Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Hugo Bain, Senior Investment Manager at Pictet Asset Management who has just spent a week in Russia gives his views on the regional outlook.
Calm. That is the surprising feeling after spending a week on the ground in Russia. This in itself is a remarkable achievement. Considering the fall in oil prices and the sanctions imposed by the West, I would have expected that Russia would be in a full blown crisis by now; the fact that the economy is in recession and not in a black hole can be seen as a positive; people are still employed, companies are under some strain but are not going bust, restaurants are full and President Putin remains popular. Maybe Russia is getting better at managing crises, given the frequency with which they happen.
When I was in Moscow, there was very little talk of either Western sanctions or Ukraine or Syria. While it is clear that sanctions have been effective in limiting access to some goods in Russian stores, the significant decline in oil prices, and the resulting fall in the Ruble, has had a much greater impact.
When you speak to Russian people about the lifting of sanctions, their view is that it would be of limited benefit.
This is in line with our view; I believe that roughly 80% of the damage done to the Russian economy last year is the result of oil price falls and only 20% due to sanctions. The one sector where a removal of sanctions would actually be a negative is agriculture, where there has been a clear increase in domestic investment.
The Russian macroeconomic environment is surprisingly benign. Unemployment remains stable, the country will still run a current account surplus this year and foreign exchange reserves have stopped falling and are now a much more significant share of GDP than they were a year ago. The current account, meanwhile, should remain in surplus under various oil price scenarios.
Food Inflation Squeezes the Consumer
The rise in inflation has been the most significant problem over the past year, most notably in the food segment. There has been a squeeze on the consumer, and in 2016 real disposable incomes will fall again. Among some segments of the Russian population, 50% of disposable income is now spent on food.
We expect a dramatic fall in inflation starting in 2016 and going through to 2017, when it is possible that the inflation rate will come back to central bank targets. For this to happen, though, we will need to see some stabilisation in the oil price and ultimately the Ruble. While the Central Bank of Russia (CBR) is on hold at the moment, we expect to see further interest rate cuts over the next 12-18 months.
The other concern we have is Russia’s fiscal balance. Why should this matter when government debt as a proportion of GDP is 13% and we live in a world with quantitative easing? The Russian Finance Ministry and the CBR seem to be almost ‘Germanic’ in their doctrines and policies. For the Finance Ministry this means that increasing government borrowing by a large amount is not acceptable. With this in mind one should expect either a cut in spending or an increase in taxation.
There was very little talk in Moscow about politics with Putin’s approval rating still very high. This year is important to watch as not only do we have the Duma elections but there are fewer international distractions given some easing of the international tensions over Ukraine. This will mean the population will refocus on domestic issues – hence, Putin’s rating could very well drop this year.
What Will Happen if Oil Prices Rise?
I returned from Moscow with my conviction intact regarding the upside potential in Russian equities. What is important at the moment from an investor’s perspective is not trying to calculate the upside, the upside is obvious.
If oil prices stabilise or return to a $50-60 range, Russia would see significant currency appreciation, inflation would fall which would make the CBR cut rates fairly aggressively. It is likely that Russian equities, which are trading at distressed valuations and are under-owned by foreign investors, in particular after the imposition of sanctions, would be amongst the best performing globally.
However, what happens should oil fall below $20? Because of the free floating exchange rate and the export dominated economy, equity prices will fall, but the economy will not fall apart as it has done in the past. Things seem much more resilient, and competent in terms of economic management, and this makes me believe that when the direction of oil does change, the Russian economy will be fully able to benefit as would investors in Russian assets.
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