Assessing Risks and Opportunities in Russia

Dilip Badlani in front of The Kremlin and Saint Basil's Cathedral in Moscow, Russia

There is no doubting Russia's importance in the global economy. Together with Brazil, India and China, it makes up the acronym "BRIC." As the term suggests, there is a tendency to group these large nations with growing economies together as a unit. For our investment purposes, however, we view each nation very much as a separate entity. For all its advantages, we do not currently invest in Russia, though it is a place that we continue to watch very carefully. We have made investments in other countries that should be direct beneficiaries of Russia's economic growth.

When the Cold War ended in 1991, Russia was viewed as an area where international investors would be able to find numerous opportunities. However, the process of transitioning to a market economy from a command economy has been turbulent. The economy has encountered several speed bumps, the most notable of which was the financial crisis of 1998. On August 17, 1998, the Russian government devalued the ruble, defaulted on domestic debt, and declared a moratorium on payment to foreign creditors.² A decade later in 2008, due to its continued dependence on commodities, the Russian economy was once again set back by the global financial crisis, which caused its economy to decline by 7.9% in 2009 and also led to a collapse in its stock market.³ As the global economy emerged from the recession, the economy of Russia recovered as well, growing by 4% in 2010.⁴

Russia's exchange rate collapsed during the 1998 financial crisis ⁵

Russia's MICEX index declined from 1,970 on December 12th, 2007 to 514 on October 24th, 2008⁶

As one of four countries in the BRIC group, the economy of Russia has to be included in any discussion of global investing. The country's GDP, while the smallest of the four BRIC economies at $1.5 trillion,⁷ is still the eleventh largest in the world. Additionally, among the four BRIC economies, Russia's GDP per capita is second, behind only Brazil's at $10,437.⁸

Blessed with vast natural resources, Russia is the world's largest oil producer⁹ and also the largest global oil exporter.¹⁰ Shifting oil prices thus have a significant impact on the country's economic growth, and fluctuations in the price of oil have created significant volatility. From 1995 until 2010, Russia's average annual GDP Growth was 3.3%, reaching an historical high of 12.0% in December 1999 and a record low of -10.8% in June 2009.¹¹

Russia undertook the largest privatization in world history from 1992 until 1997.¹² The privatization of the country's resources has created a significant amount of private wealth. Moscow today boasts the largest number of billionaires in the world of any city; it is home to 79 of Russia's billionaires. Russia also accounts for a third of Europe's 300 billionaires, and 15 of the world's 100 richest people.¹³ These billionaires have been keeping a significant portion of their wealth overseas in countries such as Switzerland. In a recent poll conducted by UBS of high net worth individuals in Russia, Switzerland was listed as the most favored destination.¹⁴ We have invested in a Swiss institution that is a global private markets management firm and should be a beneficiary of these inflows.

During my stay in Moscow, it was interesting to hear a large amount of German spoken by guests at my hotel. Additionally, walking around Moscow, I noticed several signs that had German translations in addition to Russian and English. All of this makes sense when one looks at the trade statistics between Russia and Germany. In 2010, Russian-German trade turnover increased 30% to $52 billion.^15,16 Germany is Russia's most important trading partner, and German industrials have been able to successfully export their products into the market.¹⁷ A significant portion of our investments in German industrial companies have an export angle and view Russia as a targeted area.

The significant wealth that has been created since the end of the Cold War has been spread disproportionately. While Moscow is home to the largest number of billionaires in the world, the gap between the rich and the poor has increased significantly. The bottom 40% are being paid less in real terms than they were in 1991, while only the top 20% have seen their incomes more than double.¹⁸

Russia has also seen a decline in its population since the end of the Cold War. Its population peaked in the early 1990s at approximately 148 million, whereas today the population is approximately 143 million.¹⁹ The United States Census Bureau estimates that Russia's population will decline from the current 143 million to 111 million by 2050. The main causes of Russia's population decrease are a low birth rate and a high death rate. The birth rate in the country is 10 births per 1,000 people compared to the world average of 20. The death rate in the country is 15 deaths per 1,000 people per year, which is far higher than the world's average death rate of just under 9. The average for a male is only 59 years, a result of high rates of alcoholism.²⁰

Source: Rickety²¹

Russia also suffers from a significant problem of corruption, which makes it difficult to do business there. In the release of the 15th annual Transparency International report on corruption perceptions around the world, ranking nations from least to most corrupt, Russia slid from 146th place to 154th, out of 178 countries.²² Nearly 80 percent of Russians say that corruption is a major problem and that it is much worse than it was 10 years ago.²³

President Dmitry Medvedev has stated that he wants to stamp out corruption and improve corporate governance in order to attract more foreign investment into the country as well as to help diversify the economy away from commodities. Former President and current Prime Minster Vladamir Putin stated as part of his Russia 2020 plan that "So far we have only partially occupied ourselves with modernization of the economy. As a result, Russia has become increasingly dependent on imports of goods and technology, and our role as a raw material appendix to the world economy has been reinforced. In the longer term, this can lead to our lagging behind the leading economies of the world and our country being squeezed out from the world leaders²⁴." In October last year, President Medvedev launched a "Forward, Russia" campaign to fight corruption. However, little has resulted so far, and it appears that it may still take a period of time for these changes to occur.

Our strategy, then, is to continue carefully observing events in Russia. For now, we are confining our investments to companies in various countries that have access to Russian markets and/or customers and that also boast strong corporate governance.

¹ http://www.reuters.com/article/2011/03/09/us-billionaires-russia-idUSTRE7287NA20110309
² http://research.stlouisfed.org/publications/review/02/11/ChiodoOwyang.pdf
³ http://www.euronews.net/2010/02/01/russian-gdp-slumps-in-29/
⁴ http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/RUSSIANFEDERATIONEXTN/0,,contentMDK:21054807~menuPK:517666~pagePK:1497618~piPK:217854~theSitePK:305600,00.html
⁵ http://goldnews.bullionvault.com/equity_forex_crisis_060320092
⁶ Bloomberg
⁷ Estimated by IMF staff
⁸ Data refer to the year 2010. World Economic Outlook Database-April 2011, International Monetary Fund. Accessed on April 11, 2011.
⁹ http://omrpublic.iea.org/omrarchive/12may11sup.pdf
¹⁰ http://omrpublic.iea.org/omrarchive/18jan11tab.pdf
¹¹ http://www.tradingeconomics.com/russia/gdp-growth
¹² http://www.iie.com/publications/papers/aslund0409.pdf
¹³ http://www.reuters.com/article/2011/03/09/us-billionaires-russia-idUSTRE7287NA20110309
¹⁴ http://www.minyanville.com/businessmarkets/articles/russia-economy-russia-markets-russian-makets/7/12/2011/id/35687
¹⁵ http://english.ruvr.ru/2011/05/10/50085917.html
¹⁶ http://english.ruvr.ru/2011/05/31/51086986.html
¹⁷ http://www.nytimes.com/2010/07/14/business/global/14trade.html
¹⁸ http://www.bbc.co.uk/news/business-13581730
¹⁹ Russian Census 2010
²⁰ http://geography.about.com/od/obtainpopulationdata/a/russiapop.htm
²¹ http://www.rickety.us/2009/10/world-total-fertility-rate-declines/
²² http://www.washingtonpost.com/wp-dyn/content/article/2010/10/26/AR2010102601429.html
²³ Ibid
²⁴ Speech at Expanded Meeting of the State Council on Russia’s Development Strategy through 2020, February 8, 2008, available at www.kremlin.ru (accessed on January 13, 2009).