Is the "unloved Bric" going to emerge as a safe haven this year? Russia is off to an excellent start in 2011, and analysts only expect momentum to build from here.
The Russian stock market was up 23 percent in 2010, but it soared 18 percent in December alone. Having shunned Russian equity for most of 2009, when the leading RTS index lost about three-quarters of its value from its peak in September 2008 to April 2009, investors are starting to pile back in; gains in the other Bric markets clearly ran their course last year.
Flows into emerging market equity funds recorded net inflows in 33 of the past 34 weeks, but Russia took its biggest inflow in three years in the middle of January. Increasingly, portfolio investors have nowhere else to go if they want to make the big returns they have enjoyed in emerging markets since the crisis struck. Likewise, Renaissance Capital in Moscow predicts that Russian IPOs will triple this year as Russian companies return to equity markets to raise fresh investment capital.
The economy is also doing well. The government upped its end-of-year estimate for GDP growth to 4 percent in January, but analysts almost universally predict growth will top at least 5 percent this year—not bad for a middle-income country.
“Strong growth opens up good opportunities for us to become a safe haven again amid the problems in Europe and the ongoing stagnation in the United States,” said Elena Matrosova, director of the Center for Macreconomic Research at BDO in Russia.
Foreign investment is also returning. The all-important foreign direct investment topped $40 billion in 2010, regaining its 2006 levels, but only half of the $80 billion peak reached in 2008. However, while the volume of investment remains down, the size of individual deals is going up: BP’s massive $1.5 billion investment in a tie-up with state-owned oil major Rosneft produced a lot of comment. Clearly, BP has an eye on the huge untapped oil reserves in Russia in a world where the discovery of new reserves is lagging behind oil production. More significant was PepsiCo's takeover of Wimm-Bill-Dann, Russia's biggest dairy maker also for $1.5 billion in December 2010 - the biggest takeover deal in Russia's modern history. Like BP, Pepsi is eyeing Russia massive untapped resources, except in this case it is the 142 million-strong consumer market.
Unexpectedly strong oil prices (topping $90 in January) have meant that the state finances in 2010 did a lot better than expected, with the deficit coming in at 3.8 percent at the end of 2010 – a big improvement over the 6-7 percent expected at the start of the year. In fact, the numbers were so strong that Deputy Prime Minister and Finance Minister Alexei Kudrin said in January that Russia would not spend all of its rainy-day reserve fund this year; the reserve fund was expected to be completely used up in 2011 supporting budget spending.
However, the key number is the state's external debt, which is a ridiculously low 17 percent of GDP, compared with the triple digits that most developed world economies are sporting. Put another way, for each dollar of external debt the economy has (including corporate debt) the state has $1.20 of cash reserves.
Equity investors have already caught the Russia bug, and institutional investors in the UK and U.S. such as pension funds and insurers have also said they will continue to invest in emerging markets as they offer higher yields, lower risk and appreciating currencies. And for once there is plenty to buy: The Russian government has returned to the debt market after a 10-year hiatus to finance the deficit with $7 billion in hard currency borrowing and 1.7 trillion ($56 billion) of ruble borrowing written into the budget this year.
Safe havens are likely to be in high demand this year. With the fiscal stimulus coming to an end, new storm clouds are gathering as the next stage of the Great Sovereign Debt Crisis unfolds.
In Europe, Spain and Portugal have to raise tens of billions of euros this year simply to roll over existing debt and it is not clear that they will manage it, although both cash-rich Russia and China have said they will buy these bonds if the price is right.
In the United States, things are looking even worse. Investors fled U.S. municipal bonds in December, driving up the cost of borrowing and driving state after state into deficit. Currently, well over half of the U.S. states are unable to meet their obligations and the government is due to pass a bill enabling states to go bankrupt – up to this point, no American state has ever gone bust.
Russia was briefly hailed as a safe haven as the world reeled from the subprime debacle in 2008, but following the Lehman Brothers collapse on Sept. 17, 2008 its weakness was exposed – the huge corporate indebtedness of Russia's biggest firms brought the economy to a standstill.
The crisis has squeezed Russian debt dry and this time around, if there is a fresh credit crunch, Russia is much better equipped to deal with it. Indeed, a safe haven image becomes a self-fulfilling prophecy—the more money you attract, the better you are able to weather the storm. Indeed, it is already clear that the biggest dangers Russia faces this year are inflation driven up by the arrival of "hot money" from the developed world, and asset price bubbles as investors have nowhere else to go.
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