Taking the Elephant Out of the Room

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Using the country's financial reserves to boost liquidity in the financial system is a very sensible use of money in this period of extreme uncertainty and risk. Prime Minister Vladimir Putin's announcement earlier this week that $50 billion of additional funding will be made available through the Development Bank, also known as Vneshekonombank, to help banks and other companies refinance their foreign debt obligations, adds to the sizeable amount of cash already made available to the banking system in recent weeks. Although the Development Bank's support runs contrary to its original mission -- to substantially increase investment spending in infrastructure and new industries -- this emergency funding is necessary to help mitigate a crisis that, if left unchecked, could completely destroy the economy.

The latest commitment of $50 billion may bring the total value of state support for the financial system to $135.5 billion, or almost one-quarter of the value of the country's total reserves. In addition to the Development Bank support, $44 billion was made available two weeks ago to three state banks, Sberbank, VTB and Gazprombank; an additional $16 billion was made available to the next biggest 25 banks via money market auctions; the formula for calculating the export tariff for oil was lowered by $5.5 billion; and $20 billion was earmarked to support the stock market -- state company shares in particular -- if required.

Given that the total value of debt owed by the country's banks and industrial corporations is around $440 billion and that the total amount to be repaid or refinanced over the next four month is between $27.5 billion (my estimate) and $39 billion (Central Bank estimate), the amount committed by the government is very substantial. More than that, it is significantly in excess of the amount that could conceivably be required to support the country's banks and major corporations over the next few months.

In that context, the total support package of roughly $135.5 billion is designed to send a very clear message to investors and to all participants in the economy: Russia has more than enough money to avoid bankruptcies among the country's largest financial institutions and that it will not face the same difficulties that have crippled the United States or many European Union countries.

In addition, by diversifying the mechanisms for making the money available, the government is looking to avoid restricting access to debt finance only to the very biggest institutions. It is also a public confidence-building exercise. By putting these measures in place well in advance of any refinancing risk, the hope is to avoid any rumors of fiscal problems or other events that might destabilize the markets and delay investment or spending plans.

Inevitably, such a big response to the potential problem raises fears of "What do they know that we don't know?" Many investors already sense an elephant in the room. That elephant is the fear that the debt problems in certain banks and corporations are so serious that they could result in their bankruptcies. But the message from the government is that no institution that plays an important role in stabilizing the country's financial system or to the economy will be allowed to fail. Essentially that means that any bank with a significant deposit base or a high public profile will not be allowed to fail. The state will likely broker deals in which financially strong institutions will acquire any problem banks -- similar to the recent buyouts of KIT Finance and Svyaz Bank.

Banks and industrial companies facing difficulty in securing a foreign debt rollover deal will be able to apply to the Development Bank for funding. There will be failures of course. Many of the more than 1,000 licensed banks may not be in business within six months. Some of these smaller banks will fail because of their inability to secure new financing. Others will have their licenses withdrawn if the Central Bank toughens capital requirements in the sector as expected. In theory, none of these lost banks should have any impact on the economy or the integrity of the financial system. But the government is taking no chances and is showcasing the massive liquidity support available in order to avoid any bank closure having a disproportionate effect. For the Central Bank, the current events allow it to finally make some significant progress in reducing the number of bank licenses, having progressed only slowly over the past five years.

Diverting such a huge amount of cash to ensure continued stability in the economy will inevitably slow the pace of investment elsewhere and most likely lead to a lengthening of the timeline set out by President Dmitry Medvedev to develop infrastructure projects and create greater diversity in the economy. But it is by far the lesser of two evils. Without this large financial support from the government, the entire banking system will be put at risk. Those that have money will keep it under their mattresses, and the resulting credit starvation will lead to a much slower pace of economic growth. With memories of the banking defaults in the 1990s still relatively fresh in the mind of the public, the government knows full well that any accident, or badly handled problem, in a well-known bank or corporation could easily lead to panic among depositors and huge lines at banks to withdraw money. The escalation would be hard to stop and quite quickly the country would join the ranks of those heading toward recession. At that point, it would be too late to make cash available.

In the end, the government has done the correct thing by taking fast, pre-emptive moves to avert a larger crisis.

Chris Weafer is chief strategist at UralSib Capital.