In today’s global economy prudential barriers have largely replaced legislative barriers to the free movement of capital. Private agencies award countries credit ratings which are designed to inform often ignorant capitalists about the degree of risk attached to investing in a particular country.
In fact, this practice dates from the 19th century, when the French Credit Lyonnais established itself as the leading credit rating agency in the world. Interestingly, Russia was rated in the top category of credit worthiness; largely, it seems, because of its imperial government’s exceptionally favourable debt/asset ratio. (Not surprising, since it owned most of Russia’s natural resources, and omitted amortisation from its accounts.) As a result, French investors were more than happy to buy Russian government bonds, on which the revolutionary Soviet government promptly defaulted in 1918. The failure to honour ‘Tsarist debts’ was a major factor in the virtual extinction of the international bond market for fifty years.
Can today’s agencies do better? On 8 October Moody’s upgraded Russia’s investment rating from Ba2 to Ba3 –up from junk bond to investment grade status. The ratings are a measure of the risk associated with the government’s debt –that is the riskiness of its Eurobonds. The upgrade will open Russia to a much larger pool of investors which should lead to cheaper borrowing and a rise in share prices.
Justifying its decision, Moody’s cited better fiscal discipline, improvement in debt/GDP ratio, large central bank reserves, the formation of the oil ‘stabilization fund’, rapid economic growth, pro-market reforms, and the fading of political risk. The investment grade was awarded during the very week when police with sub-machine guns raided an orphanage funded by Yukos. ‘Moody’s believes that the political infighting both inside and outside… the Presidential Administration does not threaten the broad direction of pro-market reform and development’, said the agency.
Before investors rush in, it is useful to point out the distinction between political risk and legal risk. The fact that the Russian government is now trusted to pay its debts does not guarantee that investors in Russian businesses will not have their money stolen. Ever since the collapse of communism, legal risk –the absence of what people in the West understand as the rule of law, binding not just on citizens but on the state apparatus, and including a free media to publicise abuses of power- has been the biggest obstacle to foreign investment in Russia. Insecurity of property rights and the arbitrary, corrupt, and politicised character of the legal process remain huge problems, even as the political system becomes more stable, and the finances of the government improve. As Helena Hessel of Standard and Poor, another credit-rating agency, put it with commendable restraint: ‘improvements to the functioning of the state and judicial operations continue to be modest’.
One example suffices to make the point. On 11 September British Home Secretary David Blunkett granted political asylum to the exiled oligarch Boris Berezovksy, which means that he cannot be extradited to Russia. The Home Secretary did not give his reasons, but it can be reliably surmised that his decision was based on the view that the charges against Berezovsky were politically motivated, that he would not get a fair trial, and that his life would be in danger if he returned to Russia. His action does not suggest a high regard for Russia’s legal system.
So which story do you believe-Moody’s or David Blunkett’s? The answer is that both may be true. Political risk is lower than it was; legal risk remains high. Sovereign debt may be honoured; business debt is a different matter. And while the Administration seems eager to reassure the bondholder, it seems indifferent to the sentiment of the portfolio or direct investor.
The single most practical step it could take to reduce legal risk is to grant a general amnesty for economic crimes committed in the turbulent 1990s. But that would mean a loss of one of its main levers of power – the threat of prosecution for offences in the past in order to secure compliant behaviour in the present. This is one risk too much for the frightened men of the Kremlin.
Robert Skidelsky 