Taking Stock of Bonds

August 11, 2008

Rating An Aggressive Neighbor

Just as the world gathered for the Olympics amid global bonhomie, Russia attacked its neighbor, Georgia. Tanks rolled across the borders and it could have been Hungary 1956, Czechoslovakia 1968 or Afghanistan 1979. Russian Federation flags waved over tank turrets instead of Soviet flags.

For naive US foreign policy makers this may have come as a shock. For most Eastern European governments it probably affirmed what they already knew about their increasingly belligerent neighbor.

As the chief of staff for an Eastern European nation's president once said to me privately, "You can change the colors on a bear, but you will never change its true nature."

The question now is how the flare-up in border hostilities will play out. For anyone who has watched Russian politics, today's leadership has taken a page out of the Soviet playbook. Invade a neighbor on the pretext that a minority population in the neighboring country is being oppressed. Back before the fall of the USSR the invasion or military action would have been made to support "comrades." Today, this is called a peace keeping mission by Russia.

So how should US and other business leaders look at doing business in Russia? Much has already been written about how BP has had trouble with its joint venture and there are other examples of problems for businesses operating in Russia. The question now is whether US and other rating agencies should reconsider the way they view the sovereign rating of Russia and other Russian issuers.

Can you do business with a nation that does not respect the rights of its neighbors? Can you do business in a nation where business leaders are hounded by local authorities if they oppose Kremlin apparatchiks? Can you do business in and with a society that does not respect the press and is not truly open? One of the basic ingredients of a free market is a free society.

Just today, Standard & Poor's raised its long-term counterparty credit rating for Russian BIN Bank. Perhaps on this day a more appropriate warning for investors would be the one on the CIA Web site: "Political uncertainties associated with this year's power transition, corruption, and lack of trust in institutions continue to dampen domestic and foreign investor sentiment. Putin has granted more influence to forces within his government that desire to reassert state control over the economy. Russia has made little progress in building the rule of law, the bedrock of a modern market economy. The government has promised additional legislative amendments to make its intellectual property protection WTO-consistent, but enforcement remains problematic."

The rating agencies missed the boat when it comes to problems with housing and the mortgage mess. Hopefully they get it right this time when it comes to rating Russia. At the very least, a note of some caution should be offered to investors and other business leaders.