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EM Monitor - prospects for Russia's economy

January 2020

Russia's rebound

Nikolay Markov on why Russia's economy is in far better health than many realise.

Grand-Master Putin...

Political developments made my visit to Moscow last week even more timely than originally anticipated. But despite the government’s shock resignation, I remain optimistic about Russia's economic prospects in 2020 and beyond.

The key takeaway is that Vladimir Putin has made clear he will remain head of the Russian state beyond 2024 when, according to the constitution, he is required to  step down as President. Stability at the top is positive, as is the installation of the business friendly Mikhail Mishustin as interim prime minister. He offers the prospect of even stronger economic growth in the medium term.

The National Projects initiative is designed to cement Putin's legacy as Russia's greatest ruler since the era of the Tsars.

Details are not final, but it seems the power of the Presidential office will be reduced in favour of Parliament and the State Council, which Putin is likely to head after he leaves the presidency. Putin also announced a number of measures likely to appeal to the public. He said he’d tackle increasing levels of poverty and corruption, and  announced a number of family-friendly cash incentives: increases in child benefit; free hot lunches for school kids; and 50 per cent increases in grants for large families.

From my discussions with business leaders, the resignation of Prime Minister Dmitri Medvedev, came as a surprise even to insiders. It seems to have resulted from his disagreements with Putin over the planned constitutional reforms. Furthermore,  Mishustin, a technocrat, is arguably a safer pair of hands to deliver Putin's cherished and ambitious National Projects by 2024 (of which more below).

What about the economy?

The Russian equity market should respond positively. 

Russian stocks had a sensational 2019, up over 50 per cent in US dollar terms. For more on why this might yet continue please read the analysis of my equity colleague Julian Zbar below. My view is the equity market should remain upbeat, supported by strong foreign demand, lower interest rates, record high dividend yields, as well as the successful implementation of Putin's pension reforms. 

Russia has economic fundamentals that would be the envy of many of its developed rivals.

As we said in last month's EM Monitor, we expect Russia's growth to accelerate at a faster rate than almost any other emerging market in 2020.

The bear bounces back
Fig.1 - Real GDP growth change: 2020 forecast less 2019 forecast (%Y/Y)
fig 1 Russia should a see a big bounce-back in real GDP growth in  2020 compared to 2019

Source: Pictet Asset Management, CEIC, Refinitv, Bloomberg; November 2019. 

Guided by our leading indicators, we expect real GDP growth of 2.5 per cent, above consensus forecast of 1.7 per cent (source Bloomberg 20.01.2020). This will be driven by better implementation of the ambitious National Projects and a pick-up in private consumption, supported by looser financial conditions and planned increases in social spending. Other positives are increasing trade activity with China – a repercussion of US trade policy – and sustained oil price strength, which remains Russia’s dominant export.

Strong fundamentals

Russia has some economic fundamentals that would be the envy of many of its developed rivals.
Labour market in good health

Fig.2 - Russia unemployment rate

Russia's unemployment has been on a downward trend for a decade

Source: Pictet Asset Management, CEIC, Refinitiv; January 2020

Love fiscally...

Unemployment, for example, remains on a strong downward trend. It is a rarity in running a strong fiscal surplus. It has an enviably low general government debt to GDP ratio of 12 per cent. Inflation appears well under control and trending lower.
Room to spend....

Fig.3 - Russia general government fiscal balance to GDP ratio

fig 3: over the past 2 years Russia has had a fiscal surplus

Source: Pictet Asset Management, CEIC, Refinitiv; January 2020

 And our view is the ruble is still undervalued by 5.3 per cent in trade-weighted terms as of 20.01.2020. 

We think all these factors paint a very positive picture for sovereign debt investors.

National Projects

It is against this benign economic backdrop that President Putin is launching his RUB 25.8 trillion National Projects initiative, which is designed to cement his legacy as Russia’s greatest ruler since the era of the Tsars.

Worth 23 per cent of GDP, the initiative’s aim is to double the economy’s long-term growth potential to 3 per cent and to reduce its reliance on petrochemicals. Some 60 per cent of the funds are allocated to infrastructure, roads and environment, with the rest going into demography, healthcare, digitalisation, housing, exports, education, science, SMEs, culture and productivity.

National Projects
Fig. 4 - Scope of expenses on National Projects
fig 4: the 13 National Projects planned in Russia between 2018 and 2024

Source: Accounts Chamber, MinFin, VTB Capital Research. Courtesy VTB, November 2019

In 2020, significant subsidies are being allocated to exporters, while the government is also targeting 100 per cent Internet access for the population.

We expect spending on the National Projects should be stronger in 2020 than last year thanks to robust oil revenues, which should add an additional 0.5 percentage points of growth this year and around 0.3 per year in the following years.

Meanwhile, the increase in retirement age to 65 years for men and 60 for women, should be enough to reverse the negative demographic trend and to increase the working age population in the long run.

All this taken together with a much stronger than reported residential construction activity (focused on the replacement of prefabricated Soviet era housing stock) would make a 2.5 per cent GDP growth for 2020 quite realistic. 

The sectors most likely to benefit are metals, real estate and banks. The next 12 months should also be a game changer for the retail sector given the expected pick-up in household spending thanks to real income increases, new maternity support, new social benefits and elevated dividend yields.

The risks?

Thanks to the country’s improved public finances , benign inflation, high stock dividend yields and the potential for acceleration in GDP growth, Russia’s equities have evolved into a low beta market. But there remain clear risks, not least the rule of law.

There might be good macroeconomic policy, but there is weaker microeconomic policy (anti-trust, legal system, lagging in terms of technology networks). In our view, this places a limit on private sector-led dynamism.

Putin's ongoing rule carries political risk. But for investors in Russia recent announcements push out the biggest risk into the mid to long term: namely what happens post-2024. For the foreseeable future, Putin's influence on the Russian economy and politics are to remain unchanged.

Moscow

THE VIEW FROM OUR EQUITY TEAM

By Julian Zbar, Product Specialist

The Russian market, as measured by the MSCI Russia Index, returned 53 per cent in 2019 in dollar terms. But despite the rally, we believe the market continues to offer tremendous value. A 12 month forward price-to-earnings ratio of under 7 times  represents a 47 per cent and 60 per cent discount to global emerging and developed markets, respectively*.

Quite remarkably, as the charts below show, the market has actually become cheaper on a dividend yield basis. Russian forward dividend yields for FY2020 and FY2021 have been revised up in the period between December 2018 and December 2019. As at the 31 December 2019, the FY2020 and FY2021 yields are 8.3 per cent and 9.1 per cent respectively.

*As per MSCI Russia, MSCI Emerging Markets, MSCI World. Factset consensus as at 31.12.2019

Reaping the dividends...

Fig. 5a - MSCI Russia forward dividend yield  / Fig. 5b - MSCI Russia forward payout ratio

charts showing forward dividend yield and forward payout ratio for MSCI Russia index

Source: Factset, as at 31.12.2019

Mechanically, over a defined period of time, the dividend yield can only increase if the expected dividend per share increases by a larger quantum than market prices. This has been the case in 2019 as both expected earnings per share and expected pay-out ratios have increased. Forward expectations on dividend pay-out ratios in particular have surged last year. Given the highly cash generative nature of Russian companies today, their very low levels of leverage, the improving distribution policies and, as mentioned above, the stable nature of the economy – we believe these yields are sustainable into the future.