Liam Halligan of Prosperity Capital Management -
While the global financial crisis shows no sign of abating, and if anything is getting worse, the Russian market is showing increasing signs of relative stability.
The RTS index of leading Russian shares rose 1.7% during February. Over the same period, the S&P500 fell 12.2% and the main MSCI EM global emerging markets index lost 5.9%.
Russian share valuations remain chronically depressed - with the RTS trading at an overall price/earnings of 2.4x. Several leading companies continue to be valued at less than the cash they have in the bank. Such low equity multiples, the result of waves of forced-selling in the fourth quarter, can only be justified under a "systemic meltdown" scenario that now looks highly unlikely.
It's now more than six weeks since the Central Bank of Russia (CBR) pledged to defend the ruble at a rate 41 against the dollar-euro basket. Since then, despite widespread scepticism, this limit has held. Russia's foreign exchange reserves have stabilized, ruble bank deposits are starting to grow and many short positions against the currency have been unwound.
Having fallen 70% since last summer, oil prices may also have bottomed-out. At $45 per barrel, West Texas Intermediate is flat year to date, but 17% above its pre-Christmas low.
On their own
Earlier in March, Arkady Dvorkovich, the influential presidential aide, said large Russian companies "shouldn't expect the government to provide them with further support." Dvorkovich stressed companies must "take responsibility for their own futures" and "work efficiently." This statement marks a shift in strategy. Since last autumn, the Russian government's $230bn "bail-out" package has been aimed at helping banks and other large strategic companies - particularly those with overseas debts. This led to concerns, aired in both the domestic and foreign press, about "cronyism" and an "overbearing Russian state".
Now the threat of systemic collapse has diminished, ministers say they've switched their focus away from big business and towards the population as a whole. Further help for companies is most likely to take the form of non-monetary measures. The external debt repayments facility of Vnesheconombank, the public body that has been administering emergency credits, has been closed. VEB seems determined instead to ensure state cash already earmarked or allocated is being used, or will be used, as efficiently as possible.
One reason Dvorkovich made this statement - which has since been echoed by First Deputy Prime Minister, Igor Shuvalov - is that the state's recent willingness to rollover and restructure Russian company debt has made foreign commercial creditors less willing to do so. Without this "get-out", the government calculates - probably correctly - that overseas banks will be more willing to refinance Russian companies they have previously backed.
The other reason for this change in tone is that Prime Minister Vladimir Putin and President Dimtry Medvedev, mindful that fears about political risk have weighed heavily on Russia's financial markets, seem keen to stress they want less, not more state involvement in the economy. While there are areas of concern, we feel this is largely true. Based on our close observation of both Putin and Medvedev over many years, we'd say their principal attitude is that greater state control over the economy is undesirable.
At the recent Davos summit, Putin said that "while the state's increased role in times of crisis is a natural reaction to market setbacks... the concentration of surplus assets in the hands of the state is a negative aspect of anti-crisis measures in virtually every nation." Looking at events in the US, UK and across Western Europe, it's difficult to argue otherwise.
In a passage aimed squarely at Western hawks, Putin said: "In the 20th century, the Soviet Union made the state's role absolute. In the long run, this made our economy totally uncompetitive and this lesson cost us dearly. I'm sure nobody wants to see it repeated."
The PM then added: "The spirit of free enterprise, including the principle of personal responsibility of businesspeople, investors and shareholders for their decisions, has been eroded in the last few months. There is no reason to believe we can achieve better results by shifting responsibility onto the state". These words are worth recording, as they weren't reported in Western newspapers. Having said that, politicians are best judged, of course, not by words but deeds.
Again, in our view, since taking office almost 10 years ago, the current crop of Russian leaders has generally pursued pro-market policies, showing little sign of wanting to implement the kind of "state-takeover" many Western investors fear. Since 2000, Putin/Medvedev have extended Russia's mass privatization programme - selling-off important industrial and mineral assets, including the power sector and key licenses for coal, potash, oil and ferrous and non-ferrous metals. The state controls around 30% of Russia's oil production - which is actually a far lower proportion than almost any other major energy exporter.
As president, Putin introduced a basic rate of income tax of 13% in Russia - easily the lowest of any significant economy in the world. State expenditure overall remains at 19% of GDP - compared with more than 40%, and counting, in most Western economies.
There are more privatizations to come - Russia's rail network will soon be on the auctioneer's block and further telecomunication sell-offs are in the pipeline. All in all, the government past and likely future actions do not to us appear consistent with a regime that's looking to impose a state power-grab.
As a one-time minority shareholder in the now disbanded oil company Yukos, Prosperity has said and written a great deal since that episode took place in 2002/03. We would never condone the government's actions, and we wish that state had resolved the issue in a different way. But we believe its fair to see Yukos as a one-off re-balancing of politicized power, away from the private sector and back towards the state, after one of the original "oligarchs" broke an implicit deal not to use his spectacular wealth to heavily influence party politics. In our view, the circumstances that led to the Yukos affair were unique to the early stages of Russia's transition - and are most unlikely to be repeated. But there's an important proviso to this view: sometimes the Russian government acts to "protect" strategic assets falling into foreign hands - as do many Western countries.
Over the last few years, quite a few "oligarchs" have used their core assets - including their holdings in companies controlling a significant slice of Russia's raw material wealth - as collateral when raising working capital from Western banks. In recent months, many of these creditors have faced the genuine danger that Western bankers could take over their collateral. Such banks would then presumably sell-off these highly sensitive assets to the highest bidder, presumably the Chinese. Under these circumstances, it isn't surprising the government stepped in to refinance these loans - keeping these supremely important assets in Russian hands. In terms of both strategic imperatives and domestic politics, ministers didn't have a choice. And the government has so far refrained from taking direct control of such companies - offering debt finance, rather than taking equity stakes.
Western creditors have been mindful of the sensitivity of these loans. That's why some have taken advantage of the government's concerns to exit credit arrangements in Russia at the most favourable terms possible in the current climate. Ministers are now trying to stem that practice - which is one reason they've called time on big state bailouts. It strikes us that this concern about the public finances and the burden on Russian taxpayers, contrasts with the attitude of many Western governments at the present time.
While investors worry about political risk in Russia, we maintain our long-held view that, in general, by far the most important risk faced by investors in Russia is corporate governance - the actions of other private individuals, rather than the government. Prosperity's highly activist investment approach is designed precisely to reflect and attempt to cope with this reality. So far, Western reports of upcoming government expropriation - not to say widespread political unrest - have not been borne out. And, while it is extremely difficult to predict how any government will act, not least in Russia, we see little evidence of a long-term increase in the state's role in the economy.
Liam is Halligan Chief Economist of Prosperity Capital Management
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