Russia Economics

Economic Market Spotlight: Curbed access to foreign capital, coupled with the slump in global demand for
commodities and industrial goods, took its toll on the Russian economy last year. It has now
returned to growth, and investors have grown more benign toward Russian risk; equities continue
Credit Agency Ratings to strengthen, bond spreads have narrowed to pre-crisis levels, and the rouble is facing strong
Moody’s: Baa1 upward pressure. What appears to be the new steady state, however, is unlikely to be sustained.
Much of the rebound in financial markets is being fueled by an untenable increase in oil prices and
S&P: BBB
related inflows of portfolio capital. The credit environment, meanwhile, along with the labour
Fitch: BBB market, remain exceptionally weak, putting a cap on Russia’s scope for an easy recovery.
Nominal GDP (2008)
USD 1.65 trillion
Real Economy: In 2009, Russia’s growth dynamics reversed from a brisk 7% average annual pace
to an 8% contraction. While the downturn has run its course, genuine recovery remains a more
Population (2008): distant prospect; borrowing costs remain high, supply of and demand for credit – weak, wages – on
142 million the decline, and unemployment – stubborn. February’s industrial production figures disappointed,
Total Trade / GDP: coming in at a feeble 2% y/y despite a strong base effect, though activity in specific sectors (i.e.
pipe, metals, auto production) is showing signs of life after last year’s plunge. The turn in the
48%
inventory cycle should continue to offer a lift this year, and household consumption stands to firm
Currency: somewhat on the back of pension and public sector wage increases. We expect domestic demand,
Russian rouble however, to remain a drag on growth into 2011, particularly as investment remains depressed.
Exchange Regime: Fiscal policy: The fiscal position has been outperforming expectations in recent months, owing
Managed float largely to the more buoyant oil price environment. This should enable the government to scale back
its planned borrowing program this year and bridge its financing gap with the help of the Reserve
Merchandise Imports from
Canada (2008):
Fund. Spending priorities remain centred on support to the real sector, with a particular emphasis
on industry. The medium-term fiscal program is designed to narrow the budget deficit substantially
CAD 1.41 billion by 2012, yet the combination of weak growth, lacklustre oil prices and volumes, the risk of recent
Main Sources of Foreign support measures becoming entrenched, and the challenges of reining in social spending ahead of
Exchange (excl. FDI): presidential elections, lead us to anticipate still substantial red-ink spill through 2011 and beyond.
Foreign borrowing, energy Monetary & Exchange Rate Policy: With inflation falling to its lowest in over a decade (7.2% y/y
exports
in February) and inflows of speculative capital placing unwanted upward pressure on the rouble,
Largest Trading Partners: the monetary stance remains loose. The central bank’s cumulative 475bp rate cut in the last year
Netherlands, Germany, Italy has been little effective in lowering borrowing costs for businesses, though these have eased from
China, Ukraine Q1-09 peaks. When it comes to the carry trade, Russia’s interest rate differential remains large in
Main Imports: spite of recent rate reductions, so in the absence of mooted capital controls, appreciation pressures
are unlikely to abate. That said, we see other factors bearing an offsetting influence on the RUB,
M&E, motor vehicles, steel
particularly as oil prices are forecast to fall back from their current level and growth beyond 2010
products, medicine, and
communications equipment disappoints. Tight credit and weak domestic demand should, meanwhile, keep inflation in check.
Sources: IMF, EIU & Statistics Canada External Accounts: Assuming oil prices average $69 in 2010 and $72 in 2011, we expect the
current account to maintain a comfortable surplus, while net flows of capital reverse from last year’s
Risks to the Outlook: USD 52bn outflow. Though the rouble’s recent strength offers upside for imports, it will take quite
Strong rebound in some time for these to recover in light of the weak domestic demand picture. The current surge in
commodity prices
portfolio equity purchases, while unsustainable, will drive this year’s net inflow of capital. So should
Credit unfreezes, filters
down to companies greater (and more costly) bond issuance into 2011 as the banking system fails to meet the needs of
Relapse in global risk
the private sector. Russia’s foreign reserve position continues to strengthen, yet a relapse in global
aversion and growth commodity prices and risk appetite could again swiftly place heavy demands on this war chest.
Failure to deepen
economic, fiscal reform
Outlook: Unlike ten years ago, Russia’s road to recovery stands to be protracted and uneven.
Base effects, coupled with restocking and firmer external demand, will boost growth this year. With
March 2010 banks, however, working off pre-crisis excesses, and employment slow to return, we expect growth
Uliana Haras to fall back in 2011 and underperform over the MT. The rouble will remain vulnerable to commodity
uharas@edc.ca price weakness and realignment of investor expectations. Key to the country’s MLT potential will be
progress on diversification and institutional reform; recent initiatives are encouraging in this regard.

ECONOMIC INDICATORS Bond Spreads & the Exchange Rate

04-08 avg. 2009 2010f 2011f
GDP (% growth, real) 7.0 -7.9 4.4 3.1 37
35 850
Inflation (%chg, pa avg.) 11.3 11.7 7.3 7.2 34 750
Fiscal Balance (% of GDP) 5.7 -6.0 -4.6 -4.3 32 650
31 550
Exports (%, comp. annual growth) 28.2 -35.7 16.0 7.8 29 450
Imports (%, comp. annual growth) 30.9 -34.0 11.2 13.8 28
350
26
Current Account (% of GDP) 8.5 3.9 4.7 3.8 25 250

Reserves (months current debits) 11.4 14.9 13.8 13.2 23 150

Jul-08 Oct-08 Jan-09 A pr-09 Jul-09 Oct-09 Jan-10 A pr-10
External Debt (% of GDP) 28.3 31.4 28.0 26.7
Debt Service due, to Curr. Acct. Rcpts 9.5 11.3 13.5 14.7 Ro uble/USD (LHS)

Exchange Rate (RUB to USD; eoy) 27.4 30.2 30.3 31.0 So vereign bo nd spreads, bps (RHS)
Sources: EIU, IIF, IMF, EDC Economics
Source: Haver Analytics
 Russia Economics

General Political Environment: Political power in Russia is highly centralized in the President
and the Presidential Administration within the Kremlin which exert their influence over all aspects Political
of domestic and foreign policy. Following the election of former President Vladimir Putin in early
2000, political stability gradually increased in Russia and the development of policy became more Political Structure
predictable. President Dmitry Medvedev, Mr. Putin’s protegé was elected with 70% of the popular Federal Republic
vote in the March 2008 presidential election. Mr. Medvedev’s election and his close partnership
with Mr. Putin ensures policy stability and predictability for the long-term. President
Dmitry Medvedev
Mr. Medvedev benefited tremendously from being Mr. Putin’s anointed successor and Prime Minister
endorsement by the pro-Kremlin governing party, United Russia, as its candidate. The 2008 Vladimir Putin
election cannot be considered fair by accepted democratic standards: opposition candidates were
banned from standing and the broadcast and much of the print media, which are effectively under National Legislative Bodies
the Kremlin’s control, favoured Mr. Medvedev’s candidacy. Despite the lack of fairness, the few  Lower House: State Duma
western observers present for the elections conceded that Mr. Medvedev’s victory was assured (directly elected)
given the genuine and overwhelming popularity of his predecessor; both the President and PM  Upper House: Federation
consistently enjoy between 60 and 70% approval ratings in polling. Speeches by President Council (indirectly elected;
comprised of regional
Medvedev indicate that he has chosen to focus on legal, constitutional and governance reform, as
officials)
well fighting corruption, as his key priority areas. Although ostensibly responsible for domestic
policy as PM, Mr. Putin continues to play a leading role in foreign policy as evidenced by his Major Parties (seats in
involvement in Ukrainian-Russian bilateral relations and Russia’s strained relations with Georgia. assembly)
• United Russia: 315
The State Duma is a body that is loyal to the Kremlin and thus has little autonomy. Given the • Communist Party: 57
dominance of United Russia in the Duma (in the December 2007 legislative elections United • Liberal Democratic Party of
Russia received 64.3% of the vote and in October 2009 regional elections it garnered 80% of Russia (Zhirinovsky): 40
• A Just Russia: 38
seats contested) and Mr. Putin’s position as PM, the legislative and executive branches are for all
intents and purposes now fused. There is little effective opposition with only the Communist Party Last Elections
opposing the Kremlin within the Duma; pro-Kremlin parties hold 393 of the 450 seats. In January • Duma: December 2007
2009 President Medvedev signed into law a constitutional reform that extends the presidential • Presidential: March 2008
term from 4 to 6 years; it comes into effect after the next election in 2012. This reform would
benefit Mr. Putin should he decide to return to the Presidency in 2012, conceivably giving him Next Elections
another 12 years in power under current conditions. • Duma: December 2011
• Presidential: March 2012
Investment Environment: In Russia, trade and investment matters are strategic areas of both Press Freedom Survey:
domestic and foreign policy. The Kremlin and associated political elites involve themselves directly  2009 Score: 80 (Not Free)
and actively in commercial dealings. There have been numerous cases in which the government (0: Free; 100: Not Free)
has intervened in sectors deemed to be strategic to Russia’s foreign & security or commercial freedomhouse.org
policies, such as oil and gas, minerals, defence and aerospace. Under Mr. Putin the state passed
extensive new legislation and took other measures that increased state involvement in the Control of Corruption Index:
economy, notably in the oil and gas sector under the state-owned champions Gazprom and  2008 Score: -0.98.
(-2.5: Worst; +2.5: Best)
Rosneft. There is now greater clarity as to the role of the state in the economy. The global financial
worldbank.org
crisis in the second half of 2008 hit Russian oligarchs particularly hard. The Russian state took on
increased stakes in key companies formerly oligarch jewels, such as Norilsk Nickel. The financial
crisis has provided increased opportunity for the state to assert its role in the economy, but short of
outright nationalisation of industrial sectors. President Medvedev has recently signaled that the
state plans to reduce its holdings in these commercial enterprises. Changes to the natural
resources investment laws have effectively limited foreigners from owning majority stakes in
strategic sectors. On 7 May 2008, a new Strategic Sectors Law came into effect defining foreign March 2010
investment limits in 42 sectors. Foreign firms will only be allowed to invest in these areas beyond a
certain percentage with government approval. It is not clear yet how the law will be implemented. Susanna Campagna
scampagna@edc.ca
Political Violence: Politically-motivated violence is generally limited to isolated incidents, with the
exception of chronic instability in the north Caucasus (Chechnya and Ingushetia). To date, neither
foreign nor domestic economic interests have been targets of political violence.

Political Outlook
The Putin-Medvedev tandem will continue to maintain a unified approach to governing, with perhaps some shifts in emphasis as
a result of the economic downturn. Stability is assured in the long-term. Mr. Putin will continue to play a dominant role in Russian
politics and the coterie of governing elites associated with him will remain in power exercising influence through the Kremlin and
state-owned companies. Increasing corruption and weak rule of law will continue to pose challenges to foreign investment.