Barrons Weekday Trader
Impact of Russia's Crisis Could Linger
by Lawrence Strauss
As U.S. stocks remain in positive territory for the second day in a row
and President Clinton flies back from his summit in Moscow with President
Boris Yeltsin, the chaos in the Russian markets that triggered Monday's
huge 512-point selloff appears to be fading from view.
But the collapse of the Russian ruble, stock market, economy -- and
government -- will continue to affect world markets, though its impact on
the U.S. is likely to be more indirect from now on.
After all, as has been pointed out, the exposure of U.S companies to Russia
is very small -- less than 1 percent -- in terms of profits and direct
investment, says Arun Kumar, senior U.S. equities strategist at Lehman
Brothers. "Russia is not a problem as far as direct
exposure," he says.
And though some major banks, like Republic New York Corp.(RNB) and Bankers
Trust (BT), have announced they will report multimillion-dollar trading
losses related to Russia, the major U.S. money center banks generally have
very low Russian asset exposure, typically less than 1%, Kumar says. Russia
also accounts for less than 2% of U.S. trade, says Carl Weinberg, chief
economist of High Frequency Economics.
Even U.S. mutual funds have little direct exposure to Russian investments,
except for some Russian and Eastern European stock funds and some
emerging-market and high-yield bond funds.
So, why should U.S. investors care enough about Russia to send the Dow
Jones Industrial Average down around 1,000 points in the four trading
sessions culminating on Monday?
It's really the indirect impact -- the spread of economic chaos to, say,
Brazil or Mexico, where the U.S. has more economic and financial ties --
that has people worried.
"The Russian crisis has already done its damage," says Desmond Lachman,
head of emerging market economic research at Salomon Smith Barney. "Even if
Russia were to come right, it's not going to undo the damage it's caused to
emerging markets."
Specifically, the Russian crisis has pushed up interest rates in Latin
America to compensate investors for the higher risk of holding Latin paper.
For example, the interbank rate in Chile is around 30 percent, up from 10
percent a month ago. In Brazil, interest rates have not risen -- and the
government has vowed to hold the line on both rates and Brazil's currency,
the real. But about $7 billion has flowed out of Brazil in the last few
weeks, "and that implies that interest rates could go up," says Jim
Barrineau, chief Latin American equities strategist at Salomon Smith Barney.
In July, before the Russian crisis, Latin American countries were paying
interest rates of
around 10.5%; now it's more like 20%. "Latin America now has to borrow at
ridiculous
rates," says Lachman of Salomon Smith Barney.
That will slow growth dramatically throughout the region -- including
Mexico, of course, one of the U.S.'s biggest trading partners. Last week,
the Mexican government didn't conduct its weekly auction of treasury bills
because interest rates were too high, according to Barrineau.
Also, because holders of plummeting Russian paper-including some hedge
funds -- have seen their positions wiped out as margin calls come in,
they've had to sell other, more liquid holdings, such as Latin American
securities.
The upshot is a massive selloff "that's likely to have impaired, at least
for a lengthy period, the appetite for emerging market debt," says Lachman.
"I think the investor base is going to shrink" for emerging markets
securities, he adds.
That includes stocks, of course. Indeed, some of Latin America's
best-performing stock markets over the last few years have been pummeled in
1998: Argentina, Mexico and Brazil are all off more than 40% from their
highs.
Barring a major event--like another round of currency devaluations --
Barrineau believes that Latin America has come close to hitting bottom
economically and financially. "I think we've already taken a substantial
portion of the hit" to the equities markets, he says. "I don't see a whole
lot of downside." But he doesn't see a whole lot of upside, either.
Meanwhile, Kumar and others point out that lingering political instability
in Russia could
have a significant impact on investing. After all, he notes, Russia is the
second largest nuclear power in the world.
"You should be concerned about the geopolitical implications of Mr. Yeltsin
losing control of the government and it swinging to a more militaristic and
communist government," says Weinberg of High Frequency Economics.
A return to Cold War-like relations, Weinberg says, would raise tensions in
the world again and would "inevitably lead to diverting some of our fiscal
windfall from d‚tente away from financing the retirement of baby boomers to
current military spending."
Whether you call that a direct or indirect result of the Russian crisis, it
would really hurt.
Lawrence Strauss is a New York-based freelance writer.
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