Committee for Russian Economic Freedom

Fiona Rintoul ponders aloud in the Financial Times about whether now is the time for fund managers to look more seriously at investing in Russia. Her article gives a qualified maybe, with a whole host of negative factors to consider:

The political situation is uncertain, and the Russian stock market has been in helter-skelter mode lately. Moreover, the local fund industry is littered with the corpses of fund managers who came, saw and failed to conquer; companies such as Pioneer, Templeton, Crédit Suisse and Deutsche Bank have all at one time or another withdrawn with their tails between their legs.

Vladimir Kirillov

The last time Russia looked ripe for investment was 2007, right before the financial crisis hit. Many more pre-crisis ventures failed than succeeded. Wealthy Russians retreated to funds based in Zürich or London, and the regulatory framework since has remained an obstacle for international investors.

Vladimir Kirillov, chief executive of TKB BNP Paribas Investment Partners, has a warning to those looking to get in:

The Russian fund industry is interesting for international companies but only those that are ready to develop this business in the long term. We don’t advise companies to come in and catch up.

Read the full article here.

While the state of the Eurozone remains the most pressing economic issue on the Continent, post-recession Russia isn’t expected to accelerate its growth either, according to John Bonar of British-based Business Special Report-Russia, with the challenges that marked 2011 not likely to abate any time soon:

All the leading investment banks predict more-or-less the same thing for Russia in 2012: a poor and volatile first quarter of the year with growth, investment and stock markets picking up and gathering momentum in the second half of year, barring a train wreck in the rest of Europe.

Moscow rings in the new year. Credit: AP

Bonar reports that capital flight of roughly $6 billion a month is predicted through the first quarter, with some 150,000 Russians looking to emigrate to improve their economic standing.

Lack of investor confidence in Russia also means “there is little prospect of any significant Russian IPOs” on the London Stock Exchange until the second quarter or later.

Economists, Bonar notes, are anxiously awaiting the March 4 presidential election, which, although the winner is predetermined, will be more interesting given recent demonstrations across the country.

A man protesting the results of the Duma elections is arrested. Credit: Reuters

Tai Adelaja of Russian Profile notes that this week’s demonstrations in Moscow “may have started to take a toll on the country’s economy,” as state bank VneshEconomBank canceled its Eurobond placement and two Russian mining companies have completed their escape from the MSCI Index to the FTSE 100.

VEB’s bond postponement is the first of its kind since the early 1990s, as “bond investors who initially showed interest in buying VEB bonds have started to withdraw their applications, as uncertainty clouds political future in Russia.”

Meanwhile mining companies Polymetal and Evraz became the first Russian firms admitted to London’s FTSE 100, with analysts seeing “a political undertone in their decisions.”

Two other Russian companies, Russian Railways and TNK-BP,­ are planning to meet with investors next week, the results of which could signify how money managers feel toward Russia after the election.

Read the full article here.

Blackstone Group's Steven Schwarzman

The executives of J.P. Morgan Chase, the Blackstone Group and Citigroup were in Russia last week advising President Dmitry Medvedev on how Moscow can improve its business and investment climate, writes the Wall Street Journal.

“Funds are actually scared to put money here. That’s the problem you must solve,” Blackstone’s Stephen Schwarzman told Medvedev.

Schwarzman counseled the Russian president to sell off state companies to private investors, while J.P. Morgan Chase CEO James Dimon recommended developing a “very strong set of legal rights” to lure investors, as the country’s notorious legal system and high levels of corruption often drive away investment.

You can read more here.

Nadia Popova and William Mauldin write in the Wall Street Journal about a Norilsk buyback program that has left thousands of Russian investors out in the cold – literally – as they’ve waited in line for hours to tender their shares. These types of obstacles tend to be common for the emerging investing class:

Even as semi-occupied skyscrapers rise up in Moscow’s new financial district, in hopes of luring large numbers of institutional investors, the country’s individual shareholders and bondholders face logistical issues ranging from required hand-delivered paperwork to limited redress for disputes with brokers or trading partners.

Retail investors often face bureaucratic red tape, and few are prepared for the volatility inherent in the Russian market, which has fluctuated between being the world’s best- or worst-performer in the past decade.

According to Alfa Bank the estimated number of investors participating in the buyback program has dropped from 60,000 to 18,000 due to “constraints at the registrar’s office [that] reminded us of lines that formed in the late 1980s for fresh food.”

Full article here: http://professional.wsj.com/article/SB10001424052970204777904576651081541236992.html.

The Kremlin’s human rights council earlier this week called for an amnesty for economic crimes in order to attract foreign investment and boost economic growth, according to Bloomberg News. 

Kremlin observers say that putting this proposal into action, which is unlikely, would improve President Medvedev’s standing ahead of the 2012 elections. According to a top Russian business lobbying group, one in six entrepreneurs has faced criminal charges.

Medvedev set up the human rights panel back in February.

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.

Washington Post reports that massive and unprecedented outflows from Russia signify deep uncertainty about Russia’s future and its ability to provide a stable platform for economic growth. Russia has well-known domestic infrastructure needs and President Dmitry Medvedev has made modernizing and diversifying the economy as a central issue in his presidency. But with $30 billion leaving the country in the first four months of 2011, the loss of confidence in the Russian government to make infrastructure changes and support the rule of law is evident in both domestic and foreign investors.

Russia’s currency reserves are buffered by the high price of oil, but that usually meant a stem in capital outflows. Not so this year. Evsey Gurvich, head of the Economic Expert Group in Moscow cites political uncertainty in the 2012 presidential elections as one of the reasons for capital flight,

In our country, personal guarantees, personal relations, are still more important for big businesses than laws and rules and formal regulation.”

Another reason he cited was the “weak business environment” in Russia due to the pervasive corruption and expropriation of private business by government officials.

That is another way of talking about corruption, bureaucratic capriciousness and courts that take their orders from on high.

The reaffirmation this week of the conviction of Mikhail B. Khodorkovsky, the onetime oil tycoon who lost his company and his freedom after he challenged Putin, probably translates into “several more billion dollars on the run from Russia,” Gontmakher said.

Domodedovo Airport, the only privately owned airport in Moscow, has come under relentless pressure publicly from the authorities, and that, [Yevgeny] Gontmakher, [deputy director of the Institute of Contemporary Development in Moscow] said, sets a very visible and “awful” example.”

Russsia’s stock market is falling the most in the world and investors are fleeing the country’s equity funds just as a Moscow appeals court upheld a guilty verdict for former Yukos CEO Mikhail Khodorkovsky on a second round of politically motivated charges brought by the Putin government. Investors withdrew more than $420 million from May 4 through May 18 as stocks surrendered gains amid falling oil prices, slumping economic growth and mounting concern over the increased odds of a renewed Putin presidency.

Unlike the Russian courts, the markets don’t lie,” said Pavel Ivlev, founder and chairman of the Committee for Russian Economic Freedom. “Khodorkovsky’s continued conspired imprisonment is costing investors billions of dollars.”

Source: UNCTAD

Financial Times reports of $26.3 billion in capital flight leaving Russia through April of this year. Arkady Dvorkovich, President Medvedev’s top economic advisor said,

The assessment by the president is that we did not have real progress in improving the investment climate. We need progress now in the short term. Investment is very low and capital flight is very high.

Conventional wisdom says uncertainty with the 2012 presidential election is making investors, both foreign and domestic skittish. But with little substantive difference between the tandem leadership, investors seem to reacting to Russia’s infrastructure.

Chris Barter, co-chief executive of Goldman Sachs in Russia, insists

Some kind of enduring reform of the financial and judicial system is needed because currently the rate of capital outflows is unsustainable.