Moscow Notebook May 2013

My latest four day trip to Moscow sheds some light on the frustratingly difficult situation in Russia this year.

I have been positive about the prospects for the Russian equity market for over a year now, with little to show for it. Since impressively recovering from the desperate lows of the financial crisis, Russia’s market has been trapped in a long-term corridor.

Restrained global growth has capped global commodities prices, impacting both corporate and fiscal cash-flows. Revenues have struggled and the nation’s monetary policy mechanism has stalled as the central bank has shifted from FX to inflation targeting.

GDP Disappoints

With GDP growth declining, the need to restrain inflation became a clear priority, and the central bank is well on the way toward building a credible reputation as an inflation fighter. But, the immediate benefits of such a development might well be capped by the costs, as there are serious questions as to the role of interest rates in setting Russia’s inflation today. It can be strongly argued that inflation is more a function of bottlenecks in the economy and over-reliance on the state sector.

But in fact, beyond the macro debate, investors would do well to note that the situation in Russia is not nearly so bleak as weak economic statistics imply.

A Bustling Vibe

I landed in Moscow, as usual, in the darkest hours. Twenty-four hour culture is one of the great features of modern Moscow, and nowhere is it more obvious than in the city’s airports. Of course, this partly reflects a lack of capacity, but it also reflects Russia’s attractive location between Asia and Europe. There are appealingly timed flights arriving and leaving at all hours of the day.

What was interesting about landing at Domodedevo in late May is that the airport was busier than I’ve seen it for many years. Passport control was completely backed-up, as it regularly used to be ten years ago. Russia’s airports are close to bursting as tourism booms. And reassuringly, despite the crowds, the queuing was orderly, the mood friendly, and frankly the service was swift. I was out and riding into town far quicker than I expected.

The situation at the airport caught my attention in large part because just days before, Russia had reported first quarter economic growth of just 1.6%. Yet another disappointing step down in a protracted cool off, which is heavily impacting international confidence, but bears little relation to what one observes inside Russia.

Political Battleground

That economic growth is struggling, no one denies. The debate about how to fix it is on everyone’s lips, not least because it encapsulates the fascinating political debate about whether or not the Medvedev government can survive, as political challengers step up their campaign against him.

Russians love a good political intrigue, and today they are being treated to one that has broad-reaching implications. Much is changing in Russia, as the rules of the naughties naturally expire. Government is tightening down further on political liberties, but the economic compensation it once promised in return is evaporating. The economic liberals are locked in an ideological campaign with the siloviki, who many now think have the upper hand, and who would further advance the government’s role in the economy.

  

This political showdown might well explain the increasing hesitancy among domestic investors towards starting new projects. Russia’s political future is an overwhelming issue. Even with five years of presidency ahead. And the question of whether or not the government ramps up economic influence, or backs away and gives business the freedom to flourish, is paramount.

Don't Trust the Numbers

But, the present isn’t so bleak either. Being in Russia at the moment is a reminder that the emerging markets story is still alive. Headline economic data are repressed by the dominance of the natural resources sectors. If commodities prices are repressed, so are profits, taxes and investment. Such has been the case lately. But this doesn’t mean the rest of the economy is out for the count, far from it. Russians are locked out of large swaths of the economy, but they are constantly finding opportunities and niches, and continue to believe that the future is bright. Business is flourishing to an impressive extent already, if it could see the future path of political development, it may flourish all the more.

This optimism is in large part because life in Russia, at least in Moscow, continues to improve. Russia’s opposition movement took to the streets when the government cheated Muscovites out their votes in the parliamentary election. (More so than in the presidential election, which the Moscow vote wouldn’t have swayed anyway.) When the Moscow Mayoral vote comes around in 2015, the government will need a clean fair win. Democracy will prevail, because rigging the vote would cause chaos. And the best way to assure itself of a win is to dedicate the next two years to improving the quality of life in Russia’s capital. Hence, even the Muscovites, the most demanding of Russians, are optimistic about the future.

The political issues remain at the forefront, they are impacting investor confidence. And economic policies are an ongoing concern, both fiscal and monetary. But Russia is far from being the lost case that the economic data imply.