Emerging Market Toxic Assets: The IMF Questions Russia

According to the Financial Times (June 2, 2009), the IMF has questioned the extent of bad debts in Russia. They should.

IMF tells Russia to check extent of bad loans

The International Monetary Fund yesterday called on Russia's central bank to start stress testing domestic banks as loan delinquencies rise.

Russia's central bank estimates that the percentage of loan delinquencies is 3.7 per cent of total banking assets as of the end of March, but experts say this may understate the problem, as bad loans are calculated in Russia differently than in most countries.

"The CBR does not have a full picture of the situation in the banking system, and plans for how to ensure that the banks are adequately capitalised still need to be formalised," Poul Thomsen, deputy director of the IMF's European department...

Mr. Thomsen advised caution, saying no one knows the full scale of the problem. "I don't think it is possible to make a reliable forecast before one has undertaken the kind of analysis we are proposing," he said.

This is a good example of the informational risk in emerging markets. There have been some large run ups in emerging markets recently. I believe that they are the result of excess liquidity and carry trades, but ostensibly the prices are supposed to reflect the greater growth potential. The reality is that potential growth will depend on the health of the banking systems and no one knows how healthy they are, probably not even local bank regulators. Despite the publicity, bankers in every country made bad bets, not just in the US.

I am not sure when the truth about emerging market toxic assets will become clear to the market. Remember that information has value and it is only disclosed for consideration or if there is an enforced legal disincentive. In emerging markets there are very large economic incentives to suppress the information and insufficient legal disincentives to reveal it. The stress tests in the US were criticized as inadequate and perhaps they were, but at least they were performed and the results released. It is my understanding that the results of the EU tests will not be released.

In emerging markets, the tests are not even being done. Most emerging markets are dominated by state owned banking institutions, where there are large political disincentives to revealing the level of toxic assets. The real truth about toxic assets will probably happen as more bad debts to western firms come out in the open although some of these, like Greentown bonds in China have been covered up by use of Chinese stimulus money.

The problem with inadequate information is that you cannot solve the problem unless you know the nature and extent. Many emerging markets have not even acknowledged the extent; they also do not have the legal infrastructure, a functioning bankruptcy system and fast foreclosure mechanisms, clean them up. As critics in the US have pointed out, if you do not clean up your toxic assets, you cannot expect sustainable economic growth.

Comments

[John Christy:]

If you're looking for perfect information, you won't get very far in any emerging market, not just Russia. And that's nothing new. Emerging market investing has always required the ability to judge known - and "unknown unknown" - risks. Btw, this is also true in any equity investment, not just emerging markets. Just ask shareholders of AIG, LEH, etc. You will NEVER have perfect information. Otherwise we'd all be billionaires.

The key is whether or not you get paid to take those risks. Russia has delivered almost 20% annualized returns over the past 10 years. You can argue whether or not it was driven by speculative forces, carry traders, or whatnot but the numbers don't lie. Russia was worth the risk.

Jun 03 10:30 AM

[William Mon...:]

100% increase on the RTS since March 9th, not bad going upto 1150 now.

The drop from 2500 peak to 500 lows was just incredible to watch. If you want to get involved - Market Vectors Russia ETF (RSX).

Jun 03 11:37 AM

[William Gamble:]

I, of course, do not deny that there are some great returns in emerging markets. I also do not deny that information is imperfect everywhere. It is a matter of degree depending on the legal disincentives of the individual system.

What I am challenging is the concept that fundamental analysis has value in emerging markets. Since the information has a higher probability of inaccuracy, you need to change your strategy. I would suggest that investing in emerging markets is not about the 'story' of constant economic growth perpetrated by Goldman Sachs as in BRICs. Rather it the strategy should be similar to what George Soros calls "reflexivity". Of course you can buy RSX and hold it over ten years, but you will take an enormous amount of punishment with the reward.

If you have made money, good for you. You might take it off the table. See CItigroup's analysis on MarketWatch, just published.

Jun 03 02:56 PM

[William Mon...:]

There are a few things to take into account:

Analysis in a bull market is just trodden on, disreputed or made redundant - think AIG (Cassano), GE (WTF - why the financial engineering - YOU ARE NOT A BANK) , Lehmans (all about the money) and on and on.

Analysis in a bear market is listened to over intently - we are heading into a great depression (Roubhini), we still have much to fall and don't fear inflation (Krugman).

TBH - I just go with the flow, whoever is shouting the loudest and getting listened to I buy or sell in correspondence.

There is a little too much government interference at the mo, QE - UK, US even EC which throws a wobbler sometimes, but generally I do just fine.

As for listening to Citigroup's analysis - when their own SP has gone from $55 to $1, are you mad?

Jun 03 04:11 PM

[William Mon...:]

See what I mean about government interference - 70 point DOW spike after close. Hasn't been that volume or desire all day.

Jun 03 04:35 PM

[Booba:]

This is ridiculous: IMF "questions" Russia, the country that has HUGE budget surplus, no debts and one of the biggest currency and gold assets. Isn't it funny?
IMF would rather shut up and stay quiet!
Who are adviser there? American "experts" from rotten Wall St. financial institutions?
Did they "question" recent bubble, American budget deficit and melting inflated Wall St financial infrastructure?
All their "advices" borough Argentina to financial collapse and caused enormously tough times for Russia after USSR was collapsed.
China didn't listen to them and it didn't have any crises as Argentina, Russian, Ukraine and other nations that listened to IMF did!

Jun 03 04:56 PM

[William Gamble:]

The point is not about the IMF or Citibank. It is about information. The quality of information is a function from law and economics. Information in every country and every market has a high probability for being inaccurate because it has value. Why should it be given away? Why not provide misinformation?

Quantitative and fundamental analysis and all economic forecast by anyone is based on information, but there is little if any debate about its quality. The reality is that someone is lying to you. It is simply a matter of degree.

Jun 05 03:56 PM