Chris Weafer: cjw@macro-advisory.com
Russia Macro-Politics: Friends Reunited
“History is that certainty produced at a point where the
imperfections of memory meet the inadequacies of
documentation”
Patrick Lagrange (French historian)
Economic weakness is the dominant concern for Russia. The headlines from Russia are
dominated by two issues currently; the rapprochement between Russia and Ukraine and the
still weakening domestic economy. In terms of possible market impact the former is potentially
very significant for the longer term, especially if Ukraine were to move further and start talks to
join the customs union. The latter is of much more immediate concern and unless reversed the
weak macro data will soon lead to a scaling back of domestic earnings growth assumptions.
That would hurt sentiment towards many of the domestic economy equity market themes and
add more pressure on the ruble.
The Iranian deal may impact oil later next year. The international headlines are today
dominated with the deal between Iran and the UN to curtail the country’s nuclear programme.
That news knocked almost $2.5 p/bbl off the price of Brent in early Monday trading and adds to
concern that further, more significant, price weakness may deteriorate Russia’s budget
execution in 2014 and add further downward pressure on the ruble.
Friends reunited. It is case of “friends reunited” for Kiev and Moscow, for former Finance
Minister Alexey Kudrin (he has been brought back into a formal Kremlin advisory role – see
below) and now for Tehran and the UN. The investment implications for all three have been
factored into our 2014 macro forecast assumptions and are reviewed in more detail below.
Gazprom may have to suffer a new gas deal with Ukraine. The big question arising from
the possible/probable strengthening of Russia-Ukraine relations is what does this mean for
Gazprom and for the South Stream pipeline? Gazprom’s share price traded down, against a
rising market, his morning as investors fear than a new deal on the gas price may hurt
Gazprom’s bottom line. Gazprom – and the other major gas producer Novatek - is one of the
top stock picks in Russia for 2014.
Note: for a more detailed review of sector themes, stocks, currency and debt market trends
expected in 2014 see our separate report (clients only at this stage).
But cash flow & dividend may benefit is South Stream is changed. The major reason for
the South Stream pipe is to bypass Ukraine as a transit route for Russian gas to the EU. But if
Kiev-Moscow relations actually do improve then a deal over the ownership and upgrade of the
existing trans–Ukraine pipeline is also possible. The question is “has it come too late”? This
weekend the project to launch the Serbian section of South Stream was officially launched. It is
not hard to imagine that the timing of that ceremony was planned to send a very clear signal to
Ukraine. But the most challenging and expensive part of the project is the section across the
Black Sea. Utilizing an upgraded Ukraine pipe might make that unnecessary. Russia’s Finance
Ministry would certainly welcome that as it would cut Gazprom’s capital investment programme
and free up more cash to pay the demanded higher dividend.
Ukraine expected to try and stay in the middle ground. The next presidential election in
Ukraine is set for February 2015. It is most unlikely that President Yanukovych will agree to
talks about the Customs Union ahead of that election as it would prove too divisive. The
position ahead of that is likely to be that Ukraine’s best position is to try and remain between
the EU and Russia.
Chris Weafer: cjw@macro-advisory.com
Equities follow the asset class. Russia’s equity markets continue to move in line with the
trend in the emerging market asset class. Through the first three weeks of November the RTS
and RDXUSD Indices have each lost 2.4% which is exactly the same as the loss for the MSCI
EM Index. The ruble based MICEX Index fared better, losing only 0.4%, with the 1.9% loss in
the value of the ruble basket accounting for most of the difference. Developed market indices
performed better as investors stick with that theme for now. The S&P 500 is up 2.7% month to
date as investor flows remain strong.
Weaker oil has hit the ruble today. The knee-jerk weakness in the price of Brent this
morning, following the Iranian nuclear news, has put immediate downward pressure on the
ruble while the equity market is trading better with the trend in global markets.
Investment spending fell further in October. On the macro front the October report
produced a mixed bag of results, albeit generally still weaker than had been hoped for. The
Economy Ministry estimates GDP growth at 1.4% for the past ten months and is hoping the full
year result will be between 1.5% and 1.6%. Investment remains weak but the agriculture and
consumer sectors fared better (see details in the Macro Update section below).
Duma Doves attack CBR Hawk. Duma members are urging the Central Bank to focus more
on core inflation (currently about 4.5% YoY) instead of headline inflation (now at 6.3% YoY)
and to use that as the excuse to start cutting interest rates at the next meeting in early
December. The market expects rate cuts to start only in the spring.
Preparing for the Dec 12th Federal Assembly address. The politics headlines were
dominated with the first ever meeting between the president and the leaders of the main
opposition political parties outside of the current Duma. The Kremlin press office said that the
main topic was the content of the president’s address to the Federal Assembly on December
12th. This is also the date of the 20th anniversary of the adoption of the Russian constitution.
The opposition leaders presented a list of people still in jail from the May 2012 protests and
asked for them to be included in the list of those expected to be amnestied in December (to
mark the constitution’s anniversary).
Q&A session set for December 19th. The President will hold his annual press conference on
December 19th. Usually this event lasts for over four hours and covers more issues relevant to
investors.
Seasonal dip in support for leaders. The latest polling data from Levada Center showed a
dip in support for the president and prime minister. But that is almost a normal seasonal blip
seen in previous years. Separate studies over the past decade show that people in Russia are
generally less optimistic about everything in October – November as summer fades and a long
winter looms. Usually the better holiday season mood restores some optimism in December.
(See the Politics Update section for the tables). That said, the headlines about the weak
economy and concern over prospects for future growth will also undoubtedly have played a
part.
There continues to be a lot of speculation about the prime minister’s position, especially
after President Putin said that people in government should not openly criticise policy. If they
disagree with policy they should resign. He cited the example of former Finance Minister
Kudrin, who resigned in 2011 over a policy disagreement. The speculation is that the comment
is aimed directly at the PM after he criticised the draft bill which would allow law enforcement
agencies the right to open criminal investigations into tax crimes. Still, such public
disagreements are not so uncommon (e.g. President Medvedev criticized Prime Minister Putin
several times during his term in office) and it is not expected that there will be any change in
government at least until after the Sochi games. Not 100% certain of course but most unlikely.
Chris Weafer: cjw@macro-advisory.com
Proposed restriction aimed at foreign ownership of real-estate. Another draft law which
Pas raised concerns amongst investors and foreign businesses in Russia would, if passed,
prevent foreigners from owning or renting land or any forms of real-estate in the country
without prior official permission. According to Kommersant any non-Russian citizen or a
company under foreign ownership would have to receive official permission before buying
Russian real estate or land. Foreigners are currently entitled to buy land on similar terms to
Russians. They are forbidden, however, from owning agricultural land, and land in border
zones, sea ports, infrastructure hubs and military sites.
2014 Forecast updates;
We have set 2014 real GDP growth forecast at 1.8%. The number could be better if the
government makes an appropriate policy response – on both the monetary and fiscal side – in
the spring. The first quarter is expected to be weak, especially on a yearly comparison with a
strong first quarter from this year, and that should add to the intensity of the policy debate
expected just after the Sochi games end.
Expect an average Urals price of $95 p/bbl. The Iranian deal, assuming it holds (see below),
will start to affect medium to long term price assumptions in the 2 nd half of next year. For the
first half the continuing outages in Libya, Iraq, etc, the modest global recovery and the still
weak US dollar, should be enough keep the price around $10 p/bbl. The risk of the $90 p/bbl
level being tested in the 2nd half is high.
Budget deficit of 1% of GDP. Based on the oil price assumption and budget spending plans,
plus the generally weak 1st half macro performance. The official budget assumption is that, at
an average $93 p/bbl the budget will run a deficit equal to 0.5% of GDP. My assumption is that
other revenue assumptions in the budget are overly optimistic.
Year-end (2014) ruble/dollar and ruble/euro. I expect the ruble to weaken further in 2014,
partly as a result of the expected monetary and fiscal stimulus measures likely to be taken in
the spring and also as a reaction to the expected 2 nd half oil price weakness. The end 2014
Rub/$ rate is 36.0 and the Rub/Eur rate is 46.0. That implies a Dollar-Euro rate of $1.28 on
December 31st 2014. The greater risk is that the dollar rally will be stronger coming into late
2014 (as tapering accelerates) and a year-end rate of $1.22 would imply a ruble-euro rate of
44.0 (assuming R/$36).
Friends reunited
Over the past few days three events have taken place which will have medium to long term
implications for the Russia investment case.
Tehran and the UN. The implications from this deal are negative for Russia because, if the
deal holds and is expanded, Iran could add at least 1 million barrels per day to the export
market. That extra volume may come as US production continues to rise and, probably, as the
US approves the Keystone pipeline from Canada. A lower oil price would pressure the budget
and the ruble.
Brent/Urals are more at risk in late 2014 or in 2015. But, my view is that the price of
Brent/Urals is unlikely to come under meaningful pressure until the latter half of next year or
even into 2015 rather than earlier.

Iranian production will not start to rebuild too quickly as the deal is only for a six
month initial period and hardliners in both the US Senate and in Tehran have voiced
opposition.
Chris Weafer: cjw@macro-advisory.com




Libyan output has fallen by more than 1 million barrels this year due to internal
conflicts and Iraqi production is also starting to be affected by high levels of violence.
It is unlikely that either country will soon resolve these internal issues. In fact both are
more at risk of an escalation which would further cut export volumes.
Violence in northern Nigeria is spreading. So far it has no impact on oil output but the
government is warning that the attacks may spread to other parts of the country
The US dollar is a big factor for where oil trades. Historically there has been a close
correlation between the price of oil and the trade value of the dollar. A dollar rally in
late 2014 or 2015 would put pressure on the oil price if the historic correlation is
repeated.
Global demand for oil is expected to rise by 1.1 million barrels per day in 2015
according to I.E.A. forecasts. That will be exactly matched with the expected increase
in North America, most of which will be in the US.
Alexey Kudrin and the Kremlin. Although ex Finance Minister Kudrin has always remained
on very good terms with President Putin he has now formally been brought into the Kremlin’s
economic advisory team. The inaugural meeting of the president’s economic council took place
on Friday. According to reports the meeting lasted about four hours but did not produce any
specific recommendations and was predominantly academic in nature. But the fact that the
president has set up such an advisory council and co-opted Kudrin (plus Sberbank CEO Gref,
the CBR Chairman, Economy and Finance Ministers, etc.) is encouraging. Especially if it
means a more serious effort to deal with the weak economy and to resolve some policy
inconsistencies.
No seat for the PM. Local media was quick to point out that the prime minister has not been
asked to join the advisory council.
Moscow and Kiev. A great deal has been written about this issue so there is no need to
repeat the known facts while a discussion about the strategic relationship is outside the scope
of this note. My main point here is that the impact on Russia and Ukraine’s economic
prospects and therefore on the investment markets, will be known only after we get more detail
about the level of integration planned. Ukraine membership of the Customs Union would
provide a huge boost to that group given the size of Ukraine’s population and economic
potential. The next presidential election in Ukraine is set for February 2015. It is most unlikely
that President Yanukovych will agree to talks about the Customs Union ahead of that election
as it would prove too divisive. The position ahead of that is likely to be that Ukraine’s best
position is to try and remain between the EU and Russia.
Gazprom may have to suffer a new gas deal with Ukraine. The big question arising from
the possible/probable strengthening of Russia-Ukraine relations is what does this mean for
Gazprom and for the South Stream pipeline? Gazprom’s share price traded down, against a
rising market, his morning as investors fear than a new deal on the gas price may hurt
Gazprom’s bottom line. Gazprom – and the other major gas producer Novatek - is one of the
top stock picks in Russia for 2014. This weekend the project to launch the Serbian section of
South Stream was officially launched. But the most challenging and expensive part of the
project is the section across the Black Sea. Utilizing an upgraded Ukraine pipe might make
that unnecessary. Russia’s Finance Ministry would certainly welcome that as it would cut
Gazprom’s capital investment programme and free up more cash to pay the demanded higher
dividend.
Worth reading
Moskovsky Komsomolets newapaper carried a long interview with former Finance
Minister Alexei Kudrin last week. The title of the piece is “Russian Economy's
Prospects and Oil Dependence'. The interviewer started off with the question
Chris Weafer: cjw@macro-advisory.com
“World oil prices remain high but an economic crisis is perceptible in the air in
Russia. How can such a thing happen?”
If you want a copy of that interview (6 pages) let me know and I will send it.
As mentioned, Alexei Kudrin has just recently been co-opted to the presidium of the
president’s Economic Council. Obviously this reflects the growing concern in the
Kremlin about the weak economy and, hopefully, a signal that a more serious effort
to come up with growth & reform orientated policies in 2014. Kudrin is again been
talked about as one of the possible successors to PM Medvedev if the economy
remains weak and prompts Kremlin intervention. Either way Kudrin will be one of the
most influential members of the president’s economic advisory team.
Book Choice
Title:
Author:
The Capitalist Transformation of State Socialism: Making and
Breaking of State Socialist Society, & What Followed
David Lane (Routledge series)
This book focuses mostly on the transformation in Russia and some East European
countries but also briefly looks at the way China dealt with the transformation issues.
It is partly a history of what happened at the end of the Soviet Union; partly his
opinion of why events unfolded as they did and also his view of what has worked and
what has not. He concludes, quite rightly, that a lot of what has happened over the
past twenty years is still “work in progress” and offers his opinion of the possible
scenarios from here – mainly focusing this part on Russia and China.
Politics update: Normal seasonal dip in President’s rating
Onset of winter reflected in a dip in support for politicians. Levada Center
(polling agency) has published its survey results for November. This shows a drop in
the public approval rating for both President Putin (from 64% to 61%) and Prime
Minister Medvedev (from 51% to 53%). It is quite normal for politician’s approval
ratings to drop at this time of year as other surveys also show people to be more
depressed as winter approaches. November is really the most miserable month in
Russia as temperatures drop along with the sky. It is dark or dull for most of the day.
The December holiday season usually improves the mood. The table below shows
the same seasonal effect last autumn.
Chris Weafer: cjw@macro-advisory.com
Approval Ratings for President and Prime Minister
July '12 Oct '12 Nov '12 Dec '12 Mar '13 May '13 Sept '13 Oct '13
Nov '13
Vladimir Putin
Approve
Disapprove
67%
32%
67%
32%
63%
36%
65%
34%
63%
36%
64%
35%
64%
35%
64%
35%
61%
37%
59%
39%
61%
38%
54%
45%
57%
42%
54%
45%
54%
46%
49%
49%
51%
49%
46%
53%
Dmitri Medvedev
Approve
Disapprove
Source: Levada Center
Shoigu’s position improved. The same effect is observed in the poll which asks
people which person they trust. Only Defense Minister Shoigu recorded an increase
in the trust level) from 17% to 19%) last month. PM Medvedev’s rating dropped from
14% to 11%.
Trusted Politicians
Jan '12
Putin
Medvedev
Shoigu
Zyuganov
Zhirinovsky
Prokhorov
Patriarch Kirill
Matveinko
Lavrov
Sobyanin
Mironov
None of the above
No opinion
President
Prime Minister
Defense Minister
Leader Communist Party
Leader LDPR
Businessman-Independent politician
Head of Church
Leader of the Federation Council
Foreign Minister
Moscow Mayor
Founder member of A Just Russia
Mar '12
Sept '12 Nov '12
41%
28%
11%
12%
12%
4%
7%
5%
44%
28%
9%
14%
9%
8%
5%
4%
36%
23%
10%
8%
8%
5%
6%
4%
34%
20%
16%
10%
8%
5%
4%
4%
8%
17%
5%
6%
15%
4%
4%
22%
10%
4%
24%
6%
Dec '12
34%
19%
14%
8%
8%
4%
3%
4%
4%
5%
3%
20%
9%
Mar '13
Sept '13 Oct '13
35%
17%
18%
9%
9%
6%
3%
4%
5%
2%
4%
20%
6%
36%
15%
20%
11%
8%
5%
5%
3%
6%
5%
3%
19%
7%
Nov '13
33%
14%
17%
10%
8%
5%
3%
3%
5%
6%
4%
22%
6%
Source: Levada Center
Less support across the board. The latest survey results also showed the
following:


39% of people approve of the government’s actions down from 44% in the
summer)
33% approve of the Duma’s performance (from 40% in July) while 65%
disapprove (up from 59% since July)
When asked if President Putin was following a clear course of action;




7% said “definitely”
37% said “on the whole” yes
36% said that he has a “general idea”
20% had no idea or refused to answer
When then asked what they thought the president’s key strategy is;

24% said “to stay in power”
32%
11%
19%
8%
9%
5%
2%
3%
5%
4%
3%
25%
6%
Chris Weafer: cjw@macro-advisory.com




21% said he wants to “maintain national stability”
16% said “to improve the quality of Russia life”
16% said that there is “no strategy”
23% had no idea or refused to answer
Putin met with 2nd tier opposition leaders. Apart from the speculation about a rift
between the president and prime minister the only other notable event in politics
recently was the meeting between president Putin and leaders of the nonparliamentary opposition. This was the first ever time for Putin to meet with
opposition leaders outside those parties represented in the Duma. According to the
Kremlin’s press office the reason for the meeting was because the parties comprise
the next echelon, after parliamentary parties, by their political potential, and the
president wanted to discuss issues which he plans to raise during his forthcoming
address to the Federal Assembly on December 12th. Participants included Mikhail
Prokhorov (Civil Platform party), Vladimir Ryzhkov (RPR-Parnas) and Sergei
Mitrokhin (Yabloko).
Waiting for the Dec 12th amnesty. Comments from the participants after the
meeting were general positive with one quoted as saying "Some changes have been
made for the first time in two years, and the people who come to the Bolotnaya
Square and Sakharova Square protests have started hoping that the authorities have
heard their demands and opened a dialogue" The delegates also handed over to the
president a list of political prisoners compiled by the human rights center Memorial as
well as a 500-page report on public investigation into Bolotnaya Square riots in May
2012. There is optimism that the president will include these prisoners in the amnesty
expected to be announced to celebrate the 20th anniversary of the constitution on
December 12th.
Macro update: Doves attack the Hawk
Subdued 4th Qtr rally so far. The Federal Statistics Service and several other
government agencies published data for October last week. The table with the key
numbers is below. The summary conclusion is that economic activity remained
weaker than had been expected by economists and the hoped for 4th quarter rally
has at least started on a low note. The main cause for concern is the continuing
decline in capital investment, down 1.9% on an annualized basis last month.
Real wages are still growing. The consumer sector, albeit also reporting weaker
growth than at this time last year, does again provide some compensating growth as
real wage growth and real disposable income growth remains between 4-5% YoY.
However, much of that real wage growth comes from the state sector (+22% nominal
wage growth over the first nine months of this year) and the contagion to the private
sector (+10% to end September). With declines elsewhere that trend is making the
economy even less competitive and building future problems.
But there was a pick up in estimate GDP growth for the month. The Economy
Minister estimates growth at 1.8% YoY for October, up from the average 1.2% for the
previous six months and 1.4% for the past three quarters. The big jump in agriculture
output and the seasonal increase in budget spending were contributing factors.
Chris Weafer: cjw@macro-advisory.com
Key Macro Data Points for October '13
Data Point
October YoY
GDP growth, est, % YoY*
Budget deficit, % of GDP**
1.8%
-0.7%
Industrial Production, % YoY
Capital Investment, % YoY
-0.1%
-1.9%
Construction spend, % YoY
Apriculture Output, % YoY
Cargo volumes, % YoY
-3.6%
26.3%
6.3%
Inflation CPI, % YoY
PPI, % YoY
Retail Sales, % YoY
Vehicle Sales, units
Vehicle Sales, % YoY
6.3%
2.0%
3.5%
234,481
-8%
Real Wages, % YoY
Real Disposable Income, % YoY
4.1%
4.9%
Unemployment rate
5.5%
Source: Federal Statistics Service
* Estimate for ten months is + 1.4%
** for ten months the budget surplus is 1.1% of GDP
Duma wants CBR to focus on core inflation. Last week the Central Bank
Chairman Elvira Nabiullina presented the monetary policy guidelines for the next
three years to the Duma. She made clear that the Bank remains focused on the
headline inflation number but agreed to look more closely at the core inflation
number, which is now at 4.0-4.5% (compared to 6.3% for the headline CPI). The
Duma members pushed hard for the Chairman to adopt this measure and then to cut
interest rates quickly as an effort to revise economic growth.
Headline inflation remains above 6%. The latest inflation report shows that
annualized headline inflation is running at 6.3% as at mid-November and is up 5.6%
year to date. A full year result of 6.3% or 6.4% is therefore likely. A rate cut, despite
the Duma member’s pressure, will have to wait until next quarter.