High Hopes for Russian Elections Boost Stocks, Part 1

The thinly traded Russian stock market has been on a roll recently.
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MOSCOW -- There are high hopes here that Russia's third post-Soviet parliamentary elections on Dec. 19 will help strengthen democracy's tottering foundations.

Favorable results in the elections -- and, more importantly, in the July 2000 presidential elections -- may be a step toward a re-rating of Russian asset valuations, which sell at enormous discounts to emerging market comparables.

Don't put Junior's college money in a Russia fund just yet, though. Investment in Russia, regardless of election results, will continue to take place in a hazardous environment, characterized by crippling capital flight, a flimsy currency, vacillating (at best) economic policies, the need for colossal industrial restructuring, a nonexistent banking sector and a range of other deep-seated problems. Investor perception of decreased political risk if parliamentary elections proceed as expected will be a step in the right direction, but certainly won't be the happily-ever-after scenario many may be hoping for.

Moreover, the possibility remains that the

Kremlin

will indulge in a final round of monkey business to either prevent elections altogether, or sway them to favor President

Boris Yeltsin

or the "Family," a ring of Kremlin insiders that don't want to, or are afraid to, let power slip away. Another scenario may involve a long-planned union with Belorussia -- a country that makes Russia look like a poster child of reform and reasonable, rational government -- coming to fruition, with unexpected political results.

Expectations about postelection stability have already been priced into the Russian equity market. The

RTS Index

has moved up 48% in the past nine weeks, and 88% year to date -- enough to make the Russian market the world's third-best-performing. With average daily volume tipping the scale around $15 million, though, it doesn't take much to move the Russian equity market -- so a little liquidity can go a long way.

A Bullet Dodged

One of the best things that can come out of the upcoming parliamentary elections in Russia is that they'll be held at all. Just a few months ago, the possibility loomed large that the Kremlin would engineer a postponement or cancellation of the elections to prevent its power from slipping away. A wave of apartment building bombings in Moscow in September that killed roughly 300 people fueled speculation that the Kremlin would declare a state of emergency, potentially throwing the entire elections process into question. Investor perceptions of Russia risk were ratcheted up a few more notches into the stratosphere, and the RTS Index fell more than 25% within three weeks.

But

Vladimir Putin

, the former

KGB

head who Yeltsin turned to as his next prime ministerial sacrificial lamb, has thus far been the answer to the Kremlin's prayers. Ironically, he has dramatically improved the odds of elections taking place as scheduled. Putin has ridden a wave of popularity stemming from the Russian military's invasion of breakaway republic Chechnya -- the site of a resounding defeat of the Russian military by a group of ragamuffin rebels in a bloody 1994-96 war. The Russian government has blamed Islamic militants based in Chechnya for the Moscow bombings.

As Russia's most popular politician, Putin's stock in the presidential sweepstakes has risen dramatically. This gives Yeltsin and the Family faith that they can at least see a way to hold onto some vestige of power and avoid prosecution for corruption in the post-Yeltsin era -- even if it's through the opaque Putin. If Yeltsin and the Family feel more comfortable about their prospects under a new president, they also may feel more comfortable about parliamentary elections proceeding as planned.

Next, a look at the shifting political climate within the government: What it means for the elections, and for Russian equities.

Kim Iskyan is an equity strategist at Moscow-based brokerage firm and investment bank Renaissance Capital. The firm's analysts rate the shares of LUKoil: buy, no underwriting; and those of Surgutneftegaz: buy, no underwriting; Iskyan began his career at the emerging markets trading desk of Oppenheimer & Co. At the time of publication, he held no positions in any of the companies mentioned in this column, though positions can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

kiskyan@rencap.com.