Russia: Reminders of the risks as well as rewards


Guy Norton
Published on:

"Snatching defeat from the jaws of victory." That’s one veteran Moscow-based fund manager’s view on recent events in Russia. And no, he’s not referring to the conflict with Georgia, where Russia’s still formidable military might has arguably carried the day.

Instead, he’s lamenting high-profile attacks from the Kremlin on important corporates, with the government accusing them variously of tax evasion, price-fixing or profiteering. Harsh words from former president-turned-premier Vladimir Putin about such companies as steelmaker Mechel had already sent investors scurrying for an exit from Russian equities in late July, even before the dispute between Russia and Georgia over South Ossetia descended into fighting in early August. During the hostilities in South Ossetia, finance minister Alexei Kudrin conceded that more than $7 billion of capital had left Russia.

Add in the continued ownership disputes at oil company BP-TNK and Norilsk Nickel and falling commodity prices – albeit from record highs – and there has recently been precious little cheer for market participants in Russia. "If the Russians had played their cards properly, they could have been the investment darlings of the world. The shame about recent events is that real money had begun to look at Russia; now it has made itself hostage to hot money again," says the fund manager.

The combination of a series of negative economic and political events has unsurprisingly had a dramatic effect on investor sentiment and market performance, with Russian stocks and bonds off sharply. In early August, the benchmark Russian index shed more than 15% in a matter of days, while the prices of Eurobonds issued by such companies as Evraz shed more than four points.

"Investors are asking ‘Why buy Russia when I can buy cheaper stocks in a developed country where there’s the rule of law?’," says a Russian analyst, adding: "A lot of the money that has left Russia over the past few weeks will take a long time to return."

Capital markets stalled

Antons Lubenko, fund manager at Parex Asset Management in Riga, agrees, saying that given increasingly tough political rhetoric from US and EU leaders, set against a negative international economic backdrop, he does not expect to see any significant upward movement in Russian capital markets in the near future.

"It’s difficult to see a positive catalyst for the Russian equity market right now," says Ben Carey, director of research for Russia at UniCredit Markets and Investment Banking in Moscow, adding: "People want to see some clarity on metals tariffs, inflation and taxation issues. We can’t see the grounds for a sharp re-rating of the market in the next two to three months, but we still see a 30% upside over the next 12 months."

Carey contends that recent events are a useful, if unwelcome, reminder of the political risk attached to Russia. "The market had run ahead of itself in terms of the perception of Russia as an emerged rather than an emerging market," he says.

Although there is undoubtedly a lot of pessimism about Russia at the moment, there is also optimism about the longer-term market prospects.

Florian Fenner, UFG Asset Management

"When sentiment towards Russia is at its worst, it’s often the best time to buy"
Florian Fenner, UFG Asset Management

"When sentiment towards Russia is at its worst, it’s often the best time to buy," says Florian Fenner, managing partner at UFG Asset Management in Moscow. He concedes, however: "Most investors are pro-cyclical, so nobody’s buying Russia right now."

Peter Halloran, chief executive at Pharos Financial Group in Moscow, is another investor who takes a sanguine view of recent events. "We are in a negative PR cycle with regard to natural resources, and as a result stocks like Gazprom and Rosneft have been oversold. They still have solid long-term stories."

Commenting on Putin’s attacks on the tax payment track records of Mechel and Evraz, Neil Smith, chief investment officer of fixed-income fund manager Florin Investment Management, which manages about $350 million, says: "We believe that periodically it is the responsibility of every government to remind its corporates to fulfil their social obligations to the state. After years of many corporates executing aggressive tax mitigation policies, it is clear that Putin felt compelled to address this in a public fashion and clearly in an emotive one."

Buying opportunity

He cautions, however, against taking the view that the Russian government is looking to seize assets, as it did with oil company Yukos, and argues instead that the recent sell-off in Russian corporate Eurobonds is a buying rather than a selling opportunity. "That Mechel or Evraz will be compelled to pay back taxes and possibly fines is undoubtedly correct, that they will be crushed into oblivion like Yukos is clearly a much more unlikely scenario. We think that the debt securities of these companies have been oversold and believe strongly that this is a time for accumulation.’

Given that the Russian economy still looks robust, Stuart Lawson, chief executive of HSBC in Russia, is upbeat about the UK bank’s prospects in the country. "There’s no question about whether HSBC wants to connect with Russia – we’ve just upped our capital here by $200 million to $300 million."

He adds that HSBC is looking to double its headcount in the next six months and is set to launch both private banking and premium retail banking services in 2009. "There are no limits on foreign bank ownership in Russia and foreign banks play a very important role here in terms of the introduction of new products and services and the training of staff," he says.

There have also been welcome developments on the tax front. For example, buried beneath the headlines about war in Georgia came the announcement that tax legislation for agricultural companies had been amended, with the 0% tax rate unexpectedly extended until 2012. Richard Ferguson, senior emerging markets research analyst at Nomura International in London, says that the taxation policy announcement is broadly supportive of the agricultural sector, which is increasingly viewed as a strategic industry in Russia. "Russian agriculture requires tens of billions of dollars of investment to reach its full potential and so a favourable tax regime for agricultural companies is obviously helpful." Also, Ferguson views favourably the news that the Russian government is looking to establish a grain trading agency, given the promise of state funding and enhanced pricing efficiency.