Country Risk Report of Russia

COUNTRY RISK REPORT OF RUSSIA

March 25, 2014

Author: Riste Ichev Supervision by: Utrecht University and Rabobank Netherland

Things to watch: Economic growth, socio-political situation, economic policy and balance of payments

Summary Russia takes the 9th place as world largest economy with total population of over 140 million. According to Rosstat (Russian Federal State Statistics Service) data, foreign trade amounted to USD 864.7 billion in 2012, a yearly increase of 2.2%. Total exports totaled USD 529.3 billion and imports stood at USD 335.4 billion. Even though that Russia had slightly moderate economic growth, it still outperformed most developed countries in 2012. The Russian economy is growing at its slowest pace in four years as a result of weak industrial output, slowing investment, waning consumer confidence and weak external demand. GDP grew by 1.5% in 2013. (PWC directory or high-growth-markets) CIA’s numbers for 2013 say that: Russia is ranked as 7th in the world in terms of GDP (purchasing power parity), 77th in terms of GDP-per capita, the unemployment rate is 5.8%, and the current account balance equals $74.8 billion. The high amount of foreign exchange reserves and gold, $515.6 billion, describes Russia as a country with low economic risk. However, Russia in 2013 still holds the position of highly corruptive, selective and legally undeveloped country. The rest of the report presents the current situation in Russia and also provides brief forecast for the future. Population 141.430 Million GDP 2117.831 US$ billion

High risk

Country risk Business climate (From 7-level scale: A1, A2, A3, A4, B, C, D)

MAJOR MACRO ECONOMIC INDICATORS

2011 2012 2013 2014f

GDP growth (%) 4.3 3.5 1.5 2.0 Inflation (yearly average) (%) 8.4 6.5 6.1 5.5 Budget balance (% GDP) 1.6 0.4 0.5 -1.0 Current account balance (% GDP) 5.3 3.7 2.9 2.3 Public debt (% GDP) 11.7 10.9 10.4 10.5 (f) Forecast

* Abundant natural resources (oil, gas, metals). * Skilled labor force. STRENGTHS * Low public debt and comfortable exchange reserves. * Assertion of vigorous regional and energetic power. * Industrial sector lack of competitiveness * Weak private banking sector WEAKNESSES * Weak infrastructures * Declining population * Persistent shortcomings in the business environment

Growth with focus on 2014 In 2014 the growth is expected to be exceptionally unassuming/modest. Private consumption as a main driver of the economy has held up rather well, thanks to a continued policy of wage support in the public sector, favored by low unemployment. Household demand slows down the pace, limited by high inflation expected to land at 5.4% at end-2014, marginally above the Central Bank of Russia's inflation target of 5.0% for 2014, and to average 5.1% in 2015, fundamentally in light of the government-commanded utility price freeze in 2014-2015, the anxiety of debt and economic and political uncertainties. Investment stagnated in 2013 and is not anticipated to increase strongly in 2014. Business is expected to profit from the freezing of utility prices (water, energy), yet the low level of certainty will continue to bind investment spending. Industrial production could benefit from the slight recuperation on EU markets and proceeded high growth in China. Oil exports are relied upon to develop just a touch, due to a limited increase in production volume and relative price stability. Than again Russia, could be influenced by the descending pattern of the gas price. Despite measures to limit the rise in public services tariffs, household bills are expected to rise by nearly 4%. This increment, together with the effect of the Autumn 2013 surges on nourishment prices (nearly 40% of the household shopping basket) will probably exert upward pressure on the inflation rate, which is expected to surpass the limit set by the central bank (5%). Economic policy and balance of payments The fiscal balance is expected to continue deteriorating and to post a slight setback in 2014. Oil revenues (half of the aggregate) are not expected to increase and the languor of the economy will restrict non-oil revenues. The modest growth is likely to complicate the decline in social spending and wages. Moreover, the federal budget will have to cover a new deficit in the pensions system. Russian public finances nevertheless remain strong with public debt below 15% of GDP, leaving the government, at least in the short term, plenty of leeway (PWC – 28 March 2014 issue, capital- markets). The current account balance is expected to stay in surplus in 2014, but will continue to widen. Exports, largely commanded by oil and gas (2/3 of export revenues), will be constrained by prices, which at best, are expected to stabilize. The moderate import growth will probably limit the decline in the current account balance. The forecast show that the foreign direct investment growth will still be hampered by an adverse business climate. Capital outflows ($58bn at end September 2013) are expected to continue in 2014, but at a slower pace, easing the downward pressures on the ruble (subject to the oil price being maintained). Exchange rate volatility/instability could, however, increase with the Central Bank preferring to fight inflation rather than stabilize the ruble, conceivably by presenting a floating exchange rate in 2015.The overall performance of the Russian banking system has improved but the private banks’ solvency risk remains high. Socio-political situation and impact on the Russian business environment Russia is popularly corrupt, and thus by definition, the state is an inefficient governor of any property. Despite this, well-known fact state ownership in big business has widened (Troika Dialog 2008).” State-owned enterprises are found across an extensive variety of sectors and often possess a dominant position in their industry. Furthermore, there is a pervasive blurring of the line between the public and private sectors, emerging not just from the extensive role of state-owned enterprises but also by close ties between government (at all levels) and major private firms” (OECD 2009, 17) Russia is a country where an overwhelming concentration of power and a lack of genuine political debate prevail in general. Political parties play a secondary role, whereas the political spotlights are possessed by the key political figures, which do not always represent the interests of their electorate but rather the interest of the state; can be that of the presidential administration, the government or some of the many security-related organizations. This elite/top repression does not exist in a large scale, however the delayed administration of the ruling body (United Russia) may make circumstance where genuine, alternative political plan is no more accessible. In addition, business in Russia struggles with unclear and overbearing regulation, arbitrary administrative decisions, corrupt officials and biased or incompetent judges. Corruption is still overflowing at most levels of government and the legal system remains vigorously skewed as an aftereffect of lobbying from industrial groups or powerful individuals. The judiciary is undefended, understaffed and slow- moving-recent reform efforts notwithstanding. Competition policy is underdeveloped and intellectual property is poorly protected.

In conclusion, the weak legal framework and protection of property rights impedes investment. Governance suffers from businesses’ lack of transparency (particularly regarding shareholders). Russia is positioned 176th (out of 215) in terms of combating corruption according to the World Bank Governance Index. On the picture below, one can clearly see the Russian position on socio- political plan for 2014. Update on risk-based events

The Wall street Journal: On 6 March 2014, the US government imposed the first sanctions on Russia in response to the “ongoing violation of Ukraine’s sovereignty and territorial integrity”. Ukrainian and Russian officials “threatening the sovereignty of Ukraine” are now subject to visa restrictions and will have their US assets frozen. The Wall street Journal: On 24 March 2014, Russia’s RTS Index is down 21% this year on fears that an escalating crisis in Ukraine could lead to damaging sanctions from Western countries or armed conflict. Reference list:

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