Although many investors are quite enthusiastic about emerging markets and emerging market bonds, Russia might not be especially high on the list of desirable destinations for investor money.
The default crisis of 1998 left many investors stranded and nursing huge losses and is still clear in the memory of many others. As with the majority of emerging markets, Russia’s ‘problems’ are complex and many are specific to Russia, linked to its history of central control and authoritarianism.
Ratings agency Standard & Poor’s has just confirmed that Russia’s debt rating is not going to be upgraded but is at least stable.1 Although Russia’s improved financial position was acknowledged, S&P concluded that it would need to see an improved political environment and a longer track record of reforms before it could consider raising the sovereign’s ratings to investment grade.
Russia’s long-term foreign currency debt presently has a BB+ rating, and the local currency debt is rated BBB–. S&P’s report highlights the fact that Russia’s fiscal and external positions are stronger than those of most of its peers, but on the negative side the political and policy environment in Russia is less predictable.
Rising oil and commodity prices is good news for an oil-exporting, resources-rich country such as Russia. Russia’s oil (Urals) has not enjoyed all the recent price rises seen in Brent and West Texas, however. The discount between Urals and those others has grown dramatically from an average $1.50 per barrel through 2003 to $7 in the past two months.
The discount is apparently because Urals has a higher sulphur content than the US and British grades, and one of the reasons for increased discount is related to the fact that Urals oil is similar in quality to Iraqi oil so higher supply from Iraqi fields tends to increase the discount. Even so, oil and gas prices have risen markedly and recent Russian balance of payments reports have shown healthy and growing surpluses.
The economic outlook for Russia is quite healthy, aided by this rise in commodity prices and also by strong exports. But as we know, it is the political situation that most likely holds the key to Russia’s emergence as an economic powerhouse.
In a series of interesting articles by Vlad Sobell of Daiwa Institute of Research.2, the author paints a rather more sympathetic analysis of President Vladimir Putin and his leadership than we in the West are accustomed to seeing. Sobell points out that Putin’s own popularity in domestic opinion polls remains high, despite the strong criticism meted out by the press in the West, most especially in the aftermath of the Beslan disaster.
“The victorious for the_west ending of the cold war has been an unqualified positive turn, but one of its numerous by-products has been the considerable confusion and disorientation stemming from the vanishing of old certainties,” argues Sobell.
He suggests that with the ending of the cold war the dividing lines became unclear, and quotes, but does not endorse, other analysts who argue that its ending marked “the end of history” and the start of a managed expansion of global democracy.
The events of 9/11 have so changed the world, and brought more terrorism across the globe.
Russia’s dilemma in its occupation of Chechnya has some similarities with the US-coalition’s current predicament in Iraq, suggests Sobell in that both involved ‘pre-emptive’ attacks and both have fuelled more terrorism.
But Chechnya may prove more far more damaging to Russia than Iraq will be to the US and its allies. Russia shares a long border with Chechnya and its “state and security services have decayed to a point at which the terrorists need no elaborate organisation: they simply buy their way anywhere with a pittance.”
Sobell argues that the failure of the west to sympathise with Russia adds to its vulnerability. He concludes by saying: “President Putin’s thinking (in attempting to strengthen the Kremlin’s control) must also be judged in the context of his priorities – the preservation of the Federation’s integrity in the face of oligarchic corruption and terrorist insurgency. Russia is more vulnerable than western armchair democracy builders might imagine. Given the lingering western reluctance, in some quarters at least, to unambiguously accept Russia’s legitimacy as the successor of the rump USSR, Putin’s apparently ‘paranoid’ response is understandable.”
So as far as investors in Russian capital markets are concerned, it is surely a case of caveat emptor. But, in spite of the tortuous and tangled situation it could all go very well. Let’s hope so.

1Standard & Poor’s, Sovereign Credit Ratings: The Russian Federation, Hessel and Reuss, 5th Oct 2004
2Russia after Beslan’, 20 September 2004; ‘The Kremlin under siege’, 1 October 2004, both by Vlad Sobell Daiwa Research Institute, London

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