Sunday, April 29, 2007

Financial Times - Russia 2007 (Key Points)

The Financial Times has recently come out with its annual report on Russia, focusing mostly on economic, business development issues, but keeping in mind the general macroeconomic factors, as well as the tendencies that are developing in Russia's foreign policy:

Yet, seven years into Vladimir Putin’s presidency, Russia is more than ever a country of two tendencies. Private business shows progressing dynamism, but ever more political and economic power is being concentrated in a small circle around the president, in a regime critics call increasingly authoritarian. That dichotomy, perhaps, underlies the debate over exactly what kind of Russia Mr Putin – who under the constitution must stand down next March – will leave behind.

The report lists a plethora of economic achievements that the Russian government has achieved in cooperation with its state-run enterprises. The economic boom requiring massive capital investments into new infrastructure will result in a doubling of fixed capital investment in 2010 to $357 billion, according to projections by the Finance Ministry. New private sector inflow in 2006 was $42 billion compared with $1 billion in 2005, and a $8 billion outflow in 2004 as a result of the YUKOS affair. On the government side, the oil stabilization fund has grown to $100 billion in just three years, and foreign exchange reserves have ballooned to over $350 billion; this was accompanied by a reduction of government debt to just 10% of GDP. Yet questions remain:

The authorities expect the budget surplus to fall from last year’s 7.5 per cent to around 3 per cent in 2007 and 0.5 per cent in 2008. While the government can easily finance the extra spending, the inflationary effects will be more difficult to control. Also, structural reforms remain slow. For example, the government intends to liberalise domestic energy prices but not until 2011.

The report notes that the changes for the better have come at a cost, and have been followed by an increasing desire of the current bureaucracy to stay in power with a strong belief that the changes must span four presidential terms. With regard to Mr. Putin's successor, the report goes on to say that there are other candidates beside Mr. Ivanov and Mr. Medvedev (see article on potential candidates):

“Mr Putin’s favourite style is to make it impossible for any expert to foresee his decision before it is announced,” says Nikolai Petrov of the Moscow Carnegie Centre, adding that a third name could well emerge.

The most frequently mooted third candidate is Dmitry Yakunin, head of Russian Railways. Mr Yakunin is, like the frontrunners, a trusted friend from Mr Putin’s time in St Petersburg. Russian Railways provides an independent powerbase as one of Russia’s most strategically important enterprises.

The issues that will dominate Russia's foreign policy are the ones that have already been introduced to us: Iran, Kosovo, the presence of US ABM systems in Europe, expansion of NATO in Ukraine and Georgia, and most importantly expansion of Russian businesses into Europe. With regard to the reasons behind the resurgent Russian appetite for dominating the global arena, the report notes that:

For the US, Russian concern is only one consideration among many. But for Russia, its relationship with the west is central to its view of itself and of its position in the world.

Many in Russia’s political elite still regret the loss of superpower status that followed the collapse of the Soviet empire. After political and economic dislocation in the 1990s, they think their country deserves renewed respect following its energy-powered recovery during this decade. Like President Putin they want an end to US “unilateralism” and a return to multilateral co-operation with full weight given to Russia’s views. They also want greater recognition of Russia’s role as a global energy power and its dominant political position in the former Soviet Union.

However, with the presidential election looming, Kremlin officials may need to respond to increasing nationalism. Konstantin Kosachev, Mr Margelov’s counterpart in the Duma, parliament’s lower house, said in a recent FT article: “Russian politicians’ room for manoeuvre will be limited. Most Russians are disappointed by what is happening in their region and the explanation most commonly heard is that Russia is too soft. Any politician who is not tough risks losing support.”

As for the Russian business environment, the FT predicts that with the overall oil market approaching saturation, and the overall growth in oil revenues seeing a slowdown, the industry that will see the next boom is the banking industry:

For international banks, Russia’s growing clout is impossible not to notice. M&A activity is fast expanding out of the oil industry and reached a record $71bn last year, with more than $11bn spent by Russian companies on foreign acquisitions, according to Ernst and Young.

A further surge is expected this year as state energy champions gobble up Yukos’ remains and Russia’s Aeroflot joins the hunt for a stake in Italy’s Alitalia. Electricity monopoly Unified Energy Systems is seeking to raise up to $15bn this year by selling stakes in its power generation companies to fund a mammoth upgrade of its clapped-out infrastructure. Bankers expect up to $30bn in Russian IPOs this year.

The past months have seen the return of the remaining Wall Street banks that had fled Russia after the 1998 Ruble crisis. Pending deregulation of the retail banking sector upon Russia's entry into the WTO coupled with the growing wealth of middle-class Russians opens up the vast opportunities for retail banking services in Russia. Yet as always problems remain:

The Central Bank says bad personal loans doubled last year to 2 per cent. But the real number could be higher. Rushing to secure a place in the booming market, some western banks are repeating the mistakes of the 1990s and cutting deals they would not normally do, bankers say. In an attempt to bolster positions, global investment banks are extending bridge loans to state-controlled companies at below market rates, while accepting minimal fees for the honour of organising IPOs. Western banks, including ABN Amro and Barclays, recently extended a $22bn loan to Rosneft at between 0.25 and 0.5 per cent above Libor. “Some of these deals make no economic sense,” says one Moscow banker. “You don’t want companies to have blank cheques for whatever they want to do.” Barclays say that the loans have quick maturity and therefore justify low rates.

But as the ruble steadily appreciates as a result of record capital inflows, the mushrooming debt of state-controlled companies is taking the place of the government debt of the 1990s, say economists, including former prime minister Yegor Gaidar. For some economists the growing debt could lead to a new need for a devaluation. “When the current account falls to zero, Russia is going to face significant new challenges,” Mr Aleksashenko says.

Finally, Russia's prime business, oil & gas development has seen much turmoil in the press recently. Starting with the YUKOS affair and recently continuing with Russian companies attempting to regain a fair share in oil & gas fields controlled by world energy giants such as Shell and BP (see article). In the report Igor Yurgens, of Bank Renaissance Capital notes that:

Some actions by the Russian state have damaged the country’s image – sometimes unnecessarily. The Yukos case was a tragedy which could have been tackled differently. But in the cases of Gazprom’s treatment of Ukraine and Belarus, or Royal Dutch-Shell and the Sakhalin-2 project, sometimes I think there is a cultural gap between Russia and the west. In the substance of most of those conflicts, I would say the Russians were right. But the way things were explained to the outside world was clumsy, and the behaviour sometimes appeared uncivilised. Gazprom is now hiring public relations experts, which shows they understand things need to be rectified.

Despite taking the right steps to secure control over its strategic resources, Russian state-controlled companies Gazprom and Rosneft, face significant operational and financial problems in the future:

The state’s undeniable voracity for new energy assets may still be held back by its own inefficiencies, analysts and bankers say. Debt levels at Rosneft and Gazprom are ballooning.

Most importantly, the Kremlin and state-controlled companies recognise they need foreign technology to develop complicated new provinces like the Arctic. But as with Gazprom’s snap decision last year to develop its vast Arctic Shtokman gas field alone, any foreign participation is likely only on Moscow’s terms. Foreign oil majors such as Norsk Hydro, ConocoPhilips and Total may be invited to take part in Shtokman only as contractors, Gazprom has said.

For the reasons stated above, Mr. Putin's economic adviser Arkadiy Dvorkovich, sees state ownership in the oil & gas industry slowly falling back over the years to come, through new equity issues, and co-operational development of new projects.

The entire report is available online at FT.com and is broken down into 12 parts, which includes an interview with the most likely candidate to succeed Mr. Putin so far, Mr. Ivanov (the interview was already mentioned in the blog in an earlier post)

1 comment:

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