Russia faces a financial meltdown, as emerging markets face currency crises worldwide

November 13, 2008

Russia is now likely to enter a prolonged period of hardship as the financial structure of the nation collapses under the impulse of falling commodity prices, and the heavy-handed ineptitude of the Medvedev-Putin administration.  These two appear to have believed that initiating a geopolitical gamble in the middle of a global economic crisis was a wise move, or rather, that they would be able to bully the economics of the country into submission, as they did with its people. Their scheming has failed. But I believe that the economic problems will make the government even more despotic, as they will attempt to prevent social disorder by instituting stricter controls on the country’s political and economic system, and its media. They certainly have the power to do so, and there doesn’t appear to be any alternative other than chaos, given the turbulent situation of this nation in almost every aspect.

In any case, the troubles of Russia are only a prelude to the next phase of this crisis which will severely test the resilience of emerging markets worldwide. Many of these nations owed their prospertity to the low risk-aversion of developed world investors, and as this source of funding evaporates, with global trade, and global economic activity slowing down significantly, and possibly contracting, the underlying inefficiencies and weaknesses of these nations will place them under very difficult conditions.

How much has changed in seven years! Many nations, such as Brazil, Argentina, and Turkey are ruled by individuals whose culture of governance has very little difference to that of their corrupt and bankrupt predecessors. I know for a fact that neither in Turkey, nor in Brazil the fundamental problems of the past years which used to cause periodical crashes and high inflation have been resolved. And the main characteristic of the leaders of all three nations is populism, not any particular management skill, nor understanding of the workings of the global economy. But the dreamy state of mind of investors in the developed world, their low home bias, and speculative herding, have allowed all these nations to live in false prosperity, often financed through borrowing, and supplemented through the boon of high commodity prices.

Now those bubbles are collapsing, and the return to reality will be very painful, I’m afraid.

Russia’s erratic stock market closures and the central bank’s policy of seeking to manage the ruble’s value are deepening the effects of the global crisis as the price of oil, the country’s biggest export earner, tumbles.

Slumping commodities prices, state-backed corporate probes and the war with Georgia have combined with frozen global capital markets to spook investors. The Micex Index is down more than 60 percent since Aug. 1 and holders of Russian assets have withdrawn about $158 billion, BNP Paribas SA estimates.

Goldman Sachs Group Inc. predicts the ruble may weaken 18 percent versus the central bank’s dollar-euro basket in the next 12 months as Bank Rossii continues to sell foreign-currency reserves to stave off the flight of capital.

“Russia has moved at least a decade away from becoming a real financial center,” says James Fenkner, managing partner at Red Star Asset Management in Moscow, which holds about $100 million in Russian stocks. “The government’s incompetence is making this crisis worse for anyone stuck on the Micex and RTS,” bourses.

The Micex closed and reopened for the 29th time since Sept. 16 today, having announced it would remain shut until after the weekend.

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Stocks have been further hurt after the government reopened an investigation into a 2006 mine flood at OAO Uralkali, Russia’s second biggest potash producer. The announcement on Nov. 7 knocked its shares down 10 percent and brought back memories of recent probes against steelmaker OAO Mechel and oil companies TNK-BP and Yukos, which made investors nervous about state interference in the country’s natural-resources industry.

Those cases contributed to “an environment that is not an advertisement for a country you want to place your money in. It’s the opposite,” said Andrew Bosomworth, who helps manage more than $50 billion of emerging market debt in Munich at PIMCO.

Compounding the economic woes, Bank Rossii let the ruble weaken 1 percent versus the basket on Nov. 11, a move that may spur capital flight. The central bank manages the currency against the basket to minimize the effect of currency swings on Russian exporters.

The devaluation was “clumsy,” and has “triggered a new speculative attack on the ruble,” analysts at Renaissance Capital including Kayta Malofeeva and Nikolay Podguzov said in report e-mailed today.

Oil Price

Oil’s fall is undermining the currency of the world’s biggest energy producer and it sends the $91.2 billion current- account surplus toward a deficit. Urals crude oil fell for a third day today, losing 1.8 percent to $48.80 per barrel, the lowest since January 2007 and more than $20 per barrel lower than the level needed to balance next year’s budget.

The $50 level, which Urals broke yesterday, is “psychologically important” and will increase pressure on the ruble, Chris Weafer, UralSib Financial Corp.’s chief strategist, said on Nov. 11.

“By opening the door 1 percent when nobody believes that’s the full magnitude of the fall, that just attracts speculators to short it,” said Bosomworth. “Anybody doubting before that it was going to weaken, they now know that it is going to weaken.”

The central bank should devalue the ruble in several, larger steps of as much as 7 percent, interspersed with occasional movements strengthening the currency to increase volatility and shake out speculators, the Renaissance Capital analysts wrote.

That could leave it as much as 20 percent lower against the dollar at 32 by the end of the year and would make speculative bets on the ruble dropping further “minimal,” they said.


To be sure, an overly aggressive devaluation could panic a population still smarting from the ruble’s 71 percent devaluation against the dollar in 1998.

Russians have purchased more than $3.4 billion of foreign cash in September, or almost twice as much as they bought per month throughout the year, Alfa Bank said today, citing the central bank’s figures.

Any sharp devaluation may exacerbate that trend, Anna Zadornova, an economist in London at Goldman Sachs, wrote in a note today.

“The central bank of Russia is wary to allow a large step devaluation, fearing that it could encourage capital flight and increase uncertainty about the economic stability in the population,” she said.

RBC Capital has a new target for the century-old Nortel Networks; it’s zero, predicting that Nortel will go bankrupt. It is by now a story with which we’re becoming more familiar by the day:

Nortel Networks Corp., North America’s largest maker of telephone equipment, may go bankrupt by 2011 without a cash injection from the government or financial backers, RBC Capital Markets said.

The company is “overwhelmed with debt and burning cash,” Mark Sue, an RBC analyst in New York, said today in a note. He cut his price target on the stock to $0 from $1.50.

Nortel, founded more than a century ago, has lost about 95 percent of its market value this year as customers reined in spending and switched to newer technology from Cisco Systems Inc. Nortel may be forced to sell its Metro Ethernet unit, used to deliver Internet, TV and telephone service, at a fraction of the intended price, RBC said.

“Assets sales couldn’t have come at a worse time,” Sue said. “The world moved on while Nortel was stuck in restructuring mode.”

The company may finish 2009 with $1.6 billion in cash, about the amount it needs to run its business for 12 months, Sue said. Nortel has $1 billion of debt due in 2011.

Nortel’s U.S. stock reached a split-adjusted high of almost $900 in 2000.

Bonds Fall

This week, Nortel announced plans to cut 1,300 jobs. Chief Executive Officer Mike Zafirovski has eliminated 18 percent of the workforce since taking over three years ago. Nortel has lost $3.66 billion so far this year.

The problems of hedge funds keep growing. I think that it’s a simple fact of economic cycles that there are times when one shouldn’t borrow, and isn’t this one of those times? Is a leveraged model feasible in this environment? Does the risk-reward paradigm suit the expectations of a prudent investor? The answer to these questions, obviously, is no. But hedge funds don’t seem so worried about all these for now, and it seems, despite being burned many times already, they are still willing to gamble. Greed is good, but only when tempered by fear. These people have little fear, because the money they gamble with is not their own. (Update: Hedge funds are now much more cautious about what they do)

Fortress Investment Group LLC’s hedge-fund clients have asked to pull more than $4.5 billion, or 25 percent of their money, over the next few months as the company reported its first quarterly loss since going public.

The redemption requests poured in as Fortress’s Drawbridge Global Macro funds lost 13.5 percent this year through Sept. 30 and its Special Opportunities funds declined as much as 7.2 percent, the New York-based company said in a statement today. Hedge funds fell an average of 11.6 percent in the same period, according to the HFRX Global Hedge Fund Index.

The worst financial crisis since the 1930s is battering Fortress’s primary businesses of taking companies private and running hedge funds. The company was forced to write down $50 million of private-equity holdings. Investors withdrew an estimated $60 billion from the $1.7 trillion hedge-fund industry in October, Singapore-based Eurekahedge Pte said today.

“The problems at Fortress have shifted from private equity to hedge funds,” said Jackson Turner, an analyst at Argus Research in New York. Turner, who anticipated hedge-fund redemptions of less than 10 percent, recommends investors sell Fortress shares. “Investors have lost faith in the franchise.” .


Fortress said it received $2.6 billion in withdrawal requests payable through the end of January for its liquid hedge funds, which manage $9.1 billion in assets between the Drawbridge Global Funds and the Fortress Commodities Fund.

Investors asked to pull $1.9 billion, effective Dec. 31, from its hybrid hedge funds. The Drawbridge Special Opportunities Funds and Fortress Partners Funds managed $8.2 billion as of Sept. 30. Those redemptions will be paid out over time as investments are liquidated, the company said.

Revenue Falls

Revenue dropped by 25 percent to $185.1 million. The company reported a net loss of $57.4 million, or 66 cents a share, wider than a loss of $37.6 million, or 52 cents a share a year ago. That included $298 million in compensation to the firm’s founders tied to the IPO. Fortress expects net losses for the next three and a half years because of the payments.

Earlier this week, Sparx, Asia’s biggest hedge-fund manager, with $8.5 billion in assets, posted a first-half loss on redemptions and falling stock prices. Its assets under management on a preliminary basis were 839.1 billion yen ($8.8 billion) as of Oct. 31, compared with a peak of 2 trillion yen in August 2006.

Fortress joins rivals Blackstone Group LP and KKR & Co. LP in cutting the value of assets to match a global decline in prices. Blackstone, the world’s largest private-equity firm, posted the biggest quarterly loss in 18 months as a public company on Nov. 6 as the financial crisis eroded the value of the businesses and real estate it has acquired.

Fortress said in September it wouldn’t pay a third-quarter dividend to shareholders, saying the money can be better spent by investing in financial companies.

And there’s ever more trouble with commercial real estate. Naturally the vicious cycle of tightening standards, more defaults, and more tightening will continue, until life is sucked out of the economic system, and the remaining core offers a very positive risk profile to lenders, or rather what will remain of them. Bankruptcies are the only solution to the gigantic crisis that we are going through.  

CIT Group Inc., the largest independent U.S. commercial lender, applied to become a bank holding company and requested an investment from the U.S. Treasury after six straight quarterly losses drained capital.

CIT joins American Express Co. Goldman Sachs, and Morgan Stanley in seeking to reorganize as a bank.

CIT may need cash after $2.9 billion in net losses since the second quarter of last year. Chief Executive Officer Jeffrey Peek is making fewer loans, tightening lending standards and raising borrowing costs for customers amid the worldwide credit crisis.


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