Russia Economic Outlook

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1 WELCOME Russia Economic Outlook Growth in Transition Chris Weafer Senior Partner, Macro-Advisory Ltd

2 Growth in transition The economy recorded very rapid growth, averaging gabove 7.5% annually from 2000 to The volume of GDP rose from $200 bln in 2000 to over $2.1 trillion this year. The biggest driver of that rapid growth has been domestic consumption The base-effect has now ended and consumption patterns are changing. Domestic consumption, while still growing at above global average rates, can no longer sustain high GDP growth. The boom is over but above average growth can be achieved with the right policy response The required higher growth model now needs; higher spending in infrastructure greater diversification across the economy regional investment greater support for entrepreneurial/sme activity a shrinking state foot-print across the economy Russia has the advantage of one of the best sovereign risks and strongest balance sheets amongst emerging economies. Total sovereign debt is less than 10% of GDP, the current a/c is in surplus and the budget is almost balanced. The political will support for the reforms now needed to transit to a higher growth model is starting to emerge.

3 2013 slowdown a blip or a trend? Economic growth of circa 2% is expected* this year. That is half what had been expected at the start of the year and compares with growth of 3.4% in 2012 and 4.3% in Investment spending has fallen sharply (-1.6% YoY in September) and retail sales are growing at a much more modest pace of 3% compared to over double that at the same point in rd Qtr growth was near zero, the current account surplus (+$1.1 bln) was the lowest since Q3 98 and capital outflow totalled $12.9 bln for the quarter. There should be a pick-up p in the current quarter due to the base effect of a weak Q4 in The questions are now being asked about 2014 the IMF expects growth of 3% next year but only if the government achieves the right balance between stability, stimulus and reforms. The government had talked about the need for lower interest rates and stimulus spending in the spring. That has now been shelved due mainly to continuing global uncertainties with a review likely after the Sochi Olympics in the spring. The Central Bank s priority is to maintain relative ruble stability and target lower inflation. Both have been successfully achieved so far. Annual inflation is now at 6% (6.6% 6% at end 2012) and is on course to reach 5.5%, or lower, at end * I.M.F. expects growth at only 1.5% this year

4 Very strong balance sheet Russia has the world s fourth largest financial reserves Total sovereign debt is just under 10% of GDP total foreign sovereign foreign debt is at 3.5%. Total foreign private debt is at 32% of GDP. The federal budget was in surplus in 2011, balanced in 2012 and is set for a small (-0.2% of GDP) deficit this year. The government has adopted the so-called fiscal rule which caps the amount of oil revenue which may be spent by the budget, with any surplus going to savings. The plan is to cut the non-energy budget deficit from 11% (of GDP) to 5% by end of this decade Budget assumes an average oil price of $93 p/bbl (Urals) for 2014 and $95 p/bbl in 15/ 16. A small annual budget deficit (e.g. 0.5% in 14) is planned at those levels. Budget will balance at an average of $108 p/bbl in 14; at $115 p/bbl in 15 and $109 p/bbl in 16. Russia s Sovereign Wealth Fund is divided into a budget rainy day Reserve Fund and a Wellbeing Fund. Both hold just under $100 bln each. The Wellbeing Fund is being made available to help part fund major infrastructure projects planned ahead of the 2018 FIFA World Cup.

5 One of the few with a triple surplus Source: State Statistics Service, Sberbank CIB research

6 Consumption has been the main driver Growth was initially driven by the low base-effect, then from the rapid growth in oil & gas wealth and finally as a result of surging consumer spending

7 No longer a commodities country Consumption and services expansion have been much more important drivers of overall growth since 2004 A conservative budget policy has cut the direct role of hydrocarbon revenues as a growth driver 150% 140% 130% 120% 110% 100% 90% Raw materials extraction Manufacturing Other GDP at basic prices

8 Spending has slowed but is still strong Consumer sector growth could not be sustained at the high levels recorded over the past twelve years. But expected average annual growth should still be above the European average. Salaries are rising in real terms, household debt is low and the population has an appetite for a higher standard of lifestyle. Russia has the largest consumer base in Europe with a total population of almost 143 million and 55 million households. Plans for the Customs Union may raise the populating base to 200 million. Russia is the world s fifth biggest consumer market, by spending volume. Since 2000, retail spending has grown at a Compound Annual Growth Rate of 20% and, in 2012, totalled just under $700 bln. More than half of that total was non-food related Based on the OECD definition of Middle Class, 55% of Russian households are in that category compared to 30% in Brazil, 21% in China and 11% in India. Wealthy households are also more numerous with 15% of Russian households boasting annual income above $50,000 compared to 5% in Brazil, 2% in China and 1% in India Russia s s population decline has been halted and is projected to show a modest increase in 2013 Russia s GNI coefficient *(41.7) is better than in Brazil, China or the US (45) but is well below the EU average (30.4) * C.I.A. World Fact Book

9 Plenty of scope to expand Russian Consumer Activity as a % of the European average

10 Investment spending & diversification Accelerating reforms to boost domestic and inward investment is a phrase often voiced by economists and the liberal-reform reform faction in government. Today s stability may become tomorrow s stagnation is another popular phrase. The economy needs to achieve an average annual growth rate of 5% through the rest of this decade if growth, diversification and reduced extractive industries dependency are to be achieved. Currently, the economy is probably only capable of achieving average growth of around 3% but with greater risks to the downside. The key challenges to be addressed include; Boosting inward investment Increasing the active participation of foreign companies via JVs, PPP schemes, competition Reducing the state s direct role in the economy Reversing capital flight Preventing uncompetitive cost growth (e.g. salaries have been growing in real terms for a long period) Easier and cheaper access to capital and loan financing Workforce demographics Some of Russia s regions have been much more successful in achieving these results (e.g. Kazan, Krasnodar, Samara, etc.) than has been the case at a federal level. The planned expansion and evolution of the Customs Union will have a long-term positive impact

11 Meaningful reforms already initiated WTO membership (August 2012) was a big step forward. A business amnesty, aimed at releasing over 100,000 convicted of white-collar crimes or business dispute victims, was signed this spring President Putin has ordered procedural and legislative changes to make it easier, faster and cheaper for businesses to set up and expand. The target is for push Russia ss ranking in the World Bank s Ease of Doing Business Survey up from 112 th (last year) to 20 th by 2018 Customs procedures have been, and continue to be, improved. Some visa procedures, e.g. for US citizens, have been greatly eased. There is a much more visible campaign against corruption state officials now have a much higher standard of disclosure to adhere to Russia has achieved relatively good fiscal and monetary stability Financial i sector and capital market reforms have already had very positive results Major international events, such as in Sochi (2014), the FIFA World Cup (2018) and the Expo in Yekaterinburg (2020), have imposed fixed deadlines for some infrastructure work The Customs Union (Russia, Kazakhstan and Belarus) is set to expand to a Eurasians Union in 2015

12 Dramatic change to demographics The net population change is expected to be balanced this year. The birth rate has increased, people are living longer and general health is improving Immigration has been an important factor in recent years Workforce demographics is still a problem which will require retirement/pensions changes plus changes to net immigration policies. Previous fears of a shrinking Russia are no longer valid Source; Federal Statistics Service

13 More progress is needed Russia s ranking in the Transparency Corruption Survey is too low The perception of Russia as a difficult and dangerous place to do business, and in which to invest, is too high The cost of doing business in Russia (e.g. rising wage and social taxes) is rising too fast in real terms Russia has a high % of people with university degrees but university quality is ranked far too low on a world scale. Too many graduates want to work for the government or for state enterprises. Too many entrepreneurs are still emigrating Interest rates are too high and access to domestic capital difficult The percentage of SMEs in the economy is too small planned incentives are slow in coming The privatization programme continues to move far too slowly it was scaled back again in May Workforce demographics are set to become a major issue especially outside of the biggest cities. OECD membership timetable is still too vague.

14 Investment priorities and opportunities Infrastructure spending is a key priority and will get a boost from the 2018 World Cup preparations...but PPP legislation needs to be improved Agriculture and food manufacturing have been identified as strategic priorities with the aim of greatly cutting food imports. Agriculture machinery is already a big and growing market. Similarly with Pharmaceuticals Leisure, Healthcare and Education sectors Transport and logistics Oil field services will get a boost from the expected increase in Brownfield capex JV s with the state enterprises in the so-called strategic sectors, e.g. shipbuilding. Regional employment projects are also a state priority and incentives for start-ups or JVs are expected to be more available in the coming years.

15 What s next? There is clearly more momentum for change. It is now much better understood that the higher growth rate required can only come with faster reforms and more effective policy changes. The current stability first priority is understandable given the external uncertainties and the forthcoming Sochi Olympics. We expect a much more vigorous policy debate and clearer plans to stimulate growth to emerge in the spring. There are a number of ticking clocks which can act as catalysts for the reform agenda; Major international events to be hosted in Russia The economy is likely to play a bigger role in the next election cycle The emerging middle class in Russia expects steady lifestyle improvements Russia s existing infrastructure has been starved of investment for far too long The growth of shale (oil and gas) presents a long-term threat to traditional O&G revenues Russia wants to join the OECD Tariff and competition changes as a result of WTO membership start to kick in after 3 years Key date for Russia include; February 2014 Sochi Olympics (Opening ceremony Feb 7 th. Closing ceremony Feb 23 rd ) 2015 Plans to evolve the Customs Union into a larger Eurasian Union. April/May 2016 International Ice Hockey World Championship in Russia December 2016 Duma elections March 2018 Presidential election Summer 2018 FIFA World Cup in Russia. 11 host cities. Summer 2020 World Expo in Yekaterinburg (May October)

16 Macro history & forecasts* * The I.M.F. cut its forecast for Russia growth in 2013 to +1.5% but held its 2014 forecast at +3% Source: StateStatisticsService Statistics Service, Sberbank CIB research

17 Who we are Macro-Advisory is a new company which aims to provide a bespoke consulting service for investors and companies who want to better understand the opportunities and risks in making investments and conducting business in Russia and Central Asia The two senior partners have a combined 35 years of Russia & CIS experience

October Sanctions Guide. The Impact of Sanctions on Russia. Chris Weafer Senior Partner, Macro-Advisory Ltd

October Sanctions Guide. The Impact of Sanctions on Russia. Chris Weafer Senior Partner, Macro-Advisory Ltd October 2017 Sanctions Guide The Impact of Sanctions on Russia Chris Weafer Senior Partner, Macro-Advisory Ltd cjw@macro-advisory.com 1 Summary Sanctions have created a great deal of uncertainty in the