How the Russian bear has mauled investors

The bear is baring its teeth again in Russia, and in more ways than one. The RTS index is now in bear-market territory, down over 20% from its May record peak, with the slide accelerating in the past few days as political risk has flared up again. The dispute between BP and its Russian partners in the joint venture TNK-BP has turned ugly. The venture's chief executive, Robert Dudley, has left the country, citing uncertainty over the status of his work visa and "sustained harassment of the company and myself".

While the government has said it will not intervene, the upshot of this latest "bear bites man story" is that a "Kremlin-backed energy giant" is likely to take control of the venture, says The Wall Street Journal. Prime minister Putin has previously shunted aside other big players, such as Yukos's Mikhail Khodorkovsky he was imprisoned and the company broken up in his quest to "Kremlinise" oil and gas wealth.

Putin's attack on the billionaire owner of mining group Mechel for allegedly overcharging steel manufacturers for coal and evading taxes also raised the spectre of a second Yukos affair. "If this is an indication of things to come, Russia's reputation will be damaged beyond repair," says Jack Dzierwa of US Global Investors. According to UralSib's Chris Weafer, "the last train carrying the optimists out of Russian equities has just left the station".

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But Nelli Sharushkina of newsletter group Energy Intelligence is confident sentiment will rebound: predictions that no one would invest in Russia post-Yukos turned out to be "absolutely wrong". One reason to like Russia is the consumer boom, with the fast-expanding middle-class splurging cash after strong wage rises over the past few years. Retail sales are growing by over 10% a year, while car sales grew by 41% in the first half.

In addition, says Capital Economics, a planned $1trn investment programme bodes well for infrastructure firms. Note too that any "fresh assault" on investors is likely to be confined to industries deemed of "strategic importance" energy, in short and that Russia scores quite well on investor protection when it comes to firms outside the energy industry. The market's pe ratio, furthermore, is at a two-year low of 10.7. So if investors' "worst fears go unrealised", there could be a strong rebound in the coming months.

But clouding the outlook is the sliding oil price energy stocks comprise around half the index and the fact that global investor sentiment has been "shot to pieces", as Weafer puts it. Ongoing worries over the credit crunch and the global economy do nothing to bolster the appeal of risky emerging markets.

What's more, like many emerging markets, Russia has an inflation problem, raising the spectre of a hard landing if prices continue to rise. The growth rate, an annual 8.7% in the first quarter, is "too high", according to the European Bank for Reconstruction and Development. Inflation is running at 15% and extends beyond food and energy prices; domestic demand is increasing much faster than GDP and there are shortages in the labour market, says Edward Hugh on Seeking Alpha. This all points to "overheating". So even if political worries dissipate soon, investors may be in for a rocky ride.