The dramatic worsening of U.S.-Russian relations over Kosovo, which could stop the International Monetary Fund from disbursing much-needed cash to Moscow, has turned the Russian stock market's recent rally into a rout. The RTS index was off over 5% in Wednesday's trading.

The threat of

NATO

strikes against Serbia, which prompted

Russian Prime Minister Yevgeny Primakov

to cancel this week's summit in the U.S., dealt the most recent blow to Russian equities. But things were shaky to begin with: The fundamentals which supposedly underpinned the market's recent surge are flimsy at best, while the rally has been almost entirely driven by speculative funds trying to find a home in an illiquid market.

Investing in the country is like juggling nitroglycerine: exciting while it lasts, but already threatening to blow up in investors' faces. Two key reasons are the prospect of lower-than-expected reinvestment from a domestic debt restructuring, which will be discussed below, and a delay in the disbursement of IMF funds caused by interference from the Kosovo crisis.

But for investors who crave risk like others need oxygen, and who think the pullback of the last few days is just a temporary setback, Russian blue-chips like cellular provider

Vimpelcom

(VIP)

, and oil companies

Lukoil

(LUKOY)

and

Surgutneftgas

( SGUZY) will likely continue to be beneficiaries. For more broad exposure, the closed-end

Templeton Russia Fund

(TRF)

or the open-end

(LETRX) - Get Report

Lexington Troika Dialog Russia Fund offer the most pure access to the Russian market.

How Stocks Managed to Surge

Some of the Russian equity market's 99% surge since the lows of October 1998 is warranted. In the wake of the crisis, Primakov's government sacrificed economic policy for political stability. Primakov has largely resisted the pressure to print rubles to plug fiscal gaps and meet spending commitments, and thus managed to limit both an outbreak of hyperinflation and a massive depreciation of the currency.

Perhaps most importantly, the weariness of the Russian people, and their hard-learned cynicism toward politicians of every color -- which many people have interpreted as apathy -- has meant that the political fallout from the August crisis has been minimal. Russia has not yet become an "Indonesia with nuclear arms."

The rebound of Russian stocks is also a function of what happens when a small amount of money hits a highly illiquid market. As daily volumes in the Russian equity market declined -- from $70 million a day last summer to $2 million in January and February -- it became apparent that only a few million dollars of volume was needed to move the market 5% either way. Fund managers -- always anxious not to underperform the benchmarks by which their performance is measured -- jumped on the bandwagon quickly as the market started to move, thus creating an upward spiral.

Besides a technical rebound and the realization that Russia hasn't imploded, there's not much to support any continuation of the market's gains.

Restructuring Problems

The government's latest fiddling with its domestic debt restructuring weakens one key prop supporting the market's explosive but shallow rally.

Even if that restructuring stays on track, the modest sum of funds that could potentially flow to the Russian equity market from the restructuring would at best be the ruble equivalent of somewhere between $150 million and $570 million, although the sums remain very vague. The fact that the settlement could take over a year was apparently overlooked amid the ebullience with which the scheme was initially viewed.

Furthermore, participants in the restructuring scheme could likely purchase new fixed-income instruments, such as Lukoil or

Gazprom

bonds, and avoid equities altogether. So it has been speculation of new money that was driving the Russian equity market.

Nor does the prospect of fresh funds for Russia from the IMF provide any kind of real support for Russian stocks.

Until Russia decided to let its opposition to the NATO bombing of Yugoslavia -- which began this afternoon -- overshadow the procurement of additional IMF funding promises, the Russian government was pulling out all the political stops to pry open the wallet of the IMF. Hopes were high that Primakov would be able to seal a deal during meetings this week with

Vice President Al Gore

-- until Primakov abandoned his journey to the U.S. in mid-flight Tuesday upon learning that bombings of the Serbs were likely to begin soon.

But given that it is in the interest of both the IMF and Russia to start funds flowing, Russia may experience only a relatively small delay in winning a new program to follow up on the $4.3 billion disbursement made just weeks before the August 1998 devaluation.

An IMF agreement -- which would be based on mutual political expediency, rather than sound economics -- would be heavily backloaded, requiring the Russian government to make good on promises of fiscal discipline before any funds would be disbursed.

Aside from the stamp of approval a new IMF pact would bring, the practical benefits would be few. Any new IMF money will simply be used to pay back old loans to the IMF due over the summer, and perhaps to make another Eurobond payment or two. While a deal with the IMF would also release roughly $1.4 billion in funding from other agencies, and open the door to renegotiation of

Paris Club

Soviet-era debt, these hardly constitute short-term drivers of the Russian equity market.

Flimsy Fundamentals

While things aren't as bad as they could be in Russia, there's much room for improvement.

Economically, Russia is still a mess. A ruble is now worth, in dollar terms, a quarter of its summer 1998 value, and the threat remains that the government may resort to printing money to fill in massive budget gaps or to ensure that pensioners and workers, millions of whom who haven't been paid in months, receive at least something.

Government revenues in ruble terms have hardly budged since last year, despite 100% inflation in the meantime. Most companies in Russia remain strictly in survival mode, with all thoughts of growth, expansion or investment shelved, as

GDP

continues to collapse.

Even the apparent political calm of the past several months could shatter at the drop of a Russian fur winter hat. Ever-ailing

President Boris Yeltsin

uses his brief bouts of mental lucidity to play politics, in a desperate bid to remain politically relevant as the July 2000 presidential election looms.

The threat of a Cabinet shakeup, perhaps involving the dismissal of Primakov, remains the one wild card that Yeltsin still holds. The last thing Russia, or its shaky equity market, needs now is a constitutional crisis. But that's not unthinkable, considering the lack of replacements for Primakov and the potential of the Communist-dominated

Duma

lapsing back into intransigence.

Just because Russia hasn't slid off the map doesn't mean it's worth investing in at this point. With fundamental valuations flimsy at best and the Russian equity market's recent speculative rally collapsing, the Russian bear continues to lurk.

Kim Iskyan is an equity strategist and senior analyst at Moscow-based brokerage firm and investment bank MFK Renaissance. The following are the firm's analyst recommendations and underwriting relationships for the companies mentioned in this column:

  • VimpelCom, speculative buy, underwriting relationship; Lukoil, speculative buy, no underwriting; Surgutneftegaz, speculative 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 the companies mentioned in this column, although positions can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

commentarymail@thestreet.com.