Putin and Medvedev Differ on Market Ills

ReutersA possible bailout deal for Lehman Brothers was the subject of talks Sunday.
Russian markets bounced back Friday after a dreadful midweek slump, marking a possible turning point after losing more than 40 percent of their value this summer amid tumbling commodity prices and concerns over political risk.

The ruble-denominated MICEX Index jumped 6 percent Friday to close at 1,137.76 points, while the dollar-denominated RTS Index was up 3.4 percent at 1,341.75 points, reducing their weekly losses to 7.9 percent and 8.7 percent, respectively.

The gains came as hopes grew Friday of a bailout for troubled U.S. bank Lehman Brothers and as President Dmitry Medvedev and Prime Minister Vladimir Putin talked up Russian markets.

The two leaders differed, however, on how much of the current market slump was the result of domestic factors.

Medvedev said Friday, in a meeting with the Valdai Discussion Club, an annual event for visiting foreign Russia specialists, that some of the difficulties were the result of factors at home.

"Seventy-five percent of the fall in market indexes is the consequence of the international financial crisis, while 25 percent is from our domestic problems, including the consequences of the war in the Caucasus," Medvedev said, Reuters reported.

Medvedev's comments came a day after he assured a meeting of economic ministers and state bankers that the government would step in to boost liquidity on markets and in the banking system.

Putin, meanwhile, was unwilling to admit to any connection between recent falls in stock prices and the ruble, and the Georgia conflict.

"We thought we might face a liquidity issue. It is in no way linked to the crisis in the Caucasus," Putin told reporters Friday at his residence near Sochi.

The U.S. subprime mortgage crisis "led to an outflow of speculative capital," Putin said. "Western institutions began to repatriate capital long before the crisis in the Caucasus."

The comments came a day after Putin told the Valdai club in Sochi that lower capital inflows this year were a positive, as they could help in combating inflation, and shrugged off the recent fall in the ruble as "not critical."

Investors and financial analysts put the political risk premium, driven by the Mechel affair and the conflict with Georgia, at close to Medvedev's figure.

"The political risk premium can be seen in the difference between Brazil and Russia, two commodity-driven markets," said Erik de Poy, equities strategist at Alfa Bank, noting that Brazil's benchmark Bovespa index fell by 37 percent over the same period that the RTS dropped by 48 percent.

Analysts were reluctant to attribute Friday's gains to positive talk from the government, but some said the day's trading results might signal a recovery.

"It was a valiant effort to talk up the market, but it mainly had a moral, psychological effect," De Poy said.

"Friday's actions in the markets, particularly the strong gains in [London-traded shares], suggest that investors may be ready to draw a line in the sand for Russian asset valuations," UralSib wrote in a note to be released Monday.

While Russian assets now look "heroically cheap," in the short term "there is strong selling pressure from margin sales domestically," Kingsmill Bond, chief strategist at Troika Dialog, said in a note Friday. "The problem is that this will start to show up in the real economy as losses and bankruptcies."

Two key external factors — the fate of Lehman Brothers and the direction of commodity prices — could determine whether a recovery will get under way on Russian markets.

A lot will depend on the reaction to whatever Lehman rescue deal is cobbled together over the weekend by U.S. Treasury Secretary Hank Paulson and leading Wall Street bankers, De Poy said.

On Sunday, Barclays was emerging as a "leading contender" along with Bank of America to take over Lehman, the Wall Street Journal reported in its online edition, citing people familiar with the situation.

"The market has been on a deathwatch for Lehman — pricing in a worst-case scenario," De Poy said. "What happens with Lehman will be a tipping point in [global] sentiment."

In an ironic Russian connection to the Lehman Brothers saga, the company's current chief executive, Richard Fuld, was one of a group of executives brought together in 1998 to help rescue the hedge fund Long-Term Capital Management, which was threatened with collapse in the face of the Russian debt default that August.

This time out, for Russian markets, the rise or fall of the dollar will be the determining factor, De Poy said.

"The rising dollar is currently crushing the Russian market, so a dollar fall could lift it through to the year's end," he said, adding that dollar depreciation would boost the oil price.

Investors will be hoping for concrete policy steps from Medvedev's meeting with the Russian Union of Industrialists and Entrepreneurs, a big business lobby, scheduled for Monday. Cutting oil industry taxes and enacting long-delayed pension reform will likely be the businessmen's top demands, analysts said.

"The likelihood of pension fund reform before the end of the year is relatively strong," said Yaroslav Lissovolik, chief economist for Deutsche Bank in Moscow.

The government will also likely make a decision about whether to cut taxes for oil companies or to reduce the value-added tax, he said. "They can't do both, and market sentiment is in favor of oil tax cuts," Lissovolik said.