By Dr Max Gutbrod

Despite the seemingly contradictory information in the news of late, the new face of the post-crisis Russian capital markets is nevertheless becoming clearer as are the associated risks in participating in them.

Russian banks are still in bad shape, and the overall sector is currently reported to have a negative net equity. Nevertheless, as Vice Premier Khristenko confirmed immediately after his appointment, there is huge ruble liquidity. The reasons for this are obvious.

To begin with, production in Russia is increasing, and this should drive up cash revenues as a natural consequence. Also, money lost by Western creditors has not simply disappeared but is rather reappearing in the portfolios of some banks' debtors, via reductions of loan amounts from offsets of banks and via proceeds from asset stripping. Moreover, while capital flight continues to exist, those Russians with money and an understanding of the potential for the internal capital markets here are likely to bring funds back on shore. Practically speaking, the instruments which were most likely to bind liquidity are government-fixed yield instruments, but in the aftermath of 17 August government default, they are and will continue for the foreseeable future to be viewed as unreliable.

Russian individuals and corporations would evidently put the existing liquidity into Western banks if they were available, which is the basis for government officials' favorable comments to foreign banks.

But what do Western banks do with that money? Lend to Russians? Not to any significant extent, because the already low reliability has been compounded by the absence of sincere efforts by the political elite to encourage the confidence of foreign banks in the aftermath of the crisis.

We can assume that Russian banks would be more open to lending to their Russian counterparts in the future and will therefore be better able to borrow at higher yields from those persons with available liquidity. This will put them in a stronger market position vis a vis Western banks sooner rather than later.

All of which is to say, there will once again be lending in the months ahead, but it will mostly be done by Russian banks

An alternative for the liquidity which exists in Russia would, of course, be to invest capital into the stock market. However, the structural deficiencies of the legal framework with respect to such issues as bankruptcy will continue to prevent investors from doing so. Similarly, while protection against share dilution is technically in place, it is expensive to litigate under current rules. Moreover, no rules whatsoever exist to prevent asset stripping. Finally, it can be argued that registration with either the Securities Commission or the Central Bank does not protect shareholders from concerns about the legality of new issues. Unfortunately, investors are still not fully cognizant of the risks of wrongfully issued securities which result in payment for something which never technically existed.

Therefore, it is imperative that the legal framework is fully completed and strictly enforced in order to provide capital market investors with the required measure of security that exists in the other more established jurisdictions which are competing for their money.

In spite of the serious systemic problems which remain, we can expect the market to go up, as it still presents investors with a more attractive investment option than banks. Nevertheless, the new market will be national in character as its deficiencies are such that the global markets will not risk getting burned until real improvements are made.

Investment in shares, however, could be facilitated by investment funds, which would be better able to detect risks at an early stage and would have the leverage to bring violations to court. Such vigilance in monitoring and enforcing shareholder rights would in turn compel some of the needed systemic changes to be made; changes which will never result if everyone keeps shrugging their shoulders in apathetic acceptance. Furthermore, growth in investment funds not only represents a significant opportunity for Western institutions but for Russian investors as well.

All in all, as the one-year anniversary of the crisis nears, the situation is far from hopeless. The Russian capital markets will revive themselves. Yet what is most needed is not another round of paper reforms but a genuine effort to develop a system which is not purely imported from one of the world's major financial centers but which is a homegrown response to the realities of Russia and the demands of investors.

Dr Max Gutbrod, 28 June 1999

The author is a partner at Baker and McKenzie, Moscow

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