OREANDA-NEWS. September 17, 2007. At the Russo-British Chamber of Commerce City of London Lunch "Perspective on the Significance of Russia's Economy within the Larger Framework of the Global Market"

When you think about Russia in the global context, you can’t help but see extremes. Cold but also hot. Isolated, but at the same time very much integrated into the world. Mysterious, yet in reality, quite predictable. Modern and dynamic but still often Soviet.

How can Russia be all of these extremes at once? It is largely about your perspective — whether you view Russia primarily through a political lens, reasserting its influence after nearly two decades of weakened status, or view Russia as an economic powerhouse that is and will continue to be one of the most intriguing and rewarding markets in the world. The perception of disorientating extremes is also attributable to the vastly different pace of change in different aspects of Russian society.

One’s views on Russia largely depend on where one sits — in the halls of power in one of the Western political capitals, or in the boardrooms and executive suites of a multinational company that does business in Russia. Cold or hot. Isolated or integrated. Mysterious or predictable.

The Renaissance Group is focused exclusively on business and investment and we have kept our involvement in politics to an absolute minimum. My partners and I have benefited from working, living and investing in this country of extremes. My optimism about the future of Russia and its economic opportunities is as strong today as ever.

But the political undercurrents making waves to and from Moscow and London, Brussels and Washington, Beijing and Tokyo, and other capitals around the world also affect our business, and that of our clients. So it is essential to analyze both the economic and political realities of Russia today, and to understand how and where they converge.

Much has been made in the West about whether Russia’s recent actions and statements could be catalysts for a new kind of Cold War. These speculations are grossly exaggerated. No doubt, there is a chilling of relations between Russia and the West, particularly with Britain, Germany and the United States. But we view this, as aptly put by Renaissance Capital’s Chief Strategist Roland Nash, as more of a global “Cold Sore” than a global Cold War.

The speed at which Russia has re-established itself on the global stage has come as a surprise to most and is seen as a threat by many. The path that the country has taken and the means by which it is achieving its objectives have ruffled some feathers. Russia has chosen, for better or worse, something rather different than the West had expected, planned or hoped for. While this has disappointed and frustrated many in the West, it was perhaps inevitable that Russia, given its unique history and institutional development, would have its own very specific path of development.

Russia has proven rather inventive at getting what it wants. It redistributed Yukos assets and renegotiated oil and gas deals with BP and Shell, while inviting Total to be part of the huge Shtokman project and Germany to join in the Baltic Sea gas pipeline. It criticizes the United States and Britain in the Middle East, while keeping options open with Iran. It builds strong trade ties with China, while demonstrating a willingness and ability to cut energy supplies to Europe.

These are inventive strategies that work toward achieving Russia’s objective to regain its status as a global power, while at the same time confounding traditional Western powers and keeping them on their toes.

But has this chill in the political sphere led to a lowering of temperatures in the business arena? Not in the slightest. It is interesting that on the same day that Britain announced it was expelling Russian diplomats over the Litvinenko affair, the Russian equity market posted its highest close ever.

The fact is that Russia has one of the hottest economies and financial markets in the world. Russia’s economy is growing at an estimated 7% per year and in USD terms Russia has been the fastest-growing major economy globally since 2000. Turnover in the Russian equity market has increased 500 times over the past eight years, now exceeding $5 billion per day. Some of the world’s largest IPOs are from Russia, like VTB’s $8.2 billion offering earlier this year. A large budget surplus, a strong currency and falling inflation round out the economic picture.

Businesses are lining up to take advantage of Russia’s economic boom. Even those businesses that have supposedly suffered from Russia’s heavy-handed approach in strategic sectors keep coming back for more. BP, Shell, Total and Statoil all seek to expand their cooperation with Gazprom or Rosneft or both.

Russia. Cold and hot, at the same time. A balance between isolation from and integration with the rest of the world.

A G8 member and host of the 2014 Winter Olympics, Russia is nevertheless still the only major economy in the world not a member of the World Trade Organization. It is an energy powerhouse, but on its own terms. Russia has chosen its own brand of transitional democracy irrespective of international approval.

But increasingly, Russia, whether formally or informally, is not only part of, but a leading force in the global economic system. The fact is that global economic growth is being driven by the world’s emerging and re-emerging economies.

We are entering a new global paradigm where these new economies, with Russia predominately on the list, are the driving force globally for growth and value creation. The rules and laws of economics are, if not being completely rewritten, evolving in ways that will benefit those investing in Russia now and in the future. The G7 countries have seen their 60% share of global GDP rather quickly inverted to 40%. Sixty percent of the world’s GDP is now outside the Group of 7. And these traditional powers are struggling to understand, let alone respond to, this new pecking order.

In particular they are struggling to adapt to the fact that the political, financial and business models that have evolved in the West are usually sub-optimal for Russia and the major new markets. The explosive creative process in the new economies will be mirrored by a considerably more painful adjustment process in the G7 countries. In general these countries will face declining geopolitical influence and economic importance and growing pressure on the incomes of low skill workers. They are also adopting a somewhat hypocritical siege mentality in response to the increasing appetite of investors from new markets for major G7 assets. These Western adjustment pains will increasingly, in my view, colour Western political rhetoric towards Russia and other similarly resurgent nations.

Russia’s own business influence can be seen all over the world. Russia’s outward investment in other countries has now reached $140 billion. Many Russian businesses are now of global scale, throwing off extraordinary free cash flow and setting the basis for becoming major investors abroad. Witness Basic Element’s investment in Canada’s auto parts manufacturer Magna, in Austria’s construction giant STRABAG and in LDV, here in the UK. Or Evraz’s acquisition of Oregon Steel and Severstal’s purchase of Rouge Steel in the US. Or Norilsk Nickel’s acquisition of international nickel producer LionOre. Or our own expansion across Sub-Saharan Africa, what I have called the second “once-in-a-lifetime opportunity” in my professional career. This new class of business owners and executives forged their skills in one of the toughest and most dynamic markets in the world. They have skills and organizational models that are ideally suited to other rapidly developing emerging markets and in many instances they will prove more than a match for their international counterparts.

Russia’s influence in the global capital markets is also significant and growing. In fact, Renaissance Capital first predicted last April that Moscow will become one of the world’s top financial centers in the next 10 to 15 years, surpassing Frankfurt and Paris in importance to Europe, behind only London. Russia already has the third largest IPO market globally.

Russia’s apparent dichotomies and contradictions often create confusion and bewilderment, particularly among casual observers. How can a country that supposedly holds human rights, free speech and the rule of law in such low regard also be a leading destination for foreign direct investment? How can President Putin, so often derided in the West, enjoy unprecedented popularity at home as he enters the eighth and final year of his administration? Why does the Western world “freak out” when a Russian company seeks to buy an asset in Europe or the United States while Western investors flock to equity offerings of Russia’s blue chips?

A key miscalculation of the casual observer is a failure to recognize that Russia’s 1,300-year history, and not its most recent 15-year history, makes some of these dichotomies entirely predictable. Moreover, the confusion for outsiders created by these contrasts and apparent contradictions is amplified by the fact that in many ways Russia is one of the fastest changing societies on the planet but in other respects is barely changing at all. International integration, business practices, the middle-class and modernization generally are all developing at a speed that few countries have experienced. At the same time the historical constants of highly centralized power and pervasive bureaucracy seem as entrenched as ever, if not more so.

As a liberal economist who grew up in one of the freest countries in the world I understand better than most the theoretical costs of this historical continuity. But these costs are only real in a practical sense if there is a better feasible alternative to the current arrangements. And here I have my doubts. Russia has no history of constitutional checks and balances, an independent judiciary or a broad-based, property-owning middle-class. The implementation of top-down pluralism in Russia today would, in my opinion, result in a return to much of the anarchy we experienced in the ‘90s.

But fortunately that is not the end of the story. Middle-class and broadly based small- and medium-sized business are developing at a truly remarkable speed in Russia. In my view it is the increasingly assertive demands and aspirations of this new Russian society that will ultimately lay the groundwork for the increased accountability and effectiveness of Russia’s political system.

It is these two Russias that the West must learn to cope with. Russia, in terms of geopolitical relations, can be cold, isolated and mysterious. Britain, in particular, is faced with the challenges of dealing with this Russia. Prime Minister Gordon Brown is taking a tougher line with Russia, realizing that Russia is likely to continue to kick back hard on Georgia and Ukraine. Any support for the West in Iran will be linked to Kosovo.

But the West, and again Britain in particular, is also dealing with a Russia that is constructive, engaged and predictable — an economic partner that is a key contributor to national and global economic growth. Economic links between Russia and the UK are strong. At $12 billion, Britain was Russia’s second largest foreign investor in 2006. Most of that was in retail, communications, trade and construction. The largest equity offering in London and the world so far this year was Russia’s VTB. There are few signs of a let-up in the flood of Russian floatations on the LSE.

Britain is probably taking the correct position when it shows it willingness to face up to a stronger Russia. Politics based on self-interest are evolving and, as always, are likely to look rather ugly. But by the same token, the business and financial relationship is likely to continue to deepen because that is also where the mutual self-interest lies.