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Letter from Russia: In the

  • 25Jun 18
  • Stephen Parr Senior Investment Manager, Global Emerging Market Equities

All eyes are on Russia this summer, not least the estimated one million soccer fans flocking to 11 cities across the country for the world’s greatest football tournament. And worldwide, billions more are tuning in to the ‘beautiful game’.

Indeed, the world’s greatest football tournament is an opportunity for Russia to showcase itself on the world stage. But it’s also a time when investors’ scrutiny on Russia is set to intensify – soccer fever influencing investor sentiment?

Under Vladimir Putin’s new and fourth term as president, Russia is in a better place economically. After nearly four years of European and US sanctions, the government has adopted a well-designed policy of inflation targeting and an extremely prudent fiscal rule, reducing the budget deficit and the dependence on oil, as well as overseeing an increase in productivity.

Ahead of the most recent US sanctions against oligarchs and senior Russian officials, policy-makers were on track towards achieving a targeted inflation rate of 4% by the end of 2018. Indeed, consumer price inflation hit an historic low of 2.2% in February. For now, the recent sanctions have had little noticeable impact on Russian economic growth1. And the impact isn’t likely to be material, given Russia’s $460 billion2 of foreign reserves and its low debt/GDP ratio.

So as long as the authorities continue to adhere to an extremely prudent fiscal rule and inflation targeting, sanctions should not destroy the Russian economy.

Over the longer term

In our meetings and conversations during a recent visit to Moscow, sentiment did not match this supportive backdrop. Unexciting growth prospects, concerns that sovereign debt may be targeted in a future round of sanctions, and uncertainty over the timing of sanctions have fuelled uncertainty.

Russia is still a comparatively closed economy, accounting for around 1.5% of global gross domestic product. Russia, for example, has minimal connectivity with India, although the two countries started negotiating a free trade agreement in July 2017.

Russia is also experiencing a high level of income inequality. Despite being classified as a mid-income economy, market access and competition is lacking, leading to a dearth of economic dynamism. And infrastructure remains a problem, where daily life for the 12 million Muscovites is work, food and battling notorious traffic.

Still, we have a foothold in this market, with recovering oil and commodity prices bolstering key sectors of the economy.

Economic bloodline

In the world of sports, soccer reigns. When it comes to the oil market, OPEC provides the defensive line, protecting – not always successfully – the floor price. Russia’s role is more along the lines of the creative midfielder, with the ability to create the odd surprise. And Russia’s oil giants wear the captain’s armband.

Some of the Russian oil majors are applying cutting-edge technologies in their upstream projects as they seek to exploit hydrocarbons from hard-to-recover oil reserves. And these companies are also enjoying special tax rates for the exploration of these hydrocarbons.

Steely resolve

Still, investing in Russia is challenging. With the country facing increasingly difficult geopolitics and the threat of future sanctions, investors must muster steely resolve to keep ‘oligarch-risk’ companies in their portfolios. However, the fundamentals for domestic steel producers are compelling.

As international investors in Russia, there is never a dull game.

Preparations for the footballing jamboree, including construction of stadiums3 and connecting infrastructure, have been making the most of Russian steel. With mills shutting down in neighbouring China, Russian steel continues to command a domestic market premium. The industry’s outlook is favourable as average capacity utilisation remains high, and expected to remain so due to growing demand for rolled steel.

Pitch and pit

Sanctions aside, the Russian stock market is expected to see decreased trading activity during what some see as the greatest sporting spectacle on Earth, if the conclusion of research by the European Central Bank (ECB) holds true. In an analysis4 of the 2010 tournament, ECB researchers found trading activity dropped markedly, especially if the local team was one of the competitors. The researchers also found that there’s also a strong sense that stock markets of the different nations were being driven by developments on the soccer pitch rather than in the trading pit.

Already, soon after the recent sanctions were announced, the stock market saw a spike in trading volumes of both equities and fixed income with investors selling down positions and expatriating the funds. That could be a one-off impact. But, if flows don’t return, lower volumes may persist into the medium-term.

As international investors in Russia, there is never a dull game.

Editorial image credit: Arkady Mazor / Shutterstock.com

1Transcript of the press conference on the release of the April 2018 World Economic Outlook, International Monetary Fund, 17 April 2018.

2‘International Reserves of the Russian Federation’, The Central Bank of the Russian Federation, 30 April 2018

3‘Russia transforms its infrastructure for World Cup’, World Steel Association, May 2018

4‘The pitch rather than the pit: investor inattention during FIFA World Cup matches’, European Central Bank, February 2012