Streetwise Professor

November 17, 2010

Russia Quick Hits

Filed under: Economics,Politics,Russia — The Professor @ 8:39 pm

A few interesting things on Russia that deserve some comment.

Item 1.  This article from the FT Beyond Brics blog notes that although other emerging markets are worried that Uncle Ben’s Quick Bucks AKA QE2 are putting upward pressure on their currencies, and are experiencing substantial capital inflows, Russia is the laggard, with a declining currency and net capital outflows:

At a time when most emerging markets are struggling to stem the tide of liquidity from the developed world, Russia stands virtually alone in anticipating more capital flowing out of the country than coming in this year.

On Monday, Russia’s central bank raised its forecast for net outflows in 2010 to $22bn. Although this is much lower than the outflows of $134bn in 2008 and $57bn in 2009, the contrast with the emerging world as a whole – which the International Institute of Finance expects to experience net private capital inflows of $825bn this year – is striking.

The weak ruble is particularly amazing, given that other commodity currencies are very strong.  That is a very telling commentary on Russia and its economic prospects.

The net capital outflows reflects two things: (a) relatively little money flowing into Russia, and (b) a lot flowing out.  The former is readily understood, given the very weak investor protections, and the horrible experiences of many foreign investors (Shell, BP, Telenor, Ikea, and on and on).  The latter is very revealing too, though.  The distribution of wealth is highly concentrated in Russia, so net wealth outflows mean that even the extremely wealthy–those that have investible wealth and the ability to move it overseas–perceive that the risks of investing in Russia are extreme.  Even given the vaunted discounts in Russian equity prices, they put a lot of their money overseas.  They realize that they have their wealth at the whim of Putin and the siloviki.  Better to get it (and in many cases, their families) in a place where it’s harder for the state and the power structures to get at it.  They have more influence in the system than foreigners, but “more” doesn’t mean “a lot.”

The BB post links to this article from the FT in October (which I had missed).  It gave me a chuckle:

Russia: Laws do exist but enforcement is patchy [!]

. . . .
The government, meanwhile, is making a concerted effort to do something about the bad reputation Russia has in the business world. Legislation is planned and there has already been some progress.

But the laws are not the main problem, say most experienced investors.
“The biggest problem is not the law itself, it is the implementation of the law,” says the president of a big investment bank in Moscow. Most serious legal wrangling is done in London courts, as few trust Russia’s legal system to deliver an impartial verdict.

Yes, Russia, in theory, has laws to protect investors.  And the USSR had a democratic constitution.  But as the article notes, the formal protections don’t mean bupkus in a country with a court system that gives new meaning to the words suborned and corrupt.

The FT article also states that corporate governance is a problem because “companies tend to have highly concentrated ownership – a legacy of high cash flows and low share prices when most were born.”  Uhm, not really.  Indeed, this has cause and effect reversed.  The concentrated ownership is the effect of legal weakness.  Who wants to be a minority investor in Russia?  (If you answered “yes” to this question: please just send me the money.  You’ll have as much as if you invest in Russia, and I’ll be better off.)  The lack of effective (as opposed to formal) legal protections is why (a) publicly traded Russian stock prices are so low, and (b) ownership is concentrated.  Owners of big stakes would like, most probably, to sell off some of their shares, but they can’t precommit to protect small shareholders, and the courts won’t make them do it, so the small fry only buy at a discounted price that makes the sales less attractive.

Item 2.  Foreign policy.  Stephen Blank writes a typically excellent analysis of Russian foreign policy, and the Obama administration’s delusional Russian policy.  The whole thing is worth a read, but the conclusion hits the nail:

This absence of discernible quid pro quo in return for U.S. concessions casts serious doubt on Obama’s new approach to Russia. The current administration has not shown why improved ties with the other side are important, what the positive gains may be, what the limits of this reset policy may be, and why it should command serious domestic support. Here, Washington’s silence on these important questions has opened the door to a likely Republican and conservative Democratic assault on the forthcoming treaty, which would jeopardize the continuation of the overall policy. Indeed, the same is true in Russia—and Medvedev’s lack of control over his own government should also cast serious doubt on the reset: Putin’s faction, after all, has already tried to organize military alliances with Latin American states like Venezuela and Ecuador, alliances hostile to the United States and designed to secure Russian air and naval bases in those counties (as well as in Bolivia) to support Hugo Chávez’s Bolivarian Revolution.

Clearly, pushing the reset button, from Russia’s point of view, means one thing: getting a free hand to pursue policies that are in many respects fundamentally driven by anti-Americanism and its own sense of Great Power entitlement. The fact is that Russia has long since decided that we are its prime adversary, and its model for relations with the U.S. is not far removed from the peaceful coexistence model of the Brezhnev era, another period in which détente only succeeded to a limited degree and foundered on missile placements in Europe and Soviet adventurism in the Middle East and the third world. The recent episode of the twelve Russian “sleeper” agents caught and deported by the United States illustrates the problem of the current Russian mind-set. The scope and scale of this operation (and who knows how many other such operatives are “out there”) underscore Moscow’s guiding assumption that the U.S. is its prime adversary, which in turn illustrates Russia’s addiction to Cold War tactics and thinking. Medvedev may call for “modernization alliances” with the U.S. and Europe, but his government’s actions indicate that it sees us as anything but a friend.

We should indeed take Moscow and its plans seriously. For the most part, unfortunately, those aims and interests are antithetical to the cause of stopping Iranian proliferation and preserving peace and security in Europe. A realistic understanding of Russian intentions, rather than the vacuously optimistic view shared by many commentators who should know better, ought to be the true basis for engaging Moscow diplomatically. Any reset in relations should come from a cold-blooded calculation of our interests, not sentimentality or illusion—and certainly not with a trusting (and unreciprocated) acceptance of Moscow’s self-serving definition of its bottom line or its “sphere of influence.” Getting real about Russia does not mean taking Moscow lightly or rejecting cooperation when it is desirable, but it does mean advancing our own goals as seriously as Russia is advancing its own.

Relatedly, earlier this evening I saw Hillary Clinton reading a statement advocating the passage of the new START.  It was painful for many reasons.  First, her shrieking, shrill voice.  Second, her statement that “some people say we should hit the pause button.”  I mean, give the effing button metaphors a rest, OK?  It’s not like the original button thing (in Latin type, not Cyrillic; mistranslated; dorky) worked out so well for you, Hillary.  (Steven Hayes said on FNC Special Report that listening to her makes him want to reach for the mute button.  I hear you, man.)  Third, on the substance her remarks were weak.  Fourth, she was just reading, and obviously so–kind of mailing it in.  (And for those who lament the fact that she lost to Obama–she would have been a disaster in her own special way.)

Item 3.  There are many stories about plans in the works to re-engineer Russia in order to solve the “monogord” problem.  (Monogorods are single industry or single company towns, many of which are in dire straits because the town industry/firm is itself in dire straits.) In a nutshell, the plan is to induce people to  leave the monogorods, and concentrate in 20 large urban areas.

This is the antithesis of recent Putin initiatives, which involve injecting financial support into the monogorods, mainly on an ad hoc, squeaky-wheel-gets-the-grease basis.

The articles are rather unclear on exactly how this is to be accomplished.  But it is clear that it is to be a state-directed effort:

The authors warn that new urban centers must not evolve spontaneously, so as not to pose “serious risks” for the state and create imbalances in regional development. Among the factors that could trump the novel ideas is that Russian laws do not currently allow the formation of agglomerations, as this contradicts the system of intergovernmental relations. The suggestive boundaries for such agglomerations also do not correspond to the country’s current administrative divisions, which could be a potential problem when distributing budget funds.

Spontaneous order?  Nope.  Can’t have that now, can we?  That would be so un-Russian.

There’s an irony here.  The monogorods were largely a creation of Soviet social engineering.  The de-monogorodization of Russia is to be latter day offsetting social engineering.  That’s not likely to work out any better.  The government doesn’t have the information to determine what the “right” configuration is, and what’s more (apropos Item 1), any government effort will be distorted by corruption and rent seeking.  It would be better that the government create a rational framework of laws and regulations, and (again apropos Item 1) a relatively uncorruptible enforcement system that will support the flow of resources–including, crucially, human resources, to their higher value use.

But that’s the problem.  That isn’t going to happen any time soon.  It is very hard, and the powers that be have little incentive to make it happen given how well the current system works for them.  So, again, they’ll try to reverse the perverse effects of the previous policies of treating people like animals and shunting them about to meet state purposes by creating new policies that treat people like animals and shunt them about to meet the new, improved state purposes.

If it even happens.  It looks like this is a Medvedev initiative (the policy document comes from the Presidential administration) and as noted above, clashes with the Putin approach to the problem.  And if that’s the case, bet on Putin and his approach.

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  1. Russia: Laws do exist but enforcement is patchy [!]

    And their enforcement is often subcontracted out to private companies.

    Comment by Tim Newman — November 18, 2010 @ 2:21 am

  2. QE2, QE3, QE4 or QEn will eventually get to even Russia, although the cash may do a U-turn right back out of the country. Bernanke’s biggest flaw is that he thinks this is only a credit contraction recession, so he can fix it with credit expansion tools. He doesn’t realize that he is up against (1) a generational shift to the Gen Xers who got buried in student loans, and view credit very differently from the Baby Boomers, (2) the retirement of said Boomers, the pig in the python with the largest cohort turning 48 ( the year of peak consumption per Harry Dent) in 2005 – did something change after that? And (3) technology, which slashes prices every year (OMG – deflation!). the book launched yesterday – Bernanke isn’t going to change – given his history, he can’t – and Obama doesn’t have any idea how awful his appointments were. It’s inflation coming, not deflation. Don’t ever bet against the Fed.

    Comment by Michael Murphy CFA — November 18, 2010 @ 6:29 am

  3. As we have learned in previous episodes, Russia actually needs no roads. Stay tuned to learn why Russia don’t need no stikin’ private capital either.

    Comment by Ivan — November 18, 2010 @ 12:11 pm

  4. Professor, not sure if you came across one more interesting thing about Russia- or russian state company Transneft to be precise.

    Comment by a.russian — November 18, 2010 @ 1:56 pm

  5. @a.russian: Yes . . . came across that. Was going to blog about it later. Verrrry interesting, especially in light of the facts that (a) Russia just announced a “privatization” of stakes in important state companies, and (b) Transneft was conspicuously absent from the list. Thanks!

    The ProfessorComment by The Professor — November 18, 2010 @ 2:21 pm

  6. Professor, Transneft seems to be too convenient tool for money laundering to be privatized.
    OK, we cannot expect justice for Transneft thieves in this our country- but I wonder could anything be done with crooks from PricewaterhouseCoopers?

    Comment by a.russian — November 18, 2010 @ 2:52 pm

  7. @a.russian. Exactly right. I just posted something saying precisely that. PWC is a good question . . . I was wondering the same thing. The most promising claimant against them would be the government, but for the very same reason you cannot expect justice for the Transneft thieves, you cannot expect that the gov’t will want to go after PWC either. Preferred shareholders may have a claim . . . but since it is listed in Russia, not London, same problem. You’d be going through Russian courts who would of course get the proverbial phone call and decide accordingly.

    The ProfessorComment by The Professor — November 18, 2010 @ 7:48 pm

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