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Sochi Games Are Stark Reminder Why Investors Hesitate in Russia

No country hosting a major global gathering like the Olympic Games can hope to escape the intense media scrutiny and public criticism that are a part-and-parcel of the event, and Russia is no exception.

The run-up to the Sochi games has been rife with all kinds of negative headlines, and issues ranging from the quality of the sporting facilities to the security surrounding the once-in-four-years event have been cast into the spotlight – and not in the most favorable way either.

To boot, reports have clearly stated that Sochi’s hefty $50 billion price tag won’t be a slam-dunk for Russia.

Given the negative hype surrounding the event, many aren’t sure just how much the Games are going to boost the Russian economy, which is forecast to grow at a feeble 2% in 2014, significantly down from the 7% figure recorded for 2013.  

“The Sochi Games so far seem to be well run and professional,” said Vladimir Milev, emerging markets strategist at investment firm Payden & Rygel. “But the bigger question is whether Russia is in a position to have spent $50 billion on this event, whether that price was worth it.”

Like many others, Milev believes any positive outcome from the astronomical costs of Sochi won’t be clear for a number of years.

“Sochi has been built up to become a huge vacation destination but right now, it’s difficult to see whether it’s going to be successful that way or not,” he said. What can be seen, though, are the same flaws that have dogged Russia for some time and that have caused and continue to cause hesitation on the part of many foreign investors to commit too deeply to the country, despite the opportunities that it offers.

For one, the run-up to Sochi has once again brought to light the huge problem of corporate governance—or lack thereof—in Russia, and for investors like Tim Hanson, senior analyst at Motley Fool Funds, this is one of the main reasons for not investing in Russia.

“Many Russian stocks look cheap, particularly energy stocks, and when you think about the energy reserves that Russia has, they seem like a great deal, and yet we don’t own a lot in Russia because our study of the market has shown that corporate governance in Russia has gotten worse,” Hanson said.

According to the World Economic Forum’s (WEF) most recent Global Competitiveness Report, Russia ranks 64th out of 144 countries on the Global Competitive Index, far below other countries in the G8 and even several G20 nations.

The WEF is among those that cite corruption as the continued biggest challenge for Russia and one that has a negative effect on the workings of the government and the country’s institutions—so much so that it’s become something of a joke that the best Russian companies to invest in are probably those whose management teams are closely aligned with premier Vladimir Putin.

Another obstacle Hanson sees to investing in Russia is the high level of state intervention that exists in the private sector there.

“There are some good, entrepreneurial companies in Russia but they’re not allowed to flourish there the way they are in some other emerging markets,” Hanson said. On a more positive note, though, the most recent round of global currency turbulence that has also affected the Russian ruble might work well against the corruption and governance problems, Hanson believes.

“Russia doesn’t have a current account deficit like some of these other countries, but it’s become clear that no emerging market can count on that fast and easy money anymore, so long-term, rising interest rates are probably a good thing for a country with low corporate governance, because you can’t always live with cheap money and you have to clean things up when it’s harder to get investment in,” he said.

On the fiscal side, Russia has been fairly prudent and over the past 10 years, has made an effort to properly save its revenues from the oil windfall.

However, Russia’s other big problem is its over reliance on energy exports, oil in particularly, Milev said, and this is going to become even more problematic now, “when oil prices seem to be hanging around their average and it seems we’re entering an environment where we’re unlikely to see dramatic oil price increases.” Without the boost from energy exports it’s grown to rely on, the Russian economy will have a very tough time growing.

“Other emerging markets have also had growth issues and there are concerns everywhere, so Russia isn’t alone in this situation, but Russia’s problems seem a lot bigger than other emerging markets’,” Milev said. “They’ve got to figure out ways to grow the Russian economy and that is the biggest challenge.”

Although some attempts have been made to make the Russian economy more diverse, it remains to be seen whether those attempts are going to be enough to put Russia into a higher growth category.

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