For a guy who used to work in one of the world’s deadliest spy organizations, Russian President Vladmir Putin seems to give a lot of slack to his new staff. How else could they be permitted to feed him such a distorted picture of economic reality?

This weekend Putin put his uncritical and generous management style on display by treating powerful U.S. businessmen to some local Black Sea caviar while having them listen to him speak in St. Petersburg’s Konstantinovsky Palace. The purpose of such an extravagant event? To use his staff’s reports on recent economic data to convince the Americans that Russia is a fantastic place for foreign direct investment (FDI).

Unfortunately for Putin, by failing to consider the reports within the big picture, his speech ended up being spun with enough sugar to give even the most aggressively optimistic economist the willies.

His main selling points to the conference’s prestigious attendees, who consisted of such FDI powerhouses as Citigroup, NewCorp and IBM, focused on this year’s rather cheery macroeconomic data. He stressed that the country’s GDP expansion of 5.4% makes Russia a great spot for growth opportunities. He reminded investors about the Treasury’s impressive performance, with its last report card showing a cut in external debt from a whopping 60% of GDP in 1999 to only 18% at last check. And, as if that weren’t enough to make investors want to take out second mortgages on their homes to throw more greenbacks at Russia, he announced that the country's banking system is even boasting a record $150 billion in reserves. Certainly this news should have warmed any remaining cold feet.

These are great facts, but pretty much anyone with a laptop can get these data off the internet. So why did Putin feel the need to pay for these guys’ airfare and spare his precious fish eggs for such a speech?

Perhaps he felt responsible for clearing up some of the bad reputations Russia has garnered over the past year. Last summer, just when foreign investors were seeing the country pull out of the 1990s’ struggle to lay communism to bed and started trusting the government not to meddle in the markets, the Kremlin stuck its nose in the business of one of its largest oil and gas companies, Yukos, and slammed an $18 billion unexpected tax bill in front of it. Investors were certainly puzzled, as this bill seemed to come out of nowhere considering the tax burden for 2000, 2001, 2002, and 2003 was 67%, 100%, 111%, and 83% of the company's revenue during those years. To nobody's big surprise, the move caused the enterprise to crumble. Many analysts believed that the tactic was not based on any legitimate analysis but rather designed to strip power away from the politically motivated owner, Mikhail Khodorkovsky. Markets were clearly rattled.

Then there was the Siemens debacle, a seemingly straightforward attempt by a German company to acquire a controlling stake of Russian engineering giant Power Machines that ended up being delayed, deliberated, and eventually blocked by authorities due to fears that the sale of such a strategic enterprise would endanger the state’s security. The paranoid secrecy once thought buried with the fall of the Berlin Wall was rearing its ugly head again. Not only was the government confusing everyone on the tax front, but they seemed to be making up the rules as they went along regarding what foreign companies could and could not own.

In addition to these government interventions causing foreign investors to tighten their grip on their wallets, the country’s corruption is making the situation even worse. At the last survey of Transparency International, a corruption rating organization, Russia was 90th on the list, humiliating it to a status below Armenia and Iran. When it turns out that bribes mean more than contracts, American businesses tend to steer clear.

If the legal system is questionable, then property rights are atrocious. Even items as containable as website domain names are left uncontrolled, making companies such as Kodak need to fight in Russian Supreme Courts to obtain ownership of www.kodak.ru from Joe Schmo “cybersquatters” who purposefully register for websites with names that are left unprotected due to the lack of Russian trademark laws.

These are the kinds of characteristics that make investors say the heck with it and move into more stable, predictable areas like Hungary (which, incidentally still attracts more FDI as a % of GDP despite being worse than Russia on the three fronts Putin said were so important – GDP growth, reserve status and debt). And guess what. You won’t find this qualitative information in the types of numbers spouted by Putin this weekend. Great statistics are one thing, but if the infrastructure isn’t there, the economy becomes a tough sell for FDI.

In fact, just the simple act of making such optimistic statements while continuing to ignore these important issues can do more harm than good. It shows nearsightedness and an unwillingness to drill down to core issues. Suddenly the data don’t look so cheery anymore.

So maybe next time Putin decides to spend his rubles on such a fancy conference he should double check his staff’s reports and make sure they’re telling the whole story. Because even though it can be helpful to broadcast good news, the more often investors feel cheated by bad surprises, the more often they’re going to ditch the Russian party and go try the neighbor’s caviar instead.

Posted by Michelle Smith on June 28, 2005 10:34 AM

Posted by: Craig Lebamoff at September 14, 2005 03:28 PM