This article is a guest contribution by Mark Mobius, Vice-chairman, Franklin Templeton Investments.
We just had our semi-annual analyst conference in Romania last month, and given our proximity to Russia, the giant in Eastern Europe, that was naturally a topic for discussion. Here, Gennady Zhilyaev, our Russia-based investment analyst, shares some of his personal insights on the country.
By Gennady Zhilyaev, Deputy Director, Templeton Emerging Markets Group
Russia is the world’s biggest exporter of natural gas and the second-biggest exporter of oil.[1] It is also the third-largest exporter of steel and primary aluminum.[2] However, it was one of the hardest-hit countries during the recent global economic crisis, largely due to its huge dependence on commodity prices. Oil prices plummeted and rating agencies lowered their credit ratings on several Russian banks, while the country’s GDP shrunk by 7.9% in 2009 and stock prices plunged significantly from their peak.[3] The government had to recapitalize the banking system and bail out several large state companies, thus putting further pressure on its own finances.
Many companies are still reeling from the aftermath. Some media reports indicated that the number of Russian companies that filed for bankruptcy rose by 15% in 2009, but I believe that correlates with the recent economic downturn, and it follows a global trend.[4] During the thriving years of economic growth, we saw many start-up companies emerge, flourishing in a very favorable environment. However, tested in challenging times, some companies’ business models turned out not to be viable and failed to see them through.
However, I believe the worst is over. We have already seen a sharp recovery for Russia’s GDP growth recently when commodity prices stabilized. Russian oil supply experienced significant growth in 2009 which took most forecasters by surprise. The International Monetary Fund is even more optimistic about Russia’s growth, expecting its economy to grow by 4.3% in 2010, due to rising oil prices and an improving fiscal outlook.[5]
Russia’s avenue for growth is plentiful. A key government priority is to diversify into technology. The Russian government earmarked 170 billion rubles (5.5 billion U.S. dollars) for the establishment of Skolkovo, a high-tech hub outside Moscow and Russia’s answer to Silicon Valley. Several US, EU and Asian technology companies will be taking part in the Skolkovo project, with one American multinational pumping in US$1 billion worth of investment. This project is enjoying strong governmental support, which could create a strong platform, take the budding tech industry to a new level, and bring in fresh state, institutional and private investments in a sector that seems immensely promising.
We have also seen the government take a number of initiatives to attract investors such as abolishing capital gains tax on long-term direct investments. However, significant comfort for foreign investors can only be achieved by reducing state involvement in businesses. Corruption is still prevalent and we believe the government should create clear rules to help protect private businesses. Going forward, we strongly support Russian President Dimity Medvedev’s current initiative to fight corruption at all levels.
While Russia diversifies and integrates with manufacturing and services, it is imperative to bear in mind that with more global industrialization, natural resources demands are increasing dramatically. It is challenging for a country so abundant and reliant on oil and natural gas for revenue to reduce this dependency. For oil and gas companies to weather economic storms and stay ahead of its competitors, they should have a strong exploration base, professional operations and low production costs. For instance, one such company is one of the world’s largest and lowest-cost producers of nickel and palladium as well as a leading producer of platinum and copper. It also produces various by-products such as cobalt, rhodium, silver, gold and many others. Its resource base is well over fifty years ahead, and it enjoys great demand for its products. Such companies that have outstanding business models could garner a lot of credibility for Russian investments.
[1] U.S. Energy Information Administration, Country Analysis Brief, May 2008. [2] U.S. Department of State, Background Notes, Russia, June 2010. [3] IMF, World Economic Outlook Update, July 2010.
Example of stock price fall: MSCI Russia Index down 61.09% for the 12 months to 30 June 2009.
[4] RT, 10 June 2010. http://rt.com/Business/2010-06-10/bankruptcy-economic-recovery-company.html [5] IMF, World Economic Outlook Update, July 2010.Copyright (c) Franklin Templeton Investments
