Trip Report - Kiev, Ukraine; Feb 2014; Part II - Stock Market and Business Structure

Stock Market

My interest in Ukraine began in July 2013, when it appeared on a list of one of the world's worst performing stock markets.  The PFTS index and the narrower UX index had fallen over 70% from their March 2011 highs.  Many stocks were trading at very low valuations based on ratios commonly used by the financial community such as Price / Earnings, and Price / Book Value.  

Surprisingly Ukraine's equity markets held their own after November 2013 when the Maidan protests in central Kiev started.  During its December 2013 market lows the PFTS index was down less than 10% from where it was in the preceding July.

I haven't seen any research to support this, but a rule of thumb is that markets tend to hit bottom when they do not decrease on bad news.  Give all the problems and chaos a 10% decrease did not seem so bad.

With the local markets somewhat resilient despite months of protests in Kiev’s city center I thought it made sense to see for myself what was going on. 

Another thing I liked about the country is that it already seemed like it was in the middle of a political crisis.  Protests in the center of the city had been going on for close to three months and seemed to get bigger despite the chill of winter.

“…the crisis occurs at the end of the problem – not the beginning.  The crisis actually initiates the process of repairing whatever problem created the crisis”, wrote Frederick K. Martin in, ‘Benjamin Graham and the Power of Growth Stocks’. 

But who knows where and when things bottom until after the fact? 

Dead Market. Several people I met in Kiev told me that Ukraine’s stock market is dead.  Turnover has dried-up, prices are way down, and most companies are listing abroad if they list at all.  

Bid/ask spreads can be 100% or even higher. Free-float is small and declining.  Corporate governance is weak and minority shareholder rights are virtually non-existent.  Very few companies pay dividends.  

Brokers in Ukraine don't seem to make money from trading local shares.  Instead they earn their keep by trading fixed income, equity of Ukrainian companies listed outside Kiev, and helping local clients trade foreign stocks and bonds. 

Most managements don’t want to meet with investors, don’t post their accounts on their website, and don’t respond to emails.

It sounds like it was never much of a market to begin with.  From what I was told and read there has never been more than a handful of IPOs, rights issues or other equity funding in Ukraine. 

The market was set up to trade shares that were given to the general public after the USSR’s fall and many 'listed' companies don’t want on be on the exchange.  Even when they are some don’t consider themselves to be 'public'.  It is a very strange feeling when the management of a listed company whose shares you've just bought says that they are looking forward to an IPO. 

Ukraine’s budding entrepreneurs have instead raised equity capital outside of the country, mostly in  Warsaw and London. There are at least twelve Ukrainian companies listed in Poland and at least six in the UK.   

BusinessWeek Cover
13 August 1979

Ultimate contrarian play?  If one needed a contrarian ‘buy’ signal Ukraine has more than enough.  And that’s before getting into domestic, regional and geopolitics which are seem to grow more uncertain day-by-day as I write this in mid-May 2014.  (These were discussed in the first part of this two part blog and can be accessed here).

The situation reminds me of what I've read about Wall Street in 1932 and 1979 when equities were all but given up by the general public in America.

It also reminds me of Indonesia during the 1997/98 Asian financial crisis. Indonesia is my base case emerging and frontier market as I've been following it off-and-on since it opened up for foreign investment in 1989.

But there are a lot of differences between Ukraine now and historic US and Indonesia.  Notably neither of the latter two were facing the possibility of invasion by a bigger and aggressive neighbor.  Then US President Carter was seen as weak, but nobody wanted to invade the US in 1979.  And who wanted to take over the chaos that was Indonesia during and after the 1997-1998 Asian financial crises?

One part of Ukraine’s financial chicken-and-egg problem is the lack of local institutional investors.  Except for the National Bank of Ukraine, financial industry contacts had difficulty naming any local pension funds or other institutional investors.  Many funds sprang up in the 2000s during the local market’s two rallies, but from what I can tell, the few that survived are but a shadow of what they once were.

Hope springs eternal.  I learned on my trip that the exchanges and bankers are not taking things sitting down.  In addition to plans to merge the country's two exchanges later this year (UX and PFTS), I was told of additional initiatives to reform and strengthen Ukraine’s financial sector:   

• The exchange and I-banks are working on a program to list younger, financially hungry, and fast growing entrepreneurial firms. 

• Laws strengthening corporate governance and minority shareholder rights were supposedly winding their way through parliament before they were side tracked by Maidan protests.  

• One of the exchanges is working with the government to strengthen the local pension system, which – outside of the government and a few large banks - appears to be non-existent. 

• Dual listings are also a possibility and one of the exchanges is talking to Ukrainian companies listed on other exchanges to have a secondary listing in Ukraine

The Ukraine equity markets have held up pretty well despite the all-too-obvious headwinds.  The broader PFTS index is up some 30% YTD, but flat in US dollars given the Hryvnia’s 30% fall.  The narrower UX index has not performed as well rising some 16% YTD.

Depending on what index is used this is in line or better than the Russian index and currency.  The Micex and Rouble are both down some 8% YTD.  In US dollar terms this is about the same drop as the UX index, but worse then the PFTS index.

Structure

Like most non-Anglo-Saxon countries, most of Ukraine’s business is split between powerful families and the government. In fact the entire structure is very similar to Suharto-era Indonesia. 

In Ukraine large business owners are known as “oligarchs”.  They are analogous to Asian tycoons in many respects as their business empires typically consist of several loosely related businesses. 

The key difference is that oligarchs are also politically powerful.  In Indonesia and South-East Asia business groups are typically owned by ethnic Chinese.  Their owners - due to racial reasons - have largely been excluded from political positions. 

The biggest.  The largest business group in Ukraine is Systems Capital Management (SCM).  Formed and owned 100% by Rinat Akhmetov, SCM controls some 17 listed companies, 40% of Ukraine’s power distribution (DTEK), its largest telecommunications company, and a large chunk of its steel making capacity (Metinvest).  

He and his group are similar to Sudono Salim and his Salim Group, which was the largest business group in pre-Asian Crisis Indonesia. SCM’s revenue accounts for some 5% of Ukraine's GDP according to SCM literature, or about the same proportion as the Salim group did in Indonesia in the early 1990s.  Their leaders Akhmetov and Salim, are and were the richest individuals in their respective countries.

Unlike Salim, Akhmetov is directly active in politics as he is Member of Parliament and a key backer of the Party-of-Regions. In Kiev I was told that he bankrolls a not-too-insignificant number of MPs in Ukraine's 450-seat unicameral parliament (known as Verkhovna Rada).  

This likely makes him the most powerful person in Ukraine, as he has both financial and political power.  

Assembling his conglomerate under murky and possibly criminal circumstances, Akhmetov is increasingly moving SCM and its companies toward international business standards (see Wikipedia entry here).  To keep growing, SCM needs access to international capital markets and several of the group’s companies have issued Euro bonds.  The senior managers I met at one SCM subsidiary were about as polished as any US/UK/EU MBA educated 30-something as they come.  

Interestingly Akhmetov has openly stated that he favors a unified Ukraine and seems to be backing this up according to one insightful report.  In an open letter posted on SCM's website four days after Russian forces moved into Crimea, he wrote:

“I state with all due responsibility that SCM Group, which today employs 300,000" people and represents Ukraine from west to east and from north to south, will do everything possible to maintain the integrity of our country.” Signed Rinat Akhmetov, President, System Capital Management, 2 March 2014. 

Another "First Family". The fastest growing business ‘group’ in Ukraine since 2006 was ex-President Yanukovich's family.  According to the fascinating “The Oligarchic Democracy", Yanukovich’s interests are represented by his sons, Oleksandr and Victor.  Oleksandr was in charge of business and Viktor was an MP and a member of the Party of Regions. The report calls them and their associates whom they put into powerful positions, ‘the family’.  It notes that ‘the family’, ‘…is currently the most aggressively operating group in Ukraine’.

In yet another case of history rhyming, during the last 10-15 years of Suharto’s presidency his sons become amongst the most aggressive businessmen in Indonesia, and many referred to the extended Suharto family and their associated business groups as the “First Family”. 

Independents and Red Directors.   Not all businesses in Ukraine are part of large conglomerates.  In fact some of the companies that do want to be listed, have good investor relations and more progressive management are many times independent.

Not all, but most seem to be led by true entrepreneurs.  They've built up businesses over many years and deftly navigated through Ukraine's rapidly shifting business and political environment. 

To the far left of these self-made entrepreneurs are Ukraine’s ‘Red Directors’.  ‘Red Directors’ is a term used in Ukraine to describe the controlling shareholders and senior management that think and act as if the USSR was still intact.  In general they are seen as keen to get business, but are not keen to share information about their company.  They would be somewhat analogous to the secretive, trust no-one-but-family-member groups that are increasingly rare in the Internet age.  

========

My 10-day trip to Kiev was an eye-opener.  It was my first time in Ukraine and the first time in the former USSR.  It was also just my third trip to the European continent, so there was a lot to learn. 

Like virtually all trips, it was a humbling experience. The more I travel the more I realize how little I know.  While I feel better informed about Ukraine than before the trip, I'm sure that the last two blog posts barely scratch the surface.  

Also like other trips, I was lucky to meet many smart, switched on, and helpful people that very kindly took their time to help me better understand the country and its investment prospects.  This was even more appreciated given that I was in Kiev during such an eventful week.  It takes a strong will to remain focused, when just a short distance away, one's fellow citizens are standing in harm's way. 

Trip Report - Kiev, Ukraine; Feb 2014; Part I - Economy, Politics and A Bit of History

In planning my February 2014 trip to Kiev, I envisioned the Beatles' ‘Back in the USSR’, looping in my head as I visited companies, brokers and took in the odd tourist site.  

However I was there when the Maidan protesters were shot in central Kiev (13–22 February 2014) and the Talking Head's ‘Life During Wartime’ became the trip's soundtrack.   "A van, loaded with weapons, packed up and ready to go", is much more sobering and not nearly as much fun as “The Ukraine girls really knock me out.” 

Politics, Geopolitics, and a Bit of History

I’m not a big fan of politics.  Even less so of geopolitics.  But as this is being written in May 2014, Ukraine is front and centre in what seems like the beginnings of “Cold War 2.0” so politics is hard not to comment on.

Its eastern regions are holding referendums to break away, the press is writing that Ukraine may descend into  civil war, and Russian influence in the region seems apparent looking at pictures of the uniforms and flak jackets that pro-Russian protesters/soldiers are wearing.

Political uncertainty many times create good opportunities to invest in companies that may have been oversold. I've written a bit about this before (link here).  The Ukraine market had held up very well in the three months between when the Maidan protests started and I finally got my act together and went there. 

The Internet is flooded now with lots of writings about Ukraine, Russia, and how the EU and the US will react.  Most predictions will turn out to be false if the past is anything to go on (see Nate Silver's very good book The Signal and The Noise).  The article that best describes the situation after my week in Kiev was published by Quartz.com and can be found here.

I left Kiev with the impression that the West-East divide is not as serious as the press makes it out to be.  While most press reports – and most of the world – have escalated the Maidan protests and their aftermath into a Russia vs. the EU/US confrontation, I came away from my trip thinking that it was mostly a protest against 20-years of corrupt, power-hungry leaders of which Ukraine seems to have had more than its fair share of.  (for a better summary see here).  

A recent and very good Al Jezeera video report by Michael Anderson called Ukraine: A Dangerous Game added additional insight into the current situation.  The video references a (Ukraine) National University poll which indicates that in eastern Ukraine, less than 1 in 10 young people want eastern Ukraine to become part of Russia.  It also notes that most young people don't really care which language is spoken.  

He also believes that both Russian and EU/US journalists are irresponsible in the way they are reporting the current situation.  He notes that there is heavy propaganda in Eastern Ukraine that is stoking the conflict, and that most Western journalists are playing up a conflict that is not really there. 

My largest concern is that the democratic process was sidelined when Yanukovich lost his position and Ukraine moved form a presidential to parliamentary system.  It all happened in an extremely short period of time and seems too good to be true. I’m not really sure if it all went down by the book and the quickness may come back to haunt Ukraine in the future.  As I've written before, I think it is important for the process of democracy to be respected even if the current actors in that process are not great (link is here).

Brothers.  Another takeaway from the Kiev trip is that it will be hard for Russia and Ukraine to separate.  The two seem like the US and Canada; the US and Mexico; or Indonesia and Malaysia.  They are neighbors, speak the same language, more or less and share common histories and are amongst each other’s largest trading partners and investors.  I came away feeling that Ukrainians and Russians are basically brothers and sisters.

But I'm biased as I tend to see more similarities between people and nations than I do differences.  It is very likely that I am minimizing some fundamental differences.  As a CEO of an agricultural company I met in Kiev said, “Ukrainians are farmers. Russians are warriors”. 

Not to be forgotten is that siblings tend to fight the hardest. And the longest.  Protestant and Catholic Ireland, Sunni vs. Shia in the Middle East, North and South Vietnam, North and South Korea, America’s Civil War.  

However there is a lot of cross-border business that will keep the less politically involved Ukrainians and Russians interacting.  Some of this directly affects equity and bond investors.

This is because the largest shareholder of both financial exchanges in Kiev is the Government of Russia.  The Moscow Exchange owns 43% of the more equity-centric Ukrainian Exchange  (www.ux.us) and just over 50% of the more bond-centric PFTS (www.pfts.com).   The Moscow Exchange, is ultimately controlled by the Government of Russia through five entities the make up more than 50% of its ownership.  

Many companies that I met in Kiev either sell to or have investments in Russia.  Russians own controlling stakes in many Ukrainian listcos, and numerous Ukrainian listcos do significant business and have investments in Russia.

This includes the leading presidential candidate, Petro Poroshenko.  He owns Roshen, Eastern Europe’s fifth largest confectionery company.  In addition to Ukraine it has factories and outlets in Russia.  Sales of Roshen chocolates and other products were suspended in Russia for several months in 2013 with the reason suspected to be his political support for the Maidan protesters.  Earlier this year his factory in Lipetsk, Russia was closed down after it was taken over by riot police (link here).

Russia sometimes makes it hard for Ukraine to love it.  According to an insightful article in the International Edition of The Ukrainian Week by the very talented ex-buy-side analyst turned financial journalist Lyubomyr Shavalyuk, “Russia is proactively substituting (several) products with those made domestically and protecting its domestic market”.  The article points out that Russia has introduced many non-tariff trade barriers that effectively shut out many Ukrainian made goods that were previously exported to Russia. (For additional information on Russia, my review of the book Russians: The People Behind the Power, by Gregory Feifer is here)

This fact was brought home when meeting with an executive of a listed car manufacturer.  Soon after building a car factory, Russia changed some non-tariff regulations that effectively shut down Russia as an export market.  The new regulations were a way to protect Russian car makers at the expense of the new Ukrainian plant.  Now the plant is operating at some 20% of designed capacity and needless to say is losing money. 

Language. Some press articles have said that language is an issue between East and West Ukraine, but I think this is overplayed.  According to my hosts, all meetings in Kiev that weren't in English were in Russian.  My one word of Russian, "dos vidanya" or thank-you, was met with smiles from everybody I said it to; taxi drivers, hotel staff, CEOs/CFOs, etc.  

Stockbroker contacts in Kiev - two very proud Ukrainians - admitted that they never really speak Ukrainian - but they can understand it.  Others were proud of their native Russian heritage, but admitted they did not want to be part of Russia, and felt 'Ukrainian'.  This included a few that grew up and/or spent time in Kharkov and Donetsk, two of the larger cities in Eastern Ukraine that are pegged as pro-Russian.

Ukraine is in fact more than a bilingual place, which makes sense given its central location. In 2012 none other than Victor Yanukovich signed into law a ruling that regional languages will be recognized by the government if 10% of more of the total population of the region speaks it.  Soon after, Romanian became an official language in the Village of Bila Tserkva.  In addition to Russian and Romanian, Hungarian has been made a regional language in two regional towns (article here).

History.  There are two key takeaways from my trip to the National Museum of the History of Ukraine . I learned that modern and independent Ukraine has a very short history and virtually no period when it was not very close to or under Russia / USSR influence.  

Given its short history and the previous days’ discussion about Russia’s strategic interest in Ukraine, I left the museum feeling that there is a non-zero chance that Ukraine could break apart and/or the country could face a very nasty conflict or possibly war with Russia.

Modern Ukraine owns its very existence to Russia and the forming of the USSR.  A plaque in the sparsely visited museum noted that modern Ukraine only really came about in 1939 after being put together under the Russia led USSR.  

“In the second half of the 19^th century and beginning of the 20^th century Ukraine was split between parts of the Russian Empire and the Austrian-Hungarian Empire.”  “In the second half of the 19th century the Ukrainian national-liberation movement has gained momentum”.  (Source: Hall No. 15; Ukraine in the Second Half of the 19^th century and the Beginning of the 20^th century; National Historical Museum of Ukraine)  

“In September 1939, the Soviet Union annexed the Western Ukraine using the Molotov-Ribbentrop Pact.”  “Sovietization of western regions was realized with cruel methods and was attended by a mass repression. But the unification of all Ukrainian lands as members of the USSR was historically important.  For the first time in a few centuries of its history the Ukrainians lived in one state.” (Source: Hall No. 26; Ukraine During the Second World War (1939-1945), National Historical Museum of Ukraine)  

Source:
National Historical Museum of Ukraine
Hall No. 26

Source:
National Historical Museum of Ukraine
Hall No. 15

There is some historical baggage between the Ukraine and Russia.  From the museum trip I learned about the 1932-33 man-made famine which occurred in many of the USSR’s agricultural areas.  Ukraine was the hardest hit.  Like China’s 1958-61 Great Leap Forward, many historians believe that forced collectivization of agriculture was the key reason in which an estimated 6-8 million people starved. 

Called the "Holodomor" in Ukraine one estimate puts the total loss in Ukraine alone at 10m - 4m from famine and 6m from birth defects. (see Wikipedia entry on the “Holodomor”).  Several Internet websites claim that it was a genocide perpetuated on Ukrainian agricultural peasants by the USSR.  (More information and gruesome pictures and video can be found using a Google search on “Holodomor".)

(See link here for a more complete, and more critical, history of modern Ukraine – especially under Nazi Germany and the USSR.)

Economy

From my trip, I was told that Ukraine's economy never really recovered from the global financial crisis and that it has been stagnating for years.  

This is very evident in comparison with their western-bordered neighbor Poland.  In 1991, about the time the iron curtain fell, Poland’s per capita GDP was 47% higher than in Ukraine's.  It is now more than 3x higher. 

People living in eastern Ukraine may be making the same point but using Russia as a base for their comparison.  Per capita GDP has not grown as much in Russia as in Poland, but is still almost double Ukraine's over the last 20-years.

Ukraine’s slow growth also stands in sharp contrast to countries in my neck of the woods.  Twenty years ago the average Ukrainian was more than 3x richer than the average citizen of Mainland China.  Now he/she produces almost half as much.

On a GDP per capita basis the average Ukrainian is now on par with the average Indonesian.  But their lifestyle is not likely as good as people who live near the equator don't have to worry about staying warm in the harsh northern European winter. 

	GDP/Capita 2012	GDP/Capita 1991	% change
Ukraine	3,867	1,490	159
Poland	12,710	2,187	481
Russia	14,037	3,427	309
Indonesia	3,471	705	392
China	6,091	330	1,745

Source: World Bank; GDP/Capita (at current USD)

As in other under performing economies, poor leadership seems to be the root of the problem.  Locals complain that the country has a lot of positives but has been led by people who are more interested in taking what they can from their powerful positions, rather than strengthening the government, institutions and infrastructure that Ukraine and its people need.

Widespread corruption, a compromised judiciary, and weak legal property protection add to the long list of problems. (More information about Ukraine’s corruption and economic problems can be found here).

Another big problem is that nearly half of Ukraine’s GDP is generated by imported energy-intensive industries.  Ukraine depends on subsidised energy imported from Russia as it is only 7% self-sufficient in oil and 40% in gas according to local brokers. The situation is rapidly changing and Ukraine can no longer depend on this going forward.  

Ukraine does have quite a lot of things going for it.  Its legendary ‘black soil’ gives it a natural competitive advantage in agriculture.  According to one Kiev-based broker, it is the second largest country in Europe by size with 15% of the continent’s arable land.  It is the world’s sixth largest exporter of grains (excluding rice) with most of this heading to the Middle East and Northern Africa.  It is the largest global supplier of sunflower oil and one of its largest exporters of walnuts.

It also has industry.  Ukraine is one of the key producers of railway cars in the CIS. It also has one of the largest aviation engine manufacturers in the CIS and is the center of the former USSR's aviation industry.  It supplies engines to 90% of helicopters produced by Russia.

It can also develop talent locally.  Many graduates from Kharkov’s top universities end up in Silicon Valley and other tech centers much like smart graduates from India’s famous technical universities. Only a few of the people I met in Kiev had studied abroad, but almost everybody I met spoke some if not very good English.  

I met many switched-on and forward-thinking people during my 10-days in Kiev.  I was especially impressed with those below 40 who likely grew-up in a freer environment than their communist / Soviet-thinking parents and grandparents.

In a very encouraging sign, Ukraine was listed as the world’s top reformer in the World Bank's 2012/13 Doing Business report. This report ranks countries by their support for laws that favor small and medium businesses. It praised Ukraine for implementing more pro-small and medium business reforms than any other country.  These include making it easier to start a business, dealing with construction permits, strengthening property rights, and improving credit information available to collectors and debtors. 

Travel notes

Kiev reminded me of my native DC.  The wide Dnieper river runs through the center of the city, there are lots of trees and not many tall buildings.  

There is also a lot to see.  Very impressive orthodox churches, national museums, and many historical tourist sites.  Kiev was the origin of the Russian culture and the city takes pride in this fact. 

It must be beautiful in May, when the locals say is the best month to come.  I was there in mid-February and had a very pleasant, albeit overcast and cold, weekend playing tourist.

Kiev's road system seemed like DC when I was growing up.  Roads are good and traffic seemed to flow most days, but I did experience a few very serious traffic jams and lots of potholes.  

The city has lots of cafes and prices are reasonable.  The menu selection can be eclectic though. Several restaurants have Japanese, Italian and Mexican on the same menu and likely cooked by the same chef. Lovers of spicy food may not be too impressed, but if picked vegetables, chicken and a good beer selection is your thing, you’ll probably like Kiev. 

Good Beer Selection
Roadside Market, Outside Central Kiev
Feb 2014 

Despite being there during the same week as the Maidan shootings, I never felt unsafe.  All the action took place in central Kiev.  Everyplace else I went seemed peaceful, although my contacts were concerned about my and their own safety.  After the Maidan shootings, I was told that Russians and Eastern Ukrainians thugs were travelling or already in Kiev.  These don't seem to have been substantiated as I did not hear of anything violent outside the city centre. 

I was obviously unlucky with my timing. Meetings on two of the six weekdays I was there were basically cancelled when the subway was shut and bridges into the city were closed.  On those days, staff went home early or worked from home.

Despite it being possibly one of the most important weeks in the country’s history, I was just plain bored.  With meetings cancelled and not wanting to get involved in a domestic dispute I watched all  of the action from my hotel room with walks to the restaurants and grocery store breaking up the day.

Lastly, despite the chill of winter, lack of sunshine and gloomy political mood I found that the people I met are smart, proud of their country and city, and keen to see Ukraine 'reboot' and move forward.  While outsiders seen Ukraine as a country torn between Western Europe and Russia, many people I met also saw this as an advantage as it has large markets at its doorstep and is a traditional bridge between Russian and the rest of Europe. 

On my last full day in Kiev violence in the square had stopped, the sun had broken through the clouds and I had a full day of meetings.  The last was with one of the smartest - and certainly best looking - CEOs I've ever met.  It was refreshing to get back to business.   

“The Ukraine girls really knock me out" was finally ringing in my head. 

Book Review - The Russians - The Power Behind the People

Book Review – Russians – The Power Behind the People, by Gregory Feifer, 2014, Twelve, Hachette Book Group

The Russians: The Power Behind the People does not paint a pretty picture of the country. Political repression, corruption, crony capitalism, a natural resource-based economy, expanding state influence, a compromised press, and a strongman in charge surrounded by those loyal to him.

However from my own experience in emerging markets it seems like more of the same old stuff. The summary paragraph above could describe many developing countries today and almost all countries at some point in their history.  It could just as easily describe Suharto-era Indonesia of which I witnessed first hand many years ago.

The difference – as this book points out – is that Russia appears to be going ‘backwards’. Today’s Indonesia – as well as most countries in Asia that I've followed over the last almost 30-years – are much freer and more open than they were in the past.  However the book makes the point that Russia seems to be heading back to the Soviet era in many respects.  Press freedoms are being curtailed, democracy is not as widespread as before, and respect for private property seems to be decreasing. People in power take over successful private companies.

Cold-war ear expressions, organizations and ideas feature prominently throughout the book.  Words and organizations that I thought were confined to history such as “the Kremlin”, and KGB (now called the Federal Security Services or FSB), are used widely to describe today's Russia.

What I find most interesting – and actually bizarre – is that Russians don't consider themselves Western.  How can a nation of mostly Christian white people not be Western?  Their names are Christian derivations (Mikhail is the Russian or Slavic version of your author's name), they drink like Europeans, and their food and eating habits are distinctly Western.  For this insight, the book was a real eye-opener.

Below are small snippets from the book that I found interesting.  There is a lot more but I found it difficult to cut down this already long list. 

• State-controlled economy.  “Although entrepreneurs continue earning immense fortunes, it’s now at the pleasure of those ruling bureaucrats, who tend to see private business as an extension of the state, an attitude nowhere more evident than in the rise of massive state industries run by Putin’s former KGB cronies.”
• Increasing government control. “ …the Kremlin’s share of the world’s largest oil industry (increased) from 40% percent to more than 50% and cemented Putin’s drive to put the energy industry back in state hands”"
• Using Russian oil and gas to influence countries abroad: “The Kremlin hopes Europe’s current reliance on Russia for a third of its natural gas will inevitable grow as demand inexorably increases.”
• Private property not protected.  ‘…Khodorkovsky is hardly an isolated case: in the space of a decade, one of every six businessmen in Russia faced some form of prosecution” (referencing an April 2012 Moskovskiie Novosti article).
• Russia seems to be suffering from the natural resource curse.  “The current lack of drive also derives form Russia’s natural-resources economy, in which what really matters is how to take – including by theft – rather than how to produce”
• Capital flight is nothing new.  “ Estimates for the amount of illegally spirited abroad from Russia each year reach above US$70b.  One especially well-placed source put the 2012 figure at US$49b, or 2.5% of the GDP”.
• Alcohol is a problem.  “…A 2011 WHO report estimated that every fifth male death is attributed to the effects of alcohol.“ “According to the government, 38% of Russians between twenty and thirty-nine suffer from alcoholism.  The number jumps to 55% for those between forty and fifty-nine.”
• Rampant corruption.  “The government’s own figures put the country’s ‘corruption market’ at an estimated three hundred billion dollars a year.  In 2011, the police said the average bribe paid to officials was ten thousand dollars, while Transparency International ranked Russia 143^rd out of 182 spots on its corruption index.”
• Decrease in press freedoms. ‘…(there have been) more than a dozen reporters who have been killed – probably assassinated – since Putin came to power’.  
• Russia has not reconciled or acknowledged the abuses it heaped on its own citizens during the Soviet era. “…the vast majority of Soviet archives, including informers’ names, remain secret, and only a quarter of the USSR’s mass grave sites are known.”
• Police aren't much help.  “Instead of tackling crime, the police spend much or their time falsifying statistics to meet Soviet-era quotas for cases they’re required to solve, sometimes by framing innocent people.
• On Ukraine and Russia’s expansion: “As Richard Pipes has argued, countries such as England and France, which created national states before forming overseas empires, found it easier to deal with the end of colonialism.  The Russian nation-state, by contrast, developed concurrently with an empire it directly bordered.  'As a result, the loss of empire caused confusion in the Russians’ sense of national identity,' he wrote.  'They have great difficulty acknowledging that Ukraine, the cradle of their state, is now a sovereign republic and fantasize about the day when it will reunite with Mother Russia'"
• Mistreatment of minorities. “’Tajiks in Moscow are slaves in the twenty-first century,’ one soft-spoken worker named Said Chekhanov remarked.  ‘We’re treated like animals.  The police insult us, and our employers forbid us even to talk at work.’ Everyone at the construction site had stories of attacks by masked men in the middle of the night”.  “Russia is a dangerous place to live if you’re not a white Slav.”
• Fundamental disbelief in openness and distrust of government.  “ Many foreigners also fail to notice another key trait: Russians tend to believe the rest of the world functions as their country does.  When American newspapers publish articles critical of Putin, for example, Russians often perceive them to be ordered by the White House because that’s how things are done aren't they?”. 
• Not likely to engage with the rest of the world.  “The world’s biggest country in area and volume of energy resources, it has nuclear weapons, a sizable economy and seemingly every reason to engage constructively with an international community in which it still holds considerable influence.  But Moscow, seeing conspiracies everywhere that reinforce its assumption that the rest of the world functions as it does, rarely responds to constructive engagement.”
• Bleak outlook for Russia’s future global relations: “It (Russia) will probably continue to act according to that zero-sum calculus…”.  “For Westerners in general and Americans in particular, that means Russia’s perennial instability will almost certainly create problems far into the future because even more than in Western societies, its leader’s personal needs will continue determining the direction of foreign policy."

While much of the world and “Westernized” Russians may see the above as a country heading in the wrong direction, the majority of its citizens don’t share that view.  “The Russians” note that the current government and Putin in particular are popular.  

• When Putin was preparing to step down as President in 2008, “an astounding 80-plus percent of the population said he’d done a good job"
• Russian citizens expect the government to provide for them.  "...decades of Soviet cradle-to-grave care have conditioned Russians to expect the state to provide pensions, education and subsidised utilities..."
• They are not prone to protesting.  “A Levada Center Poll in 2013 reported that more than 70% of respondents said they would refuse to take part in protests against falling living standards or in support of their rights.”
• In March this year, and soon after the book’s publication, a poll put Putin’s approval rating at some 80%.    His popularity went up after Crimea was annexed.

Much of this may come down to a real or perceived decline in living standards for the average citizen.  As the book notes, in some areas, Russia hasn't done well since the downfall of the USSR. Although their constitution guarantees free medical care, only the rich can afford it. The World Health Organisation ranks Russia’s health-care system at 130^th in the world, down from 22^nd in the 1970s.

The initial jump away from communism was a mess.  Many lost their savings and “…GDP fell 34 percent between 1991 and 1995 – a larger contraction than in the United States during the Great Depression – while wages plummeted along with employment.  Crime, including murders, doubled”.

With a controlled press, a history of a strong central government and a relatively old population who remember a more secure life under the communism, it does not take much imagination to understand the current leaders’ appeal to the man-in-the-street.  

Summary and Criticism

“The Russians” is a good book and I agree with another review which notes that it's a good introduction to the country.  This is a nice endorsement from someone who knows the country as my knowledge of it before reading this was virtually nil.

The book is also good reference for today’s news flow.  Backgrounds of many of the Russians that the US/EU has recently imposed sanctions on are referred to in the book (see link here).

One criticism I have is that the book seems to focus too much on negative aspects and may have left out some positive ones. This seems typical for this kind of book.  Adam Schwartz’s very good A Nation in Waiting, which provides a summary of Suharto-era Indonesia, mostly focused on what was wrong with that country while glossing over many its positive accomplishments.

While these books tend to provide a critical view, they would likely be pretty boring and not taken seriously if they emphasized the good stuff.  Who really wants to read a puff-piece?

Still, I thought this could have been more balanced as the author did leave out some positive news.  In the World Bank’s Doing Business 2014 report - which evaluates regulations affecting small and medium sized companies (SMEs) – Russia was amongst the top-10 countries that is improving its SME regulations.  If an amateur hack like me can find this I suspect that the author may know other positive news and could have presented a more balanced view. 

The book also does not provide details – or at least as much as I’d like – to support many of its assertions.  The writer states “…the government today is far more dependent on energy then the Soviet Union ever was.”  However this is not supported by any figures, footnotes or references.  More tables, graphs and charts to support his arguments would be a big help and add weight to his and the opinions of others that are included.

Anther criticism is that I got a bit bored with much of the author's family history that is interspersed in the book.  But that’s me and I can see how the human side of things emphasizes key points.  His ancestors’ and relatives’ live in Russia do not have a happy history.  I suspect this may have lead him to focus on the country's negatives. 

I also found myself zoning out reading the rather long section on arts and culture.  But this would likely interest someone less boring than myself.

All in all, I recommend the book.  While I have my criticisms, the writing flows well, and it is an easy yet very insightful, and certainly eye-opening read.  

Indonesia Notes - Politics, Economy and the Jakarta Jazz Festival

A handful of conversations in Jakarta left me feeling better about Indonesia and its prospects than when I arrived.  Indonesia was the first market I covered as an equity analyst and I've written several books/reports on its companies, business groups and SOEs.  One never forgets his first love.

It is very uplifting to see the progress the country has made from when I initially went there in July 1989. From the depths of the Asian financial crisis and subsequent political chaos there has been tremendous progress in the last 25 years.  

I haven't been positive on Indonesian equities for about a year.  Last Spring, high valuations and not knowing who will be leading the country in some 18 months left me with the feeling that there could be better returns elsewhere. It was a lucky call with Indonesia's main index falling 20% in the next five months before recovering to about the same level as it was a year ago.  The Rupiah has not fared as well. It fell by almost 20% vis-à-vis the US dollar between March 2013 and January 2014 before rebounding for a YoY decline of about 16%.  Renminbi-based investors would have fared a bit better with the Rubiah sliding by some 15% YoY.  Euro-based inventors would be down some 19% YoY. 

Headline valuations are still high in my opinion with more than half of the stocks in the iShares Indonesian ETF trading at PE ratios above 15x.  Like many markets Indonesia appears like a two-tiered one.  Large ETF/Index stocks are typically at much higher valuations than non-ETF/index mid-and-small caps. It seems that one can almost always find value in Asian small and mid caps if one is willing and able to do the leg work.  Several of the Asia-based small, mid-cap managers I follow had very good returns in 2013 with most beating their respective indexes.

Politics

2014 is an election year in Indonesia. Legislative elections are slated for 9 April and presidential elections for 9 July (and September if a presidential run-off is needed). It’s worth noting here that by population Indonesia is the world’s third largest democracy after India and United States.

Indonesian democracy seems to have taken root.  Everybody I talked to is expecting the upcoming presidential primary and election to proceed smoothly.  This is great news for everybody in my opinion.  I’ve written before that I think of democracy as a process and Indonesia by all evidence and feedback seems to be sticking to the process (see blog post here).

Several emerging countries are having difficulties with political transitions (Egypt, Thailand, Ukraine), but at this point Indonesia's democratic process seems intact and healthy.   This is a major positive for investors. 

I came away with the impression that front-runner Jokowi (Joko Widodo) is not the shoo-in that the foreign press and brokers make him out to be.  Amongst my contacts who can vote, several expressed reservations about him, the largest being that he doesn't have enough experience, having only been mayor of Jakarta for a short time.  His only other notable political position was as mayor of a mid-sized city in Central Java (Solo).  I was also told that he is having difficulty making substantial changes in Jakarta, as the entrenched bureaucracy is pushing-back on his reforms.   

Another candidate with a more colorful background is Rhoma Irama, who's known as the King of Dangdut, a popular Indonesian music genre.  He’s used the race and religious card against Jokowi’s right hand man and running mate, who is Christian and ethnically Chinese.  Rhoma is not the front-runner, but star-power can be captivating to voters. The Philippines elected local ex-movie star Joseph "Erap" Estrada in 1998, and the Americans elected ex-actor Ronald Reagan in 1981.  And don't forget Arnold Schwarzenegger who recently served as governor of America's most productive state. 

Economy

My contacts are reasonably upbeat about the Indonesian economy and its currency.  Consumer demand has held up better than expected despite weak commodity prices.  If attendance at the annual Jakarta Jazz Festival is anything to go by, the economy certainly seems to be doing well as many performances were packed. 

10-months into his job as central bank governor, Agus Martowardojo seems to be popular amongst the very small sampling of financial professionals I talked to.  He is seen as a strong inflation fighter having increased Indonesia’s interest rates by 1.75ppt to 7.5% since taking over.

Official inflation likely understates the true picture.  Locals - admittedly expats and upper/middle-class Jakarta residents - reckon the true inflation rate is much higher as the costs of consumer products and big-ticket items such as school fees have increased much more than headline inflation. This more-or-less in-line with my observations in Hong Kong (see blog post here).

People I asked thought that the rule to ban raw ore exports would not derail the economy.  If a recent Jakarta Post front-page article is anything to go by, it may help to induce Russian investors – who have been promising to invest in Indonesia for several years – to finally pull the trigger (article here). 

From initial research into Russia and conversations in Kiev, it seems that Russian oligarchs and businessmen are investing outside of Russia as a way to protect their assets from the greedy power structure at home. I was told that Russians prefer to take over assets rather than buy or build them. 

Trip Notes

One thing that has notably increased over the years is Jakarta's traffic.   I likely spent more time parked in traffic jams than meeting with friends and ex-colleagues on this trip. Jakarta's road system is still very third world outside many of its newer areas, and traffic can be horrendous.  The city's public transportation system remains abysmal and is not really an option for most visitors.

This was in sharp contrast to my 10-days in Kiev where I was the week before.  Kiev and its surrounding areas seem to have a decent traffic and highway system. Granted I was there in a non-typical week when the Maidan shootings occurred so my outlook may not reflect the typical situation.  And locals complained about traffic jams and the taxi situation is not nearly as convenient as Jakarta.  But nowhere was traffic as chaotic as in Jakarta.

However I spent very little time in traffic as compared to Jakarta and there is halfway decent public transportation.  Its subway is old, but it is frequent, runs well enough and is easy to navigate for a non-Russian/non-Ukrainian speaker.

Hopefully this will be fixed somewhat when Indonesia's eminent domain law comes into effect later this year - three years after it was passed and just in time for a new president to deal with.  Passing the buck. 

Jak Jazz

This year's Jakarta Jazz Festival was good.  There were some 170 performances over three days so there was a lot going on.  Compared to last year, this year's was more geared to pop bands.  But with over 170 performances over three days there seemed to be something for everyone.

Some of the most memorable performances I caught were on the Brazilian stage.  Tania Maria gave a wonderful and spiritual performance as did the more mellow Ivan Lins.  Both are amongst the most accomplished Brazilian musicians at it was great that they made the trip to Asia – especially considering that it was so close to Carnival.

Compared to last year the festival's organisation seems to have deteriorated.  Several performance times did not correspond to the printed schedule. Also one of the people I really wanted to see  - Hammond B3 organist Lonnie Liston Smith - was not there and no notice or explanation of the cancellation was given.  This was a major disappointment. 

A key gripe about the festival’s staging is that venues are close together and one can hear the performance next door.  This was particularly the case in quieter performances.  Ivan Lins complained about this during his Friday night performance when, during a quite tune, we could clearly hear the booming bass and drums form the nearby sound check.