Risky Business in Russia

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Such polar-opposite viewpoints about the country's prospects have been typical for Russia ever since its economy began to rebound — along with oil prices — after the currency crisis of 1998. While some have viewed Russia as a fabulous investment opportunity, many have been put off by the taint of corruption and political risk. To assuage such fears, then President Vladimir Putin sat down with about 30 CEOs of Western companies on the fringes of a World Economic Forum meeting in St. Petersburg in June 2007 and gave a concise rationale for why they shouldn't worry. The Kremlin, he told them, would continue to claw back control of some energy and other deals transacted in the 1990s under his predecessor, Boris Yeltsin, that Putin viewed as highly disadvantageous to Russia. But, according to two CEOs who were present but who asked not to be identified, Putin assured them that everyone else was not only safe but very much welcome in Russia. "It was a brilliant performance," says one of the CEOs. "He came across as extremely logical and reassuring."

Since then, however, two high-profile business scandals have given Westerners further pause for thought. In July, Putin — who has apparently lost none of his influence since shifting from President to Prime Minister in May — leveled accusations of price gouging and tax evasion at one of the nation's biggest steelmakers, Mechel, sending its New York-listed stock plummeting. With memories of Yukos' fate still fresh, investors didn't stop there: Putin's comments wiped tens of billions of dollars off Russia's stock market in a matter of days. The Mechel furore came on top of an ugly, months-long scrap over control of oil company TNK-BP between BP and its Russian billionaire partners. Robert Dudley, the BP-appointed CEO, last month quit Russia, citing "sustained harassment of the company and myself." BP blames its Russian partners for orchestrating a state administrative and regulatory crackdown on the firm in recent months; the Russians claim BP hasn't lived up to its contractual obligations. Asked what advice he would give other foreign investors in Russia, BP Group's CEO Tony Hayward said: "Tread with caution."

Yet the flood of new business has continued unabated. Among the most recent deals: cosmetics giant L'Oréal signed an agreement in June to build a new factory in the Kaluga region; and French bank Société Générale took a controlling stake in Rosbank, which has more than 650 branches across Russia.

Lawyer Amsterdam believes the fighting in South Ossetia is filled with important messages for the West. Among them: Putin's central role, even after ceding the presidency to Dmitry Medvedev, and Russia's apparent attempt to bomb an oil pipeline to the West, one of several new alternatives to the Russian-controlled network. It was a warning shot, he and others argue, against those who would try to challenge Russia's dominance of oil and gas supplies to Europe.

For the moment, the best bellwether of Western sentiment remains the stock market. Its recent nosedive reflects not just political turmoil, but also signs of an economy under stress. While GDP is expected to rise about 7.5% this year, Neil Shearing, an economist at Capital Economics in London, warns that unless Russian authorities get a grip on this heady growth and "take some of the steam out of the economy, we could have a fairly nasty correction over the medium term." Meanwhile, a report published by the Organization for Economic Cooperation and Development in July warned that Moscow must do much more to end domestic production bottlenecks and boost sectors not related to energy if it wants to avoid serious consequences from any big fall in oil and gas prices.

Of course, long-time investors in Russia are used to living with acute risk. "The international sentiment toward Russia has never really been as good as it has been toward China and India and Brazil. There's always been this kind of residual fear over Russia," says Roland Nash, head of research at Renaissance Capital, a Moscow-based investment bank. Still, he adds, "Eventually what will drive people back into the market is the fact that there are cheap assets here." BMW, Enel, L'Oréal and all the other foreign companies continuing to crowd into Russia wouldn't disagree.

With reporting by Adam Smith / London