Reverse Flows from Russia May Show Doubts About Stability

There is a startling incongruity between investment attitudes within and outside of Russia. Major Western banks such as ABN AMRO, Citigroup, JP Morgan, and Morgan Stanley are as bullish as can be in regards to Russia, and are pushing their investors heavily into equities. This Western confidence in Russia is underscored by yesterday’s announcement to back a loan of $24.5 billion to Rosneft – the largest loan in history to a Russian company, and the fourth largest in Europe – to help it continue its piecemeal plundering of what was once the Yukos oil company. This positive Western attitude is also reflected in the strong appetite for two new IPOs of Russian firms: the pipeline manufacturer OAO TMK and the electricity generator OAO OGK-5. The bull fever is also spreading to the commercial real estate sector. David Brush, managing director and head of RREEF Real Estate Opportunity Funds and RREEF in Europe, told the Wall Street Journal the following:

In Russia, we are currently developing apartments in central St. Petersburg, in partnership with Russian residential developer RBI Holdings. We are likely to invest around $500 million over the next two to three years. Russia can offer returns that are several percentage points higher than in many Western European countries.

However, this enthusiasm to take on Russian risk is incongruous with the bearish behavior of many Russian firms, which seem to be hedging their bets on future instability in Russia and displaying their unease with the upcoming elections. One of the most high profile of these firms is Sistema, which is seeking a large stake in Deutsche Telekom in exchange for control over MTS – Russia’s largest mobile phone operator. The Financial Times writes:

The Moscow-based conglomerate has long been associated with the city mayor, Yuri Luzhkov, a close friend of Mr Yevtushenkov. But with Mr Luzhkov’s term as mayor expiring in December 2007, analysts speculated the looming retirement of his main political patron might be prompting the Sistema chairman to look for along-term investment haven. Uralsib, a Moscow brokerage, said a DT deal “would reduce political risks, which are becoming a concern, especially with the Moscow mayoral election approaching”.

This Russian eagerness to sell their own risk and move their money outside of the country is widespread, demonstrated by other major deals such as Severstal’s failed move on Arcelor, the Vneshtorgbank stake in EADS, and the move of record numbers of IPOs to New York and London. While it is not yet clear what these reverse flows mean for the future of the Russian economy, we should all pay very close attention to these kinds of incongruities. There is a long history of opacity and misinformation in Russia, in regards to both macroeconomic data and production figures from the energy industry – the main engine of growth. Combine this with the demonstrated inability of banks such as ABN AMRO and DKW to clearly communicate political risk to their shareholders, and you have a potentially dangerous situation. I have argued that the Russian legal system is the greatest non-tariff barrier to trade ever invented. Getting it right would be worth 10 WTO successions; failing to address it allows for the growth in opacity and the inability of Westerners and Easterners to agree on what constitutes a buy or sell signal. Let’s keep our eyes on this canary in the mine.