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. Last Updated: 07/27/2016

Equities Brighten, But Buyers Wary

LONDON -- Foreign investors like Russian equity market valuations, but are wary of positioning themselves as the war in Chechnya escalates, putting World Bank and IMF loans in jeopardy while December parliamentary elections loom.

Throw year 2000 glitches into the equation and the fact that Russia is the most volatile equity market in the world and even compelling valuations, a good economic story and positive earnings are not enough to tempt investors, analysts say.

The Russian equity market remains cheap, even after a 61 percent rise in dollar terms for the RTS stock index this year, fueled largely by a sharp rise in oil prices.

The RTS index rose 2.41 percent Tuesday to 96.46 on turnover of $7.6 million. The dollar-denominated Moscow Times Index rose 1.99 percent to 73.30 on turnover of $8.971.

Russia trades on 7.4 times estimated 1999 earnings and 4.5 times 2000 profits compared with 14.4 times and 14.5 times respectively for Poland and an average of 29.2 times and 24.2 times respectively for the European Union, investment bank CA-IB said.

Many analysts are optimistic on earnings, especially oil.

Merrill Lynch increased 1999 net-income forecasts for Surgutneftegaz by 25 percent to $966 million and LUKoil by 81 percent to $817 million.

"With Surgut and LUKoil, we are looking at a very positive story, but there is no money going in ahead of the first quarter," Dan Lubash, head of European emerging markets at Merrill Lynch, said.

"Generally we see risk aversion among investors now and in Russia, the beta [relationship] on that is huge," Lubash said.

Most analysts dismiss the country's money-laundering scandal as an issue aimed at domestic U.S. consumption and as having a limited short-term impact on Russia, unless the International Monetary Fund delays disbursements; but they are worrying about the war.

"The war in Chechnya has a major cost associated to the budget, which is likely to miss its targets despite strong oil tax and VAT revenue," CA-IB strategist Shanat Patel said.

CA-IB is recommending investors take an underweight position in Russian equities on a three-month view, at 4 percent of an emerging European equities portfolio against 6.1 percent in the International Finance Corp. Emerging Europe Index.

It is recommending an overweight stance on a 12-month view.

The fallout from Chechnya is already being felt as the government has called for an increase in military spending of 10 billion rubles ($386 million) for 1999 and26 billion rubles for 2000.

Total proposed spending for the draft 2000 budget is 803 billion rubles, of which 119 billion is for national defense.

The worry that the Chechen war will drain the budget prompted the World Bank on Thursday to threaten to suspend support if the fighting hurt the budget.

The World Bank has around $1.5 billion in loans to be disbursed in Russia, but the budget has been coming under pressure since the IMF refused to disburse a $640 million loan tranche that is part of its $4.5 billion loan financing agreement with Russia.

It warned that IMF disbursements too could be threatened by military spending on the Chechen war.

"Our understanding is that the government has been able to keep the fiscal deficit under control by severely cutting nonmilitary spending. As the IMF is likely to find such a spending pattern unsustainable, a compromise may prove very difficult to reach," CS First Boston's Russia economist, Vladimir Konovalov, said.

In September, Russia spent 79.2 percent of its planned budget, however, the military spent 100 percent of its allotted portion.

A contrary view on Russia comes from SG Securities global emerging markets strategist Tim Love, who is recommending a big overweight position as part of a global equities portfolio, 1.45 percent versus 1.10 percent in the IFC Composite Index.

He recognizes the risks of a Communist revival in parliamentary elections on Dec. 19, and the risks inherent in the presidential election next year.

"Nonetheless, prospective Russian valuations are appealing - as are the oil valuations, although they are no longer a steal on less than two times enterprise value over earnings before interest, taxes, depreciation and amortization," Love said.