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Russia Budges on Politics, Economics Not So Much


Signs of strength in the world economy cannot pick oil up. Russian economic growth is dragging accordingly.

This week actually brought some encouraging news from a sphere that rarely offers any: international diplomacy. Not that anyone noticed much between the Cleveland kidnapping story and the Dow (INDEXDJX:.DJI) setting new records.

US Secretary of State John Kerry and Russian Foreign Minister Sergei Lavrov met in Moscow, and agreed to make joint efforts to end the awful civil war in Syria. Lavrov hinted that Russia would even throw its client, president Bashar al-Assad, under the bus if necessary for peace. "We are not interested in the fate of certain persons," the Kremlin's foreign policy supremo said. "We are interested in the fate of the total Syrian people."

Lavrov's boss Vladimir Putin has some purely political reasons for becoming more flexible on Syria. The more aggressive elements in US politics are pressuring a reluctant Barack Obama to intervene, somehow, on the side of the anti-Assad rebels. For more thoughtful observers, on the other hand, moral lines between Assad and the opposition are increasingly blurring, so the international community would likely welcome a settlement that stops short of a rebel military victory.

On May 6, senior United Nations investigator Carla del Ponte said that evidence pointed to the rebels, not the regime, having used chemical weapons. She was quickly pooh-poohed by the White House and just ignored by other American politicians, who have locked in on the resistance as the good guys in Syria and don't want to alter the narrative at this point.

But there is another reason for Russia's hint of dovishness that may more immediately interest investors: oil. The Kremlin tends to be more accommodating toward the outside world when petroleum prices are sagging and truculent when they are firm. Oil has been on a downward trend for two years now. The popular United States Oil Fund ETF (NYSEARCA:USO) has lost a quarter of its value since April 2011.

Signs of strength in the world economy cannot pick oil up thanks to new supply from North America and conservation throughout the developed world. Russian economic growth is dragging accordingly. The economics ministry expects a 2.4% GDP expansion this year, compared to 3.2% in 2012 and more than 6% through the mid-2000s.

So Putin and friends may finally be getting that the paradise of pre-2008, when oil prices rose more or less continuously for a decade, is lost for the foreseeable future. There are even a few hints they plan to do something about it with economic policy. Bloomberg reported yesterday that the finance ministry wants to force state-owned companies like Gazprom (OCTMKTS:OGZPY), Rosneft (OTCMKTS:RNFTF) and Sberbank (OTCMKTS:SBRCY) to pay 35% of profit as dividends, up from 25%, and to use international IFRS accounting standards for the calculation.

The Kremlin has called in respected investor Alexander Branis, a director at the country's biggest foreign fund manager Prosperity Capital, to consult on corporate governance issues. Ministers keep promising a long-delayed pension reform that would allow billions in locked-up old-age savings to flow into the stock market, the perennial cheapest among major emerging markets with an average forward price/earnings ratio around 5.5.

But these proposed tweaks hardly amount to a sense of necessary urgency as Russia faces a less bountiful energy future, and the Putin regime's credibility on broader reforms is shattered. Three-and-a-half years ago, then-president/now prime minister Dmitry Medvedev sounded the clarion call of "modernization" for Russia. Among other ambitions, he pledged to diversify the economy away from its "humiliating raw-material dependency," and turn Moscow into an "international financial center."

On diversification, exports and the stock market tell the story. Oil and gas still account for more than half of Russia's sales to other countries. Metals, chemicals, and other raw materials make up most of the rest. The only non-mineral business to break through internationally for Russia is armaments, which achieved record export sales of around $15 billion last year. (None of the big weapons producers are publicly listed, alas.) The Market Vectors Russia ETF (NYSEARCA:RSX), the most popular US retail vehicle for the market, has tracked oil prices almost exactly over three years, and lagged them significantly over the past six months.

As for Moscow as a financial center, Russia had an unexpected once-in-a-lifetime opportunity when Cyprus, the offshore domicile for thousands of Russian companies, went through total financial meltdown in mid-March. Putin beckoned business to "deoffshore," rerouting vast capital flows through the Russian motherland.

The response has been a collective implicit "lol." Oligarchs and minigarchs are studying Luxembourg, Ireland, Latvia, or the Seychelles as alternatives to Cyprus for varying bits of business. Anywhere but Russia with the imperial, sticky-fingered bureaucracy Putin has nurtured. "Nothing has changed in Russia," comments one Moscow lawyer who prefers to remain anonymous. "Entrepreneurs are still afraid that some competitor will take away their business with the help of administrative resources."

We should all hope that Lavrov and Kerry are serious about their two powers joining forces to stop the carnage in Syria. It would take some equally demonstrative moves on the economic front to pull the Russian market out of the doldrums. Thirteen years into the Putin era, that looks unlikely.
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