The collapse of the former Soviet Union into 15 independent republics in 1991 ended the cold war and Russia’s experiment with a state planned economic model. During the 1990’s under the rule of former Russian President Yeltsin, Russia began the process of transforming to a market economy from the communist command economic model. Russia’s flirtation with Western style capitalism led to greed, crony capitalism, lawlessness, opportunism and outright vast corruption which became rampant. A few well connected individuals became the oligarchs (business tycoons) of Russia and the new rich of Russian society. As market reforms were implemented, the economy adjusted but in a very painful manner. Hyperinflation and massive capital flight resulted, unemployment then skyrocketed as living standards plummeted with depressionary conditions taking hold. By 1998, corruption and political mismanagement led to the currency collapse of the Russian ‘ruble’ as it fell 75 percent in value from August to December 1998. Since 1999, the ruble has stabilized as the economy has rebounded due to the surge in the world oil price and the successful transition of political power to the current President,Vladimir Putin.
In the 1990’s, billions of dollars of foreign investment came into Russia but were misallocated in devious ways to the benefit of a corrupt few. Today, President Putin is consolidating power to a strong central state control thus minimizing corruption and allowing the authorities to be in a stronger position to redirect and control Western investment although FDI (foreign direct investment) remains at low levels due to many investors being burned in the 1990’s. Russia is a nation with a bloody and turmoil history although in the future, its bloodless fight with diseases such as AIDS and alcoholism may very well be its new major war. The Russian Federation is transforming from a dysfunctional system to a functional modern society of free democracy and market economy. Many Russian’s are now among the wealthiest in the world including the oligarchs and those who are well connected, Forbes magazine states that there are now 17 Russian billionaires. Russia is a G8 member economy and ranked at number 14 in the world in size as it also holds the title to military superpower with its arsenal of nuclear weapons. Population of Russia is 145 million and it is currently declining by 750,000 people per year with 25 percent of the nation living in poverty although overall living standards have been rising over the last 5 years.
Will Russia attain the title of next economic superpower? Below is a review of BankINTRO.com’s research on how it pertains the outlook to the Russian ruble.
POLITICS: Russian President Vladimir Putin of the United Russia party has held power since December 31, 1999, elected in March 2000 and was re-elected with 69 percent of the vote on March 14, 2004. President Putin is firmly in control with basically absolute power as the nation is currently politically stable. Russian Federation independence from the former Soviet Union empire was obtained on August 24, 1991. President Putin has been successful in reigning in control and place strength in the state to prevent Russia from further disintegrating, his visionary goal of a powerful nation for Russia. It is this strong and semi-authoritarian leadership that is required for Russia, outright democracy and total freedoms (ie. media) is likely upwards of 10 years away when Russia will be home to a stable moderate two-party political system. Mr. Putin has also shifted Russia closer to the West as he plans to fully integrate Russia into the global financial system. President Putin is committed to raising living standards and enforcing strong leadership to help minimize the widespread corruption and organized crime that presently exists - an estimated 50% of Russian GDP is thought to be part of the informal shadow economy that declares no tax ‘black market economy’. President Putin is centralizing power with an almost authoritarian rule as he is taking control of the oligarchs, the mafia and regional leaders who control the major factories and natural resources in the regions from laundering their profits out of the country, a challenging business environment in many ways. Mr. Putin in essence has a ‘dictatorship of law’ with decreased freedoms for civilians, more Presidential power for himself and less powers for the Governors.
President Putin seems to be committed to finding the balance between moderate market reforms with the need for strong government to crush widespread lawlessness and corruption, he remains popular with the Russian people. It is Mr. Putin’s political agenda to see to it that Russia achieves its goal of returning to world power status by implementing policies of strong political leadership, strengthening the rule of law, creating effective institutions such as the ‘courts’, restoring ‘trust in business’, protection of ‘property & investor rights’ while implementing new reforms from labour to simplifying the tax code. It is also President Putin’s desire to crack down on bribes, corruption and fraud within the Russian Federation. Bribery and corruption ranks Russia as one of the world’s worst offenders.
The powerful state bureaucracy is extensive with an estimated 2.8 million bureaucrats and has actually expanded under Mr. Putin’s tenure to date. Surprisingly, over a half a million of these bureaucrats receive official chauffeur driven limousines. Luxury cars are prevalent with many foreign made models including American and Japanese. Russian class structure consists of 10 percent who would be deemed as well off or rich, 30 percent as middle class and 50 percent as working poor with an estimated 40 million living in poverty, ironically very similar structure to the United States. Politically, President Putin is positioning Russia closer to the West and is allowing the United States presence in some of the former Commonwealth of States (CIS). Russia is and will be rewarded with further economic help from the United State including Russian oil exports to America which can only help Mr. Putin secure his mandate of stability and growth for Russia.
Political Risk: President Putin during year 2003 enforced his power by clamping down on the oligarchs, most notably Russia’s richest man, oligarch Mikhail Khodorkovsky who has been in jail since October 25, 2003. Khodorkovsky, a major shareholder and executive of the Yukos oil conglomerate, Yukos is alleged to owe the government $5 billion USD equivalent in back taxes. President Putin cleverily kept his power by cunningly sending a powerful message to the oligarchs, don’t interfere in politics and then the Kremlin will not interfere in business. Mr. Putin successfully avoided the detriment of an ugly political fight with the oligarchs in the recent election. Some analysts suggest that Russia is no democracy, but only capitalism, in essence more that of a managed democracy. In Khodorkovsky’s case, he is accused of being a financial backer of two opposition political parties as well as being critical of President Putin’s foreign policy, some commentators believe he may even have political ambitions himself. The political risk of confronting the oligarchs in the way Khodorkovsky was handled is sending confusing signals to international investors, some believe a public relations disaster by the Kremlin. It has the potential to harm Russia by discouraging foreign direct investment. The oligarchs ironically with a more political stable society and enforced property rights will be able to earn more money with foreign investors rather than breaking up their Russian companies and selling the assets and placing the funds offshore to a tax haven. It is estimated that Russian oligarchs who benefitted tremendously from the 1990’s privatization of Russia is thought to control upwards of 30 percent of the economy. In the 1990’s, it was the wild west of business within Russia as oligarchs took advantage of a corrupt legal system to build their wealth.
The Chechnya conflict continues even after the 1994-96 war and in Dagestan, a total of 3,200 Russian troops have been killed in these civil conflicts. Domestic terrorism is not uncommon with deadly strikes in cities including Moscow, much of it alleged on Islamic terrorism originating from the guerilla war with the separatist Chechnya region.
ECONOMY: impressive economic performance due to high oil & commodity prices. President Putin’s number one priority is to integrate Russia into the world’s economy and global financial system thus resulting in greater domestic GDP growth and higher living standards while fighting corruption, his presidential powers give him wide control of the economy. The Russian economy is well on its way to being that of large and successful, today it would rank as a middle power. The centralized state planning economy is now gone replaced by the Western market economy, the budget is in surplus, inflation has declined and the economy is growing at a healthy rate. The economy for the most part has been freed as 80 percent of the Russian economy is now privatized, it is Mr. Putin’s ambition to transform Russia into a modern wealthy nation. The crash of the ruble in 1998 has made Russian exports competitive coupled with the dramatic rise in the world oil price has given Russia robust GDP growth figures since 1998. It is this oil windfall that has helped the economy tremendously with a large increase in foreign exchange reserves to rising living standards. For comparison, by 1999 the Russian economy was only 50 percent of its size in the late 1980’s.
Foreign direct investment ‘FDI’ is minimal although foreign companies are beginning to set up plants in Russia. This investment figure is expected to increase as FDI will spur the next phase of future economic growth for the Russian Federation, the Czech Republic (2001 figure) currently receives more FDI than Russia. General Motors has made one of the biggest FDI in Russia as it plans to build 75,000 sport utility vehicles in Russia (2001) and Italy’s Fiat announced similar production quotas for cars. At present, there are no real exports particularly in the consumer goods sector that is in demand by the rest of the world for Russian products. For the most part, Russia’s economy is oil and natural gas based. Other areas of hard currency revenue are commodities-based including aluminum/nickel and precious minerals, vodka, energy and military weapons arms sales to countries like India. Russia is the largest country in the world via land mass, rich in natural resources with approximately 425 million hectares suitable for agricultural. Estimated value of Russian resources are in the trillions of US-dollars, this puts Russia’s foreign debt in a better light. Germany is Russia’s largest creditor and Iraq is its largest debtor with $8 billion USD owing. During year 2001, Mr. Putin was paying off foreign debts to the tune of $15 billion USD from surplus oil revenues.
The economy is reforming with the privatization of Russian farmland which is now legal for the first time since 1861 when land ownership was abadoned by Czar Alexander II. Mortgages and land reform are now well underway to help build the Russian middle class. The economy is diversified in area from mining to energy to shipbuilding, etc. The aerospace industry is still very advanced and powerful although much of the Russian industrial economic base needs to be modernized. Both Moody’s and Standard & Poors has given Russia a higher credit rating thus achieving investment grade in fall 2003. Tax reforms resulted in a 13 percent flat tax was implemented in 2001, personal tax collection is up 50 percent as Russia now has one of the lowest tax regimes in Europe as total tax burden is projected to fall to 31 percent of GDP. The stockmarket is booming up 50 percent year over year breaching the 700 point level recently for the RTS index in March 2004 due to strong energy sector. The real economic story is that the overall Russian standard of living is starting to rise after a very difficult 10 years, wages are up 50 percent over the last 5 years.
Economic Statistics
GDP is $1.4 trillion USD (2002) as measured by ‘Purchasing Power Parity’ with corresponding GDP/capital is equivalent to approximately $9,700 USD (2002) which is well up from $4,700 USD in 1997. GDP growth for 2004 is estimated at 5 percent of GDP, 2003 at 7.3 percent, year 2002 was at 4.3 percent, year 2001 came in at 8 percent, year 2000 at 8.3 percent and 1999 at 5.4 percent. Inflation for year 1998 was at 84 percent, 1999 at 36.5 percent, year 2000 at 20 percent, 2001 came in at 18.5 percent, 2003 at 14.5 percent and is currently running at 13 percent annual inflation with a goal of single digits estimated by 2005, disinflationary conditions. Current account surplus came in at a very healthy $35.9 billion USD for 2003, year 2002 surplus at 7 percent of GDP, 2001 at 12 percent after a stunning year 2000 at 18 percent. Year 2002 exports at $105 billion USD, oil, etc. to markets in Germany, EU, China, United States. Imports are at $61 billion USD (2002), machinery, consumer goods from suppliers in Germany, Ukraine, etc. Debt to GDP ratio has fallen significantly to 38 percent well down from 110 percent in 1998-99. Unemployment is moderate in the 8 percent range plus underemployment. Economic structure consists of agriculture at 5.8 percent, industry at 34.6 percent, services at 59.6 percent. Budget surplus is at 2.5 percent of GDP due to restraint in public wages, a huge reversal to year 1998’s fiscal deficit of 8 percent of GDP. Overall, these are all very positive economic indicators for the Russian ruble.
Oil & Russia: Russia is currently the world’s #2 exporter of oil behind Saudi Arabia, Russia will be the world’s largest oil producer although it is not an OPEC member. The current oil price of $33 to $38 USD/p/b is highly lucrative for Russia, the break-even price for oil is $12 to $15 USD/p/b for the Russian economy. The risk to the ruble is a dramatic fall in the price of oil. Exports to non-CIS countries at 2.8 million b/p/d (2000). Low priced exports to CIS countries are at 680,000 b/p/d (2000). Year 2001 oil production at 7.286 million b/p/d with consumption at 2.595 million b/p/d (2001). Reserves are estimated at 51.2 billion barrels equivalent to $1.7 trillion USD wealth approximately. In addition, Russia is the world’s #1 producer of natural gas with a massive resource of 48 trillion cu m (2001) in proven gas reserves which is the largest in the world representing 25 percent of global reserves. Natural gas production came in at 581 billion cu m (2001) and consumption at 408.1 billion cu m (2001). Russia is currently providing 20 percent of Europe’s gas needs and by year 2020, Russia could be supplying 50 percent of the EU’s natural gas requirement. The Yamal project in the Russian arctic is home to massive natural gas reserves enough to supply Europe alone for 20 years. Russian natural gas giant, Gazprom accounts for 8 percent of Russia’s GDP. Most of the Russian oil industry is now privatized. Huge oil reserves, the Caspian Sea is also home to massive future oil wealth for Russia. The oil industry with Western money, Russia will be adding production capacity with the intention to increase another 2 million b/p/d by year 2005. In the Northern Caspian Sea, Russia is presently negotiating production rights with Azerbaijan, Kazakhstan and Iran. LukOil, Russia’s largest oil company has already invested $800 million USD into the Caspian. Several global oil conglomerates including ExxonMobil, Shell and BP are investing in the future development of Russia’s energy resources, a better investment environment is now in place. The oil & gas industry is very bullish for Russia and the ruble<
Economic Outlook: positive as President Putin has pledged to double GDP within 10 years. An increase in domestic demand should take over to help the export industry. Rich in a wide array of natural resources and similar to Canada, Russia is well positioned geographically to supply nations like China, European Union, Japan and other important markets including America with oil. Russia has great economic potential, a massive wealth gain to take place as companies like Russia’s largest nickel producer modernizes with technology. Norilsk Nickel in time will realize valuations in terms of market capitalization similar to its Western nickel producing counterparts such as corporations like Canada’s Inco. Russia by being rich in natural resources particularly in energy will see continued wealth accumulation and a renewed shift in positive capital flows for FDI investments into Russia. Strategically, President Putin wants Russia into the WTO, membership most likely by 2007-10. It is likely that Russia will advance to first world status as has other rich commodity producers like Australia, Norway and Canada for example. This again is very bullish for the ruble over the long term. Rising commodity prices will benefit the economy handsomely including demand for nickel, gold & silver, uranium and other minerals, natural gas & oil and amongst a wide assortment of agricultural products.
POSITIVE: well educated nation, large merchant marine, economy advanced in areas such as aerospace (multiple nuclear warhead threat including the new strategic Topol-M nuclear missile with a range of 10,000 km), mining - Siberia rich in natural resources & energy, large market potential in financial services, upgrades in telecommunications employment gains beginning in Russia from offshoring by foreign multinationals taking advantage of lower labor costs. CONCERN: crime is a problem, brain drain, declining population figures - very low birth rate and it is estimated that the population may fall to 100 million by year 2050 if AIDS is not slowed (currently upwards of 1.5 million AIDS cases in Russia) coupled with a reversal in immigration patterns, social difficulties - suicide, heroin use is increasing, alcoholism is a problem as vodka is cheap in Russia, diseases such as tuberculosis & syphilis are making a come back, ethnic & regional tensions, widening gap between rich & poor, infrastructure in need of upgrade ie roads, bridges, areas of ecological disasters.
KNOWLEDGE: Nuclear Waste, Potential Catastrophe?
Russia is now home to much of the world’s plutonium and other nuclear storage waste in addition to its portfolio of nuclear weapons, nuclear power plants, nuclear powered submarines amongst other uses including that of major uranium producer. With its vast arsenal of nuclear weapons from storage to accountability, are any stolen? Breach of security exist? Any military officials bribed? Russia announced that it will be importing spent nuclear fuel from much of the world for processing and disposal. The program is worth $21 billion USD for importing 20,000 tonnes of spent nuclear fuel over 20 years. Alleged beneficiaries may very well be the corrupt few Kremlin politicians where much of the money may possibly be transferred abroad to tax havens. It is ironic that Russia is currently enduring a difficult time storing and processing its own current large quantities of nuclear waste, estimated at 1,000 tonnes of weapons grade nuclear material in addition to 40,000 tonnes of chemical arms. Much of the nuclear waste is to be held in the Urals and in Siberia. The city of Karaboka in the Urals is a nuclear hot spot disaster area as nuclear waste has made this region basically a nuclear dump significantly reducing life spans for the region.
The potential for another Chernobyl nuclear accident or a nuclear domestic terrorism threat? At present, 4 or Russia’s 29 nuclear plants will be 30 years old or older. By 2007, 10 Soviet-era nuclear reactors will be at the end of its life including the location of St. Petersburg. Russian research nuclear reactors have had a history of accidents, 90 malfunctions in 1999 alone. Nuclear risk is also prevalent with Russia’s aging nuclear submarines as 192 have been decommissioned out of a fleet of 270. Currency risk to the ruble obviously include a major nuclear accident as Russia is going to garner the title as the world’s largest nuclear dump. Other risks that could greatly impact Russia include global terrorism threats, dirty bomb potential? Russia’s nuclear and chemical waste problem may also in a ironic way be a vehicle to negotiate with the Paris Club for debt reduction in lieu of disarmanent.
BANKING SYSTEM: weak but stable, strengthening. In the early 1990’s, tremendous growth in large numbers of Russian banking institutions, questionnable purpose and acitivity of these banks? During the 1990’s, many of these new banks were used by corrupt government officials, oligarchs and others as a vehicle for laundering upwards of $300 to $500 billion US-dollars (‘USD’) in flight capital from Russia to tax havens abroad. Currently, it is estimated that $20 billion USD (2001) in Russian profits are laundered abroad (ie. energy profits - oligarchs) annually but this figure is falling as some analysts have this figure now pegged closer to $10 billion USD/year. The Russian central bank ‘Bank of Russia’ is now under new leadership has no plans in changing the current ruble exchange rate policy. The Russian financial crisis in August to December 1998 resulted in a large number of bank failures with many Russian depositors being burned badly by getting their net wealth wiped out in addition to the high inflation of the 1990’s destroying the purchasing power of the ruble. Consequently, there is an estimated $50 billion USD in mattress money in Russia that is not being positioned to the benefit of the banking system and the Russian economy. Many Russians are now inclined to hold the Euroland euro ‘EUR’ as the US-dollar ‘USD’ has lost global purchasing power over the last 18 months, the euro is becoming a more popular currency within Russia. BI.C believes that these ‘mattress’ monies will gradually enter the Russian banking system with time.
There are presently1300 banks (2001) in Russia of which only a handful provide traditional banking services similar to a Western bank. Currently, there are 5 large state-controlled banks (2001) that dominate in this very inefficient banking system whereby uneconomic businesses continue to be subsidized but this may change with potential privatization at a later date. State controlled savings bank ‘Sberbank’ is the largest bank in Russia. At present, foreign bank presence in Russia is increasing most recently with the entrance of Citibank which began retail operations in Moscow in November 2002. The banking system is undercapitalized and in need of reform to foster growth and wealth creation for the domestic economy. The banking system consists of too many small banks and is too small to finance a growing Russian economy. An improvement in insured deposit guarantees maybe introduced to provide stability as well as recently introduced money laundering legislation. Bank reform is underway to face these challenges.
Russia’s foreign exchange reserves are impressive at $84.6 billion USD as of March 14, 2004 and growing reflecting strong revenues from the high world oil price and commodities such as nickel, gold, etc. A weak banking system encourages capital flight, banking insolvencies. This results in many sending savings abroad in order to be protected. The authorities are implementing measures to strengthen the Russian banking system, with a return in confidence and introduction of modern Western banking technology, a reversal of capital flows will take place with money returning to Russia. A sound banking system will enhance the nation’s wealth gain as Russian companies will be valued similar to their Western counterparts. Russian exporters must give 50 percent of their hard currency earnings to the Russian central bank in exchange for rubles, this is down from 75 percent and may drop to 25 percent in the near term. This compulsory currency swap has led to capital flight and results in a low Russian investment rate. As this currency exchange is eliminated coupled with a stronger Russian banking system, capital flight trends will reverse creating appreciation pressures for the ruble with higher GDP growth rates. It is interesting to note that the Russian central bank holds gold bullion, a higher gold price is also bullish for the ruble. The Russian central bank has the Refinancing rate at 14 percent, rates have steadily fallen since they peaked at 150 percent in June 1998.
REGIONAL and GLOBAL ANALYSIS: United States, European Union, NATO
The United States has a greater presence in the former Soviet satellite states as several of these states are new NATO members. NATO itself is becoming less of a military organization as many troops are getting pulled out of Europe. President Putin is making a Westward turn for geo-positioning placing Russia closer to the West. President Putin has a good working relationship with U.S. President George W. Bush while also benefitting from a closer understanding with the European Union. Russia is now rewarded by being a junior partner within NATO for President Putin’s leadership on the global war against terrorism. Trade with both China and Japan, it is here where much tremendous economic growth for Russia lies ahead especially with Russia’s close historical ties to China. In the 21st century, China will experience an economic boom which will propel Russia economically forward as Russia will become a major supplier of natural gas and other resources to China. Within the CIS satellite states, Russia should promote a unified economic free trade zone.
CURRENCY: ISO Symbol ‘RUB’, Russian ruble. At present, the ruble has stabilized since the Russian financial crisis in August 1998. At time of review on April 8, 2004, the ruble is valued at 28.519 RUB to the US-dollar ‘USD’. It should be noted that in the large cities of Russia, Western currencies dominate and barter remains popular in the countryside. The majority of profits from corporate Russia are held in US-dollars. The ruble is used by the Russian people to buy goods whereas the USD is the unofficial currency that Russian’s generally use for savings. In fact, Russia today is the largest dollar economy outside the United States, essentially an informal parallel currency is the USD. The ruble follows that of a floating exchange rate regime although currency controls restricting exporting of rubles is in place to help prevent capital outflows & flight. President Putin supports the ruble becoming fully convertible in due course.
CURRENCY HISTORY: historical exchange valuations for the Russian ruble “RUB’ in relation to the USD include: January 2004 at 28.82 RUB to 1 USD, January 2003 at 31.83, January 2002 at 30.58, year 2001 average at 28.3, January 2000 at at 28.11, 1999 at 24.6, 1998 at 9.7, 1997 at 5,785 (old ruble replaced by a ratio of 1000 to 1 for the new ruble), year 1996 at 5,121, November 1995 at 4560, 1994 at 2,194, 1993 at 992. Historical quotes versus the Euroland euro ‘EUR’ include: March 2004 at 34.98 RUB to 1 EUR, January 2004 at 36.05 (low), January 2003 at 33.83, January 2002 at 27.01, January 2001 at 26.49, January 2000 at 28.46, January 1999 at 26.22. The currency crash in 1998 of 75 percent had the following figures, August 1998 at 7.52, September 1998 at 14.84 and by December 1998 at 20.73. The collapse of the ruble in 1998 was alleged and believed to be triggered by inside political players including former President’s Yeltsin immediate family amongst a wide array of politicians and insiders capitalizing on a financial bond scandal. Pre-1991, currency comparisons are not relevant since the former Soviet Union consisted of a population of over 400 million people under a communist command economic model.
CURRENCY FORECAST: BI.C sees the ruble stabilizing and to further appreciate versus the declining USD as a potential USD crisis looms. After the New York terrorist attacks in September 2001, there was a temporary panic ruble buying as confidence in the USD lapsed with the ruble appreciating to a very short-term high of 24 RUB to the USD from a level of 29. Currency movements can be very psychological. The 1-year forecast as estimated by BI.C for spring 2005 is for the RUB to stabilize at 24 to 28 RUB to the USD and may hit a high of 20 RUB if the USD declines significantly. It is expected that the world oil price will remain at over $30 US/lb with huge increasing demand from China and India, continued oil windfall is in the cards for Russia. The ruble is expected to stabilize and/or slightly depreciate versus a strengthening EUR (Euroland euro). The medium term and out is favorable for the Russian ruble. Increased mineral exports will allow for increased foreign exchange as the world economy is now entering a bull market cycle in commodities ie. nickel, gold, silver, platinum, etc. all of which Russia mines. Commodities represent 80 percent of Russia’s exports including forestry and energy. The government plans to increase taxes for extraction of energy and mineral resources thus increasing national revenue to help the 30 to 40 million Russians who live in poverty.
The significant currency risk to the Russian ruble is if the world oil price were to fall below $21 to $22 USD/barrel for a sustained period of time, then a currency devaluation might be forced upon the ruble as the Russian stockmarket would then be very vulnerable to a large correction in valuation. The expected demand from economies such as India and China mitigate this oil price risk. Oil and natural gas account for 20 percent of Russian GDP, with time, Russia’s economy will continue to diversify away from oil and gas as noticed in becoming an offshore centre for western congolomerates ie. software engineering.
Over the long term, there has been discussions for Russia becoming a new global currency zone in competition with the Japan JPY, United States USD, Euroland euro EUR, China CNY ‘yuan’. The Eurasian Economic Union (EEC) is a new potential zone that will consist of former Soviet states including Belarus which is adopting the Russian ruble, Kazakhstan, Kyrgyzstan, Tajikistan and Russia. In BI.C’s view, Russia with its rich natural resources is well on its way of becoming a superpower in the 21st century particularly in an era of a historic commodities bull market well underway.
UPDATE: April 8, 2004.
