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Russia: Raising Borrowing Premiums Hits Eastern Economies

Washington, 3 December 1997 (RFE/RL) -- The buzz in Russian financial circles in recent days has been what is described as the exodus of foreign investors, forcing the government to raise considerably the amount of interest it is willing to pay those who buy its bonds and notes.

Central Bank Deputy Chairman Denis Kiselev said this week that concerns about the stability of Russia's banks implied by this pull-out are exaggerated -- that the banks have been able to cover all the withdrawals and demands for payment.

But the increased cost of borrowing has forced the government to delay issuing some new borrowing instruments.

While Russian officials are debating what this all means, the private global association of commercial banks and financial institutions says this is simply the market correcting itself to reimpose the premium it normally demands for taking the risk of lending to less creditworthy borrowers.

The Washington-based Institute of International Finance (IIF) says, however, that the long-overdue raising of this borrowing premium hit Russia and Poland far more than the other nations of Central and Eastern Europe.

The premium on borrowing is called the "spread," meaning the difference between the rate the U.S. treasury must pay to borrow money -- considered the best possible borrower -- and the rate which a less creditworthy borrowing country must pay. If the U.S. treasury is having to pay six percent interest and Russia is paying nine and one quarter percent, the spread is three and one quarter percent. Lenders and investors get the "spread" to compensate for the extra risk they assume in lending to these particular nations.

The spread for borrowing by developing nations, countries in transition and emerging market countries, came under study by the institute earlier this year because of fears that the spread was getting too small -- too thin in professional parlance -- to cover the risk being assumed by borrowers.

It first had to work out a formula for determining what the spread for any particular country should be, given current circumstances. This was a task made extremely difficult by the huge number of variable factors that had to be considered.

Nonetheless, the institute's Chief Economist and Deputy Director, William Cline, said they were able to compile three different approaches into a single scale and then rank major emerging market economies. They found that due to a number of factors, among them investor overconfidence combined with a lack of information on economic conditions in many countries, the spread for most of these nations by last June had been pushed far below the risk factors they carried.

Poland, for example, should have been paying a spread of nearly 200 basis points (a basis point is one-one hundredth of a percent - thus 200 basis points is two percent) according to the institute's formula, but was actually having to pay only 36 basis points (or between one quarter and one half percent) spread.

Turkey was paying nearly a full percent (94 basis points) less than what its risk should have demanded, while the Czech Republic was paying 73 basis points (three quarters of a percent) less than its risk factor. Hungary was paying an incredibly low interest rate 150 basis points (one and a half percent) below what it should have had to pay.

That was in July and the institute was prepared to sound a warning signal to its member banks, investment houses and insurance companies that these were dangerously low spreads for still considerable risks in lending money to these countries.

However, the Southeast Asian financial crisis intervened and provided the signal needed to push the spreads back up to the levels the institute says their risk demands.

By last month, Russia's spread had risen from 303 basis points (just over three percent) to 428 basis points (four and a quarter percent) for the money it was borrowing, a figure that is actually well above the institute's suggested 312 basis point premium.

Similarly, Poland found itself in October paying 255 basis points (just over two and a half percent) for its risk, 150 basis points (one and a half percent) beyond the spread suggested by the institute's formula.

The Czech Republic, Hungary and Turkey, however, have seen their risk spread borrowing cost rise around 100 basis points or less (one percent), and now running much closer to the level suggested by the institute's formula.

The institute says this all goes to show that even the most sophisticated investors can become overconfident and lax in checking on the actual credit risk of any borrowing nation, but that the market sooner or later catches up and levels the playing field.

That is little consolation to finance and central bank officials in Warsaw and Moscow these days. The only thing is, say institute officials, it shows objectively that Russia and Poland should be able to pay a slightly smaller risk factor to their lenders.