It has taken a long time, but the Russian government has realised the importance of improving the country's investment image and investors appear to be responding positively, says Chris Weafer, chief strategist at Uralsib Financial Group in Moscow.

Following huge outflows of foreign capital in the fourth quarter of 2008 and early 2009, investors are slowly returning to Russia, with weekly fund flow indicators showing a growing preference for the country among emerging-market investors this year.

There has also been recent evidence of some switching from heavily subscribed Brazil funds into Russia funds, adds Weafer, addressing the Russia Capital Raising and Investment Summit in Hong Kong organised by AsianInvestor and FinanceAsia.

Investors have also been broadening their Russia exposure. In December 2008, 86.9% of the total value of an average Russian portfolio was invested in the country's top 10 stocks, says Weafer. By the end of January this year, that figure stood at 68.6%.

Russia is a high-beta market, as has been demonstrated by its performance in the past couple of years; it was the world's worst-performing market in 2008 and the best-performing last year.

Yet despite posting 300%-plus gains since the start of 2009, the market is not over-owned, says Weafer. Russian stocks were indeed overbought in 2008, but foreign investment slumped last year due to the global financial crisis and a sudden drop in the price of oil, he says.

Investors are now back at around neutral weighting, so there is plenty of scope for them to increase allocations as their comfort level with Russia improves, he says.

More importantly, the financial crisis has shocked the country's leadership out of complacency and it has sought to clarify rules and identify areas where it seeks foreign capital.

This greater openness to foreign investment is demonstrated by the planned issue of the country's first sovereign Eurobond issue for over a decade, says Weafer. The government doesn't really need the money, he adds, as it is earning $5 billion a month more than expected due to the higher-than-budgeted oil price.  

The government now seeks foreign capital for basic infrastructure, which has suffered from decades of under-investment, including electricity, natural gas, communications and transport. It also wants to attract capital to industries in which Russia is overly reliant on imports, such as agriculture, pharmaceuticals and food processing.

Increasingly the government is keen to attract investment from Asia, as global liquidity trends eastward; this is a new trend in Moscow, which has long viewed Europe and North America as its traditional sources of finance.

Weafer expects a greater focus by the government on trying to acquire strategic partnerships with established foreign companies. However, he says, investing in strategic industries and in planned private/public partnerships is likely to remain difficult and slow for direct strategic investors.

Significant risks remain for Russia investors, starting with oil. The country is still extremely dependent on its natural resources. Oil and gas accounts for 66% of the value of exports, says Weafer, and commodities as a whole account for 75% of exports. Oil and gas revenues account for almost 50% of the federal budget.

So while the oil price -- at $83 a barrel yesterday -- is currently well above the state-budgeted price for 2010 of $58/bbl, if it were to fall below $65, government spending would slow sharply and investor confidence in equities and the rouble will fall, he says.

Russia is also very dependent on Chinese commodity demand and on the strength or weakness of the US dollar, among other things. "[The country] is still critically engaged with the rest of the world and will be for the next couple of years," says Weafer.

But the changes that are being put in place are likely to ensure that the Russian market "roulette wheel" will be less volatile in the future, he adds. The risk profile will smooth out considerably, as the economy becomes more balanced in the coming few years.