#4 - JRL 7216
OPINION: Russia in 1997 and 2003 - Spot the Similarity
Contributed by Roland Nash, Head of Research, Renaissance Capital

MOSCOW, June 9 /Prime-TASS/ -- The most amorous 50-year old who has ever grabbed me for a dance, ran the bar in the local Intourist hotel in Ekaterinburg. Our initial meeting was not auspicious. I was with several seasoned emerging market investors who were thirsty after a long flight. She had a monopoly in the Intourist and had unilaterally decided to shut-up early.

A negotiation of sorts ensued through the gap defined by the chain holding the bar doors together, and eventually star diplomat Ben Franklin opened her heart. Once inside, the home stereo was turned on, the New Year's lights began flashing, and the chain was resolutely replaced on the door behind us. Our hostess brought out her own stash of vodka and, after alcohol solved the usual cross-cultural confusion, we danced and sang until security rescued us at 06.00. That was in the spring of 1998.

Last week, I returned to Ekaterinburg on my first regional roadshow since the crisis. At the airport we were met by an air-conditioned German-made bus that whisked us off to a business hotel that could have held its head high in Frankfurt. The receptionists all spoke English and although they insisted on taking everybody's passport, it was only to save time with check-in forms. The regulation floor ladies had been replaced with smart cards, and the mysterious Soviet sized fridge-freezers that used to thunder in dominating locations in hotel rooms were replaced by standardised mini-bars. The bar stayed open until the last customer left and German beer was served by smiling waiters in penguin suits.

Clearly things have changed since 1998. The recent debate over whether the current excitement is just another 1997 would not survive a trip to booming Ekaterinburg. The evidence of private entrepreneurship was everywhere, from the plush new apartment blocks and canal-side cafes to the organisation of the two superb company visits to SUAL and OMZ. While central Moscow remains a misrepresentation of the rest of Russia, there are other parts of the country where the rate of change is clearly at least as rapid.

Only those with an observation disorder would directly compare the Russia of 1997-98 and that of 2003-04. In 1997, Russia was a country with a budget deficit in excess of 5% of GDP, real interest rates of 15%, with a clown as a President and a stock market where LUKOIL was trading on a p/e of 99. In 2003, Russia has a budget surplus of 2% of GDP, real interest rates of minus 5%, with a President sporting a black belt in judo and a stock market where, even after the monstrous rally of the last three years, LUKOIL still trades on a p/e of 6. And most significantly, the current boom is being driven by Russian money being invested in Russian assets, not by the foreign gold-rush that chased the market in 1997.

A direct comparison is, however, to miss the point of the lessons learned by 1997. While Ekaterinburg was clearly booming, the city sometimes appeared baffled by its own success, particularly outside the private sphere. The smart waiters informed that the ownership of the hotel was a secret (ring any bells?), although we were later whispered it was owned by local businessmen with a KGB heritage. The local museum resolutely informed that without a direct order from the local bureaucratic head they would not open for us. Ten years after glasnost, the city guide still insisted on the story that the happy people of post-revolution, civil-war-mired Yekaterinburg had gamely debated and chosen the Soviet era Sverdlovsk title for their city over such other popular choices as Red City and October. On the site of the regicide of Nicolas II and his family, the town authorities were in the process of erecting not one, but two, cathedrals, generously funded by arm-twisted local business. Between night-spots, a stick waving traffic cop was unconvinced by my assurances that I was no longer legally required to carry a passport, and had to be persuaded with RUR500.

The Russian economy is a radically different looking animal than that which expired in 1998. However, much of its genetic make-up remains unaltered. The bureaucracy hangs as a dead-weight on recovery. Regional and local authorities remain corrupt and ineffective. The banking sector fails to intermediate. The economy has failed to wean itself off oil which continues to drive the budget, the current account and investment. Labour remains stoically immobile. Under investment has meant that health care and education have degraded further. And the road and rail transport networks are becoming increasingly treacherous.

While the experience of 1998 will not be repeated, that does not mean that Russia or the markets are now immune from economic logic. The Russian economy may be booming, but that doesn't mean that a flawed banking sector and weak institutions are capable of efficiently dealing with an oil inspired liquidity boom. Although information, understanding and statistical transparency have improved significantly since 1998, that will not prevent perception and reality parting ways if negative real interest rates fuel a classic emerging market feeding frenzy. Perhaps the most encouraging consensus that emerged from last week's conference was the fear that the current boom felt like 1997 - the collective memory remains aware of previous mistakes, suggesting that a repeat of past errors is unlikely. However, Russia remains an economy that is dependent on external commodity price movements that are beyond its ability to influence and which lacks the internal institutions to effectively adapt to external changes. That logic suggests an exaggerated asset price boom-bust cycle, despite the lessons of 1997.