Russia's Economy Is Out Of The Woods, Almost

Russia is adapting to lower oil prices and sanctions as interest rates, inflation, and budget deficits are expected to come down in the near term

Fri, Oct 14, 2016
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It’s always best to hedge against the unexpected, but on the sidelines of VTB Capital’s annual Russia Calling investment conference, Russia is still a buy. It’s not as cheap as it used to be, but bonds look great, and stocks will do well if the central bank is right and inflation falls next year. The Market Vectors Russia (RSX) exchange traded fund is up 27.2% year-to-date, beating the 13.6% gain in the MSCI Emerging Markets Index. There’s always room for more upside.

“If you believe that the central banks of Japan, U.K. and Europe have admitted defeat on QE, and if you believe that the Fed will hike in December, then you have a reversal of fortunes playing out in global securities whereas the developing markets are in for a decline and the emerging ones, including ones that were beat up like Russia, are on the rise,” says Tadashi Tsukaguchi, a former Black Rock derivatives trader now managing an overlay downside protection fund for Specialized Research and Investment Group in Tokyo.

“We have been increasing out exposure to the Russian stock market,” said Peter Elam Hakansson, CIO of East Capital in Oslo. He was short on details when asked what he was looking at by a Barclays fund manager in the audience. Mid-caps. Good corporate governance. That was all he gave them.

Amsterdam based investment firm T&E Inmaxxa’s fund manager Arent Thijsen said Russia, from where he sits, was an overweight.

“Heavily overweight Russian stocks and bonds if oil prices stay at $50,” he said. “Metal prices are coming back on track. The economy has adopted to sanctions and in some regards, like agribusiness, it has become a positive force of diversification. It’s under-leveraged and it’s still cheap.”

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Andrey Kostin, the VTB Bank president that’s become the jovial, charismatic go-to Russian banker on Bloomberg lately, said that Russia’s fundamentals are improving just as external forces are working against it. If it’s not geopolitics that’s got Russia in the cross hairs, its oil markets despite the recent rise, and generally high capital costs that still hinder the economy.

“It’s a bad time to be doing well,” Kostin says, adding that over half of the recent bond and equity issuance out of Russia has been purchased by Americans even as Russian financials face sanctions by the U.S. and European Union. By ‘doing well’, Kostin is referring to an economy that’s coming out from sub-zero growth. Corporate earnings are improving, suggesting positive GDP is around the corner.

Russian President Vladimir Putin gestures while speaking at the 8th annual VTB Capital “Russia Calling!” Investment Forum in in Moscow, Russia, Wednesday, Oct. 12, 2016. (AP Photo/Ivan Sekretarev)

Interest rates are still high, but coming down. They were cut 50 basis points on Sept. 16 to 10%. Inflation is 6.4%, its lowest in two years. However, Elvira Nabiullina, Russia’s central bank chief, said that the market should not get ahead of itself and assume if inflation falls, interest rates will be slashed. “We are targeting 4%,” she said. “That’s the long term target and monetary policy will be based on that, not what happens week-to-week with CPI,” she said of core price inflation. Corporate investors have cited inflation as one of their top concerns in deciding whether or not to invest in Russia, according to a recent central bank survey.

But Russian bankers also look at inflation figures through squinted eyes. The central bank often changes its basket of items that make up CPI. So oil is falling, that can be increased in the basket. Food prices are rising, so that can be decreased and — presto! — CPI is falling. Such is the argument of many Russian investment bankers.

On the spending side, Russia’s Finance Ministry will submit its budget to parliament on Oct. 28. Cuts are expected across the board, including defense spending. And with the exception of a new tax regime on oil and gas, no new taxes are in the works said Anton Siluanov, the country’s FinMin. Fiscal policy for 2017-19 will continue to force the economy to adapt to lower oil prices. “In this sense, higher oil prices might end up not doing us any good,” he said. He did not give a price target. This year’s price target was $50 per barrel

Russia’s federal budget deficit is seen declining to 3% in 2017 and even lower in the following three years, according to Siluanov.

Russia is trying to move away from its raw material based economy, something every investor has been hearing now since at least 1991 when the Soviet Union collapsed and opened Russia to Western capital. Nabiullina said that her role was to get inflation low enough that Russia becomes an attractive investment for foreign corporations in the non-fuels sector.

Russia’s Economic Development Minister, Alexey Ulyukaev, said he expected growth to be driven by consumption and net exports in the coming quarters. After that, he said the story for growth in Russia will be corporate investments in the second half.

Exports have been helped along by a weaker ruble. The currency went from the 30s in 2014 to the 60s against the dollar today. “A weaker ruble helps. A stronger ruble does us no favors,” said PhosAgro CEO Andrey Guryev in a one-on-one discussion at the Crowne Plaza in Moscow on Wednesday. PhosAgro is Russia’s leading producer of fertilizers and competes on world markets with Moscaic.

The ruble has been strengthening this year, tracking the fortunes of oil prices.

Putin vs. The World

Russian president Vladimir Putin paid his annual visit to a packed house on Wednesday, showing up roughly two hours late to a standing room only crowd. Putin gave the usual commentary from his economic team and then took questions from fund managers in the audience. Some questions were prepared in advance. Others were not.

Putin said that sanctions were indeed hurting the Russian economy.

“We like to hear that sanctions haven’t hurt us, but they have,” he said, citing sanctions against technological transfers in the oil and gas industry. ExxonMobil has been sitting on a roughly $720 million joint venture with Rosneft because of Washington sanctions against Russia; that’s a few hundred million on the sidelines because of the political battle between Russia and the West.

Putin said that talk of Germany proposing new sanctions due to Russian support of Syrian strongman Bashar Assad’s bombing raids in Aleppo were “unfortunate.” He also said that the recent cancellation of a trip to France was a mutual decision, first initiated by the French government.

“They told me that it was not a good time to come because of Syria. I said that was up to you, if you don’t feel comfortable meeting now we can do it another time. And we went back and forth with this and agreed to postpone it,” he said, adding that he and French president François Hollande have “a good working relationship.”

Meanwhile, with regards to the U.S. elections that have seen an unusual uptick in anti-Russia rhetoric this year, Putin reiterated his stance that Russia will work with any U.S. president. “Using Russia as a villain doesn’t make me look bad, but it makes all of my country and the Russian people look terrible and this is very unfortunate,” he said.

Karl Svelda, CEO of Raiffeisen Bank International, an Austrian bank that’s been in Russia since the 1990s, said Russia’s economy has bottomed. “We are staying in this market,” he said.

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