Russia Stock Gains Strengthen Putin as Ukraine Drops

By Emma O’Brien and Laura Cochrane

March 2 (Bloomberg) -- Russia, the worst-performing major stock market in 2008, was Europe’s best last month as the ruble rose and reserves stabilized. Every neighboring market crumbled.

The Micex equity index climbed 6.6 percent in February as the world’s second-biggest oil producer stopped speculators from driving down the ruble and depleting its $382 billion of foreign exchange reserves. In Ukraine, the central bank’s holdings fell 24 percent since August and the benchmark PFTS Index lost 21 percent last month. Latvia’s OMX Riga Index dropped 8 percent.

While Russia’s government said the economy will contract for the first time in a decade and currency reserves are down 36 percent from August, the nation’s relative strength is raising Prime Minister Vladimir Putin’s influence over former Soviet states. Ukraine discussed borrowing $5 billion. Kazakhstan wants Russia to buy ailing BTA Bank. Belarus is asking for $3 billion in loans, on top of $2 billion granted last year.

“Russia isn’t looking at a straight-line deterioration into oblivion,” said Kieran Curtis, who helps manage $800 million in emerging-market fixed-income assets in London at Aviva Investors Ltd. “It has enough liquid assets to take stakes in all kinds of things in the former Soviet states.”

Last year, international investors fled Russia after its war with Georgia, a 54 percent decline in the price of Urals crude, and the global credit crisis sent the Micex down 67 percent. Speculators targeted the ruble, driving it 20 percent lower against the dollar and 19 percent versus the euro. Bank Rossii spent $216 billion to keep the currency’s seven-month drop from turning into a rout.

Downgraded

Standard & Poor’s cut Russia’s credit rating in December by one level to BBB, the second-lowest investment-grade ranking. The government expects to run a budget deficit of about 8 percent of gross domestic product this year.

The central bank steadied the ruble, which gained 0.5 percent against the dollar last month, by pledging to raise interest rates and curtailing loans that banks were using to bet against the currency. Investors anticipate government plans to provide $200 billion in loans and reduce taxes will bolster the economy and push up the Micex, which is down 67 percent from its record high in May.

The Micex fell 1.6 percent today and the ruble dropped as much as 0.9 percent to its weakest level against the dollar in a week.

Russia is “still better off than others, mostly because of the reserves,” said Beat Siegenthaler, chief emerging-markets strategist in London for TD Securities Ltd.

Political Rivalry

Eighteen years after the collapse of the Soviet Union depleted Moscow’s power, Ukraine needs foreign funds to close its $12.3 billion current-account deficit after the global recession curbed demand for steel and international credit dried up. The currency, the hryvnia, dropped 44 percent against the dollar in the past six months. The country’s 22 percent inflation rate is the highest in continental Europe.

Ukraine estimates a budget deficit at 5 percent of GDP for 2009 and risks violating terms of a $16.4 billion International Monetary Fund loan agreement. Foreign-currency reserves fell 24 percent since August and are below the $30.2 billion the IMF required. The second portion of the credit, due in January, hasn’t been approved.

The country has also been weakened by the political rivalry between Prime Minister Yulia Timoshenko and President Viktor Yushchenko, who led the so-called Orange Revolution in late 2004 when the country’s pro-Russian government was peacefully overthrown.

Gas Spat

Ukraine tried to increase ties with western Europe and the U.S., seeking membership to the North Atlantic Treaty Organization last year and the European Union. Russia shut off natural gas shipments through Ukraine over a price dispute in January.

Now, the sinking economy is giving Putin, 56, the advantage. Timoshenko requested aid from Russia, the U.S., the European Union, China and Japan this year and Russia gave a “positive response,” she said Feb. 9. Yushchenko shut down what he called “unauthorized” negotiations for a loan.

“This crisis is the best opportunity that Russia’s had to rein in Ukraine and make sure nobody else moves in on their backyard for a long time,” said Chris Weafer, chief strategist at Moscow-based bank UralSib.

Moscow won’t discuss giving a loan to Ukraine until the political situation in Kiev stabilizes, Russian Finance Minister Alexei Kudrin told a press conference in Moscow today.

Flexing Muscle

Russia may be willing to draw on its reserves to prop up neighboring economies, said Ivan Tchakarov, an economist at Nomura Holdings Inc. in London. “Ukraine will require more than the $16 billion from the IMF, so they will need Russian money,” he said. “It’s the perfect time for Russia to flex its muscles.”

Russia’s foreign-currency debt is rated eight levels higher than Ukraine. S&P cut Ukraine’s credit rating by two levels last week to CCC+, seven below investment grade and the lowest in Europe. S&P also cut Latvia to below investment grade.

Investors demand a record 28.1 percentage points more in yield on Ukrainian government bonds than Russian, compared with a gap of 3 percentage points six months ago, according to JPMorgan Chase & Co. indexes. As recently as 2003, Ukraine’s bonds yielded 2 percentage points less than Russia’s.

Contracts to protect Ukraine government bonds against default imply a 69.6 percent chance Ukraine will fail to pay its debt in the next two years and 91.8 percent odds in the next five years, according to CMA Datavision prices for credit- default swaps last week.

Belarus, Kyrgyzstan

Kazakhstan is seeking to sell its 78 percent stake in Almaty-based BTA Bank, the country’s largest, to Russia’s government-controlled lender OAO Sberbank, Arman Dunayev, deputy chief of Kazakhstan’s state oil fund, said Feb. 2.

Armenia will receive $500 million from Russia, equivalent to about 2.5 percent of its gross domestic product, Putin said on Feb. 28. Belarus, which borders Russia and Poland, has a $2.46 billion credit line from the IMF in addition to loans from Russia.

Kyrgyzstan got a $2 billion loan from Russia and was promised a further $150 million in economic aid on Feb. 3. The same day, Kyrgyzstan’s government announced it would shutter the military base the U.S. Air Force has used for supplying troops in Afghanistan.

“I welcome Russia’s efforts to try and create stronger economic linkages because for investors it’s stabilizing,” said Jerome Booth, head of research at Ashmore Investment Management Ld. in London, which manages $36 billion of emerging-market assets. “It’s looking for relationships it wants to solidify in the region.”

To contact the reporters on this story: Emma O’Brien in Moscow at eobrien6@bloomberg.net; Laura Cochrane in London at = lcochrane2@bloomberg.net