Tags: russian | economy

Stock Plunge Could Threaten Russian Economic Boom

Tuesday, 16 Sep 2008 03:20 PM

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The message from the Kremlin is not to panic. But that's exactly what many investors in Russia are doing.

Russia's stock markets are down some 40 percent since the start of the year, threatening to undercut a remarkable eight-year economic boom.

Eighteen months ago, it seemed unthinkable. Russia's high-flying economy was a strong draw for investors seeking fat emerging-market returns, the government encouraged ordinary Russians to invest in the stock market via the so-called "people's IPO" for the VTB Group banking concern and, most importantly, the price of oil kept marching up, up, up.

But geopolitical tensions and sliding crude prices have contributed to a black week — and an even blacker year — for Russian equities, scaring off a thinning number of investors. Russia proudly proclaimed itself "an island of stability" at the World Economic Forum in Davos, Switzerland, in January but is now looking the most fragile of all the major emerging markets.

Banks are short of liquidity and clamoring for more ready cash from the central bank, while investors are starting to voice concerns over the economy, which remains highly reliant on its oil and gas industry. It's the No. 2 oil producer after Saudi Arabia.

Faced with plunging stock markets on the one hand and soaring inflation on the other, the popularity of Russian government is in the balance.

But it's only now that the Kremlin has started to act.

"Russia — thanks to its situation and role in the world's division of labor, thanks to its geography, thanks to its intellectual potential — will always be attractive for investments," President Dmitry Medvedev said Friday, talking to a group of Russia experts and journalists. "To destroy this, an iron curtain would need to be put up."

It was the third time in as many days that Medvedev spoken publicly to reassure investors, to limited effect.

He put the blame at the door of the U.S. subprime mortgage crisis, which sparked off an international credit squeeze and liquidity difficulties. Attributing 75 percent of the equity plunge to the U.S. crisis, he said just 25 percent of the market's fall could be attributed to Russia's own problems.

As the global financial crisis took hold, Russia's markets tracked international indexes, giving investors a rollercoaster ride in the early months of 2008. Then doubts about the Russian market itself began to weigh more heavily on investors.

A shareholder struggle blew up at Anglo-Russian oil venture TNK-BP, raising questions about government interference, which were reinforced when Prime Minister Vladimir Putin launched a verbal assault on coal and steelmaker Mechel in July over price-fixing allegations, wiping billions of dollars off the company's share price in one day.

The final straw for many was Russia's invasion of Georgia last month, which contributed to a rapid deterioriation of relations with the West and raised the prospect of Russia's growing isolation.

Worse was still to come. In recent days, the price of oil has slid to just above $100 per barrel, down from more than $147, in just three months. For the moment, many believe the economic trouble probably isn't enough to deter the government's more assertive stance in foreign affairs.

"My feeling is it is not going to constrain them much," said Ron Smith, chief strategist at Alfa Bank. "If they need to do something that they know is going to result in a bad day or two for the market, they'll probably go ahead and do it if they consider it necessary — with the understanding that the market will get over it with time."

Medvedev said Russia would not compromise its political aims for the sake of attracting investment, "but otherwise we will work day and night to ensure a normal business climate in our country."

Since the start of the year, Russia's benchmark RTS index has shed 41.5 percent. The MICEX, where the bulk of trading takes place, has plummeted by 39.7 percent. Investors note that Russia is following a similar trajectory to the stock market crash of 1998, when the markets lost around 90 percent of their value over the year.

While nobody is projecting a calamity comparable to the scale of 1998, some investors say that Russia has now reached a fork in the road.

"We're at this juncture where these equity prices can jump up because they are truly cheap at $100 oil," said James Fenkner, director of Red Star Asset Management.

Fenkner added, however, that many investors fear that crude might have further to fall, which could deal another blow to Russian markets. "It all pivots on oil," he said.

Russia has prided itself on its robust economic growth despite concerns about a global recession. The oil-fueled domestic economy expanded by 8.1 percent last year, a pace many economists said was unsustainable, but has scaled back to a slower, yet still strong, rate of growth this year. Second-quarter growth was 7.5 percent, down from 8.5 percent in the first quarter.

"A slowdown at this point would not be a bad thing, if it were a mild slowdown," said Rory MacFarquhar, chief economist at Goldman Sachs. "The concern is that the slowdown could be something other than mild, and there could be disruption on the way."

Russian markets recovered somewhat on Friday, with the RTS adding 3.4 percent to 1,341.75 points, while the MICEX index rose 6 percent to 1,137.76 points.

Smith, however, said was too soon to declare that a recovery was in progress, saying it could be "a year or so" to restore the badly shaken confidence of investors.

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