RUSSIA'S NEW PLAN FOR RESERVES FAILS TO HALT

C O N F I D E N T I A L MOSCOW 002992 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR ELLISON E.O. 12958: DECL: 10/01/2018 TAGS: EFIN ECON RS SUBJECT: RUSSIA'S NEW PLAN FOR RESERVES FAILS TO HALT MARKET SLIDE REF: MOSCOW 2978 Classified By: Acting DCM Eric T. Schultz, Reasons 1.4 (b/d). -------------- Summary -------------- ¶1. (SBU) Russia's Federal Financial Markets Service (FFMS) ordered a one-and-a-half day closure of Russia's exchanges early in the October 8 trading day after they resumed their steep declines, with the benchmark RTS Index dropping more than 11 percent and the MICEX Index more than 14 percent. A day earlier, the GOR had announced it would provide $38 billion of Central Bank reserves in the form of subordinated debt to the country's largest banks. However, this latest rescue package, like the GOR's previous efforts, failed to restore market confidence. Mounting concerns about the effects of tighter lending on the broader economy apparently drowned out any possible benefits stemming from the GOR's new plan. End Summary. -------------- Russian Stocks Race to the Bottom -------------- ¶2. (SBU) The trading day began on time today, October 8, for the Russian exchanges, but Russian stocks immediately continued their steep decline from earlier this week after a relatively day on October 7. The benchmark RTS Index fell more than 11 percent and the MICEX sank more than 14 percent in early trading on October 8. In response, at approximately 11:00 a.m. Moscow time, the Federal Financial Markets Service (FFMS) once more ordered a suspension of trading. Moreover, in what appears to be an effort to allow the markets to cool, the markets will remain tomorrow and will not reopen until Friday, October 10. Among the truncated October 8 session's biggest losers were state-owned VTB bank, which fell 16 percent, and Rosneft, which dropped 14.9 percent. -------------- Reserves to the Rescue? -------------- ¶3. (C) The rapid descent in share prices demonstrated that the week's strongly negative sentiment had remained unmoved by the GOR's latest rescue effort, its announcement a day earlier that it would use $38 billion in Central Bank reserves to restore the domestic flow of credit. The GOR had indicated late on the night of October 6 that it would once more intervene in support of the financial sector. During the afternoon on October 7, during the trading day, Finance Minister Kudrin specified the nature of the latest rescue attempt. Kudrin said the country's largest banks -- namely Sberbank, VTB, Russian Agricultural Bank, Gazprombank -- would receive the reserves in the form of subordinated debt for a term of five years. With this effort to recapitalize the so-called "formative" banks (i.e. the four largest state-owned banks that form the foundation of Russia's financial system),consulting firm FBK's Strategic Analysis Director Igor Nikolayev told us the Central Bank hopes to use them to replace the role of international lenders in the Russian financial system. ¶4. (C) Nikolayev explained that Russian firms and Russian banks no longer have access to overseas credit markets. Against this backdrop, Sberbank, VTB, and Gazprombank have been the main beneficiaries of the GOR's effort to supply liquidity to the credit-starved economy but have done little to mitigate the problem. The hope behind making the reserves available on a longer-term basis is that the recipients will do a better job of extending credit to the banks and firms that need it. However, based on the market's continuing selloff, investors either took little notice of the GOR's proposal or considered it to be "more of the same," according to Nikolayev. -------------- Suspensions Beget Suspensions -------------- ¶5. (SBU) Whatever the potential benefits of the GOR's new plans, worsening spillover effects from the financial crisis overshadowed them and contributed to the steep market decline. Carmaker GAZ announced that its own credit crunch had led the board of directors to suspend production of its light commercial vehicles for four days because of difficulty accessing credit. Magnitogorsk Iron and Steel Works, Russia's third-largest steelmaker, issued a statement that it would reduce its October output 15 percent, with possible employment layoffs as a result of the financial market uncertainty. Rosbank fixed income analyst Mikhail Vlasov told us that LUKOil sought help on behalf of Russia's hydrocarbon firms from the GOR to refinance foreign debts. Without new financing, the companies would need to adjust expansion plans. (N.B. LUKOil's share price dipped 13 percent before the FFMS suspended trading.) -------------- Comment -------------- ¶6. (C) The FFMS delayed the opening of the trading day on September 30 to allow investors to absorb the news of last week's rescue package. It didn't work; the trading week that ended October 3 was the worst week in the history of Russia's stock markets. This week, the GOR once again tried the same tactic with similar results. The latest rescue package has also failed to restore confidence in the markets amid the continuing drumbeat of bad economic news -- including negative net capital outflows of $16.7 billion for the third quarter. We don't expect tomorrow's closure to have any material effect on the markets' performance when they reopen on Friday. Russia's bumpy ride continues. RUBIN