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G7 playing 'a very dangerous game' in Russia
Financial Post, Weekly edition, Friday, June 19, 1998
As the world's leading industrial countries discuss how to help Russia this week, they'll have to weigh the risk of a Russian default against the need to push the government to cut spending and collect more taxes.
Investors expect the Group of Seven or other lenders to provide US$5 billion to US$10 billion to Russia to help cover more than US$5 billion in debt payments this month and US$33 billion this year as the government runs short of cash. Expectations of an emergency loan drew some investors into Russian debt last week.
"The market has started to anticipate the [loan] package," said Frederik Lekman, who manages US$150 million at MFK Renaissance. "They will need it if things turn worse rapidly. It's always good to have something to lean against. It's more of a confidence booster."
G7 officials have revealed no specific loan proposals and Russia insists it doesn't need a bailout. The danger is that a bailout would create a "moral hazard" by misleading investors about Russian risk and the government about the need to reform its finances.
"The G7 governments are ... obsessively concerned with not creating moral hazard," said Eric Kraus, chief strategist at Regent European Securities in Moscow. "This could be a very dangerous game. Capital flight has been stopped by the expectation of [a loan] -- if the market decides it's not in the cards, a violent reversal could occur, triggering a real crisis."
A meeting of deputy finance ministers from the G7 countries today and tomorrow in Paris will focus mainly on Russia, said U.S. Treasury Secretary Robert Rubin. President Boris Yeltsin arrived in Bonn yesterday for two days of talks with German Chancellor Helmut Kohl. German government and European Union officials said they'll support loans to Russia only through international lenders and only if the loans are tied to pressure on the Russian government to fundamentally reform its finances.
Emergency loans "will be short-term relief, but on the longer term investors need to see an austerity package fulfilled," said Bogdan Kochubey, a fund manager at Pictet Asset Management in London which has about US$500 million in Eastern Europe and Russia.
Russian officials insist they aren't seeking a loan, and are moving forward quickly to cut government spending by 40 billion rubles ($9.4 billion) and raise revenue by up to 14 billion rubles, while improving tax collection and reducing borrowing costs by selling debt in foreign markets. After raising more than US$2 billion in debt at home and abroad, Russia's central bank last week slashed interest rates to 60% from 150% and government debt yields fell to below 45%, from more than 74%.
"We have no need for extra resources," said Russian Prime Minister Sergei Kiriyenko, in Paris last week on an official visit. "The borrowing situation has changed for the better."
Russia's borrowing costs are rising after rating agencies said the risk of a ruble devaluation is higher as investors pull out of Russia's debt markets. Fitch IBCA downgraded Russia's long-term foreign currency rating by one notch last week to BB from BB+ and now rates Russia at the same level as South Africa and Argentina. Moody's Investors Service Inc. also downgraded Russia's foreign currency debt rating one notch to B1 -- four notches below investment grade -- and now rates Russia on the same level as Turkey and Lebanon.
Analysts and investors continue to say that Russia needs a loan of US$5 billion to US$10 billion to restore confidence and alleviate the cash crunch spurred by an exodus of cash from government debt markets.
"This is not a time for the IMF to be playing political games," said Julian Mayo, director of corporate finance at Regent Pacific in London, with about US$1 billion in Russia. "We expect a commitment from the IMF that they will support Russia and prevent an escalation of the financial crisis."
The G7 is unlikely to grant a loan with no strings attached, analysts said.
"The most likely outcome of the meeting is a carefully worded statement that the [G7] deputies will recommend that the G7 support a package of aid channelled through the IMF if it proves necessary," said Sonja Gibbs, chief strategist at Nomura International in London. "It remains very unlikely that an unconditional aid package will be granted. A contingent provision of a credit line is the most that can be expected."
As investors have fled Russian markets, the benchmark RTS stock index has tumbled 47% since the beginning of the year, and 33% in the past month, while treasury bill yields soared above 74% before falling to about 45% last week when investors bought on expectations Russia would receive a loan.
Though Russia sold US$950 million in treasury bills and a US$1.25 billion Eurobond last week, it still must raise US$33 billion to pay maturing debt this year. The government failed to raise enough money at the last four debt auctions to repay maturing debt. Central bank reserves stand at about US$14.6 billion, including gold.
Stocks and bonds fell yesterday as investors waited for the G7 to decide on the emergency loan. The three-month treasury bill, series 21090 maturing Sept 9, yielded 40.43%, up 246 basis points from trading on Friday. The yield on the one-year T-bill, series 21126, maturing May 12 1999, rose 316 basis points to 51.66%.
Moscow will offer as much as 18 billion rubles in debt securities at its weekly auction tomorrow, and it must raise at least 7.07 billion rubles to roll over maturing debt.
A vote of confidence from the G7 could help the government raise that cash, said James Fenkner, managing director of CentreInvest Capital Management, which has about US$13 million invested in Russia.
"I think you may see an announcement -- in terms of an aid package -- [today] which could make [tomorrow's T-bill] auction very attractive," he said. "It's not that Russia's going to go down the toilet, there are just some problems of collection and spending. The way [T-bills] are priced now, they are priced as if Russia is on the brink of failure. It would only take a small amount to bring equilibrium back in this country, and a verbal commitment that the ruble will not slide."
Source: This information is provided by the Financial Post.
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