World Economic News
Default Fears Hit Russian Banking System
Two medium-sized Russian banks have recently defaulted on bonds and were shut down by the government, spreading concerns for a repeat of the 1998 crisis, when Russia defaulted on government bonds. Like Brazil, Turkey, and other so-called "emerging markets," the Russian banking system is now suffering from repatriations of foreign hot money. Furthermore, the Russian government has started to impose tighter money-laundering legislation.
The first victim, Sodbiznesbank, was shut down under the new money-laundering laws, and, as a consequence, defaulted on ruble-denominated bonds on May 25. When rumors spread that CreditTrust, another medium-sized Russian bank, was linked to Sodbiznesbank, investors withdrew money from CreditTrust and sent it into liquidation as well. In early June, CreditTrust therefore failed to meet its bond obligations.
Many more, and probably bigger, default cases are expected to erupt soon in the Russian banking sector. Russian banks are closing down credit lines to other Russian banks, meaning that liquidity in the interbanking market has disappeared. Usually, interbank interest rates in Russia are about 2% to 3%. But on June 8, this rate quadrupled, from 3% late on the previous Friday to 12%, while at some point in the day it even shot up to 20%. The Russian media is speculating about a blacklist of other troubled banks, which might be targetted by the government in the coming weeks.
Brazil Goes Back to Refinancing Dollar-Denominated Obligations
Brazil has gone back to refinancing dollar-denominated obligations, for the first time in more than six months, and is, thus, proceeding full-steam-ahead toward default. Last month, Brazil's Central Bank cancelled several debt auctions, because they were not willing to pay the interest rates "the market" demanded. Now, with June not half over, the Central Bank held an auction to sell dollar-swap credits, to roll over 40% of the over $900 million of the swap credits which come due on June 17.
The decision reversed a seven-month policy of redeeming outright, all dollar-denominated bonds, as well as the dollar-swaps which companies use to hedge on the value of the real, when they came due. By not rolling over the debt, the bank reduced the percentage of its total public debt which is linked to the dollar, from over 37% about 18 months ago, to around 17% today, and cut the total dollar hedge contracts outstanding in half, from $26.1 billion in November, to $13.2 billion now. The government repeatedly held up those facts as "proof" that Brazil was no longer so vulnerable to a debt crisis.
In a floating-rate system, dollar-linked debt is the most vulnerable to fluctuations of a nation's foreign exchangeas Mexico found when the infamous tesobonos blew out in December 1994. Every time the national currency devalues, the value in local currency of the dollar-denominated debt soars, and if creditors demand payment, the Central Bank has to have enough foreign exchange to cover the outflow.
In response to the latest news from Brazil, the "markets" drove down the real again.
(Note: In a swap contract, the central bank pays investors an interest rate in dollars, and receives in exchange, an interest rate in local currency. When the contract comes due, the central bank owes investors money if the dollar-based rate returned more, including swings in the currency, than the local currency rate. The bank collects money from investors if the local currency rate returned more. In other words, it's a speculative hedge.)
British Households Buried in Debt
British households are in a far worse debt situation than either the government or Bank of England are calculating, according to new research from the Capital Economics think tank, wrote Guardian economics editor Larry Elliott June 7.
In April, net mortgage borrowing had risen 27% over April 2003; 60% over April 2002; and a "staggering" 131% over April 2001.
But mortgage debt is not the only debt burden on British households. The new Labour Chancellor is claiming that low interest rates make any repeat of the end-1980s crash impossible, but his calculations leave out financial reality.
Researcher Vicky Redwood of Capital Economics, reports that, while interest rates now are 4.25% rather than 15% in 1989-90, overall debt is much worse. If mortgage principal payments, credit card, overdraft and other unsecured debt repayments are added, "income gearing" is now much closer to 1989 levels. (Income gearing refers to the percent of profits eaten up by gross interest.) Current "income gearing" is at 19% rather than the 7% claimed by the government, because unsecured debt is growing faster than secured debt, Redwood reports. "If interest rates rise in line with market expectations to 5.25% by the end of 2005, and debt continues to rise at its recent rate, income gearing will surpass its 1990s peak by the end of 2004in fact, income gearing (including repayments of debt) is already above the level at which household borrowing started to slow in the late-80s."
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