Georgia clash makes investors in Russia nervous

— -- Russia's invasion of neighboring Georgia last month was a big hit with a domestic population grown tired of second-class global status in the 17 years since the Soviet Union collapsed.

But investors were less impressed: The Russian stock market has shed 18% of its value since Prime Minister Vladimir Putin sent in the tanks.

The post-invasion drop is part of a broader market decline. Since late May, the benchmark RTS index has lost more than 39% of its value, shaving roughly $500 billion from the value of Russian stocks. That tab is almost equal to Russia's entire stockpile of foreign currency reserves. One sign that foreigners were heading for the exits: Russia saw a $7 billion capital outflow in the first four days after the attack, according to Russian Finance Minister Alexei Kudrin.

"Putin has talked of Moscow as a global financial center and of the ruble as an international reserve currency. This is nothing but jokes now," said Anders Aslund, an expert on the Russian economy at the Peterson Institute for International Economics in Washington, D.C.

Less likely now

Prospects for Russia to be fully integrated into the global trading system also have dimmed. Following the Aug. 8 attack on Georgia, which followed a Georgian strike against separatists in the province of South Ossetia, Western officials discussed possible sanctions, such as denying Russia's bid for World Trade Organization membership. That prompted Putin to publicly disavow his commitments during earlier negotiations and belittle Russia's need for membership, which it first sought in 1993.

Coupled with a series of arbitrary moves by the Russian government against foreign investors, the Georgian incursion raises questions about whether the risks of investing in Russia now outshadow the potential rewards.

"There's a lot of bad news in the price (of Russian stocks). But it all boils down to one question: Does Russia want investment or not?" says Roland Nash, head of research for Moscow-based investment bank Renaissance Capital.

Amid Russia's recent oil-fired boom, those rewards have been ample. Since 2000, the Russian market has risen 761%. "People are looking for returns. So long as they feel comfortable with the risk premium on their investment, they'll invest," says Charles Movit, research director for emerging Europe at Global Insight in Waltham, Mass.

Soaring oil prices are behind Russia's political and economic resurgence. Since 2003, annual oil revenue has increased by more than $100 billion to an estimated $158 billion this year. That's given Putin cash to rebuild his military and emboldened him to routinely issue provocative criticisms of the U.S. He has said the U.S. may have deliberately instigated the war in Georgia to benefit one of the candidates in its presidential campaign, a presumed reference to Republican nominee Sen. John McCain, a frequent Putin critic.

The Russian economy is expected to grow at an annual rate of 7.8% this year, down only slightly from last year's 8.1%, according to a recent International Monetary Fund report. But in recent months, Russia's swagger has been unusually pronounced.

In the highest-profile dust-up, British Petroleum engaged in a long-running dispute with its Russian partners over control of the TNK-BP joint venture.

BP's billionaire Russian partners clashed repeatedly with Robert Dudley, CEO of the joint venture, over management of the country's third-largest oil producer. Dudley, who left Russia this summer after the government refused to renew his visa, complained of government harassment, including repeated tax raids.

Last week, BP and its Russian partners settled their differences in a deal that will result in Dudley leaving the company. The deal preserved BP's foothold in Russia, which once seemed threatened, while providing the joint venture's Russian co-owners with the financial benefits they sought.

Likewise, Putin this summer publicly accused Mechel, a Russian mining company listed on the New York Stock Exchange, of tax evasion after criticizing the company, saying it overcharged domestic companies.

Fears come into play

Both episodes illustrated investors' nightmare of a government openly intervening in commercial disputes rather than acting as an honest broker. For years, government officials here, including Russian President Dmitri Medvedev, have filled prominent commercial positions at the helm of state corporations, such as Gazprom.

"They not only rule Russia. They own Russia," says Andrei Piontkovsky, a veteran Russian political analyst.

Still, similar issues have dogged Russia's post-communist development since the 1990s without discouraging foreign investors. Last year, foreign investors funneled $27.8 billion into Russian ventures, up from $6.8 billion in 2003, according to the World Bank.

Despite fears of arbitrary state action and corruption, Russia outperformed other top developing countries when measured on a per-person basis. Russia attracted $369 for each of its 141 million people, more than twice Brazil's per-person figure and six times the comparable mark for China.

As a result, some veteran Russia hands see the Georgia controversy as only a temporary impediment to further investment. Nash expects Russian officials soon to reassure Westerners grown leery.

"The last 15 years, we've seen the good face of Russia and the bad face of Russia," he says. "I'd be surprised if in the next three months we don't see the good face again."