Ben Aris in Moscow -
The outlook for Russia's economy recently got worse after the central bank downgraded its economic forecast for this year again to a 3% contraction, with the recovery not expected to begin until 2017. Things are bad and Herbert Moos, deputy president and chairman of VTB Bank Management Board, tells bne IntelliNews that he is not optimistic they will get better any time soon.
VTB, Russia's second largest lender, was the first of Russia's banks to report its 2014 IFRS accounts on, of all dates, Friday, March 13. The results were appropriately bad. Profits on the bank's core lending business were down 56% from the year before and it reported big losses on other business lines like investment in securities. The only reason the bank didn’t book an outright loss was thanks to a large and cheap loan from the state Deposit Insurance Agency. The sanctions on Russia were, of course, to blame – a situation unlikely to change soon. "I don’t see sanctions ending any time soon. They are a game changer," says Moos.
Sanctions have made doing business immeasurably more difficult, especially for VTB, which is explicitly named as one of those banks that has had its access to international financial markets restricted. "The problem in the way the sanctions are framed is that they apply to either a EU "person" or a US "person". That includes corporate entities," says Moos. "The two financial sanctions regimes pretty much mirror each other. However, every major European bank normally has an entity in the US, which makes it subject to the US sanctions as well."
That means even if the EU sanctions expire in June, VTB and other state-owned banks on the list will still be unable to tap the international capital markets even in the EU. Thanks to the global nature of the international financial system, the sanctions are effectively viral, irrespective of where they were originally imposed.
And there are already examples of how contagious the sanctions are. The rules preclude sanctioned banks issuing new securities like bonds. However, it was common for holders of global or American depository receipts (GDRs, ADRs) to convert them into the locally traded underlying shares and make money on the difference, or go the other way to tap the greater liquidity on the international markets. The trouble is it is not clear if these depository receipts count as "new securities" or not. VTB Bank has requested a clarification from US authorities and received a positive opinion on the basis that GDR conversion does not generate any new capital for VTB, it is a service for investors. EU regulators (after thinking about it for over six months) said “no” on the basis of a purely “bureaucratic” argument that GDRs represent “securities”, and securities issuance is restricted by sanctions.
The restrictions have also affected the Russian banks at the personnel level. Moos is actually a German national and so under the sanctions is not allowed to advise his own bank on issuing debt or equity, despite him being the chief financial officer. So VTB has had to hire an advisor to deal specifically with this sort of question.
But what has really put a spanner in the Russian banking system's works was the US regulator's decision to fine French bank BNP Paribas just under $9bn for doing business with Russia, following French President Francois Hollande refusal to cancel a multi-billion-dollar contract to sell two Mistral-class helicopter carriers to Russia – a decision that Russian President Vladimir Putin called "blackmail".
The Kremlin was outraged, but bankers are now just fearful. The fine has made the entire Russian banking system toxic, as no compliance department is willing to risk being hit by that sort of fine on the basis of what are clearly very confused sanctions rules. "The psychological impact on any European person [of the BNP Paribas decision] is enormous and the cost of the judicial action was excruciating," says Moos.
Hit in Ukraine
VTB Bank has more than doubled its provisions for bank loans in the last quarter as the economic slowdown, falling consumer demand and income, as well as 1990s-style high inflation bites into profits. VTB's provision for bad loans has more than doubled, going from RUB96.9bn (€1.5bn) in 2013 to RUB255.4bn in 2014.
But the provisioning on bad debt in Russia, which still remains manageable, is nothing compared to the provisions that VTB has had to make at its Ukrainian business, where it has tucked money away to cover bad debt equivalent to three-quarters of its entire loan book. "We have been trying to wind down our positions and we had some non-performing loans but we have provisioned for 75% of our corporate loans, or about RUB50bn ($820m)," says Moos. "Of course, we are still trying to recover the debt but I'm not very optimistic."
Although Russia is effectively at war with Ukraine, Russian banks accounted for a third of the country’s entire banking system assets before the fighting began, with a collective exposure of some $30bn. And following the exit from Ukraine by many European banks, that share has gone up. Incongruously, Russian banks are now the backbone of Ukraine's financial system.
If the situation in Ukraine stabilises, then Russian banks will find themselves at the fore in financing the subsequent growth and recovery. But Moos remains pessimistic about any short-term rapid recovery in Ukraine.
"The new [Ukrainian] government was a glimmer of hope but the hope is not being realised," says Moos, who remains pessimistic about any short-term rapid recovery in Ukraine. "There have been so many chances for Ukraine to flourish in the past but they were all squandered. Now there is another opportunity. I really hope they seize this one, as Ukraine's enormous economic potential is obvious. Indeed, VTB believes in the country's long-term, which is why we still have a bank there."
In comparison to Ukraine, Russia's economic outlook looks much better, but it too is suffering heavily compared to the boom years in the noughties. Of all the body blows that Russia's economy has received in recent months, Moos says the hike in interest rates to 17% in December was the most damaging. "Russia is in an unusual position because for much of the last two decades it has had negative real interest rates. Today we find ourselves with huge positive rates, which make it impossible to borrow," says Moos.
Even with the subsequent 3-percentage-point cut in rates, Russian companies are facing commercial borrowing rates north of 20%. "Who can afford that?" asks Moos. "No one."
Thus VTB, like all Russia's leading banks, finds itself in a dilemma: the customers it would like to lend to can't afford the cost of the money, and those customers willing to borrow at any cost the bank doesn't want to lend to. "Our loan portfolio has stopped growing," says Moos.
That's bad news for Russia's economy, which will struggle until the cost of borrowing comes down to a point where loans can once again grease the wheels of industry. The Central Bank of Russia (CBR) has already cut rates twice this year to 14%, but Moos would like it to go even faster. On March 12, the CBR lopped another 1 point off the prime rate, but the banks were pushing for a 2-point cut.
Still, the picture is not entirely black. Moos points out that such a steep devaluation of the ruble will give the economy a fillip and should improve productivity and competitiveness – both of which are badly needed and hard to realise while the ruble was strong and the state's coffers full. "Wages have been rising pretty continuously over the last 10 years despite the fact that in the last couple of years there has been almost no increase in productivity," says Moos. "Therefore, the more painful the current devaluation episode is, the more likely it is to force changes in the way that Russia works. In good times people get complacent. It's human nature."
Moos also points out that the devaluation has killed off imports and this will have a double beneficial effect in first clearing the market of imported competition, and secondly reducing the costs of investment and production into local versions of the same goods. Some import substitution has already been seen, with the agricultural sector in particular seeing a sharp spike in growth in November. And the dearth of imports means Russia will run a current account surplus of some $50bn this year, "enough to cover debt redemptions and capital flight," says Moos.
But there is a big difference between Russia in 1998, the last time there was a big devaluation, and today. Russia's economy is now a lot bigger and more sophisticated, so the benefits of devaluation will be less – and probably not enough to make up for lost ground. Companies have also learnt their lesson from previous crashes and squirreled away significant resources before the meltdown. So while a full-blown crisis is highly unlikely, no one is expecting the situation to normalise any time soon.
"Sanctions is a multi-year story," says Moos. While they are in place, Russia's economic potential has affectively been taken down a step and will remain so for the foreseeable future. Different industries react differently. There may be a net positive effect of devaluation on the companies in the consumer sector, but the more complicated and sophisticated sectors will be hurt. We were too myopic previously. However, this is a unique opportunity to restart the investment story and re-engineer the economy."
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