Peter Elam HÃ¥kansson of East Capital -

"What do you think about 2009?" This is probably the most common question we are being asked at the moment, by everyone we meet both at home and during our travels. It's a good question that's not easy to answer.

In the autumn, the International Monetary Fund (IMF) published its world forecasts for 2009, only to release a new, revised version a few weeks later. In this case, a revision means less growth and, for many countries, considerably lower performance figures.

This week, it was the turn of the European Bank for Reconstruction and Development (EBRD) to make a similar move. The forecast for 2009 that was released two months ago was heavily revised, and all of a sudden there were very few countries in our investment region (which corresponds to the EBRD's) expected to post positive growth. Of the larger countries in the region, the EBRD expects Russia to post 1% growth, whilst Turkey is expected to contract by 3%. The Baltics and Ukraine are expected to see the worst growth, and Central Asia should perform best, with an obvious star performer in the shape of Turkmenistan, closely followed by Azerbaijan.

At East Capital, we think these revisions are a good thing; unfortunately, we think that the figures could be worse than those shown in the report.

Russian roulette

Take Russia, for example: the country benefited last year from high raw materials prices, as well as a strong wave of investments. The average oil price for the year was $91, compared with today's $45-50. Anything could happen, of course, but this area alone will cause a large negative effect. The ever-important steel sector has seen its capacity fall by 30-40%, and the demand for steel construction is likely to slump. Like everywhere else, Russia currently has problems with its banking sector, which means that investments in the real estate sector, among others, will have to wait. These facts lead us to believe that the more realistic outcome to expect is one of negative growth rather than stagnation.

This does not, however, take anything away from the fact that the Russian stock market is very attractively valued. We find it hard to understand, for example, why stock markets such as Pakistan have higher valuations than Russia. And it is equally hard to understand why Russian companies in general have much lower valuations than corresponding companies in other countries. The market currently stands at a price/earnings ratio of around 3. Compare this to other emerging markets. Russian oil companies currently trade at between $0.7-2.6 per barrel on the market; Western oil reserves are naturally valued much higher, but how can Petrobas from Brazil or PetroChina be valued at $9.7 and $7.3 respectively? Similar comparisons can be made in the power sector, where once again Russia is extremely undervalued.

So why are Russian stocks so cheap? It actually all comes down to four areas of concern: oil, the rouble, corporate governance and financial market regulations.

If we start with oil, the heavy price fluctuations in the oil price have demonstrated the vulnerability of Russia's, as yet not fully developed, economy. Oil has in turn had an effect on the rouble, which has been under heavy pressure since it became clear that foreign currency loans (often from foreign banks) were much larger than previously expected. Lower oil revenues put pressure on the ability to refinance these loans.

It is difficult for Russia to influence the first two factors, but the remaining two are even more important for the country to focus on. Corporate governance is once again in the spotlight, after the autumn saw some dubious interpretations of what is right or wrong under Russian legislation. And lastly, financial market regulations have been making the news after the markets on occasions were shut down in such a way as to baffle observers and appear over-dramatic.

Peter Elam HÃ¥kansson is CEO of East Capital in Stockholm

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