What Foreign Investors Fear the Most

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The Russian stock market would have been caught in a global selling downdraft under any circumstances. There was simply too much vulnerability in the country's political, economic and financial landscape to have hoped that a serious disruption of the global economy would not affect Russia in a significant way.

The country's economy is overly reliant on commodity exports, its top companies and financial institutions carry large foreign currency-denominated debts on their balance sheets, its business practices are murky, political interference in business is rampant, and the legal system is weak and politicized.

Economic reforms have not only bogged down, but they have gone in reverse. Business rules and regulations are complex, and official corruption is rampant. The nation consumes far too much and invests and saves far too little. Its population is declining, which is hardly a good sign for the long term. And only 10 years ago the country went through a debt default, in which Russian companies rode roughshod over the interests of foreign investors and creditors.

In June 2007, I published on these pages an article titled "A Weak Link," in which I argued that Russia, far from being a safe haven from the nascent international credit crunch, could become an Achilles' heel of the global financial system. A test of how shaky investor confidence in Russia really was came in January, when financial markets around the world suffered their first sharp drop. The Moscow market was one of the biggest losers, plunging about 20 percent in a matter of days.

But not even diehard pessimists could have imagined that Russia would shoot itself in the foot so spectacularly -- in particular, that it would be foolish enough to raise grave concerns about its investment climate just as global markets entered a major bout of selling and when oil prices tumbled. It was truly bad timing for Russian investors in oil company TNK-BP to pick a fight with their British partners, for Prime Minister Vladimir Putin to mount a vitriolic attack on the country's mining giant Mechel and for Russian troops to march into Georgia.

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Vedomosti runs a forum in which readers can sound off about what they read in the newspaper. It was surprising to me that as major stock indices in Moscow halved in value, with the RTS going from a peak of 2,500 in May to just over 1,300 on Wednesday, most of these supposedly savvy businessmen and corporate executives wrote that the stock market didn't matter much, that it was just churning up speculative money -- much of it foreign -- and that its performance had no bearing to the real economy, which was otherwise healthy and productive.

This attitude, which was cultivated during the Soviet era and rooted in Marxism-Leninism, permeates Russian society and reaches to the very top of the Kremlin leadership. Soviet rulers, too, disdained financial markets and "speculators." They believed that their control over a large portion of the world's oil reserves and an even larger share of natural gas reserves gives them superpower status. In recent years, attempts to use oil and gas to bully and intimidate its neighbors failed spectacularly even in the case of poor nations such as Ukraine and Belarus. Nevertheless, the Kremlin continues to brandish this weapon, clearly unaware of the fact that every time it does so, the long-term value of the country's natural resources declines precisely because its reliability as a supplier of these resources diminishes.

The Russian stock market may have been nothing but a speculative roulette when it first started, but now it is a force to be reckoned with. At its peak, the market's capitalization exceeded $1 trillion, measuring close to 100 percent of gross domestic product. All of the country's leading companies are valued by this market. Although the stock market may be less important for Russian companies as a source of funding than Wall Street is for U.S. companies, it is at least an important bellwether and points to the future performance of the Russian economy.

Stock markets are, by definition, forward-looking. The price of a share represents the discounted present value of all future dividends accruing to the owner of that share. In other words, the stock market values all goods and services the company will buy and sell in the future, calculates its profit and prices the share of that company accordingly.

For that reason, Wall Street is usually an accurate predictor of economic recessions and upturns. Its track record is far better that that of private economists, international agencies or the U.S. government.

In the present economic environment, Russian stocks would have fallen in any case, as investors factored in and discounted weaker demand for oil in a slowing global economy, the international credit crunch and higher interest rates as a result of the subprime crisis in the United States.

But now the market is discounting something far more ominous.

Communism is enjoying a nostalgic revival in Russia. Putin long ago declared that the collapse of the Soviet Union was the greatest tragedy of the 20th century. Pro-government Russian media have declared that the West needs Russia far more than Russia needs the West, a statement that may presage the curtailment of commercial ties with the rest of the world. And now, many government officials relish the return of the Cold War, and this reflects the mood among a significant part of the population.

This picture brings back horrible flashbacks of the 1970s. Foreign investors are feeling the cold Soviet winds as well, and they have pulled about $25 billion out of Russia during the past three weeks, according to French investment bank BNP Paribas. After all, Soviet communism and the stock market make very bad bedfellows. Remember what the value of the RTS index was under Leonid Brezhnev? Zero, of course, because there was no stock value and no stock market under communism. This is what foreign investors fear the most as they watch precariously where Russia is heading.

Alexei Bayer, a native Muscovite, is a New York-based economist.