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. Last Updated: 07/27/2016

June Election Clouds Capital Markets Outlook

Anticipating investment flows in 1996 requires a rather short-term outlook, as the June presidential election is a wild card that is likely to determine the direction of Russia's capital markets for the remainder of the year and beyond.


Experts agree that foreign investors -- who still drive this market -- will hold off on sinking significant cash into Russian equities until after the election. And domestic investment, which is ultimately needed to develop a broad, liquid market, will remain in the doldrums due to a lack of financial instruments for the average saver.


Some of Russia's estimated $25 billion to $50 billion in capital flight could also return, if interest rates and yields on government paper remain high.


While much progress was made last year in developing the stock market's infrastructure, the sagging market is unlikely to get a boost in the next six months, stalled by foreign investors concerned that a new regime could turn back the clock on reforms.


"There probably won't be large inflows into the market until after June," said Nancy Curtin, head of global emerging markets at Barings Asset Management in London.


Curtin said she believed even a Communist victory in June would not steer reform off course, but investors will worry about the party's financial policies.


"If they were to win the presidency, I still think they would be devoted to reform," she said. "But people will be concerned to see how much increased spending, social spending [there would be] and its effect on inflation." The government in 1995 followed a fairly austere monetary policy, reining in inflation from 17.8 percent in January to 4.5 percent in November.


Communist Party leader Gennady Zyuganov told a meeting of the American Chamber of Commerce?Moscow in October that his party welcomes foreign investment, and if in power would not return to the past.


Though foreign investors have only dabbled on the stock market since last fall, they anticipated the strong showing of the Communists in the parliamentary elections, and some analysts said the run-up to June could see a small surge in the stock market. "Foreign investors were really looking at coming back before the elections, and after the [parliamentary] elections they will come back almost independently of the results," said Viktor Agroskin, vice president of Rinaco-Plus. "I think this will be a time for short-term gains."


Thomas Reed, an analyst with AIOC Capital, said foreigners already present in the market are likely to stay and could fuel an upswing. "The foreigners who are here will remain here, and will probably trade before June," he said. "I think there's a good chance for a small rally before spring, but nothing sustainable until after the elections."


One factor that will help lure foreign portfolio investment is the entry of domestic players onto the market.


"Foreigners are very well aware that they are the predominant force in this market. They want to see domestic institutions participating," said Bernard Sucher, managing director of Troika Dialog. "If foreigners read political results as a bad thing, they all head for the exits at the same time. What they don't see now is a domestic constituency."


That domestic constituency, though, could remain elusive in 1996. The outlook for newly created Russian mutual funds -- heralded as the tool to finally draw some of the country's estimated $20 billion in mattress savings -- looks grim, analysts said.


"I don't believe this will change much the structure of people's savings," said Agroskin.


The Federal Securities Commission has issued 14 regulations on the mutual funds -- called unit investment funds -- since President Boris Yeltsin decreed them into existence in July. But a key regulation on taxation has yet to be released.


"The major taxation question is not resolved," said Agroskin. "We have grounds to believe that the Ministry of Finance and the State Tax Inspectorate are not ready to approve this scheme."


He added that time was scarce, before June, to convince Russians to explore these new investment tools. "It will require more than half a year," he said.


Compounding the problem of luring domestic capital into these vehicles is Russians' previous experience with investment funds, most notably the MMM pyramid scheme, which collapsed so fantastically in the summer of 1994.


"The problem with selling mutual savings funds to the populace is that they've had bad experience with these things in the past," said Chris Van Riet, associate director of investment banking at Alliance-Menatep. But he said when firmly in place, the funds will prove an effective investment tool.


"Right now, the biggest investors in Russia aren't Russians -- at least not the Russian populace -- and mutual funds will start funneling in what will be the biggest investors in the Russian marketplace," he said.


In the meantime, the equities market is set to remain fairly flat in the first six months of 1996. The Moscow Times Index of 50 liquid stocks will likely rise about 10 percent during that time, according to Sergei Skatershchikov, president of Skate Press Consulting Agency, which compiles the index. The MT Index rounded out 1995 with a loss of 30.4 percent in dollar terms.


In the first 10 months of 1995, $840 million flowed into Russian equities, according to data from Brunswick brokerage. At the height of the stock market's boom in the summer and fall of 1994, some $500 million per month flooded onto the market.Some analysts said this year could outpace 1995's investment performance, but cautioned that it was nearly impossible to make predictions beyond June.


Total market capitalization, though, looks set to rise next year, due partly to changes in the market's composition, particularly after the integration of the oil companies.


"There could be a serious increase in market capitalization, but it may not translate into increasing the market value of equity holdings owned by investors, because of the increases will come from artificial changes in corporate structures," Skatershchikov said.


He estimated current market capitalization at $16 billion, and said it was likely to rise to $20 billion to $25 billion in the first half of the year.


Alfred Kokh, acting chairman of the State Property Committee, said last month that Russia's capitalization -- which he put at $6 billion to $7 billion -- could increase from 10 to 15 times in 1996. Other estimates of the market's value run as high as $18 billion.


Certain industrial sectors look poised to perform better in 1996 than others.


An informal poll of 12 leading brokerages and fund managers in early December revealed that 75 percent thought the telecommunications sector would take off this year, but that was based on the Italian firm STET winning a tender for Svyazinvest, a holding company encompassing some 84 regional telecoms operators.


At the end of the year, however, STET pulled out, raising a major question mark over whether even the first stage of the privatization would go ahead.


Seven of the 12 firms surveyed marked the metals industry as on its way out, as shares of many big enterprises in that sector have been mostly bought up. Other blue-chip favorites, such as oil and gas enterprises, got mixed reviews. Four said oil and gas companies will be losers in 1996, while five said they would be winners.


In an interview with the German magazine Stern, published Dec. 21, Zyuganov said his party supported state control of the oil and gas industry, along with railroads, defense and science.


The stagnant stock market affects most players here, as equities account for nearly all portfolio investment in Russia. But a depressed stock market means more cash is channelled into the government's treasury bill program, and those buying T-bills should continue to enjoy healthy yields for the next several months. But investors are unlikely to enjoy the sky-high returns of last summer, analysts said, as yields are expected to fall.


"We expect yields to still be profitable next year but not like this summer," said Reed, adding that the government laid out huge sums in 1995 to stifle inflation and stabilize the ruble, and may not have to finance such high yields this year.


Gleb Shestakov, president of Global Fund Management, which invests in fixed-income instruments, said he expects yields to fall until March to about 60 percent, then pick up again. Average annualized yields dropped from about 120 percent to 90 percent in the run-up to the Dec. 17 parliamentary polls.


But if yields remain high, Russia could see the return of some flight capital. Some is already heading back, one economist said.


"There is a lot of capital coming back because interest rates are very high," said Brigitte Granville, a senior research fellow with the Royal Institute of International Affairs in London.