INSIDE FINANCE: Newest GKO Restructuring Is Worst Possible Decision

There is plenty to be surprised at in the details of the restructuring of Russia's domestic debt, known as GKOs, announced last week.


If you owe money and cannot pay it back, and you want to retain investors' trust, there is only one way to do it: You must agree with creditors on a schedule of repayments that suits both sides and then try to pay off the whole debt. That could even allow you to receive more loans once it is recognized that you are meeting commitments.


There is also a second option if you don't care about maintaining a relationship with investors: Pay nothing at all.


And then there is option three: Announce unilaterally that you will only pay part of the debts. But that still won't rebuild your good name with investors. Paying nothing back or just part of the debt amounts to the same thing. No one will lend you any money in the future.


The Finance Ministry has chosen option three. This has been calculated from the point of view of an accountant closing the books. The Finance Ministry worked out how much it could pay each month and spread it out between the debts it had to cover. That gave rise to a complicated system of dubious securities that are heavily discounted from face value. This will still disappoint investors who have been hurt by the default.


Another point. There will be restrictions on allowing foreigners to take part in the special trading sessions where they can partially convert the rubles they receive into dollars. Foreigners will have to have a document proving they do not have any outstanding claims on Russian banks. To put it bluntly, before they can change rubles into dollars, the foreigners have to write off the debts owed by Russian banks on forward contracts.


If I were a Russian bank, I would make sure that foreigners paid very dear for the documents about settlement of disputes over forwards.


It is also troublesome that the Central Bank intends to open special accounts for foreigners from which no money can be removed for a year. It is as though foreigners will be getting specially marked rubles. There are rubles you can spend in shops, there will be other rubles you can use to pay taxes (more precisely tax arrears), and there will be rubles you cannot use at all.


So maybe it would be cheaper to refuse to pay any of the GKOs rather than do something that is basically an insult to creditors. It will come to the same result: No one is going to lend anything to this government.


The GKO restructuring,, announced on Aug. 17, has been a mess from the start. On the evening of Aug. 16, the Central Bank and the government agreed on a different restructuring scheme. It involved setting different repayment schemes for foreigners and residents. Each was to receive what they most wanted. Foreigners would get hard currency securities, which would allow them to forget about the risk of rubles. Residents, who started to have liquidity problems as soon as GKO payments were frozen, were to get a larger share in rubles. That would have prevented a collapse in the banking system. The International Monetary Fund in Moscow agreed with these proposals.


But in the course of the night, the IMF's position changed suddenly and it started to insist that non-residents and residents should receive identical terms in the GKO restructuring. The IMF made this a condition of its support for the decision announced on Aug 17. The Russian government lacked the nerve to get into a dispute with the IMF. It accepted the flawed principle of equal terms. This meant Russian GKO holders were still suffocated and illiquid. And the foreigners were still subject to the risk of the inevitable and dramatic devaluation of the ruble. The announcement of the terms was postponed for two days until Aug. 19. The task was given to Boris Fyodorov, then head of the State Tax Service, who was specially raised to the rank of deputy prime minister.


On Aug. 19, the government was due to pay out the next tranche of GKOs. It either had to make the payments or announce new terms for repayment. But Fyodorov chose the worst option - default. Fyodorov spent another week trying to come up with something palatable that observed the principle of equal terms for all. Deutsche Bank and J.P. Morgan were brought in as consultants. Fyodorov wanted these esteemed companies to sign off on the restructuring, guaranteeing the support of the world investment community. But the foreign consultants refused to approve the scheme. Fyodorov's plan failed and, as a result, Prime Minister Sergei Kiriyenko lost his job.


So what did the new government do? At first, Prime Minister Yevgeny Primakov announced that all decisions were illegal and promised to reverse them. But then it turned out that it just wasn't possible to reverse the devaluation of the ruble. And then the government could not find an alternative to the moratorium on the debts of Russian companies. And now we have a decision on GKOs. And it is exactly the decision that was made by Kiriyenko, albeit one of the worst possible options that he was considering. It is a joke.