70 Finance & economics The EconomistJune 29th 2019
2Buttonwood Russian orthodox
BuyingthedreamSource:CentralBankofRussiaNon-residentholdingsofRussiangovernmentbonds
%oftotal2012 13 14 15 16 17 18 1905101520253035A
visitor toMoscow inquiring about
the outlook for Russia’s economy
will often be met with answers that take a
detour into the country’s past. Ask, for
instance, why Russia runs such conser-
vative budgetary and interest-rate poli-
cies and you may be told that the trauma
of default in 1998 bred a strong desire for
low debt and low inflation. Ask why
property rights are weak and you may be
taken further back, to the end of serfdom
in 1861. Until then many Russians did not
even own their own souls.
Not all investors are history buffs. But
looking at Russia through the lens of risk
and reward they see a dichotomy. On the
one hand, the emphasis the authorities
place on controlling public debt and
curbing inflation makes it an attractive
place for bond investors. Russia is fixed-
income heaven. On the other, the econ-
omy lacks dynamism, in large part be-
cause the venturesome cannot lay secure
claim to their investments. For equity
investors, Russia can be hellish.
Start with its charms for bond in-
vestors. Their aim for their money is to
get it back with interest. They would also
like it to retain its purchasing power.
Their big concerns, aside from default,
are inflation and (unless they are buying
hard-currency bonds) devaluation. So
there is much to like about Russia. The
public-debt burden is light, at below 20%
of gdp. True, a lot of tax revenue is tied to
the vagaries of oil prices. But Russia now
has a fiscal rule. Its budget is based on an
oil price of $40 a barrel. Any excess rev-
enue goes into a reserve fund. Last year
the budget was in comfortable surplus.
By stopping the government from
overspending, the fiscal rule also helps
keep a lid on inflation. The Kremlin
allows the central bank to set monetary
policy without meddling, to meet a goalof inflation of 4%. The bank’s governor,
Elvira Nabiullina, is admired for her pro-
fessional competence—and also for per-
suading Vladimir Putin, Russia’s presi-
dent, to allow the rouble to drop in 2014.
Inflation has since come under control.
She has cut interest rates slowly, to 7.5%.
For bondholders this is wonderful:
decent yields, low debt and stable in-
flation. The rouble is steady. American
sanctions, imposed after 2014 in response
to Russia’s military intervention in Uk-
raine, led many affected Russian firms to
pay down foreign debt. Sanctions act like a
global-capital quarantine. And Russia runs
a biggish current-account surplus.
But Russia is a more hazardous place
for equity investors. A stock ought to be a
claim on a company’s assets. A quick
survey of modern history throws up rea-
sons to doubt that such claims are secure.
In 2003-04 the state seized Yukos, a giant
oil company. More recently a dispute over
oil assets between Rosneft, the state-
backed firm that absorbed Yukos’s assets,
and Sistema, a big conglomerate, rattled
investors and gutted Sistema’s share price.Yet for the intrepid, Russian stocks
still have appeal. For a start, they are
cheap. msci’s Russia index has a price-to-
earnings ratio of six, compared with 12
for its broader emerging-market index.
That kind of value is bait for stockpick-
ers, who hope to sort good long-term bets
from the ones that might turn ugly. They
cautiously avoid firms such as Gazprom,
a state-owned gas producer, that are
instruments of the Kremlin’s strategic
goals. (American sanctions have made it
unwise to hold such stocks in any event.)
Instead they go for well-run firms with
strong consumer brands, such as Sber-
bank, Russia’s biggest bank, or Yandex,
its internet-search firm. The state is
unlikely to mess with firms on which the
economy’s day-to-day stability depends.
Give Russia some credit, say boosters.
Macro-stability is not a given. Central
banks have come under political attack
in other emerging markets—India, South
Africa and Turkey—and now in America,
too. Optimists say that plans to cut red
tape and increase public investment will
lift Russia’s gdp growth potential.
Still, for the unwary investor, Russia
is a snare. Even old hands can be caught
out. Michael Calvey, the American boss
of Baring Vostok, a private-equity firm,
was arrested in February amid a conflict
with an investment partner who has
connections to the security services.
Despite testimonials from the boss of
Sberbank and the founder of Yandex, Mr
Calvey remains under house arrest.
Realists say it is the big-picture stuff
that holds the economy back. Estab-
lishing the rule of law and property takes
political will. But it takes time, too. In the
early 1990s a prominent Western econo-
mist was asked how Russia could be-
come a thriving market economy. His
advice? “Get yourselves another history.”For bondholders Russia is a dream; for equity investors it can be a nightmareto see what framework the eu27 offers. “We
are a global financial centre so we need to
see if the price is worth paying.” Mr Bailey
reckons that unless the eu27 follow Britain
towards principles-based regulation, they
will have little chance of developing more
vibrant capital markets or bigger financial
centres. And in private, officials express
doubts as to whether eu27 countries really
want outsized quantities of financial risk
shifting to European capitals.
Such confident views are typical of the
City. Yet there is more than a whiff of com-
placency. Passporting is not all the City islosing: also gone is its reputation for politi-
cal stability and predictability. British gov-
ernments of all stripes have long supported
financial services. But Brexit’s toxic poli-
tics changed that. Mrs May earned a reputa-
tion for being hostile to the City. Boris
Johnson, her probable successor, said
“fuck business” in pursuit of a hard exit.
The shadow chancellor, John McDon-
nell, has recently begun courting the City.
But the Labour Party’s plans, which include
heavy taxes on the rich, giving a tenth of big
firms’ equity to workers and nationalising
utilities and rail, are viewed with dread. MrMcDonnell is rumoured to be plotting
retroactive capital controls and clawbacks
of bankers’ compensation from the crisis—
though he insists that strong economic
growth under a Labour government would
mean no need for capital controls.
Some hear echoes from history. In the
18th century Amsterdam’s financiers used
to lead the world, but they lost faith in the
city’s future under Napoleon and moved to
London. For a financial hub facing the twin
threats of an acrimonious Brexit and a
hard-left government, that is a lesson
worth heeding. 7