Issuu on Google+

OUTLOOK 2011 Russia Ukraine Central Europe Southeast Europe Eurasia


58

I Outlook

bne February 2011

RUSSIA 2011: Growth but state-led recovery is bad news

W

Russia is recovering well from the crisis, but even leading officials admit that the state is carrying the can, while the private sector and consumers are still recovering from the shock of the 2008 collapse. How quickly this confidence returns – and it’s likely to take another two years until it’s completely restored – will be as important, if not more so, for the rate of growth than oil prices in 2011. The government is under pressure. Thanks to the budget deficit, rising imports, and a shrinking current account surplus, it has to make reforms work over the next two or three years, or else it will face a another bout in the "periodic devaluation trap," argues Deputy Economy Minister Andrey Klepach. The trap is set Thus far the state has been unable to come up with anything better than pumping more investment into the economy through the large state-owned enterprises, which – without the private sector and consumers – is what drove the less than spectacular recovery in 2010. Nowhere is this more clearly illustrated than by the budget’s break-even oil price, which was running at $110 at the end of 2010, up from (the still extremely high) $70 pre-crisis. This is not a sustainable policy; or at least it condemns Russia to a boom-bust cycle that follows commodity prices swings. On the upside, the Russian capital markets should do well in 2011, with the RTS likely to outperform other emerging markets. FDI and investment should both pick up simply because they lag the crisis by at least a year, and 2010 was the low point in the cycle. Domestic production should also pick up as, while imports soared in 2010 putting the current account under pressure, the statistics show that most of this was down

On closer inspection, however, the official numbers look disappointing, with the private sector moribund. The government's results may paint a rosy picture in the European context of bailouts and spiking credit default swap (CDS) spreads, but the blanks in between are a cause for concern. Whilst the state and state-owned business have enough money and momentum to keep nudging the economy out of the deep hole it fell into in 2008, everyone is still waiting for consumer and small business confidence to return to the point where Russians start to shop again and businesses start to invest. "Russia enjoys a very low debt/GDP ratio of about 10%, so we can borrow and remain reluctant to cut spending. The deficit is projected to be 4.8% this year, 3.6% next year before falling to zero in 2015," Deputy Finance Minister Dmitry Pankin told delegates at a December conference. "We are not under a lot of pressure and we can continue fiscal stimulation, as there is no danger of solvency problems."

Ben Aris in Moscow

hile Western Europe is once more staring into the abyss of sovereign default, Russia is expecting to see the strong growth that was originally forecast in the second half of 2010 (but was delayed by the fires in the summer) finally arrive in the first half of 2011.

bne February 2011

to companies re-tooling ahead of the next super-cycle and recovery of domestic consumer demand. On the downside, inflation and the deficit remain a problem. The pressure on the current account, added to a $90 ceiling on oil prices has economists worry that the dwindling current account surplus could turn negative by the end of 2011, which may lead to a mild devaluation of the rouble. However, these problems are fairly mild and it means that the Finance Ministry will have to go to work for once, rather than simply organising how to spend the huge flood of petrodollars that used to pour into Russia’s coffers. At least the Kremlin appears to realise the scale of the problem and what will happen if they fail. "The economy is now starting a new phase of growth,” says Klepach. “There will

"The Finance Ministry will have to work, rather than simply organise how to spend the flood of petrodollars" be big qualitative changes [in the structure of the economy] otherwise the economy will not be competitive and we will not be able to escape the periodical devaluation trap.” State-led rescue On the face of it, the pace of economic growth is picking up fairly well, with 2010 expected to see an expansion of around 3.8%, while the deficit has fallen further and faster than anyone expected (the end of year estimate is 3.5%-4% of GDP). Meanwhile, with about $500bn in reserves, Russia's public finances are amongst the most robust in the world.

Russia is going to have a good 2011, with much of the strong growth that was expected in the second half of 2010 arriving in the first quarter of 2011 instead. Both consumer and corporate confidence were knocked sideways by the fires in the summer of 2010, but by the fourth quarter they were both growing, as evidenced by the gathering momentum of bank lending. As for full year, much depends on the external environment, but also the key will be how well the government performs in pushing through real and, more importantly, effective reforms. The state’s first challenge will be to move the core of economic growth out of the state-owned sector and into the private sector, which won't be easy. Vasily Vysokov, president of the Rostov-on-Don progressive Centre-Invest Bank, put his finger on the problem when he said: "We shouldn't increase the rate of growth of a bad economy, but use the crisis to change the nature of the economy and its direction. The state support takes money out of the pockets of those that work well and puts it in the pocket of those that work badly." • GDP The official estimate for Russia’s economic growth in 2011 is 4%, but the band of estimates on what it will actually be varies widely from 3.5% to over 5%. • Inflation After falling to record low levels of about 4% in the summer of 2010, inflation had begun to rise towards the end of 2010 and is expected to reach 8-8.5% in 2011 – slightly (but not a lot) higher than Russia’s comfort zone. Much of the increase was caused by a one-off hike in food prices after a third of Russia’s crop burnt in the summer; indeed, the cost of a basket of staple goods was up by a quarter in 2010. The central bank has already ended its string of interest rate cuts with the first hike in nearly two years over the Christmas holidays and will probably hike rates again later in 2011.

Outlook

I 59

• Budget deficit The reappearance of the budget deficit since the start of the crisis is the other major macro problem that the government has to deal with. Economic Development Minister Elvira Nabiullina said that in 2011 the official budget deficit forecast is 5.3% of GDP, although it is more than likely to come in significantly below this level at between 3.5% and 4.0%. Finance Minister Alexei Kudrin already said that thanks to rising oil prices, the government probably won’t spend all the money in the reserve fund this year and analysts are speculating the government could balance the budget sooner than the planned 2015. • Privatisation The budget calls for RUB300bn ($30bn) a year, every year, of privatisations for the next three years, which could go up to $50bn if the market conditions are good, says Dmitry Pankin, deputy economy minister. • Borrowing programme The budget has a provision for $7bn of international borrowing over the next three years, however the state has

"We shouldn't increase the growth rate of a bad economy, but use the crisis to change the nature of the economy" made it clear it will borrow as little as possible overseas. The bulk of the money – the budget calls for RUB1.5 trillion a year for three years – will be raised from the domestic market. • Consumption "The second key question for growth in 2011 is what will the consumer do? Incomes are still rising, but they are rising half as fast as they did pre-crisis. However, we expect that lending will increase," said Deputy Economy Minister Andrey Klepach. Real incomes have continued to rise throughout the last two years, but this did not feed through into an increase in retail turnover in 2010. • Ruble In 2011, the capital account should improve and the current account remain in surplus. Increased global risk appetite and the attractive valuations of Russian assets (both equities and bonds) should attract higher foreign portfolio flows. • Equity Russian stocks are so cheap that several banks and funds have started to overweight Russia for 2011. UniCredit has been a fan of Russian stocks for most of last year, while HSBC Global Asset Management and Goldman Sach’s chief economist, Jim O’Neil, both said in December they were


60

I Outlook

overweight Russia. HSBC said it had Russia as its biggest overweight position in emerging markets, predicting 2011 returns would outstrip the 10-30% gains it expects from broader emerging equities. The least analysts say the RTS will return in 2011 is 15%. In 2011, Russian indices will rise by 15-20%, forecasts the head of the Investment Management Department at Raiffeisen Capital, Igor Kobzar. Analysts at VTB Capital forecast that the RTS Index will reach 2200 points by mid-2011. All told, there is a very good chance that the RTS will surpass its all-time high of 2487.92, set on May 19, 2008 in 2011.

bne February 2011

• Fixed income Russian bonds paid well in 2010 – as of December, delivering an 8.3% dollar return on sovereigns, a 13.8% dollar return on corporate Eurobonds and a 12.2% ruble return or a 9.0% dollar return on local corporate bonds. Russian officials point out that Russia has no solvency problem (its debt/GDP level is less than 10%) and for that reason the state has decided to take some leverage. “We are not under a lot of pressure and we can continue fiscal stimulation as there is no danger of solvency problems,” Pankin said in December.

The experiment with genuine democracy has come to an end, as under President Viktor Yanukovych the system has reverted to some extent to its old ways. Yanukovych has ruthlessly seized control of both the presidency and parliament, the Verkhovna Rada. Even so, last decade's Orange Revolution wasn't for nothing - despite his strong grip on power, the president remains accountable and the population politically active. It is now critical for the government to push through badly needed reforms, a process that should pick up momentum in 2011. If Yanukovych is successful, then not only will the country flourish, but it should also begin the process of decoupling from Russia. Until real and sweeping reforms are implemented in Ukraine, the Ukrainian capital markets will simply follow Russia's volatile bounces. In the meantime, the economic growth that was already gathering pace as 2010 came to a close, driven by internal

• Pensions Social spending weighs heavily on the state budget and a reform of the system is due to start in 2011. This is likely to be controversial, as there are reports that the state will attempt to raise the retirement age.

• Tax reform Protestors were out in force in December to protest against a new tax code that increased taxes on small and mediumsized enterprises, while reducing them on big business. • Industrial production Manufacturing is recovering well in Ukraine. Industrial output was up by 10.2% on year in October, unchanged from the previous month’s record and Bloomberg consensus estimates of 8.5%. Growth in the first 10 months of 2010 stood at 10.7% on year, said Dragon Capital.

bne

U

the start of a comprehensive reform programme that will include local administrative overhauls and a new package of anti-corruption laws. Without these additional elements, the changes could have limited positive effects.

The bill on the first phase of the pension reform, which the government will soon submit to the Rada in line with its agreements with the IMF, will contain a proposal for a gradual increase in the retirement age for women to 60, the first deputy head of presidential administration, Irina Akimova, said in December.

UKRAINE 2011: Better placed for a bounce back

kraine had a terrible crisis, but with a $15bn standby agreement with the International Monetary Fund (IMF) in place and an end to political instability, the country is in a better position to bounce back than it has been for at least half a decade.

bne February 2011

demand, is expected to accelerate in 2011, although the rate is comparatively modest given the very low base of 2009. The consensus forecast for GDP growth in 2011 is 4.6%, with the main risks to growth internal factors related to tariffs and fiscal policies, as well as the stability of the banking system. Inflationary pressures are to be slightly less pronounced this year due to the smaller budget deficit (around 6%) and the National Bank of Ukriane (NBU) probably allowing greater hryvna flexibility. As the Russian stock market is expected to grow strongly by between 20% and 45% (depending on what happens to the global story), Ukraine should follow suit. Some of the reforms that are on the agenda for 2011, at the IMF’s insistence, are: • Administrative The administrative sackings in December were written off by many commentators as little more than a reshuffle, with key players such as Prime Minister Mykola Azarov staying in place. But Yanukovych's chief of staff, Serhiy Lyovochkin, promised in a meeting with journalists that this is just

• Consumption Consumer spending was also recovering as 2010 came to a close, but doing less well than industry, hindered by the slowdown in real wage growth and weaker consumer confidence. Growth in organized retail turnover remained little-changed in October, at 10.7% on year (versus 10.4% in September) and growth in 2011 will depend on overall economic activity. But in general, confidence was improving amongst the population, as most people overestimated the impact of this crisis as the last one in 1998 was so bad.

Outlook

this fulfilling the domestic quota of 53% of the total (against 66% in 2010). • Privatisation The privatisation of several big enterprises is on the cards for 2011-12. In particular, stakes in Turboatom, Dniproenergo, Centrenergo, Zapadenergo, Donbassenergo, Odessa Port Plant and Krivorozhsky GOK of Oxidized Ores can now be offered for sale. The authorities plan to raise up to $1.5bn from privatisations in 2011 (about UAH12bn, on par with the 2010 plan if accounting for the privatisation of Ukrtelecom). • Hryvnia and capital controls Analysts at Dragon Capital said: “We think this will give the central bank more room for manoeuvre with the UAH:USD exchange rate next year. We currently forecast the hryvna’s end-of-period and average exchange rates for 2011 at UAH7.90 per dollar and UAH7.95 per dollar, respectively.” • Equity outlook Bonds dominated the action on the domestic capital markets in 2010, but after the frenzy had died down investors were switching into equities before the end of the year. Over the last two months of the year, the UX index gained 13.7% versus growth of just 2% over the summer, but has yet to win back all that was lost during the worst of the crisis in early 2009. • Bond outlook Bonds had a great year in 2010, with the government’s VAT bonds proving especially popular. However, the bond rally ran out of steam in the autumn and attention began to switch to equities. By the end of October, Ukrainian bonds were performing poorly versus other emerging markets and the EMBI+ Ukraine index spread widened by 2.8%, or 15 points, to reach 536 points, while the EMBI+ Global index spread narrowed by 11.5%, or 32 points, to 251 points. Still, analysts say that fixed income will remain an attractive asset in 2011.

Real disposable income grew by a strong 11.8% in the second quarter of 2010, after falling 8.3% a year earlier, but the growth rate is from a low level and still less than pre-crisis levels. Household income remains low with GDP per capita at about $2,500, versus around $15,000 in Russia and $31,000 in the EU. • 2011 budget Since assuming office, Yanukovych’s administration tried to hold the deficit to 6% in 2010 and has set a budget deficit of 3.08% for 2011. The draft version of the state budget for 2011 adopted by the parliament in the first reading stipulates borrowings of UAH91.6bn ($11bn) for the budget (down 8.6% compared with the 2010 budget), which analysts say is reasonable, but the domestic rates and/or yields will have to rise to make

I 61

"The consensus forecast for GDP growth in 2011 is 4.6%"


62

I Outlook

bne February 2011

CENTRAL & SOUTHEAST EUROPE 2011: A tale of two cities Nicholas Watson in Prague

E

merging Europe had a much better year than most countries to the west, and a combination of factors point to a repeat of that in 2011. For all that, the region is still facing a twin-speed recovery. A major theme for 2011 in emerging Europe, as it is over much of the world, is a continuation of Keynesian re-flation giving way to Germanic fiscal restraint – and this fiscal tightening is, if anything, even stronger in the emerging markets. "We're all Germans now," states Mark Cliffe, chief economist at ING, in a take on the monetarist economist Milton Friedman's comment that, "We are all Keynesians now." The reason why countries in emerging Europe are proving better able to push through deeper cuts more swiftly than are being attempted elsewhere on the continent is that it's much easier to tighten fiscally if you have strong economic growth – and that's exactly what emerging Europe has, unlike Western Europe. With a variety of institutions, from the European Commission to the World Bank, continually issuing and updating GDP forecasts, it can be a little confusing, but all tell a similar story: the older EU member states will mostly either contract or grow slowly in 2011, while newer members and candidate countries will mostly grow relatively quickly – albeit at lower, but more sustainable, levels than before the global economic crisis hit. In November, the World Bank said it now projects the EU as a whole to grow by 1.7-1.8% in 2010. The previous month, the European Bank for Reconstruction and Development (EBRD) put 2010 GDP growth for the emerging markets it covers at 4.2% – a significant improvement on the developed markets and an impressive turnaround from the 5.5% contraction the region suffered in 2009. For 2011, the European Commission (EC) said in November that it now expects the Eurozone to grow 1.5% and the EU to grow 1.7%. In emerging Europe, only Romania and Croatia will fail to exceed the EU average, the EC says, with Turkey putting in the most growth at 5.5% (after surging 7.5% in

Outlook

bne February 2011

I 63

Growth in real GDP (In per cent; EBRD forecasts as of October 22, 2010)

GDP Growth (year over year per cent change) Current forecast 2008

EBRD forecast in July 2010

2009

2010

2011

2010

Change Jul-Oct

2011 Change Jul-Oct

Central Europe and the Baltic states Croatia

2.4

-5.8

-1.5

1.9

-1.3

-0.2

3.0

-1.1

Estonia

-5.1

-13.9

2.4

3.2

0.2

2.2

3.4

-0.2

Hungary

0.6

-6.3

0.8

1.7

1.2

-0.4

2.1

-0.4

Latvia

-4.6

-18.0

-1.0

2.6

-2.0

1.0

3.0

-0.5

Lithuania

2.8

-14.8

0.5

4.0

-1.0

1.5

3.0

1.0

Poland

5.1

1.7

3.3

3.5

2.7

0.6

3.3

0.2

Slovak Republic

6.2

-4.7

4.0

3.5

3.1

0.8

3.4

0.1

Slovenia

3.7

-8.1

1.1

2.1

0.0

1.2

2.6

-0.6

Average1,2

3.5

-3.0

2.2

3.0

1.7

0.5

3.1

-0.1

-0.1

Southeastern Europe

2009), followed by Estonia with 4.4% and Poland, the only EU country to avoid recession in 2009, with 3.9%. As such, the region is facing a twin-speed recovery. While some economies will impress, others will be held back by the legacy of the last decade's credit bubble. "Turkey and Poland will continue to lead the way, followed by Slovakia and the Czech Republic," says Neil Shearing of Capital Economics. "Elsewhere, however, vulnerabilities are much greater… A combination of weak banks, competitiveness problems and hefty external financing requirements mean that the Balkans still face a long slog back to health." Engine of the locomotive The standout performer in the Eurozone in 2010 has been Germany, and the performance of the world's largest exporter has been key to the revival of the countries to its east. The rebound in world trade has been particularly beneficial for the world's exporting economies. As such, the German economy recovered remarkably swiftly and vigorously from

Albania

7.7

3.3

3.0

2.2

1.4

1.6

2.3

Bosnia and Herzegovina

6.0

-2.8

0.8

2.2

0.4

0.4

1.7

0.6

Bulgaria

6.2

-4.9

0.4

2.4

-1.2

1.6

2.5

-0.2

FYR Macedonia

4.8

-0.8

0.8

2.3

0.5

0.4

2.5

-0.1

Montenegro

7.5

-5.7

-0.6

2.5

-0.1

-0.5

2.0

0.5

Romania

7.3

-7.1

-2.0

0.9

-3.0

1.0

0.0

0.9

Serbia

5.5

-3.1

1.6

2.9

1.9

-0.3

3.0

-0.1

Average1

6.8

-5.4

-0.6

1.6

-1.5

0.9

1.2

0.5

Armenia

6.9

-14.2

4.0

4.5

8.0

-4.0

3.5

0.9

Azerbaijan

10.9

9.3

4.0

2.5

4.0

0.0

4.0

-1.5

Belarus

10.0

0.2

6.0

4.0

6.0

0.0

3.5

0.5

Georgia

2.1

-3.9

5.5

4.0

3.5

2.0

4.5

-0.4

Moldova

7.2

-6.7

4.5

3.5

4.0

0.5

3.5

0.0

Ukraine

2.2

-15.1

5.0

4.5

4.0

1.0

4.1

0.4

Average1

5.0

-8.0

5.0

4.0

4.6

0.4

3.9

0.1

Turkey

0.9

-4.7

8.0

5.0

5.9

2.2

4.0

0.9

5.2

-7.9

4.4

4.6

4.4

0.0

4.6

0.0

Kazakhstan

3.3

1.2

6.0

5.0

4.0

2.0

5.3

-0.3

Kyrgyz Republic

8.4

2.3

-3.5

7.1

-3.5

0.0

7.0

0.1

Mongolia

8.9

-1.6

7.0

9.0

8.0

-1.0

9.0

-0.1

Tajikistan

7.9

3.4

5.5

5.0

6.0

-0.5

6.5

-1.5

Turkmenistan

10.5

6.1

11.0

12.0

11.0

0.0

12.0

0.0

Uzbekistan

9.0

8.1

8.2

8.5

8.2

0.0

7.0

1.5

Average1

5.6

2.7

6.7

6.6

5.4

1.3

6.5

0.1

4.1

-5.5

4.2

4.1

3.5

0.7

3.9

0.2

Eastern Europe and the Caucasus

Russia

"Turkey and Poland will continue to lead the way, followed by Slovakia and the Czech Republic" the crisis, posting six consecutive quarters of export-led growth that is above what many consider to be the economy's longterm output potential. The EC expects German GDP growth to come in at 3.7% in 2010 and 2.2% in 2011. That's good news for Central Europe, investing in which is sometimes referred to by fund managers as a "leveraged play on Germany." The outlook for European exporters in 2011 could be improved further if, as many expect, there is a revaluation of Asian currencies over the coming months. With Germany a member of the euro, which is a freely floating currency, the bulk of the

Central Asia

All transition countries Average1

1 Weighted

averages. The weights used for the growth rates are EBRD estimates of nominal dollar-GDP lagged by one year. Weighted averages for July 2010 forecasts shown above might vary from weighted averages used at the time due to revisions in nominal GDP weights. 2 Weighted averages do not include the Czech Republic, for which EBRD no longer produces a forecast. With the Czech Republic included (using IMF October 2010 projections), the Central European and Baltic average would be -4.2 per cent in 2009, 0.6 per cent in 2010 and 3.4 per cent in 2011; and the average for all transition countries would be -5.7 per cent, 3.1 per cent and 3.9, respectively.


64

I Outlook

adjustment has to come from Asia, particularly China, whose renminbi, the US claims, is being kept artificially low. Chinese manufacturing data for November suggest that GDP growth is accelerating, putting further upward pressure on inflation, which has already surged above 4%, meaning the government will miss its inflation target in 2010 and possibly also in 2011. "The bad inflation number could eventually contribute to easing tensions between China and the US, as it will increasingly be in China's own interests to let its currency appreciate to ease inflationary pressure," reckons Flemming Nielsen, a senior analyst at Danske Bank. Though the signals are still weak, analysts believe the ground is being prepared by the Chinese for a sustained and significant appreciation of the renminbi over the next year or so, which should be particularly beneficial for Germany and other exporters in the Central and Eastern European region. "The Chinese are not arguing about the principle of revaluation, but the pace… and are probably trying to extract some political concessions along the way," ING's Cliffe told investors at the ING 13th Annual EMEA CEO/CFO Forum in Prague at the end of November. "This is good news for Europe, and especially Germany, as they try to penetrate these Asian markets." With a continued cost advantage making it a magnet for foreign direct investment, CEE is, in the words of one Asian executive quoted recently by the Financial Times, "the factory of Europe, just as China is the factory of Asia." The problems ahead for the region, therefore, are likely stem from success rather than failure. Icebergs ahoy! Timothy Ash, emerging markets economist at Royal bank of Scotland, argues we are in bubble territory: "We all know it – it feels like a bubble, it smells like a bubble and it probably is." Certainly, the tide of money that has flowed into emerging markets, which only picked up as the US embarked on another round of quantitative easing (QE2), has been huge. The fund tracker EPFR reported that by November emerging market equity funds had taken in $84.3bn for the year, putting it ahead of last year's record-setting $83.3bn. "For the third year running, cash in the developed world is returning close to nothing. And this is turning into a significant problem because ageing populations in the rich world need income to supplement their falling retirement plans. Financial assets seeking income must now travel further afield," says Plamen Monovski, chief investment officer of Renaissance Asset Managers. That of course has resulted in surging stock and bond markets, which brings with it risks as well as benefits. The MSCI Emerging Markets Index was trading around 1,130 on December 7, which is up about 140% from its low hit in the depths of the financial crisis in 2008. "Most of QE2 has gone to emerging markets, and this is not a short-term phenomenon but a long-term shift, and that causes a number of difficult policy implications," Dr Nouriel

bne February 2011

Roubini, professor of economics at New York University's Stern School of Business and the man who has acquired the nickname Dr Doom after predicting the financial collapse, grumbled to investors at the ING conference. "In some countries [price/earnings] ratios in emerging markets are very high and in some cases may not be justified by GDP differentials. In some countries currencies are already overvalued… and in some countries the reduction in credit spreads has been excessive and is unjustified." Others dispute this, pointing out that the while the markets are certainly not as cheap as they once were, the MSCI EM Index is still well below its pre-crisis peak of 1,340 and these countries still have scope for export-led growth and an improved trade performance based not on undervalued currencies but rapid productivity growth capitalising on FDI inflows. "Look at the MSCI – we are not back to the peak despite strong economic growth, profit growth and strong fundamentals in the fiscal condition and fiscal reserves," says ING's Cliffe. Perhaps, but few doubt that the capital markets will be volatile as long as the spectre of sovereign debt default hangs over the Eurozone, meaning that periodic setbacks from the developed markets should be a perennial problem throughout the year. The most bullish, of course, would argue that these setbacks present buying opportunities. Roubini touches on another potential problem for some of the countries in emerging Europe, which is "reform fatigue." The region's countries have, by and large, put the Eurozone periphery to shame with their swift and decisive actions to cut spending to meet budget deficit ceilings imposed either by the International Monetary Fund (IMF) as part of a bailout plan or in the context of the EU's Maastricht Criteria for joining the euro. Even so, the EC forecasts have only six countries out of the 27 member states posting a deficit below the 3% ceiling required by the EU's Growth and Stability Pact. While none of the emerging European countries run deficits as high as Ireland, UK, Spain and Greece have, inflated deficits remain a big issue and further steps need to be taken. "The EC acknowledges the efforts undertaken by the Romanian authorities in the summer of 2010 to consolidate public finances, but at the same time sees substantial risk that some unpopular measures could be reversed," says Eugen Sinca of Banca Comerciala Romana. So while the fundamentals of most of these emerging markets are sound, or at least sounder than those of the advanced economies, no country is an island and there are many risks – macro risk, sovereign risk – that will have a bearing on these markets throughout 2011. Those economies that have stronger macro, financial and policy fundamentals are going to do better than those in this region that display financial rigidities and macro-policy uncertainties, which will make them prone to greater corrections. "Over the next few quarters, investors in emerging markets have to ask tough questions: which of these economies are becoming overvalued in terms of their equity markets, fixed-income markets and currencies, and what are the risks that shocks coming from advanced economies have the potential for causing a correction in these emerging market economies," Roubini concluded.

Outlook

bne February 2011

I 65

EURASIA 2011: Slower rising commodity prices to determine 2011 Clare Nuttall in Almaty

T

he strong rise in commodity prices in 2010 allowed the Eurasia region's hydrocarbon-rich states to emerge from the global economic crisis. A slight slowdown in growth is forecast for 2011. A number of crisis-related issues remain – notably Kazakhstan's backlog of non-performing loans (NPLs) and relative lack of activity outside the natural resources sector. However, the strong performance of the hydrocarbons and mining sectors in Kazakhstan, Azerbaijan and Turkmenistan in particular resulted in stronger-than-expected growth in 2010. The catchup effect was also a factor, contributing to positive growth across the region. Smaller economies such as Tajikistan and Armenia benefited from the revival of the Russian economy and the consequent increase in migrant remittances. The only Eurasian state not to perform well was Kyrgyzstan, where a year of political turmoil resulted in negative growth. Commodity prices will determine 2011's growth rates in the largest regional economies, and a slight slowdown in growth is forecast according to most estimates, since the sharp rise in prices for commodities including oil, copper and uranium is unlikely to be repeated. After a strong 2010, the "catch-up" effect has to a large extent been used up already.

expected to slow – its 2011 expansion will keep pace with the previous year's. "GDP was up more than we expected in 2010, due to the recovery in prices for commodities including oil, gold, copper and uranium," says Jean-Christophe Lermisaux, head of research at Visor Capital. However, he adds that there are disparities between the natural resources sector and other sectors of the economy, in particular the banking sector, which is "still convalescing". Milena Ivanova-Venturini, head of research, Central Asia at Renaissance Capital, says: "In 2009, many metals companies had been producing at only around half capacity. Now they are at full capacity, so there is less opportunity to increase production. Future growth will depend on commodity prices. Can we double commodity prices again? Absolutely not." With the opening of new pipelines linking the West Kazakhstan oilfields to China, Kazakhstan's eastern neighbour remains the largest – and increasingly important – market for its raw materials. As well as underpinning global commodities demand, China accounts for 30-40% of Kazakhstan's exports.

More of the same in Kazakhstan Kazakhstan's economy will grow by 6.5% in the 2010 financial year, according to Visor Capital. Forecasts for the country's GDP growth in 2011 are in the 4-5% range; Troika Dialog forecasts 5% growth in 2011, and Renaissance Capital between 4.5% and 5%. Inflation is expected to be 7-8%, according to Renaissance Capital. The tenge is expected to remain relatively stable against the dollar throughout 2011, though there may be some slight appreciation.

“China is the primary influence on Kazakhstan. If China’s growth remains at the same pace for 20-30 years, Kazakhstan will be safe,” says Askar Yelemessov, chairman of the board of directors, Troika Dialog Kazakhstan. In the longer term, however, he forecasts that China will change from an exportdriven economy to a consumer-driven economy. “I expect the drivers of Chinese economic expansion to change. This won’t happen in 2011, but if China changes its model, economic growth will no longer require the same increase in demand for consumption of metals, oil and gas. This will have implications for Kazakhstan.”

Essentially, 2011 will be a continuation of 2010, with strong commodity prices driving growth and a smaller catch-up effect than in 2010. But since Kazakhstan is slightly behind countries such as Russia and China – where growth is

Within Kazakhstan, the situation in the banking sector is gradually returning to normal after the agreements on debt restructuring for BTA Bank, Alliance Bank and TemirBank. However, loan growth is expected to decline in 2010, and


66

I Outlook

bne February 2011

analysts estimate it will take around another two years for the problems of non-performing loans to be worked out. "While we don't expect any more shocks in the banking sector, some banks may remain in a zombie state for a while,” says IvanovaVenturini.

ally untapped natural resources combined with its proximity to China aroused a high level of interest among investors. At a conference in September 2010, Roland Nash, then head of research at Renaissance Capital, said he expected Mongolia would be the best performing market for the next decade.

As Kazakhstan leaves the crisis behind, important future developments are coming into clearer focus. As of late 2010, there were more questions than answers – the answers are expected in 2011. "2010 was a transition year for Kazakhstan; 2011 will be the year of big decisions," says Visor Capital's Lermisaux.

The country's largest development – the massive Oyu Tolgoi copper-gold mine – moved a step forward in December when Ivanhoe Mines and Rio Tinto agreed on a new financing plan.

In July 2010, the Customs Union comprising Kazakhstan, Russia and Belarus was formally launched. Towards the end of the year, signs the three countries plan to push ahead towards a single economic space emerged. This could be positive for Kazakhstan, which is already far ahead of Russia in terms of FDI per capita, and has a more favourable tax regime. “Dozens of companies have been thwarted from penetrating the Russian economy due to the restrictive import regime, although this is now being watered down,” says Yelemessov. “However, companies entering Kazakhstan as a possible access route to the Russian market may create some M&A activity.” The launch of the first phase of Kashagan – the world's largest offshore oil and gas project – is expected in late 2012 or early 2013. More important than whether the first phase starts a few months earlier or later, says Lermisaux, is agreement between the Kazakh government and the international consortiums developing the field on the second phase of the project. "The government wants to benefit more from large assets, both in increasing taxation income and in increasing the state share in Kazakhstan's big oil and gas fields. Negotiations are ongoing at the three mega fields, Kashagan, Karachaganak and Tengiz. While questions about the finalization of those negotiations remain open, this may affect the timing of investment decisions," says Lermisaux. Decisions on the hotly anticipated IPOs of a number of companies from within the Samruk-Kazyna state holding company are expected in early 2011. The main purpose of the IPOs will be to raise money for capital expenditure, and only minority stakes are expected to be floated. A list of those that will list shares is likely to be released early in 2011, and is expected to include National Company KazMunaiGas, national rail operator Kazakhstan Temir Zholy and the Development Bank of Kazakhstan. Analysts expect dual listings, with an offering on the KASE and in either London or the Hong Kong. Since China is the primary consumer of Kazakh raw materials, investor interest in Hong Kong is high, while London remains the international hub of emerging markets investment. Mongolian attraction Next to Kazakhstan, Mongolia attracted the most attention among the Eurasian countries. The country's rich and virtu-

"Future growth will depend on commodity prices. Can we double commodity prices again? Absolutely not" Rio Tinto will provide up to $1.8bn for the $6bn project, and buy out 20 million Ivanhoe shares. Eurasia Capital forecasts a wave of Mongolian IPOs on the Hong Kong stock exchange after the IPO of Mongolia Mining Corporation (MMC) in 2010. Erdenes Tavan Tolgoi, which holds the license for the Tavan Tolgoi coal deposit, is likely to hold an IPO in late 2011. But despite the excitement over Mongolia's natural resources, alarm bells sounded in November when the government announced it would cancel more natural resources licences. Best of the rest Among other Central Asian countries, Uzbekistan's economy grew by a healthy 8% in 2010, according to the International Monetary Fund (IMF), thanks both to its relative isolation from the crisis and the high prices for its main exports – gas, gold and cotton. Despite the country's obvious potential, investors still face a frustrating and difficult environment. Things went downhill in early 2010 when several prominent businesspeople were arrested. The perennial problem of currency convertibility has not been solved, and Uzbek banks appear increasingly focused on shoring up bankrupt industrial enterprises. Several investment houses which previously had a strong focus on Uzbekistan have turned elsewhere. In December, however, President Islam Karimov's address to the parliament focused heavily on plans to reform the business climate. It is too early to say how seriously these reforms will be pursued. Turkmenistan has been one of the "stars" of the Eurasia region, largely avoiding the crisis due to its isolation from the global economy. According to the IMF, Turkmenistan grew by 6.1% in 2009 (down from 10.5% in 2008), making it the fastest growing economy in the CIS after Azerbaijan. It is set to pass into first place in 2010, with 9.4% growth forecast, rising to 11.5% in 2011.

bne February 2011

Outlook

Relations between Turkmenistan and Russia deteriorated in 2009, and Ashgabat is looking for alternative export markets for its gas. The Central Asia-China pipeline opened in December 2009. In 2010, Turkmenistan signed an agreement with the other participants in the planned TAPI (Turkmenistan – Afghanistan-Pakistan-India) pipeline, increased exports to Iran, and continued discussions with EU countries on the planned Nabucco pipeline. Kyrgyzstan was the only one of the Commonwealth of Independent States (CIS) to see its economy contract in 2010, after the April revolution and deadly ethnic violence in June. However, the long-awaited appointment of a new Prime Minister, Almazbek Atambayev, in December 2010, gives hope for a return to normality in 2011, and will open the way for investments into the country to resume. The IMF takes a positive outlook for 2011, forecasting growth of 7%. Although Tajikistan remains the poorest country in the CIS, growth is relatively rapid. GDP increased by 5.5% in 2010, according to the European Bank for Reconstruction and Development (EBRD), and is expected to accelerate in 2011. The recovery of migrant remittances from Russia was an important factor. Construction of the Roghun hydropower plant will allow Tajikistan to increase exports of electricity in future, but has damaged relations with neighbouring Uzbekistan, which opposes the project. Meanwhile, the terrorist insurgency in the Rasht Valley has raised fears about Tajikistan’s internal stability. In the Caucasus, Azerbaijan maintained strong growth throughout the crisis, and is expected to grow by 4% in 2010. However, the EBRD forecasts a gradual decline in the country's growth rate in the near term – from 10.9% in 2008 and 9.3% in 2009 to just 2.5% in 2011. Hydrocarbons remain the main driver of the Azeri economy, and international investment is going strong with BP-Azerbaijan forecasting $20bn of investment into the offshore Shah Deniz field. Azerbaijan is also highly likely to be the first country to sign a supply deal for the Nabucco gas pipeline in mid-2011. Armenia is expected to return to growth in 2010 after seeing a 15% contraction in GDP the previous year. Growth of 4% is forecast for Armenia in 2010 and 4-5% in 2011, according to the IMF. The faster than expected upturn in 2010 is due both to increasing metals prices and to the revival in remittances from migrant workers, mainly in Russia. However, foreign direct investment in Armenia fell again in 2010, with the country receiving just under $349m in the first nine months of the year. According to government figures, Georgia's GDP increased by 6.6% on year in the first half of 2010. However, FDI figures were disappointing, with under $800m expected during 2010 – 33% below the government’s original forecast. Georgian President Mikheil Saakashvili announced in December plans for a "new economic course" for the country, aimed at creating a better business climate. The government plans to return to public debt markets in 2011 with a Eurobond issue.

"If China’s growth remains at the same pace for 20-30 years, Kazakhstan will be safe"

I 67


BNE_Outlook_02_11