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Russia

Is Russia Really Such A Solid Investment?

Op-Ed: Right now, Russia is 'in' with investors. But the giant economy is both less dynamic and more risky than many realize.

Bubbles in Moscow...? (senekin)
Bubbles in Moscow...? (senekin)
Frank Stocker

Josef Ackermann, CEO of Deutsche Bank. Citigroup boss Vikram Pandit. Jim O'Neill, head of asset management at Goldman Sachs. These three global heavy hitters and six other top representatives of the finance world took part in a discussion at the St. Petersburg International Economic Forum (SPIEF) a few weeks back. It was one of the many symposia at the Forum focusing on the future of the BRIC countries. At the end, the moderator asked participants which of those countries - Brazil, Russia, India or China – currently holds the best investment potential. The favorite? Russia.

It's not surprising. And it isn't only finance world titans who harbor sympathies for Russia right now. So do hundreds of managers of emerging market funds. In the monthly Bank of America/Merrill Lynch survey, Russia also emerged a favorite.

As O'Neill put it: Russia isn't just about oil and gas anymore. ‘‘Where else in Europe can you find such innovative Internet companies?"" he asked.

"Russia's economy is in considerably better shape than it was before the financial crisis,"" said Marcus Svedberg, head economist at East Capital, a fund specializing in eastern Europe.

Its growth rate over the next few years is expected to be higher than it was before the crisis – and won't only be commodities driven, but increasingly driven by consumption. Many Russians are now able to get consumer credit, which is why consumption can be expected to pick up soon after rising inflation rates caused a slow-down.

All of this sounds wonderful, a classic emerging-nation growth story. Investors love those. But a number of factors would seem to indicate that many investors, apparently blind to a whole series of negatives, are getting overly carried away. Because the negatives are pretty conclusive. Bottom line: Russia's economy is not growing.

Let's start with the consumption boom. It may actually play out in the coming months. But it will mainly be driven by extremely low interest rates. The current rate of inflation is 9.6%, but the base rate of the Russian National Bank is 8.25%: no surprise then that credit is easy to come by.

Russian demographics are disastrous

The second big problem is that there are fewer and fewer Russians. Christian Gattiker-Ericsson, head investment strategist at Julius Bär, the Swiss private bank, called Russian demographics ‘"disastrous."" The population has been shrinking for 15 years; there are 6 million fewer Russians today than there were in 1995.

Low life expectancy, low birthrate, and emigration are thinning the population. Even if some Russians start to consume more, it's doubtful that that can make up for the loss in the number of consumers. "Russia isn't a domestic economy story,"" Gattiker-Ericsson concluded.

And finally: the economic framework. On this point, even Svedberg had to admit that changes—structural reforms—are necessary. Asked what that meant concretely, he mentioned privatization, investing in infrastructure, reforming the pension system, land, taxes, joining the World Trade Organization (WTO) … In other words, Russia needs a complete overhaul.

Let's remember that, oil and gas aside, Russia has no significant production sectors. Eighty percent of its exports are oil and gas. And exports account for around 25% of their gross domestic product.

Even if a few innovative Internet companies have cropped up, like the Mail.ru e-mail service or the Yandex search engine, both of which are listed on the stock market, they are mostly active only in Russia and therefore remain small players. They don't have what it takes to be an international success story; they couldn't even begin to compete with companies like Google or Facebook.

Russia‘s stock market will for the foreseeable future remain geared to oil and gas prices. That much is clear from the share prices on the Moscow exchange -- in dollars they follow oil prices almost slavishly. Let me rephrase: make that followed. Over the past few months, they've been a little lower than the price of oil. Definitely not a growth story.

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photo - senekin

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