9 December 2015

Russia not quite so bad

We have been turning more positive on during the autumn and there are several factors that give us comfort looking into !"#$.

The first, and perhaps most important, is that inflation is expected to half from the current %!' by the mid of next year and according to some economist reach "' by the end of it. The drop might seem dramatic, but two thirds of the current inflation is a translation effect stemming from the ruble losing half of its value during last winter, suggesting that underlying inflation adjusted for this is around !'. This price drop will be accompanied by a series of interest rate cuts, several hundred basis points. This, in turn, will lead to a rebound in consumption, bank lending and most likely also Russia has bottomed out economically and inflation is expected to fall sharply in 2016, which should be bond inflows accompanied by massive rate cuts and a rebound in consumption. Photo: East Capital

The second point is that we believe there is a on the ground. A combination of important year, the Governor of the Sakhalin region was possibility that European sanctions will be lifted substitution and relative strength has supported arrested for bribery. High-level cases regarded in $#%&, at least partially. The sanctions may a number of domestic oriented companies as a deterrent is the classical modus-operandi of be temporarily prolonged when they expire in Russia while many of the exporters were Russian anti-corruption work, but there is also in January but probably not for more than “protected” by the weaker ruble. We have seen a lot of activity with regards to petty corrup- six months. The situation in Eastern Ukraine how market leaders like Magnit, and M tion. The number of people facing corruption has stabilized and it seems like all parties are Video have grown their EBITDA by (#-&#' in charges has increased more than ! times over moving towards implementation of the Minsk the first half of this year even as the economy the past two years and more than "### officials II agreement, which is a pre-requisite for lifting was contracting by almost !'. And retailers like are under investigation. the sanctions. Some of the financial sector Lenta and grew their sales by (#- sanctions are likely to be removed first, which "#' in the second quarter when the economy The two most important factors for the market would enable the large Russian state-owned was bottoming. There are obviously companies are probably the likely partial lifting of sanc- banks to re-enter the Eurobond market, that struggle but the above examples are not tions in $#%& and the expected rapid decline decreasing hard currency borrowing costs only anecdotal, corporate profits have overall of inflation and interest rates in the next %$ significantly. been very strong this year. months. The economic and political situation will not look particularly great in the beginning The third point refers to macro in general and Finally, Russia is reforming and this realization of $#%&. But it will look decidedly better than the ruble in particular. The currency move- should help the market and the economy in it did a year ago and that is what financial ment over the past %.! years – a result of oil the longer term. Even though we would like markets tend to trade on. To put it differently, prices, sanctions and macro in that order – has to see more growth and efficiency-enhancing the Russian financial market tend to perform been extraordinary and is the main reason the structural reforms, there have been at least when sentiment is shifting from bad to not quite equity market underperformed and financial three major improvements lately. First, Russia so bad. stability was maintained. We believe the ruble has amended its pension system and the may appreciate slightly due to an expected government now supports the resumption of modest rebound in oil prices, a partial removal contribution into private pension funds. Gold- Jacob Grapengiesser of sanctions and a slight macro improvement. man Sachs estimates that pension investments Partner, based in

The economy is in recession and will continue into Russian equities will increase by USD &#bn to operate much below potential but we believe or !!' of the current free float by $#$#. Second, growth bottomed out in the second quarter. Russia continues to improve the business cli- The direction has changed and the risks may mate and just moved up another three notches Marcus Svedberg therefore be on the upside, especially as in the World Bank doing business survey. Chief Economist expectations are so low. The point is that when Russia retains its position as the best ranked the downside risks are deemed smaller than BRIC economy at !%st place after being %$(rd the upside, investors and companies may start five years ago. Third, the anti-corruption drive investing again. seems to have been re-started. This is a more intangible process but graft is not only getting The fourth point is about companies. We have exposed but also taken to court. The Governor repeatedly argued that there is a big discrep- of Komi was recently arrested and accused ancy between macro headlines and realities of fraud and criminal conspiracy. Earlier this www.eastcapital.com