#6 - JRL 7255
Yukos re-awakens foreign investors' Russia worries

LONDON, July 18 (Reuters) - Foreign investors who have held Russian debt and equities have been on a bull run since Vladimir Putin succeeded Boris Yeltsin as president three years ago, and until now politics has generally not been a concern.

But with the investigation of Russia's largest oil company Yukos widening and largely seen as motivated by a desire to warn its billionaire chief executive Mikhail Khodorkovsky to keep out of this year's parliamentary and next year's presidential election, investors are re-assessing their view.

"Under the Yeltsin administration, political risk was the highest rated risk, but under Putin problems appeared to matter less, we were perhaps getting ahead of ourselves in the idea that politics did not matter," said Douglas Helfer, fund manager at London-based emerging markets specialist F&C.

Russia has outperformed most other assets since Yeltsin departed and Putin surprised many investors and analysts by striking a deal with the so-called oligarchs who control much of Russian industry and not reversing a large chunk of the gains they made under the flawed loans for shares schemes of the 1990s.

Since Yeltsin made his surprise resignation speech on December 31, 1999, Russian debt risk premiums over U.S. Treasuries have declined from 2,432 basis points (24.32 percentage points) to 316 bp now.

The price of its 2030 Eurobonds, issued as part of a debt deal with banks in February 2000 -- a period which marked Putin's role as acting President -- has risen in price to 92 percent of face value from 33.

This year, despite expectations of a flat year, equities and debt have both performed well, with Russia's portion of the JPMorgan Emerging Markets Bond Index Plus (EMBI+) gaining 15.55 percent and equities in dollar terms are up 19.3 percent, according to the S&P/IFC Investable Index in dollar terms.

Part of the gains came from a more than $6 billion deal from BP to buy a stake in Russian oil giant TNK, which was the largest ever foreign investment in Russia and was portrayed as having redrawn the investment and regulatory map in Russia.

The idea was that if BP could commit so much money, investments in Russia must be really safe.

Now, western investors are starting to question that view.

QUESTIONS OVER PROPERTY, MARKET ECONOMY

"Potentially at stake in the belligerent pursuit of Mikhail Khordorkovsky's Yukos by Federal prosecutors is one of the central pre-requisites of a functioning market economy -- clearly defined, operable property rights," said Philip Poole, head of emerging market research at ING.

"The 'benign' interpretation is that this is just the Kremlin reminding the business community to stick to the agreement and stay out of politics," Poole said.

"The alternative view is that, freed from an agreement struck with Yeltsin and his extended 'family' which only encompassed a first term, Putin is preparing to reshape corporate ownership rights in Russia to his own ends," he added.

Foreign investors have certainly caught the jitters.

Russia's 2030 Eurobond has fallen some 3.8 percent since July 3, the date the Yukos affair started with the questioning of Khodorkovsky associate Platon Lebedev.

That move in itself has been part of a selloff in Russian debt which has fallen more than nine percent since mid-June as domestic buyers have evaporated.

The big concern for the Russian authorities is the pattern of capital inflows which has seen Russians bringing back capital from offshore centres like Cyprus could reverse.

The first indication of these concerns came in data for the week beginning July 11, which showed international reserves fell by some $200 million, compared with a trend of a weekly average gain of $800 million year to date.

Poole at ING said sovereign debt prices may have bottomed, but equities may see further pressure and, along with other analysts, that this need not turn into a capital flight crisis.

But action was needed in the form of a decisive intervention from Putin himself to draw a line under the concerns of foreign investors and make it clear the actions are aimed purely at politics, rather than at legal rights.

"What Putin needs to do now is to find a way of continuing to deliver these messages without raising the risk of a destabilising capital outflow," said David Lubin, head of emerging market research at HSBC.