Bouncing back

by Elliot Wilson

Alexander Isakov, VTB Capital

Compared with 1998, when the rouble crisis sent inflation soaring, Russia’s open economy, which has learned the hard way to adapt to external shocks, is in a strong position. 

True, the economy is expected to contract by between 3.1% and 4.3% in 2015, according to forecasts from VTB Capital. Sanctions have cut off several leading domestic corporates and banks from the global dollar funding markets, crimping their ability to borrow, lend and invest.

Yet the economy has also proven to be more resilient than many had expected.

Sergey Aleksashenko, the former first deputy chairman of the Central Bank of Russia (CBR), and now a non-resident senior fellow at the Brookings Institution, believes the economy is “more stable than many believe”.

With that sense of stability returning, and the impact of sanctions mitigated, investors, officials and corporate leaders believe the worst is now in the past.

Energy superpower

Statistics back up this view. As an energy superpower, Russia has suffered from oil prices, which tumbled last year, before plateauing at around $50 a barrel. Yet if oil remains locked in around that level, Alexander Isakov, VTB Capital’s economist for the Russia and CIS region, expects to see “a pickup in economic activity and particularly in private investment next year”.

In a September 23 research note, VTB Capital tipped real gross domestic product to expand by up to 0.7% in 2016, with inflation falling to 6.5%, from 12.5% in 2015. The rouble, meanwhile, will continue to stabilise without securing major external gains, maintaining a rate of around 70 to the US dollar next year.

There is good reason to believe in a sooner-than-expected return to net growth. One is a strong expected uptick in domestic investment in 2016, driven by the rising importance of non-state pension funds.

Isakov notes that these funds are “set to receive up to R700 billion ($10.8 billion) in new investable capital next year, thanks to the influx of capital from workers who opted to take part in the second-pillar pension system”.

This system grants every worker the right to channel a sizeable share of their pensionable savings into a personal account managed by either a public or a private pension fund, channelling new sources of much-needed capital directly into leading lenders and corporates.

In fact, reasons to be optimistic about Russia’s immediate future are everywhere. Seasoned analysts feared that unemployment would spike sharply when oil prices tumbled last year. Yet there are few signs of a deteriorating labour market. In fact, the jobless rate remains close to historic lows.

There may even, economists say, be more spare capacity in the economy than the current unemployment rate suggests, offering genuine hope for a return to strong, stable growth once the current squalls have passed through.

Russia’s economic and financial leaders have also done a solid job of steadying the ship. Current CBR governor Elvira Nabiullina has proven the doom-mongers wrong, hiking interest rates then judiciously allowing them to inch down again. Nabiullina has won wide-ranging praise for her well-timed actions, securing a slew of prestigious international accolades.

Russia’s stock market has proven remarkably resilient, with domestic shares up on the year, despite the negative factors buffeting most developed and emerging markets (EM).

Many energy and mining firms were expected to see a sharp fall in revenues and earnings this year. Yet a weaker rouble – the value of Russia’s currency versus the US dollar fell late last year before recovering – has been of considerable benefit to commodity exporters.

Elsewhere, notes Isakov, “higher levels of profit among companies in the tradable sector will also provide another source of future funding for investment”. This list includes sectors such as agribusiness, fertilisers, oil and gas majors, and commodity exporters.

In its September 23 note, VTB Capital noted that private investment will “likely become the driver of the recovery”, with businesses exploiting opportunities offered by cost competitiveness both in the local market (because a weaker rouble provides a natural barrier to imports) and externally (because of the attractive cost of labour in FX terms).

Government efforts to promote a more investment-friendly environment will also bear fruit, VTB Capital added. Key federal projects include a freeze on new taxes, and the creation of new industrial and technology clusters, which will cut taxes and slash red tape.

Rise of the corporates

Isakov also expects to see lending to leading corporates rise again in the first half of 2016, as financial conditions normalise and interest rates inch down, instilling the economy with fresh impetus.

Privatisation will also make a welcome return, while companies will look to raise capital from the local and international debt and equity capital markets. Bond investors have been happy to hold on to debt securities issued by Russian corporates – particularly exporters and commodity giants.

The twin impact of sanctions and slacker oil prices appear to have done little to dispel the notion, among holders of EM bonds, that Russian corporates, and the Russian economy in general, are great long-term bets. Two big domestic firms, gas major Gazprom and the miner Norilsk Nickel, are eyeing a return to the international debt markets in the weeks ahead.

Then there is oil. As prices slumped last year, remaining low well into 2015, alarm bells rang in Moscow, as well as across the oil-producing world. Yet again, Russia appears to have weathered the worst of the storm.

Bloomberg’s forward curve points to oil prices averaging out at around $60 a barrel in 2016. Given that level as a base-case scenario, economic growth will turn positive next year, coming in at 0.8%, limiting the effects of capital flight. If oil levels out at $70 a barrel next year, growth is projected to come in at 1.3%; at $100 a barrel, the magic gross domestic product figure rises to 3.7%.

In short, there are many reasons to expect the current slowdown to be shallow and brief.

Finally, there is Russia’s renewed relationship with Asia. For decades, Moscow looked west in search of trade partners. Yet recent landmark gas deals signed by Russia and China are just the start of a more eastward shift in economic focus.

“The potential in Asia for Russian corporates and enterprises in the long term is considerable,” notes Isakov. “If we look at the structure and nature of Russian exports to China, they are following the same basic growth path as exports to the European Union, so in time those countries and regions will become of equal significance to the Russian state and Russian corporate exporters.”

Russia’s relationship with Asia, he adds, was “overlooked for many years. There is a huge upside potential for Russian companies with the ability and the desire to become more present in Asia, from the mineral commodities sector to agricultural interests.”