BUY RUSSIA IN 2008
by Yiannis G. Mostrous
Editor, Growth Engines
January 3, 2008

I’ve long favored Russia as a destination for investment, building my case primarily around its energy sector. But I’ve also highlighted the increase in domestic demand and the infrastructure boom taking place there. 

Russia is currently in a sweet spot: It’s a net oil exporter, has good GDP growth, isn’t dependent on foreign capital flows, is relatively stable politically, boasts reasonable market valuations and, above all, enjoys solid exposure to the biggest growth story of our time, Asia.

President Vladimir Putin, whose party won another electoral victory recently, is credited with making the changes necessary for Russia to advance. The Yeltsin years, by contrast, were essentially a lost decade; Russia had no direction and no clear vision of its future.

Because of the changes Putin has pushed, Russians are confident and more open to doing business with and learning from the rest of the world. These factors were lacking in previous cycles. Note that this cooperation doesn’t include selling Russia’s natural assets to foreigners or their local representatives, as previous advisors had once counseled.

As a result, the Russian market has easily outperformed the rest of the BRIC (i.e., Brazil, Russia, India and China) countries since 2000.

This outperformance flies in the face of the rubbish eager politicians and their advisors have been feeding people about the beginning of a new Cold War. Heeding the expert opinions expressed during the past seven years in The Economist and other publications heralding an imminent Russia collapse would’ve cost you the huge returns the Russian stock market has generated for investors willing to look beyond smoke screens.

The economic interdependence between the growing Russian economy (now the eighth-largest in the world) and the West is increasing rather than subsiding. (See Growth Engines, 7 June 2007, Vladimir and Angela.) It won’t be a smooth ride, but cooler heads will prevail. Russian practices haven’t changed overnight--far from it. But things are looking much better, and the positive news should continue. 

The Russian economy surprised to the upside in the third quarter of 2007, with growth of 7.6 percent on a year-over-year basis. This growth is mainly driven by domestic sectors, especially the machine building sectors, which shouldn’t be too exposed to a sharp slowdown in global growth.

The Russian market is currently trading at a discount in most sectors to its emerging market peers. Given the fact that the Russian economy is well insulated from outside economic shocks and its financial institutions have no exposure to subprime problems, this divergence remains a mystery to me.

The only serious economic problem that Russia will face entering 2008 is the recent inflation acceleration, which could rise into the mid-teens next year--a symptom of strong domestic demand.

Such a development will permit the Russian Central Bank (CBR) to allow for a faster appreciation of the currently undervalued ruble, which will also help the economy’s domestic demand growth as its middle class continues to expand.

As long as Russia continues to grow and modernize its economy and its middle class increases in size and influence, its political culture will also increasingly reflect more Western-style characteristics.

Nevertheless, Russia remains open for business. Companies and investors that play by the local rules--as they must do in any other country they invest in—haven’t only profited handsomely but have also established strong foundations for the future.

We’ve invested in Russia since The Silk Road Investor’s inception, and there’s still a lot of upside. However, expect short-term pullbacks given the precarious state of the global economy. View such pullbacks as a buying opportunity.

A Look Ahead

It seems like only yesterday that people around the world were finding eccentric ways to celebrate the new millennium. As we’ve long passed the midpoint of the new millennium’s first decade, investors continue to ignore the fact that developing economies around the world are gradually assuming global economic growth leadership.

I expect this substantial change will continue--along with necessary booms and busts along the way--for a long time.

The developed economies are still the most important ones for the stability of the global economic and financial system, but real growth will only be found in emerging ones. And going forward, the serious emerging economies will be able to institutionalize themselves and increasingly become a more substantial force in the global economy. Investors who are able to identify and understand the above dynamic will come out on top as the story unfolds.

© 2008 Yiannis G. Mostrous
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