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From Russia with Loving Returns on Funds

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This post first appeared on Russia Insider

The author is chairman, Disciplinary Committee, National Association of Corporate Directors, Russia

Time to consider the Russian ruble. The zero interest rate policies (ZIRP) employed by the US Fed and some other central banks were to have been a means of “stimulating” economies, but by now, given ZIRPs’ power to artificially depress bond yields, they mainly allow cheap funding for deficit-spending governments. Current elections in the US, the expectations of “imminent” rate hikes post-election, and popular attention is diverted. Since 2014, markets have steadily reduced their estimates of the level of central bank’s policy rates. Some foresee a negative rate for the ECB, which is a shift from a ZIRP to a NIRP (negative interest rate policy). Central banks in Denmark, Sweden and Switzerland already have adopted NIRPs and since 2012, the ECB with a rate of just 0.05 per cent recently implies it is not ruling out a NIRP as cans are kicked.

Wherever and whenever deployed, ZIRPs and NIRPs have been detrimental to saving, investment, production, and the efficient working of the market-price system. It seems to me that any position that ensures either no returns (ZIRP) or an outright loss (NIRP) on saving and investment is not a “stimulus” to any economy at all. Even discussions of policy shifts, whether from a positive to a zero return, or from a zero to a negative return, cause both savers and investors to withdraw and search for positive yield alternatives.

Happily, not all countries and their central banks are bent on following this ZIRP and NIRP path to “interesting times”. While stability, transparency, the US Dollar, Yen or Euro have been and to largely remain bywords appealing to analysts and investors – positive returns on money (or the lack thereof) are changing such perceptions and risk appetites faster than was ever expected or planned for.

In Russia, since the double shock of a collapsed oil price and broadly imposed sanctions had their main effect in 2014. Since then, some unforeseen, unintended consequences have been evolving. The ruble, never considered globally an investment grade currency when compared to the USD or Euro. Now that we are at the end of 2016 and going into 2017, the ruble looks increasingly solid, even attractive in the present economic climate. The conservative Russia Central Bank policy of 10% looks a bit healthier than 0.5% or 0%, even if it means holding rubles today. In re-examining the Russian ruble dispassionately, while not in the SDR league (perhaps thankfully), it is backed by a popular stable government/social contract within Russia, significantly deep resources, and the proven ability in extremis to operate independently from the USD and Euro.

The firm OPKO Russian Market Partners, based in Moscow, have confirmed greater engagement and increase of foreign investors and companies structuring their presence in Russia. They told me the reasons were to try and take advantage of positive returns on funds (Russian Corporate ruble bonds, and similar), or to position themselves early in Russia particularly in the sanctions mandated import replacement markets through Special Investment Contracts (SIC).

Foreign companies have been actively searching for ways to engage in their business and conduct free trade with or via Russia frozen by sanctions. One path, which gained traction and use since legally approved in July 2015, is the SIC.

The SIC was developed to allow those companies who intend to establish a manufacturing or industrial presence inside Russia certain key guarantees. Each SIC is individual, allowing for the creation and legalization of exclusive conditions for a company to succeed in its specific project. The higher the percentage of localization and sourcing, the more benefits the investor can rely on getting. Benefits are not from any state subsidies or budget’s, they take the form of tax breaks, lowered rents and other privileges that are made law. In addition, the government guarantees that the conditions stipulated in the contract will remain unchanged throughout its timeline. This includes rendering the investor immune to any changes in the contract but also from a change of legislation. For instance if new taxation regulations appear, the investor will not be subject to them. This effectively reduces risk of uncertainty and permits for long term planning.

The SIC path is being followed today by several pioneering firms like Claas (agricultural tech), Kosovit (machine tools for metalworking), Mazda (engine production and new car assemblies), with more than 97 SIC’s now in the pipeline applied for by foreign companies. As SIC’s focused on import replacement, not every business can take advantage and use this vehicle. However, if your business has been negatively affected by trade blockage to supply goods and technology due to sanctions the chances are good that you can qualify for a SIC in Russia. Note that SIC’s do not apply to the food industry, or to extractive industries such as oil and gas.

Russia has been showing a steady, sure recovery curve based on visionary pragmatism, which meshes well with the long term goals many foreign companies find increasingly difficult to find in “developed” markets. Russian manufacturing PMI inched into positive expansion for the third consecutive month in October while exports had the smallest fall in nearly two years. The unemployment rate has remained on a solid downward trend since March 2016. Due to their more manageable scale of operations in Russia, and the comparative ease of modernization into more efficient digital banking, several foreign banks operating in Russia have been noticeably profitable when contrasted with other countries. For example, Societe Generale in Russia delivered a €7 million profit from an €18 million loss the prior year, recovering from the steep oil drop and sanctions effect.

If you still have faith in ratings agencies, even S&P’s R. Bhatia said this about Russia; “The economy has turned the corner, we expect the return to positive real GDP growth in 2017-2019. And this, hopefully, will be the last year of economic contraction.” Rising production among manufacturers and growing domestic orders outweighed a continued decline in new business from abroad while import substitution efforts are dynamically underway. The manufacturing gauge rose to 52.4, its third consecutive month of expansion. The improving situation in Russia is playing out well in the market, seeing the ruble gaining more than 16 percent against the dollar in 2016, second only to the Brazilian real. Russian Central Bank Governor Elvira Nabiullina’s September pledge to keep local rates at 10 percent have boosted carry trades in the ruble. Borrowing dollars at near zero percent to buy assets denominated in the Russian currency has handed investors almost 7 percent in the past three months alone, the most among 31 major currencies. The trades will more than double that gain by the end of next year by returning an estimated 15 percent according to some forecasts, and barring Black Swan events. Again, I repeat my mantra – Russia is a market which no amount of English language reading will adequately or objectively describe. Seeing and learning for yourself in person in Russia is perhaps the only usefully profitable way to separate fact from useless spin. Perhaps when ones mindset changes, everything on the outside will change along with it, and probably for the better.


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