#18 - JRL 7247
OPINION: Raising ghosts of privatization past
Contributed by Oles Kopets, Analyst with Foyil Securities New Europe, Kiev, Ukraine

MOSCOW, July 10 /Prime-TASS/ -- "Most, if not all, privatizations are arguably deficient and, therefore, vulnerable to attack," Wimm-Bill-Dann warned potential ADR investors in its prospectus, and the past week's events have given credence to those ominous words.

But the fact that the Russian equities market received a sudden jolt and then quickly stabilized after news of the arrest of one of the country's wealthiest businessmen gives reason to be both confident and concerned about the rambling financial juggernaut that is eastern Europe. Confident, that is, that the fundamentals of the Russian economy are stronger than they have hitherto been, and concerned that the foundations of the major private companies do not necessarily rest on solid ground. In many ways, the open attack on Yukos bigwig Platon Lebedev is a typical Kremlin political power struggle, and, of course, investors should take heed. But the manner of the strike reveals that the nature of the struggle has shifted in an important way that should bolster confidence.

The Yukos story involves a 10-year old privatization saga, one of the many that gave birth to those companies in which investors are now looking to place their money. However, this time the scandal does not involve the great investor fears of embezzlement and asset stripping. The state, albeit for less than subtle political purposes, is trying to build a legitimate case out of a decade-old alleged fraud incident that occurred during one wave of privatization. What the powers that be seem to be doing via the arrest of Lebedev is reminding executives to mind their own business. That is, to stick to business and leave politics alone. This is only the latest in a series of high profile cases. The most notorious to date have been the pending extradition of Boris Berezovsky and the exile of Vladimir Gusinsky. Yukos executives reportedly support political forces not affiliated with the current regime, and considering that parliamentary elections are to be held this December, pro-Kremlin forces are using this opportunity to disarm their opposition.

These events reveal one established and one emerging trend. It is more than apparent that the state still possesses powerful levers to influence the stock market in ways that could destabilize the maturing Russian capital markets. After a heady rise during the first half of this year, Yukos shares slipped backwards with the investigation into its chief handlers, even though the issue had naught to do with the oil giant. This is old news. What is new is that a reckoning of the past is in effect and festering secrets are likely to ooze from beneath the closed boardroom doors of the country's most prominent corporate structures. This will change the way business is conducted in the Newly Independent States.

There are those who have compared the steady rise of the Russian stock market over the past six months with its similar rise during the same period in 1998, when the RTS index topped 500 in early July. At that time, the overheated market contributed to the economic crisis the country experienced in the fall of that year. However, this time round only the numbers are the same. The fears that foreign investors harbored about Russia over profit embezzlement and asset stripping now languish in the dustbin of modern financial history, along with that era's bad financial policies. Those who survived 1998 nowadays enjoy a considerably different environment: the RTS index may be up about 40% for the year, but Russian bonds are now among the lowest yielding in their class and the government is maintaining fiscal responsibility.

The recent RTS growth has mainly been the result of investor over-confidence, which has led investors to ignore a number of warnings that under less excited circumstances might have drawn more public attention. Lawsuits surrounding privatization have been going on since 1994, and so there was plenty of legal, financial and political activity to indicate the shape of things to come. The end result is that the lure of rapidly rising markets has blinded some to the inherent risks.

This now begs the question of what actually constitutes the greatest risk to investors. Flawed privatization itself is not a major direct threat since many old Soviet enterprises have been transformed into hugely profitable private companies. The threats of embezzlement and asset stripping have now been downgraded with the near complete division of important former state assets and by the lure of a rapidly growing Russian economy. We would argue that the greatest threat to the investment climate now is the readiness of state authorities to use their weapon of mandated, almost arbitrary power against business. State interference in a company's operations is a sword of Damocles hanging over the Russian market, perpetuating the perception of Russia as a high-risk environment, and thus inhibiting further expansion of the market.

However, as one popular soviet-era anti-hero stated: "the rescue of those who are drowning is the concern of those who are drowning." In other words, Russians will likely be the saviors of the Russian market. Locals have been substantially responsible for the recent growth in stock prices. At the same time, some institutional investors consider the Russian market expensive now, with locals buying in on a scale not seen before. Russians are showing faith in their market with their cash, and the availability of domestic financing will increase as more people empty their mattresses and deposit money with financial intermediaries. Locals have an intrinsic advantage on the market -- they genuinely understand the risks involved and have their own ways of acquiring first hand information. They also operate in an environment with fewer constraints than elsewhere, which means that locals can play the game without being inhibited by the need to explain to their investors what happens and why. This unties their hands in comparison with foreign investors.

The major threat to the Russian economy and foreign investors no longer emanates from the oligarchs. The current trend among Russian oligarchs, which ironically is a part of the legacy of 1998's financial disaster, is towards transparency and retirement. The oligarchs can be seen cashing in and freeing up space for Western investors to assume roles on shareholder and executive boards, like Sibneft's Roman Abramovich has done. Furthermore, long-term investment requires long-term policies, which tend to be better served by more transparent activity. This makes acts of large-scale embezzlement and wholesale asset stripping much less likely. There can be no doubt that the remaining great menace is the state, and if not those at its uppermost reaches, then those who protect their positions.