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Russia Country Overview for Retail Business

June 2013


Retail Opportunity Assessment Overview Russia may not be the early opportunity market, but it is slowly developing as one of the fastest-growing retail destinations in Europe after the recent European crisis. Dynamic growth in its retail sector has been fueled by consumer activity. Despite global economic uncertainty; growing incomes, pent-up demand and widespread availability of improved access to consumer credit are helping create a considerable scope for solid growth in private consumption and, hence, a positive business environment for the retail sector in the country. Despite the fact that the country’s regulatory and political reforms remain uncertain, Russia still exhibits lots of opportunities for further development, as its retail market is significantly less saturated in comparison to the developed Western Europe. This research paper documents in brief some of the macroeconomic, regulatory and business aspects of ‘Retailing in Russia’.

Macroeconomic Environment

GDP

14.1%

11.7%

9.0% 8.5%

8.4% 6.9%

5.2%

4.5%

4.3%

5.1%

3.4%

6.9%

3.4%

6.2%

6.0%

6.0%

6.0%

3.8%

3.7%

3.6%

3.6%

3.6%

6.0%

-7.8% 1.30

1.66

1.22

1.53

1.90

2.02

2.21

2.37

2.54

2.73

2.95

3.18

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Source: IMF

GDP (USD Tn)

GDP Growth Rate (%)

Inflation (%)

Since the collapse of the Soviet Union, the Russian economy underwent significant changes, moving from a globally-isolated and centrally-planned economy to a more market-based and globally-integrated one. Currently, it is the eighth largest economy in the world by nominal value and the seventh largest by purchasing power parity (PPP). As of 2012, Russia is estimated to have a GDP of USD2.02 Tn, which is forecast to reach USD3.18 Tn by 2018 – an average growth of c. 7.8% (at current prices). Services sector accounted for 60.1% of the total GDP contribution in 2012, followed by the Industrial sector with 36% and the agriculture sector with the remaining 3.9%. The per capita GDP of Russia stands the highest among the BRIC nations in 2012 at USD14,247, which is projected to grow at a CAGR of 8.2% to reach USD22,906 by 2018. Inflation has always been a problem for Russia as the consumer price index has never been consistent in the past. At current prices, inflation has not been consistent for the past five years. In 2008, it went as high as 14.1%, but dropped to 5.1% in 2012. As per the forecast suggested by the International Monetary Fund (IMF), inflation is projected to converge towards the target of 6.9% in 2013. Moreover, inflation will further continue to grow at 6%7% till 2018.


Population 143

143

143

143 142

0.0%

142

0.1% 141

141 140

140

-0.1% -0.3%

139

139

-0.4%

-0.4%

-0.4%

2016

2017

2018

-0.3%

2007

2008

2009

2010

2011

-0.3%

-0.3%

-0.3%

-0.3%

2012

2013

2014

2015

Population (Mn)

Source: IMF

Population Growth (%)

Russia is the ninth most populous nation on the earth and the largest in Europe. It is one of those countries where population is actually declining. With an estimated population base of over 141 Mn as of 2012, Russian population is estimated to reach 139 Mn by 2018. As of 2011, close to 74% of the population resides in the urban areas of the country, which is projected to decrease at an average rate of 0.2% till 2015 (source: CIA and World Bank). Russian population is comparatively middle-aged, with the median age of 38.8 years – the highest among the BRIC peers. As of 2013 estimates, only 16% and 11.5% of the population falls in the age range of 0-14 years and 15-24 years, respectively. The majority of Russians, i.e. 59.4% fall in the age bracket of 25-64 years. Only 13.1% make the older generation of 65 years and above (Source: CIA). About 12.7% of the Russian population was considered poor (population below poverty line) in 2011 (Source: CIA).

Unemployment

8.4% 7.5% 6.1%

2007

6.6%

6.4%

2008

Source: IMF

6.0%

2009

2010

2011

2012

5.5%

5.5%

5.5%

5.5%

5.5%

5.5%

2013

2014

2015

2016

2017

2018

Unemployment Rate (%)

Russia has a decent labor pool of over 75 Mn, out of which almost everyone is literate as of 2012. Around 64.7% of the country’s workforce is engaged in the services sector, followed by the industrial sector, accounting for nearly 27.4%. Russia’s labor participation rate among persons aged 15 years and above is as high as 71% for men and 56.3% for women. Unemployment rate in Russia decreased to 6% in 2012, the lowest since the past two decades. The rate is projected to stagnate at 5.5% from 2013 to 2018 (source: World Bank). According to the World Bank estimates, growing income, low unemployment and low inflation will help reduce the number of poor people in Russia to 15.9 Mn in 2014 from 16.9 Mn in 2012.


Business Environment Market 19.2%

1075.5

15.4%

977.9 809.9 627.8

555.2 456.3

526.5

666.5

882.0

736.8 10.5%

9.9%

2013

2014

6.2%

10.9% 8.9%

10.0%

-17.8%

2008

2009

2010

2011

2012

Retail Sales (USD Bn)

2015

2016

2017

Growth Rate(%)

Russian retail sector is very dynamic and has been driven by growing earnings and rapid development of domestic retail. Overall, the growing retail sector is pushing the structure of the Russian retail basket toward western consumption standards. Despite global slowdown, the country’s retail industry has been witnessing growth in sales during the last three years. However, the impact of global recession was registered by the Russian retail industry as retail growth shrank 17.8% in USD terms during 2009. Russian retail industry is estimated to be USD666.5 Bn in 2012 and is forecast to grow at a CAGR of c. 10% annually during 2012-17 to surpass the USD 1 Tn mark by 2017. The country’s retail sales will exhibit around 70% of the total household consumption — a high proportion as per the developed country standards. The growing demand for income-elastic goods will be fueled by the rising income of the country. According to industry estimates, the proportion of households earning over USD25,000 and USD35,000 are expected to more than double by 2017. Small independent food shops and open markets significantly dominate the Russian retail sector, but are slowly losing popularity and market share to modern retail formats. According to an Infoline Agency report, in 2012 the top 130 Russian retailers opened a record number of 4,059 new outlets, which surpassed the previous pre-crisis record of 2008. Domestic retailers X5, O'Key and Magnit are the largest players, followed by France-based Auchan and Germany-based Metro Group. The top five retailers capture only c. 15% of the retail market, leaving a huge opportunity for retail expansion in the country, which hosts only 80.5 square meters of retail space for every 1,000 shoppers – less than one-third of the EU average.

“…The Russian retail market is one of the most dynamic and fastest-growing retail markets in the world. The X5 Retail Group and Magnit have continued to move up the rankings, moving from 100 to 83 and 152 to 124, respectively. Moreover, Magnit is ranked second among the top 50 fastest-growing retailers, and is in the top 30 list in terms of Q-ratio…” >> Egor Metelkin, Partner, Deloitte

“…More than 90 percent of the most popular European brands operate in the Russian market already, with the rest considering entry. Within the coming years, the high level of disposable income and the rapidly growing middle class will make the Russian retail market one of the European leaders in terms of turnover…” >> James Brown, Head of EMEA Retail Consulting and Research, Jones Lang LaSalle


Consumers

90 88 85

86

89

88

87

86 84

82

84

82

75 Q1 09

87

84

81

74 Q2 09

Q3 09

Q4 09

Q1 10

Q2 10

Q3 10

Q4 10

Q1 11

Q2 11

Q3 11

Q4 11

Q1 12

Q2 12

Q3 12

Q4 12

Q1 13

Consumer Confidence Index

The country’s consumer confidence index has been consistently below 100 over the last four years, suggesting an overall pessimism on the part of consumers. Russia has been witnessing a consistent decline or stagnation in consumer confidence over the last one year. At 81, Russian consumer confidence ranks well below the world average of 93 in Q1 2013. In the quarter, the consumer confidence decreased 3 points from the earlier markup of 84 in the last quarter of 2012. According to a survey by Sberbank CIB, the recent drop in Russian consumer confidence can be attributed to the concerns over persistently high inflation, which has made consumers more cautious over large purchases since the starting of 2013. Despite the fall, Russia still ranks top in consumer confidence at an overall level in the entire Eastern Europe.

“…Consumers in Russia have retained confidence in job market and many believe in the stability of personal financial situation. But with growing grocery and utilities prices, they now find themselves with less disposable income. This is one of the reasons of the slow recovery of Consumer Confidence in Russia…” >> Dwight Watson, Managing Director, Nielsen Russia and NorthEastern Europe

"...Russian consumers don’t believe in the future, they believe in today.We like to spend, we like to buy a Mercedes whether or not we can afford it...” >>Oleg Tinkov, Chairman, Tinkoff Credit Systems (a Russian consumer lender partly owned by Goldman Sachs)

“…There is an equal share of money at the top and in the middle. Russia’s middle class today has the same share of income as the upper class and has remained an untapped opportunity by many international corporations…” >>Dr. Venkatesh Bala, Chief Economist, the Cambridge Group


Regulatory Environment FDI 

Russia progressively relaxed restrictions and opened the retail sector for foreign investments in 1990s. But the actual process of liberalization in retail started in 2000s, which opened the gates for foreign investments to the extent of up to 100% in multi-brand or single-brand retail. This not only boosted the growth but also helped increase the completion within the retail industry in Russia

Russian retail sector is less saturated with only few big box retailers such as Metro and Auchan, who entered the Russian market in the early 2000s, before the country’s domestic competitors became wellestablished. Metro and Auchan have been the only non-Russian firms, which feature in the top-10 leading food retailers of Russia, to command a leading position in the retail sector. Other international retailers such as IKEA, OBI H&M, Inditex, Uniqlo and Mango are also operating in many Russian cities

Carrefour and Wal-Mart are the two notable retailers missing from the list, although both had attempted to enter Russia in the past. In 2009, Carrefour opened its first store in Moscow, followed by a second one in Krasnodar. But only four months later the company announced plans to close its operations in the country, citing absence of sufficient organic growth prospects and acquisition opportunities. Similarly, Wal-Mart too waited until the late 2000s to make a move to enter Russia, but after Carrefour's failed attempt, Wal-Mart ruled out its investment plans for the country

Real Estate 

Acquiring real estate property in Russia is difficult, as the real estate market is limited and expensive. Also, both the federal (the Russian Land Code) and regional regulations are considered while purchasing a land

Foreign individuals or legal entities cannot own a land adjacent to national border. Also, there are special laws in place to regulate transaction involving farm land that can only be leased (not owned) by foreign entities. Typically, a land is available under lease for a maximum term of 49 years. Renting or acquiring state property may require winning a tender/auction

Unlike other emerging countries, most of the foreign retailers prefer leasing over a property in Russia. Occupational leases are transparent and provide retailers secure tenure. Standard lease terms are between 3 years and 5 years, which is extended up to 10 -15 years. Service charges (VAT) are applicable (currently 18%) on rented property. Local property taxes are not paid separately as they are generally included in the service charges

Although renting results in faster growth, it is also at greater risk for increasing costs, as landlords regularly raise rents. There is a widespread practice among supermarket and discount chains to acquire or lease space from existing over-the-counter convenience stores which were built during the Soviet era

Labor 

Labor relations in Russia are primarily regulated by the Labor Code of the Russian Federation, which was initially adopted in December 2001 by replacing the old Soviet code of 1971. Post that the Labor Code underwent numerous amendments

There is a minimum monthly wage fixed as per the law – Rubles 4611 (USD164) as of June 2011. The standard working hours should not exceed 40 hours per week. Overtime is permitted for certain categories of employees and should be paid at 1.5 times the normal salary per hour for the first two hours and 2 times for the subsequent hours

Employees are entitled to 12 paid public holidays along with an annual leave of at least 28 calendar days. Over and above, employees are also entitled to sick leave allowance, severance pay and maternity leave

The Russian Labor legislation also prohibits the termination of labor contracts for certain categories of employees at the initiative of the employer

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