Why Russia Is ‘China In Reverse’

In the fun-house mirror of the global economy, Russia is the mirror opposite of China.

China consumers are the driving force behind the market. Russian consumers are hobbling along and maybe stuck in a middle income trap. China needs less investment. Russia needs more.

China used to be all about infrastructure investment: new roads, new bridges and airports. Now it’s Russia’s turn.

The kind of investment Russia needs doesn’t lend itself to a lot of sex appeal. We’re not talking about oil and gas giant Rosneft investing billions in Arctic drilling.  This is about roads and very big bridges.

“Russia is a reverse-China,” Alexei Yakovitsky, global CEO of VTB Capital said. ”China is a consumer theme for investors today,” he said, noting that not too long ago, investment was China’s theme. Now, investment is Russia’s theme. Years ago, it was the consumer. “Russian consumers still have room for growth, but that is no longer the story here. The story in Russia today is investment,” he said last Tuesday on the sidelines of VTB’s Russia Calling!, an annual investor’s forum in Moscow.

Consumers were the main growth driver in Russia for more than a decade. That was mostly because Russian consumption was bouncing off such a low base from the 1998 financial crisis, known as the “Russian flu”.  An overvalued currency, a war in Chechnya, and a bloated government led Boris Yeltsin to default on a $5.5 billion loan.  Russia was nothing but one big junk bond. Yields on its debt was stratospheric. Cosmonaut Yuri Gagarin could have seen them from space at 47%.

Consumers were the story again when Russia used its oil wealth to pump around $60 billion into banks and the stock market. Financial transfers in the form of higher wages and big pension fund gains thanks to government stimulus kept Russia’s economy whistling while everybody worked.

The whistling has stopped. There’s barely a  hum. The economy has grown just 1.5% so far this year, where a normal growth rate is closer to 3%.  The consumer story is stable, but waning.  While China shops and spends less on infrastructure, Russia retail sales are benign to flat. For the last three years, retail sales growth month over month averages about 0.6%, according to the country’s Federal Statistics Service. It reached a record low of -26.3% in January of this year.  China retail sales averaged about 1.18% month over month from 2010 to 2013, according to China’s National Bureau of Statistics. Its worst month in that period was a gain of 0.19%, recorded in January 2012.

The problem with Russia’s China reversal is this: take it away Alexey Ulyukaev, Russian Minister of Economic Development.

“Investment in Russia is shrinking,” Ulyukaev told a hush-hush room of hundreds of investors recently. “There are a lot of wealthy people in Russia, but they don’t invest as much as we’d like. We have to take measures to keep this money in this country.”

Ulyukaev is one of those Russians that match perfectly the American idea of the Russian archetype. The man’s a bear with short, gray-spiked hair. In the three years I’ve been coming to Russia Calling!, I’ve never once seen him smile.

Perhaps he has a reason. Foreign direct investment into Russia, the measure of foreign capital coming from corporates and portfolio flow, has gone from $74.7 billion in 2008 to $51.4 billion in 2012. That’s down from $55 billion in 2011, according to the International Monetary Fund.

“There is a very low participation of private Russian capital in our economy,” said Alexei Moiseev, the Deputy Finance Minister. “It resembles an old Soviet left over. I know a lot of people in the government would disagree with me. The truth is, we are aware of this problem and are doing something about it.”

Building the new Moscow to St. Petersburg M-11 highway. One of a handful of big infrastructure projects Russia is undertaking.

Creating investing rules that are in accordance with that of the Organization of Economic Cooperation and Development is a starting point.

Let’s not forget, Russian capitalism is only 21 years old. If you start with the dissolution of the Soviet Union in January 1992 (officially was Dec. 26, 1991) as the start of Western-style economic practices being incorporated in the Russian economy, then you’ve got a capitalist system that turns 22 the day after Christmas 2013.

To use a drinking metaphor, by U.S. standards Russia is one year in to being legally able to handle its liquor. Bottom’s up.


Top Down

The macro view of Russia is a mixed bag. The investment view is a bag full of holes.

“We’re now trapped in an intermediate level of development,” said Moiseev. “This is not a cyclical slowdown in Russia. This is a structural one and it concerns us all.”

Like China, it’s mostly the government investing billions of dollars in roads and bridges. One of the biggest investments, however, is a private public partnership between government owned Rosavtodor and the North West Concession Company, a Russian and French highway builder. They’re building the massive 403 mile (650 km) Moscow to St. Petersburg M11 toll road.

Last year, the Russian government spent around $1 billion on the world’s longest suspension bridge in Vladivostok, the peninsula that juts into the Sea of Japan. The Russky Island Bridge was built to help Russia tend to a number of big events happening in the east, like the Asia-Pacific Community Summit.

Russia has the Sochi Olympics to tend to this coming winter.

The Sochi airport terminal, which is expected to cater to 3,800 passengers an hour during the Olympics, is undergoing renovations to the tune of around $200 million. Basel Aero is doing the work, a company owned by metals tycoon and FORBES’ No. 131: Oleg Deripaska.

Russia launched a new investment strategy for civil aviation this year. The investment volume is estimated at $9 billion, with over 100 sites currently undergoing reconstruction and modernization with help from both the private and public sector.

So this is what China looks like in Russia. A lot of cement. A lot of steel. A lot of truck rentals.

Ulyukaev is hopeful. “We expect and forecast a serious increase in investment and hope it reaches 4% in 2014, 5.5% in 2015 and over 6% in 2016,” he said. Wait…did he just smile?

If Russia can sell itself better — never an easy task for an amateur at 22 years of age — then more institutional money will flow. New policies will liberate big investors like pension funds to invest long term. It’s not going to happen over night, but neither did China’s move from $2 a day laborers pouring cement in Shanghai, to $50,000 a year Shanghai one-percenters shopping at Huang Shu Chi in Xintiandi.

The United Arab Emirates is taking note. The Abu Dhabi Department of Finance, the capital city’s long term investment vehicle, said last month it will invest $5 billion in Russian infrastructure projects over the next seven years.


Russia Today

“Our problem is that we are not efficient,” said president Vladimir Putin to the usual standing-room-only crowd at Russia Calling. “Our economy is as big as Germany’s. Our per capita income is as high as some European countries. But the good news stops there,” he said.

The Putin smirk. Call it his Mona Lisa smile. The Russian president said the economy was “inefficient” during VTB Capital’s Russia Calling! conference in Moscow on Oct. 2.

Not really.

This is not the 1990s. If Putin has anything to say about it, this economy will never ever resemble Russia’s tween years.

If VTB’s China comparison is correct, then investors should expect Russia to remain slow and steady. They’ve already come to expect the government to be extra cautious.

Despite a weak investment climate, the ruble remains strong. Their current account has a surplus. The federal budget deficit is almost zero, and will be minimum for the next three years, promised Finance Minister Anton Siluanov.  The country’s debt to GDP ratio is under 11%, around seven times less that of the United States. “We’ve based our budget on just 1% GDP growth. We’re not exaggerating our opportunities here,” said Siluanov.

Private capital outflows re-accelerated in the third quarter to $12.9 billion from $7.9 billion in the same period last  year. That lifted the 12 month rolling total to $56.5 billion from $51.5 billion in the second quarter.

The reverse China theme better settle in quick if Russia is to ever shake off its last place status among the big four emerging markets.

When Mexico become confident in itself, the rich began to invest, pointed out Nathalie Wallace, a portfolio manager at Boston-based quant fund Batterymarch. “I think you’ll see the same in Russia.”


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