PortfolioConstruction Forum - Unravelling the contemporary Russian riddle

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Unravelling the contemporary Russian riddle

by David Thomas | Monday, 15 October 2007

This year, in anticipation of the 2008 presidential election, the state of Russia's political and economic climate has been vehemently debated. It's timely and necessary to tackle the big issues that investors and observers might be considering in relation to the direction of the Russian economy.

Is the "Spookocracy" igniting a Second Cold War?

Recent observations on domestic political dynamics have inspired allegations of Russia's morph into a quasi-authoritarian, neo-KGB state, intent on regaining its superpower status by instigating Cold War-like hostilities and pursuing a foreign policy whose central pillar is defined by antagonism with the West. While this view is supported by somewhat peculiar political developments, in my opinion, it is considerably inflated. It perpetuates out-dated, xenophobic stereotypes of the Soviet-era, inhibits interest and research into business and investment opportunities, stifles Russia's economic development and complicates the country's successful transition into a market democracy.

Rather than entertain hysterical notions of Russia's rule by an elite group of security service agents and an ex-KBG autocrat, it should be understood that policies that demonstrate Putin's desire to strengthen the state and consolidate political power are essentially pragmatic responses to the legacies of the Soviet command-administrative system and the rapid market reforms of the Yeltsin era. Moreover, it must be recognised that these structures have contributed to the consistent, responsible economic policies undertaken by the administration resulting in annual GDP growth of almost 7% per year, and providing confidence that the government and Central bank have the means to support the level of rouble liquidity in Russian markets to finance the economy.

There are plenty of reasons to be optimistic – in fact, the recent Cabinet reshuffle has strengthened the position of liberal economic reformers within the government, which some commentators expect will shift policy focus away from asset redistributions in the oil industry to investments and infrastructure.

Concerns regarding the problems Western companies face when doing business in Russia have also been over stated. The case of BP and Royal Dutch Shell, in which assets were handed over to the state-owned Gazprom, was widely reported and documented. However, the facts suggest that there are only problems in markets that the government deems "strategic". In other sectors, such as the retail and automotive industries, foreign companies are able to hold 100% stakes and Russian regions actually offer incentives to attract foreign investors, including low taxes and cheap land.

The irresistible opportunities available to foreign investors have been marginalised in favour of fears that Russia will use its oil and gas industries as a foreign policy tool in the interests of furthering its "great power" ambitions. Indeed, Putin's 'Munich speech' in February clearly indicated that Russia has adopted a more assertive foreign policy stance and is committed to becoming an influential player in world politics. Surely, with the world's eighth-largest economy, and awareness that this mind-set is entrenched firmly within the country's historical development and political culture, this objective should not be resisted by the West? Particularly important for investors to note is that the Putin administration is aware that a democratic society and liberalised economy are fundamental to the realisation of this vision.

Separating economics and politics

The most important rule to observe in understanding the direction of today's Russia is to separate the economic sphere from the political. Russia is a middle income country, with a large budget surplus, huge currency reserves and a massive stabilisation fund (as their insurance against periods of turmoil in international oil prices). It is striving to bolster economic growth. The almost surreal case surrounding the poisoning of the former spy, Litvinenko in Britain, and Russia's blatant rejection of perceived US hegemony, has done nothing to curb enthusiasm for the emerging Russian economy.

Taking a commercial flight from Sydney to Moscow to observe the booming business environment, or wandering around big city centres boasting Western-style retail shopping centres distinguished by timeless Russian elegance and grandeur, are far more indicative of how to deal with the return of the bear with designer sunglasses.