Streetwise Professor

November 11, 2008

Putin Plays King Canute, and Faces Hobson’s Choice

Filed under: Commodities,Economics,Politics,Russia — The Professor @ 9:01 pm

Vladimir Putin has sharply criticized businesses and individuals that have taken capital out of Russia. Central Bank head Sergei Ignatyev seconds that emotion.

Central Bank Chairman Sergei Ignatyev backed Prime Minister Vladimir Putin’s call for stricter banking oversight by government, law-enforcement and financial authorities amid capital outflow.

“When there is a significant capital outflow, a more effective, tighter oversight of the situation is needed,” Ignatyev said Monday in comments broadcast on Vesti-24. Net private capital outflow reached $50 billion in October, he said, citing preliminary estimates.

Lenders that have received government funds meant to boost liquidity in Russian markets are increasingly transferring money abroad, Putin said during a government meeting Monday, according to Vesti’s web site.

He also on Monday warned against “corporate egoism,” saying that emergency funding must work “within Russia, as intended,” he said, Interfax reported.

Putin and Medvedev clearly desire to step capital flight, and various ideas have been mooted to achieve that objective in the aftermath of the $50 billion outflow in October. All of these ideas involve the employment of state power in one way or another.

Rather than attempting to stop the flow through capital controls, or by exerting pressure on Russian businesses and banks, Putin, Medvedev, and Ignatyev would be better served by stepping back and asking: “Why is capital fleeing the country at such a rapid clip?” But then again, they probably wouldn’t like the answer. It is a vote of no confidence in the security of capital from the predations of the state, in the the government’s policies, and the country’s investment prospects.

After a week of relative quiescence in both Russia and the West, economic tremors are being felt again. We are not through the woods yet. In this environment, the relative vulnerability of Russia to investor yips and the resulting capital flight are pronounced. Putin can attempt to command the capital to stop, but it won’t. Indeed, the more he attempts to impose additional controls, the more he will frighten investors about the security of capital, and the more desperate and creative they will become in their efforts to get their money out. Putin will have no more success in stemming capital flight than King Canute did in commanding the tides to cease. (And I am aware that there are alternative interpretations of the Canute myth, one being that he issued his famous command to rebuke flattering courtiers. That’s definitely not Putin’s motivation.)

In other, related news, Ignatyev also conceded that the Ruble is likely to fall:

“I do not rule out more flexibility in the ruble exchange rate with some tendency toward a weakening of the ruble against some foreign currencies in the current conditions,” Ignatyev said.

That’s central banker-speak for “Going Down!” And the market reacted, right on cue, with the Ruble selling off almost 4 percent (for December delivery) on the CME, and the Ruble spot down about 1.8 percent.

Here’s my interpretation, FWIW. The currency is the most visible indicator of economic conditions and confidence in the Russian economy and the government’s management thereof. Regardless of what Russians see on TV, they will know things are not going well if the Ruble continues to depreciate. From an internal political management perspective, I doubt the government wants to see a substantial decline in the Ruble. Such a decline would alert people to the severity of the economic situation, give the lie to the soothing “it’s not our problem” rhetoric coming from the Kremlin, and represent a repudiation of the government’s management of the economy.

But macroeconomic considerations, capital flight, and especially the decline in the price of oil will make it extremely difficult to defend the Ruble. The fundamentals are not auspicious. Moreover, Russian corporations and oligarchs, including those near and dear to the Kremlin and the White House (on the Moskva, not the Potomac) owe substantial amounts–in hard currency–to Western banks. Margin calls and debt repayments will force Russia to choose between dipping into hard currency reserves to pay off the debt, or letting the companies fall into foreign hands.

Russia has large currency reserves compared to 1998, but the demands on those reserves are much greater too; state debts are much more modest, but private and corporate debt is massively greater, and is secured by assets that the Kremlin is loath to lose control of. I see the willingness to let the Ruble decline despite the political dangers this entails as an admission the $500+ billion in reserves is insufficient to defend the currency and pay off foreign creditors, especially in the face of a likely extended slump in oil prices. Given this Hobson’s choice, Putin and Medvedev have chosen to keep Russian companies in Russian hands, and to let the currency take care of itself; the political fallout will be managed by, uhhmmm, other means, most likely.

As I said some time back, the financial crisis is showing that “$570 billion can evaporate in a trice.” It may not evaporate in Russia, but it will decline steadily and perhaps precipitously in the coming weeks and months. And it is coming pretty clear that it will go primarily to Western banks to keep them from obtaining big stakes in Russian corporations, rather than to defending the currency. Ordinary Russians will pay a price, in terms of higher prices for imported consumption goods, and domestic substitutes.

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  1. Seems like it has already evaporated. By my reading, the Kremlin has admitted that it can’t any longer afford to create a Potemkin stock market and ruble, and will cease the bloodletting from the reserves in both areas. Given that the consequences for the nation of a plunging ruble and stock market will be dire, that appears to confirm evaporation. The stock market is down over 20% in less than two days, yet more confirmation. It’s down over 75% in six months, the same kind of drop the U.S. market had during the Great Depression — except that it took years to achieve. When it occurred, the American people speedily moved to the opposition party. Russia can’t. It doesn’t have one. Vladimir Putin strangled it in its crib.

    The USSR replace the Tsar. Russia replacd the USSR. What now will replace Russia as the nation once again collapses in spectacular fashion?

    Comment by La Russophobe — November 12, 2008 @ 5:42 am

  2. It will be getting tougher these coming months. Not only is capital fleeing Russia, it will be hard convincing investors to put money into the country. One of the reasons: the risk of putting money into a market where property rights are not fully protected or can be set aside by courts that can be bought off or politicians who want to help their friends (or themselves). The Financial Times has a nice piece on the risks facing investors and why many are staying away from the Russian market. An excerpt:

    When a Siberian court issued an injunction at the end of last month to freeze Mikhail Fridman’s 44 per cent stake in Vimpelcom, the Russian mobile phone operator, just as western creditors were moving in, some investors feared it could be a repeat of practices honed in the August 1998 financial crash.

    Then, the country’s business tycoons concocted elaborate schemes to keep their assets out of the reach of western banks, sometimes enlisting the help of Russian courts.

    But in a sign the government is anxious about Russia’s reputation as a borrower during the credit crisis, it moved fast to ease such concerns by issuing Mr Fridman’s Alfa Group a $2bn bail-out loan to pay off creditors in full. This immediately lifted the threat to the stake and, soon afterwards, the court injunction.

    Nevertheless, some investors still fear that other businessmen could revert to old practices as the cash squeeze tightens.

    Topping investor concerns in the wake of a market rout that has wiped more than 70 per cent off the value of the Russian stock market are the return of complex schemes that key investors claim some of Russia’s biggest businessmen may be deploying to corner cash and control assets.

    Investors and international lenders say some of the schemes are raising questions about the sanctity of contracts and the security of collateral in the country at a time when it is increasingly difficult for anyone to win funding.

    But the shenanigans over redefining the company as a strategic company is provoking fears over the value of Russian collateral among international lenders.

    “From my point of view as an institutional lender, when choosing between Brazil, Turkey, India or Russia, at this point in time Russia isn’t even on the list because the framework isn’t there,” says a senior executive at a large international lender. “For us to be able to step up to the plate, we need confirmation from the government that people can’t use that strategic asset law as a pretence to walk away from obligations,” he continues.

    “If you can just readily put your company on the strategic asset list it will be impossible for international lenders to use Russian assets as collateral,” the executive adds. “These days, Russia really needs capital. But as long as this issue is outstanding that’s going to be closed.”


    Comment by Michel — November 12, 2008 @ 5:18 pm

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