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. Last Updated: 07/27/2016

It's Only a Matter of Price

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The second trial of former Yukos CEO Mikhail Khodorkovsky has reignited the debate over whether prominent business scandals -- such as the destruction of Yukos, the pressure applied to force a restructuring of Sakhalin-2 or more recently the actions against fertilizer producer Uralkali -- cause serious damage to the country's investment climate or whether the fallout is only temporary. There is no straightforward answer to that question.

These high-profile cases involving Russia's commercial titans -- plus the hundreds of cases involving ownership issues among the country's small and medium-sized enterprises -- clearly have an impact on investors' perception of Russia. But this does not mean that investors avoid countries because of high risk alone.

Investors with a low risk tolerance, such as many pension funds and trust banks, will generally avoid all but the safest assets, and that means generally avoiding emerging markets. For most other investors, it is usually just a matter of price. Put another way, there is a price for everything.

A good example of this was when Khodorkovsky was arrested in October 2003. The stock market fell sharply, but within six months the RTS Index had hit a new record high. It was not that investors approved the government action against Khodorkovsky, but they better understood the issues and felt comfortable pricing in the risk to asset valuations.

For investors who accept the risk-reward trade-off in emerging markets, the most important factor is to understand the rules of the game. Then investors can establish a valuation comparison with similar assets where the risk-reward balance is different.

The equation for companies looking to establish a business in a country like Russia, is not much different. For example, oil companies -- historically accustomed to operating in very volatile and high-risk environments -- will not be dissuaded from investing as a result of negative events such as Yukos or Sakhalin-2. These cases are more likely to make risk-adverse companies in manufacturing and service industries, for example, more cautious and to delay their investment commitment to Russia.

Right now, fears over the negative effects of low oil revenues and a declining currency are the most important issues for investors who have already made the commitment to Russia.

When other investors decide to avoid Russia, they probably place more importance on everyday corruption and the country's stifling bureaucracy. Nonetheless, the Yukos controversy and others like it play an important part in shaping investor perception. We can see that from the fact that even when Russia's daily revenue from oil and exports was approaching a record $1.3 billion in early July, the valuation of assets in the country never reached parity with similar assets in other emerging economies. It wasn't that investors stayed away from Russia; quite the opposite, in fact. In early 2008, the average daily turnover in all Russian equities and related instruments regularly exceeded $10 billion. But because of the blend of risk and reward, those investors were unwilling to pay as much for Russian assets as they did in China, Brazil and elsewhere.

For the government, investor perception of Russia as a high-risk country is a very serious issue. One of President Dmitry Medvedev's key programs is to create a diverse economy and to encourage a higher level of foreign investment.

In July, he urged the government to put an end to the bureaucratic practice of creating "nightmares" for businesspeople, such as needless inspections and various extortion schemes to force businesses to pay bribes to bureaucrats to stay in business. Those nightmares will have to stop if Medvedev's ambitious program is to be realized.

No investor expects a risk-free investment environment. Russia is an early stage developing economy, which implies both opportunity for growth as well as high risk.

But until the surprises that cause the nightmares stop, investors will not be comfortable in assessing the risk-reward balance. That will keep many away, while others, such as those active in Russia today, will come away with a big discount.

Chris Weafer is chief strategist at UralSib Capital.