Kazakhstan: Readying for a milder boom

CIS MACRO OUTLOOK Russia: Let s play leapfrog Still pain in Ukraine Kazakhstan: Readying for a milder boom Sep 213 CONTACTS: Ivan Tchakarov, PhD Chief Economist Russia/CIS T: + 7 (495) 258 777 x74 M: + 7 (915) 232 9481 E: itchakarov@rencap.com The emerging markets investment firm

3 Key Cyclical Messages: Russia will see modest growth upside in 2H13 and 214 Cyclical low reached in 2Q13 at 1.4% YoY GDP growth GDP growth to accelerate from 1.5% YoY in 1H13 to 3.% YoY in 2H13 GDP growth at 2.2% (2.3% consensus ) in 213 and 2.9% (3.% consensus) in 214 Inflation will moderate on lower food prices CPI peaked at 7.4% YoY in May 213 Effects will gradually dissipate later in the year, with eop CPI at 5.8% in 213 (6.6% in 212) New fiscal framework preserves prudency, but enhances structural weaknesses Headline deficits kept at below 1% of GDP by 216 Non-oil deficit to moderate to 7.8% of GDP in 216 from 13.9% in 29 (1.3% in 212) Expenditure to shift from education and health to military The emerging markets investment firm 1

3 Key Structural Messages: Russia to hit the middle income trap (MIT) in 213/214 Gerschenkron s advantages of backwardness fast slipping away Fast-growing economies slow tend top slow down at per-capita PPP-based GDP of $16 Russia to hit against this constraint in Q4 213/Q1214 The economics of the middle income trap has 3 political economy implications MIT type of growth ensures no messy political transformation MIT type of growth may, however, mean prolonged political and economic stasis This could be counteracted by pursuing a borrow-and-spend policy a-la Greece Which model of economic development should Russia pursue? Become like Canada/Australia Become like Norway/Saudi Arabia Become like China Become like Greece Reform The emerging markets investment firm 2

CYCLICAL PICTURE The emerging markets investment firm 3

Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Dec-13 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Dec-13 SOFT PATCH Slowdown across the board Figure 1: Real economy Jul-13 Jun-13 YtD 25-28 21 211 212 Industrial production, % YoY -.7.1. 4.1 8.2 4.7 2.7 Fixed investment, % YoY 2.5-3.7 -.1 15. 6. 6.2 6.6 Retail sales, % YoY 4.3 3.5 3.8 13.7 4.4 7.2 6. Real wages, % YoY 6.6 5.3 5.6 14.2 4.6 4.1 8.2 Real disposable income, % YoY 4.2 2.2 4.3 1.6 4.3.7 3.9 Unemployment, % 5.3 5.4 5.6 6.9 7.2 6.3 5.3 RenCap-NES leading indicator points to mild recovery over next 2 quarters (YoY and QoQ) 12% Actual GDP Our forecast 4% Actual GDP Our forecast 8% 4% 4Q13 2.1% 2% % 1.2%.8% % -4% -8% 1.4% 3Q13-2% -4% -6% -12% -8% The emerging markets investment firm 4

Jan-6 Jun-6 Nov-6 Apr-7 Sep-7 Feb-8 Jul-8 Dec-8 May-9 Oct-9 Mar-1 Aug-1 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 SOFT PATCH 2 1-1 -2 Industrial production is also softening, % YoY Industrial production Extraction Manufacturing Electricity -3 Jan-7 Dec-7 Nov-8 Oct-9 Sep-1 Aug-11 Jul-12 Jun-13 4 3 2 1-1 -2-3 as is investment, % YoY as is consumption, % YoY 2 Real disposable income Real wages Retail sales 16 12 8 4-4 -8-12 Jan-7 Dec-7 Nov-8 Oct-9 Sep-1 Aug-11 Jul-12 Jun-13 despite tight labor market, % YoY 73 Employed people, mn Unemployment (right), % 1 72 9 71 8 7 7 69 68 6 67 5 66 4 Jan-7 Dec-7 Nov-8 Oct-9 Sep-1 Aug-11 Jul-12 Jun-13 The emerging markets investment firm 5

Jan-5 Jun-5 Nov-5 Apr-6 Sep-6 Feb-7 Jul-7 Dec-7 May-8 Oct-8 Mar-9 Aug-9 Jan-1 Jun-1 Nov-1 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Sep-1 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 18 15 12 9 6 3 SOFT PATCH Inflation has topped off, % YoY CPI Core CPI PPI (right) 4 3 2 1-1 24 21 18 15 12 9 6 3 driven by food, % YoY Food Non-food Services -2 The emerging markets investment firm 6

Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Feb-9 Apr-9 Jun-9 Aug-9 Oct-9 Dec-9 Feb-1 Apr-1 Jun-1 Aug-1 Oct-1 Dec-1 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 6 4 2 3, 1, -1, SOFT PATCH Money supply is contained, % YoY Monetary base, % YoY Money supply (M2), % YoY Money multiplier (right) 8 4. -2. Jan-7 Dec-7 Nov-8 Oct-9 Sep-1 Aug-11 Jul-12 Jun-13 Liquidity is still tight, but improving RUBbn Banks current accounts, deposits and OBR holdings with CBR Banks liabilities to CBR Net banking system liquidity -3, Jan-8 Sep-8May-9 Jan-1 Sep-1May-11 Jan-12 Sep-12May-13 3. 2. 1. FX interventions have resumed, $bn 2 15 1 5-5 -1 Rates are elevated, if moderating % MOSPRIME overnight RUONIA Index 7 6 5 4 3 2 The emerging markets investment firm 7

STRUCTURAL PICTURE The emerging markets investment firm 8

US Czech Republic Poland Hungary Russia Turkey Kazakhstan Brazil South Africa China Ukraine India Czech Republic Hungary Poland Russia Kazakhstan Turkey China Brazil Ukraine South Africa India HITTING THE MIDDLE-INCOME TRAP 5, 4, 3, 2, 1, Russia is very close to the middle-income trap threshold... GDP per capita, PPP (constant 25 international $), $ Middle income trap threshold...and we estimate that it will hit it in 213 24 235 23 225 22 215 21 25 2 1995 199 Year when average income reaches around $16, in 25 prices The emerging markets investment firm 9

HITTING THE MIDDLE-INCOME TRAP 5. 4.5 4. 3.5 3. 2.5 GDP growth in the MIT will be modest, % YoY Middle income trap Avoiding the middle income trap Western economies lost steam in first half of 197s, Japan suffered a similar fate in at the same income levels, SK in 1995, Singapore and HK in early 198s, Taiwan in in late 199s US hit MIT in 1963, UK in 1981 CZ in 1997, Hungary in 24, Poland in 28, Russia in 213, KAZ in 216, Turkey in 217, China in 22, Brazil in 224, Ukraine in 229, SA in 235 and India in 24 2. 1.5 1. 212 213 214 215 216 217 218 219 22 221 222 The emerging markets investment firm 1

HITTING THE MIDDLE-INCOME TRAP PPP-based per-capita GDP differs significantly across scenarios, % YoY PPP-based per-capita GDP levels grows much faster if MIT is averted, 25 US dollars Middle income trap Avoiding middle income trap Historical path 1 5-5 -1-15 24 22 2 18 16 14 12 1 8 6 Avoiding middle income trap Middle income trap Historical path The emerging markets investment firm 11

Saudi Arabia 199 Australia 1962 Canada 1965 Norway 1965 USA 1959 Russia Poland 27 Greece 1975 Mexico Turkey Brazil China* SA India BECOME LIKE CANADA AND AUSTRALIA? NOT WITH THIS PRIVATISATION POLICY Per capita in 21, unless otherwise stated, in 25 constant PPP dollars Share of state-owned enterprises (SOEs) among countries' top 1 firms (% of total), 211 data 16, 14, 12, 1 9 8 SOE shares among countries' top ten firms (% of total) 1, 7 8, 6 6, 4, 2, 5 4 3 2 1 The emerging markets investment firm 12

Qatar (-1) Kuwait (-7) Brunei (NF) Eq.Guinea (-5) Norway (1) UAE (-8) Oman (-8) Saudi Arabia (-1) Libya (-7) Azerbaijan (-7) Kazakhstan (-6) Angola (-2) Gabon (-3) Trinidad & Tob. (1) Congo, Rep. (-4) Venezuela (-3) Iraq (3) Russia (4) Algeria (2) Iran (-7) Canada (1) Turkmenistan (-9) Ecuador (5) Nigeria (4) Colombia (7) Chad (-2) Sudan (-2) Mexico (8) Malaysia (6) Yemen (-2) Syria (-7) Argentina (8) Bahrain (-8) Uzbekistan (-9) Egypt, Arab BECOME LIKE NORWAY OR SAUDI? NOT WITH LOW ENERGY PRODUCTION PER CAPITA Oil (lhs) and gas (rhs) production per capita, with Norway, Saudi Arabia, Canada and Russia highlighted (Polity IV scores in brackets) 4 35 3 25 2 15 1 5 Oil production (bpd per capita *1) lhs Gas production (cubic metres per person) - rhs Left-hand scale capped at 4 Right-hand scale capped at 4, 4, 3,5 3, 2,5 2, 1,5 1, 5 The emerging markets investment firm 13

BECOME LIKE CHINA? NOT WITH RUSSIA S LOW SAVINGS Loans, deposits and the net position as % of GDP - China's deposit surplus vs Russia's deficit helps explain interest rate differentials 2 15 1 5 Russia deposits/gdp Russian loans/gdp China deposits/gdp China loans/gdp Russia net position as % of GDP China net position as % of GDP -5 The emerging markets investment firm 14

Singapore Taiwan South Africa Korea Czech R. Poland China Chile Thailand Brazil Hungary Mexico Turkey Russia Peru Indonesia India BECOME LIKE GREECE? NOW WE ARE TALKING! Public debt in 212 as % of GDP (Greece in 198) Retails loans, % GDP, 212 9 8 7 6 5 4 3 2 1 6 5 4 3 2 1 The emerging markets investment firm 15

198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 BECOME LIKE GREECE? NOW WE ARE TALKING! 3,5 3, 2,5 2, 1,5 1, 5 Potential public debt scenarios, GDP and public debt ($bn on lhs, % of GDP rhs) 212 213 214 215 216 217 218 9 8 7 6 5 4 3 2 1 GDP ($bn) - IMF base case Debt/GDP ($bn) - IMF base case Debt/GDP ($bn) - modest increase Debt/GDP ($bn) - aggressive increase Debt/GDP (%) - IMF base case, rhs Debt/GDP (%) - modest increase, rhs Debt/GDP (%) - aggressive increase, rhs 2 18 16 14 12 1 8 6 4 2 Public debt ratios since 198 Brazil, Russia and Greece Greece Russia Brazil The emerging markets investment firm 16

Ease of Doing Business Rank (1 is best, 2 is worst) OR JUST IMPLEMENT REFORMS Ease of doing business ranking (213) vs ranking in Corruption Perceptions Index (212) by Transparency International 2 18 R² =.5971 16 Bhutan 14 12 Brazil Nigeria Kenya Russia 1 China 8 6 4 Turkey Poland Hungary SA Mexico CIS countries Kazakhstan 2 Armenia Georgia 2 4 6 8 1 12 14 16 18 2 Corruption rank (1 is best, 2 is worst) The emerging markets investment firm 17

HOW CORRUPT IS RUSSIA? The emerging markets investment firm 18

HOW (UN)DEMOCRATIC IS RUSSIA? The emerging markets investment firm 19

WHAT DO RUSSIANS WANT? Roots of discontent What causes frustration or anxiety in your life? May 211, % Unreasonably high cost of living 67 Low quality of medical services 53 Widespread corruption among public servants 49 High level of crime 48 Influx of migrants 41 Deplorable state of education system 39 Moral decay of society 39 Weak protection of property 36 Limited career opportunities 35 State of pension system 35 Increasing intolerance in society 27 Absence of an independent judiciary 26 Growth of Russian nationalism, xenophobia 16 Authoritarian regime 15 Restriction Moscow of media City freedom inequality is high, but declining 14 fast Source: The Economist, Levada Centre, Novaya Gazeta Does Russia need democracy?, % of respondents Jun-5 Dec-6 Dec-7 Jun-8 Jun-9 Dec-9 Jun-1 Jul-11 Oct-11 Jul-12 Yes, Russia needs a democracy 66 56 67 62 57 57 6 55 61 63 No, democratic government is not for Russia 21 27 16 2 26 23 24 32 25 24 No answer 13 17 17 18 17 2 16 13 14 13 Source: Levada Center What type of democracy does Russia need?, % of respondents Jun-5 Dec-6 Dec-7 Jun-8 Jun-9 Dec-9 Jun-1 Jul-11 Oct-11 Jul-12 Like in developed countries in Europe and America 24 18 22 2 2 23 23 23 19 27 Like in the Soviet Union 16 13 1 13 18 14 17 16 14 2 A special type, in accordance with Russian national traditions and peculiarities 45 48 47 45 39 43 44 45 49 38 Russia does not need democracy 6 1 7 8 1 7 7 7 7 3 No answer 9 11 14 15 14 13 1 1 11 12 Source: Levada Center The emerging markets investment firm 2

South Africa Russia India Indonesia 195 196 197 198 199 2 21 22 23 24 25 26 27 28 29 21 Brazil Colombia Hungary Turkey Thailand Poland China Mexico Korea South Africa India Indonesia Russia China Turkey Thailand Brazil Colombia Hungary Mexico Poland Korea Russia Poland Brazil Colombia Hungary Korea Thailand Mexico Turkey Indonesia China India South DEMOGRAPHIC REVIVAL? Female life expectancy in line with that of other EMs 1 8 6 4 2 Life expectancy, females, years (21) The difference in male/female life expectancy is largest in Russia 12 1 8 6 4 2 Female and male life expectancy difference, years Male life expectancy is less so Population peaked in 1995 8 7 6 5 4 3 2 1 Life expectancy, males, years (21) 1,2 1, 8 6 4 2 Brazil Russia India China peak in 25 peak in 215 peak in 23 peak in 21 The emerging markets investment firm 21

1989 1991 1993 1995 1997 1999 21 23 25 27 29 211 213 215 217 195 1975 199 1993 1996 1999 22 25 28 211 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar- Mar-1 Mar-2 Mar-3 Mar-4 Mar-5 Mar-6 Mar-7 Mar-8 Mar-9 Mar-1 Mar-11 Mar-12 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 DEMOGRAPHIC REVIVAL? 18 16 14 12 1 8 Births are rising and deaths are falling Number of births per thousand persons, quarterly Number of deaths per thousand persons, quarterly improved economic conditions after the sovereign crisis related to government policies to encourage birth Deaths are correlated with alcohol consumpiton 2 18 16 14 12 1 Number of deaths per thousand persons Liters of pure alchohol per capita (RHS) 12 11 1 9 8 7 6 5 4 Life expectancy has been on the rise Gap btw births and deaths is closing 75 73 71 69 67 65 63 Life Expectancy at Birth Govt target life expectancy by 218, % 27 25 23 21 19 17 15 13 11 9 7 Number of births per thousand persons Number of deaths per thousand persons The emerging markets investment firm 22

Still pain in Ukraine Sep 213 CONTACTS: Ivan Tchakarov, PhD Chief Economist Russia/CIS T: + 7 (495) 258 777 x74 M: + 7 (915) 232 9481 E: itchakarov@rencap.com The emerging markets investment firm

Mar-2 Nov-2 Jul-3 Mar-4 Nov-4 Jul-5 Mar-6 Nov-6 Jul-7 Mar-8 Nov-8 Jul-9 Mar-1 Nov-1 Jul-11 Mar-12 Nov-12 STILL PAIN IN UKRAINE 15 GDP falls for three consecutive quarters 1 Broad balance is still deep in negative territory,12mma, $bn 6 1 GDP, % YoY 5 4 2 5-5 -5-1 C/A -2-4 -6-1 -15-2 -15-2 FDI Broad balance (rhs) -8-1 -12 The emerging markets investment firm 24

Jan-9 Mar-9 May-9 Jul-9 Sep-9 Nov-9 Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 STILL PAIN IN UKRAINE Deposits are still stable, UAHbn FX share of deposit are falling 7 6 5 FX deposits UAH deposits 52 5 48 4 3 2 1 46 44 42 4 38 The emerging markets investment firm 25

Kazakhstan: Readying for a milder boom Sep 213 CONTACTS: Ivan Tchakarov, PhD Chief Economist Russia/CIS T: + 7 (495) 258 777 x74 M: + 7 (915) 232 9481 E: itchakarov@rencap.com The emerging markets investment firm

READYING FOR A MILDER BOOM Until 27, KAZ was booming like the Baltics, the US or periphery Europe, with double- or tripledigit bank lending and property price rises When bust came, KAZ banks defaulted on the bonds that fuelled that boom KAZ being the fastest-growing among MSCI Frontier Markets Total debt levels today are again very low and real estate market is returning to life, so that there is plenty of room for a milder re-run of the boom along with Energy production per capita enough to secure political stability Business friendly reforms have put KAZ into 49 th place globally according to WB Ease of Doing Business 212 rankings KAZ is not an imminent boom story, we think this is a country with good prospects for asset price growth However, rapid growth in credit and asset prices will only follow more success in cleaning up NPLs in the banking system, and when there is growth in deposits to fund further lending The emerging markets investment firm 27

Qatar (-1) Kuwait (-7) Brunei (NF) Eq.Guinea (-5) Norway (1) UAE (-8) Oman (-8) Saudi Arabia (-1) Libya (-7) Azerbaijan (-7) Kazakhstan (-6) Angola (-2) Gabon (-3) Trinidad & Tob. (1) Congo, Rep. (-4) Venezuela (-3) Iraq (3) Russia (4) Algeria (2) Iran (-7) Canada (1) Turkmenistan (-9) Ecuador (5) Nigeria (4) Colombia (7) Chad (-2) Sudan (-2) Mexico (8) Malaysia (6) Yemen (-2) Syria (-7) Argentina (8) Bahrain (-8) Uzbekistan (-9) Egypt, Arab Rep.(-3) READYING FOR A MILDER BOOM Oil (lhs) and gas (rhs) production per capita, with Norway, Saudi Arabia, Canada and Russia highlighted (Polity IV scores in brackets) 4 Oil production (bpd per capita *1) lhs Gas production (cubic metres per person) - rhs 4, 35 3 25 Left-hand scale capped at 4 Right-hand scale capped at 4, 3,5 3, 2,5 2 2, 15 1,5 1 1, 5 5 The emerging markets investment firm 28