GROWING CONCERNS OVER RUSSIA'S EXTERNAL DEBT

C O N F I D E N T I A L SECTION 01 OF 04 MOSCOW 000534 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR MCFAUL E.O. 12958: DECL: 02/09/2019 TAGS: EFIN ECON RS PGOV PREL SUBJECT: GROWING CONCERNS OVER RUSSIA'S EXTERNAL DEBT REF: MOSCOW 00502 Classified By: AMB John R. Beyrle, Reasons 1.4 (b/d). -------------- Summary -------------- ¶1. (C) Russia's external debt situation has become a source of increasing concern and speculation among local analysts and international bankers. The mid-February tempest over a press report that the GOR planned to coordinate a large-scale restructuring of much of Russia's private external debt underscored the degree of nervousness. Fueling that nervousness is at least $140 billion in short-term loans, much of it private sector or quasi-private, that are coming due this year. The GOR has signaled that it will guarantee the loans of state corporations. Foreign banks had been hopeful that the GOR would also support other private sector debt repayments. However, the GOR appears to have dashed that hope as it has said publicly and privately that it will no longer bail out private companies, such as Oleg Deripaska's Basic Element, currently locked in difficult negotiations over a reported $14 billion in short-term loans. ¶2. (C) Some local analysts argue that the GOR has already transferred about $100 billion in reserves to banks and private companies through the ruble's gradual devaluation and that this will be enough to avoid defaults. However, other analysts believe the decision not to support Russia's private sector reflects the GOR's eroding financial position and predict that several private Russian companies will experience payment problems this year, including potential defaults, and that the GOR will have difficulty covering the expected large capital account deficit this year. End Summary. -------------- February Tempest Reveals Concerns -------------- ¶3. (SBU) The mid-February reports of a possible GOR-sanctioned debt renegotiation briefly sent chills through Europe's banking sector. Japan's Nikkei news service reported on February 10 that Duma Deputy Anatoliy Aksakov, who is the president of the Russian Association of Regional Banks, announced the GOR was prepared to help renegotiate $400 billion in debt held by Russian firms. As the report circulated, with other news services picking it up, the euro fell against the dollar amid speculation that Russian firms would have difficulty repaying $140 billion in short-term debt due this year, much of it held by European banks. ¶4. (SBU) The GOR went into full-fledged damage control after the story broke. Aksakov gave a subsequent interview in which he disavowed his previous comments and senior GOR officials, including PM Putin, Finance Minister Kudrin, Kremlin Chief Economic Assistant Arkadiy Dvorkovich, and Government Spokesperson Dmitriy Peskov, all strongly denied the story. The official reaction eased market anxiety, at least for the moment, about whether Russia can manage its external debts and, as the day ended, the euro recovered some ground. However, the question raised by the report remains foremost in many people's minds: just how bad is Russia's financial position? -------------- Deripaska and Russia's External Debts -------------- ¶5. (C) According to the Russian Central Bank (CBR),Russia's foreign debt totaled $540 billion on September 30 -- the latest date for which information is available -- including roughly $140 billion due in 2009. About $70 billion was due in the fourth quarter of 2008, although some might have been rolled over into 2009. The public sector component of Russia's total debt is rather small, less than $50 billion. A large part of the markets' anxiety reflects questions about the extent to which the GOR will guarantee the debts. Many of the lenders apparently believed when they made the loans that the Russian government and its substantial reserves would back the loans made to state corporations and political insiders. However, as Russia's reserves have dwindled in recent months anxiety among foreign banks about Russia's external debts -) especially among European banks with heavy MOSCOW 00000534 002 OF 004 Russia exposure -- has risen. ¶6. (C) In the last two weeks, the GOR has taken several steps that clarify the situation. According to Tim Ash, the Royal Bank of Scotland's Head of Research for Central and Eastern Europe, the GOR has extended a sovereign guarantee to external debts held by state corporations, such as Rosneft and Gazprom, and state banks, such as Sberbank. This raises the total public debt to approximately $220 billion out of the $540 billion. ¶7. (C) At the same time, the GOR signaled in private and in public that it would not do more to bail out "private" companies, including most famously Oleg Deripaska, who has gone from Russia's "richest man" to Russia's "most-indebted" man in fewer than six months. The GOR loaned Deripaska $4.5 billion late last year to cover external debts but apparently drew the line as he has sought to roll over or restructure a reported $14-$16 billion in debt due this year, at least half of which is owed to foreign banks. (The other $7 billion, owed to Russia's state banks, may be repaid via an equity for debt swap, with the banks acquiring a percentage of Deripaska's RusAl holdings.) ¶8. (C) RenCap's Deputy Chairman, Amcit Bob Foresman, told us that motivated by Deripaska's situation, representatives of 65 banks, mostly European but including some American, met recently with First Deputy Prime Minister Shuvalov and Deputy Prime Minister Sechin to ask that the GOR guarantee the external debts of Russia's private sector. According to Foresman, the GOR officials rebuffed the bankers and said the GOR would not commit another large amount of its reserves to guaranteeing private sector debts, including those of Deripaska. ¶9. (C) President Medvedev's Chief Economic Assistant, Arkadiy Dvorkovich, last week at the Krasnoyarsk Economic Forum reiterated his previous comments that the GOR would not support private sector external debts. Deripaska has apparently accepted his fate, publicly (and implausibly) claiming that he neither needed nor was seeking GOR support. Dvorkovich confirmed to the Ambassador in a late February meeting that the GOR had decided that, for the time being, it could not afford to bail out Deripaska or any of the other oligarchs (reftel). -------------- Can Russia Manage? -------------- ¶10. (C) The GOR's loss of more than $200 billion in reserves, most of which were used to gradually devalue the ruble, has unquestionably complicated its financial situation. However, RenCap's Head of Research, Roland Nash, is among those local analysts who believe that the GOR, either deliberately or through a happy accident, transferred CBR reserves to private corporations through its gradual devaluation of the ruble. According to this theory, the CBR allowed private sector firms and banks to convert the ruble liquidity the CBR had injected into the system into foreign exchange and thereby to profit (reportedly to the tune of nearly $30 billion) from the ruble's depreciation. The result, according to Nash, is stronger balance sheets and an increased ability in the private sector to cover external debts. ¶11. (C) Another proponent of this view is Troika Dialog Chief Economist Evgeny Gavrilenkov. In a February conference call, he said Russian companies late last year probably added about $100 billion to their balance sheets by exchanging rubles for dollars during the CBR's managed devaluation of the ruble. Gavrilenkov said firms were "probably" planning to use most of these funds to repay external debts due this year. He added that the GOR is also probably counting on larger Russian corporations being able to roll over some of their debts until 2010. ¶12. (C) However, not everyone is so sanguine. Russia's former Deputy CBR Chairman and former Russia Merrill Lynch President Sergei Aleksashenko in a conversation with us last month told us Russia's fiscal position is fast eroding (septel). Aleksashenko said that while Russia's private sector debt was relatively low as a percentage of GDP at about 40 percent, its short-term private debt, at 12 percent, was a major problem and he doubted many foreign banks would willingly rollover the debt, given tight credit conditions MOSCOW 00000534 003 OF 004 internationally. ¶13. (C) The President of Global Rating, Richard Hainsworth, told us the ongoing crisis would present "challenges" for some Russian firms and banks, which would have difficulty making payments this year. Foresman noted that even in 1998, few Russian companies had defaulted to lenders and expressed concern that if it happened on a widespread scale in this crisis, international credit markets could be closed to Russian firms for years to come. ¶14. (C) The odds of any major defaults this year by Russian companies are probably unlikely, primarily because it not in any foreign bank's interest to foreclose. In Deripaska's case, for instance, in addition to the $7 billion RusAl owes foreign creditors there is another $10 billion owed by his holding company, Basic Element. The GOR will not allow the foreign lenders to obtain shares in RusAl and the non-transparent Russian court system would be an effective deterrent to such an attempt. In Basic Element's case, there is no underlying asset to seize. A default would therefore yield the foreign banks virtually nothing; better therefore to reschedule the debts and try to get something back from Deripaska in the future. -------------- Implications for Russia's Balance of Payments -------------- ¶15. (C) At this stage, it is unclear how much of the $140 billion in debt that will come due this year will be rolled over and how much will be repaid. In that regard, it is also unclear what portion of the $100 billion that Nash, Gavrilenkov and others claim has already been transferred to the private sector will be used to repay foreign loans. The answers to these questions will go a long way toward determining how difficult Russia's balance of payments situation becomes this year. ¶16. (C) In addition to the $140 billion due this year, Aleksashenko estimated there would be another $50 billion in capital outflows resulting from services and interest payments. Aleksashenko predicted that the capital account could, therefore be as much as $200 billion in the red, depending on how much of the external debt is rolled over. While the figure is likely to be less, it will still be substantial and this deficit, as Aleksashenko noted, would have to be made up in one of three ways: through the trade balance (implying a further devaluation of the ruble), through additional foreign borrowing (problematic this year), or through the use of CBR reserves. ¶17. (C) Lending credence to Aleksashenko's concerns, the World Bank's Russia representative, Klaus Rohland, recently confirmed that Russia's financial authorities have begun discussing a World Bank loan guarantee should the GOR seek to borrow on international credit markets. Although no formal request had been made, Rohland claimed that given Russia's track-record of fiscal prudence, the World Bank was inclined to be helpful. He said the guarantee would enable Russia to borrow at below market rates but while he thought Russia could borrow, he acknowledged that the interest rate was likely to be high (we've heard 10 percent at a minimum) and that there were questions about how much they might be able to borrow. ¶18. (C) Alexander Lebedev, oligarch, philanthropist and Kremlin critic told the Ambassador last month that another potential solution to Russia's emerging balance of payments problems that Russia's economic elite is discussing is having the GOR take on all of the private sector debt, converting it into sovereign debt. With an explicit government guarantee backing the debt, it could be rescheduled over a longer term and at lower rates. This would forestall any potential payments difficulties and would certainly be better for Russia's long-term reputation than defaults, even private sector defaults, but could involve substantial moral hazard for the government by bailing out Russia's over-leveraged oligarchs at the expense of the Russian government and taxpayers. -------------- Comment -------------- MOSCOW 00000534 004 OF 004 ¶19. (C) It has been an article of faith with the Russian Government and most Russia watchers that the GOR's fiscal prudence of recent years )- strong budget surpluses resulting in large reserves )- put the country in a good position to weather the economic downturn. That optimism is ebbing along with Russia's reserves. The GOR's politically risky decision to cut off the oligarchs from additional government help with their external debts is a case in point. It is not a decision it would have chosen to make, as evidenced by the initial support it offered Deripaska, Alpha's Fridman, and other influential oligarchs last fall. It was a decision it had to make given that there are more pressing priorities, including especially social spending to dampen rising tensions as the crisis worsens. ¶20. (C) Absent a rise in commodity prices, the situation could be even more complicated next year. Continuing pressure on the ruble and on reserves, along with the large deficit the government will run this year, will exhaust much of the GOR's financial resources. In the face of a continuing economic crisis, the GOR will undoubtedly want to maintain high social spending next year as its primary anti-crisis measure. To do so, it may have little choice but to borrow abroad, most likely commercially at high interest rates but without the tough conditionally that would accompany loans from international financial institutions. BEYRLE