Government Hesitance Worrying to Investors

As Russian markets suffer their worst crash since the 1998 default crisis amid earth-shattering global turmoil, longtime investors in the country warned that it was time for the government to wake up.

"Officials are showing a remarkable degree of sang-froid — deer in the headlights is another way of putting it," said Eric Kraus, an adviser to brokerage Otkritie who has worked in Russia for more than a decade.

The lack of confidence-building statements is "not reassuring," said Kraus, who closed his own fund 12 months ago amid initial global liquidity jitters.

Russia's RTS Index has plummeted by 57 percent since mid-May, while the oil price has fallen 37 percent from its July 11 high of $147 per barrel. In the month since the war with Georgia, more than $20 billion of foreign capital is thought to have quit the country as tensions between Russia and the West worsened amid perceptions of political risk.

President Dmitry Medvedev said last week that the flood of capital from Russia was caused 75 percent by global turmoil, and 25 percent "is from our own investment problems, including the consequences of the war in the Caucasus."

While the Central Bank and Finance Ministry have pumped billions of dollars into the markets since last week, top government officials have appeared indifferent or even dismissive, a factor that has contributed to the lack of confidence in Russia's ailing exchanges, bankers said.

On Wednesday, the government offered $44 billion in loans to the country's three biggest banks, while state auctions saw banks taking up $19 billion in short-term cash, a day after they borrowed $20 billion.

As regulators closed Russia's markets for the second time in two days Wednesday, Medvedev and Prime Minister Vladimir Putin issued a series of statements that appeared aimed at boosting national self-esteem.

On Wednesday, Medvedev signed friendship treaties with the Georgian breakaway regions of South Ossetia and Abkhazia, formalizing Russia's military, diplomatic and economic cooperation with what it sees as independent states, and told his Security Council that it was time to draw up a law grabbing part of the disputed resource-rich Arctic.

In a televised meeting Tuesday, Putin said Russia had built up a "security cushion" to prevent it from economic shocks — before announcing that defense spending would rise 27 percent next year to nearly $100 billion.

Sitting on $574 billion of foreign currency reserves and $175 billion in two oil stabilization funds, the government is in a wholly different position than 1998, when the ruble collapsed and the country defaulted on its sovereign debt.

Yet then, as now, the country's top leadership appeared at a loss for how to react, several bankers said.

"The Central Bank and the monetary officials in Russia can inject extra liquidity, as they have before," said Hawk Sunshine, head of equities at Metropol. "For how long? It's a matter of confidence, a bit of a show game."

"The drain of liquidity is going to really hurt the mid-cap companies that are looking for financing," he said. "Russians don't lend money to other Russians cheaply, period."

Others said there was only so much the government could do.

"It's a complete crisis of confidence," said James Fenkner of Red Star Asset Management. "The investors don't trust the brokers, and the brokers don't trust the investors."

"No one knows who owes how much to whom," he said.

The market swirled with rumors Wednesday that several brokers were due to fail. KIT Finance was the first brokerage to stand on the brink, as it announced it was seeking strategic investors to save it from financial obligations it was unable to meet.

"What the market is saying is that it's heading for a complete and total collapse," Fenkner said. "Either that's true, or if they deal with this right, we'll look back and see it as a great buying opportunity."

"At this point, it's not about words," Fenkner said, adding that the government should instruct state-controlled banks such as Gazprombank and VTB to step in and lend, buy bonds and allow brokers wide margins.

"This is the classic crisis of capitalism, where you have everyone acting in their own self-interest, holding back on doing what would be good for the whole market — and that's when you need the government to step in," he said.