Could the Putin factor put investors off Russia?

30th September 2011

Russia is still an emerging market, but as part of the BRICs, i.e. Brazil, Russia, India and China, it has been hailed as one of four crucial markets in the future economic development of the world. At times, the Russian stock market has seen stellar returns but in the last few months, the market has dropped significantly prompted by falling oil prices, and, possibly, political uncertainty. In terms of the personnel, it is more certain at least but what about the policies.  

Here Business Week reports on Medvedev's justification for stepping aside – that Putin is more popular.

Clearly Putin has remained a hugely powerful figure anyway, holding the office of Prime Minister. He was barred from standing for a third consecutive Presidential term.  Many commentators are debating whether it was Putin or Medvedev who was responsible for a slight thaw in relations with the West. Diplomats say that at least Medvedev is more polite over dinner.

Medvedev also placed much greater emphasis on the rule of law and that includes as it applies to doing business. Yet somehow his actions never matched the rhetoric.

For example, Mikhail Khodorkovsky, the oil oligarch who fell from grace, recently saw his jail sentence extended despite Medvedev's disapproval.

As a result the uneasy stand off continues between oligarchs and the political class. The billionaires understand that if they get too vocal, they could find it very difficult to do business and might even face prosecution.

But would Putin liberalise the climate to allow business to prosper? The Moscow Times assesses the challenge. It suggests that Russians want more than just to put food on the table something that satisfied them the last time Putin succeeded. They now want the sort of things that the middle class everywhere want. This could be good news for investors.

The paper writes: "Putin has to take into account the ever-growing demands of the Russian people. In 2000, a weary population just wanted to be able to put food on the table after the chaotic 1990s and even 1980s, and they were willing to forgo democratic freedoms in exchange for stability. Today, the country has a sizeable middle class that wants to see its salaries increase with inflation. Putin must find a way for these citizens to maintain their purchasing power.

"Opportunity: Investors can supply the growing demands of the middle class in Moscow and the other 11 cities with populations of 1 million or more. These consumers have an expanding appetite for goods ranging from cars to health food. By meeting these demands, investors can also supply jobs - and good salaries – to a bright, well-educated work force."

Yet some doubt Putin is ready to rise to the economic challenge even when he wins out in the political stakes.  The Globe and Mail suggests the departure of finance minister Alexi Kudrin is a particular reason to be worried as it could mean the end of fiscal prudence. It writes: "Mr. Kudrin was a fiscal hawk in a shamelessly profligate governing apparatus. He nursed Russia's finances back to health after the 1998 crisis. Thanks to him, Russia's ratio of public debt to gross domestic product is barely 10 per cent. True, spending has surged recently: the oil price needed to balance the budget today is about $110, twice what it was in 2008. But now that he is no longer there to say no, the non-oil budget deficit may stick at around 10 per cent of GDP."

The Globe and Mail notes that the stock market returned over 1,100 per cent during Putin's first term but suggests that it will be much more difficult to achieve such growth this time around.

It also says that Putin's first term was disfigured by the political dismantling of oil and gas giant Yukos which led to Khordorkovsky's prosecution.

Actually despite what many people see as the unfairness of the Oligarch's treatment, another oil related issue is causing Putin concern.

This week Reuters reported on Putin publicly addressing one of the most serious corruption allegations against him, saying he did not help businessman Gennady Timchenko create the Gunvor oil trading empire.

"Timchenko, who has repeatedly denied media speculation that his close friendship with Putin was behind his business success, is ranked Russia's 17th richest man by Russia's Finans magazine."

But whether these denials are true or not, many investors believe it has an impact on the business climate.

Oil and gas and related industries remain one of the biggest plays in Russia. But the risks are very obvious to some British investors. For example, BP's Russian Arctic adventure has proved disastrous, playing into the hands of US oil giant Exxon. It has just announced a new deal with Russian giant Rosneft to drill in the Russian Arctic and unlike BP did not have to promise to give away shares in return. Here is the Economist's assessment.

"Exxon's plans already look more promising than BP's did. When announcing that proposal, Bob Dudley, BP's boss, trumpeted his knowledge of Russian politics. In fact it was BP's misjudgment of Russian politics and corporate culture that did for the deal. Mr Dudley wrongly believed that getting into bed with a powerful Kremlin firm would cow his existing oligarch partners. Having now alienated both, BP appears to have little protection against being pushed around in Russia-as the raid on its offices may suggest."

So if a UK oil giant can't make the right the decisions, can U
K retail investors expect to do better? Well, actually in certain ways, it is easier. For a start risk is less concentrated if you own several Russian shares. 

You can invest in Russia simply to get exposure to energy and energy related stocks. You may wish to look out for shares that could benefit from the emerging middle class. But you should also be aware that political risk will always be a factor in Putin's Russia. Some might say that if you are not invested, you might sit it out until we find out the economic implications of Kudrin's resignation.

In addition, investors would be wise to remember that the oil price is down over global economic fears, and that means more pressure on Russian finances. Investor cash and indeed private wealth is still leaving Russia as the BBC reports.  So perhaps Russia remains a simple oil play. And if you think it is too much risk to buy Russian stocks, you could alway just buy Exxon instead.

For further reading the New York Times reports on the swift retribution exacted on Kudrin. He lost his country residence just after he quit his job, despite 20 years of government service.

Here Columbia University's journal of international affairs asks if Russia is experiencing a resource curse and concludes that the fears may be exaggerated.

More from Mindful Money:

Russian Investment Opportunities: The Drivers and the Hidden Gems

BRICs: What has happened to the building blocks of global growth?

BEYOND BRICS: The Opportunities & Risks of Investing in Africa

No BRICs cavalry to help the euro zone


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