russia under putin – emerging market or stagnating...

Russia Under Putin – Emerging Market or Stagnating Regime?A presentation for ESADE Globalisation Lab

January 2012

Roland [email protected]+7 495 980 7373

2

• Russia today – the economics of the politics.

• Russia tomorrow – can Putin solve the failures of Putinism?

• The market – what are the implications?

Source: State Statistics Committee

3

The Fall and Rise of RussiaReal GDP, 1991 = 100

50

60

70

80

90

100

110

120

130

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E

–

One of two superpowers

Nigeria with snow... GDP per head USD1,352 (Egypt = USD1,450)

–Dynamic BRIC... GDP per head USD11,709 (Poland, 2007 = USD11,200)

50

60

70

80

90

100

110

120

130

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E

Source: State Statistics Committee

4

The Fall and Rise of RussiaReal GDP, 1991 = 100

Life expectancy at birth – 68.9 yearsMarriages – 8.6 per 1000 heads annuallySuicides – 26.5 per 100ths heads annuallyBirth rate – 1.7 children per woman

Life expectancy at birth – 67.1 yearsMarriages – 5.8 per 1000 heads annuallySuicides – 35.3 per 100ths heads annuallyBirth rate – 1.2 children per woman

Life expectancy at birth - 67.9 yearsMarriages – 8.3 per 1000 heads annuallySuicides – 27.1 per 1000 heads annuallyBirth rate – 1.5 children per woman

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

Spain EU27 Greece CEE Hungary Chile Poland Russia Brazil LatinAmerica

South Africa Bulgaria China India

28

31

4751 52

53 55

7277

91

134

Source: IMF, UN

5

GDP per head comparedGDP per head USD, and Rank out of 183, 2011

0

10

20

30

40

50

60

70

80

91

85

57 5037

51

Source: World Bank* Latest data available. Years vary, most in the last 5 years

6

Income inequality comparedGini coefficient – 100 = completely unequal; 0 = completely equal*. Rank is out of 91 countries.

Russia’s middle class

77

% of population in middle class

Source: State Statistics Service

11,7

18,8

26,9

34,5

40,4

45,9

05

101520253035404550

2005 2006 2007 2008 2009 2010% of population with monthly per capita income over 15 000 RUB

53%

39%

20%

9%

14%

55%

0%

10%

20%

30%

40%

50%

60%

US UK Brazil India China Russia

Source: UN Database

8

Well educatedPercentage of school leavers going on to tertiary education

The wiring of Russia

99

Number of people using the internet in Europe, mn

Source: Internet World Stats

0

10

20

30

40

50

60

70

Germany Russia UK France Turkey Italy Spain

Internet penetration, selected countries, %


0

10

20

30

40

50

60

70

Brazil Russia India China Greece Spain Italy


Growth in language use on the internet, 2000-2011, %

0

500

1000

1500

2000

2500

3000

Increase in internet penetration, % of population

Source: Internet World Statistics, ITU

0

5

10

15

20

25

30

35

40

45

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Russia World

Economics

10

Annual GDP growth by country

Source: IMF

Russia

-10.0

-5.0

0.0

5.0

10.0

15.0

China

IndiaBrazil

US

Russia is not an easy place to do business, and it also has a perception problem

• Russia is ranked as the 123rd worst place to do business on the planet

• It is also ranked as less transparent than Nigeria and Pakistan…

• ...yet Russia ranks alongside Chile and Hungary, and just behind Italy, in terms of actually paying a bribe

11

Inability to run a business

Group CountryGroup 1: 50% or more

Afghanistan, Cameroon, India, Iraq, Nigeria, Sierra Leone, Uganda

Group 2: Between 30 and 50%

Bolivia, Kenya, Lithuania, Mexico, Pakistan, Ukraine, Vietnam


Chile, Hungary, Peru, Russia, Thailand, Turkey, Venezuela


Argentina, Austria, China, Greece, Italy, Japan, Singapore, Taiwan

Group 5: Less than 6%

Austria, Brazil, Korea, Norway, UK, US

% Of respondents who report paying a bribe to any of nine different service providers in the past 12 months

Corruption Evidence Table

Source : Transparency International

Ease of Doing Business

Source : World Bank

Country Rank 2010 (123 out of 183)Singapore 1UK 4US 5Germany 22China 79Italy 80Pakistan 83Russia 123Brazil 127India 134Nigeria 137

Corruption Perception Index

Source : Transparency International

Country Rank 2010 (154 out of 178)New Zealand 1Switzerland 8UK 20US 22South Africa 54Brazil 69China 78India 87Nigeria 134Pakistan 143Russia 154DR Congo 164

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

0%

5%

10%

15%

20%

25%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Net available capacity at peak, MW (rhs) Reserve margin, % (lhs) Technically acceptable minimum reserve margin, % (lhs)

Search for a new paradigm – Aging Infrastructure

12

Source: UES, InterRAO, Russian Statistics Agency

Investment in Russia – reaching the end of Soviet legacy

0

10

20

30

40

50

60

70

China

Saud

i Ara

bia

Cana

da

Braz

il

South

Kor

ea

Indon

esia

Arge

ntina

Mexic

o

Germ

any

India

Unite

d Stat

es

Unite

d King

dom

South

Afric

a

Italy

Fran

ce

Japa

n

Turke

y

Russ

ia

Source: Gallup

13

Russians are most pessimistic about the future (2009 data)Gallup Personal Economy Index (mean scores based on adults' responses to four questions about the local job market,local economy, and personal living standards)

14

Russia is, in many ways, a typical country shifting from weak autocracy to weak democracy…

• A middle income economy

• A rapidly growing middle class

• Well educated

• Wired with information readily available.

• Suffered a sharp economic downturn

• An unresponsive government

• Deteriorating public goods.

• And naturally pessimistic.

The question today is whether Putin is capable of correcting the mistakes of Putinism.

Russia – Pregnant for political change.

15

• Russia today – the politics of the economics.



Source: BP, CIA World Fact Book, Metal Bulletin

Resource endowment – Natural resources

% of Global Production and Reserves

Russia is the world’s Central Bank of resources…

• It has a quarter of the world’s conventional gas.

• It is the world’s biggest oil production, and it continues to rise, despite expectations to the contrary.

• It has 16% of the world’s water and one of the two last remaining major arable land sources.

• It has more timber than Brazil

Net hydrocarbon exports

Russia % of Global Russia % of GlobalOil (mn bpd)/(bn bbls) 9,6 12 80 7Gas (bcm)/(bn boe) 656,2 23 281 26Nickel (mt of Ni content) 320000 20 6600 10Platinum (ounces) 980 16 82137 12Palladium (ounces) 2668 41 308991 44Gold (mt) 162 7 3000 7Timber (mn cm)/(bn cm) 184 6 82 23Fresh water n.a. n.a. 4262 15Land mass n.a. n.a. 17075 11

Production Reserves

-600

-400

-200

0

200

400

600

Russ

ia

Saud

i Ara

bia

Norw

ay

Austr

alia

Indon

esia

Cana

da

Nige

ria

Qatar

Vene

zuela

Kaza

khsta

n

Libya

UAE

Mexic

o

India

China US

Millio

n to

nnes

of o

il equ

ivalen

t

The equity market produces return, with volatility.

17

Source: Bloomberg

Indices Levels Compared (All Rebased to 100 on 9/1/1995)

0

500

1000

1500

2000

2500

3000

RTS S&P500 MSCI EM MSCI China MSCI Brazil

Source: Verno Capital, Russian Statistics Agency

18

Russia’s Trade Turnover with Europe:2000: 66.3$bn, 48.4% of Total2010E: 298.8$bn, 49.5% of Total

Russia’s Trade Turnover with CIS:2000: 25.4$bn, 18.6% of Total2010: 82.4$bn, 13.7% of Total

Russia’s Trade Turnover with China:2000: 6.2$bn, 4.5% of Total2010: 58.0$bn, 9.6% of Total

Russia’s Trade Turnover with USA:2000: 7.3$bn, 5.4% of Total2010: 22.7$bn, 3.8% of Total

Russia in a geographic context

0.1

0.8

1.0

2.2

3.5 3.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1500-1820 1820-1900 1900-1950 1950-2008 2010-2016 2008-2050

Long-term, trends are in Russia’s favour

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Global growth, GDP per head very long term % change per annum

Source: Angus Maddison, IMF, Citigroup Global Economics, Buiter 2011

The underlying trends in demand for commodities are very strong

20

0

10

20

30

40

50

60

China India

Source: BP

Japan South Korea Taiwan Africa

Oil consumption per capita

21

Russia remains one of the least understood growth opportunitiesGDP of the top 20 largest economies globally, selected years, USD bn – forecasts from IMF September global outlook

Source: IMF World Economic Database, September 2011

Country 2000 Country 2003 Country 2005 Country 2008 Country 2009 Country 2010 Country 2012 Country 2014 Country 20161 USA 9951 USA 11142 USA 12623 USA 14292 USA 13939 USA 14527 USA 15495 USA 16623 USA 182512 Japan 4667 Japan 4229 Japan 4552 Japan 4880 Japan 50333 Germany 1892 Germany 2428 Germany 2771 Japan 5459 Japan 6126 Japan 6440 Japan 67834 UK 1481 UK 1863 UK 2283 Germany 3641 Germany 3307 Germany 3286 Germany 3708 Germany 3820 Germany 39295 France 1332 France 1797 France 2843 France 2632 France 2563 France 2889 France 30626

China 5878 China 7744 China 9560 China 11780China 4520 China 4991

China 2257China 1198 China 1641 France 2138 UK 2679 UK 2182 UK 2250 France 3268

7 Italy 1101 Italy 1510 Italy 1781 Italy 2307 Italy 2117 UK 2604 UK 2894 UK 32248 Canada 725 Spain 885 Canada 1134 Italy 2055 Italy 22889 Mexico 672 Canada 866 Spain 1132 Spain 1468

10 Mexico 700 Spain 1601 Canada 1338 Canada 1577 Italy 2364 Italy 247611 Spain 582 Korea 644 Mexico 849 Canada 1503 Canada 1826 Canada 1965 Canada 210612 Korea 533 Korea 845 Spain 1410 Spain 1575 Australia 1694 Australia 180813

Brazil 3373Brazil 2617 Brazil 2971

Brazil 2090Brazil 1601

Brazil 1655Brazil 642 Brazil 890

Brazil 556

India 1632 India 2477 India 3027India 2013

India 1265India 591 India 1251

India 476 India 809 Mexico 1094 Australia 989 Australia 1237 Australia 1572 Spain 1661 Spain 176414 Australia 401 Australia 543 Australia 1061 Mexico 879 Mexico 1034 Korea 1275 Korea 1465 Korea 168615 Netherlands 387 Netherlands 540 Australia 737 Korea 931 Korea 834 Korea 1014 Mexico 1242 Mexico 1369 Mexico 150516 Taiwan 326 Netherlands 640 Netherlands 875 Netherlands 796 Netherlands 781 Indonesia 936 Indonesia 1137 Indonesia 138217 Argentina 284 Switzerland 325 Turkey 483 Turkey 730 Turkey 614 Turkey 735 Netherlands 882 Turkey 949 Turkey 113318 Turkey 266 Sweden 315 Belgium 378 Poland 529 Indonesia 538 Indonesia 707 Turkey 802 Netherlands 922 Netherlands 96819

Russia 1661 Russia 2570 Russia 3088Russia 2117

Russia 1480Russia 1222

Russia 764

Russia 430

Russia 260 Belgium 312 Switzerland 372 Indonesia 511 Switzerland 492 Switzerland 528 Switzerland 727 Switzerland 745 Sweden 78420 Switzerland 250 Taiwan 311 Sweden 371 Belgium 507 Belgium 472 Poland 469 Sweden 630 Sweden 711 Taiwan 767

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

Greece USD 5Y CDS Portugal USD 5Y CDS Italy USD 5Y CDSIreland USD 5Y CDS Spain USD 5Y CDS France USD 5Y CDS

Source: Bloomberg

22

CDS spreads for Europe make 2008 look like a walk in the park.CDS spreads in Europe

23

What can Putin actually do?There will be two periods, pre-May inauguration and the first year of Putin’s presidency…

Tactics - Pre-May inauguration• Putin has repeatedly said that he will not make the mistakes of Gorbachev and liberalize quicklyNonetheless....• Free presidential elections, quite possibly with a second round• Better managed democracy• New faces promoted, old ones demoted• A public sector Khodorkovsky• A populist fiscal and monetary policy

Strategy - Post-May inauguration• The holy-grail of medium-term economic growth• The big infrastructure spend• Some increased accountability over government officials• Better management of state-owned companies• Another wave of reforms• Possibly capital controls

But in the end, whether Putin is successful or not depends as much on Berlin, OPEC and China as the Kremlin

24

Russia is clearly an integral and important member of the global community of fast growth economies…

• It is the global storehouse of natural resources

• It has a large and rapidly emerging middle class

• It is one of the world’s fastest growing dollar economies

• It has low government debt

• The economy is under-leveraged

• The private sector is dynamic and changing very rapidly

But, just like any other large fast growth economy, it also has its own, unique problems and challenges...

• As well as a relatively rich emerging economy, Russia is also the poorest of the European economies.

• Relative to many fast growth economies, Russia has a large and expensive ‘European’ set of social services

• The government is moving much slower than the private sector

• Russia is not in control of its economic future

• Russia lacks the institutional flexibility to adapt to changing domestic demands

• The middle class demands to be heard, making Russia in both the short term and the long term, inherently unstable.

Emerging Market or Stagnating Regime?

25

• Russia today – the politics of the economics.



Equity Market – Big and Liquid

• Russia has a large and liquid equity market

• The top 2 most liquid stocks in EM are Russian

• However, it is more concentrated in energy than most of its peer group

26

Equity market – Breakdown by sector

Source: VTB Capital

0%10%20%30%40%50%60%70%80%90%

100%

China

Braz

il

India

Kore

a

Russ

ia

Taiw

an

SAR

Mala

ysia

Mex

ico

Indo

nesia

UtilitiesTelecomsITFinancialsHealth CareCons StaplesCons DiscIndustrialsMaterialsEnergy

Equity market capitalization compared, $trln

0 1 2 3 4 5

JapanChina

GermanyBrazilIndia

RussiaItaly

Spain

Source: Renaissance Capital

Equity Market Liquidity Compared


Company Daily Value Traded, $mn Market Cap, $bnSberbank of Russia 1153 79Gazprom OAO 1005 159Vale SA 859 182Petroleo Brasileiro SA 744 222Samsung Electronics Co Ltd 612 131Hy nix Semiconductor Inc 487 15China Mobile Ltd 434 198China Pacific Insurance Group Co Ltd 402 30Kia Motors Corp 381 21Industrial & Commercial Bank of China 370 234MMC Norilsk Nickel OJSC 259 59Lukoil OAO 220 54Rosneft Oil Co 214 89

Russian equities in context

27

Source: Thomson Reuters

Country P/E 2011 EPS Growth 2011, % P/E 2012 EPS Growth 2012, %Chile 15.8 5.1 13.6 16.4Hong Kong 13.0 21.4 13.9 6.3India 13.8 1.0 11.7 17.6Morocco 14.3 6.8 12.9 10.7Philippines 15.3 6.8 13.6 13.1Malaysia 15.4 11.9 13.4 14.8Indonesia 15.1 20.8 12.9 17.0United States 12.3 16.8 10.7 14.5Taiwan 14.0 -3.5 11.4 21.8Thailand 11.6 19.3 10.2 10.3South Africa 12.5 30.8 10.2 22.9China 10.0 14.7 8.7 15.3Poland 8.9 23.6 8.6 3.3EM 10.2 13.6 9.0 13.5Peru 11.0 37.6 9.8 5.3Turkey 9.1 -3.7 8.1 13.3Korea 9.1 18.7 8.1 12.5Hungary 7.7 16.2 6.6 17.8United Kingdom 9.6 17.0 8.7 11.2Israel 8.6 11.4 7.8 9.7Argentina 8.5 16.8 7.3 16.3Brazil 10.3 10.7 9.5 8.4Egypt 9.8 12.0 7.8 25.3Lebanon 7.8 9.0 7.1 8.0Pakistan 6.8 19.6 6.0 14.1Russia 4.9 19.8 4.7 5.2

Equity Market – Cheap on a sectoral basis

28

Russian equity market by sector

Source: Thomson Reuters

Sector Russia P/E 2012 GEM P/E 2012 DM P/E 2012 Discount/Premium Russia to GEM Discount/Premium Russia to DM Russia EPS Growth 2012Consumer goods 16.0 15.9 13.4 1% 19% 79%Energy sector 3.8 6.4 8.9 -41% -57% 0%Financials sector 5.9 8.4 8.4 -30% -30% 14%Materials sector 8.3 8.3 9.4 0% -12% 25%Telecommunications sector 7.6 10.6 10.9 -28% -30% 18%Utilities 8.2 9.9 12.2 -17% -33% 59%

Russia is a cheap market, with earnings growth

29


Chile

Hong Kong

MoroccoPhilippines

Malaysia

Indonesia

United States

TaiwanThailand

South Africa

China

PolandEM

Peru

Turkey

Korea

Hungary

United Kingdom

IsraelArgentina

BrazilEgypt

Lebanon

Pakistan

Russia

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

5.0 7.0 9.0 11.0 13.0 15.0 17.0 19.0

EPS

Grow

th 20

11, %

P/E 2011

0

200

400

600

800

1,000

1,200

Russia USD 5Y CDS China USD 5Y CDS South Korea USD 5Y CDS Poland USD 5Y CDSBrazil USD 5Y CDS Mexico USD 5Y CDS South Africa USD 5Y CDS Turkey USD 5Y CDS

Equity Market – Cheap compared to the debt market

30

Source: Bloomberg

Russia trades at a premium to EM debt

Cheap does not mean performance

31

Performance of top 5 cheapest and top 5 most expensive

Source: Citigroup

Company P/E 2007 31-Dec-07 31-Aug-11 Return5 Expensive OnesUralkali 53.2 37.3 50.5 35.6%X5 Retail Group 38.9 34.2 36.2 5.6%Magnit 34.6 10.4 23.8 129.0%NOVATEK 32.0 76.9 136.3 77.2%Eurasia Drilling Company 20.8 27.3 22.3 -18.2%5 Cheap OnesAFI Development 10.8 9.5 0.7 -92.6%Evraz Group 10.5 70.5 24.0 -65.9%Gazprom Neft 7.1 6.2 4.4 -28.8%LUKoil 7.4 86.5 60.2 -30.4%Norilsk Nickel 6.7 27.1 25.1 -7.3%The MarketRTS Index 2290.5 1702.3 -25.7%

Equity Market – Cheap On A Historic Basis

32

Source: Bloomberg

The gap between Russian P/E and EM P/E is bigger than it has been since 2002

0

2

4

6

8

10

12

14

16

18

Forw

ard P

/E

Russia EM

Contact Information

Email: [email protected]

Russia: United States of America: Europe:[email protected] [email protected] [email protected]

8, Ivana Franko, Moscow121108, Russia+7 (495) 980-7373

Verno Investment Management Limited together with its affiliated entities provides advisory and investment management services. Thisdocument is only directed at investors who have experience of investing in unregulated collective investment schemes and emerging markets.The investment presented herein is unlikely to be suitable for most private individuals. This investment is speculative and includes a high level ofrisk and investors may not receive back the original amount of money that they invested. Although the information contained within this documenthas been obtained from sources believed to be reliable, we do not accept liability for its accuracy, completeness or fairness. Under nocircumstances should any part of this document be construed as an offering or solicitation. Past performance is no guarantee of futureperformance and the value of investments can go down as well as up. The contents of this presentation are for the sole use of the addressee.This document may not be reproduced, distributed, transmitted, displayed, published or broadcast by any recipient for any purpose without theprior consent of Verno Investment Management Limited.

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