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. Last Updated: 07/27/2016

Kasyanov Warns of Too Much Money

Moody's surprise investment rating upgrade could trigger an influx of cash that would destabilize the market, Prime Minister Mikhail Kasyanov warned at a Cabinet meeting Thursday.

His comments came as traders sobered up and paused to ponder the effect of the upgrade. Moody's Investors Service raised Russian debt to investment grade status Wednesday -- the first time Russia has received such a high rating.

The benchmark RTS index on Thursday finished at 628.87, almost the level it closed at on Wednesday.

The exception was the currency market. Expectations of a foreign capital inflow sent the ruble surging 15 kopeks to a nearly two-year high of 30.23 to the dollar in record trading -- despite an unprecedented buying spree of more than $1 billion by the Central Bank.

Financial markets "remain weak and limited," Kasyanov told the Cabinet. "The volatility of quotes remains high, and the capital that is likely to come will most likely be short-term," he said, Reuters reported.

Kasyanov suggested inflows of foreign capital would be good for the economy but at the same time present a challenge to Russia's fragmented and undercapitalized banking system.

The question now is, observers said, what the government will do to prevent an opportunity from becoming a crisis.

"I just hope this upgrade does not lead to even more complacency in respect to structural reforms," said Christof R?hl, chief economist at the World Bank's Russia department.

He echoed some analysts in saying the upgrade was premature. "There are still underlying structural problems that will become apparent only when the oil price falls," R?hl said.

A jump in foreign direct investment will only reveal weaknesses, not cause them, said Al Breach, chief economist at Brunswick UBS. "Investment grade opens the opportunities that are really good for us," he said. FDI is the kind of investment that tends to be more long-term and brings the advanced technology that currently tends to stay clear of Russia.

He said he was puzzled by Kasyanov's reference to short-term capital. "Sure, short-term capital generally comes first -- but investment grade rating means it comes along with long-term capital," he said.

Larger global funds, which have more than $1 trillion to play around with, could join the emerging-market investors who only have a tenth of that amount. Breach said he expected healthy investment levels, noting that global funds invest just 0.08 percent of their portfolios in Russia compared with 0.8 percent -- 10 times more -- in Mexico alone.

"In the medium term, all classes of Russian assets will grow in value by a very significant margin," Alexei Moisseyev, chief economist at Renaissance Capital, said in a research note.

More skeptical economists were busy dusting off their emerging-market case files and pointing to previous upgrades in places like Poland, Hungary, South Africa and Mexico in the late 1990s and 2000.

Upgrades usually come at a mid-point of an extended bull market, said Steven Dashevsky, managing director of research at Aton. After a long upward tick in response to the investment-level grade, markets eventually correct to the point where they were before the upgrade, he said. "Investment grade tends to come in the middle of a powerful rally -- and people start buying not on fundamentals but on the 'greater fool theory,'" he said, referring to a perceived strategy in which investors buy high hoping to sell off "to a greater fool."

James Fenkner, equity strategist at Troika Dialog, agreed, saying, "Look at the last couple of days -- it was not pension money pushing this market."

"But we can play this game a bit longer," Dashevsky said, noting that based on the fundamentals a 10 percent to 15 percent increase is justified.