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. Last Updated: 07/27/2016

2005 Is Year of Russian Markets

Fantastic -- that's the word dominating financiers' reports at the end of 2005. For the first year since the 1998 meltdown, Russian indexes are out-jumping their rivals in other emerging markets.

The dollar-denominated RTS index and the ruble-priced MICEX both burst through the 1,000-point mark in the second half of 2005 to rack up more than 80 percent growth since the start of the year.

In comparison, indexes in South Korea and Turkey rose by about 50 percent, in Brazil by 30 percent -- and in China, the leading market dipped nearly 9 percent.

The MSCI global equity benchmark pitches the combined performance of the RTS and the MICEX as the world's fourth-best emerging market this year.

"We're sitting on top right now," said Erik DePoy, equity strategist at Alfa Bank. "For the first year ever, Russian equities are not trading at a strong discount relative to peer groups within the growth emerging markets."

In contrast to a relative lull in trading during 2004 -- as investors remained unnerved by the smashing of oil major Yukos -- the economy bounced back on untapped energy this year, said Valery Petrov, vice president of the MICEX.

The dynamic growth of Russia's major indexes -- indicators of the overall direction of shares on an exchange -- released "like a loaded spring," he said, as the country's economic potential outweighed post-Yukos jitters.

"Investors always look not just at the current shape of things but at the potential for future returns," Petrov said.

Tight control over the budget, booming oil prices and President Vladimir Putin's pledge to stop "tax terrorism" helped forge the perception that the financial climate had improved, he said.

Another factor was "big-time spin doctoring in the second half of this year to make the country attractive to investors," said Vsevolod Malev, head of the securities department at CIT Finance, formerly known as Web-Invest. Malev mentioned the launch of the Kremlin's English-language news channel, Russia Today, and the government's end sprint to liberalize foreign ownership of Gazprom shares this year.

The charm seems to have worked.

The RTS and MICEX both recorded a string of highs in 2005.

The volume of trading on RTS's classical market rose 37 percent, while average daily trading reached $44 million in the second half of 2005. The bourse's index, which comprises 50 Russian companies with the biggest market capitalization, passed the 1,000 mark in late September and the 1,100 mark mid-December.

The MICEX crept up to the 1,000 mark earlier this month and has since hovered 15 points above that. The MICEX controls 80 percent of all domestic share trading and recorded average daily trade volumes at $3.6 billion in the first nine months of 2005, compared with $2.2 billion in 2004.

"In truth, we expected a rally, but not one this size," Petrov said. "Whether it's 900 points or 1,000 points does not matter. The significance is in the level of growth."

Russia's indexes -- ranking fourth, behind Egypt, Colombia and Jordan in the MSCI emerging-markets index -- far surpassed Brazil, China and India, Christine Chardonnens, vice president of equity research at MSCI, said by telephone from Geneva.

The figures may be a success story for the domestic market, but most analysts agree that it is foreign cash that is fueling the success.

When Standard & Poor's, the most conservative ratings agency, this month lifted Russia's sovereign rating to one above investment-grade level -- matching valuations set by Moody's and Fitch Ratings earlier in the year -- the country opened up to a new kind of investor, one with a much bigger bag of spending money.

"At a new grade level, you get new investors," Malev said.

International funds that were restricted in their investments suddenly found Russia on their radar screen, he said.

"Within the Europe, Middle East and Africa region, Russia has been by far the single-biggest beneficiary of fund inflows this year, with a total of $2.5 billion, compared to just over $0.5 billion for Israel and about the same for South Africa," the Cambridge, Massachusetts-based Emerging Portfolio Fund Research said in a November report.

Alfa Bank's DePoy noted a considerable increase in interest in Russia in October, soon after the RTS crossed the psychologically important 1,000 mark and the government took concrete action on liberalizing Gazprom shares.

In turn, Russian bourses have actively sought to become user-friendly, introducing a number of measures aimed at keeping domestic investors and companies at home -- and away from London and New York.

The RTS allowed anonymous bidding, put a limit of 50 on the number of companies in the index, launched futures contract trading -- a move the MICEX copied last week -- and capped the weighting of any one company at 15 percent.

"Interest in our stock markets is awakening," said Andrei Kostokov, an analyst with the RTS. Deutsche Bank's sale of 10 percent in MTS shares "within a few hours" in June this year proved that domestic bourses could support major deals, he said.

Meanwhile, the MICEX has separated its equities market from other trading floors so that it now has more flexibility and can react faster to investor needs, Petrov said.

"Our aim is to become the leading domestic bourse for Russian companies, where the greater part of their share trading takes place," he said.

Whether either bourse succeeds in winning over Russian companies in the prestige war with London and New York will also depend on the Federal Service for Financial Markets.

In an interview with Rossiiskaya Gazeta last week, service head Oleg Vyugin said the two bourses ought to merge within the next two years, as the country did not need two markets.

Already, the momentum gained this year is forecast to slow in 2006.

In a survey of seven top Moscow investment banks last week by Bloomberg, only two forecast the RTS Index to grow more than 20 percent next year, while two more believed it would not climb at all.

With most of the market already fully valued -- and the biggest motivating factors such as the recent liberalization of Gazprom shares priced in -- "another 82 percent in 2006 is an extreme," said James Fenkner, managing partner of Red Star Asset Management fund, which has more than $70 million invested in CIS markets.

"Next year is looking positive ... but people should really thank their lucky stars for 2005."