COMMENT: Peering into the shadows

By bne IntelliNews July 16, 2012

Kirill Goryachikh of Renaissance Asset Managers -

Stuck in a Moscow traffic jam surrounded by Porsches and Bentleys, I opened the newspaper and came across this item: "Average salary in Moscow approaches RUB42,000 ($1,300) per month". Looking out the window at the cars, not surprisingly I didn't feel at all average. Sky-high real estate prices, fancy restaurants packed to the gills and decadent nightclubs brimming with conspicuous consumption suggest something is missing in this calculation of Russia's "average" salary.

As a Russian citizen, I wondered: "How much money is in fact hidden and what are people really earning?" Then as an investor, I asked the other obvious question: "How can I benefit from it?"

Estimates of the value of the global shadow economy run into the trillions, ranging from 9-10% of GDP in the UK, the US and Switzerland, to more than 40% in many Emerging Markets (EM), according to management consultants A.T. Kearney (see graph below). And as the global economy slows, more business is being pushed into the shadows. The upshot is that to make sound investment decisions, the investor needs to have a good grasp of the shadow economy and its effects - both positive and negative.

Unsustainable growth models, corruption and bad corporate governance all spring to mind when talking about the shadow economy and consequently EM, and are a big reason why so many EM stock markets trade at a substantial discount to developed market peers.

However, as always, first impressions are superficial. Companies can not only benefit from this kind of environment, but also maintain a high level of corporate governance in a less-than-perfect economy. While exporters are often politically connected, state owned or heavily regulated, companies catering to domestic demand are less exposed to these risks and therefore often have strong corporate governance and attractive growth models.

And not all sectors are affected equally: no matter how businesspeople come by their money, they all need goods and services. Receiving your pay in a brown envelope may jip the government out of some of its tax take, but the extra cash ends up in the real economy. Moreover, the "easy come, easy go" aura that surrounds "grey money" makes it easier to spend, as people prefer to hold something tangible like a nice car or apartment.

There is obviously a lot of cheating in Russia. Back-of-the-envelope calculations, totting up rent and average size of restaurant bills, suggest real incomes in Moscow, Istanbul and Warsaw are close to what people earn in London, Paris and Berlin.

Rents in Moscow average about $1,300-1,500 per month and the bill in an average cafe is between $20 and $30. London rents are slightly higher at $1,500-1,700 per month, while the cost of an average dinner is the same as in Moscow, according to, and RAM estimates.

Markets in Emerging Europe are not yet saturated and thanks to the low level of competition there are multifarious opportunities for domestically oriented companies to capitalize on. For example, Russia has just 25 square metres (sqm) of accommodation per capita against 40-50 sqm in developed markets, and 0.25 cars per capita versus 0.5-0.6 in the West. Organized retail's share of total retail sales in EM is just over 30%, less than half that of developed markets, according to PIK Group, Troika Dialog, Otkritie Research and RAM estimates.

Despite the widespread belief a big shadow economy negatively affects equities' valuations, the domestically oriented companies actually benefit from the extra cash in the system. Not surprisingly, many EM retailers are booming, resulting in a rally in their share prices. And this story is far from over. There are still many companies in the EM universe well positioned for growth, well managed and cheap, thus well positioned to experience the same rally. Add to this the economic and political reforms the crisis has forced on many governments, and the grey economy is becoming whiter. The multiples that companies trade at will only increase as this process unfolds. Unfortunately, this probably means the traffic jams will get worse too.

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