Following the global economic slowdown, emerging nations are leading the recovery with high rates of economic growth and increasing consumer demand. Among emerging countries, the four BRIC countries- Brazil, Russia India and China-are identified as the future economic powerhouses. These countries are propelling the global recovery as their economic growth rates exceed global averages. This week we look at Russia, its prospects and the opportunities which are available to investors.
Review of Russia's economy
Russia, the world's largest country by landmass, has the distinct advantage of being one of the richest in natural resources. It is home to the eighth largest proven oil reserve and the second largest reserve of natural gas globally, and accounts for roughly 20 per cent of the world's oil and natural gas production.
Additionally, Russia possesses abundant reserves of iron ore, nickel, platinum, copper, gold and one-fifth of the world's timber resources. With its abundance of natural resources, the Russian economy is mainly dependent on the exploitation of its vast reserves of oil and natural gas. However, this very dependence on oil production eventually resulted in a reversal of Russia's fortunes. As the economic slowdown set in, global demand declined and oil prices plummeted causing the Russian economy to plunge into recession in 2009. Russia's growth turned red when the economy contracted by 6.4 per cent as indicated by Figure 1.
Over the past decade the Russian government has been successful in reducing their debt levels, with the government's debt as a percentage of gross domestic product (GDP) falling from 12.9 per cent in 2005 to 9.5 per cent in 2010. Figure 2 illustrates Russia's debt levels relative to fellow BRIC nations, India and Brazil. Russia began saving for "rainy days" building their foreign currency reserves to its current value of US$465.4 billion, the third largest reserve in the world. As such, Russia was able to finance the US$20 billion stimulus package in 2009 without compromising the fiscal stance. In 2010, Russia's economy began to recover and expanded by 4.0 per cent, despite experiencing a severe drought in mid 2010. Extreme weather conditions caused agricultural production to decline by approximately 12 per cent as wheat, corn and sugar-beet crops were lost. Russian growth is expected to continue and the International Monetary Fund (IMF) projects the economy will expand by 4.8 per cent in 2011.
Global increases in food prices and the domestic loss of agricultural output have been the main driver of inflation in Russia, with food accounting for 38 per cent of the Consumer Price Index. The April inflation rate of 9.3 per cent was well above the Bank of Russia's target rate of between 6 to 7 per cent. In response to the higher prices, the Central Bank has been tightening monetary policy by increasing the reserve requirements of banks and hiking the main policy rate to 8.25 per cent. The international credit rating agency, Fitch upped Russia's economic outlook to stable from negative and affirmed its investment grade BBB status in 2010. Russia's positive outlook stems from renewed investor confidence owing to higher oil prices, net capital inflows into the country and the reductions in budget deficits. Also, the privatisation of key industries by the Russian government is perceived as a step towards greater competitiveness and will provide approximately US$33 billion in government revenues.
Another positive move by the Russian government is the attempt to diversify the economy and reduce the vulnerability to oil shocks by developing the technological research sector and strengthening the financial sector.
Equity Markets
The Russian stock market has been performing favorably after recovering from the global economic slowdown. Over the past two years, the Russian stock index, the RTS USD Index, outperformed the MSCI Emerging Markets Index and the S&P 500 Index as depicted by Figure 3. On a year-on-year basis, the Russian RTS Index was up 5.02 per cent while the S&P 500 increased by 5.25 per cent. Investors willing to bear higher levels of risk and earn relatively more competitive returns can look to Russian stocks. There are many Russian based companies that are worthy of consideration, owing to their high-grade investment status. Investors may consider companies in the energy sector such as Lukoil Holdings and Novatek which recorded a ten per cent and 11.72 per cent year-to-date return. Investors can also look to Sberbank-a leading Russian bank and Bashneft ANK, which are generating positive returns on a year-to-date basis.
Bond market
For investors who are attracted to the safety and stable cash flows associated with fixed income instruments, Russian bonds may be an appropriate consideration. Russian sovereign bonds are government guaranteed with investment grade BBB rating. While government bonds offer relatively low yields of 3.08 and 4.63 per cent, respectively, for the 2015 and 2020 bond issues (evidence of the perceived strength of the Russian economy), quasi-government and corporate bonds offer relatively more attractive returns. The Russian government has strategic interests in several major companies. For instance, Gazprom, a Fortune 500 company and the world's leading natural gas producer, holds a BBB credit rating and its 2016 bond issue is currently offering a yield of 4.26 per cent. Another noteworthy Russian quasi-sovereign company, VTB Bank, is 75.5 per cent owned by the government and its 2015 bond offers a yield of 4.27 per cent.
TNK-BP is Russia's third largest oil producing company and one of the ten largest privately-owned oil companies in the world, presenting investors with a competitive yield of 4.36 per cent for its 2016 issue. Vimpelcom, Russia's largest telecommunication company, with a BB credit rating, strong business fundamentals and large market share, makes is another viable alternative. The 2016 and 2018 bond issues of Vimpelcom offers attractive yields of 5.2 and 6.3 per cent. Russia is an upcoming economic powerhouse and has the potential to provide investors with the opportunity to diversify their portfolio and earn relatively attractive returns. Investors with higher risk appetites may consider Russian based equities, while those who prefer the relative stability associated with bonds can choose fixed income securities which meet their desired levels of risk. As always, investors are recommended to seek consultation from a qualified investment advisor before undertaking any investment ventures.