Is Russia Less Attractive?

It would seem that the foreign investors who so enthusiastically entered the Russian securities market in the summer have now decided to take a sabbatical. For most of them, it took about two years to complete a cycle: from calculating how inexpensive it would be to get a piece of some Russian enterprise, to finding seemingly reliable Russian partners on the securities market, to running into unexpected problems, to growing tired and disillusioned and, finally, to winding up their activity altogether.


But we need to ask ourselves, has Russia really become less attractive to investors? Has the typical experience of buying shares in Russian enterprises really been so negative? Or was it just a matter of getting past unjustified illusions?


The problems of privatization and the complications that emerged from that process relating to deals involving securities from privatized firms did not suddenly emerge with the appearance of former State Property Committee chairman Vladimir Polevanov, the war in Chechnya or the collapse of the Mexican peso. All these problems existed long before any of this.


It was already clear, for example, that during privatization, in most cases, the directors of enterprises became their owners, and they had no interest whatsoever in submitting to any outside control. It was also clear that most enterprises sorely needed additional capital far beyond what privatization could bring them. Even the apparent undervaluing of enterprises was essentially meaningless since there did not (and cannot) exist a true market for enterprises which could establish their true value taking into consideration their worn-out condition and technological backwardness.


Therefore, it was a serious mistake to speak of shares in Russian enterprises as "inexpensive," since no one had bothered to calculate how much real money it would take to enable these enterprises to realize their production potential.


It should also have been clear from the beginning that the most attractive Russian enterprises in the eyes of foreign investors were in sectors of the economy that the government considers vital to the political and economic interests of the country. As a result, foreign investment in these strategic sectors will always be subject to machinations on the political level and will always come under particular government oversight. Finally, everyone knew from the outset that Russia lacked both the necessary infrastructure and legislative framework to support the securities market.


However, the temptation to speculate in shares of newly privatized monopolies in this emerging market was just too great. The potential profits, which back then were measured in terms of doubling or tripling your investment annually, compelled investors to risk. It certainly was not a matter of ignorance or naivet? on the part of investors.


The defining characteristic of the boom in the Russian securities market was the domination of short-term investors who were intent on quick profits. There were relatively few strategic investors looking for partners for long-term production ventures. In the early months of the securities market, short-term investors determined the shape of its activity. They pushed brokers and banks to buy up shares from the public, put together major share packages and resell them to other, more experienced middlemen who again resold them abroad.


Under normal circumstances, a purely financially oriented, stable demand for capital is possible only when the market is dominated by strategic investors and when small investors are gradually entering the market. However, in Russia major, long-term investors remained extremely wary; the risks of the Russian market were too great for individual investors from the West; and Russian small investors were syphoned off by MMM-type pyramid schemes.


Speculation, without which any securities market would be impossible, increased the availability of information on the Russian market, making it more effective. As a result, potential profits that were predicated on the ineffective operation of the market, began to fall. The lack of steady demand from other groups of investors forced financiers to reduce share prices in order to increase their profits among the better-informed market players. Last September and October marked the end of mass speculation on the Russian securities market. Speculators rushed to pack their bags and head home.


Now we can say with confidence that a new stir in the market focused on oil, raw materials, telecommunications, energy and aluminum enterprises -- that is, on those areas that were so attractive to investors in the summer -- will not happen. On the contrary, the increasing availability of financial information and the continuation of all the problems enumerated above will mean that the market will not really heat up again until the middle or even the end of the year.


Investors need a breathing space to understand and evaluate coming opportunities. However, there really isn't much time to spare. It is clear that, given political stability, strategic investors will be increasingly drawn to small and medium-sized concerns which are not subject to such tight political control but which can be more easily brought into the world market. The spring will be devoted to establishing ties with Russia's regions and with these small and medium concerns in order to determine which are the most attractive. We should expect that such firms will be particularly active with new share issues.


So far, though, many investors are wasting this valuable breathing space by trying to figure out where the speculators will go next or looking for signs of the next boom in oil and energy stocks. Doing so, they risk being left behind and losing potential profits. Only a very few have begun really preparing the ground for the future and, over time, they will turn out to be way ahead of the game.





Vladimir Milovidov is a professor at the Institute of World Economy and International Relations. He contributed this comment to The Moscow Times.