David Damant’s Interview to Expert Magazine
Mr. Damant, I would like to start with a question about trends in the world economic system. When the financial crisis broke out in 1998, it looked as if it would be spreading out further. But for some reason this did not happen. Why?
I do not know a precise answer to this question and hardly anyone in the world knows it. It is very difficult to discuss macroeconomic topics. However, there are some trends that can suggest an indirect answer to your question.
In the past fifty years, the system of government control of economy in different countries has been improving all the time. They tried to use centralized control, monetary policy, etc. Although no one has invented a clear method of control, the conclusion was that the best way was «soft» control on a trial and error basis. In the past, both European and North American regulators used to wait for the economy to reach the peak of growth and only then they tried to manage the situation. Now they start getting the growth under control at the very beginning of the growth phase. Therefore for the past seven-eight years the Western countries have seen a rather stable economic development. So American and European countries managed to go through this financial and economic crisis without significant losses. At the moment Japan is also recovering. After Japan eliminates the impact of the crisis, there will be a cushion preventing the crisis from spreading out further.
The fact that the economy is becoming increasingly manageable provides evidence of stock indices that are higher than one might have expected.
Nevertheless, American stock indices, primarily NASDAQ, have been quite volatile. So, is it really possible to state that the Western economy, the US one in particular, is stable?
You should look at the stock indices in all major markets. Internet shares are likely to be exceptions to the rule because shares of most companies from traditional market sectors can hardly be considered overestimated. In addition, their quotations tend to decrease. However, even given the fact that the Internet market forms only part of economic system, one cannot exclude that its crash will cause a chain reaction. Therefore the task is to find a balance between stable core economy and ‘hot’ shares of new industries.
To this end, I would like to point out that one can forecast increased regional diversification of investments, especially on the part of US investors. I focus on the United States for two reasons: firstly, so far they have been very conservative and preferred not to invest overseas, secondly, it is a matter of huge financial resources. And this is important for everyone, including Russia.
Order and Culture
As for regional investments, could you identify countries that are the most attractive from investors’ view?
There are two measures of country’s attractiveness. The first one is general cultural background. In this context, the oriental culture, Eastern countries, in particular China, are very attractive. They have certain talent. But it does not follow that other countries are second to them. I will give Central Europe as an example. When reforms started in all these countries, investors from all over the world showed preference for Hungary because it had had capitalist economy even under the Communist regime. Czechoslovakia was in the second place because Czechs were so smart and intelligent. There were lots of articles by investment bankers stating how attractive Hungary and Czechoslovakia were. And no one even mentioned Poland that turned out to be the most successful country in Central Europe.
So you should not focus solely on culture. Although it is very difficult to struggle with some hardliners, if you learn to keep inflation under control, develop efficient markets, ensure equal treatment of all participants, create solid corporate governance and financial transparency, you will be able to change the attitude of investors for the better. Any country can do it.
How does Russia lool like in terms of the attractiveness of its order and culture?
I would not like to comment on the economic policy because you never know what to expect. Let’s take Malaysia as an example. Many countries acted in the right way after the economic crisis while the Malaysian leader did everything which, in the view of the World Bank and IMF, was a terrible mistake. Nevertheless, Malaysia recovered from the crisis, maybe even better than many other countries. Therefore it is very difficult to provide any comments with respect to Russia. However, there are obvious weaknesses that need to be eliminated.
Firstly, it is necessary to improve Russian corporate governance. There are many reasons why managers should work for the benefit of shareholders. As a rule, if they start working like this [i.e. for the benefit of shareholders], companies are becoming more profitable and attractive for investors.
Secondly, it is necessary to make companies more transparent and facilitate relationships between companies and government agencies. Let’s take Switzerland as an example. I would not like to state that the corruption in Switzerland was the same as in Russia. Nevertheless, the non-disclosures by Swiss management were comparable to those in Russia. The fact that Nestle completely changed its corporate governance system and became transparent resulted in higher attractiveness for investors.
But this is a complicated problem. If a limited number of individuals manage the enterprise, naturally, they make profits on related party transactions. In this context, it makes sense to be non-transparent. So when you suggest that such a limited number of individuals become more open, provide transparent financial disclosures to a wide range of shareholders, at first they do not understand how beneficial it is. Therefore some law or rules need to be adopted in order to encourage higher openness of companies.
Thirdly, stock market development. The new Russian Government should encourage the Federal Commission for the Securities Market and its regional branches to continue developing the stock market. This is a very important area because if investors can easily sell their shares in the market, they will require lower return. So if thousands of companies are quoted in the market, they will be able to raise cheaper capital.
Finally, it is necessary to raise the quality of financial reporting by enterprises and seek international standards.
Stupid Waste of Resources
As for IAS, the most common objection to their immediate adoption in Russia is the fact that no one needs them in this country. There are very few Western investors that are willing to come to Russia in order to start all these efforts. Our tax authorities and other domestic organizations generally do not have any need for them.
Firstly, it should be noted that in three-four years all the countries will move to International Accounting Standards. The only exception is the United States that will be moving in five-seven years. Secondly, IAS reflect economic reality while current accounting standards do not. This means that absolutely all money in Russia is invested at a wrong cost of capital. If this money had been invested at the right price, the resources saved might have been used to build thousands of hospitals.
So you mean to say that without adopting international standards we are getting very expensive money?
Yes, under the non-transparent accounting system investors tend to include a risk premium in the cost of capital and money becomes more expensive. Lower risk investments provide lower returns and, accordingly, they are cheaper. So if you adopt a tax-driven accounting system, you are deliberately killing children in hospitals because you are wasting investment resources.
This is a tough statement.
Yes, it is because the wealth, assets and financial resources are so stupidly wasted. This is true not only about Russia. This happens everywhere.
David Damant is the President of the European Federation of Investment Analysts.
This article originally appeared in the Expert Magazine # 18 (229) dated 15 May 2000. Expert Magazine website address is http://www.expert.ru.