Sudip Bandyopadhyay’s Blog

In the summer of 2008 when I landed in St. Petersberg, the first thing which struck me was the beauty of the lovely city,  erstwhile capital of Russia.  However once one starts looking beyond the majestic buildings , palaces and the gardens, one starts getting the distinct feel that though a modern city, the standard amenities, taken for granted in a Western European city may not be easily available in St. Petersberg.

This is a time when the economic crisis had not yet hit the Russian economy fully and the world was yet to face the collapse Lehman and other large US institutions.  Commercial activities,  capital markets and trade were all chugging along. Clearly hope and change for a better future was writ large on the horizon.Then came the world financial crisis and great drop in oil prices.  Russian markets went into a major down ward spiral  impacting  the economy and also the hope for the future.

The recovery of 2009 particularly in the World capital markets to a great extent by-passed Russia and somehow even now this market is viewed with a significant amount of caution. Russia has tremendous growth potential, as penetration levels for most goods and services are well under half those in western Europe; mortgage penetration for example is 3 per cent of GDP and only 20 per cent of people have cars.

For those companies that have been able to seize the opportunity, the rewards have proven tremendous, and Russia now boasts the largest markets in Europe for mobile subscribers, beer and white goods. Meanwhile Russia is the world’s greatest repository of natural resources, and Russian companies are blessed with colossal amounts of commodities, valued at a fraction of their global peers.Lacking as it is in capital, Russia is a high return market, with returns on equity (ROE) before the crisis of nearly 20 per cent.

This has been one of the foundations for the superb performance over the last decade, when the Russian market was up eightfold, the best performer among major markets.Contrary to the various scare stories we have heard during the crisis, debt levels are low in Russia. Government debt and household debt are both under 10 per cent of GDP, bank loans to GDP are 39 per cent, and in the recent McKinsey study of the global credit bubble, Russia stands out for its extremely low level of total debt to GDP (71 per cent), half that of China and a quarter that of developed markets.

Consequently, Russia will not be held back by the deleveraging facing other markets.And into this relatively benign mix comes a catalyst that we believe will electrify the story in 2010 - disinflation. For the first time since the end of the Soviet Union, inflation has now fallen into single digits for an extended period. From 13 per cent in 2008, inflation fell to 9 per cent in 2009 and is currently running at about 6 per cent, where we think it will end the year.

The government will thus be able to continue to cut the cost of money, and we anticipate a further 150 basis points of rate cuts this year. All of this leads to growth: in 2010, GDP growth of at least 5 per cent is expected.The usual counter to a positive stance on Russia is to cite transparency, corporate governance, and corruption. On transparency, the environment has changed radically in the last few years, with Russian companies adopting international accounting standards and disclosure.

On corporate governance, a number of high-profile cases such as Mechel, Vimpelcom or Uralkali were favourably resolved over the last year; in a world of Madoffs and Enrons, Russia is perhaps no worse than its peers. Corruption remains a problem and a drag on growth, albeit an issue that the government is seeking to address.

Fears of a new cold war were always far-fetched given Russia’s new capitalist direction, and we are likely to see much less concern about this given a new government in Ukraine and more accommodating US policy.The main issue that should concern investors is the oil price, given that the rouble, government finances, and profits are heavily dependent upon this. Below $60 a barrel the market gets nervous, and more than $30 a barrel the whole macroeconomic framework looks fragile. This is the main tail risk.

The tragic events unfolding in Greece & it’s impact on EU as well as the entire world economy has confused the world capital markets. The call for bail out of Greek economy & public debt is getting shriller & shriller. However a careful scrutiny of the unfolding events clearly highlights that Greece does not need a bail-out. It needs more reform and, in the long run, nudging Greece in the right direction may be more important than providing short-term assistance.Greece can avoid a bail-out if it demonstrates convincingly to the markets that the reforms in its stability programme will be implemented in a timely fashion.

They also have to be big enough to ensure that the government meets its commitment to cut the budget deficit from 12.7 per cent of gross domestic product to 2.8 per cent by the end of 2012. But even at the end of the adjustment period the debt to GDP ratio will still stand at 113 per cent, which is no smaller than it was in 2009. To bring the debt to GDP ratio level below 100 per cent, not to mention the 60 per cent level required by the Maastricht treaty, will require further adjustment over the coming decade. So the reform process that starts in 2010 should be sufficiently robust to ensure that Greece also reduces its debt burden substantially.

Today’s opportunity to transform the economy for good should not be missed as the country may not have another chance.To speed up and enhance the content of the reforms in the stability plan, there needs to be a bold new privatisation programme to unleash the economy’s potential. Much could be gained from further privatising an economy that is probably the last “Soviet style” economy in the developed world.The Greek state not only runs hospitals, universities and churches but also casinos, lotteries, hotels, marinas, ski resorts, trade fairs, exposition centres, ports, airports, water, electricity and natural gas companies, oil refineries, postal services, transport, banks, and insurance companies.

The state’s stake in listed companies on the Athens Stock Exchange is worth more than €9bn ($12.3bn). Real estate holdings in major state property-management companies are conservatively valued at more than €300bn and yet yield next to nothing.Privatisations, therefore, represent a huge untapped opportunity to re-establish discipline in public finances while, potentially, reducing public debt to more manageable levels.

The stability programme refers to privatisations as a potential source of funds of €2.5bn or 1 per cent of GDP in 2010, while doubling that amount over the period 2010-2012. Clearly, given the magnitude of state control in the economy, these figures are suboptimal and would mainly be achieved by selling government stakes in state enterprises through the stock exchange.However, what is required is a complete severing of the umbilical cord between the state and the economy.

If a wider privatisation programme was carried out, it has been estimated that the total raised could amount to as much as 10 percentage points of GDP - in other words equivalent to the amount by which the budget deficit needs to be cut between now and the end of 2012.Socialist governments in Greece have been credited in the past with the success of major stabilisation efforts.The current government has to outdo its predecessors because conditions are vastly different. The potential for success is clearly there. The task is Herculean for a government in a country with very low credibility.

The way out therefore is to opt for market-orientated additional reforms so that stabilisation comes with improved growth potential that will make implementing the three-year stabilisation programme fail-proof. It is not just about fiscal consolidation. It is about far-reaching reforms that will guarantee beyond doubt that the stability plan is implemented in a way that is credible for markets.