Russian Companies Owe Foreign Banks Billions

Despite Russia's plunging stock markets, Prime Minister Vladimir Putin, like other authoritarian capitalists in China and Venezuela, has at least been comforted by the thought that the financial crisis is a repudiation of the West's brand of free-market capitalism, and a golden opportunity for his country to shine. "Faith in the United States as the leader of the free world and the market economy and trust in Wall Street has been undermined forever," gloated Putin recently. Now, he predicted, Russia, China and India would be the "locomotives of world economic growth."

Reality, though, is turning out a little differently. True, Putin did prudently stash the bulk of Russia's oil-fueled budget surplus into a $150 billion rainy-day fund, and the Central Bank's foreign-currency reserves still stand at $485 billion. But that may not be enough to weather the fiscal storm Russia now faces. Russia's corporations owe a total of $857 billion, and its banks $637 billion—with more than half that debt dollar- and euro-denominated. At the same time, an estimated $70 billion has left the country over the past month, and the stock market has crashed by more than 70 percent since May (the ruble is down 20 percent against the dollar in the same period). The Kremlin has to juggle bailing out Russian corporations and banks as their debts come due—while simultaneously hemorrhaging upwards of $15 billion a week defending the ruble.

Falling prices have obviously hurt Russia's petrol-driven economy—but oil is still at $60 a barrel, the same as in 2006 when Russia was booming. The real problem is that the crisis has exposed a critical vulnerability—massive corporate debts to famous banking icons of Western capitalism like Deutsche Bank and HSBC. According to a study by UralSib Bank, Russia's corporate debt to Western banks is running at around $187 billion, plus $116 billion in corporate Eurobonds, while Russian banks owe $193 billion abroad. Why did petro-rich Russia borrow so much? Because its own banking system was expensive and clunky, with state-controlled banks unwilling to lend and private banks often unreliable. Not surprisingly, swathes of Russian companies sought cheap financing abroad. Put bluntly, Russia's proudly independent brand of state capitalism was built not by oil money, but on western banks' loans.

With the global financial system paralyzed and Russia's sovereign credit rated "negative," whole sectors of Russia's economy are now unable to find lenders willing to finance their debts. At the same time a consumer downturn has crippled their cash flow. Particularly hard hit are real-estate developers—which account for fully 6 percent of GDP—as well as airlines like S7 and KrasAir, retail chains like X5, and auto manufacturers like GAZ, Kamaz and AvtoVaz. Already, 10,000 workers at the GAZ plant in Nizhny Novgorod have been sent on paid leave, 27 Russian firms have defaulted on ruble-denominated bonds and the Kurgan energy retail company went into bankruptcy after customers stopped paying their electricity bills and left the company unable to cover $133 million in ruble debts.

Officially, the Kremlin believes that it has the capital to spend its way out of the credit crunch. Russia's President Dmitry Medve-dev has put almost $230 billion into a bailout package for banks and other firms. Medvedev even signaled Russia's confidence by offering a $5 billion bailout to Iceland two weeks ago, while the Moscow News daily predicted that Russia could become the "lender of last resort" for a cash-strapped Europe. But in practice, there's no way the Kremlin can bail out every failing bank and business in Russia, let alone Europe.

Which firms sink and which are saved will be dependent on their ties to the Kremlin. Already Alfa Bank, owned by oligarchs Pyotr Aven and Mikhail Fridman, has had a $2 billion debt to Deutsche Bank picked up by the state in exchange for Alfa's 44 percent stake in VimpelCom, Russia's largest cell-phone provider. If Alfa doesn't repay the loan, VimpelCom will become a state-owned company—an ironic reversal of the loans-for-shares deals of the mid-1990s. Rosneft, the state-owned oil giant, also owes $21 billion to Western banks—and was bailed out last week by Putin, who cut a deal with Chinese Prime Minister Wen Jiabao for loans of nearly $30 billion from Beijing against future oil exports. Rusal, Russia's largest aluminum company, has also just received a $4.5 billion refinancing package from the state.

This politicized bailout process will certainly exacerbate tensions between the Kremlin favorites and the rest. The spectacle of oligarch bailouts may also ultimately sour Putin and Medvedev's populist appeal. Public disgust will grow more intense as incomes falter, while the nation's oil windfall goes into Kremlin cronies' pockets. Russia would be well advised to embrace the free-market values Putin is currently disparaging—more state control will only decrease productivity and increase corruption. But it's more likely that the Kremlin will choose to bail out its friends and various lumbering state corporations, however inefficient. And when the money runs out? They'll worry about that later.