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The Pittfalls of Investing in Russia: Not Your Everyday Emerging Market

By Edited Nov 13, 2013 0 0

Investors in Russia Beware

A good value investor does not confine himself to just one country when searching for value investment options. Emerging markets - while often overstated - are an important element of the equity market to thoroughly investigate. But just because the nationality changes does not entail that your investment fundamentals should. That said, there are certain countries where no investor should place their money and trust in. Unfortunately, Mother Russia represents just such a country. Investors looking for a growth story might be tempted by an outsiders analysis of the country's equities, but beware. Russia faces a complex set of barriers to growth which make the
cost of investment both prohibitive and dangerous. If Russia were a beach-front, the sign would read: Swim at Your Own Risk! Here are some reasons why you should NOT park your money in Russian stocks.

1) Government Efficiency - An important obstacle to economic prosperity which is related to the need for foreign and domestic investment, is the complex tax and regulatory system. “Opportunities for abuse of power abound in areas such as Russia’s complex tax and customs systems, in capital controls and financial market regulation, and in wide-ranging regulations on businesses.”[1] The system is ripe for meddling with by those with access (read: money) to the machinations of the bureaucracy.

2) Concentration of  Wealth- A key related issue to establish the backdrop for pervasive corruption is the concentration of wealth in the hands of a few powerful individuals at the expense of shared prosperity. In Russia 2003, sales by the five largest conglomerates accounted for 12.7 percent of the GDP Concentration of wealth combined with the demand for credit to extract Russia’s vast untapped resources ensures that any available credit is gobbled up by the “big five” conglomerates. The innovator or at the bottom of the pyramid thus has little access to credit and the costs of entrepreneurship become prohibitive.

3) Lack of Entrepreneurial Possibilities - An integral part of spurring economic prosperity is in providing a safe climate for small businesses to be created and stay operative. In any developed country, a vital entrepreneur class is essential to growth, shared prosperity, and enhanced opportunity. In Russia, the regulatory system is both expansive and weak at the same time. The challenges the poses to “micro enterprises” is evidence by the following, “Furthermore, the elaborate system of regulations with which firms must comply, in combination with a lack of accountability for regulatory enforcers, has created a corrupt cadre of government officials who frequently engage in rent-seeking behavior while monitoring and enforcing firm compliance.”[2]

Conclusion: What Needs to Happen Before I Invest in Russia

One vital step Russia must take to improve the rule of law, efficiency in government, and long term economic vitality is to embrace one simple step in fundamental civil service reform. Powerful businessmen and regional politicians are often able to purchase or influence federal bureaucrats to do their bidding especially since the Russian civil service does not use examinations or other measures of professional merit to fill vacancies. If nothing more, the Russian people need proof that the system works after witnessing the dual failures of both command socialism and what was purported to be market liberalism. This is only a partial solution because it requires a strongman like Putin to shepherd it through the system so as to avoid it becoming another euphemism for the same old corrupt practices. To increase confidence in the system, both for the sake of domestic and foreign investment, a wide ranging overhaul of the regulatory and tax structure must be undertake with the goal of both disentangling and reducing. Entrepreneurs need predictability and trust in the system before they are going to put their skin in the game. Since Russia clearly has issue already with tax and regulatory compliance and enforcement, simplification is a common sense solution. This will also aid the goal of increased transparency as well, something that is one of the key inhibitors of growth and public trust.

[1] James Roaf, “Corruption in Russia,” European II Department IMF: Conference on Post-Election Strategy, (April, 2000), pg. 2.

[2]Mehnaz Safavian, “Corruption and Microenterprise in Russia.” P.H.D. dissertation, Ohio State University (2001), pg. 2.



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