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Home > Blogs > Ian Fraser and Anthony Harrington > 2011: The Year Ahead - Russia’s prospects and problems

2011: The Year Ahead - Russia’s prospects and problems

Economy 2011 | 2011: The Year Ahead - Russia’s prospects and problems Ian Fraser and Anthony Harrington

Despite the self inflicted public relations disaster of the second Khordokovsky trial, with its absurd guilty verdict, the Russian Federation is still rated a good bet by both the International Monetary Fund and the World Bank. The IMF predicts that Russia’s GDP will come in at 3.7% for 2010 and will reach 4.3% by the end of 2011. The World Bank puts Russia’s 2010 GDP at 4.2% and sees it pipping that by 0.1% in 2011 (4.3%). 

However, as the Khordokovsky trial demonstrated, all is far from well with Russia’s bid to be taken seriously as a modern economy rather than simply as a commodities exporter. The view that the state is in the pocket of a few powerful men and that the rule of law is straw in the fire if it doesn’t suit them, was reinforced by the recent WikiLeaks cables which saw Russia branded as a “Mafia state”.

However, on the plus side, Dmitri Medvedev, the country’s president, has led a high-profile campaign to improve corporate governance in Russian companies and to choke off corruption. Whether current Prime Minister Vladimir Putin will share Medvedev’s stance when he positions himself for a bid for reelection to the presidency in 2012 remains to be seen.

At present even seasoned Kremlinologists can’t figure out if Medvedev really intends to run against his former mentor or will dutifully hand the reins of power back to Putin. Putin’s strong regard for due process was highlighted when he called Khordokovsky “a thief who deserves to be in jail” just days before the court was due to deliver his verdict. Many saw this as Putin giving the judge a direct steer as to where his duty lay. Medvedev, interestingly, responded by saying that “no official had the right to comment before the verdict”.

The legacy of the privatization deals of the 1990s, which saw some astute and well positioned individuals grabbing the lion’s share of the former Communist state’s assets and transforming themselves into billionaires overnight, still casts its shadow over business life in Russia. However, history, of course, is replete with examples of dubiously won wealth transforming itself into respectability over time, so a murky start in life is not necessarily fatal. Rosneft, Russia’s leading oil company, which was founded with the assets stripped from Khordokovsky’s Yukos Oil after the company was bankrupted by some very dodgy tax charges, now has an exemplary Business Code of Ethics available for all to see. The company also has a very strong non-executive director presence on its Board to ensure that good corporate practice is driven through by the board.

There is no doubt that although corporate transparency has some way to go in Russia, and despite some undesirable business practices, the country continues to be seen as a very positive emerging market by a substantial number of emerging market funds – ensuring a healthy appetite through 2011 for Russian companies seeking to raise money through bond issuance. According to a recent article in Business Week (December 23) Russia’s successful Soccer World Cup bid for 2018 has helped to drive a sustained bond rally as the government prepares to spend some $3.8 billion on stadiums, airports and roads.

Russian corporates prefer dollar bond issuance, but the Russian Government itself is reported to be considering a $5.5 billion euro bond issuance this year. This follows a similar sized dollar bond issuance in April 2010, which was Russia’s first foray into the bond market since 1998, according to Reuters. The return to the bond markets has been prompted in part by Russia’s budgetary deficit, which is set to continue until at least 2015. In a research note, Bank of America Merrill Lynch said that emerging market corporate bonds, including Russian corporate bonds, “should remain a preferred destination for new investor flows through 2011”.

Robin Geffen, manager of the Neptune Russia and Greater Russia Fund, is particularly bullish about the Russian Federation’s prospects in 2011. He said:

"We expect to see Russia continue to bounce back strongly in economic terms over the course of 2011. Whilst most global economies should register slower rates of growth in comparison to 2010, we expect Russia to increase in terms of output growth. This acceleration in growth will be led by a continuing resurgence in investment and consumption, supported by a more accommodative monetary policy when compared with most other emerging markets. In addition to an accelerating economic growth profile, the Russian equity market remains at a significant valuation discount to emerging market peers, trading on 8x forward earnings compared with 18x in India and 14x in China.”

Geffen, however, ought to be aware of the real reasons for these discrepancies in valuation and that they are unlikely to be rectified any time soon. In an interview with Time Magazine, William Browder, (whose Hermitage Fund was the largest foreign investor in Russia before 2006, when he was banned from entering the country after running into a conflict with a state-run company), was quoted as saying that Russian companies are valued at less than half their peers in other emerging markets as a direct result of the Kremlin’s kleptocratic tendencies.

"The reason is simple: [in Russia], you have property rights conditional on the whims of various corrupt officials who may decide to take [your assets] away from you at any time."

Russia still faces many other challenges. The World Bank believes that unemployment is likely to get worse in the first half of 2011, before improving towards the end of the year. Its “takeaway” strap line on the country is “growth with moderation and uncertainty”. It expects a better investment climate and more robust foreign direct investment but it has some concerns over the high expenditure levels planned by the Russian government and volatility in key commodities, particularly the price of oil, could pose some downside risks.

Further reading on the Russian economy and emerging markets:

Tags: corporate governance , disclosure , Dmitri Medvedev , GAAP , IMF , Khordokovsky , Russia , Vladimir Putin , World Bank , Yukos
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