Russia, which in 2004 boasted an impressive 7.1% annualised GDP growth and a record current account surplus of $58.2bn, returned barely 8% from its equity market. Why? The answer lies in public perception.
At first glance, the events of 2004 gave the “Chicken Littles” of the world the chance to warn us all that the sky was falling in Russia. The alarmists announced that the Kremlin’s fight with oil giant Yukos was the prelude to a nationwide renationalisation campaign, that Russia’s involvement in Ukraine’s elections marked the beginning of a new Cold War and that the cancellation of elections for regional governors marked both the death knell for democracy and the advent of authoritarianism in Russia.
These perceptions were reinforced by the media. Hermitage Capital Management’s survey of Western media outlets in the final six weeks of 2004 shows 320 articles on Russia’s interference in Ukraine or the Yukos saga – but just two on the booming Russian economy. Thus the risk premium for Russian equities reached its highest level in three years.
Not all bad news
Can the news for Russian equities be that bad? Look at the evidence. First, the campaign against Yukos is not the beginning of a renationalisation programme but the outcome of a highly publicised dispute between president Vladimir Putin and Yukos’ controlling shareholder, Mikhail Khodorkovsky. The latter had so entwined his own fate with that of his company’s that the only way the Kremlin could stop him from using his wealth to challenge its authority was to take away his company’s assets. While this outcome was distasteful for shareholders, there was a silver lining. The attacks demonstrated the power of the state, so that oligarchs who used to ignore the government are now paying their taxes and leaving the formation of public policy to government.
Second, the “Orange Revolution” in Ukraine – and Russia’s response to it – prompted fears of a new Cold War and concern that Ukraine would be split by a civil war. While these predictions made exciting headlines, they have not come true. Ukrainian president Viktor Yushchenko’s first foreign state trip was to Moscow, and the economic ties between Russia and Ukraine ensure continued regional co-operation. US president George W Bush and Mr Putin met for a cool but productive summit in Bratislava in February.
Third, Mr Putin’s decision to appoint rather than elect regional governors was less a nod to authoritarianism than a response to what was a crisis of public finance and accountability in Russia’s regions. Of 89 federal regions, 71 operate with chronic deficits that are funded from the federal budget. In this context, preservation of the status quo was less an endorsement of democracy than an excuse for incompetence.
Recent improvements
This is not to say that Russia is a flourishing democracy with a transparent economy and political structure where the rule of law always prevails. The country still has serious problems, but the past four years have shown it move from horrible to just bad. Public perception has yet to catch up, and lagging opinion always produces opportunities for investors.
The alarmists are missing one of the world’s most compelling emerging market growth stories. GDP growth has averaged near 7% for the past five years and is set to reach 5.7% in 2005. Among peer economies, Russia has the largest current account surpluses (as a percentage of GDP). It is one of only three countries in the world with twin trade and fiscal account surpluses. Government spending remains austere. Despite macroeconomic statistics that show it has one of the world’s best-performing economies, its stock market is the cheapest emerging market, priced at slightly over seven times earnings.
Russian equities are priced for the worst. If things do not turn out as bad as some would have us believe, there is a great opportunity at hand.
William Browder is the chief executive officer of Hermitage Capital Management
