Committee for Russian Economic Freedom

Ambassador John Beyrle

A new trove of Wikileaks documents includes a cable from the Obama administration’s man in Moscow on Russia’s failure to attract direct foreign investment (DFI).

U.S. Ambassador John Beyrle writes that an “unpredictable legal system” in Russia is undermining investor confidence, adding that foreign firms who do business there are more often focusing on international and private arbitration to resolve disputes than the unscrupulous Russian courts.

Beyrle offers an oft-told solution for attracting DFI:

Persuading Russia to improve its adherence to international norms, including standards for enforcing judgments in Russia, would make its investment climate more attractive.

In the same cable Beyrle mentions the cases of Yukos, the Bank of New York, Hermitage Capital and German businessman Franz Sedelmeier as concerns that have been adversely affected by the unpredictability of the Russian legal system.

He also quotes a “British oil and gas lawyer” who agrees with the premise that Russian markets are weakers and international deals are fewer because of legal unpredictability, saying that “the very public (and recent) disputes of Telenor-Vimpelcom and TNK-BP further decrease the value of potential deals in Russia vis-a-vis other emerging markets. This is the ‘Russia Discount.’”

The Wall Street Journal reported on two negative economic forecasts, one from a senior Russian economic official and the other from HSBC.

Andrei Klepach

Deputy Economy Minister Andrei Klepach is predicting a weaker ruble and slower growth over the next three years, as well as a weaker industrial sector.

He estimates the ruble may fall as much as 10 percent by 2014 and blames stagnation in oil prices and a general slowdown of global economic growth.

These comments represent a reversal from last month when Klepach predicted steady growth and a strong ruble.

Meanwhile HSBC “sees the ruble falling nearly 25 percent by 2014,” according to the Journal. The banking giant’s outlook comes from a belief that Russia will continue to experience massive capital outflows.

An estimated $30 billion has already left Russia this year.

This month’s fluctuations in the world financial markets are having an outsized effect on the Russian economy, the editors of Vedomosti wrote Wednesday.

The authors note that the RTS and MICEX have “dropped almost harder than the other” markets due to the expectation that investors would shed investments in oil in favor of more reliable assets like precious metals and (irony aside) U.S. bonds. (Russian markets were already in a disadvantageous position, as analysts have estimated that Moscow trades at a 30-50 percent markdown compared to other emerging markets – what’s often called the “Khodorkovsky discount,” after the former head of Yukos.)

While gold and oil tend to make major moves during economic panics, those moves aren’t always upward, as is the case this month, write the editors:

Raw materials often serve as a crisis alternative to securities. But today, only gold is going up in price, which, in essence, is not even a raw material, but money. Oil got cheaper […as] investors are expecting a cooling of the economy in China and a recession in the U.S.

A cooling of demand for oil, and a continued price drop, does not bode well for the Russian economy as its constructed in 2011. Citi analysts wrote earlier this week that, as compared to the economic crisis of 2008, the Russia’s dependence on oil has grown: “In 2008, the budget was balanced at a price of around $60 per barrel, but now the required price is about $120.”

During the last financial panic, in 2008, it took about six to nine months before Russia felt its worst affects. That time may conveniently fall after the next presidential election, when the new/old victor will be able to implement his own austerity measures – with nearly six years left in his term to see how they play out.

Either way, Russia’s intransigence on modernization and continued reliance on fossil fuels will only hurt its standing among investors looking to cash in on emerging markets – and, down the line, will hurt a nation badly needing public sector assistance to ease poverty and create jobs.

It’s been five years since Yukos was forced into bankruptcy, its assets seized by the state and top officials imprisoned. The shutdown still haunts foreign investors, writes Tim Osborne of international holding company GML (the former majority shareholder of Yukos) in The Moscow Times – not to mention the Russian economy and the Russian people, who have suffered the most from this liquidation and the precedent it set:

[T]he fallout from the Yukos affair cannot be measured in financial terms alone. The longer term and far more detrimental effect is that there is now an assumption of political interference, corruption and the arbitrary use of state powers in civil disputes.

Half a decade after the forced bankruptcy of the most successful post-Soviet concern, Russia still severely lags behind other BRICs in terms of GDP growth. That assets can be taken away so easily is alarming to both domestic entrepreneurs and foreign investors, Osborne writes, making the risks of investment outweigh any potential success.

Sure, the Russia government faced corruption accusations prior to Khodorkovsky’s arrest. But the destruction of Yukos, accompanied by the decision to withdraw Russia from the Energy Charter Treaty and other backward-looking measures, was a huge step in the wrong direction. Investors have yet to be incentivized to return en masse.

Is there a solution? Osborne cites an IMF report that suggests two options: reform, by strengthening property rights and modernizing the judiciary and the bureaucracy, or face another recession. He concludes:

As the Russian government once again prepares to embark on a major state privatization program, foreign investors must clearly make their own calculations about whether the potential success of their Russian ventures outweighs the risks. For us, that calculation is simple. We have lost far too much already.

A personal plea from someone who learned the hard way what it means to invest in Russia.

In an op-ed published in Vedomosti, Yevgeny Gontmakher and Igor Yurgens of the Institute of Contemporary Development (a centrist, pro-business think tank of which President Medvedev is the chairman) write that Russia faces a crossroads with the 2012 presidential election. The nation can either choose to modernize, which may be risky, or it can opt for the status quo, which, they believe, means “stagnation, degeneration [and] inevitable national catastrophe.”

Recent efforts to modernize Russia, they write, have been met with resistance:

We see attempts to move the situation from degeneration to progress in the struggle with corruption, in improving the entrepreneurial climate, the formation of an effective foreign policy. But there continues to be no decisive breakthrough [as] even the most elementary actions by Dmitry Medvedev along the path of modernization are […] directly sabotaged.

Gontmakher and Yurgens suggest that top business leaders, who, save Mikhail Prokhorov, have largely remained silent on political issues of late, should take the role of forming a “civic coalition for modernization” to ensure that Medvedev’s nascent modernization program does not regress or die out. This movement would give cover to small- and medium-sized business owners concerned that their political activism would cost them their shirts.

The idea that influential businessmen could sway the 2012 Russian presidential election is a controversial one, as previous attempts by business leaders trying to influence politics has not gone well in the past. And Prokhorov’s recent foray into party politics has had mixed reactions and few tangible results.

But Gontmakher and Yurgens may have a point – that this “civic coalition” may be the best chance Russia has to modernize in earnest – or else risk economic and political collapse.