Igor Kostikov, Chairman of the Federal Securities Market Commission (Rus. FKTsB), announced last week that Russian stock market capitalization now totaled $212.2 billion as of January 20, or 45% of GDP. Moreover, market growth doesn’t show any signs of slowing. In the first three weeks of 2004, the RTS Index gained 10%, while in 2003 it grew by 58%.
Virtually at the same time the head of FKTsB made this optimistic statement, Aton Investment Company published research on the prospects for the Russian stock market in 2004. The report’s main point was that a potential market bubble is threatening the Russian stock market. “We don’t see the fundamental factors for a boom,” Dmitri Lukashov, a senior analyst at Aton, told Expert. “Instead, the market could see the speculative ballooning of quotes.” Based on these concerns, Aton has downgraded its annual forecast for the RTS from 715 to 600 points.
Last autumn, Igor Kostikov was the first to see the signs of an inflating bubble on the stock market. To prove his thesis, he pointed to the gap between the amount of financial market resources and the amount of investment in the economy. Following Kostikov, Western analysts also began to express their anxiety regarding increased investor interest in the Russian market. This January, William Rhodes, Senior Vice Chairman of Citigroup, said that he “sees a risk that developing countries’ stock markets could go beyond what basic economic factors will allow, as was the case before the 1997 Asian crisis.”

On the face of it, there is indeed cause for investor anxiety. Russian stock market growth is mainly propped up by high prices for raw commodities and natural resources. Excessive ruble liquidity has been its engine and catalyst. In addition, in the second half of 2003, the Russian stock market became notably more volatile –after five consecutive years of declining volatility. There is also a drastic difference between stock value growth rates and the expansion of domestic production output. Last year, Russian stock market capitalization increased by 72%, meaning it outstripped GDP growth by more than ten times.
Investors are also concerned about a possible tax increase for Russia’s natural resource companies, in particular oil companies. This could reduce corporate profits at major oil, natural gas, and metal companies. These concerns are quite reasonable. For example, Prime Minister Mikhail Kasyanov proposed increasing taxes for natural resource companies if oil prices will be more than $25 per barrel. In the opinion of Aton analysts, only a substantial drop in export oil prices – down to $20-22 per barrel – could save the oil industry from an increased tax burden. If prices fall, oil company profits would decline, and the issue of increasing tax revenues from the oil industry would not be so pressing. However, even the most confirmed pessimists don’t foresee any decline in prices at the moment. On the other hand, no one expects oil prices to rise, either. “World oil prices are high, and a further dramatic rise is unlikely, which limits how much natural resource companies will be able to increase revenues,” Valery Petrov, a member of the Board of the Investment and Financial Analysts Guild, has concluded. “At the same time, oil companies will be subject to a heavier real tax burden, which will restrain potential stock growth.”

The fact that fuel company stocks have reached their peak doesn’t mean that a crisis in the stock market is inevitable. “Even if tax rates increase, companies will remain quite profitable,” believes Igor Vain, Director of the Customer Relations Department at United Financial Group. “There will be no critical reduction in yield that would stop them from making further capital investments. Therefore, we don’t think that a potential increase in taxes will affect company activity.” Other experts share this opinion. “Prices still look good. Metal prices are going up and oil market conditions remain favorable,” says Sergei Suverov, head of the Analytical Department at Zenit Bank. “The current situation in the global economy – China’s economic expansion and its demand for Russian raw materials and energy supplies, as well as the recovery of the US economy –gives important support to our market. In addition, companies themselves are learning how to invest funds more efficiently and are enlarging the scale of their operations.”
Analysts don’t consider the rapid growth of domestic stock market capitalization versus GDP as sufficient grounds for concern, either. “We can talk about a bubble when quotes diverge significantly from companies’ fundamental indicators,” states Denis Agaponov, an analyst with Troika Dialog Investment Company. For the time being, however, many Russian companies’ stock, especially second-tier stocks, remains undervalued.
Of course, the market is experiencing excessive liquidity, but this doesn’t present a significant threat. “Foreign investors tend to be more active, and this tendency has become apparent since last September,” notes Yuri Danilov, Senior Economics Advisor at the Center for Stock Market Development. “Long foreign money, along with `easy money,’ has brought about the growth we have observed. The movement of Russian stock transactions from Russian to Western stock exchanges, which started in August-September, is proof of this.” Western analysts have noted qualitative changes in the behavior of Russian investors, as well. In contrast to 1997, they carefully analyze the financial status of Russian corporations before investing.
But the fact that investors still show little interest in the stock market is, perhaps, the most convincing argument in the “bubble” debate. “If extremely high ruble liquidity continues, it may cause stock market performance indicators to break away from fundamental macroeconomic indicators,” admits Valey Popov. “However, stock market growth is only slightly dependent on increased ruble funds in Central Bank correspondent accounts. This demonstrates that investors have no intention of making serious investments in the stock market at present.”

No analyst rules out the possibility of the stock market falling back to mid-2003 levels or even lower, though. As the government and business hammer out their differences, this could have a greater effect on the market than the notorious bubble. So far, those in power have not given any clear indication of whether they intend to cooperate with big business in a constructive manner. Vice-Premier and the Minister of Finance Alexei Kudrin’s statement at the economic forum in Davos that the government intends to take a serious look at oil companies’ past tax reduction schemes indicates just the opposite. If officials don’t settle down, foreign investors, who by rough estimates make up about half of the total Russian stock market, may leave just as easily as they arrived. Then, even last summer’s 500 points would become an impossible dream for the RTS.

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