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Letter from Russia

Letter from Russia

  • 31Jul 18
  • Stephen Parr Senior Investment Manager, Global Emerging Market Equities

Many eyes were on Russia this summer, not least the estimated one million soccer fans who flocked to 11 cities across the country for the World Cup.

The World Cup was an opportunity for Russia to showcase itself on the world stage. But it’s also a time when investors’ scrutiny on Russia is set to intensify.

Under Vladimir Putin’s new and fourth term as president, Russia is in a better place economically. After nearly four years of European and U.S. sanctions, the government has adopted a well-designed policy of inflation targeting and an extremely prudent fiscal rule, reducing the budget deficit and the dependence on oil, as well as overseeing an increase in productivity.

Ahead of the most recent U.S. sanctions against oligarchs and senior Russian officials, policymakers were on track towards achieving a targeted inflation rate of 4% by the end of 2018. Consumer price inflation hit an historic low of 2.2% in February. For now, the recent sanctions have had little noticeable impact on Russian economic growth.1 The impact isn’t likely to be material given Russia’s $460 billion of foreign reserves and its low debt to gross domestic product (GDP) ratio.2

Sanctions should not destroy the Russian economy as long as the authorities continue to adhere to an extremely prudent fiscal rule and inflation targeting.

Over the longer term

In our meetings and conversations during a recent visit to Moscow, sentiment did not match this supportive backdrop. Unexciting growth prospects, concerns that sovereign debt may be targeted in a future round of sanctions and uncertainty over the timing of sanctions have fueled uncertainty.

Russia is still a comparatively closed economy, accounting for around 1.5% of global GDP.

Russia is still a comparatively closed economy, accounting for around 1.5% of global GDP. For example, Russia has minimal connectivity with India although the two countries started negotiating a free trade agreement in July 2017.

Russia is also experiencing a high level of income inequality. Despite being classified as a mid-income economy, market access and competition remains lacking. This leads to a dearth of economic dynamism. Infrastructure also remains a problem.

But there are reasons we believe investors should have a foothold in this market. Recovering oil and commodity prices are factors that have been bolstering key sectors of the economy.

Economic bloodline

When it comes to the oil market, the Organization of the Petroleum Exporting Countries (OPEC) provides the defensive line that protects the floor price (though it’s not always successful). Russia’s role is more along the lines of the creative “midfielder,” with the ability to create the odd surprise. Russia’s oil giants wear the “captain’s armband.”

Some of the Russian oil majors are applying cutting-edge technologies in their upstream projects as they seek to exploit hydrocarbons from hard-to-recover oil reserves. These companies are also enjoying special tax rates for the exploration of these hydrocarbons.

Steely resolve

The fundamentals for domestic steel producers are compelling.

Preparations for the World Cup included the construction of stadiums and connecting infrastructure made the most of Russian steel.3 Russian steel continues to command a domestic market premium as some mills shut down in China. The industry’s outlook is favorable as average capacity utilization remains high. It’s expected to remain this way given the growing demand for rolled steel.

Investing in Russia remains challenging. Investors must muster steely resolve to keep “oligarch-risk” companies in their portfolios as the country faces increasingly difficult geopolitics and the threat of future sanctions.

As international investors in Russia, one thing is for certain. There is never a dull game.

1Transcript of the press conference on the release of the April 2018 World Economic Outlook, International Monetary Fund, 17 April 2018.

2‘International Reserves of the Russian Federation’, The Central Bank of the Russian Federation, 30 April 2018

3‘Russia transforms its infrastructure for World Cup’, World Steel Association, May 2018

Important Information

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Trading in commodities entails a substantial risk of loss.

Image credit: Olga Popova / Shutterstock.com, Arkady Mazor / Shutterstock.com

ID: US-250718-69239-1