November 24th, 2010

Take the Money and Run, to Indonesia?

Sergei Ignatyev, Russia’s central banker, announced on Tuesday that capital outflows have reached over $22 billion in the first 10 months of 2010. Compare this with the other BRIC nations that are seeing capital inflows and the overall emerging markets expect to take in $825 billion in private capital inflows this year.

In Seeking Alpha, Craig Pirrong writes

The net capital outflows reflects two things: (a) Relatively little money flowing into Russia, and (b) a lot flowing out. The former is readily understood, given the very weak investor protections, and the horrible experiences of many foreign investors (Shell, BP, Telenor, Ikea, and on and on). The latter is very revealing too, though. The distribution of wealth is highly concentrated in Russia, so net wealth outflows mean that even the extremely wealthy–those that have investible wealth and the ability to move it overseas–perceive that the risks of investing in Russia are extreme. Even given the vaunted discounts in Russian equity prices, they put a lot of their money overseas. They realize that they have their wealth at the whim of Putin and the siloviki. Better to get it (and in many cases, their families) in a place where it’s harder for the state and the power structures to get at it. They have more influence in the system than foreigners, but “more” doesn’t mean “a lot.”

The lack of effective law enforcement in Russia is reflected in the low prices of stocks on the Russian stock exchange as well as the concentrated management of Russian firms. Without say in the management or direction of the company, investors are not inclined to invest a lot of money.

Which leads us to, where are investors going with their money?

Emerging markets are still where investors are taking their money and BRIC companies make up a large part of those investments. The $48 billion MSCI Emerging Markets Index Fund has a portfolio that has half of the companies in BRIC countries. In the first 10 months of this year, investors have added $75 billion to emerging markets equity mutual funds compared with $15 billion in US large equity funds.

But seeing Russia’s issues with corruption and capricious governance, investors are turning towards Indonesia to replace Russia in the marquee emerging market acronym.

For plenty of money managers and economists, however, the Russo euphoria is all but gone. From Nouriel Roubini to Morgan Stanley, they are calling either for Russia to be ousted from the BRICs altogether in favor of Indonesia or, at the least, for Indonesia to join the other four. They are put off by the policymaking drift in the Kremlin, Russia’s demographic atrophy, and endemic corruption. Indonesia’s fiscal prudence, economic growth—6 percent this year, according to the International Monetary Fund—and strengthening social and political institutions have far more appeal. Twice-elected President Susilo Bambang Yudhoyono has directed funding toward schools and health care, and Indonesia’s coffers are full enough to put the onetime IMF bailout case on the brink of an investment-grade credit rating.

Despite President Medvedev’s roadshow to Silicon Valley and Washington DC, the continued uncertainty over the 2012 presidential elections adds another layer of uncertainty to any investment in Russia. Even wealthy Russians are taking their money and going elsewhere. Should you?

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