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By John Helmer in Moscow

In theory, Russia’s economic performance is correlated with global supply and demand for mined materials and commodities, and thus with the rate of global economic growth, especially China.
In the Russian market, 80% of earnings come from commodity stocks. Before the collapse, the enormous gains in market capitalization of Russian producers and exporters of gas, oil, nickel, copper, aluminium, iron-ore, coal, steel, potash, nitrogen fertilizers, and precious metals showed how dependent Russian asset value was on the belief that global demand was in an unstoppable super-cycle, sustained by China.

In addition, the valuation of the ruble itself is dependent on commodity prices; at low oil prices, the ruble needs to fall in order to counter the terms of trade shock. Therefore, the easy forecast for 2009 is that the market will remain subject to the global growth cycle, as everyone could see when it bottomed out in 1998 and 200, and bounced back over 2003-2007.

The not so easy question, then, is whether or not Russia will start to move up faster or slower than the rest of the world — as a leader or a laggard in the recovery cycle. The International Energy Agency (IEA) argues that the underlying shortage of crude oil supply in the market is so significant that as soon as global growth returns, the oil price will rise. As the oil price is the principal variable for Russia’s macro position, and one of the few reliable sources of tax revenue for the Russian state budget, the market should be expected to react positively and rapidly.

But the counter argument in Moscow, put politely, is that the damage done by Russian companies to their corporate governance, their investor base, and their treasuries has been so significant that equity investment, as well as debt issues, will be delayed. The non-transparent way in which the Prime Minister Vladimir Putin, who also chairs the government’s bail-out bank, Vnesheconombank (VEB), is conducting liquidity support operations reinforces the suspicion that the recovery of Russian asset value will be slower than the rest of the world. So long as this suspicion remains, and the oil price does not stabilize above $70 per barrel, the downward pressure on the ruble will continue. And that means no bottoming for equities, no relief for corporate debt, no cash for new mining projects.
There is a simple reason why the Russian market plunge is deeper than others, and why it may last longer: when Russian corporate owners face liquidity and loss-making pressures, they loot what asset value they can lay their hands on. This behaviour, typical of the Russian oligarchs who dominate the resource and commodity economy, but not limited to them, led to the August 1998 financial crash, when the state itself defaulted. Most of the oligarchs themselves survived to prosper again; and the resource concession system, by which the Russian government corruptly awards property rights to the oligarchs in return for corruptly taxing the oligarchs’ cashflows, was reinforced.

The great opportunity in the present crisis is that the Russian government would use its accumulated cash reserves and undoubted political support to end the oligarch system; retrieve assets stolen corruptly a decade or more ago; end transfer pricing and schemes that have leveraged domestic capital in order to buy safe-haven assets abroad; and restructure both corporate governance and economic policy. This can be done through effective direction, conditioning and auditing of the flow of funds now moving from the Central Bank, the National Wellbeing Fund, the state budget, the state development bank Vnesheconombank (VEB), and the state trading bank, VTB.

If this doesn’t happen, if the oligarchs are bailed out, in return for kickbacks, then once again, Russia will be at the mercy of thieves. The tell-tale signs are obvious. Unless VEB puts auditors in place, the actual flow of the bailout funds will not be clear, certainly not publicly. The money could disappear. Government officials may issue public warnings to banks that if they receive government financing to improve their liquidity, they should not send the funds abroad, but lend at home.

The market is skeptical: it thinks there is no telling what will happen next. Domestic depositors pulled almost 8% of the domestic banking system’s deposits out in September and October, largely to convert into US dollars; and the rouble continues to fall. So, with the man on the street removing his money for safe-keeping in US currency, it can be expected that the commanding heights of the Russian economy will be surrendered in the same way.

A VEB loan of $1.8 billion to the leading steel, coal and iron-ore group Evraz, owned by the well-known oligarch Roman Abramovich, is another sign. Announced in a press leak in late November, this is in fact a bail-out of foreign debt, acquired by Evraz to finance loss-making asset acquisitions in the US and Canada. So long as this scheme kept driving up the Evraz share price, the stockholders grew happily richer; while in Russia, Evraz continued to turn out steel for the construction boom, and coking coal and iron-ore to fuel the furnaces. When the crisis struck, however, Evraz’s Russian steelmills claimed they were so short of cash, they couldn’t afford to meet their tax bills. The company’s market capitalization dropped from $48.3 billion, at share price peak in May of 2008, to $1.6 billion in November, just ahead of the VEB announcement. With debts exceeding $10 billion, including short-term obligations of more than $4 billion, Evraz was in virtual bankruptcy.
The Russian government could have obliged Abramovich to forfeit the North American assets to the banks, or secure the bailout with his own personal wealth. In case VEB’s accountants needed inventory help, a convenient list of Abramovich’s personal assets was issued by Justice Christopher Clarke in the UK High Court earlier this month.

Instead, the unaudited government cash support was announced, lifting Evraz’s market cap — and, of course, Abramovich’s wealth — by more than $1 billion. Not a single voice in the State Duma (parliament) was raised in question or criticism. Neither the Communist Party opposition, nor the pro-government majority, noticed that the bailout was for American steelmaking, not Russian.
Without the normal mechanisms for supervision and accountability of state finance, the Russia forecast is more than a gamble on global commodity price recovery. It is a roulette wager on a wheel that is rigged. VEB officially refuses to confirm its loan transactions, though it is state funded and controlled. Parliament isn’t notified. The Finance Minister doesn’t say. Arranging commissions and kickbacks can be hidden easily. Those in position to know claim that the going price demanded for these bailout loans is high.

One month before the August 1998 crash, the entire capital of an International Monetary Fund (IMF) emergency stabilization loan — $4.5 billion — disappeared, and was subsequently understood to have been stolen by a handful of proprietors of the banks, in league with government officials. Subsequently, the IMF announced that its “investigations found no evidence to support the allegations concerning misappropriation of funds.” If the IMF could not stop the stealing and would not acknowledge what had happened in the last crisis, VEB will not, and cannot, now.

One reason the international market will continue to view Russia risk so negatively, keeping equity prices low, relative to their international peers, is that the market understands this: in a crisis, Russian corporates loot their treasuries for the bailout of managers and controlling shareholders. They leave nothing of value behind. If this can happen when Putin is prime minister, his return to the presidency — much speculated about in political forecasting for 2009 — will make no difference at all.

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