Russian Market Update – Q1 2010
As a high-beta play on the current global recovery, the Russian equity market is well positioned to outperform the broader emerging market universe in the next several quarters. While recent macroeconomic trends in Russia have been noticeably weaker than in the other BRIC countries, the Russian market delivered considerably higher returns in US dollar terms than Brazil, China, and India in 1Q2010. As I have noted before, cheapness tends to be a more important factor in picking an emerging market than economic growth and Russia remains the cheapest among chief emerging markets (with higher forecast corporate earnings growth in addition). Offsetting comparatively sluggish domestic macro data has been the fact that the Russian Central Bank is nevertheless in the time of action of cutting interest rates, which is supportive for the equity market. Additionally, rising commodity prices are lifting the fortunes of Russian exporters, which should ultimately filter by to the rest of the economy. And the Russian market is more than just a commodities story already though the oil & gas and metals & mining sectors keep basic to the economy. The best performing sector so far this year has been utilities. Shares of the Russian strength generating companies rallied as investors grew more confident in the sweeping sector reforms being implemented by the Russian government. In the telecom sector, the Svyazinvest reorganization triggered re-rating of the regional fixed line operators. additionally, a number of possible consumer-related IPOs this year will allow investors to increase exposure to that sector of the Russian economy. Bottom line: several interesting opportunities can be found outside the commodities story in Russia.
Inflation moderated further in March falling to an annualized rate of 6.5%. The CBR cut the refinancing rate by another 25 bps to 8.25. In the near term, there is room for probably two more cuts, after which we would expect the CBR to pause. The Finance Ministry warned that the downward trend in inflation may reverse later in the year should interest rates become too low. According to the CBR, the average interest rate on corporate loans dropped from 13.8% in January 2010 to 12.7% in February. However, bank lending remains sluggish slightly because edges are nevertheless concerned about the quality of the borrowers and slightly due to the fact that some companies have chosen to borrow in the corporate bond market, where the cost of funding is sometimes lower. The Finance Ministry estimates bank lending will grow 5%-10% in 2010.
The World Bank has recently upgraded Russia’s 2010 and 2011 GDP forecast from 3.2% to 5.0%-5.5% and from 3.0% to 3.5%, respectively. The World Bank sees domestic consumption as the meaningful growth driver in 2010. Indeed, consumer sentiment has improved recently and growth in real wages has accelerated, which bodes well for future consumption. Real retail sales edged up 1.3% year over year in February. The World Bank believes capital investment may keep ineffective in 2010. Investment fell around 8% in the first two months of the year compared with the same period of 2009. The Russian Economy Ministry has upgraded its 2010 GDP forecast in addition, from 3.1% to 4.0%-4.5% on the back of stronger than expected oil prices. Admittedly, the domestic manufacturing sector has been slow to retrieve. Russian manufacturing PMI has been hovering around 50 since August of last year without a meaningful change in the trend. Industrial production was up just 1.9% year over year in February. Recent electricity consumption, steel consumption, and railroad quantity data, all suggest only modest improvement in manufacturing activity. The Economy Ministry estimated that seasonally modificated GDP fell by 0.9% month over month in February as investment remained ineffective. On a year over year basis, GDP was up 3.9%. Given the low base effects, GDP growth of around 5% for the complete year 2010 seems very realistic.
The natural resources sector continues to assistance from rising commodity prices. Notably, Russian oil output is up around 3% year to date. On a positive observe, the sets sector continues to retrieve as evidenced by the sets PMI, which reached 53.6 in March compared with 51.0 in February. The Russian current account surplus reached $33.9 billion in 1Q2010 compared with $9.7 billion in 1Q2009. This is supportive for the ruble. To finance the budget deficit, the government is preparing sales of certain state-owned assets. The Economy Ministry expects to raise around 100 billion rubles by asset sales in 2010. Earlier this year, the government slashed the number of strategically important companies that cannot be privatized from 211 to 41. During the first two months of the year, the budget deficit was around 3% of GDP, well below the official target of around 6%. Budget revenues have been ahead of the plan while expenditures stayed in line.
In terms of GDP’s traditional elements, consumption, investment, and net exports, we observe the following trends in 2009. Consumption (around three quarters of GDP) was down 5.1%. Private consumption fell 7.7% while government purchases truly increased by 2.0% reflecting various economic stimulus measures. Investment plummeted 37.4% while net exports soared 56.8%. Given improved GDP trends as we exited 2009 coupled with a low base effect, we believe that the 5% GDP growth in 2010 projected by many economists is a reasonable forecast and could however prove conservative.