Liquidity Slips Into Everyday Lexicon

Liquidity, a term rarely heard outside of boardrooms and brokerages just months ago, has been making its way into kitchen-table conversations, as a financial crisis catalyzed by the integration of global financial markets has come to threaten the country's recent prosperity.

Most ordinary people, however, have very little understanding of what the liquidity crisis is, what caused it and what it means for them — something borne out by the results of a survey by the VTsIOM public opinion agency released at the beginning of November.

More than 60 percent of the 1,600 Russians surveyed said they had no idea about the causes of the crisis. Another 13 percent said it was brought about by unreasonable social and economic policies of the world's superpowers, 4 percent blamed the mortgage crisis in the United States, 3 percent said the banks were responsible and another 3 percent said it was driven by rising energy prices.

The 4 percent who said the Russian crisis was related to the mortgage crisis in the United States were likely closest to the truth. The collapse of the U.S. mortgage market sent shock waves through its economy, with major investment bank Lehman Brothers filing for bankruptcy after enormous losses on subprime mortgages and the U.S. government stepping in to take over Freddie Mac and Fannie Mae, which guaranteed about 50 percent of the mortgages in the country.

The spillover from these shocks in the United States turned rapidly into a crisis of confidence among global financial institutions and a steep reduction in lending. The drop in business and consumer lending has now cut into economic growth.

As Russian incomes and the banking system have developed, so has the propensity to take out loans.

"The debt-to-income ratio in Russia has grown rapidly over the past two or three years, reaching over 6 percent this year. This is similar to levels seen in developed economies," said Sergei Nikolayenko, deputy head of forecasting and statistics at the Bureau of Economic Analysis. "As incomes are going to dip due to the crisis, however, this ratio will increase to dangerous levels."

Nikolayenko said the rate of defaults on consumer loans has risen gradually from 1.25 percent in 2003 to 3.15 percent in September, but the October data may show a sharp jump.

The number of borrowers behind on payments to the Agency for Housing Mortgage Lending grew to 9.1 percent in the third quarter, up from 7 percent for the first two quarters of the year, as people are beginning to have difficulties repaying debts.

While many people felt the reports of the liquidity problems had little bearing on their lives, the multitude of stories making the rounds about job cuts and layoffs are bringing the problem closer to home.

Reports are rife of firms sending employees on extended unpaid vacations in the hope that they will leave the companies on their own — meaning no severance pay — or of companies creating newer, lower-paid positions for workers. Other employers are simply slashing salaries or paying them late.

All of this intensifies difficulties with liquidity, as people lose part or all of their salaries and are unable to make loan payments, putting greater pressure on the banks.

"Currently there is no real panic among the population, but the biggest concern is that the next phase will see people stop repaying their debts, increasing losses to the banks and deepening the crisis," Nikolayenko said.

The tightening of global liquidity has had a direct effect on Russia, leaving companies carrying significant debt without instruments for refinancing and banks without access to affordable capital. This leaves the Russian government as the only actor that can step in to ease the pain.

"A tough situation with financing has persisted for a while now," said Nikolai Podguzov, an analyst at Renaissance Capital. "We are, in this case, dependent on other markets. Until the situation globally becomes much more predictable and positive, the Russian financial system will face a shortage of capital."

One indication of just how tight the liquidity situation has become was a spike in the MosPrime rate, at which banks lend to each other in rubles.

On Monday, MosPrime, based on the rates offered by the country's 10 leading banks, jumped to a historic high of 22.67 percent — the highest level ever and double the rate from the Friday before. It was down to 7.92 percent on Thursday, but concerns over short-term fluctuations remain.

Podguzov said the pressure on the rate is likely to continue in the short term.

"The Central Bank will hold three auctions this week to provide banks with financing, but companies also need to make 200 billion rubles of tax payments Monday, which means increased capital outlays for them," he said, adding that banks would have to pay back 827 billion rubles in noncollateralized loans to the Finance Ministry and Central Bank by the end of next week.

The first payments came due Wednesday, when companies had to return as much as 243 billion rubles. As a result, banks were converting foreign currency on hand into rubles — which resulted in a temporary strengthening of the ruble against the currency basket.

"Over the past several months, the risk perception of Russia has changed — oil prices have fallen by 70 percent since July, Russian companies have to repay $40 billion of debt in the fourth quarter and over $100 billion in 2009, ruble reserves are falling and the trade balance is shrinking," said Anton Struchinevsky, a senior economist at Troika Dialog. "All of this contributes to reduced ruble liquidity."

In order to ease problems, the Central Bank held auctions on Monday and Tuesday and will hold a third on Saturday, giving banks the opportunity to borrow up to 900 billion rubles — as much as 150 billion rubles of it for six months, the first time it has offered such an extended deadline.

At Monday's auction, the banks signed on for 143 billion rubles.

But borrowing is becoming more costly, with the rate on five-week, noncollateralized loans costing 9.5 percent and future auction money becoming even more expensive.

This is part of the Central Bank's policy, analysts say, to try to prevent banks from shifting out of ruble-based assets, which only increases the liquidity difficulties.

The Central Bank refinancing rate is the overnight annual interest rate at which the Central Bank lends money to commercial banks to help them stay liquid. On Nov. 12, the Central Bank raised the refinancing rate for the fifth time this year, to 12 percent, in an effort to reduce capital outflows and contain inflation. This is in stark contrast to recent history, as this rate has fallen steadily over the last few years.

"The Central Bank is raising the refinancing rate to make rubles more expensive and prevent banks from converting them into dollars, on the expectation that the dollar will appreciate," Struchinevsky said.

If banks convert money to dollars and the ruble depreciates, the amount banks have to pay back shrinks, but the Central Bank is trying to remove the stimulus to do so by raising the refinancing rate.

"This is not 100 percent effective but is an economic method of fighting capital flight and supporting the ruble," Struchinevsky said.

The government has also sent the message that it might resort to nonmarket methods to prevent this flight, with both President Dmitry Medvedev and Prime Minister Vladimir Putin emphasizing in recent weeks that shifting money received from the state out of ruble assets instead of passing it down through the banking chain will not be tolerated.

The capital flight resulting from the preference for dollar assets has been significant — according to Central Bank Chairman Sergey Ignatyev, capital outflow for October will weigh in at about $50 billion.

"When people sell rubles to buy dollars, or sell ruble-based assets such as stocks and convert the money to dollars, the rubles end up back in the pocket of the Central Bank, while dollar reserves fall," said Alexander Anisov, treasury head at RTS. "This creates additional pressure on the ruble, as the Russian government is seen to be less stable, but also means that there is a contraction of the money supply — less money in the system for economic development."

Russia's international reserves equaled $475.4 billion on Nov. 7, 2008, down from $484.6 billion on Oct. 31, and continue to fall.

The liquidity crunch is not, however, bad news for everybody. It has, for example, finally helped to shift the real estate market in favor of renters. Landlords, worried that it will be tough to find new tenants under current economic conditions, are suddenly keen to agree on fixed rent charges for the year ahead.

"I was thankful for this crisis when my landlord said he wants to fix my rent for the next 12 months," said Tatyana Voronova, a reporter at Vedomosti. "In 2007 and 2008, he raised it two or three times a year."

But the impact continues to be overwhelmingly negative, and public awareness of that fact is becoming more pronounced.

A full 32 percent of respondents to this month's VTsIOM poll said they thought the international economy was plunging into crisis, and another 32 percent described it as unstable.

And there is already an investment joke making the rounds.

"I prefer to invest in vodka," it goes. "It offers a guaranteed 40 percent return."