Russia 110204 Basic Political Developments

For the Record

Mobile TeleSystems said Thursday that Bank of New York Mellon transferred an interest payment to holders of bonds issued by its MTS Finance subsidiary. (Bloomberg)

Russia’s international reserves rose $2.7 billion to $484.7 billion as of Jan. 28, the Central Bank said Thursday. (Bloomberg)

Sugar and grain producer Razgulai gained 1.9 percent Thursday, as sugar futures surged to a 30-year high following crop damage in Australia and India. (Bloomberg)

Aeroflot said Thursday that it expects sales to reach $3.7 billion this year, from about $3.5 billion last year, while net income last year exceeded $100 million. (Bloomberg)

Russia Forum Buzz - Consumer & Retail: Rise of the Russian Middle Class

http://www.bne.eu/dispatch_text14149

Troika Dialog - press release

Lev Khasis (X5 Retail Group) - X5 Retail Group is Russia's largest food retail chain (in revenue terms) but has a market share of just 5%, which implies spectacular growth potential. Sector consolidation will continue going forward, implying increasing competition. Accelerating inflation will have a generally negative impact on the economy but should be supportive for food retail chains, which will likely be able to pass on the impact to customers and could see faster LFL sales dynamics. The regions, despite lower disposable income, offer decent opportunities due to lower entry costs and limited competition. Selling prices in Moscow discounter stores are actually lower than in the regions, which explains the higher ROI in regional stores.

Sergey Galitsky (Magnit) - The company reiterated its positive outlook for 2011 and does not foresee a slowdown in revenue growth from the current 40%+ per annum in ruble terms. The next three years will be interesting for the development of the industry, as the environment is becoming more predictable and company-specific factors will determine growth, profitability and ROI. The regulatory environment remains a concern, as federal laws are not always properly adhered to by local authorities, and it can take considerable time to resolve bureaucratic issues. The upside for producers will come from import substitution, as even in food retail, its proportion is high.

Ksenia Ryasova (Finn Flare) - Finn Flare offers pure exposure to development of the Russian middle class, and the retailer's diversified format has allowed it to successfully withstand the challenge of recent years, as the discounter segment outperformed in 2009, while the company is now seeing customers returning to "mass market" stores. A number of Finn Flare's competitors went out of business in 2009, mainly those focused on the upper-middle segment (Tom Tailor, Diesel, Kookai). As a result, real estate has become more available, and Finn Flare opened 73 stores in 2010, bringing its total to 252 by year end. The retailer projects revenue growth above 40% in 2011. Cost inflation is the main concern, as cotton prices have doubled in China, which will start have an impact on selling prices (and potentially demand) in the spring. The pace of consolidation in the industry is very slow, and we should not expect large M&A deals in this space.

Mikhail Kusnirovich (Bosco di Ciliegi) - The company saw LFL sales growth of 30% in euro terms in 2010, which points to underpenetration of the Russian market. The retail sector's role is understated in Russia, with none of the largest retailers among the top 10 Russian brands, while the sector's potential for growth and increased employment is not widely advertised.

Ivan Svitek (Home Credit Bank) - The bank's revenues climbed 30% in 2010, while profitability improved. Home Credit Bank introduced its "0 0 24" loan program (zero deposit, zero interest for 24 months) in July/August, with 30% of consumer electronics purchases in specialized stores being financed with loans extended via the program. The bank sees plenty of pent-up demand in Russia, with consumers revealing changes in consumption patterns, switching from washing machines and refrigerators to education loans. There is also substantial demand for financial services in the regions, while competition with Sberbank remains very low in some areas.

Sergey Petrov (ROLF Group) - The company is a car retailer, with a particular focus on the middle class. ROLF Group was badly hit by the downturn, revenues plummeting more than 50%. However, the recovery is underway, revenue growth hitting 100% y-o-y in January. For now, the company regards 30% of the population as potential customers, while the figure stands at just 3% for luxury brands. In addition, the company thinks there is a shortage of highly qualified labor, which is reinforced by the high degree of automated production processes.

Dmitry Yeremeev (Richemont Russia) - The company's main area is the production of luxury watches (e.g. Cartier and Montblanc). According to Richemont, the typical Russian consumer is quite different from the international one, as he/she is less rational than the European counterpart and not looking for innovative products like the Chinese, for example. Notably, for some brands, sales to Russian clients generate 40% of revenues, while sales in Russia account for 5% of revenues. The company sees opportunities for long-term development via offering a better assortment in Russian stores.

http://www.bne.eu/dispatch_text14149

Troika Dialog
February 4, 2011

> Sergey Riabokobylko started the discussion by noting that last year was a turning point for the real estate market in terms of investment deals. Approximately 80% of deals were completed by Russian investors and only 20% by foreign investors.

> Tomas Dukala added that foreign investors operate in various markets and Russia is only one of them, so they need to look at Russian in comp arison with other markets. Russia looks more attractive than Europe, as it has higher growth and no issues with debt. However, foreign investors are focused on purchasing completed projects, while Russia prefers development deals.

> Igor Levit said that investors took a negative view on Russia overall during the crisis and a very negative view on the property market in particular. Before the crisis, property companies were overvalued due to huge demand for this sector. The crisis' impact was very sharp, apartment sales volumes dropping almost to zero. Developers with the right strategy and moderate debt levels have done relatively well.

> Amiran Mutsoev believes that the focus on retail and entertainment centers saved his company during the crisis, as tenants pay a percentage of turnover on top of the fixed rent. During the crisis, people started spending less on expensive goods, but continued visiting malls for entertainment and shopping. As a result, rental i ncome did not suffer much, and low retail space per capita provides potential for future growth.

> Sergey Demin agreed that retail property performs well, but projects in all other segments also have a right to live, though careful selection is required. There were two criteria for a developer to successfully make it through the crisis - no change in ownership and no loss of key assets.

> Alexander Khaldey remarked that developers are not currently earning such fantastic returns on investments in developments, as was the case before crisis. But high-quality projects in all segments are in demand.

> Brian Patterson has had good experience with the Russian property market so far, and believes that high-quality projects have downside protection. There are three key factors to success: good location, high quality and not growing too fast.

> Sergey Kuznetsov explained that the construction segment's contribution to GDP is very large and important, and that residential housing is the largest part. At present, Russia has a very low housing stock per capita and an additional 2 bln m2 of housing stock is required. However, effective demand is only 10% of this amount and is very price elastic. The main goal is to provide a normal return on construction and affordable prices for finished housing simultaneously. This is currently impossible due to the high cost of infrastructure.

> In general, the panelists believe that the bottom of the crisis has passed, but the recovery will be slow and will take several years.

http://www.bne.eu/dispatch_text14149

Troika Dialog - press release
February 3, 2011

Joseph Stiglitz opened the discussion. He mentioned basic problems that economies based on natural resources usually face. Dutch disease and overvaluation of the national currencies, instability of global prices and the resulting unsustainable dynamics, and poor governance were among these problems. In his view, Russia is facing all of these challenges. Optimal domestic policy should include the development of industries. It should support the market, but the market is unable to substitute the government. More attention should be paid to the development of small and medium-sized businesses, and the government should encourage this process.

Mikhail Pogosyan thinks the aviation industry could become the key for the realization of the country's innovation potential. This industry is seeing very strong competition on the global market, and its effectiveness is very high. Russia is still very competitive on the military aircraft market. United Aircraft Corporation is a good example of cooperation with foreign companies. The company may be the basis for developing small and medium-sized businesses as an important customer of their services.

Odd Per Brekk sees Russia's major problem in the instability of economic development. The sensitivity of economic processes in the country to changes in the oil price is too high. Unfortunately, economic policy over the last 10 years has added to this instability. The Russian government needs to change this policy. In addition, capital flows are also sensitive to oil prices: investors become too optimistic toward Russia if the oil price rises, and too pessimistic if it falls.

Russia needs to tighten economic policy. It is possible to slow inflation and simultaneously maintain a high pace of economic growth. Improving the effectiveness of budget expenditures should be the government's priority. Brekk takes a positive view of increased exchange rate flexibility and believes that economic growth of 5% is achievable in Russia.

Andrey Belousov believes that Russia's economic growth was previously based on three factors: increasing exports in real terms, expanding household consumption (due largely to high oil prices), and booming credit. These factors no longer drive the economy. Labor productivity improvement has become a major factor behind growth.

Russia should return to 6-7% growth to solve social problems. Belousov sees potential in the development of machinery exports, growing investments and improving labor productivity due to imported technology. This is possible, as the savings ratio in Russia (27% of GDP) is among the highest in the world. But the government should create a comfortable business environment.

Belousov does not believe that it is possible to reduce budget expenditures. He thinks that Skolkovo may be the basis for creating infrastructure to develop exports of intellectual services.

Zeljko Bogetic believes that the recovery in foreign trade and the restocking process were the major drivers for post-crisis growth in Russia. Consumption growth was sluggish. As a result, the country's economic recovery was not sustainable. The country should switch its focus to expanding domestic demand and investments. Russia should develop infrastructure and small businesses. He also sees room to improve the effectiveness of budget expenditures.

Kirill Androsov thinks Russia's major weakness is its poor efficiency. But improving effectiveness will stimulate economic growth in the country.

Evgeny Gavrilenkov does not believe that Russia has limitations for economic growth. The foreign debt/GDP ratio is extremely low. The demographic situation is not perfect, but not tragic, and increasing labor productivity and immigration will easily compensate for the expected decline in the working-age population. Budgetary policy remains the Achilles heel. The acceleration of inflation at the beginning of the year shows that the economy does not need the injection of budget expenditures that is typical for December.