Fixed investment has been rising strongly over the past four years, as Russian factories retool to take advantage of booming demand. But very little of this spending is financed with bank loans. Russia’s banks are still not playing their traditional role as financial intermediates, so where is the money coming from?
Putting in double-digit growth for most of the past six years, fixed investment growth has started to slow down in the past two months: fixed investment was up 10.7% year-on-year in July, a little less than the 12.5% average over the first half of the year.
This summer’s mini-banking crisis has caused a mild credit crunch and small and medium-sized enterprises are having to pay more for already hard-to-find loans. Economists are not expecting the slow-down in lending to hurt economic growth – the Economic Development and Trade ministry is predicting between 6% and 6.5% growth for the year and the economy grew 7.4% over the first half of the year. But some sectors have been hit hard.
Construction has been the main victim. It expanded by 14% in 2003, more than twice as fast as average industrial growth, but construction is one of the few sectors in Russia that works on bank credit; Alfa bank estimates that between 70% and 90% of construction projects are done with debt, the vast majority in Moscow.
Work at buildings sites across the country had more or less ground to a halt this summer as banks cut off credit lines in the face of a liquidity squeeze that had already taken hold this spring, and construction company profits fell 19% over the first half of this year, while aggregate corporate profits were up 44%. The slow-down in construction, which accounts for 7% of GDP, goes some way to explaining the overall fall in fixed investments.
Retained earnings
Retained earnings still accounts for roughly half of invested capital, according to investment bank Aton, while private-sector lending to the non-financial sector remains at a low 17% of GDP against the 50% in central Europe and over 100% in the west.
Part of the problem is that limited resources are spread between too many banks, which are unwilling to lend even if they have money. Some 800 very small banks have 10% of the total banking assets, another 380-odd have another 10% leaving the top 20 banks holding the remaining 80%, and bank credits financed only around 4.8% of fixed investment in 2003, according to Moscow Narodny Bank.
Although the amount of bank loans has remained stuck at between 4% and 5%, the total volume of lending for nearly a decade, the volume of loans has risen rapidly since the 1998 financial crisis and is roughly keeping pace with rising domestic savings: lending to the private sector has increased from a low of roughly $30bn in 1998 to about $130bn now, while deposits have grown from $20bn to $110bn over the same period.
Ironically, the failure of the banking sector to play its traditional role prevented this summer’s mini-crisis from spinning out of control, but the inability of banks to play a significant role is also holding back faster growth. With total assets at end-2003 estimated at Rbs4200bn ($141.7bn), equivalent to 42.1% of GDP, the banking sector remains small.
Exchange rates
The mini-crisis will make life even more difficult for smaller companies hoping for a bank loan, but life was already becoming more difficult in April when the Kremlin ordered the Central Bank of Russia to stem the relentless rise of the rouble against the dollar in an effort to protect domestic producers from foreign competition.
“Interest rates went up not just because of the crisis but also because of a change in CBR policy,” says Alexei Moisseev, an economist with Renaissance Capital. “In April, [President Vladimir] Putin called in [CBR chairman Sergei] Ignatiev and ordered him to lower the rouble [against the dollar].” As a result, there has been a significant outflow of foreign funds from the market, which in part triggered the bank crisis. It is a policy that presumes that two-dozen Russian industrial companies are more important than millions of citizens.
Russia’s big companies enjoy significant lobbying power in the government and the Kremlin is worried about the political fallout from massive unemployment that closing down some of these Soviet-era behemoths would bring.
“The exchange rate policy is designed to protect industry but it is a tax on the consumer, forcing them to pay more for poorer quality goods. It also means a harsher environment for companies that find it harder to raise money,” says Mr Moisseev.
With the rouble bond market closed to all but the biggest companies, the rest have become even more reliant on the banks. This is also expected to drive interest rates up.
“Primary issues [of rouble bonds] have dried up and without the competition from the capital market, the banks are free to charge higher interest rates for credits,” says Mr Moisseev.
He points out that as interest rates had already fallen so low, banks were offering negative real interest rates on the expectation of falling inflation. There is still plenty of room for interest rates to rise without doing that much damage to economic growth.
However, pushing the rouble down just as oil prices rise to record levels, bringing a flood of petrodollars into the economy, does raise the threat of inflation.
Foreign borrowing
Between them, retained earnings and bank credits only account for just over half of all invested capital last year. A big chunk of the rest came from borrowing abroad by Russia’s leading companies and banks.
“Half of last year’s inflows were structured borrowing,” says Paul Forrest, chief economist at Moscow Narodny Bank. “In all, Russia received about $22bn in structured loans and bonds, $6bn in FDI and another half a billion in portfolio investment. Syndicated loans made up $5bn of the structured lending.”
International banks have fallen back in love with Russia and syndicated loans are a favourite way of lending to the blossoming economy while keeping risks to a minimum.
Eurobonds have also been popular, but the summer doldrums, coupled with a wobbly banking sector, persuaded many companies to delay their issues until at least the autumn. However, Mr Forrest is expecting issues to resume in the autumn and the hand of many banks may actually have been improved by the mini-crisis.
“The bank crisis will not really affect Russian companies’ ability to borrow abroad in the medium-term. There were some scare stories going round [during the worst of this summer’s instability], but many Russian banks have come out of the crisis strengthened. The fact that they survived unscathed only enhances their reputation,” says Mr Forrest.
Confidence levels
However, the bank crisis did have an immediate effect. In the last week of August, ING and Société Générale decided to pull out of a deal to extend a $600m syndicated loan to oil major TNK-BP, citing the Yukos affair and general uncertainty as the reasons for their decision.
Russia has been going through a period of instability since the attack on the oil company Yukos began last summer, but most analysts believe it is a temporary set-back and that Putin is committed to reform and putting Russia on a market footing. Russia’s press reported that TNK-BP would still be able to raise the money as BNP Paribas and ABN AMRO were ready to step into the breach left empty by ING and Société Générale.
Differentiation
Still, the structured finance, retained earnings and bank credits can’t account for all the money companies invest from the “other” category. International bonds and syndicated loans are available only to two or three dozen of Russia’s top companies; most of Russia’s companies have to rely on their rich customers for financing.
“A lot of companies struggle to get loans and don’t have enough working capital. If they get an order from, say an oil company, part of the deal is that the oil company will provide loans to complete the job,” says Peter Westin, an economist with Aton.
In effect, big companies have set up mini-banking departments to ensure their suppliers can finance the production of inputs. Dairy producer Wimm Bill Dann was giving dairy farms loans only a few years ago after it began to struggle to find enough milk in Russia to meet its demand.
Russia’s well-known companies have no problems borrowing money from banks. As competition becomes increasingly fierce, some banks have gone down the ladder a few rungs to up-and-coming medium-sized companies where the margins are better. But because of the general lack of transparency in Russian business, even bankers willing to lend to companies other than the blue chips have a limited choice. The smallest companies have no chance of borrowing at all.
“There is a whole swath of potentially smaller companies that can’t borrow at all. It is not that these companies are no good, but for the banks, the time and effort needed to check their credit-worthiness means it is not profitable to lend to them,” says Mr Westin.
