Behind the Russian Stock Market Meltdown

A series of shocks, including fears of a new Cold War, caused share prices to fall even before this week's turmoil. Foreign investors may not return soon

by Jason Bush

Is history repeating itself? That's surely a question many Russians must be asking themselves. Almost exactly 10 years after the financial crash of 1998, Russian markets are once again in turmoil. On Sept. 16, Moscow's largest stock exchange, MICEX, fell by a jaw-dropping 17.5%, the largest one-day loss in a decade, while the rival RTS exchange was down by 11.5%.

The free fall continued on Sept. 17, causing Russia's stock market regulator to suspend trading on both exchanges. The Russian central bank pumped a record $14.1 billion into the financial system, while the Finance Ministry said it would provide $44.9 billion in short-term loans to the country's biggest banks.

Compared with the gyrations in Moscow, the 5% declines in other global markets look pretty mild. What's more, the collapse in Russia is not simply a knee-jerk response to bad news elsewhere. Well before this week's chaos on Wall Street, the Russian stock market was imploding. Since the beginning of July, the RTS has lost 54% of its value, equivalent to some three-quarters of a trillion dollars.

The mounting losses have spurred frantic debate within the country's political and business elite.

Time to Face the Crisis

"The Russian economy is facing new and serious challenges. We require an active anti-crisis policy," Alexander Shokhin, the head of the country's main business group, the Russian Union of Industrialists & Entrepreneurs, told President Dmitry Medvedev at a meeting on Sept. 15.

Only a few months ago, Russian financiers and politicians were boasting that Russia was a financial safe haven, apparently immune from the global credit crunch. As recently as June, an International Monetary Fund mission to Russia concluded that "there are no significant negative spillovers from the global financial market turmoil."

The sudden panic shows how several seemingly unrelated events, taken together, can combine to create a potent downward spiral. The first big shock came in late July, when Russian Prime Minister Vladimir Putin made an unexpected public attack on Mechel, a leading steel company, accusing it of price-fixing. An acrimonious shareholder dispute at Anglo-Russian oil company TNK-BP (TNBPI.RTS) added to market nerves.

Subsequently, both conflicts appear to have been resolved (BusinessWeek.com, 9/4/08) more or less amicably.

But the market hardly noticed, because on Aug. 8, Russia went to war with Georgia. Fearing a new Cold War, foreign portfolio investors took fright (BusinessWeek.com, 8/27/08), selling the ruble and Russian bonds as well as stocks.

"A Reflex Reaction"

By the beginning of September, says Evgeny Nadorshin, chief economist at Trust Investment Bank in Moscow, the panic had spread from foreigners to locals. Fearing a further slide in the ruble, Russian investors also began piling out of ruble assets. "The times when the dollar was considered a much safer investment aren't that long ago, so many people just had a reflex reaction," he says.

As often happens in times of market panic, the collapse has been self-reinforcing. Having taken out loans to buy stocks, many investors suddenly found themselves forced to put up extra collateral as stock prices began to fall. The only way to raise cash in a hurry was to sell more stocks, creating an unstoppable vicious circle. "Once things start, you get automatic mechanisms that kick in. People don't know where it's going to stop," says Richard Hainsworth, general director of the Rus-Rating credit-rating agency in Moscow.

For Russia, the biggest fear now is that the chaos on Wall Street will deepen the global economic slowdown, pushing oil prices still lower. They've already fallen 35%, to the current $95 a barrel, after peaking at $147 in July.