Features : Open Season


Russias attempts to broaden its economic base away from a resource-driven model are proving as profitable as they are successful.


Russia is becoming more authoritative, there is considerable uncertainty over who will be the next president, and sentiment toward the countrys markets was roiled by the recent upsurge in global volatility. But the country remains a growth story, fueled by rising incomes and an accelerating shift away from a resource-driven export model toward one based more on domestic demand for goods and services.

Russias economy is powering ahead, with GDP expected to have swelled by 6.3% in 2006, according to the average of predictions of leading international economic forecasters. Those same pundits see growth at 6% in 2007.

That means that Russia has avoided the key pitfall that tripped up many other resource-driven economies, in which sectors other than resources were crowded out. Anna Yudina, an analyst at Raiffeisen Zentralbank in Moscow, points out that steady growth in household incomes, along with the rapid growth in consumer financing, has bolstered support for private consumption. Over the last couple of years real growth of more than 11% in private consumption has accounted for more than 80% of the growth in GDP and boosted the development of consumer-oriented industries.

Take just one industry: the food sector. Russia has come a long way from the days when shop windows were empty or contained sorry displays of dusty cans. But compared to the West, it still has far to go. The top-five players control just 8% of the market, according to Svetlana Sukhanova, an analyst at UBS in Moscow. That compares to a figure of 35% in the United States and between 60% and 80% in Western Europe. That fragmentation is changing fast, as modern retail formatsotherwise known as supermarketstake over. In 2006 just 28% of food sales were made through supermarkets; by 2010 UBS estimates that percentage will have risen to 45%.

That consolidation will almost certainly not just be a domestic affair. International retail chains have long had a toehold in the fastest-growing markets such as Moscow and St. Petersburg. But the action is getting hotter. Russian hypermarket chain Karusel was reported to be in talks with a US retail giant at the end of February. Karusel has already granted an option to Amsterdam-based food retailer X5, entitling it to buy 100% of its stock. X5, which is Russias largest food retailer based on sales, confirmed in late February that it would exercise that option if the price were right.

Such developments have been reflected in the shift of emphasis in stock buying. During 2006 and the first few months of 2007, companies outside the hydrocarbon sectormetals, utilities, consumer companiessaw much faster growth in their stock prices than oil and gas plays. Spurred by this attention, a large number of companies have offered stock on the Russian markets for the first time, while many of those already listed have turned their attention overseas. Sberbanks late-February $8.8 billion IPO grabbed the most attentionand, like most things connected with the banks, attracted controversybut more typical will be the planned listing on the London stock exchange of miner Eurasia Gold, slated to raise between $130 million and $150 million. Analysts expect up to $30 billion of IPOs and placements on the Russian market in 2007. As Global Finance went to press, markets remained volatile, dimming prospects for a flood of new issues, but observers were suggesting the market fall was a correction rather than a fundamental reversal in sentiment toward emerging markets such as Russia.

Oleg Vyugin, head of the Federal Financial Markets Services, says, The market slump is not yet critical, but the time has come to reconsider the risks. The key Russian Trading System (RTS) market shed 2.7% of its valuation on March 27, which was the worst day of trading.

Growing Markets, Growing Influence

Russias increased clout in world markets has already been reflected in a rebalancing of the key MSCI index in late February. At 10.6% of the global emerging markets index, Russia now commands bigger weightings than either Brazil or China.

One key element of the Russian economic revival story has been the remaking of its financial sector. The countrys banks are on a searing run, churning out record profits as they benefit from the countrys booming economy and restructuring. We are very optimistic about the Russian banking sector, says Kurt Geiger, director of financial institutions at the European Bank for Reconstruction and Development. And while richer Russians increasingly are reaching for their pocketbooks, they are also turning to banks to help them fund their growing spending habits. Lending to individuals surged by 85% in 2005, the last year for which figures are available, and all indications are that growth in car loans and mortgages has accelerated faster since.

The figures suggest there is still a lot of potential growth to go. Domestic loans to the private sector stood at 25.7% of GDP, well under the level of many counties immediately to its west.

Bank profits are rising fast, too. State-owned VTB recorded a 400% increase in year-on-year profits for the first six months of 2006. But even at that level, internal profit generation is not enough to keep pace with demand for loans. VTB, despite a December 2005 $1.5 billion cash injection from the government, is mulling a float on London and Moscow stock exchanges later this year. VTBs case might be uniqueit is the nearest that Russia has to a national champion in the banking industrybut many other banks are urgently contemplating capital injections.

Just a couple of years ago, investors would largely have fought shy of risking their money. Many Russian banks were the private playthings of rich businessmen and conducted banking in a manner barely understood in the West. At the fringes, money laundering was rife. Management was often capricious, and internal systems were weak.

There is still some of that around, of course, and some of the old demons resurface from time to time. In September 2006 those demons reappeared in characteristically grisly fashion when gunmen shot dead Andrey Kozlov, the reformist deputy governor of the Russian central bank. But Kozlovs death has not, as yet, slowed the pace of change in the sector. There is a development of strong institutionalization and good practice, says Geiger. Indeed, in its 2006 transition report the EBRD granted Russia an upgrade to its marks for banking reform and interest rate liberalization. The EBRD cited continued strong growth in private credit, especially to households; rise in foreign ownership in the sector, albeit from a low base; implementation of regulatory reform by the central bank.

The central bank is widely regarded as a committedand reasonably effectiveregulator. It has withdrawn licenses from institutions that dont meet required standards or have question marks over their ownership. From January 2006 overseas investors can now buy shares in Russian banks without the prior approval of the central bank.

Foreign ownership has been a key source of renewal for the banking sector, importing international standards and expertise. But there may well still be some way to go in Russia; in countries such as Croatia, the Czech Republic and Hungary, over 80% of bank assets were in foreign hands by early 2006.

That Russian assets outside the hydrocarbon sector are becoming increasingly attractive to outsiders is all the more compelling a story as it plays against a background of political uncertainty. President Vladimir Putin has made it clear he will not stand for reelection when his term expires in September 2007. He hasdeliberately, say Kremlin-watcherselevated two potential candidates to equal positions in the hierarchy so as to promote competition. Who will eventually win is anyones guess, but one thing is reasonably certain: The opportunities in Russia will keep on growing for a long time to come.

Mark Lehane