Natalia Orlova of Alfa Bank -

Non-performing loans (NPLs), previously of interest only to banking analysts, are becoming a macro issue. Russian companies' $220bn of near-term debt repayment obligations, when combined with January's 9% drop in GDP, will drive NPLs to 15% and require a $90bn injection to recapitalize banks. Much of this injection will finance capital outflows, implying another 15-20% drop in the ruble despite lower import levels.

Russia's total corporate debt (local and foreign bank debt plus bonds) is $780bn. The two key risks posed by this debt are its high exposure to foreign currency risks and its short maturity. Foreign debt represents around 40% of total corporate obligations, similar to Indonesia in 1997. Some $220bn of debt, or 30% of the total, is due in the next 12 months, hampering companies' ability to repay their loans and driving up NPLs.

Given January's 9% drop in GDP, the economic environment is working against borrowers, and we reiterate our view that consumption trends will deteriorate substantially in the coming months. However, the retail loan portfolio of Russian banks is equal to only 10% of GDP, one-third of banks' corporate exposure, so the retail segment shouldn't be as large a concern for the banking system as the corporate segment.

Best case is 15% NPLs

If growth remains weak, global markets stay closed and the ruble continues under pressure, we anticipate that NPLs will rise to $88bn, or 15% of total corporate loans. This would be equivalent to 80% of the entire banking sector's equity capital, or 7% of GDP. The lowest estimate for the amount needed to recapitalize banks appears to be around 5% of GDP.

We believe that until now, only the banking community has been concerned about the increase in NPLs. However, it will soon become a macro issue. Should NPLs be covered by the direct recapitalization of Russian banks or the creation of a special state agency, this additional injection of state funds will at least partially finance capital outflow, adding to ruble depreciation and higher inflation. If the state delays solving the problem of NPLs, payment arrears will continue to increase.

While the 40% year-on-year drop in imports in January-February is good news for the ruble in the very near term, the risk of NPLs lead us to forecast another 15-20% depreciation of the currency by year-end, all else being equal, as the unavoidable injection of liquidity into the banking system gets turned into capital flight.

Natalia Orlova Chief Economist of Alfa Bank

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