WSJ Cover Story. As Russian Markets Swoon, World Wonders What to Do
By MARK WHITEHOUSE, ANDREW HIGGINS and BOB DAVIS
Staff Reporters of THE WALL STREET JOURNAL
For seven years, the West has spent billions of dollars propping up
Russia's economy and financial markets.
Thursday, after months of tremors, that financial system buckled badly.
Now, the world is wondering whether billions more are needed, where it
would come from and whether it would do any good.
Russia's stock, bond and currency markets all snapped amid investor fears
that the government would default on its domestic debt, devalue the ruble
or do both. Trading froze as banks and brokers refused each other's
business. Annual yields on ruble-denominated bonds soared to more than
200% from 150% as even the hardiest investors shunned the risk. The
stock market had to be closed for 35 minutes as prices crashed. It ended
down 6.5% on little volume because stocks simply couldn't be traded. So
far this year, it has lost more than 75% of its value.
But the fears surrounding Russian
markets go well beyond investors or
the country's borders. From
Washington to Bonn to London,
world leaders are treating the crisis
as their own.
Just five weeks after President
Clinton helped Russia get a $22.6
billion aid package led by the
International Monetary Fund -- one
of several multibillion-dollar loan
programs that the U.S. has
spearheaded this decade -- his
administration was busy Thursday
figuring out what could be done now
to avert more-serious problems.
Of course, the country's markets could snap back, as they have before,
when Russia and the West have agreed upon combined action. Despite its
current problems, the country has made considerable strides toward
capitalism -- privatizing its state-run industries, inviting foreign investment,
developing bond and stock markets and controlling hyperinflation.
Investors had rewarded that progress by buying the country's securities.
Just last year, in fact, Russia was the world's best-performing emerging
market.
The need for action prompted high-level officials of the Group of Seven
industrialized nations to hold an emergency conference call Thursday to
discuss Russia's plight, which has become the Clinton administration's main
economic worry. Said White House spokesman Michael McCurry: "It's
critical that the Russian government act quickly to restore confidence in
their economy."
U.S. Treasury Undersecretary for International Affairs David Lipton met in
Moscow with Prime Minister Sergei Kiriyenko to determine whether
Russia has the political resolve to salvage itself. The U.S. administration,
facing a skeptical Congress, is skittish about discussing new money if
Russia doesn't show that it can take drastic measures. Indeed, the past
few weeks, during which the IMF has poured in $4.8 billion, have shown
U.S. officials that the money goes out nearly as quickly as it has come in.
The main concern in Washington is that the lack of confidence about
Russia will spread beyond its borders and be picked up by investors in
Brazil, Argentina and South Africa, among other locales. After
multibillion-dollar bailouts in Russia, Indonesia and South Korea, the IMF
worries that it doesn't have the money to prop up other fallen economies.
And lurking not far beneath the surface, as it has since the collapse of the
Soviet Union in 1991, is concern about Russian political stability, the future
of the Yeltsin government and the safety of the country's thousands of
nuclear weapons.
Says Anders Aslund, a former adviser to the Russian government who
now is at the Carnegie Endowment in Washington: "This is a situation
when you have to act fast."
Standard & Poor's Corp. downgraded Russia's foreign-currency debt, its
banks and its local governments. The credit-rating agency cited "Russia's
mounting liquidity problems, compounded by the banking crisis, and the
likelihood that sharp declines in output and living standards will weaken
domestic support for the Yeltsin administration's economic-reform
program."
Much of the worry stems from the belief among some that Russia won't be
able to muddle through this time, that it has only two choices: sharply
devalue the ruble or default on some of its debt. Neither option bodes
well. Devaluation would bring the crisis home to the Russian people, who
so far have been spared its worst effects. The ability to purchase foreign
goods is one of the benefits of post-Soviet economic reform. Devaluation
would make even simple foreign products too expensive for the average
Russian, who sees the stability of the currency as one of the few tangible
fruits of more than six years of economic reform.
Devaluation might bring some immediate relief to major exporters such as
oil companies and would reduce the cost of servicing ruble-denominated
debt, but it would badly dent the government's credibility-and President
Boris Yeltsin's as well.
The central bank has repeatedly said it won't devalue the ruble. Irina
Yasina, the central bank's chief spokesperson, contends that no one would
benefit. "It wouldn't increase tax revenues, it wouldn't stimulate exports,"
she says. "It would lead only to social conflicts and inflation."
Defaulting on the debt -- put more politely, restructuring -- would buy
Russia time. It would reduce the demands on its dwindling $17 billion in
reserves and already-overstretched budget. But it would diminish the
confidence of investors, both foreign and Russian, who will be needed to
dig the country out of its deep hole.
A default would likely push Russia into recession and restrict its access to
foreign capital for several years. The most likely form a default would take
would be a declaration by the Kremlin that it would convert part of its $60
billion in short-term domestic debt into longer-term debt-but at sharply
reduced interest rates. The amount most likely to be restructured is the
$18 billion of high-interest government debt that is estimated to come due
by year end.
There is no talk of Russia defaulting on its $135 billion in foreign-currency
obligations, much of which was restructured in the past several years,
opening the way for Russia's return to foreign capital markets.
Nevertheless, say banking experts, foreign investors would likely avoid the
Russian market after any kind of default, and capital flight by domestic
investors would surge. Moreover, foreign banks would be unlikely to
renew their credit lines with Russian banks. Short of the foreign exchange
needed to purchase imports, Russia would risk recession.
Yet, a default probably wouldn't hurt Russia as severely as it did Mexico
in 1982. Mexico essentially was unable to borrow on foreign markets for
nearly eight years. Russia isn't likely to face that severe a consequence
because it isn't as indebted as Mexico was. And the U.S. and other major
industrial powers may feel more pressure to help Russia mend its finances
than they did Mexico.
Marcel Cassard, a former IMF Russia specialist, says an additional $15
billion loan package is needed. Russia has "enough money to hold on for a
few months," says Mr. Cassard, who now is Deutsche Bank's chief
economist for Russia, "but there isn't enough money to create a level of
comfort."
Funding Difficulties
But the chances of putting together such a package are slim, especially if it
calls for substantial funding from the U.S. and other major powers. The
U.S. Congress, which is already hesitant to provide additional funding to
the IMF, is likely to balk at yet another Russia package, especially
because the Russians haven't carried out the terms of the one announced in
July. That's why officials of the U.S., Germany and IMF have urged the
Russians to adopt measures that would improve tax collection and
overhaul the tax code, which are viewed as the minimum requirement to
gain credibility.
How did Russia get in such a mess?
The easy answer, but not necessarily the most complete one, is dithering
on economic reform and rampant corruption. But U.S. officials note that,
while all that may be true, much of what troubles Russia has been outside
its control. In fits and starts, the country has been trying to transform itself
from a military-command economy to something resembling capitalism.
Oil-export dollars and revenue from the country's other considerable
commodities were going to pay for this transformation.
But this year, the bottom dropped out of commodity markets world-wide,
with oil taking one of the biggest hits. Russia may have lost as much as $4
billion in revenue this year from lower oil prices alone, a number,
coincidentally or not, that is close to what the IMF has disbursed from the
latest loan package.
In addition, the Asian economic crisis forced emerging-markets investors
to monitor their investments closely, and Russia's messy political and
economic foundation didn't hold up under scrutiny. In the spring and
summer, the country's markets began to drop, and the IMF stepped in to
lead a $22.6 billion loan package secured by promises that Russia would
crack down on widespread tax evasion and step up privatization, among
other measures.
Duma Recalcitrant
But the Duma, the Communist-dominated lower house of Parliament, went
on vacation after gutting crucial parts of an anticrisis program endorsed by
the IMF. The government asked lawmakers to reconvene, but the Duma
refused.
President Yeltsin has signed a raft of decrees to try to repair the damage,
but Duma assent is still needed to enact a new tax code.
With Asia's markets falling again and Russia's response uncertain, the dam
burst Thursday. Investors said their concern about devaluation was
heightened by a letter, published Thursday in the Financial Times, from
multibillionaire George Soros, one of the biggest investors in Russia. He
proposed a "modest devaluation" of 15% to 25%, coupled with creation
of a currency board to hold the ruble's value steady. He also proposed
that the G-7 countries support Russia with billions more in reserves.
A major problem has been that Russia's political leaders didn't seem to
understand the dire straits the country was in. When the market seizure hit,
many top officials, including the central-bank chairman, Sergei Dubinin,
were on vacation.
Mr. Yeltsin also is on vacation and has said nothing in public. Prime
Minister Kiriyenko appeared briefly on television, but only to reiterate that
the government will press on with a reform package agreed upon with the
IMF last month. Still, many top officials "don't fully understand how
domestic developments get linked to international events-and how quickly
capital moves," the senior U.S. official said.
Little Trading Volume
They learned it Thursday if they didn't know it already. Russia's markets
didn't just drop; they virtually ground to a halt. Volume on the Russian
Trading System, which last year reached as high as $200 million a day,
was a mere $10 million Thursday in a market with a capitalization of about
$18 billion. Only about five of 51 issues saw any significant trading.
Brokers, fearing other brokers could go bankrupt, refused to deal.
"We're not participating in this madness," said Dan Rapoport, director of
sales at the CentreInvest brokerage in Moscow.
The market malaise has also exposed the weaknesses of Russia's
commercial banks, many of which have built their fortunes on risky
investments and large portfolios of high-yielding government debt. Now
that the debt has depreciated to default levels, the banks are left without a
source of ready cash, and this week some began reneging on their debts.
As a result, Russian banks no longer trust each other, refusing to lend
money or make currency deals. Western banks that have lent money to
the Russians on the collateral of dollardenominated bonds are demanding
payments, known as margin calls, to make up for the loss in value of the
collateral. Some Russian banks haven't met the calls, and the Western
creditors have liquidated the collateral, fueling a drop in prices.
Thursday, Moody's Investors Services downgraded its long-term
foreign-currency deposit ratings for 11 Russian banks. German banks
have also been rocked by Russia's troubles because their Russian
exposure dwarfs that of other lenders. German banks have about $30.5
billion in exposure to Russia-about 13% of their total capital-compared
with only $7.1 billion for U.S. banks and $7 billion for French banks.
Some German bank stocks fell as much as 4% before recovering toward
the end of the day.
However, Matthew Czepliewicz, an analyst with Salomon Smith Barney,
says investors are overreacting. For one thing, more than half of the
German loans are either on the books of public-sector banks or are
guaranteed by the German government. Besides, Deutsche Bank AG,
Dresdner Bank and the others have already set aside reserves of 60 cents
on the dollar for the portion of their Russian loans not guaranteed by the
German government.
The only thing yet to plummet in Russia's markets is the ruble. Over the
past few weeks, the central bank has spent nearly $2 billion of its precious
international reserves to prop up the currency. Fearing an attack on the
ruble, the central bank Thursday tightened emergency controls on currency
trading, demanding that commercial banks prove that they are buying
dollars for clients and not for their own accounts. Nonetheless, the ruble
Thursday was trading at 6.4 to the dollar, below the target value set by the
central bank.
--Betsy McKay in Moscow and Carla Anne Robbins in Washington
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