Global equity turmoil causes panic on the Russian market
Issue:
October 2008, Vol.3, No. 9
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The terms ‘volatility’ and ‘fragility’ as well as well ‘panic,’ ‘redemption packages,’ ‘uncertainty over who is next,’ ‘sacrificial lamb’ etc., became the most frequently heard words/phrases across major global stock exchanges in mid-September as key equity indices, including the Russian blue-chips, repeatedly swapped pluses with minuses and vice-versa as U.S. market regulators and leading world central bankers searched for the most viable ways of saving distressed financial institutions, the latest victims of the subprime crisis and other woes that have been bombarding Wall Street and other global financial centers since last August.
The crisis took a more ominous turn, with all the global equity indices going down as U.S. regulators, acting contrary to expectations, allowed Lehman Brothers (LB) — seen as the ‘sacrificial lamb’ — to collapse after nearly 160 years of existence and took more time than necessary to arrange a long-overdue bailout package for AIG, another comatose landmark financial enterprise, whose bankruptcy would have finally pushed the depleted U.S. economy, and indeed, the global economy, into an abyss. However, the global equity indices slightly recovered on September 17 after the U.S. Fed Reserve belatedly agreed to rescue AIG by pumping $85bln into the ailing insurer in exchange for a 79.9% stake, and also took other serious measures, such as injecting $50bln into the stabilization of the financial market and keeping the interest rate intact, thus lowering the risk of further economic slowdowns in the United States and across the globe.
"The crisis took a more ominous turn, with all the global equity indices going down as U.S. regulators, acting contrary to expectations, allowed Lehman Brothers (LB) — seen as the ‘sacrificial lamb’ — to collapse after nearly 160 years of existence and took more time than necessary to arrange a long-overdue bailout package for AIG, another comatose landmark financial enterprise, whose bankruptcy would have finally pushed the depleted U.S. economy, and indeed, the global economy, into an abyss."
However, the unnecessary interlude between the sudden demise of LB, Merrill Lynch’s sale to Bank of America and the announcement of the belated AIG package stoke fears about the soundness of the health of the U.S. financial market, which, given the general frailty of the U.S. economy, was more than enough to cause unprecedented damages across the globe as shareholders of U.S. equities and other investors entered into a mourning mood. The tailspin on the U.S. market, where major indices dipped by 3.5-4.5% as Morgan Stanley and Goldman Sachs — two of the remaining independent largest investment banks on Wall Street, previously seen as relatively safe from the current crisis came under serious investor pressure — instigated a cascade of negative reactions across the globe, pulling down major EU equity market indices, which lost between 1.63-3.43% and key Asian stock indices that went down by 5.0-5.5%.
The damages from the latest rounds of the financial crisis at the peak of the equity turmoil from ‘coast to coast’ across the major international stock markets have run into hundreds of billions of dollars. Thus, such leading international institutions as the Eurocommision and European Central Bank, have estimated the damages at $500bln, which is on the more conservative side, while IMF Managing Director Dominique Strauss-Kann has put his estimate at a more staggering sum of $1.3trln, up from the IMF’s previous estimate of $1trln, a figure that seems to be the more realistic approximation of the devastations caused by the financial chaos. “The economic damage that developing countries, already reeling from high food and fuel prices, could suffer from this global financial crisis, could finally push them over the edge,” World Bank President Robert Zoellick said.
To reverse the swirling negative trends, the central banks of leading industrialized nations pumped between $250bln and $300bln through various forms of interventions into the global economy. This yielded some temporary positive results as all key global equities recovered their losses across major financial hubs on September 19. To attain a much longer-term stability, the U.S. financial authorities have announced plans to inject additional $700bln into the local financial system, while a similar step on the global financial markets will require a more grandiose sum, about $1.3trln, a commitment that will be unprecedented in the history of financial interventions on the world financial markets.
The Russian equity market takes worst hit
With the worst news blowing from all across the globe, the Russian equity market had no alternative than to follow the ‘contagious’ bandwagon trends, posting the worst one-day plunge in its nearly 20-year history. This drop was so radical and threatening that it prompted both the nation’s major exchanges, RTS and MICEX, to halt trading on September 16-17 to prevent the local equity indices from sliding into uncontrollable tailspin that could have instigated more unpredictable consequences for the whole of the economy.
However, after the nearly $50bln-interventions into the equity market and nearly 2trln.rubs to support the local banking system to stave off the increasingly growing acute liquidity shortages, the Russian stock market was also halted twice on September 19 after the local equities rallied aggressively at RTS and MICEX by about 23% and 30%, respectively, to new historical heights. “The halts became necessary to prevent an escalation of the situation, give time for traders and investors to calm down and reanalyze the rapidly changing situations on the equity market, and thus take more informed decisions on the ways to best navigate the crisis,” Federal Financial Markets Service (FFMS) Director Vladimir Milovidov said, explaining the necessity to intervene on the local exchanges.
"With the worst news blowing from all across the globe, the Russian equity market had no alternative than to follow the ‘contagious’ bandwagon trends, posting the worst one-day plunge in its nearly 20-year history. This drop was so radical and threatening that it prompted both the nation’s major exchanges, RTS and MICEX, to halt trading on September 16-17 to prevent the local equity indices from sliding into uncontrollable tailspin that could have instigated more unpredictable consequences for the whole of the economy."
Indeed, the FFMS’ intervention now seems a logical reaction, because at the height of the plunge on September 16, the benchmark RTS Index lost a record 11.47% to close at 1,131.12, which is a 54.5% fall from its highest close of 2,487.92 on May 19, while MICEX spun off almost 17.45% to close at 881.17. In natural terms, the capitalization of the Russian equity market lost over $83.94bln, or about 10.95% at its peak value of $766.54bln, to peg tentatively at $682.6bln, another negative landmark record for the local economy, and about a whopping 52% drop in value since the beginning of 2008. Expectedly, the nation’s major blue chips suffered the worst day in their trading history, led by the VTB Group and Sberbank, whose shares dipped by 29.0% and 15.3%, respectively. They were closely followed by the oil and gas stocks, as Rosneft’s share value plummeted by 19.2%, Gazprom shed 17.2% and Novatek going down by 15.4%. Others such as metallurgy and telecom companies also took serious beatings at RTS. At MICEX, the situation was also equally pathetic, as the exchange’s Oil & Gas Index lost 16.61%, Telecoms Index dipped by 18.37%, Metals & Mining Index dropped 15.66%, while the Financials Index slid the by day’s negative record of 20.65%.
Without mincing words in its commentary to investors on the events of the day, Moscow-based investment bank Troika Dialog called the situation on the Russian equity market ‘carnage’, noting that the word ‘redemption’ was the most-often heard word on the trading desks as there were practically no new trades on the options market. Also expressing similar pessimism in its daily market wrap-up, Aton, another local investment bank, noted that the Russian equity market ‘was in a free fall,’ as its major indices, which began trading on September 16 at minus 5%, quickly fell further by 5% to minus 10% during the day, with the banking sector taking the worst hits.
First victim and assets buyback options
It, therefore, came as no surprise that the spiraling negative trends claimed their first victim on the Russian financial market at the peak of the storm. The victim, KIT Finance, a large Russian investment bank, has reportedly entered into takeover negotiations with a strategic investor, Leader Asset Management, which lists Gazfond Pension Fund and Gazprombank as its major shareholders, for a sale of a controlling stake, following its failure to meet its repo obligations, reportedly worth about 6-8bln.rubs, on September 16.
Admitting KIT’s default and shaky position, Sergei Grechishkin, a board member and head of the bank’s investment department, blamed the market turmoil for the bank’s default on its repo obligations to counteragents. “Because the market is plummeting and some of our clients failed to fulfill their obligations to us, we, in turn, also failed to fulfill our obligations to our counteragents,” he said. “We understand our entire responsibility to the market and are doing all we can to handle the situation in the best possible way to close all our clients’ deals.”
However, local experts are reticent of listing names of potential victims, but the general contention is that those most likely to follow are companies with the highest debt exposures to the global markets but with insufficient funds, other collateral and foreseeable bailout packages, including from third parties, to help them weather the raging financial storms.
However, there is a positive side to these negative trends, as the market’s current weakness is offering Russian companies a good chance to buy back shares at amazingly cheap multiples, according to Troika Dialog. “In practice, however, many companies do not have ample cash balances to conduct buybacks. Even if a company is not leveraged, it is impossible for it to raise loans for buybacks under the current conditions,” it said, citing VTB as a spectacular example of this trend. “Needless to say, the primary debt market is effectively closed for all borrowers, regardless of their credit quality.”
However, other analysts believe that some local big leaguers, especially from the metals, oil and gas sectors, still have significant cash balances relative to their market cap to foot buybacks. Thus, according to Aton, Severstal has already announced plans to buyback its stocks worth about $400mln, or about 2.5% of the company’s charter capital. From the energy sector, a similar has already been taken by LUKoil’s top executives — company’s president, Vagit Alekperov, and vice president, Leonid Fedun, who have jointly acquired 0.7% of the company stocks for 910mln.rubs.
Russian officials’ actions
Commenting on the on the fragility of the local equity market, both Russian President Dmitry Medvedev and Prime Minister Vladimir Putin have squarely placed the lion’s part of the blames for the current episode of financial crises on the global markets, and especially on the United States. “This is not the first time that Russia has been feeling the negative impacts of dependence on the global economy. But if we were to assign blames for the current financial instability, I would say only about 25% of the causes of the volatility on the Russian equity market and the capital flight from the country in the past few weeks are of local origin, while 75% are of external nature, Medvedev said at meeting with the FFMS director. “We cannot change the situation in the United States in terms of this crisis, as it ought to solve its problem, though I must say that the United States has made all countries more vulnerable. But the Russian government has the means to bring situation under control in the country.”
Also attributing the blame to external factors, Milovidov noted that the situation on the Russian financial market in general, and the equity segment in particular, is a reflection of the negative crisis processes in the more developed economies, notably the United States and EU zone. “Monitoring these trends on daily basis, we do see these frequent negative changes, but at the same time, we also see that there are no fundamental reasons in the Russian economy to necessitate such dramatic dynamics, a situation that sharply contrasted with the more fundamental negative changes on the Western markets.”
"This is not the first time that Russia has been feeling the negative impacts of dependence on the global economy. But if we were to assign blames for the current financial instability, I would say only about 25% of the causes of the volatility on the Russian equity market and the capital flight from the country in the past few weeks are of local origin, while 75% are of external nature."
Assuring investors and other equity players, Milovidov noted that the situation on the Russian financial market is ‘correctable,’ as the Russian market has over the past 2-2.5 years been the global equity markets growth leader. “Consequently, what is happening today is a ‘correction’ toward the global trends. This is because after tripling its size in the past three years, a fall of 40% in the equity market capitalization in the past days and months, in my opinion, should not be viewed as dramatic,” he added. “However, the current market situation will prompt us to take not only short-term and emergency measures, but also to take long-term steps that will enable us to boost the size of the Russian capital market, first and foremost, through larger involvement of our local investors.”
Also calling on investors and analysts not to ‘dramatize’ the situation, Russian president noted that the negative changes would be short lived, and long-term stabilization in sight, as the government plans to take all the right and necessary measures to fight the negative trends. “This is because it is obvious that most Russian stocks today are highly undervalued, thus meaning there is more huge potential for further growth. And secondly, I believe that the government is capable of returning the market to the level of indices that were registered at the beginning of the year.”
Swinging into actions to implement the president’s orders to stabilize the local financial market, both the Finance Ministry and Russian Central Bank (CB) have announced measures to boost the liquidity by as much as 3trln.rubs to calm the situation on the local capital market. This should be enough to meet the needs of the banking industry now and in the foreseeable future, CB noted in an official statement. “Today, after analyzing the market trends, we came to the conclusion that we need, first and foremost, to support the ‘backbone banks,’ such as Sberbank, Vneshtorgbank and Gazprombank, which, in turn, will help stabilize the interbank rates market through the provision of affordable loans to the medium and smaller banks, thus helping them to handle the current liquidity crunch,” Finance Minister Alexei Kudrin said. “The volume of federal resources available to these three banks has been increased by additional 282bln.rubs to 1.5trln.rubs, because with foreign borrowing stopping, we understand that we must mitigate the resulting negative impacts with more additional funds to stabilize the situation.”
Also, the CB has ‘softened’ the obligatory deposit requirements for commercial banks, a move that will allow the financial institutions to have more resources at their deposal to handle the acute liquidity shortages. “This policy will liberate up to 300bln.rubs in the banking sector. These resources will be available to all banks to enable them meet all their obligations to clients as well as fund all their operational necessities,” CB Chairman Sergei Ignatiev said. Putin weighed in later to calm the investors at a Cabinet, noting that Russia has a huge ‘safety bag’ that will enable it to weather the progressively worsening storms on the global financial markets and its negative impacts on the local market with little or no damages to the people and the local economy.
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