The bear totters on the brink

The liquidity crisis in Russia could trigger something even worse.

YOU remember Boris Yeltsin on top of that tank outside Moscow's White House in August 1991. But on Thursday at a meeting inside the now famous building 50 Western bankers and investors added a new image to their memory banks. From 6pm to 7.30pm Moscow time, Prime Minister Sergei Kiriyenko, central bank chief Sergei Dubinin, and a clutch of other government officials stood at a podium explaining why, 10 days into a classic liquidity crisis, their country did not face a financial meltdown.

The meeting nearly came unstuck. Representing the combative billionaire Dart family, one of the largest US investors in Russian shares, a lawyer rose to read a prepared statement. The country faced a financial meltdown, she asserted, because it was riddled with crony capitalism.

The lawyer painted a black picture of the country. Greedy, self interested oligarchs were in charge, she said. State assets were being ripped off. There was no justice for investors outside an inner circle. The men running Russia listened. As the lawyer finished, central bank chief Dubinin asked: "Were you describing the Russian economy or the US economy?"

Emollient voices filled a shocked silence. Diplomatic relations between the Russian government and the Western financial community were restored. This weekend, nonetheless, Western bankers in Moscow recalled the breach and wondered if this, indeed, is the moment when events finally overwhelm Moscow's seven-year effort to transform Russia into a market-based economy.

"The situation is in the balance," said Arnab Das, a JP Morgan emerging market analyst in Moscow last week. "There is significant political risk attached to the financial crisis. The situation could get significantly worse."

Literally speaking, of course, Russia is only a blip on the screens of global financiers - "Indonesia with nukes," as one banker put it. The City in particular has little to fear directly from a financial meltdown. Robin Monro-Davies at credit rating agency Fitch-IBCA estimates total British bank exposure to Russia is $600m, compared to $30bn for German banks, a bigger but still manageable swallow.

International investment banks managing their Russian exposures from London are having it rough. Market rumours place Credit Suisse First Boston losses in the Russian treasury bond market anywhere from $500m to $1.5 bn. "The likes of Credit Suisse First Boston, which now faces high fixed expenses - in Russian real estate, for example - along with plunging revenues, are in for rough times," warned John Leonard, European banking analyst at Salomon Smith Barney.

But the interweaving of stock market prices and national security issues grows ever tighter and more complex. Tomorrow Russia will announce plans for restructuring its treasury bond market which last week officially closed down. As the week progresses, analysts will nervously watch to see if there is a run on the country's $25bn in bank deposits.

There is also the risk that the reaction of government officials to the crisis will atomise - efforts to rescue the treasury bond market, the rouble, and the country's banks each going off in a conflicting direction. Take Russian banks. The strong ones are using offshore branches to stay current with Western creditors while the weak ones are hiding behind the Yeltsin government to delay paying foreign creditors what they owe. "What's going on in Moscow?" a Russian banker laughed grimly last week. "A lot of bankers are panicking."

On 1 September President Bill Clinton is due to meet President Yeltsin in Moscow. If the meeting is not cancelled or postponed, there is the prospect of Clinton's problems with Monica Lewinsky and Yeltsin's problems with the communists in the Duma baying for his blood igniting each other against a background of the renewed American war against international terrorism.

"The financial situation in Russia can be controlled," said Marcel Cassard, a former International Monetary Fund official now working for Deutsche Bank in London. "But the measures taken could lead to the renationalisation of the banks. If we get to that point, that's not good."

Russia's terrible problems are only partly of its own making. Last autumn the Asian financial crisis laid waste to the country's first fragile shoots of economic growth. As the price of crude oil dwindled from $18 to $12 a barrel, hitting Russia's biggest foreign currency earner, and as Western investors began pulling money out of the country, the government failed to rise to the challenge. On 21 July the International Monetary Fund weighed in with a $22.6bn bailout while holders of government treasury bonds were allowed to exchange them for longer dated eurobonds.

"The euphoria lasted for a day and a half," said Morgan's Das, then the drain on Russia's foreign currency reserves resumed. As international and Russian investors traded in roubles for dollars, Das calculates, the outflow from the central bank accelerated from $800m a week last month to $2bn two weeks ago.

The Russian stock market plunged 9.1 per cent on Tuesday 12 August. Two days later Moscow was swept by rumours that SBS-Agro Bank had failed to pay $100m it owed the French bank Societe Generale. SBS-Agro, so the rumour went, had to get emergency funds from the central bank to paper over the default. "First, the central bank confirmed this rumour," said Parvoleta Shterva, an analyst at MFK Renaissance investment bank in Moscow. "Then it said it could not confirm it."

Last weekend Russian officials in Moscow were rebuffed when they rang round the Group of Seven for the second time in two months asking for additional official loans. By this time banks had stopped dealing with each other. "They weren't processing each others' credit cards," said MFK Renaissance's Shterva. The government concluded it had run out of market initiatives to stabilise the country.

Last Monday the government announced a default on treasury bonds maturing before the end of 1999. It declared a moratorium on debts owed to foreigners by the country's banks and companies for 90 days. The government also effectively devalued the rouble - whose stability has been the greatest accomplishment of President Yeltsin's government - 34 per cent.

On Tuesday Western bankers got wind of a Russian plan to give domestic holders of defaulted government treasury bonds a better payoff than international holders of the same treasury bonds. The City and other international centres howled in protest. Bankers warned that Russian would never raise a pound from the international community again.

On Wednesday the government backed down. It announced it was seeking the advice of two Western banks, Deutsche and Morgan, on the default and restructuring of its treasury bond market. Central bank chief Dubinin sent a "Dear Eddie" letter to Bank of England governor Eddie George and his counterparts in other Western capitals asking for assistance in calming and clarifying the situation.

The meeting in Moscow's White House on Thursday evening offered further clarification, if only by way of demonstrating that rescue plans are being made on the hoof.

On Friday the government tried to cork another potential leak in the country's dwindling central bank reserves. It guaranteed Russian bank deposits. There are $25bn in Russian bank deposits. If next week or thereafter the Russian man in the street makes a run for his deposits in the hope of converting his rouble savings into dollars, the country could literally go bankrupt.

That was the situation going into this weekend. Yesterday and today further meetings between officials, Russian bankers, and Western bankers have gone on. Many have been run by Boris Fyodorov, the first vice-minister for economic affairs appointed on Monday who served in the Yeltsin government in its early days and is described by one Western banker who knows him as a "cynically charming fellow".

Fyodorov, along with prime minister Kiriyenko and other officials are putting the final touches on plans, due to be announced tomorrow, spelling out what kind of payoff investors holding defaulted treasury bonds can expect. "The government realises it is not going to get private foreign money in the near future," said Deutsche's Cassard. "The issue is whether foreign creditors investors stay out for 18 months or four years."

"People in the markets are going to take a haircut," added Morgan's Das. "That's what happens when there's a default." The total value of defaulted treasury, or GKO, bonds is $45bn. A third of this bad paper is held by foreigners. But beyond the issue of what happens to Russia and its foreign creditors lies the unresolved issue of how economic policy is going to be made in the country and by whom. Not even the Russian banker at the centre of the country's elite will predict what is likely to happen politically in Moscow in the near future. But President Yeltsin will be under pressure as never before.

Deutsche Bank's Cassard reckons that, whatever happens, the power held by the oligarchs the Dart family's lawyer complained about at the White House meeting last Thursday, will increase. "Chaos always helps the oligarchs," he said.

Additional reporting by Justin Keay

Russia in global finance

How Moscow's market capitalisation compares with other stock markets, in $bn.

1 US 11,309

2 Japan 2,217

3 UK 1,996

4 Germany 824

5 Australia 697

6 France 674

7 Switzerland 575

8 Canada 568

9 Netherlands 469

10 Hong Kong 413

11 Italy 345

12 Spain 290

13 Taiwan 288

14 Sweden 273

15 Brazil 255

16 South Africa 232

17 China 206

18 Mexico 157

19 Belgium 137

20 India 128

21 Russia 128

22 Singapore 106

23 Denmark 94

Source: International Finance Corp