* Russian discount in equity/corporate debt, not sovereign
* Politics stable despite volatile business, legal sphere
* Can Russia remain cheap for long with expansion of EM?
By Mike Dolan
LONDON, Sept 22 (Reuters) - If political risks alone explain investor wariness of Russia, the discount on the country's equities may now be excessive.
Russia has leapt off investment research pages this year on one glaring statistic -- its main equity indices are trading far cheaper than either their developed or emerging peers.
Estimated price/earnings ratios for the Russian equity market, based on comparative MSCI country indices, are almost half those of major world bourses for this year and next and some 40 percent below emerging market peers.
Strategists, corporate chiefs and top government officials gathered for Reuters investment summit in Moscow last week cited a host of possible reasons for this "discount" -- over-reliance on the energy sector, governance and corruption concerns, an all-pervasive state and, of course, political risk.
When you tot all that up, it amounts to a pretty hefty drag. And yet commodity skews, corporate graft and a heavy state hand are hardly unusual in the sorts of emerging markets that investors are falling over themselves to chase this year.
So is the Russia discount then down to worries over political stability and over-dependence of the country on the fortunes of one political figure -- or at most two?
With Prime Minister Vladimir Putin widely expected to run again for a newly-extended, six-year presidential term at 2012's election -- a reprise of his eight years in the Kremlin between 2000 and 2008 -- that anxiety seems legitimate.
But Russia's "strong man" political structure can hardly be something new to investors.
And for all the concern about Putin's "democratic deficit" and geopolitical muscle flexing, is his leadership role and that of close ally and current President Dmitry Medvedev that much more of a risk than China's communist party or South Africa's African National Congress, for example?
STABLE SOVEREIGN
To look at sovereign securities, the answer would appear to be 'no'. Investors appear relatively comfortable about the stability of the state itself and its willingness and ability to pay back its relatively modest debts.
Russia's sovereign dollar eurobonds, for example, are trading at yields some 2.2 percentage points over U.S. Treasury bonds, close to emerging credit peers like Brazil, at just over 2 percentage points, and well below the JPMorgan EMBI emerging market benchmark at 2.8 percentage points.
And the rouble, with year-to-date gains on the U.S. dollar of some 2.5 percent, has outperformed other 'BRIC' currencies from Brazil, India and China.
So the Russian discount is equities specific -- or at least corporate related. For example, Russian corporate debt premia, unlike the sovereign, are some 57 basis points higher than JPMorgan's CEMBI emerging world corporate benchmark and second only to China companies within the BRIC universe.
For many, this corporate risk is a result of the personalisation of Kremlin power; the relatively high risk of state expropriation; and the intense Kremlinology and "local knowledge" required to assess that risk. It has loomed large over Russian equities since the arrest of oil magnate Mikhail Khodorkovsky in 2003 and dissolution of his oil firm YUKOS.
As if to ram home the point, the World Bank ranks Russia 120th internationally in terms of ease of doing business.
Bank of America Merrill Lynch, in a note to clients this month, said there is progress and planned government privatisation and modernisation programmes will help. But it stressed cautious optimism and advised treading carefully.
"The message to foreign investors is still not very clear as exemplified, for example, by the delay to amending the law on strategic investments, which prevents investments in critical industries like natural resources," it said.
But with Putin and Medvedev still commanding about 70 percent public approval ratings, the "chaos" of the 1990s still fresh in people's minds and economic growth back in excess of 4 percent per annum, Russia appears comfortable with its course.
"There is for now no demand for political modernisation in Russia. For there to be demand you need a social group who can demand it," Anatoly Chubais, one of the architects of Russia's post-Soviet economic reforms told the Reuters summit last week.
"Economic modernisation can and should be started without political modernisation," he said, adding the former could only be completed with the latter.
With demand for emerging market debt and equity rarely higher as western economies go through painful, debt-laden repairs of broken financial systems, the big question is whether Russia can remain "cheap" for much longer.
The morphing of the G7 club of top economic powers into the G20 last year to include the big emerging powers means the centre of political gravity in the world has shifted and external political pressures on Russia will be inevitably less.
Russia will increasingly be seen as part of a global investment menu for all institutions rather than just emerging market specialists and will be hard to avoid, for all its risks. Cheap valuations may well be looked back upon with nostalgia.
Goldman Sachs estimates developed world investment institutions will actively purchase roughly $4 trillion of emerging market equities over the next 20 years. It is hard to imagine Russia not being part of that.
(Editing by Ruth Pitchford)