BUSINESS

Russia's dollar fixation is a big part of the country's risk perception problem and one of the reasons why assets here trade at a discount.

Two weeks ago, when the Central Bank announced the partial free float of the rouble, it probably thought that the decision would buy a lot of time before it again faced having to take some drastic action.

Instead all it did was paint a target (of 41.0 against the dollar/euro basket) for traders to aim at. On Monday, they almost hit the bull's eye - and they surely will soon.

As a result, investors now assume that the government is again faced with having to make a major, and imminent, decision about the rouble.

Given the uncertainty over the currency, albeit with a prevailing view of continued weakness, the consequences for the country's investment credibility of taking no action will be just as damaging as making the wrong decision. Right now, investors expect the rouble to continue weakening and that is one of the main reasons why Russian assets have been sidelined and are languishing at such a cheap valuation relative to their peers in other big emerging markets.

Expectations of a major action are growing. Although Sergei Ignatyev, the Central Bank chairman, has said the 41.0 lower basket limit will be defended until the price of oil dips to $30 per barrel (and stays there) most investors assume that that, in reality, this luxury really does not exist.

The country's foreign exchange reserves reached $386 billion last week and trying to defend the rouble at this new rate will only ensure that the value of the reserves continues to fall speedily. In that case, it is assumed that it is only a question of when, rather than if, the rating agencies withdraw the country's investment grade status.

Investors are already beginning to assume a higher risk that it may be lost and this is another reason why asset prices and investment flows are so low. But, in any event, extending the lower end of the basket again will hardly calm nerves as most will see it as only presenting speculators with a fresh target to aim at - especially with the price of oil still tracking lower.

Russia's currency dilemma is unique in major emerging markets and adds considerably to the risk perception of the country amongst investors. It is a legacy of the chaotic 1990s, when people and corporations embraced the U.S. dollar as a counterbalance to the several currency and banking crisis of that decade. But the fact the dollar has remained so widely used by both individuals and corporations is definitely a big problem today.

Stepping out onto any high street in Russia, one is immediately confronted with a plethora of exchange booths advertising the current rouble-dollar rate. It is a benchmark for how people view the economy and their confidence in the future. In no other major emerging economy does that situation exist. In countries that have experienced big devaluations over the past few months, currency weakness is not a major issue in domestic commerce and is much less of an issue in how investors view the stock market.

This year the dollar-denominated RTS Index is showing a loss of 19.6 per cent. That is a bad result when compared to the 9.0 per cent drop in the emerging market average. Because the RTS is the headline index, with the longest history, and despite the fact that its volumes are very small, that is the number that investors are most familiar with. It also adds to the perception of risk in Russia. By contrast, the rouble-based MICEX Index is actually up 1.1 per cent year to date, a much more favourable result relative to the emerging-market average.

Until the widespread use and reliance on a foreign currency is ended, Russia will always set itself up as the exception amongst emerging markets and, in periods like this, that means exceptional risk in the opinion of most international investors.

Businesses in other emerging economies don't price goods or services in e.u. (economic units), at a rate decided almost arbitrarily by the proprietor but loosely based on the rouble-dollar or rouble-euro rate. This was a widespread practice in 1998 to 2000 - and is again making an appearance, despite the fact that it is illegal.

Most Russian companies report their financial results in U.S. dollars and at a time when the rouble has devalued so much the practice adds considerably to the risk perception and distorts historical comparison.

What logic is there for a company, with a mainly domestic business, to report its results in a foreign currency? Companies in Thailand or Brazil or India don't do that. They report in baht, real and rupees respectively. The practice in Russia adds an unnecessary complication to t he investment process, justifies a valuation discount to peers and makes it a lot easier for international investors to simply stay away.

- Chris Weafer is chief strategist at UralSib Capital.

By Chris Weafer