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Moscow talks up a financial markets future

By Kim Iskyan

The Russian government says that it wants to turn Moscow into an international financial center. But such hopes face many obstacles -- not the least of which are the government's own efforts to encourage the development of national champion banks.

In March, the government announced the creation of a high-profile advisory committee consisting of the heads of a number of powerhouse global banks to advise President Dmitry Medvedev on the project. This will bolster the series of working groups supporting the initiative headed by Alexander Voloshin, a savvy government insider with a reputation for competency. The government also announced it would create a $10 billion investment fund that will be managed by state-controlled development bank Vnesheconombank.

The needed regulatory and market infrastructure is also progressing. Two key regulatory bodies are merging, allowing for a more efficient oversight. Efforts to require large private companies to adopt international financial reporting and accounting standards should substantially improve transparency. Also, the pending purchase of RTS, Russia's second-largest trading floor, by the MICEX exchange would result in a larger Russian exchange with greater visibility and credibility.

Yet obstacles to such a goal will probably limit Moscow's future role in global financial markets. Among the chief short-term roadblocks is the crowding out caused by the ongoing privatization program that will primarily raise funds on the London and New York markets rather than Moscow's. That decision of course also reflects that lack of depth in local capital markets. On another front, domestic pension reform would mark a big step toward developing more local expertise but it's been delayed for years and appears unlikely to be placed on the agenda well until after the 2012 presidential election.

Another factor is the rise of state-owned national champion banks Sberbank and VTB. Moscow's efforts will further reduce the level of competition throughout the banking sector and make the market less attractive to private (including foreign) banks. The late April news that HSBC is pulling out of retail operations in Russia underscores this dynamic.

There are also problems with the broader investment environment, ranging from endemic corruption and weak rule of law to a stifling bureaucracy and personalized politics. Progress on these fronts is critical if Moscow is to make any real headway in establishing itself as an international financial center. Russia's investment environment will benefit from some of the changes, but it remains unclear whether the government will be willing to launch the comprehensive reform program needed to address the economy's underlying weakness.

Kim Iskyan is a director with Eurasia Group's Eurasia practice.

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