MOSCOW—The stability of Vladimir Putin's government was once the keystone of Russia's investment model. Buffeted by volatile oil prices and capricious international sources of funding, the financial community could always point to what appeared to be permanent support for the country's leaders, as well as to low levels of sovereign debt.
Now an element of political uncertainty and the prospect of more large protests are shaking Russia's markets.
Mr. Putin's United Russia received less than 50% of the popular vote Dec. 4 in parliamentary elections, which were nevertheless widely criticized as unfairly favoring the ruling party. President Dmitry Medvedev has broached the idea of United Russia forming a coalition in the Duma, the lower house of parliament.
Few observers see enough widespread popular dissatisfaction to cause a forced change in government, although a large protest Monday night triggered a heavy police presence the next day, helping to send Russia's RTS Index down 4.7% Tuesday.
Fear gripped the market again on Friday as investors sold on the eve of what may be Russia's largest demonstration in years near the Kremlin on Saturday. The RTS slipped 4.3% Friday, compared with a 2% drop for the MSCI Emerging Markets Index and little movement in Brent crude-oil prices. The ruble dropped against the dollar and the euro.
Politics hasn't weighed on the Russian market this much since the arrest and trial of Yukos Oil Co. founder Mikhail Khodorkovsky, investors said.
"There's a knee-jerk reaction that maybe it's going to all come tumbling now, particularly when markets are so sensitive," said Mattias Westman, head of Prosperity Capital Management, which holds about $4.5 billion in Russian equities. "Investors interpret things according to views that they had previously, and of course most people had some kind of adverse view on Russia."
Mr. Westman, who manages the investments of Norway's oil fund in Russia, doesn't anticipate significant violence on the streets, nor a sustained investor pullback from Russia, which, after all, hasn't been very popular among investors in some time.
Over the longer term, the emerging political forces could lead to reforms that would boost transparency and efficiency at state-controlled companies such as OAO Gazprom and pipeline operator OAO Transneft.
"If they want to stay in power they're going to have to give people some of what they want," Mr. Westman said, referring to Mr. Putin's United Russia. "It's not going to work to try to go back to more control of state companies."
Russia investors will be keenly watching the demonstrations over the weekend and the government's response. "Whatever the results are, it will be the top item in our discussions with clients on Monday morning, said Konstantin Nemnov, portfolio manager at TKB BNP Paribas Investment Partners.
The alleged vote-rigging has struck a nerve among a much broader swath of Russia's new middle class than many analysts and politicians had expected. Moscow society ladies—rarely known for their politics—were discussing on Twitter Friday what to wear to the demonstration.
If 20,000 people or more take to the streets in Moscow on Saturday, Mr. Medvedev may come under pressure to share power or compromise with the opposition, which could lead to an accelerating capital outflow in the short term and a potential selloff of Russian assets, said Julia Tsepliaeva, BNP Paribas SA's chief Russia economist.
Russia is expected to see $85 billion in net capital outflow this year, with much of it blamed on wealthy local businessmen concerned about political risk and European banks moving money from their Russian units.(online.wjs.com)