Streetwise Professor

Russia has announced plans to curb foreign borrowing, and to oversee the foreign financing of big Russian companies (h/t LR):

Russia is limiting access to the Eurobond market to prevent a repeat of the surge in foreign- currency indebtedness that triggered company bailouts in 2008 as borrowing costs tumble.

The government created a group last week to monitor overseas debt by state companies and “systemically” important financial institutions. OAO Gazprom, Russia’s largest company, and diamond monopoly ZAO Alrosa are among state-controlled borrowers planning their first Eurobond sales in at least a year as the economic rebound sends yields to a record low.

“Issuance by major borrowers at the same time could destabilize and worsen market conditions,” Deputy Finance Minister Alexei Savatyugin said in an interview on Sept. 30 after his appointment to head the Inter-Agency Working Group for Monitoring the Conditions on the Financial Market.

This reflects a couple of related factors.  First, it is an admission by the Russian government that it cannot pre-commit not to bail out big Russian companies, like Rusal or Severstal in the event of another financial crisis.  In particular, it cannot precommit not to bail out, when the failure to do so would result in these companies falling into the hands of foreigners.  To limit the potential demand of these companies on the public purse ex post, the government believes it necessary to control their foreign borrowing ex ante.

Second, this may be part of an effort to bolster Russian banking and capital markets.  Historically, due to the underdeveloped nature of Russian financial markets, foreign currency earnings (primarily from commodity exports) have flowed to foreign banks, where they are then directed back to Russia in the form of loans or direct investments.  Medvedev in particular has made plain his desire to foster the development of Russian financial markets, and limiting access to foreign finance is one way of doing that.  I am skeptical that this force feeding will work.  The underdevelopment of Russia’s financial markets is fundamentally a structural problem, driven by the lack of the institutions (property rights, contractual rights, investor protection, rule of law) that are necessary for financial markets to work properly.

The announcement provides a glimpse of the reasons why investors are always jumpy whenever the Russian government sticks its nose into the markets:

The advisory group may cause concern because of the potential for the government to meddle in company plans, said Neil Shearing, a senior emerging-market analyst at Capital Economics in London.

“Everything will depend on the implementation,” Shearing said. “Greater state involvement always starts red warning lights flashing in this regard.”

Ya think, Neil?

These institutional weaknesses, and their effects on the Russian economic environment are reflected in this story from the FT’s Beyond BRICs blog:

Emerging markets are starting to resemble pole-vaulters who, no matter how high the bar is raised, jump over it effortlessly. Back in April, the Institute of International Finance – a global club of banks – had predicted private capital inflows to emerging markets would total $709bn this year; it now recognises emerging markets will pass that level with ease. So the IIF has raised the bar: its new estimate is $825bn – that’s $116bn higher.

However, while the greatest pole-vaulters were Russian, the most favoured emerging markets are certainly not. Russia will actually receive less capital inflows than initially thought – with Russian stocks attracting barely half of what was predicted in April.

The IIF estimates that inflows into Russia will be $67.5bn this year, down from $72.4bn estimated in April. Russian equities, which were expected to bring in $12.5bn, will now account for just $6.7bn of the total.

The explanation?  I’m glad you asked:

The explanation, says Philip Suttle, chief economist at the IIF, is two-fold. On the one hand, Russia’s economy continues to suffer from state intervention and dubious governance. On the other, the extent of the country’s own boom and bust – with banks suffering from having granted excessive consumer credit – has been overlooked.

As a result, optimism that a firming oil price would bring foreign investors into Russia appears to have been misplaced. It appears that, however often analysts say Russian equities are attractively priced, few foreign investors want to move first.

Yes: institutional weakness and the residual effects of a financial crisis that hit Russia harder than just about any G-20 nation.  To which I would add the realization, based on recent experience, that the country is still uniquely vulnerable to another such shock.  Given the shakiness of the developed world economies, the probability of such a shock is bounded well away from zero.  (For instance,  look out for the effects of the ongoing foreclosure firestorm–it could crater banks worse than the original crisis, or force the government into an extraordinary HAMP/TARP-on-PCP bailout.)

Foreign direct investment was an important contributor to Russia’s 2000-2008 growth, especially in 2005-2008.  It has gone, and not come back.  The above report indicates that it is unlikely to come back anytime soon, even though other BRIC countries are worrying about too much money flowing from overseas.

And about that “Russian equities are attractively priced” bit.  Yes, Russian equities are cheap.  They are cheap for a reason: the risks of investing there are huge. Thunderbird is cheaper than Romanée Conti.  Quality matters.  You get what you pay for.

Investor angst over Russian government interference was plainly evident at the Russia Calling! forum sponsored by VTB. [Russia calling?  Sorry.  Wrong number.  Nobody home.  We don’t want any.  Whatever I have to say to make you go away.]  Julia Ioffe describes the Q&A that Putin endured–barely:

Someone asked about a corrupt court decision — said to have been worth some $300 million — and Putin, who tends to say nothing about the extremely independent Russian judiciary — promised to look into it. Someone asked about the privatization of a chunk of VTB. Someone asked about Gazprom’s market capitalization.

Then a lady got up, and asked Putin to address the fact that, “all the investors I meet with have big concerns, and they see that when the [Russian] government enters [into a deal/holding/etc.], the share price falls to nothing.” The conference, after all, was partly to convince foreign investment to come back to Russia, which it hasn’t really done since many billions fled in the fall of 2008.

Putin tried to convince her that that was not the case, that they sold out of enterprises like that for money. That the arrival of companies like Transneft (state oil transport concern) was good for them.

Lady: “Are they scared of you?”

Putin: “There’s no need to be scared of us.”

Then the lady brought up Yukos and the whole room froze. “There’s no meeting that goes by,” she said, “where investors haven’t asked about it.”

“Yukos is a special case,” Putin thundered, suddenly losing his jokey, back-slapping demeanor. He was pissed. Seriously, seriously pissed.

Ah, yes, the Pavlovian Putin, who begins salivating like a rabid dog at the very mention of Yukos and Khodorkovsky.  [That woman questioner has brass–kudos to her!]

Putin may not like it, but those kinds of things live on in memory.  Putin actually doesn’t make things any better by putting Khodorkovsky on trial again (his lame assertions that he didn’t even know there was a second trial being completely risible).  Putin mentioned that “it had been proven by a court” that Yukos’s security head had been involved in murder.  Even if this is true, has Khodorkovsky ever been charged, let alone convicted of this of this specific offense?  Even in a Russian kangaroo court?  No.  So shut up about it.

Look, if Putin gets “pissed” because Khodorkovsky is a martyr, he has no one to blame but himself now, for Putin has consciously extended his martyrdom indefinitely.  It is a testament to how much Putin hates–and likely fears–Khodorkovsky that he continues the relentless prosecution even though it undermines his goal of attracting more investment to Russia.  Ditto Browder and the egregious official response to the Magnitsky affair.

You know, Vladimir, you reap what you sow.  The years of expropriation, theft, and corruption have left their mark in the minds of foreign investors.  I don’t see any way for Russia to erase that mark any time soon.  It will definitely not happen as long as Putin and the siloviki are in the saddle.