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#6 - JRL 7258
Wall Street Journal
July 21, 2003
A Bitter Clash in Russia Alarms Foreign Investors
Official Attacks on Yukos Move Some To Reassess Nation's Political Climate

A bitter clash between the Russian government and one of the country's largest companies is threatening to derail what has been one of the best-performing emerging markets of the past two years.

The controversy centers on a probe of Yukos. Earlier this month, the government arrested Platon Lebedev, a major shareholder in the energy company, on charges of defrauding the state. Russian prosecutors then launched a 16-hour search of Yukos's offices.

Accusations traded between government officials and Yukos Chief Executive Mikhail Khodorovsky -- who has donated money to parties opposed to President Vladimir Putin -- raised the anxiety level among foreign investors and sparked a two-week selloff in Russian stocks. "I don't think it's over yet," says Mark Madden, who runs the Pioneer Emerging Markets Fund in Boston.

Moscow's RTS index had tumbled more than 15% since the scandal erupted before rising 2.8% on Friday. Yukos's share price was hit even harder, falling about 20% until Friday's 6.3% rebound.

Despite Friday's bounce, analysts warn that unless the controversy is resolved quickly, it could snuff out a lengthy rally that powered the RTS Index ahead 40% during the first half of the year after a 26% gain in 2002. Already, it is forcing investors to reassess whether Russia's improving economic outlook, relatively stable currency and exposure to strong oil prices have led the market to naively discount the political risks.

"What Yukos has really amplified is that people had become complacent about the political situation in Russia ," says Christian Stracke, an emerging-markets analyst for the research group CreditSights. "That led to an overinvestment in both Russia's stocks and bonds."

Even worse, the Yukos investigation raised the possibility that Moscow would go after other Russian tycoons, the so-called oligarchs, who benefited from Russia's privatization program. That could encourage capital flight if it reversed the process of how companies went public. The government tried to ease those fears on Thursday when the prime minister said Moscow wouldn't review the privatization process.

That pledge was considered important to wealthy Russians who had parked their money abroad following the country's financial crisis in 1998. Recently, these investors have been repatriating their savings, and cash made available as Russian bonds have matured, into the Russian market. But like many foreign fund managers, they haven't forgotten the violent collapse in the market five years ago.

"This is a reminder that institutions in Russia continue to be fragile," says George Hoguet, head of emerging markets at State Street Global Advisors in Boston. With a parliamentary election in December and a presidential one next year, he says that investors will keep an increasingly close watch on the state of politics in Russia . "Certainly around elections, we often see crises in emerging markets," he adds.

Most U.S. investors consider President Putin a welcome change from his predecessor, Boris Yeltsin. Under Mr. Yeltsin's administration, the volatile political landscape raised the risk premium associated with investing in Russia . If the stability under Mr. Putin has helped Russian 30-year bonds triple in value to about 93 cents on the dollar during his three and a half years in office, his government's investigation of Yukos has also raised concerns about how he might treat investors if they cross him.

"It makes foreign investors wonder what their rights are in Russia ," Mr. Madden says.

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