Russia’s economy at a tipping point: can it return to positive growth?
5 October 2016
FTSE Global Markets
Against a tricky political background, it is no secret that Russian investment has been becalmed in recent years. In 2014, the imposition of trade sanctions and a recession largely attributed to a free-fall in the price of oil; it resulted in a number of international corporates putting their deals on ice while institutional investors reduced their exposure to Russian assets to a minimum. A number of major institutions scaled back their Russian operations and the flow of international capital into the country dried up. Adding to these woes was a general rotation by investors out of emerging markets. However, Russia is now at a tipping point: Riccardo Orcel, deputy chief executive of VTB Group, head of Global Banking at VTB Capital, looks at how international investors and corporates are returning to Russia and why.
The outflow of investments from emerging markets was predicated on the expectation that the US would rapidly raise interest rates and that the European economy was poised for a pick up. At the time, we disagreed with this view and continue believe that as a growing portion of the world’s GDP, population and growth, emerging markets will continue providing diversification and good opportunities, albeit with some volatility.
In the first decade of this century, BRICS was the word on everyone’s lips. BRICS countries offered high returns, relative stability and a willingness to band together to form an economic block in its own right. By 2014, all of the constituent countries barring India had been touched by difficulties. Brazil underwent political changes and China faced an economic slowdown creating turmoil in the financial markets. Similarly, South Africa’s economy began to slide. Investors fell out of love with BRICs and 2014 can realistically be described as a nadir in the fortunes of emerging markets.
Two years on and the majority of the BRIC economies are still in the process of recovery. The Russian economic landscape is showing signs that it might be starting to improve. The World Bank forecasts that Russia’s GDP decline throughout 2016 will be 1.2%; a notable improvement over the previously predicted 1.9%drop in GDP. Moreover, the World Bank expects the country’s GDP to rise by 1.5% next year and by 1.8% in 2018. This comes in sharp contrast to the World Bank’s view that global growth will fall from 2.9% to 2.4% by the end of 2016.
Equity investors have also benefited from the MSCI Russia index gaining 24% in dollar terms so far this year, more than twice the 11% return of emerging markets as a whole. While political restrictions still weigh on the economy, a floating currency regime and the slow but progressive improvement in oil prices has contributed positively to the economy. Early, albeit feeble, signs that other commodity prices bottomed out is also a positive factor in the outlook for the country which looks on track to outperform expectations.
There are other pluses. Russia provides high single-digit dividend yields and attractive bond yields. The country’s balanced corporate system with major exporters earning foreign currency, the de-risking of several companies with a sharp reduction in foreign currency debt, the development of the domestic capital markets and other factors have created a safety net compared to the value offered by Russian assets. This hasn’t gone unnoticed, with a number of recent Russian transactions finding favour abroad. The bank is actively involved in Russia’s privatisation program and, in our communication with international investors, we are seeing significant interest for high-quality assets with promising performance. This has been substantiated during the recent sale of Alrosa shares, aggressively subscribed to by overseas funds.
Russian companies have also been very active in the eurobond market, first buying back their own debt that was underpriced by investors in 2015 and then placing more than $11bn with VTB Capital-led transactions in 2016 to date. These bonds include major names such as Global Ports in the infrastructure sector, Russian Railways and State Transport Leasing Company (GTLK). The recent bond issue for O1, a property market leader in Russia, underscores the high level interest in the recovery of the cyclical sector. Of course the best evidence of renewed demand for Russian assets was seen in the recent eurobond issue for the Russian Federation which completed a tap issue of $1.25bn. The deal was an enormous success receiving orders for over six times the size of the offering with over 50% placed with US investors and 30% in the UK.
For investors more familiar with Russian assets the stabilised exchange rate is also attractive and presents a good investment opportunity. The rouble reached a record high of 82.45 against the US dollar in January 2016, but has settled into a range around 65 for the last 6 months. Stability of the currency is coupled with the second best world’s real interest rates and a falling inflation outlook.
With the European economy slowing down and China’s outlook not as bright as before, international players are looking at rates that can be achieved in ruble with great interest comparing with negative rates in Europe and Japan and very low rates in other developed economies. Similarly, this stability is attracting new investments from international investors with the largest increase coming from Asia, in particular from China, Vietnam and India.
Overall, we believe that the BRICS story is not over, quite the contrary. The trajectory has inevitable volatility and it looks like it is being given a new life this year. The New Development Bank (NDB) announced its first series of loans in April 2016, highlighting the impressive strides the block has been making of late. The NDB was set up by and is jointly co-owned by the BRICS countries and is a testament to the cooperative spirit of the nations involved.
Cross-border activity between BRICS countries and their respective leading corporates has substantially accelerated over the last two years. However, with Brazil and China still dealing with their own issues, as well as issues in South Africa, there is a continued argument to be made for selectively choosing which of the BRICS represents the safest investment on a risk/reward basis, while still having attractive enough yields to justify the decision to hold the assets through the cycle.
With the indications that Russia’s economy is improving there’s a feeling of confidence returning. Since the beginning of 2016, over RUB810bn worth of international investments have been attracted into the Russian economy by our bank alone. In addition to the large number of Russian deals completed so far this year, even more transactions that were on hold are being put back on the table.