2018: Не говори гоп, пока не перепрыгнешь(*) (*) 2018: Don't say hop, until you jumped over

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1 2018: Не говори гоп, пока не перепрыгнешь(*) (*) 2018: Don't say hop, until you jumped over Ludovic Subran, Chief Economist Sergey Zuev, Sector Advisor Moscow, 26 October 2017

2 Agenda 1 Let s grow 2 Russia: Risks and Opportunities for

3 Russia to benefit from accelerating world growth World growth is accelerating in a more synchronized manner. Upward revisions outweigh downward revisions on growth. 6% 5% 4% 3% 2% 1% World GDP growth, q/q annualized Fragile four are Brazil, Russia, Turkey and South Africa Others APAC ex China ex Japan Japan China World aggregate Fragile Four India Europe US 17Q2: +3.7% Global GDP growth forecasts (%) Latest forecast Revision (pps) Latest forecast Revision (pps) World GDP growth United States = Latin America = 2.2 = Brazil United Kingdom = 1.0 = Eurozone members Germany France Italy Spain = Russia Turkey Asia = 4.8 = China = 6.3 = Japan = India = 0% -1% 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1 Middle East = 2.6 = Saudi Arabia = Africa = South Africa = 1.2 = * Weights in global GDP at market price, 2016 NB: The revisions refer to the changes in our forecasts since the last quarter Sources: IHS, Euler Hermes Sources: Bloomberg, Euler Hermes, Allianz Research 3

4 Business confidence Strong upside surprises from the Eurozone, while Emerging Markets acceleration was expected There are good reasons to get bullish on the Eurozone: Sentiment indicators are above longterm average. Europe: Consumer confidence vs. Business confidence* Emerging economies formerly in recession are back to (low) growth; yet Emerging Markets are not accelerating broadly speaking. Emerging Markets: Growth per country group United Kingdom 9% 8% 7% 6% Recessionary economies* Frontier Markets Bulk of EMs Germany 15 Euro zone 10 France Italy Spain Portugal 5 Netherland s Greece Consumer confidence 5% 4% 3% 2% 1% 0% -1% -2% F 18 F * August 2017 value minus the respective average since (*) = Brazil, South Africa, Russia and CIS Sources: Bloomberg, Euler Hermes, Allianz Research Sources: IHS, Euler Hermes, Allianz Research 4

5 Emerging Europe continues to surprise on the upside Growth in the region as a whole to pick up to +3.1% in 2017 (+1.8% in 2016) as EU members accelerate (+3.9% in 2017), Turkey rebounds (+5.2%) and Russia has left recession (+1.5%). Monetary policy in EU member states set to tighten gradually by end GDP growth in 2016 and 2017 (forecast) and short-term country risk as of Q Monetary policy interest rates BB1 C4 A1 B2 D4 B1 B2 C Sources: National sources, IHS, Euler Hermes, Allianz Research Sources: National sources, IHS, Euler Hermes, Allianz Research 5

6 Global trade is back and protectionism contained Dollar depreciation is driving values a bit further up. Volume growth is only back to figures. US protectionist measures against China have increased notably in % Global exports of goods and services Number of protectionist measures taken in the US directly aimed at China Volume Price in local currency Currency impact Value 7.0% 5.7% 30 Remaining of the year 5% 0% 2.8% 3.6% 1.8% 3.7% 2.7% 2.0% 4.2% 3.8% January to August per year -5% -1.9% % -10.3% % Sources: Bloomberg, Euler Hermes, Allianz Research Sources: GTA, Euler Hermes, Allianz Research 6

7 This time around political risks are outside of Europe In the US: Critical deadlines for fiscal issues to return in December. Date December 8, 2017 (No hard deadline, as extraordinary measures will probably be used again) US federal fiscal policy timeline Policy Action needed / pledged Debt ceiling needs to be increased (Alternative option: Further suspension for a period of time) Risk of policy inaction and/or prolonged policy confrontation Failure to raise debt ceiling would be unprecedented and represent a large negative demand shock; missed interest payments would send shock waves across global markets. Rising threat of a military conflict in the Korean peninsula is a source of uncertainty. Japan and Korea stock markets In July, North Korea test fires a long-range missile into the Sea of Japan, which could potentially reach Alaska In August, tensions escalate as North Korea threatens to attach Guam In September, major economies intensify sanctions on North Korea. The latter fire ballistic missile over Japan December 8, 2017 From late September Funding bill must be passed (Alternative option: Another temporary financing via a Continuing Resolution) Debate on and release of a framework for individual/corporate tax cuts/reform Failure to pass a funding bill would result in a partial government shutdown; GDP growth negatively affected as federal employees would be furloughed. If tax reform is not implemented, growth above 2% would be hard to achieve next year Kospi (left) Nikkei (right) Sources: Bloomberg, Euler Hermes, Allianz Research /17 03/17 05/17 07/17 09/17 Sources: IHS, Euler Hermes, Allianz Research

8 What if Russia was back? Net capital outflows have normalised since mid-2015, partly as external debt repayments have moderated. Net capital inflows/outflows by the Russian private sector (USD bn) The strong risk appetite from global investors benefits emerging market debt, more than offsetting the negative impact of sanctions. Russia 5-Year Bond Yield (%) Sources: Central Bank of Russia, Euler Hermes Sources: Bloomberg, Euler Hermes, Allianz Research 8

9 Agenda 1 Let s grow 2 Russia: Risks and Opportunities for

10 Three scenarios for Russia: The new normal? Improving environment (10%) The New Normal (75%) Deteriorating environment (15%) Triggers: Oil price rebounds markedly for sustained period and/or Lifting of sanctions Accelerated recovery: For each USD10 higher on the Brent oil price in 2017, GDP growth will be increased by +0.5pp If sanctions are lifted, GDP growth may be increased by up to +0.3pp in the following 12 months Capital and FX controls: None Sovereign default: Not in Scenario: Average oil price of 52 USD/bbl (Brent) in 2017 and 56 in 2018 Sanctions remain in place in : continued isolation, import substitution, fiscal stimulus for certain sectors (defense) Modest economic recovery: GDP growth: +1.5% in % in 2018 Insolvencies: +8% in % in 2018 Capital and FX controls: Forced RUB buying by companies Controls on specific FDI flows possible (retaliation for sanctions) Sovereign Default Not in : FX reserves are stable and higher than in 1998 Triggers: Very low oil prices for sustained period and/or Serious escalation of sanctions (e.g. SWIFT payment) Delayed recovery: For each USD10 lower on the Brent oil price in 2017, GDP growth will be cut by -0.5pp If sanctions are stepped up markedly, economy may move back into recession Capital and FX controls: Intensified FX and capital controls Sovereign default: Not in : FX reserves are stable and higher than in

11 Economic activity set to continue its path of gradual recovery into 2018 Activity a little softer but becoming more broad-based in Q as industrial production growth slows down while retail sales growth continues to edge up. Both the Manufacturing PMI and Consumer Confidence Index give positive signals going forward. Industrial production growth (y/y) and Manufacturing PMI (quarterly averages) Real retail sales growth (y/y) and consumer confidence index (quarterly averages) Sources: National sources, IHS, Euler Hermes Sources: National sources, IHS, Euler Hermes 11

12 Growth up, inflation down We expect a gradual acceleration on the back of recovering investment and consumption, and political continuity beyond March World Cup effect: Infrastructure investment (RUB 760bn) and tourism revenue should add +0.2pp in 2017 and +0.1pp in RUSSIA forecasts weight GDP 100% Consumer Spending 53% Public Spending 19% Investment 21% Stocks * - 1% Real Exports G&S 29% Real Imports G&S 21% Net exports * 8% Industrial production Real retail sales Current account (% of GDP) Nominal exports of goods (USD bn) Nominal imports of goods (USD bn) RUB per USD (aop) RUB per EUR (aop) Inflation (%, aop) Fiscal balance (% of GDP) Change over the period, unless otherwise indicated. * contribution to GDP growth Impact (average per year) on real GDP Real GDP growth Net contribution of World Cup % 1.9% Around +0.25pp Around +0.1pp Impact (average per year) on real investment Real GDP growth Net contribution of World Cup % 2.7% Around +1.10pp Around +0.40pp Sources: IHS, national sources; IMF, Euler Hermes Sources: National Sources, Euler Hermes 12

13 Uptick in oil prices and rate cuts are good news for the economy The RUB per USD rate should average at 56 in A currency carry trade situation could drive more investors to Russia. USDRUB and benchmark Brent oil price Supported by inflation and interest rates cuts both consumer and corporate credit continue to recover. Inflation, monetary policy and credit growth 8.5% 7.5% 3.0% 2.5% Sources: IHS, Euler Hermes Sources: National sources, IHS, Euler Hermes 13

14 Import substitution has worked: Short-term resilience may cost longer-term productivity issues Russia s trade embargo from Q cut down share of imports in food consumption and produced some winners and losers among the trade partners. Share of imported goods in household consumption Market share gained/lost in Russian Agrifood imports 2016 vs 2014 (% change) 60% Share of imports in non-food consumption Share of imports in food consumption 50% 40% 30% 20% 10% 0% Sources: National sources, Euler Hermes Sources: National sources, IHS, Euler Hermes 14

15 The question is who will finance Russia s return to growth? The gradual moderation of the private sector financial surplus since 2016 reflects the start of improvements in private investment and consumption. Sectoral financial balances, 4 quarters cumulated (By definition, the three balances must net to zero) 25% 20% 15% 10% 5% 0% -5% Foreign sector financial balance Government fiscal balance Private sector financial balance The sharp rise in the private sector financial surplus in reflected both more savings (mainly by corporates and rich individuals, including capital flight) and declining investment. H GDP details support this view: fixed investment up by +4.3% y/y (after -1.8% in 2016) and private consumption up +3.6% y/y (after -4.5% in 2016). -10% -15% -20% -25% Sources: National sources, IHS, Euler Hermes 15

16 Policy mix to be more supportive if needs be Russia continues to accumulate fiscal deficits (import substitution strategy) while FX reserves stabilise thanks to the interruption of the long decline of commodity prices. Depending on the external environment, some policy support may be needed. 25 Russia current account balance and fiscal balance Commodity price level and FX reserves Russia current account balance (USD bn, 2-Y ma, LHS) Russia fiscal balance (RUB bn, 2-Y ma, RHS) Bloomberg commodity price index, LHS FX reserves (USD bn, RHS) If sanctions are lifted, GDP growth may be increased by up to +0.3pp in the following 12 months. In contrast, if sanctions are stepped up markedly, economy may move back into recession. For each USD10 higher/lower on the Brent oil price in 2017, GDP growth will be increased/decreased by 0.5pp. Sources: National sources, Euler Hermes Sources: National sources, IHS, Euler Hermes 16

17 The banking sector troubles might not be over just yet The nonperforming loans are still much higher than the pre-crisis levels and several banks call upon the Central Bank for dollars (USD1.5bn swap in September e.g.). Nonperforming Overdue loans loans (NPLs; and % NPLs of total loans) (percent of total loans) The failed bank troika (Yugra, Otkritie, B&N Bank) created some stress in the banking sector. Perpetual bonds prices of top-10 private Russian banks (by assets) in 2017 Source: IMF Sources: Bloomberg, Euler Hermes 17

18 For the invisible bank (suppliers), the situation is improving slightly Companies get paid on average 11 days later than in 2007 but earlier than the global average (forecast at 64 days in 2017). Average Days Sales Outstanding (DSO) of listed companies (number of days) The first three sectors with the biggest supplier pressure on the payment terms are Electronics, Aeronautics and Household goods. Average (DSO-DPO) by sector (number of days) Global average Sources: Bloomberg, Euler Hermes Sources: Bloomberg, Euler Hermes 18

19 The 4-year uptrend in overall insolvencies is forecast to reverse in 2018 Insolvencies expected up by +8% in 2017, reaching about 11,300 cases, before falling by -5% in 2018 thanks to economic recovery. Business insolvencies (number of cases and annual change in %) Lower value-added sectors (incl. foodstuff, metals) are improving, while services and chemicals, e.g., continue to face rising failures. Business insolvencies by sector (annual change in %) F F Sources: Interfax, Euler Hermes forecasts Sources: Interfax, Euler Hermes 19

20 Exports recovery to continue in 2018, at a more moderate pace: +USD26bn (after +USD60bn in 2017) Exports to the EU and China on the rise. The UK (weaker GBP) and Belarus (low growth) will import only slightly more. Potential 2018 export gains for top 18 trading partners (forecast by EH trade model) Energy accounts for half of the potential 2018 export gains. Chemicals, agrifood and metals will also gain markedly. Potential 2018 export gains by sector (forecast by EH trade model) Sources: IMF, Chelem, Euler Hermes Sources: IMF, Chelem, Euler Hermes 20

21 Exports risks: 3 of Russia s top 5 export partners to see a rise in bankruptcies in 2018 Our Export Insolvency Index (IDEX) for Russia is expected to improve to -3% in 2018 yet many hot spots. Weighted average of insolvency variations for Russia s main export partners (in %) Russia f 2018f IDEX -6% 2% -3% Trade partners Export share Change in insolvencies 1 China 8.9% 9% 19% 8% 2 Germany 8.0% -7% -5% -3% 3 Turkey 4.7% -10% 4% -4% 4 U.S. 4.0% -2% 0% 5% 5 Japan 3.8% -4% 0% 1% 6 Italy 3.8% -9% -11% -6% 7 The Netherlands 3.6% -17% -20% -5% 8 Poland 2.9% 8% 12% 0% 9 South Korea 2.6% -23% -5% 2% 10 France 2.5% -7% -7% -4% 11 Belgium 2.2% -6% 4% -5% 12 Latvia 1.8% -9% -10% 0% 13 United Kingdom 1.6% -1% 5% 6% 14 Finland 1.6% -7% -13% 0% 15 Lithuania 1.2% 37% 21% -15% 16 Sweden 1.1% -6% 0% 1% 17 Czech Republic 1.1% -10% -9% -7% 18 Spain 1.0% -18% -3% 0% 19 Singapore 1.0% -1% 5% 5% 20 Slovakia 1.0% -20% 227% 6% Sources: Chelem, National sources, Euler Hermes Insolvencies in Russia and its main trade partners (weighted) to improve in 2018, while global insolvencies begin to rise. Russia IDEX, Russia Insolvency Index, and Global Insolvency Index Sources: National sources, Euler Hermes 21

22 The sector risk profile of Russia has been improving for one year and half, albeit painfully slowly 5 upgrades in the last 4 quarters, but still no sector at a low level of risk. Evolution of the sector risk levels in Russia Fewer sectors in distressed situation for demand, profitability and liquidity, but still a low numbers of sectors with strong fundamentals. Evolution of sector risk subcomponents in Q (vs. Q3 2016), in number of sectors Automotive manuf. Automotive suppliers Household equipment Textile Construction Transportation Electronics (Q4 16) Retail (Q2 17) Software & IT Services (Q3 17) Computer & Telecom (Q3 17) Agrifood Chemicals Pharmaceuticals Metals (Q3 17) Machinery Transport Equipment Energy Paper Low risk: sound fundamentals; very favorable or fairly good outlook. Medium risk: signs of weaknesses; possible slowdown. High risk: imminent or recognised crisis. Sensitive risk: structural weaknesses; unfavorable or fairly bad outlook. Source: Euler Hermes Source: Euler Hermes 22

23 Chemicals the sector is doing well enough in withstanding price pressures from abroad The main Russian player (PHOSAGRO) might cash in on an upswing in fertilizer prices till next year. PPI of fertilizers* as a whole in Russia Low refining oil and gas prices in Russia help the ethylene price across Central Europe keep up with foreign competition. Petrochemicals in Central Europe F 18F F 18F *Phosphate and Urea fertilizers Sources: Green Markets, Bloomberg, Euler Hermes estimations Sources: Nexant, Bloomberg, Euler Hermes estimations 23

24 Pharmaceuticals the sector has hardly retrieved some of its past high momentum in the global generic market The share of generics in the global drug market is expected to run out of little steam, with a level below 9.5% over The #1 Russian drug maker has still long way to go before it can claw back its 2.4% market share of Evolution of the market share of generic drugs in worldwide pharmaceuticals (in value) Estimation of PHARMSTANDARD s market share in the global generic drug market (in value) F 18F F 18F Sources: EvaluatePharma, Euler Hermes Sources: Bloomberg, EvaluatePharma, Euler Hermes 24

25 Food state support should help growth and limit the risks The Food sector enjoys stable local demand supported by continuing import substitution. Russian Food sector output, imports and exports % +3% F 18F Value added output (real USD bn, LHS) Food sectors imports (volume, mn tonnes, RHS) Food sectors exports (volume, mn tonnes, RHS) Export risk outlook for some of the key destinations for the Russian food sector still remains sensitive. Sector risk 25% Export risk map for some of the key destinations China // Turkey Egypt Japan Saudi Arabia South Korea Finland Germany US Latvia 8% 5% 3% 2% 1% % of total Food exports 0% Sources: Federal state statistics service, Euler Hermes Sources: Chelem, Euler Hermes Insolvencies forecast for the Food sector: -14% in 2017 and -10% in

26 Metal - sector risk grade upgraded in Q on the back of higher prices but 2018 still uncertain Stable outlook for the sector output considering the rebound of metal prices. Russian Metal sector output and global metal prices Most of Russia s top export destinations in Metal sector are hot spots. Export risk map for some of the key destinations % +0.2% F 18F Value added output (USD bn, 2010=100, LHS) Metals and minerals prices* (Index, 2010=100, RHS) *Index includes aluminium, copper, iron ore, lead, nickel, tin, zinc Sources: Federal state statistics service, World Bank, Euler Hermes Sources: Chelem, Euler Hermes Insolvencies forecast for the Metal sector: -15% in 2017 and -5% in

27 Construction the industry will continue to struggle in the short term but planned investments could help The improvement in the construction sector output in 2016 was short-lived as the sector is expected to contract this year. The infrastructure backlog until 2030 is good news for construction and metal sectors. Russian Construction sector output Segment Number of Projects Sum of Planned Financing (USD bn) % +1.4% F 18F Civil engineering (real USD bn) Non residential Building (real USD bn) Residential building (real USD bn) Railway Transport Roads and Bridges Power and Utilities Maritime Transport Air Transport Inland Water Transport 9 5 Total Sources: Federal state statistics service, Euler Hermes Sources: EY, Euler Hermes 27

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