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Russia in the Spotlight Market performance in Q3 2011 MACROECONOMIC SITUATION IN RUSSIA IN 2008 VS. 2011 Performance movements of the Russian MICEX and RTS indices from 1 July to 30 September. 10% 5% 0%
30 /0 6/ 11 07 /0 7/ 11 14 /0 7/ 11 21 /0 7/ 11 28 /0 7/ 11 04 /0 8/ 11 11 /0 8/ 11 18 /0 8/ 11 25 /0 8/ 11 01 /0 9/ 11 08 /0 9/ 11 15 /0 9/ 11
with or above consensus. In addition, inflation is running at around 7% and key indicators have shown resilience: industrial production was up 6.2% YoY as at the end of August, retail sales were up 7.8% YoY, and real wage growth rose 3.9% YoY. All these are firm signs that consumption is driving economic expansion. Russia’s budget performance remains excellent with year-to-date surplus on the back of oil price support at USD 110 bbl. Let’s make a comparison of some of the key features of the situation today versus in 2008. Decrease of external debt. Private sector* external debt fell by 24% from the beginning of June 2008 to April 2011. This significantly reduces the risk of debt refinancing and possible pressure on the rouble.
External private sector debt, bn USD
Source: Micex, RTS and TKBBNPPIP
* ex. State-owned companies/ banks and direct investors’ liabilities
350 300 250 200 150 100 50 0
Jan 2 Ap 006 r2 Jul 006 2 Oc 006 t2 0 Jan 06 2 Ap 007 r2 0 Jul 07 20 Oc 07 t2 Jan 007 2 Ap 008 r2 Jul 008 2 Oc 008 t2 Jan 008 2 Ap 009 r2 Jul 009 2 Oc 009 t2 Jan 009 20 Ap 10 r2 Jul 010 20 Oc 10 t2 0 Jan 10 20 Ap 11 r2 01 1
At the beginning of August, both the Russian equity and bond markets performed negatively on the back of external factors. The continuing uncertainties over debt levels in the US and Europe, potential for growth to stall in many developed nations and the possibility of sovereign defaults in the eurozone periphery all acted to create significant volatility of Russian equities. At first glance, the dynamic of the Russian market in July-August 2011 was similar to that in July-August 2008, being largely driven by events in developed markets. Viewed separately, the Russian economy has grown steadily in 2011. Its forecast GDP growth is >4%, and the mid-year financial results issued by many big corporations indicated earnings growth in line
Source: the Central Bank of the Russian Federation, TKB BNP Paribas Investment Partners, August 2011
2 - Russia in the Spotlight - BNP Paribas Investment Partners - Q3 2011
Decrease of corporate leverage. The net debt-to-equity ratio decreased from 27% in 2007 to 14% in 2011*. The main positive influence during this period was the significant growth in share capital (including through IPOs and SPOs).
Credits / deposits 125% 120% 115%
Net/Debt equity of listed stocks
20 0 Au 8 g2 00 Oc 8 t2 0 De 08 c2 0 Fe 08 b 20 Ap 09 r2 0 Ju 09 n 20 Au 09 g2 0 Oc 09 t2 0 De 09 c2 00 Fe 9 b 20 Ap 10 r2 0 Ju 10 n 20 Au 10 g2 01 Oc 0 t2 0 De 10 c2 01 Fe 0 b 20 Ap 11 r2 01 1
Source: Central Bank of the Russian Federation, TKB BNP Paribas Investment Partners, August 2011
20% 0% Russia
Source: Citibank, 2011
According to the Russian central bank, the average loan period has increased from 1.9 to 2.5 years and the average maturity of the domestic corporate bond market has increased from under a year to 2.5 years, which reduces the risk of short term funding stresses.
Average maturity of loans from the Russian banking sector 50% June 2011
Floating exchange rate. Since the global financial crisis, Russia’s central bank has been pursuing a soft policy regarding rouble fluctuation. As a result, should oil prices fall, the negative impact on the economy will be partly offset by further weakening of the currency. The potential outflow of portfolio investment from Russia is lower. After net inflows of portfolio investment in Russia during 2006-2007, we saw such investments withdrawn in 2008, which influenced equity and bond markets. In 2009-2010 the net portfolio investment flow remained negative, reducing the risk of a plunge in the stock market and a drop in the rouble rate.
Net inlow / outflow of portfolio investment, bn USD 20
181 d-1 year
2000 < 30 days
Source: Central Bank of the Russian Federation, August 2011
Source: Central Bank of the Russian Federation, TKB BNP Paribas Investment Partners, August 2011
Positive changes have occurred in the financial sector. According to the central bank, the loan-to-deposit ratio of the largest 30 banks has fallen from 115% in 2008 to 95% now. Moreover, the capital sufficiency ratio has risen from 15.5 in 2008 to 17.2 in June 2011. Over the same period, the share of bad debts has increased, though this could be due to the fact that, in 2008, banks were less cautious to whom they offered loans.
Government finances are more dependent on oil prices than they were in 2008, which may negatively influence markets in the short term. In 2008, the Russian government achieved a balanced budget with the oil price at USD 65 per barrel, but now this break-even price is USD 115 bbl. There is still a strong dependency on energy sector revenues within the federal budget, which means the country is still vulnerable to downturns in oil prices. In the event of a global downturn it is clear that domestic earnings growth will also falter. Market performance in the near term will be largely influenced by two factors:
* according to Citibank
• Outlook for risk appetite • Oil prices, with demand from China and emerging Asia the most important indicator as demand from Europe and the US is expected to remain flat-to-negative
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3 - Russia in the Spotlight - BNP Paribas Investment Partners - Q3 2011
PRIVATISATION PROGRAMME ANNOUNCED BY RUSSIAN GOVERNMENT President Medvedev has approved an expansion of the government’s privatisation programme, making it the largest such initiative for 15 years. The plan suggests that, by 2017, 14 state companies (including: Sovcomflot, Sheremetyevo International Airport, Aeroflot – Russian Airlines, the federal grid company INTER RAO UES, VTB Bank, United Grain Company, diamond mining company Alrosa, RusHydro and Rosneft) should be fully privatised and four state companies should be partially privatised. Overall, the revised privatisation plan is likely to generate some 1 trillion roubles (USD 35 bn) in annual revenue for the budget over the next six years – three times the total amount envisaged from the programme proposed a year ago – according to Ministry of Economy estimates.
There are also proposals for the period 2012-2017 to reduce the government’s stakes in United Shipbuilding Corporation and United Aircraft Corporation to controlling stakes (50% +1 share), and down to 75% plus one share in machine-building company Uralvagonzavod, as well as Russian Railways, electricity transmission company, FGC UES, and oil pipeline company, Transneft. Also there are plans to privatise the company formed through the merger of telecommunications businesses, Svyazinvest and Rostelecom. We think the recent increase in government spending should encourage the authorities to implement the privatisation plan more actively, particularly once current market volatility decreases. Overall, this programme should increase both foreign investments in Russia and market liquidity, improve the quality of corporate governance and make government policy more investor-friendly.
DR MARKET On 1 July, President Medvedev instructed the government to eliminate restrictions on the issuance and trading of Russian securities abroad. This should make it easier for Russian companies to issue IPOs and depository receipts (DR) abroad. Currently, DRs are limited to 5%-25% of the total share equity (depending on the level of the listing) and offerings abroad are limited to 50% of the total offering. In addition, the government was instructed to move to pass a law that would enable the creation of a central depository and ensure that foreign depositories can open accounts in institutions registered in Russia. It is expected that the Duma (parliament) will adopt the central depository law during the autumn session this year. The news immediately boosted selected local stocks that had been trading at substantial discounts to their DRs because they were less liquid than the related DRs. These stocks can be converted into DRs via brokers. The news had such a large effect because of the arbitrage opportunity it created: buying local stocks and selling DRs.
Discount as at the end of 30 June 2011
Performance of local shares on Friday 1 July **
Discount as at the end of 1 July 2011
* stocks with the largest discounts as of 30 June 2011 ** in rouble terms Sources: Bloomberg, TKB BNPP IP calculations, MICEX
This will allow for Russian securities to be traded freely in the form of ADRs/ GDRs (American Depositary Receipts/Global Depositary Receipts) on foreign stock exchanges. Currently, companies registered in Russia are only able to place a small portion of their stock on foreign stock exchanges. This amount is defined by the category in which the companies were included when they listed on the Russian stock market.
RESULTS OF ST PETERSBURG INTERNATIONAL ECONOMIC FORUM Addressing the 15th St Petersburg International Economic Forum (SPIEF), President Medvedev said that the period of direct State involvement in the Russian economy is over. As an illustration, he cited the selling of the State’s controlling stakes in big companies. Arkady Dvorkovich, the president’s top economic adviser, mentioned that such plans could include selling a controlling stake in Rosneft. Privatisation revenues from 2012 to 2014 should thus amount to at least USD 16 billion a year, 60% up on the previous annual target of USD 10 billion. According to Medvedev, the State increased its involvement in the economy in order to bring about stability following the chaotic 1990s. Now this need has passed, the country should move to an economic model that encourages private businesses, which Medvedev believes should drive wealth creation, as an economy based on State-run businesses may lose its competitiveness
and become vulnerable. It is certainly clear that the greater role of private enterprises and a boost in investment activities meet Russia’s current needs and concerns. Guests at the forum discussed prospects for western investors on the Russian market and Russia’s accession to the WTO (the latter being Russia’s top priority for external trade relations). ”Markets are like parachutes — they work only when open. Without an open economy, we will fall very badly,” said Medvedev, while asserting that, while Russia’s admission to the WTO was a realistic aim for the year-end, it would be fulfilled only under acceptable terms. Russia’s relations with China were a separate item on the forum’s agenda. Presidents Hu Jintao and Dmitry Medvedev signed nine cooperation agreements, including in the energy sector. A gas supply contract is already in its final stage. Forty-seven agreements worth a total of USD 12 billion were signed at the For professional investors
4 - Russia in the Spotlight - BNP Paribas Investment Partners - Q3 2011
SPIEF, including a deal for the purchase of eight Sapsan high-speed trains and two Mistral helicopter carriers. Att SPIEF, Dmitry Medvedev also outlined 12 key points for Russia’s budget policy. He said the main priorities for the next three years are to raise the efficiency of State governance, modernise the economy, strengthen the country’s defence and improve living standards. In addition: • Russia needs to increase the taxes levied on oil and gas companies, alcoholic and tobacco products; boost revenues from federal property, and improve the efficiency of State spending in order to fulfil all the government’s social commitments • The tax burden on the gas sector needs to be further increased to boost budget revenues. The Russian government is discussing measures to raise the sub-soil tax on gas production from next year and double it for the gas monopoly, Gazprom
• The government needs to reduce considerably its interference in the economy by expanding privatisation to help create better conditions for an inflow of investment and fair competition • Russia must totally restructure its system of State purchases and limit acquisitions in which there is no tender process • Medvedev ordered proposals by 1 December 2011 on the possible decentralisation of power among federal, regional and municipal governments • The Russian government should offer a 150% incentive to spend more on R&D by Russian businesses to add to their total expenses to apply for tax benefits. ”We need to gradually get rid of tax system elements that obstruct innovative development” Medvedev said.
FITCH AND STANDARD & POOR’S CONFIRM RUSSIA’S RATINGS International rating agency Standard & Poor’s confirmed Russia’s ratings at BBB/A-3 for its foreign currency debt and BBB+/A-2 for local currency issues with a stable outlook. The affirmation reflects the agency’s view that the Russian government’s assets slightly exceed its liabilities due to budget surpluses in previous periods and its moderate current deficit, as well as the country’s general position as an external net creditor. The overall Russian government debt-to-GDP ratio of 9% (IMF estimate for 2011) remains at a level far below the average in either ‘BBB’ or even ‘A’ rating groups. International reserves are large enough to cover all government debt more than three times over. At the same time, we should also note that the Russian economy is both clearly vulnerable to oil prices and their effect on fiscal performance and not immune to the risk of a global slowdown. Fitch confirmed its long-term rating of Russia as BBB, and its shortterm rating as A-3. The agency noted that presidential elections in 2012 are unlikely to alter the country’s policies or add to investor risk. The
rating and positive outlook “balances its exceptionally strong sovereign balance sheet... against its structural weaknesses and the delay in fiscal tightening, which heighten its vulnerability to a severe oil price shock,” Fitch Managing Director, Ed Parker, said. Fitch’s positive view also took account of Russia’s flexible currency exchange rate and falling inflation. Standard & Poor’s said that the elections next March were adding uncertainty to Russian politics and the economy. The agency said the result of the elections could influence future budget and economic policy, including how decisively the government would carry out its consolidation of the public finance sector and promote structural reforms to pensions, the business environment and privatisation. Fitch assessed the Russian economy’s 3.7% growth in Q2 2011 as “balanced, though not strong.” It forecast Russia’s GDP growth to reach 4.2% by the end of 2011 thanks to higher-than-expected oil prices, good harvests and a rise in domestic consumption. The federal budget’s deficit by the end of the year would fall to 1.2% of GDP compared with 4% in 2010.
ROSNEFT AND EXXON MOBIL SIGNED A STRATEGIC COOPERATION AGREEMENT The Russian State-controlled oil company, Rosneft, and US energy giant, Exxon Mobil, signed a strategic cooperation agreement that includes approximately USD 3.2 billion to be spent funding the exploration of East Prinovozemelskiy Blocks 1, 2 and 3 in the Kara Sea (one of the world’s largest oil discoveries in the last 50 years) and the Tuapse License Block in the Black Sea. Rosneft will own 66.7% and Exxon Mobil 33.3% of a joint venture to develop the blocks. It is expected that the first production of the fields could begin in the next decade. Exxon Mobil said on its website the blocks “are among the most promising and least explored offshore areas globally, with high potential for liquids and gas”. Rosneft said that exploration in the Arctic area will be done in waters at depths of between 40 and 350 metres, under difficult ice conditions, with extreme winter temperatures. The Hibernia field project in Canada, in which Exxon Mobil participates, is similar in terms of climatic conditions.
Exxon is already working with Rosneft on the Sakhalin-1 project and according to top Russian energy officials offered significantly better terms than those offered earlier by BP. (In January, Rosneft and BP agreed on a USD 16 billion deal that also involved a share swap and an Arctic shelf development project, but this was later blocked by a court injunction following legal action by the AAR consortium, which represents BP’s partners in the TNK-BP Russian joint venture). There is no equity swap element to the Rosneft/Exxon Mobil deal, though this is possible in the future. But the agreement means Rosneft will now be able to operate on Exxon Mobil’s turf in the United States - in the Gulf of Mexico and Texas – and in other countries. Rosneft expects to start participating in Exxon Mobil’s deep-water projects in the US early in 2012. The companies will also create an Arctic Research and Design Centre for Offshore Developments in St. Petersburg and implement a programme of staff exchanges.
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