By GRAHAM FROST 17/11/2010
In October I attended a Fund Strategy conference in St. Petersburg. Our hotel was located just off Nevsky Prospect, the main thoroughfare through this beautiful but congested city. It took us an hour to travel 3 km on a bus trip to a modern tyre factory run by a Finnish company before we decided to abandon the trip! The average office worker earns hundreds, not thousands of dollars. If he can access credit or a mortgage, the interest rate is likely to be high double digits at best.
Current outlook
The average citizen seems demoralised by centralised government but they have little will to change it. The Director of macro economic research at Moscow University, believes the credit crunch showed Russia's economy was not stable and one should treat economic releases with scepticism. This is in contrast to the widely held view that Russia is back to pre crisis levels of activity. The country has lost three years of growth, much worse than other emerging markets, because there was a lack of credit.
The Russian economy
Russia remains dependent on commodity prices and although export volumes have recovered, it is not possible to increase volumes because of supply constraints. Russian shares seem correlated to the oil price, however, 90% of oil revenue over $35 (oil price is now close to $90) goes into the Reserve Stabilisation Fund, which acts like a buffer in the downturn but holds back the country in the good times. Russia is well known for having poor economic policy, having been the only emerging market to bail out it’s banking system. A lack of rule of law, corruption and a prohibition of foreign takeovers have all contributed to the muted recovery in the region. Prof Sergei Sutyrin, Saint Petersburg State University economist added that Russia is not a real market economy as government still controls prices. A lack of a research and development budget is resulting in an exodus of intellectual capital as the well educated leave the country. Social uncertainty is reflected in a falling birth rate and poverty is everywhere. There are no elected state governors, just Presidential nominees.
Bestinvest’s view
Commentators expect Russia to grow at 4% over the next few years. Our sense is that any growth will largely be because of a favourable oil price rather than a wealth creating society. The heatwave in Russia has reduced grain production by about one third and means they will have to import 10 million tons to meet demand. Massive potential exists but it is smothered by public apathy, political interference and corruption. Of course most Russian fund managers will tell you that such dismal views are all in the price with equity valuations very supportive and Russia's discount to Emerging Markets at historically high levels. But with crumbling infrastructure and one of the lowest investment rates of any Emerging Markets, and state controlled companies accounting for the bulk of GDP, Russia’s desperate need for capital may go unsatisfied as investors seek out more friendly destinations. We advise using experienced managers to navigate through this minefield.
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