The banking schism
“Many people are waiting for the banking crisis to repeat itself, and there are signs that this could happen,” says Sergei Suverov. “Banks still have short liabilities and long assets that don’t correspond. This was the way things were before, but before banks could cover the difference by refinancing on the inter-bank credit market. Now, however, a schism is growing increasing plain. On one side are the large banks that lend to each other and on the other are the small ones the big banks don’t really want to have anything to do with. This situation is creating the preconditions for potential crisis and bankruptcy of smaller banks.”
For this reason, a local liquidity crisis could occur at any moment, as it did in early September. The general lack of money was exacerbated by banks’ misplaced bets on the currency market. They expected the Central Bank to raise the dollar exchange rate as it had in August. Due to the resulting liquidity deficit, the Bank of Russia had to hold additional repo sessions for the first time since the June crisis.
As the market is currently living in constant anticipation of rising interest rates in Western countries, banks’ desire to play the currency market could lead to further liquidity problems at any moment. As a result, banks will have to sell bonds or announce an offering immediately and if one issuer cannot fulfill his obligations, Russia will see its domestic lending market collapse, closed to new borrowers and doomed to long-term stagnation.
Two things could save us from such a turn of events. The first is to attract foreign capital to Russian markets. However, we shouldn’t bet on it. The second, more effective way to protect domestic securities markets from potential collapse is to set up a broad system to refinance banks.
Yet the Bank of Russia has already chosen its preferred way of solving this problem. The plan bankers have thought up is simple and even beautiful in its own way. The Central Bank’s main mechanism for refinancing banks at present is repo, or credit with state securities as collateral. State banks are historically the main holders of these securities, which is why they have exclusive access to the Bank of Russia’s funds today. Private banks with far smaller amounts of state bonds already sold them off during the crisis to maintain liquidity. After getting money via repo at 6-7% p.a., Sberbank and Vneshtorgbank pour this money onto the inter-bank market and lend it to major banks at 10-11%, making a neat profit for doing basically nothing. Naturally, this does nothing to improve the liquidity of the banking system while increasing the gap in profitability and assets between state and private banks. As we already mentioned above, this is the main direction of today’s economic policy.

State-owned monsters
The main point of this policy is to gain government control over strategic industries in the domestic economy. As a result of the Gazprom-Rosneft merger and anticipated addition of YUKOS assets to this alliance, the state has control over the oil industry. The planned unification of all hydroelectric power plants into one state company will allow officials to control energy. Last week’s presidential decree to create the Avionika defense concern, in which the state will hold a 51% stake, fits the pattern. So does the recent nomination of presidential aid Viktor Ivanov to the board of directors at Aeroflot. We can assume that the consolidation of the domestic aviation industry made up of over 300 airlines will proceed much more quickly and that Aeroflot will benefit most from it. We have already noted the increased influence of Sberbank and Vneshtorgbank that was forced on the banking industry.
Perhaps, the only strategic industry left untouched by the state is non-ferrous metallurgy. Yet it seems this is merely a matter of time. A recent announcement by the Tax Ministry that metal companies were inappropriately reducing taxes “due to transfer pricing and tolling” completely fits the pattern. It seems that the main target is not aluminum companies, which after the formation of Rosgidroenergo will be at the beck and call of officials. All officials will have to do to bankrupt these companies is raise energy prices. More likely officials will strike Norilsk Nickel. It is hard to believe that the security clique in the government could resist the temptation to get their hands on the largest company on the plantinoid, gold, nickel, and copper markets.
Undoubtedly, state companies will have almost unlimited possibilities to attract investment. First of all, their state-owned status will dazzle investors with the sparkle of Russia’s gold reserves, budget surplus, stabilization fund, and other wonders. Secondly, as mentioned above, they are already key players in their segments of the huge Russian market and for this reason have strong export potential. Thirdly, they will be able to exploit their powerful political clout. The process of attracting investment via state-owned companies has already begun at the highest level. More and more foreign investment is coming to Russia due to various types of international agreements. As a result of the Korean president’s visit to Russia last week, officials signed investment agreements totaling more than $4 billion. A package of investment proposals discussed when the premier of the Chinese state council came to Russia foresees $12 billion in Chinese investment in Russian energy projects by 2020. It’s not hard to guess that most of this money will move through state-owned banks one way or another to state-owned companies.

The money pit
There is only one thing that prevents us from being truly happy at the bureaucrats’ investment victories: the serious suspicion that the lion’s share of this money will disappear into the bowels of the state-owned monster companies. The example of Rosneft is enough to make one worry. Despite less than brilliant achievements in oil production, the company has somehow managed to acquire massive amounts of debt, so much so that analysts at S&P are at a loss. Should they raise Gazprom’s rating after it merges with Rosneft or lower it due to the crushing debt?
Even more elegant are the attempts to take over the defense industry. The wave of terrorist attacks three weeks ago forced government bureaucrats to reexamine its funding of defense agencies. The hastily formed anti-terrorism commission led by Prime Minister Fradkov proposed amending the federal budget draft as early as October and increasing spending on national security. Additional funds will go to the FSB, the SVR, the Ministry of Internal Affairs and the Ministry of Defense toward investigation and intelligence and new equipment for officials and agents The exact amount the security and defense gang will get has yet to be announced but is already clear now that officials are talking in the tens of billions of rubles. No one is arguing against improving security, but will these funds do the trick? Over the last five years, state defense orders alone have nearly doubled from $1.7 to $4.8 billion. By simple economic logic, we should have seen an incredible upswing in domestic machine building as a result. This hasn’t happened because the money was simply stolen.
We should add here that in the last fifteen years not a single state company with the exception of Gazprom under Rem Vyakhirev has completed a single major investment project. Bureaucrats’ hemming and hawing about the eastern oil pipeline demonstrate that there is no one willing to take on the risks that are always associated with investment decisions. Thus, there will be plenty of international agreements, but when they will become realities and how well they will be carried out remains in question.

A triple-decker economy
The third level of the new Russian economy is made up of leading mid-sized companies. As a rule, these companies operate on highly competitive markets such as food production and services. They grew particularly rapidly over the last two years and made a significant contribution to the investment boom of 2002-2003. Or perhaps vice versa: the financial system in those years became increasingly well inclined toward companies of this type. The debris from the crumbling liberal capital market will likely do at least minor damage to these companies. Beginning in 2002, bonds (for the most progressive) or bills (for the weak and unknown) became a major source of funds. Loans from banks also played an increasingly important role in their finances. However, today the only major outside source of funds these companies can rely on are bank loans. Expensive loans at that. Thus, their prospects for active investment are in doubt. Moreover, recently many of these mid-sized companies have faced political risks of their own. In recent months, tax and other inspectors have started paying them frequent visits and unavoidable changes in regional politics that have yet to yield clear results are undoubtedly having a negative effect on their investment plans.
Of course businesspeople are fighting this negative pressure. However, as the result of an informal poll show, there is an equal number of optimist companies planning to continue active investment, companies with strategic plans for years to come that don’t want to miss the chance that excellent market conditions offer and of companies that are quickly cutting back on investments. And even the optimists point to slower growth in their market segments.

Summing up
Obviously, this triple-layered economy cannot grow quickly, as each level is facing its own complicated problems. In this sense, Russia should expect creeping stagnation that does not turn into outright economic decline only thanks to high oil prices, major state investment, and the investment activity of Western companies, which are in a favorable position versus Russian ones. However, there’s no use crying over the ruined capital market. It has collapsed and we need to build a new one. However, the authorities are obviously focusing on centralizing and directing the capital market so that key decisions are made by a limited group of state banks. This resembles what happened in post-war Japan or later in other Asian countries. Yet Japan was at the time in the midst of initial modernization of its economy. Russia already did so during the Soviet era. It’s not clear why the government wants to do it again. What may work for initial modernization will not work now. Modernization implies obvious basic economic trends. Nothing is obvious today, not in Russia and not in the world as a whole. To prevent Russia from being left behind again, we need a diversified economy financed by a diversified capital market. Japan had a clear development concept, which Russia doesn’t. Finally, we have heard Western financiers tell us more than once, “God help you if you go the way of Japan.” Because at the end of this road is an overheated market and then a long depression. Because things have changed. The global economy will not stand for that kind of economy, even if managed by enlightened officials.
How can we fix the situation? We need to build a new liberal capital market, one that will be stronger thanks to state resources. State projects will only stand to benefit from this approach, as the foundation for the market can be laid via federal bond issues. However, this will not be possible if two or three state-owned banks dominate the market. This means that the Russian banking market needs to be subtly restructured in cooperation with the banking community that is still alive and kicking. The banking community is ready to cooperate, by the way. Restructuring will take some time, during which there will be a brief investment break, but as a result we will end up with a stable market capable of providing Russia with long-term economic growth.
At the same time, we are also witnessing the birth of new survival tactics for businesses in the era of backwards dirigisme. Russian entrepreneurs are actively seeking Western partners with access to cheap financial resources, good management, and few political risks, as bureaucrats are unlikely to grab property belonging to a major Western company. Examples include Novatek’s sale of a blocking stake to Total and Irkut’s sale of 10% of its shares to EADS. Of course, some might call this selling off Mother Russia, but in truth this is just a slightly strange kind of insurance born of globalization that allows us to hope that the coming stagnation will not in the end lead to collapse.
Maxim Borisov, Yana Galukhina, Yuri Korotetsky, Andrei Naumkin, Ilya Stupin, Yekaterina Shokhina, and Alexei Khazbiev assisted in the preparation of this article

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