8/14/98 NY Times. Ruble Scare: Another Blow to Major World Markets
By JONATHAN FUERBRINGER
The growing possibility of a devaluation of the Russian ruble
swept the world's markets on Thursday. Although the Russians
insist there will not be a devaluation, the threat has already led to a
major selloff in emerging markets and proved a drag on Wall Street
and other major stock markets.
But the prospect of immediate shocks in the markets is only the first of
many worries. Given all the other problems clouding the world's
economic outlook -- like the falling yen and the deepening woes in the
rest of Asia -- Russia's crisis could be a sign of a broadening malaise
that would stunt the stubbornly strong economy in the United States.
"If what is going on in Asia and Russia spreads to Latin America, I
can't see how the United States can be immune from that," said
Desmond Lachman, managing director of emerging markets economic
research at Salomon Smith Barney.
The ruble scare, which has been a low-level worry for some time,
stole the spotlight from Southeast Asia on Wednesday as the Russian
government imposed currency controls, seen by some as a precursor
to a devaluation.
Thursday, the Russian stock market plunged and was closed
temporarily as sellers swamped buyers. Yields on short-term Russian
bonds jumped to nearly 200 percent. The main stock market index fell
6.5 percent for the day, resulting in a loss of almost 50 percent in just
the last four weeks. Adding insult to injury, George Soros, a
well-known financier, called for major financial reforms and a 15
percent to 25 percent devaluation of the ruble.
"It is a very complex situation, and the risk is that investors will rush
for the door," said Constance Hunter, a portfolio manager for Firebird
Management LLC, which runs three hedge funds investing in equities
and bonds in the countries of the former Soviet Union.
Russia's woes have been building for some time despite the approval
of a $22.6 billion rescue package cobbled together in July by the
International Monetary Fund and various nations.
The ripples have been felt in places that do business with Russia and in
other emerging markets whose currencies are considered particularly
vulnerable. Although three of Latin America's main stock markets --
Mexico, Brazil and Venezuela -- rose Thursday, they had plunged on
Wednesday and their main indexes are down 22 percent or more for
the last four weeks. The stock markets in Poland and Hungary all fell
Thursday and their main indexes are off 14 percent or more for the
four weeks.
As the riskiness of debt from emerging economies has become more
apparent, investors have demanded ever higher yields. The premium
on bonds issued by emerging market countries has soared, jumping to
nearly 9 percentage points over comparable U.S. Treasury rates from
around 6 percentage points at the end of July.
"Its been fairly ugly the last week," Lachman said.
The world's developed stock markets have been more insulated. But
some sectors, especially German banks, are vulnerable given their
lending activities and investments in Russia. The uncertainty in Russia
added to the negative sentiment in the United States and European
stock markets Thursday, contributing to a 1.1 percent decline in the
Dow Jones industrial average.
And the list of risks to the markets and the world's economies keeps
growing: the drag of the Asian crisis on corporate earnings; the
performance of the new Japanese government; the threat of China
devaluing its currency; President Clinton's testimony in the Lewinsky
matter on Monday;, and Iraq's refusal to permit full weapons
inspections.
A ruble devaluation, of course, would lead to bigger concerns. "If
Russia devalued, the second-biggest nuclear power on the planet
would be in a severe financial crisis, which would raise the issue of a
growing political crisis," said Jeffrey Applegate, chief U.S. investment
strategist at Lehman Brothers. While he does not expect a
devaluation, he said, "No one is immune from that increase in political
risk."
German banks seem to be the most vulnerable to the new financial
turmoil in Russia. According to the Bank for International Settlements,
German banks had $30.5 billion in loans outstanding to Russia at the
end of last year, about 40 percent of Russia's total borrowing.
According to Merrill Lynch in London, the four biggest German banks
say their net exposure, after offsetting credits and reserves, is $3
billion, but their stocks have slid sharply. Deutsche Bank stock is
down 18.9 percent since July 21 while Dresdner Bank is off 17.4
percent since July 22.
American banks have far less exposure, with $7.1 billion, according to
the BIS. Charles Peabody, a bank stocks analyst at Mitchell
Securities, said in a recent report that "the good news is that U.S.
bank exposure to Russia is minimal."
"J.P. Morgan is probably the largest exposure, which I estimate at
$1.5 billion to $2 billion," he said. Chase Manhattan also owns
Russian Treasury bills, known as GKOs, which would lose value in a
devaluation or a debt restructuring designed to give Russia more time
to pay.
Analysts caution that parsing the impact of a Russian devaluation is
complicated. The effect on emerging markets, which have a habit of
swooning en masse when one of their own is in trouble, would
certainly be greater than on the markets of Europe and the United
States. And the overall impact would be less severe than that of a
Chinese devaluation of its currency, the yuan, which would worsen the
situation throughout Southeast Asia.
In Russia, "the political risk over the next couple of years is more
important," said David Bowers, European equity strategist for Merrill
Lynch in London. "You may end up with a more nationalist tone."
Bowers says the economic risk is greater from Japan, a much larger
economy now mired in recession.
Despite Russia's deepening financial mess, some investors still expect
the IMF, the United States and its key industrial allies to come up with
additional aid to stabilize the situation and the currency.
The consequences of a ruble devaluation would be too severe, they
argue, as it would re-ignite inflation and threaten to undermine the
current government. And there is a history to support that argument.
Clinton is scheduled to go to Russia on Sept. 1 and 2, and the United
States took action to support the falling yen and provide stability in
Asia before the president's visit to China in June.
"I think the reason you haven't seen it get worse is that people are
banking on the United States and the G-7 to step up and give more
assistance," said Hunter of Firebird Management. That hope may
explain why Russian stocks and bonds bounced off their lows
Thursday and why there was a rally in Latin America.
But the crisis has frozen some money. Mark Mobius, the managing
director of Templeton Asset Management, moved aggressively into
Russia in the last few years through his Templeton Russia Fund, whose
net asset value lost 52 percent for the first seven months of the year.
"I didn't buy anything," he said of his strategy since the first wave of
the Russian crisis hit in May. "I had a lot of doubts at the time, and
anyone who got in at that time was quite brave."
And what is he doing now? "Now we are trying to assess what the
next step for Russia is. Is it going to be a political crisis as well as an
economic one?"
Copyright 1998 The New York Times Company
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