Putin power will increase the Russian market's sky-high beta

Will Russian asset prices start to outperform relative to peers now that the pre-election congress of the ruling United Russia party has – as expected – provided the occasion for the top leadership to remove uncertainty about the political future?

During the seemingly interminable build-up to this moment of truth (which came on Saturday, 24 September), my call was that supplying political visibility would in itself suffice to trigger an equity market rally – regardless of which member of the “tandem” was going to be president in the next cycle. I argued that this positive market impact would be stronger and more immediate in the event – which I wrongly predicted – of Dmitry Medvedev getting a second presidential term but that even if Vladimir Putin decided to return to the Kremlin (as we now know he has done), the market would also react positively. To the extent that foreign investor sentiment – the decisive short-term driver for this market – would share the disappointment felt by many educated Russians about Putin’s refusal to bow out, such reservations would, I expected, be dispelled soon enough not only by the welcome restoration of political certainty but also by the rhetoric about renewal and fresh policy initiatives with which Putin would most likely seek to counter impressions of a return to Brezhnev-style stagnation.

Revised call: Political visibility will boost an externally-driven equity market rebound

All this was to reckon without the coincidence of this political turning point with a global market panic in which Russian equities, despite initially staging an unusual show of defensiveness (back in late July), have ended up in their usual maxi-beta place – down, after last week’s market massacre, nearly 40 per cent from their April peak. So all forecasts must obviously take account of this dire market environment, and I now modify our call as follows:

1. The political trigger – along with all other domestic drivers – will be powerless against the present hurricane-force global headwinds. In other words, only developments outside Russia (such as some relief from the Eurozone debacle or, say, some more bullish news out of China) have the power to alter the market’s present inclination to price in a sharp oil price correction on the back of a new global economic downturn.
2. If anything, the initial lack of enthusiasm that was always on the cards if Putin decided to become president again will now accentuate the Russian market’s traditional underperformance in a risk-averse environment. When already attuned to the negative, markets will naturally latch onto risk factors (such as the fiscal deterioration cited by long-serving Finance Minister Alexey Kudrin when announcing his unwillingness to serve in the planned Medvedev-led government) and become that much more sensitive to the less attractive aspects of any big event. The negatives in this case of Putin’s return include the stultification of Russia’s political development (at least in comparison with the alternative scenario of Medvedev remaining president) to the detriment of key investment climate drivers such as transparency, accountability and progress against corruption.
3. Rather than being altogether lost, however, the positive potential of this removal of political uncertainty will eventually be feed through to Russian asset prices in the form of an additional market rebound booster once global risk aversion finally abates. The bottom line is that the outcome of this political cycle in Russia will reinforce the market’s traditional high-beta characteristics – that is, not only on the downside but also on the upside.

Reality check: Where exactly does the positive potential lie?

Many investors might be sceptical of this positive potential – that is, Putin’s capacity to charm the markets as he embarks on the next, six-year leg of his already long rule over Russia. Here is the cue for an initial brief “post mortem” on my incorrect prediction that Putin would allow his protégé Medvedev to remain president for a second term – a forecast reiterated in our August note Russia’s tandem heading for a second term.

As argued in that report, Medvedev as president with Putin as prime minister created a positive form of stability – one that was skewed towards dynamism rather than stagnation. By contrast, Putin’s return to the Kremlin is an altogether different political construction: as a result of his resuming direct control of the vast powers accorded to the presidency by Russia’s constitution, the premiership – even in the hands of a former president – will revert to its natural strictly subordinated state. In other words, this revised configuration of the tandem signifies continued stability (that for sure), only now skewed to stagnation rather than dynamism.

The problem is related not so much to the substance of policy: Putin will go out of his way to demonstrate support for policies that until now have been most closely associated with Medvedev; in fact, the main part of his speech to the United Russia Congress on 24 September contained plenty in that vein. Rather, the stagnation risk stems from the simple fact of Putin’s long incumbency, denying Russia the natural political benefits of leadership rotation: the generation of fresh political capital, the deepening of systemic legitimacy and the discarding of negative baggage.

The overlooked key: Medvedev to replace Putin as leader of United Russia

Some Russian commentators have already expressed regret that Medvedev has buckled under rather than challenge Putin and thereby inject much-needed oxygen into the country’s political life and policymaking process. The first thing to be said about this is that any such challenge would have failed, with the temporary breath of fresh air giving way to a sullen and brittle political atmosphere. Instead, the prospect we now have is not one of complete political asphyxiation. My view that the tandem would continue unchanged was based, above all, on the evident priority for Putin of maintaining the stability of the ruling establishment that he has created and leads. I reasoned that Putin could not sideline Medvedev without the risk of some destabilization. An important development on 25 September – that is, the day after Putin and Medvedev’s set-piece announcement of the “tandem switch” – indicates that the new political deal goes beyond simply offering Medvedev the premiership: Medvedev is also set to take over the leadership of the United Russia party.

This part of the plan was revealed by the Kremlin Chief of Staff Sergey Naryshkin (who, significantly, hails from the Putin camp) and then confirmed (even more significantly) by Putin’s spokesman, Dmitry Peskov – contradicting the guidance on this point which he (Peskov) had given the previous day. By taking control of the United Russia apparatus and gradually packing this core power base with his own people, Medvedev would in due course be positioned to take over the supreme leadership in his own right. This, which more than anything else must account for his smooth acquiescence in the “tandem switch”, will dilute the fundamentally negative aspects of Putin’s decision.

Timing of the political boost for the market

It follows that the key event to watch in the aftermath of Putin’s inevitable victory in the March 2012 presidential election is not only whether Putin appoints Medvedev prime minister as advertised – and gives him a reasonably free hand in both policymaking and ministerial appointments – but, above all, whether Medvedev replaces Putin as the leader of United Russia.

The timing for all these indicators is spring 2012. As it happens, at the equivalent stage in the previous political cycle (autumn 2007 – spring 2008), external developments resulted in the political trigger for a market rally being delayed until after the March presidential election. In the plausible scenario that the present global market turbulence will persist for a good while to come, similar timing could well apply this time round.

With best regards,

Christopher Granville
Director of Russia & FSU Research, Trusted Sources