Russian Stocks Fall Far and Fast

By rights, this year's Sochi Economic Forum should have been a victory lap for Vladimir Putin. Russia's president turned prime minister had just, in his own words, "punched the face" of upstart Georgia, and a year of record oil prices had boosted Russia's currency reserves to $700 billion.

But instead of triumph, Russia's premier business-schmooze event was deep in gloom. Since the Georgian war in early August, an estimated $45 billion in foreign investment has left Russia as spooked investors have fled. Now Russian stocks are 57 percent off their May peak—compared with the average emerging-markets hit of 30 percent.

Putin was quick to blame the United States for the market's crash: "A systemic breakdown has occurred in global finances," he told an audience of businessmen, bureaucrats and oligarchs. "This is because of the unsatisfactory economic and financial policies of the world's leading economies, including the U.S." As for the 30 percent difference between Russia and other emerging markets, Putin just ignored it, insisting that Russia was in "a rather stable political and social situation."

Investors beg to differ. What with Georgia, the falling price of oil and a growing record of abuse of foreign investors, Russia seems more and more a broken BRIC. President Dmitry Medvedev tried to stabilize the market by promising a $44 billion credit line to secure banks, and even offering $19.6 billion to buy up flagging shares. But with inflation rising, business costs soaring and the state apparently unwilling to protect investors, the promises aren't working.

That said, Putin is partly right: the market troubles are not all of the Kremlin's making. A 28 percent drop in the price of oil certainly helped drive down Russian stocks. And many foreign investors have reined in their emerging-market portfolios in response to a credit crunch back home. But markets have fallen farther and faster in Russia than anywhere else except China (where red-hot stocks were overdue for a major correction). And while there are still plenty of longer-term China bulls, investor confidence in Russia is now almost non-existent. At least two major Russia funds, the Nikitsky Russia Fund and Hermitage Capital, have pulled out of Russia for good over the past year.

Investor confidence was already falling long before Russia's surprise invasion of Georgia. An ongoing feud within the TNK-BP joint natural-gas venture showed that the Kremlin was at best unwilling to protect foreigners' rights. Meanwhile, Vladimir Putin's ominous warnings that the head of coal giant Mechel (who was allegedly avoiding taxes and social obligations) should "see a doctor" resulted in the company's stock losing 60 percent of its market capitalization in one day.

Russia desperately needs foreign capital, especially in the energy sector, where it doesn't have enough expertise to fully exploit hard-to-reach reserves. But its plan for reversing the rush for the door doesn't inspire much confidence. At one of the discussions at the Sochi forum, titled "How to Make 'Brand Russia' More At-tractive," one Russian participant opined that Russia is "great and powerful" already and "doesn't need foreigners anymore." Sergei Polonsky, a 34-year-old billionaire Moscow real-estate developer, suggested "jailing all journalists who s––t on Russia." To prevent tempers from flaring higher, the discussion's moderator, Russia's Deputy Minister of Economic Development Stanislav Voskresensky, called a halt. "I will take advantage of the absence of democracy in Russia and declare an end to this discussion," he joked nervously—but also pretty much describing the government's own last resort: close the door and pretend everything is OK.

In truth, the Kremlin does know exactly what needs to be done—but there seems an ever-dwindling chance of it actually doing it. When he took power in May, Medvedev talked of taking on Russia's culture of "legal nihilism," warned bribe-seeking bureaucrats to stop "terrifying" businesses and swore to tackle corruption—which seems to be the only growth industry left in Russia. "The shadow economy is at least twice as big as the real economy of Russia; we reported the figures to President Medvedev," says Kiril Kabanov of the Independent National Anti-Corruption Committee, an NGO.

It's gotten so bad, some free-market advocates in Russia hope for a free fall in the price of oil to shake the Kremlin's growing grip on the economy. But the more likely scenario is that oil prices will hover high enough to keep the status quo, even as the credit crunch pops bubbles in the property and retail markets. As the Kremlin is discovering, there's more to national greatness than just tanks—markets matter, too, and they are becoming Russia's Achilles' heel.