Russian Stock Market Plunge Broadly Affects Economy

Sources: Financial Times, Medvedev and Putin at odds on market fall; Russia ready to tap wealth fund; Liquidity crunch hits Russian tycoons; Medvedev fails to halt Russia stock slide; Moscow facing lending crisis

A major drop in stock prices this week spells trouble for the Russian economy. The RTS stock market index fell 7.5% on Tuesday, the biggest one-day drop since June 2006, and fell again 4.4% on Wednesday and 2.7% on Thursday. This adds up to nearly a 50% drop in Russian stock prices since May, though there are differences of opinion on the reason for the decline. Russian Prime Minister Vladimir Putin denies that the conflict in Georgia is responsible, while President Medvedev claims that the conflict was a contributing factor, though a necessary move politically for Russia. He estimates that 75% of the decline is a result of international conditions, rather than the conflict.

The immediate cause of declining stock prices was a combination of political risk highlighted by the Georgia conflict and falling oil prices. Another factor is the liquidity crunch that has finally arrived in Russia, spurred by capital flight estimated by some to be as high as $20 billion. As investors pull their money out of the Russian economy, credit becomes short, exacerbating the stock market crash. Bankers and traders have focused on this element, noting that banks and funds have been forced to sell even attractive assets in order to come up with cash.

The liquidity crisis has also affected a handful of wealthy Russian individuals who used loans to buy shares in Gazprom and Sberbank, the state-owned investment bank. Others bought shares in metals using borrowed money before share and commodity prices fell. The individuals pledged some shares back as collateral in order to qualify for loans, and when the economy began to falter many faced margin calls or sold stock early to avoid greater losses.

Those looking to borrow money, especially in the real estate sector, have found it impossible to do so, and the Russian central bank’s attempt to build confidence in the economy by injecting over $10 billion into commercial banks in a single day does not appear to have had a significant effect. Proposals to use money from the national wealth fund and pension reserves to stabilize the economy have emerged, drawing criticism from those who believe the government should instead use oil revenues to stabilize the economy. Standard & Poor’s also warns that putting public funds at risk would lower Russia’s sovereign rating.

Medvedev continues to talk up the economy to try to draw investors back to Russia, and made a proposal Thursday for a comprehensive economic re-structuring plan. Its components would be considered in the Russian Duma in 2009.

Questions:
1) Will short-term cash injections have lasting impact on the Russian economy, or is it too late for the central bank to save the situation?
2) Will the Russian economy follow the trends of the rest of the world, or is there a better hope of rebound given unique political and market conditions?