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July 29, 2014 6:01 pm
Even before Russia was hit with the latest round of western sanctions on Tuesday, the mood in Moscow was as if the blow had already landed.
After a month-long lull, financing conditions for Russian companies were fast deteriorating, according to investors and bankers, as the windows to foreign capital appeared to be closing.
“This is completely different from the first rounds of sanctions: much clearer and more limited, but in a very painful way,” said the head of a Russian financial holding company backed by one of the country’s leading oligarchs.
Since the 2008 global financial crisis, European capital markets have become key financial conduits for Russia’s banks and companies. The country’s banks sourced about 50 per cent of their funding from Europe over the past three years, according to estimates by London-based bank analysts, making it their single biggest regional source of foreign capital.
With the combination of capital market restrictions imposed by Washington last week and now similar ones in Europe, many big borrowers are seeing their options dwindle. “There used to be a lot of room for arbitrage between the US and the EU, but that is disappearing now,” said the Russian holding company executive.
The need for foreign financing is considerable: Russia’s non-financial state companies have $41bn in external debt coming due over the coming 12 months and state banks another $33bn, according to Morgan Stanley. Private banks add another $20bn, and non-financial private companies a whopping $67bn.
“Sanctions would cut off a major source of financing. [Russian banks] have an insatiable need for money,” said Bruce Johnston, a partner at Morgan, Lewis & Bockius, a law firm that represents several Russian banks.
“If you cut banks off from the US and Europe, where do they get their money from? Maybe the Russian central bank, although the interest rates are higher on rouble debt. The renminbi market in [China] is one possibility, so is Hong Kong or Singapore dollars. But whether those markets are deep enough to keep things going in the longer term we’ll have to see,” he added.
The Moscow head of a US bank said sectoral sanctions were already rippling through state oil firm Rosneft and state policy lender VEB, both partly barred from US capital markets last week. “They won’t be able to take on any new projects, and their funding base is going to shrink as well. You’re pretty much back to the emergency situation in 2009 when the central bank was the lender of last resort,” he said.
The larger question is how soon before such financing conditions strangle the broader economy. “There is a good chance that things could get quite bad quite quickly,” said Neil Shearing, chief emerging markets economist at Capital Economics.
Still, he and many other economists argue that Moscow’s hefty foreign exchange reserves, its healthy fiscal position and the boost that exports and oil and gas revenues are receiving from the weaker rouble put the government in a relatively safe position to manage the economy.
After a sharp slowdown of growth and a jump in capital outflows in the first quarter of this year, both industrial production and investment appeared to be staging a modest recovery in the three months to June 30.
Economists say that trend is now unlikely to hold once broader EU sanctions are in place, raising the risk the economy will fall into a full-blown recession. “As more public funds will be needed to shore up state banks and big enterprises and keep voters happy, they will have to cut elsewhere, so public investment is likely to be squeezed,” Mr Shearing said.
The government appears to share that view. The central bank hiked rates by half a percentage point last Friday in a surprise move widely seen as an attempt to brace for EU sanctions. In its accompanying statement, the bank dropped previous remarks indicating it expected an economic revival in the second half of the year.
For all the damage western sanctions may wreak, many Russian executives warned that private businesses were poised to bear the brunt of the punishment – not the leadership and tycoons most closely linked to it.
“In fact, Russian companies and investors who are not Putin’s cronies, who are perfectly clean and built a viable business from scratch, are being hit,” one Russian billionaire complained. “You have to make a difference between Russians and Russians. Otherwise you’re going to destroy the part of Russia that is the west’s friend – the part that offers the best chance of making Russia open, capitalist and democratic.”
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