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Excerpts from the JRL E-Mail Community :: Founded and Edited by David Johnson

Investors nervous about 2012

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Several dozen international investors with money to spend in emerging markets gathered in London last week for a rare opportunity to meet the management of Russia's top companies face-to-face.

But while representatives of Russia's most successful businesses sang praise to Russia's economic potential, protesters outside the building where the conference took place, with cell phone tycoon in exile Yevgeny Chichvarkin at the helm, had a different story to tell, and they seem to have cold stats on their side.

"Despite the risks, we are still seeing a fair amount of interest in Russia, especially since the oil price has been high for most of this year," an equity portfolio manager from a large Western bank, who wished to remain anonymous, said at VTB Capital's "Russia Calling" investment forum.

VTB Capital, the investment arm of state-run VTB Group, was understandably keen to plug the plusses of investing in Russia, namely high economic growth, a shrinking budget deficit and stock valuations that many analysts agree are underpriced. "The Russian economy is looking stronger than many others," said Alexei Moiseyev, the head of macroeconomic analysis for VTB Capital. "The ruble has strengthened significantly and inflation is on a clear path to reduction."

But outside the up-market hotel where the forum was taking place, gathered a small group of protesters. Led by Russian cell phone mogul Yevgeny Chichvarkin, who fled Russia in 2008 to avoid a possible jail sentence on charges he says are politically motivated ­ an accusation officials categorically deny ­ the dozen or so protesters drew attention to the risks of investing in Russia.

They wore T-shirts with the faces of jailed tycoon Mikhail Khodorkovsky and Hermitage Capital lawyer Sergei Magnitsky, who died in jail in 2009 after accusing tax officials of graft, to highlight what they say is Russia's consistent neglect of the rule of law.

The risks of putting money into Russia are well known, and investor worries can be gauged in cold hard cash: political and oil price instability led to a net capital outflow from the country of $7.8 billion in April.

"Russia is still not very friendly to investors; neither domestic, nor foreign," Sergei Guriev, the rector of the New Economic School in Moscow, said during a panel session at the forum. "The president and prime minister have said that the investment climate will improve and corruption will decrease, but currently I do not think investors are convinced by such speeches, which is why capital is leaving Russia."

Nevertheless, President Dmitry Medvedev has been credited in recent months for a string of positive steps to change Russia's reputation as an energy-dependent country riddled with corruption.

The most notable is a 10-point plan to strengthen corporate governance, weed out graft and boost investment. The plan's most controversial clause (on paper at least), to replace government ministers on the boards of state-run companies with independent directors, has already come into effect.

Although largely symbolic ­ Deputy Prime Minister Igor Sechin was allowed to choose his replacement on the board of oil giant Rosneft ­ analysts say the move is a step in the right direction and that the plan is more broad-based and realistic than previous attempts to employ a top-down approach to modernization, such as the setting up of an innovation hub at Skolkovo near Moscow and talk of establishing Moscow as an international financial center.

The Kremlin's privatization drive has also impressed investors, though its aims are centered more on plugging a hole in the budget than modernizing the economy. In contrast to past privatization plans, which lacked ambition and were poorly executed, this state asset sale, the biggest since the 1990s, marks a real change in policy and could significantly reduce state participation in the economy.

The government raised $3.3 billion from a sale of 10 percent in VTB, Russia's second largest lender, in February, and a stake in the biggest lender Sberbank may be offered in September this year. Add Russia's expected entry to the World Trade Organization later this year, and a recent proposal to create a $10 billion equity fund for joint investments between the Kremlin and private equity funds and the signs of change start to look more promising.

In a bid to show that the president means business, his chief economic aide, Arkady Dvorkovich, broke with the government's usual elusive air recently by meeting with foreign bankers and economists to hear their views on what Russia can do to make itself more attractive to foreign investors.

Christopher Granville, managing director of research firm Trusted Sources, said the Kremlin's drive to root out corruption has already had some positive effects.

"The fight against corruption doesn't get the recognition it deserves," Granville said. "Most of the steps taken so far have not been very visible, but the process is slow and Russia needs to start somewhere." Nevertheless, analysts warn that the 2012 presidential elections may throw a spanner in the works of the modernization drive.

Financial analysts and political pundits watch the ruling tandem for signs that PM Vladimir Putin will ­ or won't ­ return to the presidency, something some worry may significantly slow the momentum built up by Medvedev and his team of largely young and ambitious advisors.

"The elections are a big question that worries everybody," Guriev said on the sidelines of the conference. "The modernization agenda, Skolkovo and the international financial center are projects that are more Medvedev's personal projects than the government's important priorities, so everybody worries that if Medvedev doesn't remain the president after 2012, these projects will be neglected."

Medvedev said himself last month that he envisages a faster pace of modernization than Putin, whose policies have traditionally favored stability over reform. Putin told the State Duma, Russia's lower house of Parliament, last month that the country would have "no radical economic experiments," an idea supported by a majority of Russians still scarred by the "shock therapy" policies followed by President Boris Yeltsin's "young reformers" in the early 1990s.

In view of this, investment bank JP Morgan described the reelection of Putin as a "decade of slow progress" in a recent report. "The fact that capital is leaving Russia even though the oil price is very high means that investors are very nervous about this [elections]," Guriev said. "They are afraid that the new government may be composed of the same people but will be more anti-market than this government, and that worries everybody."

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