Russia: rouble reform not enough

While Russia has dropped its restrictions on rouble convertibility, more change is needed to make the market investor-friendly, says a recent report. By Judy Kuan.

In moving toward reforming its foreign exchange regulations, Russia has made its currency fully convertible. However, while the recent lifting of restrictions on rouble convertibility demonstrates good faith by the Russian government to create a more welcoming locale for foreign investors, it seems that the move won’t have all that much of an impact for private equity firms – or other foreign investors – active in Russia’s market, at least not without accompanying reforms to provide for greater political and economic stability.

Russia’s rouble reform: first step to a robust economy

“I think that full currency convertibility is a sign that Russia’s economy is robust and capable of integrating with markets,” wrote Michael Calvey, founder and co-managing partner of Moscow-based private equity firm Baring Vostok Capital Partners, in an email to PEO. However, he added, “I don’t expect much of a tangible change for our businesses, since the currency has already been convertible inside Russia for many years with few restrictions.”

Calvey pointed out that one potential effect of rouble convertibility could be additional pressure on Russia’s currency to appreciate against the US dollar and the Euro, which could bolster Russian companies targeting the domestic markets, while weakening exporters. “Currency appreciation has been happening anyway for the last few years due to Russia’s large trade and budget surpluses, so it won’t be a new surprise,” said Calvey.

Ekaterina Panteliushina, investor relations director for Moscow- and New York-based Delta Private Equity Partners, agreed, also in an email, that the rouble convertibility assists Russia’s movement toward being a global player within the international financial markets and a more viable destination for foreign capital – but that investors would welcome further changes.

“Strong Russian currency is a sign of mature economy and stable financial system,” said Panteliushina. “We hope that the new law will be followed by other similarly important initiatives introduced by the Government aimed at further strengthening of the economy in the country.”

What would make a significant change for private equity firms and other foreign investors? According to a report released yesterday by the Organisation for Economic Co-operation and Development (OECD), the lifting of rouble convertibility controls comes ahead of schedule – previously anticipated to be implemented by 1 January 2007 – but needs to be accompanied by additional reforms to capital controls and greater policy transparency.

According to the OECD report, entitled Investment Policy Review of Russia 2006, such measures include improving the reporting system for financial activities, as well as stronger oversight of financial institutions to prevent money laundering, tax abuse, and corruption.

From a practical standpoint, the convertibility of the rouble won’t mean much to foreign investors unless the Russian currency is easily accessible outside of Russia and can be invested directly into assets in Russia. At present, it is still challenging to buy roubles even in markets like New York or Hong Kong.

Besides, it has become standard practice for private equity firms to acquire companies in Russia via offshore vehicles domiciled in Cyprus or other jurisdictions which have favourable tax treaties with Russia – in addition to permitting private equity firms to invest in dollars, these also sanction the application of English or US partnership law, thereby allowing the enforcement of tag-along and drag-along rights.

Adopting a fully-convertible currency regime is a step in the right direction for improving Russia’s investment environment, but more is needed before the market can truly be accessed with ease by foreign investors.