Letter from... Russia

Can Russia really escape the credit crunch? asks Howard Gethin

At the end of 2007, the sense of hubris emanating from Moscow as the world financial crisis unfolded was almost palpable. Russian politicians lined up to say that the crisis was a Western problem, and that Russia's huge reserves and low levels of individual and corporate debt meant it was immune.

Debt levels are indeed low - corporate debt is around 43% of 2008 GDP, household debt only 8% and Government debt 4%. But half of corporate funding is from abroad, and according to one estimate in October only US$608 bn of private capital is available domestically. Around US$1,022 bn needs to be refinanced. With low levels of institutional money and bank deposits, the rest has to come from abroad. The foreigners are failing to roll over the debts, and that's starting to hit the Russian economy.

The warning signs came earlier. The markets were the first to fall, starting a record plunge in July that only now seems to be approaching the bottom after losing around 67% of their value. Sentiment was worsened by the events of the war in South Ossetia in August, which spooked foreign investors.

The next victims in Russia have, not surprisingly, been banks. In October, the government stepped in to take over (via state-owned companies) four medium-sized lenders - KIT Finance, Globex, Svyaz Bank and Sobinbank. Some analysts think the crisis could lead to a wave of amalgamation, cutting the number of financial institutions by a third. The government has guaranteed all bank deposits for private savers up to 700,000 roubles.

Real estate is also starting to take a hammering, with many developers very exposed by foreign borrowing. Commercial and residential builders are announcing projects placed on hold. Observers predict falls of 20% or more in Moscow residential property, ending a seven-year boom. The Mayor of Moscow, Yuri Luzhkov, has promised US$2 bn in financial assistance to several developers.

Agriculture, so often the Cinderella of the Russian economy, is also facing serious problems as a result of lack of credit. The sector has only recently started to recover after a decade of stagnation, thanks to a write-off of debts by the government.

But farmers are still reliant on credit for sowing the spring harvest next year, and the state has had to step in to increase the charter capital of some of the banks supporting farming.

Many of Russia's richest men have suffered huge losses due to the credit crisis. Oleg Deripaska, owner of Rusal, the nation's biggest aluminium-maker, lost a stake in Canadian car parts-maker Magna, and German builder Hochtief, when margin calls forced him to relinquish his stakes. He may yet lose a 25% share in Norilsk Nickel, if he fails to find a lender with US$2 bn to repay a stake he took in that company earlier this year.

But other oligarchs have cleaned up - Mikhail Prokhorov, owner of Onexim Group, grabbed half of Renaissance Group for US$500m - a fraction of what it would have been worth months ago.

The response by Government has been decisive, if somewhat patchy. The banking system has received almost US$200 bn in liquidity. The Government has begun buying stocks on the local markets in an effort to stop the slide in share prices. In a more bizarre move, the Government has also cracked down on the media, banning state channels (almost all of them are state run) from even mentioning the term ‘financial crisis'. It has even offered funding directly to some companies, mainly those in the defence sector or others deemed to be especially important.

The real bogey for Russia might not be the liquidity crisis, but the fall in oil prices. Urals blend dipped below US$70 a barrel briefly in October, less than half what it had been in June. That places Government budget spending in doubt, with oil bringing in a third of revenues. A cut in OPEC production in November is likely to shore things up, but it is a timely reminder of just how tenuous the situation is for Russia's undiversified economy. Further down the road, the fall in capital expenditure resulting from this crisis and a slide into recession by most of Russia's trading partners means that next year's 4-5% GDP growth might well be higher than the year after.

Howard Gethin is a business journalist based in Moscow, Russia