ONE trillion dollars. That may be the cost to Russian investors of Vladimir Putin’s rule. It is the equivalent of about $7,000 for every Russian citizen.
The calculation stems from the fact that investors regard Russian assets with suspicion. As a result, Russian stocks trade on a huge discount to much of the rest of the world, with an average price-earnings ratio (p/e) of just 5.2. At present, the Russian market has a total value of $735 billion. If it traded on the same p/e as the average emerging market (12.5), it would be worth around $1.77 trillion.
Not all of this discount is down to the actions of the Russian government. But it is probably responsible for the bulk of it. Investors have been nervous about corporate governance in Russia, thanks to a series of high-profile incidents such as the jailing of Mikhail Khodorkovsky, an oil magnate who fell out with Mr Putin, the expulsion of William Browder, a hedge-fund manager who campaigned against corruption, and the trouble faced by oil companies such as BP and Shell in dealing with local partners. All those events occurred well before Russia’s annexation of Crimea and its backing of separatists in eastern Ukraine, steps that have prompted Western sanctions.
Most Russian citizens will not notice the problem since they do not own stocks individually or collectively, in the form of pension schemes and mutual funds. (By itself, one might argue, this is an indictment of the regime.) But it will hurt the many oligarchs who are close to Mr Putin. And for the broader population, the result is a lack of foreign investment (and capital flight abroad) that must be contributing to the country’s poor growth: its GDP fell by 0.4% in the first quarter.
From time to time, analysts point to the low Russian valuation as a sign that the market is cheap and that international investors should go on a buying spree. But such calls tend to be swiftly followed by new evidence of the Putin regime’s caprice, prompting further disillusionment. The low rating of the market has been remarkably persistent (see chart).
At the global level, investors have learned to shrug off geopolitical risk. Ever since the first Gulf war of 1991, when markets rallied as soon as the fighting started, the pattern has been the same. Markets may wobble for a few days over wars, or rumours of wars. But no recent crisis has resulted in anything more than a regional conflict, nor has any resulted in the kind of economic disruption that occurred in the 1970s, when soaring oil prices fostered stagflation. Indeed, investors seem to have great faith that most problems can be solved by central banks, either in the form of near-zero interest rates or bond-buying programmes.
Yet the same is not true at the level of individual countries, where political risk still clearly applies. Several other countries show evidence of what might be dubbed the “DOG factor”: a discount for obnoxious governments. Iran, like Russia a target of Western sanctions, trades on a p/e of just 5.6 and has a total stockmarket value of $131 billion; were it to be rated on a par with the average emerging market, its market value would be $292 billion, so its DOG factor is $161 billion or 55%.
Argentina’s government has manipulated its inflation rate, defaulted on its debt back in 2001 and, thanks to the legal battle that ensued, may do so again in a few days’ time. Its stockmarket trades on a price-earnings ratio of 6.1. As a result, its total value is $56 billion, rather than the $115 billion it might have commanded (a DOG factor of 51%). After its hyperinflationary episode last decade, Zimbabwe’s rating has recovered a bit, although it still lags the emerging-market average.
The stockmarket is not the only way that investors penalise untrustworthy governments; Argentina’s 20-year bonds yield 9.8%, more than five percentage points above the yield on the equivalent Mexican bonds. (Russia cancelled a bond auction this week, citing “market conditions”.) The more the government spends on interest, the more it has to tax its citizens and the less money it has available to spend on services. The bond-market vigilantes may have been neutered in the developed world by central banks and their quantitative-easing programmes, but they are still capable of inflicting damage in emerging markets.
Many people in the affected countries see these discounts as proof of Western bias or a sign of the malign impact of international capitalism. But the acid test is what they would do with their own money: would they trust their government enough to keep it at home, or would they rather send it abroad?
Economist.com/blogs/buttonwood
This article appeared in the Finance & economics section of the print edition under the headline "Trillion-dollar boo-boo"
