Do you have the nerve to invest in Russia?

Investors in Russia have always needed nerves of steel, but events over the last few weeks will have tested the faith of even the most fervent believers in Russia's transition to capitalism. First, the closure of a number of small local banks a few weeks ago prompted a flurry of cash withdrawals, raising the spectre of a run on the banking system and a repeat of the 1998 financial crisis. Second, the opening of the trial of Mikhail Khodorkovsky, the former chief executive of oil giant Yukos, raised fears that the Putin government is trying to recreate the Soviet Union. Then the shooting of Paul Klebnikov, the editor of the Russian edition of Forbes, the US financial magazine, reawoke fears of a return to the lawlessness of the 1990s.

Worries about another run on the banks began to subside over the last week, and the police promise to hunt down Klebnikov's killers helped ease fears of further Mafia-style hits. But for those concerned that the Putin government is determine to turn back the clock, reinstating the apparatus of the Soviet state, events of the last few weeks have been particularly unsettling. On 11 July, Putin effectively recreated the KGB after he signed a presidential decree that reunited the domestic and foreign spy agencies for the first time since the end of the Cold War. He's also presided over a dramatic governmental clampdown on the independent media. Three controversial TV programmes have recently been axed. The changes follow the takeover by Kremlin loyalist Vladimir Kulistikov, of NTV - one of only three channels broadcasting to the whole of Russia that is not directly state-owned.

Above all, the one thing that has spooked investors into fearing that Russia is on the brink of becoming a neo-Communist state, is the tearing apart of Yukos. Few doubt the case is politically motivated. What began with a dramatic raid of the company's Moscow offices last July and the subsequent arrest of Khodorkovsky three months later, last week led to Khodorkovsky being charged with grand theft and tax evasion and the government seizing Yuganskneftegaz, the firm's main oil production unit, which it plans to sell for a fraction of its true value in order to cover the unpaid bill.Whatever the legitimacy of its claims to unpaid taxes, observers agreed that the government's actions were excessive and looked like a calculated attempt to destroy the company. "Frankly, it's similar to performing a heart transplant on a man with a cough," said one broker. The Economist is in no doubt what is at stake: "The forced annihilation of one of Russia's biggest and most successful companies would be seen as a damaging sign of how far the Kremlin is willing to bend the law to its own ends." Fiona Marharg-Bravo on Breakingviews.com was equally gloomy. "By putting Yukos in the hands of his friends, Putin would be well on his way to an economy that depends on the state's goodwill. But he will be hard-pressed to achieve his other aim - double GDP by 2010. For that you need to have investors."

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But is Putin really trying to resurrect the Soviet Union? Is capitalism doomed in Russia? No, contend Patricia Kranz and Jason Bush in BusinessWeek. They argue that it is far too soon to write Putin off yet. "Putin, after all, was handpicked by Yeltsin to continue the monumental task of reviving Russia. Putin learned the tactics of reform while serving under St Petersburgh Mayor Anatoly Sobchak, one of the earliest liberal politicians in Russia Putin even found time to earn a PhD in economics."

The West has, apparently, overlooked many of Putin's reform successes so far, say Kranz and Bush: "Skeptics assume that [Russia's] impressive performance stems mainly from high oil prices. Yet Russia's growth is also being driven by a surge in productivity across all sectors - a predictable result of the market reforms launched in the 1990s and continuing, with much greater consistency, under Putin. Overall, labour productivity is growing by 14% a year."

Others too are optimistic. "The Putin reforms are about giving individuals more liberties. He's trying to get the state to back off individuals and support private enterprises," says Al Breach, economist at Moscow broker Brunswick UBS. "Putin was familiar with Western influences even in Soviet times, so he fits this role [of reformer] better than Yeltsin," notes Alexei Muhin, director of Moscow's Centre for Political Information.

So far, it is clear that whatever anxieties they may have, investors have not given up on Russia yet. As Guy Chazan noted in the Wall Street Journal Europe, there's no sign of a repeat of the 1998 financial crisis. "There [has been] no debt default or rouble devaluation. The economy is in robust health, with world prices for oil, its main export, at highs. Unlike in 1998, when the crisis brought down almost all the country's big private banks and wiped out the savings of millions, this month's turbulence affected only a handful of small and medium-size institutions."

So should investors continue to put cash into Russia? Absolutely, insists Derek Moorehouse in The Fleet Street Letter. He reckons the reactions of some people to the Yukos affair have been profoundly irrational. "Investors should look beyond the frightening headlines about Yukos and consider investing in RussiaThe Economist Intelligence Unit predicts growth of almost 6% in 2004, compared with just 2% in the European Union Investors should also benefit from continued appreciation of the rouble. The EIU forecasts the rouble will strengthen by more than 4% this year and by a further 1.5% in 2005."

There are plenty of ways to invest in Russia, depending on your appetite for risk. Broker Seymour Pierce recommends investing in Avocet, Palladex and Trans-Siberian Gold, all of which have mining operations in Russia, while others favour UK-listed Peter Hambro Mining. Good investment opportunities also lie in the telecoms industry, with firms such as VimpelCom and MobileTelesystems, the country's two top cellular-phone providers. Energy-related stocks, such as oil and gas, continue to be popular.

Cautious investors should stick to a fund such as the Jupiter Emerging European Opportunities fund, which invests 50% of its portfolio in Russia and has doubled in value since its launch 18 months ago.