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Back to serious opinions on Russia and where it’s headed under Medvedev and Putin. Below is an opinion piece from today’s JRL (Johnson’s Russia List) by one of the most astute analysts on Russian business today. Roland Nash is a Managing Director at Renaissance Capital in Moscow. The analysis Roland offers below is the very type of intelligent and well researched writing which is so sorely missing from the likes of the New York Times and the Washington Post, not to mention The Economist.

If you want to contact Roland Nash you may do so at +7-495-258-7916 or by email at rnash@rencap.com

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OPINION: Medvedev-Putin - Encouraging focus on economics
Contributed by Roland Nash, head of research, Renaissance Capital

MOSCOW, May 12 (Prime-Tass) — Last week, Renaissance completed its move into the Naberezhnaya Tower of Moscow City, the tallest building in Europe in what will be the continent’s largest financial centre. From the 51st floor, Friday’s military fly-by, the first of its size since the break-up of the Soviet Union, looked particularly spectacular. Looking down at the cranes, it is clear how much Russia is changing, and how much is still to come.

While less vertiginous, the economic goals which dominated Putin’s speech to parliament on Thursday emphasised much the same point. After a major overhaul of the structure of power, focus seems now to be shifting to economic policy, from changes to the tax system to the rebuilding of Russia’s infrastructure. After a long period of assuming the status quo, the equity market may begin discounting a new wave of economic change. International markets allowing, such a shift in sentiment could bring both domestic and international buyers back to the market simultaneously for the first time in 18 months, catalyzing a re-rating of the equity market.

The most eye-catching remark in Putin’s speech was clearly his promise to reduce the tax burden on the oil sector ‘to encourage oil production’. The policy itself was not new the finance ministry had provided a more detailed proposal in February. But that Putin used what was effectively his first speech as Prime Minister to commit his government to reduce oil taxation marks a highly significant shift in attitude towards the sector. Previously both the government and the presidential administration had consistently stated their view that the oil sector had enough slack on the cost side to raise income and hence financing if required. Policy in recent years has been that the diversification of the economy away from natural resources and towards value added required very high tax rates on upstream.

Putin has now effectively stated that the government is willing to regulate taxes to help fund the capex needed to restore oil production growth. While the extent and the form of the tax breaks are still not defined, a 2008 p/e of 9.0 for the sector at current tax rates (with LUKoil at 8.3), seems too pessimistic. With net income presumably to rise and production growth to be encouraged, the sector could move back to a premium over the EM average of 10.8.

The rest of the speech was of less immediate importance to the equity market, but it was equally encouraging. The focus on lowering taxes, curbing inflation and investing into infrastructure was not unexpected and, given the forum, might have been been left as rhetoric. But Putin specifically chose to define more carefully the type of strategy his government would employ. Tax decreases are to be aimed at stimulating the business environment through, specifically, rationalizing the amortization process. The fight against inflation should involve opening up agriculture to investment. The rebuilding of Russian infrastructure will require the participation of private investors and a partnership with business through setting the correct tariff policies. The elaboration was unusual in an address to the generally quiescent Duma and suggests that the message was aimed at a wider audience.

The scope of the speech, and its obvious importance relative to those of Putin’s predecessors in the post of Prime Minister begs the question of the nature of the power-sharing agreement between Putin and Medvedev. If Putin is defining the country’s strategic goals, then what is the role of Medvedev? In my view, the relationship is still very much a work in progress. Medvedev’s inauguration and Putin’s appointment as Prime Minister mark the success of the constitutional transition of power. But the actual transition is ongoing. As in any political system, clarity will only emerge as each political player begins to exercise his new authority. The difference in practical decision-making power exercised by Putin and Yeltsin illustrates well the importance of situation and personality in defining the role of what is ostensibly the same constitutional position. With this said, it is, however, possible to identify some important parameters in the new power system.

First, Russia has arguably its first truly competent Prime Minister. Gaidar, Chernomydrin, Primakov and Putin (in his first incarnation) all had specific roles to play, but none had anywhere close to the authority and the proven track-record enjoyed by Putin. In a country where implementation has always been the stumbling block, having a head of government who is able to manage power to effectively execute policy marks a major change from the past. When Putin became President, his overriding priority was to establish the strategic direction for Russia. Now, the emphasis is far more on the implementation of policy. Whatever the criticism of Putin in the West, it is clear that there are very few in Russia who are as capable of managing government. Put another way, if Medvedev had moved into the Kremlin without cutting the deal with Putin as Prime Minister, we may well have been hoping that Putin would be his first choice as Prime Minister.

Second, Medvedev represents a shift towards much of what Russia has been criticized for missing under Putin. Without the baggage of a history in the security services and with his background in law, Medvedev represents a different type of authority in Russia. Both Medvedev and Putin have consistently stated that stability is key for guaranteeing Russia’s future development. But whereas Putin relied on his own cadre of insiders to establish the institutional framework for power, Medvedev has consistently emphasized the supremacy of law. If Medvedev is able to move towards ending the ‘legal nihilism’ he has consistently identified as the biggest threat facing Russia, he will have gone a long way to completing Russia’s transition.

Third, it is entirely plausible that Medvedev without Putin would not have been a viable President. Perhaps the biggest danger for Russia during the transition of the presidency was, and remains, that power slips from the Kremlin back to the interest groups which dominated under Yeltsin. The power structure that Putin created relied on the web of relationships established during his presidency. In that sense, it was inherently temporary. Without Putin to guarantee stability, Medvedev may never have had the opportunity to establish his own authority. At the very least, it would probably have taken somebody with a similar background to Putin to hold onto the reins of power.

Fourth, the relationship as it stands seems to offer a decent balance between cooperation and confrontation. The similarity of the emphasis in Medvedev’s speech in Krasnoyarsk and Putin’s speech to the Duma suggests that the same set of advisors were influential in the penning of both. At least on economic policy, both the White House and the Kremlin seem to be pointing in the same direction. Equally as important, the monopoly of power in Russia is clearly ended. Unless one is entirely dominant, there will inevitably be some friction between the Kremlin and the White House. A monopoly on power tends to result in less than optimal scrutiny of policy. At its best, limited friction should help prevent some of the more hasty decision making seen under Putin.

As the dust settles on the official transition of power, the initial evidence suggests that the market is likely to be pleasantly surprised by the strategy that emerges from Russia’s new political system. Most of what both Putin and Medvedev have outlined for policy is as encouraging as we had hoped. I expect there to be more of the same in coming months as both the Presidential Administration and the Government begin to focus again on policy after the long hiatus marked by the confusion surrounding the transition of power. It would be naive to expect everything to run smoothly. Quite probably, there will be attempts by various interest groups to establish influence, a process which may look ugly. However, the defining of policy under the new regime is likely to offer more positive surprises for the market, in my view.

The danger for Russia’s markets remains very much in the conditions outside of the country’s direct control. The international financial situation could well create the sort of risk aversion which again causes money to be pulled out of Russia. Inflation caused by rising food prices and the monetary inflow resulting from USD125/barrel oil looms as Russia’s major macroeconomic problem. The lack of flexibility in Russia’s capital and labour markets suggests a boom-bust economy over the longer term. But fundamentally, the assets of one of the world’s biggest commodity producing countries, where equity has underperformed and where the government is surprising with an under-appreciated economic programme may well be poised to outperform.

Making the (large) assumption that the worst is over in global credit, the Russian equity market looks set to catch-up both with its underperformance of other emerging markets over the last 18 months and with the price of hydrocarbons which has failed to have the impact that might otherwise have been expected. Shifts in sentiment have proved powerful drivers of Russia’s markets in the past. If international and domestic investors simultaneously begin again to feel comfortable with both the international situation and Russia’s domestic political situation, then equity could move a major step change closer to our RTS target of 3000. Buy oils.

// 05.12.2008 at 5:35 pm // Tagged economy, russia