Despite Russia’s rapid growth – the RTS index has jumped by more than 800 per cent in dollar terms over the past 10 years – many investors are still hesitant about ploughing money into the country. Political risk has scared off some, but investors are also concerned by corruption, bureaucracy and the general economic outlook. But what are the real risks associated with investing in Russia and is there really any need for investors to worry?

There are certainly grounds for concern. After years of growth, the Russian market fell by 17 per cent in the first quarter of 2008. But volatile equity markets are a worldwide problem and many believe that the troubled US economy and Russia actually have a lower correlation to each other than most.

“We are confident that the risks to Russian corporate earnings are limited. Correlation levels between US growth and the rest of the world have fallen dramatically over the past 15 years and Russia only exports 5 per cent to the US, with considerably more going to China and western Europe,” says Martin Majdaniuk, manager of the Baring Emerging Europe Trust at Baring Asset Management.

But East Capital’s chief economist Marcus Svedberg admits that there is a secondary effect of the fall in the US economy via Russia’s trade with Europe. Despite the downturn, he is still bullish about Russia.

“Although it’s been a tough start to the year, the underlying economy is strong, growth is rapid and the Russian market is still very cheap. That can be matched by few emerging market countries,” Mr Svedberg says.

Domestic factors could also hamper the economic outlook going forward. Over the long term, demography is posing one of the greatest challenges for the Russian economy and the Russian government expects the population to decline from 144 million in 2007 to 139 million in 2020. In its report on Russia’s economic outlook up until 2020, Raiffeisen Zentralbank warned about a depopulation trend. But although official statistics paint a gloomy picture, there are indications that things have already started to improve.

“The demographic situation is challenging but perhaps not as bad as it might seem. For example, many immigrants – mainly from Caucasus – are not included in those statistics. The government is also taking action to improve the birth rate and increase life expectancy,” says Mr Svedberg.

But economic growth means little if property rights and the rule of law are not respected. Uncertainties over the rules of the game have been the main worry for investors. It peaked after the scandal surrounding Russian oil firm Yukos and the politically charged forced selling of its assets and imprisonment of head Mikhail Khodorkovsky.

“Property rights are of course a problem and a reason for concern after what happened with Yukos. But the situation has dramatically improved and I don’t expect the Yukos affair to be repeated,” says Angelika Millendorfer, head of emerging market equities at Raiffeisen Capital Management.

Mr Svedberg is also confident things are changing for the better and says property rights are more of a concern for direct investors.

“As a financial investor, I don’t think there’s as much need to worry, since you are investing such a small share in each and every company. But the risk is there and that’s why you need to diversify and put your money into a wide range of firms,” he says while emphasising the importance of having a solid understanding of Russia in order to reduce the risk.

Although the political risks in particular – whether perceived or real – still present an obstacle for many investors, the recent election may have put some at ease. Dmitry Medvedev’s victory in the Russian presidential elections hardly came as a surprise, but the end of Vladimir Putin’s rule has still led to some insecurity.

“Any perceived political risk disappeared with the election. But really, the election has been a non-issue for the economy and there was no noticeable reaction from the market,” says Mr Svedberg.

Ms Millendorfer agrees and is confident that Mr Medvedev by and large is set to represent a continuation of Mr Putin’s rule. Mr Medvedev has said he will tackle corruption and bureaucracy and Mr Svedberg is confident institutional and bureaucratic reform will be the new president’s priorities. There are uncertainties, however, over how well the power sharing structure of the Medvedev-Putin team will work, with Mr Putin becoming prime minister.

“Russia will still have great volatility going forward. Together with Turkey, they remain the most volatile markets in eastern Europe, but also have the greatest liquidity. There are still inefficiencies built into the system, such as complicated bureaucracy, trade barriers and corruption – these are the most important risks,” concludes Mr Svedberg.

Printer friendly version

Email this article to a friend