Repost from the WSJ: Stock Market Plunges as Russia
Raises Interest Rates to 150%
By BETSY MCKAY, MATTHEW BRZEZINSKI and BOB DAVIS
Staff Reporters of THE WALL STREET JOURNAL
May 28, 1998
MOSCOW -- Russia, caught in its worst financial crisis in years, sent interest rates soaring to defend its currency and watched its stock market plummet more than 10%.
Investors and officials in Moscow and Washington said Russia, which just a few months ago appeared to be bouncing back from its post-Soviet collapse, may now be in need of a financial bailout from the International Monetary Fund.
The Russian Central Bank, in a bold move to shore up the ruble and shaky financial markets, Wednesday raised its two key interest rates by 100 percentage points, to 150%. The move failed to buck up investor confidence: Russian stocks continued plummeting after the rate increase. Stocks fell 10.6% on the Russian Trading System index, to close at 187.55 points, down from 209.33 Tuesday. Yields on short-term government debt soared 20 percentage points to 84%, amid fear that the central bank wouldn't be able to defend the ruble. But the ruble itself held fairly steady, closing at 6.19 rubles per dollar, down from 6.18 Tuesday.
Wednesday's plunge in share prices was so fierce that President Boris Yeltsin convened his top economic advisers for emergency talks on how to keep the rout from spiraling out of control. Share prices have fallen about 50% so far this year.
More IMF Help Is Likely
In Washington, officials indicated the International Monetary Fund is likely by this weekend to give its blessing to Russia's plans for shoring up the economy. That would free up $670 million in loans to Russia from an existing $9.2 billion program for the country by mid-June, a step that could help bolster Russia's crumbling reputation among international investors. "The Russians and the IMF are closely engaged, and we hope for a prompt agreement on strong measures that will get Russia back on its IMF program," said Deputy Treasury Secretary Lawrence Summers, a chief architect of the West's economic program for Russia.
But it is far from clear that the IMF's current aid program for Russia, of about $2.7 billion in annual loans through March 1999, or a total of $9.2 billion, will be sufficient. A senior Clinton administration official predicted Russia would quickly need "between $8 billion and $10 billion" to halt its downward spiral. Top Treasury Department officials, including Mr. Summers, have been on the phone with Moscow "two, three, four times a day," this official said. "It's moving too fast to send a delegation. We're doing it all by phone."
Aleksei Mozhin, Russia's delegate to the IMF, said he wasn't aware of any negotiations for a larger aid package, a view echoed by Martin Gilman, the IMF's chief representative in Moscow. But sometimes market expectations of large bailouts force the IMF to change plans. Aid packages for South Korea and Indonesia, for instance, turned out to be much larger than some in the IMF and U.S. Treasury thought necessary, largely because the market came to believe only huge bailouts would calm investors.
After having committed billions to bailing out Asian nations, the IMF would be stretched to find resources for a bigger Russian bailout. The IMF might have to tap a special $24 billion credit line that it hasn't used in years to help Russia further. The IMF could also tap the World Bank and other multilateral institutions, but other big IMF members such as the U.S., Germany and Japan don't appear ready to fund a larger program with separate contributions of their own.
Concern Over Rosneft
The immediate catalyst for Wednesday's sell-off in Moscow was news that the government had failed to attract any bidders for a crucial privatization deal, a 75% stake in state oil company NK Rosneft. The deal had promised to fetch at least $2.1 billion for the cash-strapped Russian treasury and would have thrown the government a much-needed fiscal lifeline.
The sale's failure sparked fresh concerns among Russian investors and bond traders over where the government would now find enough funds to pay off its short-term debt load -- and still keep its promise to pay off $1.4 billion in back wages owed to protesting coal miners.
With Indonesia's political upheaval fresh in mind, emerging-market investors have closely monitored these strikes, in which miners last week blockaded important railway lines across the country to force the government to act on unpaid wages. The barricades were lifted Sunday, but only after authorities promised cash would be found to pay off the wage arrears, which in some cases stretch back two years.
These forces are behind the slide in Russian stock and bond prices. "Fear is completely ruling the market," said Martin Diggle, head of trading at Brunswick Warburg in Moscow. "People are selling at any price."
Russia is at a delicate moment -- poised between an economy that seems on track for recovery, and political chaos that threatens to derail it.
Inflation fell to a record low of 12% in 1997, and is expected to fall further to 8% this year. What's more, the country's gross domestic product last year posted its first growth this decade, albeit just 0.8%.
Yet the recent market slide has revealed just how fragile Russia's hard-won economic stability is -- and just how much more work the new government of 35-year-old Prime Minister Sergei Kiriyenko must do. While the economy is starting to grow, its transformation is far from complete. The country's economic future -- with all its consequences for the rest of the world -- depends largely on the ability of Mr. Kiriyenko to take the bold steps that his predecessor shied away from.
With markets in a tailspin, Mr. Kiriyenko's team has weeks, rather than months or years, to implement the fundamental structural reforms on which sustainable economic growth in Russia depends. Because of the financial crisis, economists currently say the Russian economy is likely to grow at most 1% this year. If the new government can produce results quickly, investment should return and the country stands a chance of achieving stronger growth by the time the next presidential elections roll around in 2000. If Mr. Kiriyenko gets bogged down in political wrangling, as the previous government did, then Russia's economic achievements of the past six years could unravel, damping chances for a reformist candidate to succeed Mr. Yeltsin.
Mr. Kiriyenko is, in essence, paying for the political sins of his predecessors, who often gave in to financial groups whose interests are at odds with thorough-going reforms. The current mass exodus of foreign capital from stock and bond markets has shown just how little progress the country has made in recent years on such reforms as overhauling the tax system, cutting wasteful subsidies, and boosting revenue collection.
Devaluation Ruled Out
The strongest action Wednesday came from Central Bank Chairman Sergei Dubinin, who continued to defend the ruble and categorically ruled out any devaluation. Appearing on Russian television, Mr. Dubinin said the 100 percentage-point increases of the bank's Lombard and discount rates were short-term measures designed to "quell the appetite of financial speculators for trying to make fast, easy money by playing against Russia's national currency."
Since Friday, the central bank has spent $1.5 billion to prop up the ruble, leaving itself with $14 billion in hard currency and gold reserves. Russia's reserves are down from a peak of about $24 billion last fall, before the Asian financial crisis struck. U.S. officials note that about $4 billion of reserves are in gold, and estimate that Russia's hard currency reserves have dropped to as low as $9 billion, down from $10.5 billion. "Foreign holders of treasury bills have between $15 billion and $20 billion. If they decided to pull out fast we're in real trouble," an official said.
The ruble has held steadier than the country's stock markets. But the central bank is raising rates in order to encourage international and Russian investors to keep their money in ruble assets, out of fear that a sharp conversion of rubles into dollars will force the bank to spend its waning reserves on a defense of the Russian currency.
By Wednesday, there were growing calls on the IMF to step in with an emergency bailout package for Russia similar to those made in Asia last year. If the IMF doesn't act fast, investors said, Russia could lose one of the most reform-friendly governments it has had in years. "It's appalling how the IMF is taking its time on this," said Mark Holtzman, president for Central and Eastern European corporate finance at ABN-Amro in London.
About $4.2 billion of the $9.2 billion IMF program for Russia has been disbursed so far. To get a bigger bailout, Russia would probably have to pledge the kind of tough reforms the IMF extracted from Seoul and Jakarta.
'Issue Is Credibility'
U.S. officials are urging that Russia come up with a new government budget based on a cut in expenditures and that it tighten its feeble tax-collection system. Officials are also insisting that expenditure cuts don't come out of state employees' wages. "The issue is credibility with the markets. If you stop paying wages you just create another arrears balloon six months down the road," the official said.
Privately, Clinton administration officials said they will be watching closely Thursday's planned meeting between Russian President Boris Yeltsin and Prime Minister Sergei Kiriyenko and Central Bank Chairman Sergei Dubinin. "I hope his word is, 'These are my guys and we're going to have a tough program and stick to it.' " the U.S. official said.
Even if fresh loan money comes, it will only temporarily solve Russia's problems. This latest crisis shows that Russia relies too heavily on foreign investors to support its domestic debt market, economists say. When Russia was the world's best-performing emerging market not long ago, that approach worked, since billions of dollars were flowing in to fill government coffers. Now, it has proved costly. Capital flight from the treasury-bill market has left the central bank with two grim options to prop up the ruble: raise interest rates, or deplete foreign-exchange reserves.
The exodus has raised the cost of debt servicing at a time when the government is fighting to keep its budget deficit down. Russia's domestic debt is fairly low, at 14% of GDP. But servicing it at interest rates of 150% would cost 21% of GDP if those rates stood for whole year.
Mr. Kiriyenko says the government is talking with the IMF about restructuring some of this short-term ruble debt through a foreign-currency loan to bring debt-servicing costs down.
Deficit on Target
Russia has done a good job this year of keeping its budget deficit down. The 4.6% deficit recorded for the first quarter was exactly on target. But Moscow's failure to either boost tax collection or introduce a new tax code means that revenues always fall short of targets. After rising slightly, tax-collection levels have dropped since April, said to Alexander Pochinok, head of the state tax service.
To boost revenues, Mr. Kiriyenko must unravel a cycle of nonpayments in the industrial sector, which leave Russian companies with no money to pay taxes. And he must force through bankruptcies of insolvent industries and cut off subsidies.
But some investors remain bullish. This new government, they say, is the best Russia has had in years. The country's fiscal performance, while still dim, is improving. "I'm trusting that the people in office over there now are bona fide reformers," said Jim Severance, portfolio manager for the State of Wisconsin Investment Board, which has about $60 million of its total portfolio of $1.4 billion in Russia. He says he hasn't sold, but has actually bought, stock during the past few weeks. "I'm bullish on Russia over the long term," he said
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(c) he WSJ
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