Reforming Russia wins new respect

WHILE scores of well-placed Russians looted State assets and turned themselves and associates into multi-millionaires in the mid-1990s, gullible foreign speculators poured billions of dollars into the country. Then, in August 1998, the government defaulted on some of its debts, devalued the rouble and watched as the domestic financial system collapsed and the global financial system trembled.

So today, as observers examine the return of foreign investors, the inevitable question is the one posed by a former manager of the New York Yankees baseball team who famously enquired: 'Is it deja vu all over again?'

Are we witnessing the inflation of the next speculative bubble or is a new, more efficient and trustworthy capitalist Russia finally emerging from the rubble of the Soviet empire?

The past three years have been good to Russia. In Moscow, it is not only the wives, daughters and mistresses of the well-heeled beneficiaries of Nineties corruption who are flaunting their ill-gotten gains, crowding into designer goods stores such as Gucci, Dolce & Gabbana and jeweller Bulgari, making the city a more profitable business location for some of them than Paris, London or New York.

As the International Monetary Fund's World Economic Outlook points out, Russian stocks have been flirting with post-1998 highs and spreads on the nation's debt have narrowed dramatically. And the past few weeks have seen the first signs of a serious long-term commitment of capital in Russia by major Western multinationals since the rouble crisis.

Last month, British oil giant BP said it was braving Russia's notoriously unreliable corporate governance systems and increasing its stake in oil group Sidanko from 10% to 25%. A week later, BP's French rival Total-FinaElf said it was buying 52% of a major Siberian oil field. By BP's standards, its $380m (£261m) investment was small beer. For Russia, however, it was an important vote of confidence for it amounts to one-tenth of annual foreign direct investment.

Even tiny Hungary has been enjoying similar volumes of such investment for a decade. And herein lies a tale. So great has been the distrust of Russia since 1998 that foreign direct investors have kept away. So it is indeed remarkable that today, Mikhail Khodorkovsky, the chairman of Yukos - its second-biggest oil business - is defending his company's independence by raising the spectre of a near-Western takeover of the industry within five years.

Oil analysts estimate BP pays only $1 a barrel for the reserves underlying its Sidanko stake, making them cheaper to acquire than boring exploration wells around the world.

No less important in the eyes of Western oil firms is that Russia's vast company-owned oil fields are in a region looking comparatively stable these days, compared with State-owned equivalents in the Middle East. Moreover, so important are oil and gas to the Russian economy and the West that foreign entrants can expect to enjoy tacit support from governments at home. They will also be sheltered under the protective wing of President Vladimir Putin. He has cosied up to the West and recognises foreign capital and expertise is essential for the efficient exploitation of his country's bountiful natural resources.

But another stampede into paper, or other sectors of the economy, would be different. The IMF points out that due to exports of higher-priced oil and gas, rouble devaluation and fiscal prudence, annual growth has averaged 6% in the past three years. Budget deficits have been replaced by a surplus of 2% of gross domestic product and inflation has fallen from more than 100% in mid-1999 to 20%.

It also says a healthier investment climate has emerged 'as a result of tax reform, deregulation, strengthening property rights and developing financial markets and institutions'. But it adds: 'Much remains to be done.'

Some of the reforms that are still needed, such as restructuring State industries and ending the subsidisation of energy and travel prices to consumers, will test Putin's political popularity as much as a collapse in oil prices would test his economic strategy. The enigmatic and politically gifted Putin is recognised as the one man capable of continuing to drive through reforms as the going gets tougher.

But, as Peter Worthington of Credit Suisse First Boston, puts it: 'Reform is a one-man show.' This will continue to make investors cautious.