Tuesday, September 16, 2008

MOSCOW | Russia‘s incursion into Georgia last month has accelerated a financial downturn, creating a credit crisis that could impact Moscow’s increasingly muscular foreign policy.

The downturn began several months before the Aug. 8 escalation in the Caucasus and has as much to do with global trends and other political and economic developments as it does with Russia’s actions in Georgia, specialists here say.

“There is a clear risk premium on Russia, but to say that Russia is unique is to ignore what the rest of the world is doing,” said Erik DePoy, equity strategist at Alfa Bank, one of Russia’s largest private banks. “The Russian market is not falling in isolation.”

The RTS index, where Russia’s most prominent and liquid companies such as natural-gas giant Gazprom are traded, has declined by 46 percent since its peak in May - 29 percent since August. The Central Bank of Russia has allowed the ruble to depreciate against the dollar and the euro, contributing to an already high inflation rate of 13 percent.

Additionally, the equity-risk premium on investments in Russia has reached a five-year high just above 15 percent - levels last seen at the height of the Yukos affair in 2003, when the Russian government arrested the head of a major oil company on trumped-up charges of tax evasion and forced the company into bankruptcy

The picture has clearly worsened since the fighting erupted inthe Caucasus. Estimates of capital outflow in the past month range between $15 billion and $20 billion.

Doug Rediker, a Russia specialist and former investment banker, now at the New America Foundation in Washington, said the ability to finance debt was more important than the stock market in terms of potential pressure on the Russian government.

“If the Chinese were to stop lending to the United States tomorrow, it would have a severe impact, but we would still have a pool of domestic funds available,” Mr. Rediker said. “In Russia, they don’t have the means to replace” global lenders.

“The Russian banking system is not developed enough to provide the long-term financing that companies need to grow.”

Russia’s financial woes mirror those of other resource-rich nations as commodity prices have declined. According to Goldman Sachs, the Brazilian Bovespa index has fallen by 37 percent since May.

The liquidity constraints are also in line with global trends. These may take a toll on highly leveraged property developers in Moscow. Although prices have not fallen, new construction is down by 2 percent or 3 percent.

Blows to investor confidence precede the Georgia fighting.

Prime Minister Vladimir Putin made what appeared to be off-the-cuff comments in July about the pricing strategy of Mechel, a major Russian steel producer, and its executive Igor Zyuzin. Mr. Putin’s comments, which were made during a steel industry conference and resulted in an investigation of the company by the Russian Federal Anti-Monopoly Service, caused Mechel to lose billions of dollars in value on the New York Stock Exchange.

Subsequently, a dispute between British Petroleum (BP) and its Russian partners, Alfa Bank and Access Industries/Renova, over control of a joint venture called TNK-BP, escalated, with the venture’s chief executive, Robert Dudley, forced to leave the country and the future of the project called into question. Mr. Dudley and other BP foreign specialists had to leave Russia when the government refused to extend their visas.

Russian officials said the dispute had nothing to do with politics.

“It is unacceptable that commentators are trying to move this dispute into political territory,” said Sergei Kislyak, the newly appointed Russian ambassador to the United States. “The conflict in TNK-BP is strictly business, and it has already moved towards resolution with no government involvement in the terms of that resolution.”

Few here accept this official line. The government has shown a clear willingness to intervene in the natural resource industry, which has contributed to the enormous wealth accumulated by the state.

“Fundamentally, there has been no change in the Russian economy,” said Natalya Orlova, chief economist at Alfa Bank. “The change is mainly in perception, and the government is reacting accordingly.”

Still, the government appears to be taking the situation seriously.

The Russian central bank, Finance Ministry and the Kremlin have launched a psychological counterattack, aimed at quelling investors’ fears and stabilizing the markets.

President Dmitry Medvedev has met with investors; the Finance Ministry has announced an ambitious investment strategy; and the government is considering a reduction of taxes on the oil sector.

TNK-BP shareholders reached a negotiated settlement in early September; the Mechel affair ended with the company agreeing to review its pricing strategy and paying a fee; and Russia has been withdrawing troops from Georgian territory.

But Russia is unlikely to reverse its recognition of the breakaway republics of South Ossetia and Abkhazia.

Emerging from a decade of political humiliation and economic gloom, Russia saw the conflict in the Caucasus as an opportunity to make gains after being obliged to swallow NATO expansion, the independence of Kosovo and a U.S. missile-defense system to be installed in Europe.

“We must remember that Russia is still a country in transition,” Mr. DePoy said. “A country that just 15 years ago shook off communism and lived through a humiliating and difficult period in its history as a great power.”

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