The credit crunch spreads east
By March this year, monthly inflation in Russia had crept up to an annualized rate of 13.3%. While the central bank has drawn praise for its speedy and attentive approach to reassuring the supply of liquidity to the banking system, it might be that it is fixing the wrong problem. Caught up in the national campaign to boost growth and take GDP per capita from $13,700 today to $30,000 by 2020, the central bank and the government seem to be ignoring inflation and perhaps storing up greater problems ahead.
Russia’s banks are nervous because their vulnerability to the absence of long-term funding at home has been rudely exposed. Negative real rates and high inflation make any solution to this harder to achieve, being a clear disincentive to save in any form, institutional or other.
"Our own bank has been lobbying hard for injections of liquidity and even, crazy as it sounds, to have more of the stabilization funds invested inside Russia in the hope that we may be appointed managers of this money," complains one exasperated Russian banker privately. "But they don’t seem to realize that in doing so, they risk increasing inflation and inflation expectations and even destroying the domestic bond markets in which we had a promising franchise."
Many Russian bankers shy away from even discussing inflation. It’s not a topic they generally bring up unprompted. And when they do there is a tendency to blame the rising rate on imported inflation and to ignore, for example, the impact of increased federal budget and state corporate spending in the later stages of 2007 and at the start of 2008.
It is against this uneasy backdrop that debate continues in Russia about how best to invest the country’s pension funds and also the substantial public savings that have accumulated from the foreign-currency proceeds of oil and metals exporters. The country’s oil stabilization fund, at first maintained purely for investment outside Russia as a hedge against a falling oil price, has recently been split into various new funds, a portion of which will be invested in domestic infrastructure and social development.
There is a risk that domestic investment might further fuel inflation. But the debate has shifted over how to mobilize public funds to promote the domestic capital markets.
Alexander Sobol, deputy chairman of Gazprombank, notes: "The finance ministry has agreed to change the rules on Russian state and private company pension fund investments so that a portion can be placed in the corporate bonds of certain Russian issuers. This is long-term money that, to this point, has only been invested in government securities and investments abroad."
Banks too, especially the higher-rated banks, are making the case that their bonds should be eligible for these long-term investors to buy. Nicholas Chitov, president of City Mortgage Bank, the Moscow-based mortgage lender acquired by Morgan Stanley at the end of 2006, has even been lobbying in the Duma for changes in the law to make it easier to sell mortgage-backed securities in Russia. "Domestic pension funds can only buy mortgage bonds that are backed by the government. I think that’s wrong. If MBS are well structured, pension funds should be able to buy into the senior tranches, which will offer a lot of protection as well as a high rate of interest." So far, he says, there has not been a true marketable, multi-tranche securitized deal in the local market.
There is some Rb350 billion of so-called silent pension fund money of those who have not yet chosen a private pension fund provider, and growing by Rb60 billion to Rb70 billion a year, now residing at Vneshekonombank’s management company. "In 10 years’ time this will grow substantially, creating a sizeable pool of money available for long-term investment," says Andrey Ilyin, deputy chairman of MDM. "Mutual funds are at the embryonic stage and there is more the government could do, and in fact is likely to do, to promote these, through taxes or even some form of guarantees – not against market losses but, for example, against fraud at private fund management companies. The trust of the Russian people in the financial system is still a very relevant issue."
Dmitry Levin, chief executive of Russian Standard Bank, the country’s pioneer in consumer financing, notes: "Russia is still a very cash-oriented country. As consumers become more sophisticated, we see more brand awareness, more desire for good-quality products, also greater price sensitivity, and this is as true for financial services as anything else. In future, we will develop longer-term products like life insurance and pension funds, but right now the demand is for current accounts, deposits, personal loans and cash credits."
With inflation running so high, Russians have plenty of incentive to borrow and acquire assets, in the expectation that asset values will rise and inflation will erode their debts. Personal saving is unlikely to increase without tax or other incentives.
The traditional policy prescription for controlling inflation is to allow currency appreciation. But the rouble has already enjoyed a steady rise against the dollar. "That encouraged capital inflows which, unlike export earnings, are not sterilized, and so rouble appreciation helped create further inflation," says Evgeny Gavrilenkov, chief economist at Troika Dialog. "So the exchange rate won’t control inflation. Meanwhile, money supply is growing at 45% to 50%, which is faster than the demand for money. Interest rates aren’t going to slow inflation. It’s fiscal policy that needs to change but the government seems to think that investment must increase at double the projected GDP growth rate to achieve its aims of a $5 trillion economy by 2020." He concludes: "It’s when the oil price falls that we’ll see the correction here."
For corporate borrowers, Vladimir Stolyarenko, chairman of Evrofinance Mosnarbank, offers a similar prescription to Russian corporates facing a funding squeeze. "If the crisis in western markets continues and cuts off their overseas borrowing what should replace it? Financial discipline should replace it. They should focus more on balancing their budgets."