RUSSIA - LOOKING INTERESTING
On Tuesday, February 16, 2010 16:15 by Sudip BandyopadhyayIn 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.