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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