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ANDBANK RESEARCH Global Economics & Markets

Alex Fusté Chief Economist alex.fuste@andbank.com +376 881 248

Working paper - 62 And yet … there are good reasons to stay interested January 15th , 2014


Corporate Review

The ten points describing the external perception of the Russian economy. 1. Russia’s entry to the World Trade Organization in August failed to boost business confidence. 2. An official pledge to swiftly improve Russia’s ranking in “doing business” tables has not materialized. 3. Quite the opposite, persistently high inflation is perceived to result from the politically driven upward manipulation of utility prices in favor of oligarchs, 4. … the same Oligarchs who control utility companies 5. Gross fixed investment has stagnated for more than a year reflecting a general policy failure. 6. The Kremlin may appear strong but local politicians frequently block centrally-mandated infrastructure projects. In this respect Russia, with its 83 regions, looks more like India than China. 7. Governance and institutional development has disappointed… 8. … drawing negative commentary from overseas, 9. Prices across the commodity complex are weakening … 10.… and Russia’s stranglehold over key energy markets is threatened by new unconventional supplies.

Then, why foreign investors should remain involved?

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Two potentially significant silver lining in this gloomy picture.

1. The potential willingness to replace Prime Minister Dmitry Medvedev with Alexei Kudrin, a well-regarded former finance minister for several reasons:  Is seen as being internationalist.  As Finance Minister, Kudrin was widely credited with prudent fiscal management, commitment to tax and budget reform and championing the free market.  Under Kufrin, Russia’s government paid most of the substantial foreign debt it had accumulated in the 1990’s leaving the country with one of the lowest foreign debts among major economies.

2. Full employment means that Russian producers are being forced to upgrade their capital stock (if they want to enhance productivity), by replacing out-of-date machinery with more efficient German models. Russia is the 4th largest market for German machinery exporters, with some forecasts suggesting its demand for metal processing machinery may triple by 2016. (http://www.gtai.de/GTAI/Navigation/DE/Trade/maerkte,did=780940.html). In doing so, productivy growth will accelerate and, whit it, GDP growth.

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Living standards have maintained steady improvement due to three major forces

1. An economy operating at full employment is pushing up wages. They keep growing at an average nominal pace of 13% yoy in 2013 (indeed, inflation remains stubbornly high at 6.5%, but wages continue growing at a healthy 7% yoy in real terms). 2. Tax revenues from oil & gas output tends to go into social spending (mainly pensions and healthcare). For the moment there is no clear threat to such transfers. 3. Loans to households have increased at nearly 33% annualized in the last 4 years (see chart 2)

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RUSSIA - WAGES

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(% 1YR) A vg. Monthly Wages, Nominal, Rub - Russia Andbank, Goskomstat of Russia

ŠFactSet Research Systems

10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

Russia - Loans to Households

+216% flat in 4 years (or 33% yearly) 9.5trn BRL = USD287bn (or 14% of GDP)

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Loans to individuals, Billion RUB - Russia / 1000 Loans in foreign currency to individuals, Billion RUB - Russia / 1000 Andbank, Bank of Russia

ŠFactSet Research Systems


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Putting all these elements together, … we can see now the result

The Russian middle class has become large enough to have a material impact in the Russian consumer economy!!   

Vehicle sales in Russia are running at 3mn a year (a touch below German levels) Russia’s retail market is now bigger than either that of France or Germany, with annual sales of €550bn The WTO estimates that Russians spent $43bn abroad last year, being the second after the Chinese tourist


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Russia also runs an approximately balanced budget and enjoys a very low level of public debt (12.4% of GDP in 2012).

Suggesting some "muscle" to withstand the vicissitudes of a bearish commodity markets, for at least a few years.


Corporate Review

Within this 12.4% of Government Debt, the Public External debt represents only 2.8% (or US$62.7bn) It is when we consider the private sector External Debt (US$634bn or 30% of GDP) that we realize that the National External Debt is much higher (US$ 714bn). Nevertheless, the overall figure barely represents a 34% of GDP

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An external debt that is not fully covered by Fx reserves (that amount to an equivalent of 22% of GDP), but ‌ ‌ despite this, the coverage ratio (Fx Reserves / National External Debt) is still at a healthy 64%. A situation that distances Russia from a crisis in the Balance of Payments (BoP)

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Despite the “normalization” seen in the net external sector, the Current Account continues being balanced. This, added to budget balance, suggests that there are no risks arising from a “wild” twin deficit. Certainly a good position, specially in a global environment where monetary conditions are tightening


Corporate Review

Since Trade balance is firmly in positive territory ‌

 ‌ in order to have a CA balance near 0%, it is necessary the Net Interest Income account to be negative (by an equivalent 8% of GDP).  This simply means that the interests paid to foreigners investing in the country are much larger than the interests received from investments of locals abroad.  In other words. Foreigners are heavily investing in the country.

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Still think we exaggerate?

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BOP - Foreign Direct Investment

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In the last twelve months, the average quarterly Foreign Direct Investment has amounted usd22bn, or USD88 bn annually.

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This is a healthy 4.4% of GDP

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(MOV 4Q) BOP, Direct investment (USD bn) Andbank, Bank of Russia

ŠFactSet Research Systems

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Corporate Review

Our conclussions 1. As long as global growth does not crater, and with it energy and commodity prices, there are good reasons to think that Russia can muddle along and perhaps recover the rate of expansion seen in recent years.

2. The macroeconomic balances of Russia remains very healthy, with extremely low level of public debt and decent levels for private debt.

3. Current account is declining but is still in surplus, which argues against any nasty scenario.

4. The momentum in its strong consumer market, and the need to update its capital stock (machinery) benefits those companies best able to serve these markets.

5. We would recommend to stay long in these Equity Russian’s sectors: Machinery and Equipment, Business Services and Consumer Goods.

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Corporate Review

Legal Disclaimer All the sections in this publication have been prepared by the financial institution’s team of analysts. The views expressed in this document are based on the assessment of public and private information. These reports contain evaluations of a technical and subjective nature on economic data and relevant social and political factors, from which the financial institution’s analysts have extracted, evaluated and summarized the information they believe to be the most objective, subsequently agreeing upon and drawing up reasonable opinions on the issues analysed herein. The opinions and estimates in this document are based on market events and conditions that took place before the publication of this document, and therefore cannot be determining factors in the evaluation of future events that take place after its publication. The financial institution may hold views on financial instruments that differ completely or partially from the general market consensus. The market indices chosen have been selected using the exclusive criteria that the financial institution regards as most appropriate. The financial institution cannot in any way guarantee that the predictions or events given in this document will take place, and expressly reminds readers that any past performances mentioned do not in any circumstances imply future returns; that the investments analysed may not be suitable for all investors; that investments can fluctuate over time in terms of their share price and value; and that any changes that might occur in interest rates or currency exchange rates are other factors that may also make it unadvisable to follow the opinions expressed herein. This document cannot be regarded, under any circumstances, as an offer or proposal to buy the financial products or instruments that may have been mentioned, and all the information herein is for guidance purposes and should not be regarded as the only relevant factor when it comes to making a decision to proceed with a specific investment. This document does not, therefore, analyse any other determining factors for properly appraising the decision to make a specific investment, such as the risk profile of the investor, his/her knowledge, experience and financial situation, the duration or the liquidity of the investment in question. Consequently, investors are responsible for seeking and obtaining appropriate financial advice in order to assess the risks, costs and other characteristics of any investments they wish to make. The financial institution cannot accept any responsibility for the accuracy or suitability of the evaluations or estimates of the models used in the valuations in this document, or any possible errors or omissions that may have been made when preparing this document. The financial institution reserves the right to change the information in this document at any time, whether partially or in full.

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Working paper 62 russia