI+ index.

The cost of protecting bonds sold by Russia's government jumped the most in three weeks, rising 26 basis points to 290, according to CMA Datavision in London. Credit default swaps on Ukrainian government debt also soared 57 basis points to 900, the highest among Europe's emerging markets, CMA prices show.

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.

Friday, October 3, 2008

Russia's Services Expansion Continues In September

Russian service industries continue to expand, and they even did so at a slightly more rapid pace in September than in August. Evidently confidence has yet to feel the impact of recent financial developments, at least that is the conclusion which can be drawn from the latest VTB Bank Europe Purchasing Managers' Index report. According to the VTB survey growth in services rose to 55.5 from 55.4 in August. Nonetheless this was the third-lowest reading since the survey started in 2001.

It is clear that the Russian services sector - and especially the financial services and real estate components - is going to slow more, and probably considerably more, and that end of year GDP growth will be down on the kind of levels we have been seeing over the last 18 months or so. How much down? I will need to see some more data from the real economy to get a "fix" on that I think. Just remember, patience IS a virtue, and better a later result than a more rapid one which is completely worthless. Mark to market, but in due course and not before.

RTS Index Has Worst Week In Nine Years

Russia's RTS Index had its worst week in nine years this week, forcing the exchange to halt trading yet one more time, as the biggest slump in commodity prices in a half century sent raw-material producers lower. OAO GMK Norilsk Nickel, Russia's biggest mining company, had a record loss on the Micex after saying first-half profit sank 33 percent. OAO Gazprom dropped the most since Sept. 16.

The dollar-denominated RTS plunged 7.1 percent to 1,070.98, bringing its weekly drop to 17 percent, the biggest since 1999. Trading was halted three times this week on the RTS exchange, Russia's second-biggest bourse, because of stock declines. The ruble-denominated Micex Index lost 5.3 percent to 924.55 today.

Commodities, as measured by the Reuters/Jefferies CRB Index of 19 raw materials, have tumbled 10 percent this week, the most since at least 1956. Crude oil has fallen 11 percent so far this week on declining U.S. demand and economic growth concerns.

Norilsk Nickel plunged 18 percent to 2,757.57 rubles, its biggest decline since listing on the Micex last year. The world's largest producer of refined nickel said first-half profit fell to $2.7 billion from $4 billion a year earlier on lower nickel prices and higher costs. OAO Uralkali, Russia's second-biggest potash producer, sank 8.2 percent to 117.83 rubles after dropping 11 percent yesterday.

Russia's Crisis Spreads Right Across The Domestic Credit Market

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......

Sunday, September 28, 2008

Happy Families Russian Style

"Happy families are all alike; every unhappy family is unhappy in its own way"

President Dmitry Medvedev’s recent decision to inject $20 billion into Russia’s flagging stock markets – which were down nearly 50% from last May at the time - together with the $60 billion odd dollars of support injected into its groggy banking system served to draw attention to the fact that it wasn't only “over there” on the other side of the Atlantic that the financial turmoil was busy raging. This simple point was further emphasised, if need there was for it, by the fact that both the Russian bourses – the MICEX and the ruble denominated RTS - were only working on a “now you see me now you don't basis” for the best part of a week in mid September. Stealing an idea from Tolstoy’s Anna Karenina, every financial boom is (boringly) the same, but every financial crisis is different in its own special (and intriguing) way. What just happened in Russia merely serves to prove Tolstoy’s point.

Friday, September 26, 2008

Moody's Downgrade Russian Bank Outlook To Negative

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.