June 16th, 2011

Putin says to investors: Trust me

St. Petersburg

As the St. Petersburg Economic Forum gets underway, Prime Minister Putin is telling investors to trust him and put away their wariness of heightened risk because of corruption and weak rule of law in Russia. Russian authorities are pulling out all the stops to encourage much needed foreign investment. Deputy Economy Minister Stanislav Voskresensky, Putin’s director of foreign investors had this advice:

Do not scratch your head and wait: Russia is open for business and the potential profits are huge.”

Russia needs to offer high rewards for investing there as its attractiveness has faded despite recent strong commodity prices. Recently Chevron ended its partnership with Rosneft in the Shatsky Ridge deal in the Black Sea. Russian authorities loathe to cede any profits to multinationals, but the Shatsky deal was a concession to the fact that Russia cannot conduct offshore exploration without outside assistance.

Capital outflows have reached record heights from foreign and domestic capital. Over $55 billion has left Russia over the past eight months according to the International Monetary Fund.

Mikhail Khodorkovsky, former CEO of YUKOS estimates that due to graft in the economy, oil would have to be $200 a barrel before Russia can match the growth of the BRIC powerhouses China and India.

Economic reforms require 100 percent guarantees for private property and an effective, lawful state,” Khodorkovsky, 47, said in written answers to questions relayed through his lawyers. “Under the current political and economic model, to get a 10 percent growth rate for the Russian economy the oil price would have to remain solidly above $200 per barrel.

The World Justice Project released their 2011 Rule of Law Index and had this to say about Russia’s situation:

Russia shows serious deficiencies in checks and balances among the different branches of government (ranking 55th), leading to an institutional environment characterized by corruption, impunity, and political interference. Regulations are not always enforced (ranking 52nd), and civil courts, although accessible, are corrupt and inefficient. Crime rates in Russia are not as high as those in other middle- income countries (ranking 8th out of 19), and the criminal justice system is relatively effective (23rd). Violations against some fundamental rights, such as freedom of opinion, freedom of association, and arbitrary interference with privacy are areas of concern. [Read the full report here.]

With all these warning signs investors are right to be cautious about Russia. The market efficiency hypothesis in economics states that financial markets are “informationally efficient”. This hypothesis explains why Russia lags China and India in foreign investment and why until Russia makes comprehensive and visible changes to its legal and judicial systems, even the promise of excess market returns by the Prime Minister will not convince investors.

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