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Bullish on Russia

Today, I ran across an article in Market Watch, which argues a ‘contrarian point of view’ towards investing in Russia. An example of longer-term investment thinking based ‘buy when there is blood in the streets’, but the question is ‘will there be blood or should we buy now?’

Russia’s protests will create buying opportunity

By Matthew Lynn

LONDON (MarketWatch) — Even in the chill of a Moscow winter, it now looks unlikely the Russian protests will end any time soon.

Last weekend, some 3,000 people gathered in the capital’s Bolotnaya Square to demonstrate against rigged election results earlier this month. It was down on the week before. But with presidential elections scheduled for March, and with the country’s leader Vladimir Putin running for office, it does not look as if the backlash against his authoritarian style of rule is going to subside any time soon.

The markets hate political turmoil — and they hate it in Russia perhaps more than anywhere else.

In the run up to the elections, however, it may also create a great buying opportunity. Few countries in the world have as attractive prospects as Russia. If the country can move forward from post-Soviet authoritarianism, if it can liberalize its economy, and open up its society, then it should be able to grow as fast as anywhere.

In the Parliamentary elections at the start of the month, Putin’s United Russia party won 49.3% of the vote. Most parties in the developed world would be pretty pleased with that result. But for Putin, who specializes in a heavily manipulated form of democracy, it was a disaster, stripping the party of its constitutional majority. In the far more important presidential elections scheduled for 2012, when he was set to resume the presidency he briefly allowed his sidekick Dmitry Medvedev to keep warm for him, Putin is no longer assured of an easy first-round victory.

No one at the moment thinks Putin is about to lose power. But his total domination of Russian politics may be coming to a close.

Not very surprisingly, the Russian market has taken a beating. It was already down significantly this year, along with all the emerging markets. It has taken another battering in the last couple of weeks. From a high of more than 2,100 back in April, the benchmark RTS index has dropped all the way back to slightly over 1,300 and shows little sign of steadying. If the protests planned for Christmas Eve attract a big turnout, expect the index to take another tumble.

No one needs any encouragement to take their money out of Russia at the first sign of political trouble. You hardly need to know much history to realize that there are few countries more likely to lose you everything.

Not this time, however. While Putin may have stabilized the country, he has increasingly modelled himself on Leonid Brezhnev, the 1970s Communist leader who presided over years of dull stagnation. Over the past few years, the economy has stagnated along with the political system. Wealth has been concentrated in the hands of a tiny mega-rich elite. A middle-class, broadly-based consumer and industrial economy has struggled to emerge.

Most outside investors assumed that under Putin the country was drifting back towards a form of mild authoritarianism. Money would be made by a few lucky investors in the oil and gas industries, so long as you had the right political connection, but there would be limited opportunities for wider investment in the stock market.

That could be about to change. Russia should be one of the most vibrant emerging markets in the world. It has vast mineral wealth, low debts, and a well-educated workforce. It has always been among the most culturally sophisticated and scientifically advanced societies in the world. This, remember, was the first country to put a man into space. The gaudy Russia of oligarchs and gangsters is relatively new — underneath, it has always been a technical, advanced society. There is no reason why it should just be a resources-based economy. Russia’s engineers, scientists and designers are the equal of any in the world.

It has even turned around its terrible demographics. In the wake of the collapse of the Soviet Union, the Russian birth rate dropped dramatically, way below the level needed to keep the population stable.

In the last three years, that has started to turn around dramatically. The Russians are having babies again. It has not quite got back to replacement level, but it looks to have escaped the demographic death trap, where a declining population, and a lot of old people, make it hard for a nation to sustain itself, let alone grow. The fertility rate hit a low of 8.7 births per 1,000 people in 2000 but is now up to 12.6, almost 50% higher (helped by a $9,000 bonus for the second and third child per family).

Its growth rates are the envy of most countries. This year has been a difficult year for most countries, but economists at the Royal Bank of Scotland expect Russia to grow by slightly more than 4% for the whole of this year. It forecasts growth of 2.6% for 2012, as it gets hit by the slowdown in the euro zone, but that is still a lot faster than most countries in the world will expand.

The investment bank Renaissance Capital points out that Russia’s GDP per capita is about $15,000 on a purchasing power parity basis. At those kinds of levels of reasonable affluence, very few counties have ever slipped back into dictatorship. It is far more likely that it will make the transition from being a weak to a strong democracy.

Putin probably won’t lose in March. But he may see his dominance of the country significantly curbed. True, the Communists have been gaining in the polls. But most experts see that simply as a protest vote. Few people want to see Marxism back. More likely, European-style center right and center left parties will emerge.

None of that is reflected in the stock market. Russian stocks are down 18% this year, and trade on less than five times estimated earnings for 2012. Its fellow BRIC markets — Brazil, India and China — are trading at double that.

True, there will be turbulence ahead. As it moves towards a more democratic and open society, there will be bumps in the world. But if it can make that transition — and everything suggests it can — it will be one of the fastest-growing economies in the world. And one of the best to invest in as well.

Matthew Lynn is chief executive of Strategy Economics, a London-based consultancy.

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