Georgia War Hits Russian Investment

Out of the frying pan and into the fire. When Russia recognized the independence of the breakaway Georgian regions of Abkhazia and South Ossetia on Aug. 26, the benchmark Russian Trading System (RTS) stock index dropped 4%, sending the market to its lowest level in almost two years. The Russian move seriously exacerbates the strain in relations between Russia and the West, already in a state of crisis following the war between Russia and Georgia (BusinessWeek.com, 8/22/08).

Even before Russian tanks rolled into Georgia on Aug. 8, investors in Russia were shaking their heads in gloom. Since peaking in the middle of May, the Russian stock market has plummeted 36%, with two-thirds of the decline occurring before the war began. Currency and bond markets also have taken a hit: Official figures released on Aug. 21 show that Russia's foreign exchange reserves fell $16.4 billion in the week beginning Aug. 8, the largest outflow since the ruble crisis and financial meltdown of 1998.

The outflow follows a barrage of shocks to investor sentiment that has revived old fears about the stability of Russia's investment climate. "It has certainly been a crescendo of bad news," says Erik De Poy, chief strategist at Russia's Alfa Bank. "It's just one bad thing after another."

Drumbeat of Troubles

In the weeks leading up to the war, investors in Russia were perturbed by other problems. Not least among them was the raging shareholder dispute (BusinessWeek, 7/31/08) at Anglo-Russian oil venture TNK-BP (TNBPI.RTS), one of the largest foreign investments in Russia, which is 50%-owned by British energy giant BP (BP).

Then there were the alarming fraud allegations by Hermitage Capital (BusinessWeek.com, 4/4/08), a portfolio investment fund managed by the British bank HSBC (HBC). Most recently came a scandal involving Mechel (MTL), one of the largest Russian steel companies. When Russian Prime Minister Vladimir Putin on July 25 accused Mechel of price-fixing, it raised fears of a state crackdown, causing the RTS to shed 5% in a single day.

No one could have guessed that these upsets were just the prelude to an even bigger crisis. The ongoing diplomatic fallout from the Georgia dispute may yet see Russia expelled from the Group of Eight club of the world's largest economies. Russia's bid to join the World Trade Organization (WTO), meanwhile, seems to have been put on ice. Little wonder that investors are now bolting for the exits.

Time to Buy?

Yet most market analysts remain bullish on Russia's longer-term potential—and attribute some of the investment chill to broader global economic concerns. Indeed, many argue that the precipitous fall in Russian stock prices creates attractive buying opportunities. "Short-term, foreign investors are clearly taking fright and leaving. Does that mean that the investment story is over? I don't think so," says Kingsmill Bond, chief strategist at Russian investment bank Troika Dialog.

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