Why you shouldn't gamble with Russia

Despite the turnaround in Russian stocks this year, investors should be skeptical about investing in this emerging nation.

By InvestorPlace Dec 29, 2009 1:14PM

Russia © Radius Images/JupiterimagesBy Robert Hsu, InvestorPlace.com

 

My expertise is in international investing, and because of this I'm often asked whether I think investing in Russia is a good idea. Certainly, one can't argue with the positive results seen in the country's benchmark RTSI index. It's been one of the best-performing stock markets year to date, up an incredible 130% in 2009.

 

Yet despite the impressive move in Russian stocks this year, I remain a skeptic when it comes to the upside potential of investing in this emerging nation. Why am I so skeptical? Well, there are two primary reasons.

 

The first reason is the relative lack of economic growth. After about a decade of posting average economic growth of about 7% annually, Russia closed out 2008 with 5.6% GDP growth. The economic picture grew dim in 2009, with negative 7% growth in the first quarter and a nearly 9% contraction in the second quarter.

 

And while Russia's economy started to recover from the global economic crisis in the third quarter, springing back with 13.9% growth over the second quarter, the nation's economy is on pace for an 8.5% contraction in the full year 2009.

 

The reason Russia's economy was hit so hard over the past 18 months is that it's a one-trick pony. Russia's economy is way too dependent on energy commodities for its economic health. In fact, Russia is the largest energy producer in the world, and its No. 1 export is natural gas. And, as a result, energy accounts for nearly 70% of Russia's economic growth. This leaves the Russian economy at the mercy of global oil and gas price fluctuations. Sure, the country benefited greatly when global oil prices were trading near $150 per barrel. But when prices plummeted last year, Russia's economy made a decided turn for the worse.

 

Of course, Russia's economy started to show signs of recovery with the boost in oil and gas prices this year. But I think Russia's lack of diversification in its economy threatens the country's prospects of sustainable growth in the future. Even the country's president, Dmitry Medvedev, stated that it could take as long as 15 years for Russia to move away from its strong reliance on natural resources -- definitely not a good sign for its economy in the near future.

 

The second reason I have my reservations about investing in Russia is the country's Soviet-style planned economy. Remnants of the old Soviet economic model make the country fairly hostile towards capital, and this anachronistic thinking will likely keep the nation from granting the necessary respect for capital and free enterprise required to really allow it to grow. In fact, unless you're a friend of the state -- or one of the many oligarch billionaires that exert undue influence over the economy and the society -- economic opportunities are still scant in Russia.

 

Now, along with the economic problems facing the country, Russia also deals with corruption. Russians are faced with corruption in their daily lives, and it's such a huge problem that many businesses have a "problem-solving" box on their ledgers with funds dedicated for necessary bribes to local officials, inspectors or police officers. As a result, corruption can add up to 40% of business productions costs in the country.

 

A recent survey by PricewaterhouseCoopers discovered that 71% of Russian companies were victims of "economic crime," which could include fraud, bribery, corruption, data theft and asset misappropriation. I don't know about you, but that doesn't make Russian companies an appealing investment to me.

 

Along with corruption running rampant, Russia's prime minister, Vladimir Putin, certainly hasn't forgotten his KGB roots. Putin appears to want to rebuild the former Soviet empire, and he's provoked and prodded many of the independent governments in former Soviet states such as the Ukraine. This militarism and aggression against former Soviet states troubles me. I think Russia needs to be a little less hostile diplomatically and a little more capital-friendly before I'll feel comfortable embracing this nation.

 

Simply put, there are better opportunities to be found in other emerging Asian markets that offer a greater risk/reward ratio. In fact, I believe that China will continue to be the fastest-growing economy in the world next year, and the market uptrend will continue. So, we will likely see another strong year for China stocks.

 

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