Repost from WSJ: Heard on the Street, May 18, 1998
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Thread,
I think it's a good idea to take a wait-and-see approach for now on Russia, pleanty of time, no need to rush anything.
Thomas
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Russia May Be Next Market
To Collapse as Ruble Slides
By MICHAEL R. SESIT and ROBERT BONTE-FRIEDHEIM
Staff Reporters of THE WALL STREET JOURNAL
LONDON -- With Indonesia swept by a storm of riots, arson and looting and Asian stock markets giving up big first-quarter gains, some traders and money managers fear Russia could become the next emerging market to hit the skids.
The Russian stock market has fallen for seven consecutive trading sessions, dropping 18% since May 5 and 35% so far this year. On Friday, the Russian Trading System index, the most followed measure of stock performance, closed at 258.10, down 2.1%.
Russian government bond prices have also plummeted. In the past week, yields on one-year securities surged to 39 1/2 % from 33 1/4 %. And a growing number of analysts predict the central bank won't be able to prevent the Russian ruble from going into a freefall.
"If the ruble collapses, it will be a major setback for Russia's long-fought battle to gain financial stability and control inflation, and it will turn a regional emerging market crisis into a global one," says James Lister-Cheese, an international economist at Independent Strategy, an investment-consulting firm in London.
Mr. Lister-Cheese says a Russian crash would ripple throughout markets in Eastern Europe, adding, "the risk premiums for emerging-market investments would rise globally. Brazil could be the next fall guy." Up 7% this year, Brazil is one of the world's best performing emerging markets.
Tiny in size until the mid-1990s, Russia has blossomed into one of the world's larger emerging stock markets. With a market capitalization of $128 billion at the end of 1997, it was marginally smaller than India, 18% smaller than Mexico and roughly half the size of Brazil. But it was more than twice the size of Argentina and bigger than Chile and Malaysia.
Nonetheless, many analysts say Russia's significance is more political than economic. "It's a different animal than the Mexican or Asian crises," says Matthew Linsey, a director at Baring Asset Management in London. "Russia is obviously more sensitive than these other markets, because it has nuclear weapons."
Russia, says Mr. Lister-Cheese, "is caught in a financial Catch-22." The prices of its major exports, oil and gas, are falling, causing the country's current account -- a wide measure of trade and financial transfers -- to fall into deficit at the same time its foreign-exchange reserves are shrinking.
To attract foreign capital to finance that deficit and stabilize the ruble, the central bank has had to jack up interest rates to sky high levels. But those high rates are hurting stock and bond prices, widening the government's budget deficit and slowing economic growth.
Moscow's foreign exchange and gold reserves are dwindling fast. As of the end of April, they stood at $16 billion, down from $16.9 billion a month earlier and $24 billion a year ago. Even worse, Anthony Thomas, an economist at Dresdner Kleinwort Benson in London, says that "net of gold, hard currency reserves are around $11 billion." Mr. Thomas projects that Russia will end this year with a current account deficit of $5 billion or more, compared with an estimated $5 billion surplus in 1997.
Russia's central bank has a policy of steadily letting the ruble slide in line with inflation, which central bank Chairman Sergei Dubinin a few days ago said should average 8% this year. But if the bank finds it lacks the reserves to defend the ruble or that interest rates must be kept too high for too long, and the ruble starts to fall, "it's all over," says Mr. Thomas.
Even if the ruble holds and one-year interest rates stay in the 30% to 35% range for the rest of the year, Independent Strategy's Mr. Lister-Cheese says stocks could tumble another 15% to 20%. "But if the ruble proves unsustainable because growth implodes and interest rates are pushed to crisis levels of more than 50%, the downside will be much greater," he says. Mr. Lister-Cheese believes the odds are 50-50 the ruble will suffer a "maxi" devaluation of 20% to 30%, before even counting the impact of inflation.
A tool J.P. Morgan & Co. developed to analyze the likelihood of a crash in small, high-yielding currencies ranks Russia as the fourth most likely country out of 19 to experience a sharp devaluation in the next month, up from 12th at the start of the year.
Faced with these risks, traders and money managers are paring back. "We are at our lowest level of investments since we started our proprietary division," says Gareth Williams, a proprietary trader at Deutsche Bank in London.
Fiduciary Trust Co. International currently has no investments in Russia. "We continue to be very concerned about [Russian President Boris] Yeltsin's health and the impact (a serious ailment) would have on Russia and its markets, and the currency is a big concern," says Sheila Coco, chairman of the firm's global-investment committee in New York.
Russia's stock market has been so weak that last week, Moscow announced it was postponing the privatizations of three oil companies: Russian Eastern Oil, Tyumen Oil and Slavneft. But the delays deprive the government of sorely-needed dollars. "This is a problem for government finances," says Mr. Williams of Deutsche Bank. "How they shore up their cash requirement is quite a tough question."
Still, others contend that Russia has little to gain from a "maxi" devaluation of the ruble. Adam Elstein, head of Bankers Trust Co. in Moscow, notes that the Russian banking system is hobbled with unpaid debts and being drained of deposits as companies withdraw cash to pay pensioners, salaries and taxes.
Just as important, Mr. Elstein adds that on a net basis, Russian banks owe dollars to foreigners. "As a result, the central bank will fight a shock devaluation, because it won't want to damage the Russian banks," he says.
In a bold attempt to defend the ruble, the central bank on Friday raised its 15-30 day Lombard rate -- effectively that at which banks borrow from the central bank -- to 40% from 30%. The day before, Mr. Yeltsin approved a cabinet proposal to bar any additional government spending that wasn't backed by new revenue sources. Despite Moscow's efforts, the ruble Friday fell to 6.1850 to the dollar from 6.1375.
Two weeks ago, Prime Minister Sergei Kiriyenko said that roughly 26% of Russia's 1998 budget wasn't backed by revenues. The nation is widely known for its bloated bureaucracy and military, corruption, problems collecting taxes and dire need for tax reforms.
What's more, investors in Russian shares are concerned about more than just the economic outlook. Minority investors worry that their stakes in Moscow utility Mosenergo and oil producer Tatneft will be diluted by changes in corporate structures and rules. "We're still seeing abuses of shareholder rights among the leading blue-chip companies," says Sadie Wighton, an analyst at Regent European Securities Ltd. in London.
Despite these and other problems, Mr. Elstein of Bankers Trust cautions investors against writing Russia off completely. "On a five-year span," he says, "you still have to be in Russia; it's the largest emerging market in Europe" and larger than many Latin American nations. "This is a market that is too big to be forgotten about."
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