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#11 - JRL 9326 - JRL Home
Date: Thu, 22 Dec 2005
From: James Beadle <jamesdbeadle@yahoo.co.uk>
Subject: Christmas Wishes For The New Russia

The Russian equity market is up an astounding 70%+ year to date, underscoring the inherent risk-reward ratio of doing business in under-developed economies. Few predicted such a windfall year at the outset, in fact 2005 began as depressed as any on record. The government had freshly demonstrated its corruptibility and greed by botching the final stages of its senseles! s slaughter of a market-leading enterprise, and investors were reeling with shock at its serial incompetence.

So what has changed in six months (besides the perception of risk and the opinion of the average Russian market observer)? The answer is very little, the list of real improvements over the year is quite short:

1. Progress on the Gazprom share liberalisation.

2. Emergence of some interesting new Russia listings (albeit overseas).

3. Continued (relative) fiscal prudence.

4. A whiff of market-orientation in the Kremlin (state-owned enterprises looking to go public).

Meanwhile, the causes of concern remain. Visiting Russia today is in many ways a trip back to the late 1990s. With so much cheap cash slopping around, the price of basic amenities has gone through the roof and the country remains as corrupt as ever. Oligarchs ! are selling out and foreigners are buying in. Market strategists are queueing up to spout age-old reasons for buying Russia, the most compelling is rarely mentioned: Buy just because it’s going up.

With Putin set to takeover the G8, 2006 represents another unique opportunity for Russia to prove itself. The fear is that, rather than prove its 21st Century potential, the nation will inevitably expose its true self. I say this not to criticise Russia for its shortcomings, but to counteract the flood of misconception that follows any cyclical decline in risk perception.

It is true that Russia has evolved into a fiscal powerhouse, which well protects it from the type of financial disaster that continues to linger in the market memory. However, beyond such macroeconomic prudence, little has changed.

The Yukos affair, coupled with the Kremlin’s strategic sectoral dominance, has driven corporate governance and better transparency off the radar. Low developed market interest rates and high oil prices have allowed Russia to recover financially, without instilling responsibility.

With fast cash continuing to run the nation, there remains a veritable galaxy of unlocked potential, but one has to ask: has the recent run priced this in? Domestic commentators, true to their obvious interests, claim not, but then their obsession with the Russia that could be frequently trumps coverage of the Russia that is. It remains a fact that market risk, which is transient by nature, is the ultimate determinate of investment return.

While I agree that Russia’s potential remains suppressed, the fear going into 2006 would be that risk perception returns to the market while value is unlocking. Such an eventuality implies healthy downside protection, but would deny the market another stellar performance.

This year’s rally came from a decline in negative news, backed-up by strong oil prices (which have run high enough to feed the both the budget and the special reserve). Going forward, Russia will have to change gears and start delivering positive news flow to realise its growth potential.

Christmas is supposed to be a time of charity and giving, but with the capitalist instinct so deeply ingrained in modern Russia culture, I feel little shame in presenting an ambitious Christmas wish list:

1. Clean out the administration, top-down.

Specifically, please change those persons lacking the credibility to at least appear impartial or fair. The Prime Minister, Minister of Telecommunications and the Mayor of Moscow leap to mind as major burdens on the nation’s development, but the list could run indefinitely. Loyalty to cronies with tainted records is Putin’s key weakness.

2. Allow (a little) opposition.

It is fascinating that such a powerful administration is so scared. Allowing a token opposition would give credence to pro-Western claims, without risk of losing either control or power. It would also enable Western administrations to save face in dealing with an essential energy provider (if the Kremlin believes other west! ern leaders are as blatantly corruptible as Schroeder, they are likely to be mistaken).

3. Land legislation.

Energy is Russia’s most commonly cited competitive advantage; land is another, which is sadly overlooked and as deservedly undervalued. Corrupt property ownership implementation is a major hamstring to development.

4. Judicial procedure.

Impartial and uncorrupted legislative procedure is essential to the emergence of an effective business climate. Russia will remain heavily discounted to peers as long as the judicial verdicts are openly purchasable.

5. Economic diversity.

As fast as the price of oil rises, Russia extends its dependence. Certainly, the Putin administration has walked a sensitive line between utilising its windfall and feeding populist concerns, but 2006 may well prove the peak of this cyclical run. Time then, while the cash is still pouring in, to re-engage some of Russia’s other competitive strengths and give a healthier breadth to the economy.

6. Streamline the bureaucracy

In the first years of a presidency its possible to blame one’s predecessors, but Putin has by now had ample time to clean up the state structures. Preposterous levels of bureaucratic constraint inhibit economic dynamism, and will certainly suck the wind out of Russia’s sails should commodity markets revert to mean levels.

I know it’s a lot to ask, but with so many people celebrating Russia’s resurgence as an investable emerging economy, surely it is not too much.