Highlights
– Russia invasion of Georgia has had a negative impact on the country’s economy
– Investors have questioned the stability of Russia’s investment climate
– We do not believe Russia has descended into an unstable or dangerous business environment, but uncertainty persists
Since the beginning of 2008, Russia has proudly proclaimed itself a country of stability, setting itself apart from the tumult of the global financial crisis. When Dmitry Medvedev was elected President on March 2, 2008 and inaugurated in May, there was optimism that Russia would become more economically liberal and more investor friendly, as attracting foreign investment has been a top priority for the new Russian President.
However, all this was severely impacted on August 8, 2008 when the Georgian military invaded South Ossetia and Russia responded with overwhelming force. Within hours of Russia’s retaliation to Georgia’s move to take back the breakaway republic, Moscow attracted widespread condemnation, threats of isolation and expulsion from the international community.
On the economic front, current and potential investors remain wary of possible mid to long-term consequences for Russian actions against Georgia, as Western politicians are hinting at sanctions, visa restrictions, isolation, and even possibly denying the country the right to host the 2014 Sochi Winter Olympics.
The implementation of targeted sanctions or any attempts by the West to isolate Russia will certainly have a negative impact on potential investment in the country, something Dmitry Medvedev vowed to increase after becoming President.
Markets Affected
With the international community debating possible ways to punish Russia for its actions in Georgia, the potential from being isolated from global investors is what may hurt Russia the most. Recent actions by Russian President Dmitry Medvedev and Prime Minister Vladimir Putin risk undoing many of the successes of the past 10 years, ranging from the country’s robust economic growth and ability to attract foreign investment and economic partnerships.
Since the invasion of Georgia, stock markets in Russia have plunged. According to Finance Minister Alexei Kudrin, more than $7 billion was pulled out of the country in just two days, largely exposing the fragility of Russia’s nine-year economic boom.
Russia’s RTS Index of leading stocks fell more than six percent on August 8, 2008 when hostilities erupted and reached their lowest point in nearly two years when President Medvedev formally recognized the independence of Abkhazia and South Ossetia. According to Bloomberg News reports, the Russian ruble is headed for its biggest monthly decline against the US dollar in more than nine years as investors reduce their Russian holdings. The country’s Central Bank says more than $16 billion was lost following the military operations, as financial observers are largely attributing the loss to nervous investors pulling capital from Russia.
Much of the nervousness among investors’ has resulted from the recent European Union (EU) summit held in order to discuss a unified response to the Russian-Georgian crisis.
EU Response
EU members met on September 1, 2008 in an attempt to unite behind a strong response to Russia’s recent actions in Georgia. The United Kingdom is seeking a tough line with Moscow, while France and Germany are opposed to measures that may provoke the Kremlin. Eastern European countries, such as Poland, are also pushing for a more hard-line approach. Ultimately, EU leaders are tying future cooperation with Russia over a troop withdrawal from Georgia, agreeing to postpone talks with Moscow on a new partnership pact scheduled for late September 2008 if the country does not withdraw its troops to pre-conflict positions.
Currently, there is much disagreement and division within the EU on how to respond to Russia’s actions in Georgia. There is increased skepticism among several European countries to react harshly and implement sanctions against Russia, primarily because Moscow supplies almost 40 percent of its natural gas and is one of the world’s top oil producers.
Russia is continuing to talk tough with the EU, vowing to respond to any threat to its interests at home and abroad. Because of Europe’s dependence on Russia for energy supplies, EU leaders are limited in their options when trying to deal with or influence Russia. The energy dependence and ideological differences throughout the continent will likely hamper the ability of Europe to issue united responses to Russia, as the country is showing increased assertiveness in its foreign relations.
Near-Term Economic Outlook
There is little doubt that Dmitry Medvedev’s case for investment in Russia was dealt a blow when Russia invaded Georgia and recognized the two rebel regions of South Ossetia and Abkhazia as independent states. The issue leaves investors with a serious dilemma: join the exodus as Russia’s foreign policy draws fire from Western governments, or bet on Medvedev’s pledges to eliminate corruption and build the country’s economy into one of the world’s strongest.
With a series of harsh sanctions against Russia by the EU appearing unlikely, current and potential investors will be focusing on Russia’s next foreign policy move. Before committing money, investors need to be convinced that another Cold War with the West is not brewing. Any sign of Russian hostility towards Ukraine could portend another round of selling and result in further investor wariness.
While we currently do not anticipate that Russia will become an unstable investment environment, the business climate does remain uncertain and largely will depend on Russia’s mid to long-term relationship with the West and its near-term relations with its immediate neighbors.
