It was almost 20 years in the making, but Russia’s entry into the World Trade Organization (WTO) last August was a major milestone for the country and one that may prove to be the catalyst needed to bridge the vast gap between the great investment opportunities, on one hand, and the giant risks, on the other, that are a hallmark of this important nation.
Russia is rich in natural resources (namely oil and gas), it has a young population and a huge labor force. Foreign currency reserves are strong and Russia has little public debt outstanding. And yet among the important emerging market nations of the world, Russia is one of the hardest for foreign investors to navigate, according to Joop de Kort, Assistant Professor of Economics at Leiden Law School in The Netherlands, and a Russia specialist. The country has a low track record with respect to transparency and governance, and corruption is known to be endemic. The tax regime is still relatively murky, and provisions for the protection of property rights are very low, he said.
“Russia’s accession to the WTO cements its position in international trade and is a hallmark of a market economy, but there’s still lots to be done, not least honoring the rule of law, applying it and enforcing it,” de Korp said. How Russia will step up to the plate is yet to be seen, but like all nations that are part of the WTO, it must commit to long-lasting economic changes that go hand-in-hand with both legal and institutional changes, he added.
“We’re hoping that the WTO entry can bring about many potential changes that need to occur in Russia and that, over time, we’ll see an investor-friendly outcome that will pay off for the country,” said Vlad Milev, Emerging Market Strategist at investment firm Payden & Rygel.
As Russia keeps pace with the rules of the WTO, “there’ll be an incentive to go further,” agreed de Kort, particularly since Russia does need to attract foreign capital.
For his part, Milev is particularly keen on the deepening of financial sector reform: something to which the Russian government had given its verbal commitment. That's at the top of the Russian agenda because the authorities are very keen to develop Moscow into an international financial center on par with any other. There has been a significant effort to make sure this happens, Milev said, including the creation of a centralized securities depository in Russia, and the merger of the country’s two stock exchanges, the MICEX and the RTS.
“The Russian government and the corresponding institutions have also been working hard to make it easier for foreign investors to access the domestic fixed income markets. The plan right now is that in 2014 they would also allow foreigners to directly access the local equity markets,” Milev said.
Although he has been investing in Russian bonds--sovereigns as well as local currency government debt, with the latter still yielding high returns going into 2013--being able to directly access domestic securities “is a big deal for foreign investors, and is a key tenet of a free and liberalized market economy that goes far beyond the rhetoric,” Milev said.
Milev also points to measures the authorities have taken to ensure that the Russian central bank becomea more of an inflation-targeting institution, in the same vein as its developed market peers. That would constitute a huge change and from an investor point of view can only be positive, he said.
But like many others, Milev is also cautious about Russia. Not only for its poor track record on governance, transparency and the rule of law, but also because the country is still heavily dependent on oil revenues and little effort has been made to encourage diversification into other industries. If this doesn’t change, then sustaining its advantages will become very difficult for Russia going forward, Milev says.
While some figures estimate that GDP growth in Russia will increase significantly as a result of its WTO membership, the future of the economy is contingent upon long-lasting change in many areas, de Kort said. “This is just the first step for Russia, and it’s a big one,” he says, “but the country has many major changes to make to really convince international investors of its merits.”