Tuesday, 31 July 2007

Putin unlikely to allow political risk to spoil the Russian party

Financial News: Focus on Russia

Market participants give their views on three critical questions about the country’s political climate

We do not expect Indonesian-style instability in Russia and the process will be carefully stage-managed by outgoing President Putin and the Kremlin - Chris Weafer, Alfa Bank

1 Could the political situation between Russia and the UK damage capital market activity between the two countries?

2 What are the main risks to capital market activity and the Russian equity markets posed by the upcoming elections?

3 If Putin goes, who will best secure investor confidence in Russia’s economy?

Roland Nash

Head of research,
Renaissance Capital

1 Political relations between Russia and the UK may have fallen to the lowest level since the Soviet era but financial and business ties have never been stronger.

On the same day as the UK expelled the four Russian diplomats, the Russian equity market posted its highest close. The UK, for the first time, became the biggest source of foreign direct investment into Russia in the first half of this year – roughly $5bn (€3.6bn).

London is the city of choice both for companies to list and for Russians to live. There is an enormous vested interest on the Russian side and the UK side to make sure business channels remain open.

If business relations are better than ever, despite the difficult diplomatic relations, then it seems to me it will take much more than the current diplomatic confrontation to undermine capital market activity.

2 There are three outstanding questions concerning the Russian elections. Who will be Russia’s next President? What will Putin do next? How will the interests of the elite be protected under the next President?

While the answers to these questions remain unanswered, there is an added risk premium to investing into any Russian asset. Perhaps the biggest risk is the elite attempting to grab private sector assets for personal reasons and because it plays well to the domestic electorate. If property rights receive another public bashing, it will scare away potential investors.

3 The current, rather simplistic, consensus is that Dmitri Medvedev is the good guy in the election race, and Sergei Ivanov is the bad guy. The situation is far more nuanced.

Medvedev is probably more business-friendly than Ivanov, although the difference between them is quite small. They both believe Russia needs a strong economy to be a powerful country, and that a strong economy in the modern world requires a private market. Equally, they both believe the state has a large role to play in the economy. Against the more business-friendly image, Medvedev is probably weaker than Ivanov.

In Russia, stability has historically been perhaps the fundamental requirement for economic success. Therefore, while the market may initially take an Ivanov presidency badly, I think in the longer run, he could prove a better President, from the perspective of protecting investment, than Medvedev.

Mattias Westman
Chief executive,
Prosperity Capital

1 No. There have been problems for some time and initially some people were hesitant but those people were generally not investors. The private sector is driving the capital markets and they are not very concerned.

Also the Russian companies do not have a realistic alternative since the New York Stock Exchange has become unattractive to foreign companies post-Sarbanes-Oxley.

2 The elections are unlikely to create much uncertainty. Putin will most likely indicate his support for a candidate and his popularity will be enough to carry that candidate to power.

The parliamentary elections in December might be more interesting since it is less of a winner takes all. There the main uncertainty is if the communists or nationalists have a strong showing. It is unlikely but a potential risk.

3 Russian entrepreneurs are the main investors in the Russian economy and they appear to be confident. Investment is booming, even ahead of the elections. This is a good indicator of private sector confidence and of its estimate of political risk.

Chris Weafer
Chief strategist,
Alfa Bank

1 If the situation were to escalate, then it is possible that as well as damaging trade and investment relations between the UK and Russia, it would then also cause a problem between Russia and the EU. But I do not think that this will be allowed happen. It is not in the interests of either country to allow this row to escalate beyond the diplomatic arena.

Clearly the UK had to make some response to events and it was timely for the new Prime Minister to make a strong statement. Russia’s response has been well balanced and it has said it will not escalate.
With the summer holidays coming up, I expect both sides will be happy to see this situation calm down. It will be a backdrop issue for a long time to come and prevent a friendly relationship between both governments.

But business leaders and investors just want a pragmatic relationship. That is what is most likely now that the tit-for-tat moves have been made. Russians have adopted Chelsea as a proxy national team and west London as a home from home. Come the start of the English Premier League next month, the mini-crisis will give way to the real passion that is football. And don’t forget that England and Russia face each other in crucial Uefa Cup games in the autumn.

2 Political change in any emerging market causes concern to investors and investment activity. Far too often when investors think election and emerging market, they think Indonesia. But we do not expect any of the Indonesian-style instability in Russia and the process will be carefully stage-managed by outgoing President Putin and the Kremlin.

There will be no instability but because it is a big election transition, it will cause some slowing of investment as investors play it safe.

I describe it more like the board of directors of a large corporation changing the chairman.

Most of the people in the Kremlin (the directors) will stay on the board, the policy objectives and working strategies of the country (the corporation) will remain unchanged and even the out-going President (chairman) will retain an important role.

3 The main effect may not be felt for two or more years, in other words, mid-way through the next presidency. That is the time when the country is most likely to face problems and hard choices.
That is when the choice of the next President will matter and also what role Putin has managed to retain.

Kim Iskyan
Co-head of research,
Uralsib Capital

1 I don’t think either the UK or Russia will let rhetoric get in the way of what has been a positive dynamic on the capital markets over the past few years. As in any relationship, there are ups and downs; this is a down, but I doubt politicians will let their tit-for-tat have an impact on their economic or financial relationship.

2 As uncertainty increases, perception of risk increases, boosting required returns and thus dampening activity and sentiment. There’s otherwise no real risk, in my mind.

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