Speaking Of Bears
The other major subject market participants are discussing is the stream of positive developments out of Russia. They’re also very interested in the US Federal Reserve, but more for tactical reasons; their focus on Russia is of a long-term nature. Some, aware of SRI’s long-held positive views on the Russia, seized the opportunity to share their assessments.
One conversation centered on a colleague’s observations of the tenth St. Petersburg International Economic Forum, held June 13 through June 15. My friend was extremely impressed with the caliber of people from the international scene that were in attendance. In addition to prominent investment bankers and figures from international organizations, many CEOs and other high level executives of companies from around the world participated. CEOs in attendance included those of BHP Billiton, Angloamerican, Nissan, Mittal Steel, Goodyear and Siemens. Other companies represented include Boeing, BP, Cargill, Citigroup, ConocoPhillips, Total, UBS and Unilever.
Overall it was a very impressive turnout, a good rehearsal for the G-8 Summit that St. Petersburg will be hosting for the first time July 15 through July 17. Russia’s hosting duties were hammered out during what was then the G-7’s 2002 summit in Canada, and signify completion of the process for full membership.
The majority of presentations concentrated on economic growth activities and how to finance them. At the same time, my friend got the feeling that Russia is becoming more international in regard to business. During the conference Norilsk Nickel, the world’s largest producer of nickel and palladium, announced its alliance on minerals exploration and development with BHP Billiton’s Russia operation, and the celebrated CEO of Nissan, Carlos Ghosn, signed the company’s St. Petersburg investment agreement.
Many company executives spoke openly of their positive experiences in doing business in Russia–they were able to buy land at the lowest possible price allowed by federal law, and import tariffs on parts were lowered. It’s no wonder then that St. Petersburg is now home to assembly plants of companies like Ford, General Motors, Nissan and Toyota.
To be sure, no one was willing to say that Russian practices have changed overnight–far from it. But everyone agreed that things are looking much better, and that the positive news would continue.
President Putin was credited with making the changes necessary for Russia to advance. The Yeltsin years, by contrast, were described by many as essentially a lost decade–Russia had no direction and no clear vision of its future.
My take, based on these first-hand observations, is that Russians seem to be confident once again and that they’re now more open to do business with and learn from the rest of the world. These factors were lacking in previous cycles. Note that this cooperation doesn’t include selling Russia’s natural assets to foreigners or their local representatives, as previous advisors had once counseled.
It seems this new confidence bolstered the reasoning that’s led the Russian government to proceed with the convertibility of the ruble, for the first time since before the October Revolution, as of July 1.
Beginning next week, Russians and foreigners will be able to take rubles abroad, foreign investors will be allowed to open ruble bank accounts and restrictions on fixed-income, ruble-denominated investments will cease. Although the domestic market is still quite small for this change to have any major impact, the point to note is that the investment process for Russian companies will now be more efficient, as they’ll be allowed to source funds in rubles. It’s expected that the ruble will strengthen, perhaps trading closer to 25 rubles per USD1 by year’s end. See the chart below (a lower line means fewer rubles per USD1, thus appreciation of the currency).
Source: Bloomberg LP
When the argument that Russia’s rising fortunes rested solely on high oil prices was raised, a fund manager in our company pointed out that Nigeria has enjoyed increased oil revenues but nothing’s changed otherwise. In contrast, Russia is set to pay off all its bilateral foreign debt to the Paris Club, an informal group of official creditors whose role is to find coordinate and sustainable solutions to the payment difficulties experienced by debtor nations.
According to the organization’s official Web site:
Negotiations held between the representatives of the Paris Club creditors and of the Government of the Russian Federation on the 15 and 16 June 2006 resulted in an agreement regarding the early repayment by Russia of all its Paris Club debt. This agreement is about to be signed by Russia.
After the early repayment of its debt which amounts to about US$ 22 billion in face value, Russia will no longer be a Paris Club debtor, while remaining a major creditor within the Paris Club. This operation will represent the largest prepayment ever made to Paris Club creditors.
As things stand, Russia seems to be an economy–a re-emerging one–with some good things going for it: a USD236 billion FOREX reserves surplus and more than USD50 billion in its oil reserve fund. The government runs a fairly conservative fiscal policy while inflation is relatively well behaved and could decrease below 9 percent (see the chart below).
Source: Bloomberg LP
Another fund manager who’s been active in Russia pointed out that local liquidity has increased as local institutions have increased investment in the domestic stock market. He suggested taking a look at the MICEX Stock Exchange Index, a ruble-based index of the most liquid Russian stocks. Below are the charts of the ruble-based and the USD-based indexes. A cursory study validates his point. 
Source: Bloomberg LP
The ruble-based exchange dwarfs the volume of the USD-based one, as the chart below indicates. 
Source: Bloomberg LP
Regular readers are aware of SRI’s long-held view that the world economy is going through a transformation, the outcome of which will be a change in economic growth leadership. The expectation is that this leadership will be assumed–in due course–by the East, and although the process will not be a smooth one, it is irreversible.
Russia will participate in this change, maybe not as a leader, but certainly, given its huge energy supplies, as a facilitator.
Russia is currently in the sweet spot: It’s a net oil exporter, has good GDP growth, isn’t dependant on foreign capital flows, is relatively stable politically, boasts reasonable–if not cheap–market valuations and, above all, enjoys solid exposure to the biggest growth story of our time, Asia.
SRI suggests that investors look for entry points to buy long-term growth stories in Russia if they want outperformance in coming years. This isn’t to say that a global recession or a choppy market won’t hurt Russia, or that a commodities bubble won’t happen. Regardless, Russia will continue to modernize and improve its economy, and to perform well while doing so.
Portfolio holding Gazprom (see SRI, 31 May 2006, Looking For Answers) was often referred to as the “state within the state” or as a “cash cow” for its top management during the Yeltsin years.
The company accounts for 8 percent of Russia’s GDP and about a fifth of the state’s tax revenues. It’s therefore been a priority of the current administration not only to take control, but also to do everything possible to clean it up, at least by Russian standards. Gazprom still suffers from a bloated cost structure and many insiders still take their cut, as noted in an annual report on the company published by Hermitage Chairman Bill Browder, one of the most successful Russia-based money managers.
Browder, a well known and widely respected money manager, had his visa revoked last November. It’s rumored that his Gazprom report caused the revocation. I claim no inside information, but I have no problem believing this may actually be true. Some habits, after all, do die hard. The fact is that a lot of high-end lobbying is underway to get Browder back inside Russia. Even Jack Straw, England’s No onside in the real story will be claimed here, but I have no problem believing that this might actually have been the reason. Some habits do die hard after all. The fact though is that a lot of high end lobbying is taking place to get him into Russia again. Even UK Foreign Secretary Jack Straw is rumored to have been involved.
Nevertheless, there has been progress–even Browder has said so–and SRI expects it to continue. The economic and investment communities have warmly received Gazprom CEO Alexei Miller, the company is flush with cash and its latest numbers show quarterly profits up by 25 percent. Portfolio member Gazprom remains SRI’s favorite in Russia. 
Source: Bloomberg LP
That said, I’ve received many questions regarding more ideas on Russia. Although I’m not yet adding any more Russian companies to the Portfolio, here are some I do like and follow. Please note that SRI won’t provide regular updates on these companies.
- Lukoil (OTC: LUKOY)
- Vimpel-Communications (NYSE: VIP)
- Wimm-Bill-Dann Foods (WBD)