How prepared is our business for recession in Russia?
This is the key question multinational companies should be asking themselves as they develop strategic plans for their business in Russia.
Multinational companies are increasingly relying on growth in Russia to compensate for dwindling demand as the eurozone recession deepens and much of Central and Eastern Europe slows. And while Russia has performed relatively better than most of CEE – it grew 4.2% in 2011 – this has been mostly on the back of high oil prices.
High oil prices have supported the ruble, funded high government spending, and benefited Russian consumers who in turn have helped boost GDP growth. However, high oil prices have also made Russia a much riskier market to operate in. Russia will balance its budget this year at US$117/barrel oil up from US$37 in 2007. The country’s rainy-day fund is less than half of what it was in 2008 when it helped the country stave off the worst effects of the global financial crisis. And Russia’s economy is as far as ever from true diversification away from energy.
What does this mean for the country’s economy? Standard & Poor’s estimates that if oil prices fall to US$80/barrel, Russia will be in recession; a decrease to US$60/barrel will lead to a 5% economic contraction. This will reverberate through the whole economy, impacting companies across industries. It will also lead to capital flight, currency depreciation, and, unlike in 2008, political instability.
Although Standard & Poor’s estimates the likelihood of these scenarios playing out in the next 2 years to 30%, there are valid reasons why multinational companies should invest resources in planning for this risk. Global oil prices are not supported by supply-demand fundamentals, and will experience significant declines if the eurozone plunges into deeper recession, China’s slowdown continues, and there is an easing of international tensions with Iran. All of these events are, to some extent, already under way.
This makes planning for a significant slowdown or even recession in Russia is not just an exercise in counterfactuals; it’s an essential piece of how MNCs should be thinking about protecting their business in Russia and preparing it to take advantage of the opportunities a recession will no doubt bring about.
Consumer spending will remain high through H1 2012, benefiting the consumer goods and technology sectors. However, a struggling industrial sector and a rise in inflation will reverse this trend starting in H2 2012.
Drivers
Historically low inflation, averaging 6.1% in 2011, will support household spending through H1 2012. However, utility and residential tariff hikes scheduled for June will lead to a sharp uptick in consumer prices in the second half of the year.
Unemployment, at 6.1% in December, is at a historic low and is supporting a positive consumer outlook.
High energy prices are supporting the ruble, driving up consumer demand for imported goods.
Frontier Strategy Group View
High consumer spending will buoy demand for consumer goods, pharmaceuticals, consumer electronics, and durable goods through the first half of 2012.
A decline in energy prices remains a downside risk to the broader Russian economy, including to the consumer sector.
Over the next two years, some of the social spending increases promised by Vladimir Putin during his presidential campaign will be carried out, providing support for Russian consumers.
Social spending increases will have the strongest impact on sales of fast-moving consumer goods and out-of-pocket pharmaceuticals.
Original article appeared in Business Insider
MNCs should anticipate some political and economic liberalization, particularly among regional authorities, after Putin returns to the presidency. However, we expect any new reforms to have limited positive effect on the business climate in the country.
In the short term, Russia may see increased investor uneasiness paired with ruble depreciation and capital outflows, as the elections will be followed by protests. However, we expect the situation to stabilize and investor confidence to return by 2H 2012.
Putin is neither willing nor capable of delivering the reforms demanded by the Russian middle class. Over time, this will erode Putin’s legitimacy and power base. To avoid large-scale political change that may threaten their personal wealth, Russia’s political elite may decide to sacrifice Putin in a partial political liberalization that would see him replaced before his six-year term as president ends. This scenario is particularly likely if there is a major external economic shock, such as a sharp decline in energy prices.
As exports and consumer demand slow and regional governments seek to reduce spending, growth is weakening across the region and a difficult year is ahead for both B2B and B2C MNCs. GDP growth forecasts will likely be revised further down as CEE economies struggle with continuing volatility and recession in the eurozone. Kazakhstan and Russia continue to benefit from high energy prices, but remain vulnerable to an oil price decline
- Bulgaria: The economy will slow in 2012, but a conservative budget will act as a buffer against an external macroeconomic shock
- Croatia: Croatia is in for a challenging 2012 that will bring austerity measures, pain for local consumers, and possibly a recession
- Czech Republic: Avoiding a deep recession in 2012 is possible if there is clear progress on the eurozone crisis and the German economy remains strong
- Hungary: The government will struggle to regain investor confidence as its controversial policies are undermining market trust in Hungary
- Kazakhstan: MNCs can expect continuity in government policies and populist measures in 2012
- Lithuania: The liquidation of a major local bank threatens to offset the budget this year and may mean more austerity measures
- Poland: MNCs pursuing investments in Poland are well-positioned to capitalize on the country’s undervalued currency
- Romania: Romanian consumers remain deeply pessimistic about the economy’s prospects, a trend that will impact consumer goods MNCs
- Russia: Economic performance will slow only moderately as the government will support high consumer spending ahead of the elections
- Serbia: The key driver for Serbia’s growth this year remains the economic performance of the eurozone
- Slovakia: The consumer outlook remains negative through 2012 as any new government would have to cut public spending
- Turkey: Economic growth will slow gradually over the next several months
- Ukraine: Growth will slow this year and could decline sharply if commodity prices drop as a result of the recession in the eurozone
Full article on MarketWatch
Russia’s acceptance into the World Trade Organization last month didn’t just mark an end to nearly two decades of negotiations, but opened a door to free up global trade with a nation that is one of the world’s largest oil producers and home to the globe’s biggest natural gas reserves.
And if the impact on the last large economy to join the organization — China — offers any clue, the outlook for Russian trade and its economy has much improved.
On Dec. 16, the World Trade Organization approved Russia’s membership. WTO trade ministers have said Russia’s accession to the organization will bring the nation more firmly into the global economy and make it a more attractive place to do business.
“Russia took 18 years to complete its WTO negotiations, but in the end it walked away with a great deal,” said Martina Bozadzhieva, senior analyst for Central and Eastern Europe (CEE) & Russia at Frontier Strategy Group. “Over the long term, WTO accession will increase the competitiveness of the Russian economy and [foreign direct investment] inflows.”
The outlook for Central and Eastern Europe is getting gloomier by the day as the eurozone crisis is weakening regional economies. While there is a significant level of volatility and uncertainty around the eurozone’s performance in 2012, there are several clear trends that will impact MNC performance in CEE this year:
- 2012 GDP growth projections are low across the region and will be revised further down
- Decreasing exports will hurt local producers
- Tight lending will limit local companies’ ability to make investments and will dampen consumer demand
- Austerity measures across the region will slow government and consumer spending but will ease inflation
- Local currencies will remain volatile and weak against the dollar
MNCs should plan to adapt their product portfolios, purchasing policies, and partner relationships to respond to weaker demand and tighter lending conditions in CEE.
However, not all CEE markets will fare the same – some will be impacted more than others (see table).
This creates opportunities for MNCs that pay attention to the nuances of the different regional economies and zero in on the markets that will outperform the rest of the region. The two most obvious ones are Poland and Turkey. In Poland, resilient domestic demand will sustain growth despite the negative impact of slowing export demand. Turkey will definitely see a slowdown this year, but its macroeconomic fundamentals remain solid and the country offers excellent opportunities for long-term growth. Both countries are presently experiencing currency depreciation, creating opportunities for cheap investment and acquisition of attractive local assets at a discount.
Trend
The ruble is depreciating against the dollar as markets anticipate Russia will run a deficit in 2012. We expect the Russian government to intervene in the foreign exchange market in Q1 2012, but a significant decline in oil prices could lead to rapid ruble depreciation as Russia would lose the hard currency necessary to support the ruble
Drivers
- The eurozone crisis is driving investors away from emerging markets currencies, including the ruble. The result is a stronger dollar which will put downward pressure on oil prices. Low oil prices will in turn weaken the ruble in H1 2012
- Weak exports combined with Russian demand for imports (see Trend #2) are also contributing to a weaker ruble
- Large capital outflows, expected to reach over US$70 billion for 2011, are putting downward pressure on the ruble. The outflows will continue to impact the exchange rate at least through the March 2012 elections
FSG View
- We expect the ruble to remain weak through H1 2012 and to depreciate significantly when the eurozone crisis leads to a decline in oil prices
- The Central Bank of Russia is able and willing to intervene to keep the ruble from depreciating significantly and will do so increasingly as elections draw near. However, it does not have the firepower to offset the effects of a sharp decrease in oil prices
- A weak ruble will contribute to the gradual deterioration of Russian consumer outlook in late Q1 2012 and negatively impact B2C companies and MNCs importing into Russia. Companies producing locally will be well-positioned to take advantage of consumers switching to cheaper, domestically-produced goods
- The weaker ruble will strengthen the position of Russian exporters but will not compensate for the decrease in demand from European markets
- MNCs need to factor a weaker ruble and higher volatility in their planning for 2012 and consider forward-pricing and hedging strategies to limit the impact of a weaker ruble on their business
(Image from Euronews)
The popular protests following the latest Duma elections revealed a fundamental shift in Russian popular opinion which has been forming for over a year now: as Russians realize that the economic prosperity of the pre-crisis 2000s is slowly but surely turning into long-term stagnation, they are no longer ready to pay for it with their political freedom and sense of personal dignity. Russians feel humiliated by a state they see as increasingly captive to interest groups and corrupt officials. This is bad news for Russia’s political elite, but good news for multinationals.
We are not seeing an Arab Spring in Russia, and neither is any opposition group or personality powerful enough to galvanize the disenchanted voters. Barring a major Black Swan event, Putin will return to the presidency in March for a six-year term. However, the legitimacy of his power has been undermined and will continue to be, making him a weaker leader. As Russians increasingly demand change, he may be able to last through his six-year term, but he is unlikely to be elected for another one. Meanwhile, the power groups that stand behind him may decide an unpopular Putin is a liability they don’t want to bother with. A post-Putin Russia is much more likely to be ruled by a political leader unofficially promoted to national prominence by the established elite, than by an opposition leader who will be an outsider to Russia’s power circles.
For multinationals, this means that the overarching political environment in the country will remain unaffected in the short term, but there will likely be some reshuffles and instability within Russia’s elite, including among high-level state officials. To respond to demands for change, Putin will introduce some new faces to the government after the March elections, and MNCs should be positioned to engage with them through a more nuanced government relations strategy.
The perception of increased political risk will continue to drive capital outflows from Russia, putting downward pressure on the ruble and contributing to rising inflation. Capital markets, already highly sensitive to risk in Emerging Europe as a result of the eurozone crisis, will be cautious at best on Russia, making financing more costly to Russian companies. As a result, MNCs should expect high volatility on the Russian market at least until the outcome of and reactions to the presidential elections in March are clear.
And while MNCs will likely see some of their Russian partners struggle with tighter lending and a weaker ruble, this period will create opportunities as well. We expect high government spending through the March elections as Putin seeks to appease the population. The weaker ruble and higher volatility also make this an opportune time for MNCs interested in pursuing M&A. Even major Russian companies are increasingly struggling to raise money on the global capital markets, creating opportunities for strategic acquisitions by MNCs with a long-term vision for the Russian market.
As Western Europe continues to struggle with the sovereign debt crisis and currency depreciation, declining exports, and lower 2012 growth prospects engulf Central and Eastern Europe, the outlook for Russia seems surprisingly solid. Despite a slow downward revision of 2012 growth forecasts from earlier this year, Russia is still projected to grow at about 4% in 2012.
However, the 2008-2009 crisis made it painfully clear that Russia is not and cannot be an island of stability when European and potentially global markets are in turmoil. Since 2009, Russia has grown even more dependent on energy exports, with its 2012 budget balancing at oil price of over $110 per barrel.
In the short term Russia is growing on the back of strong consumer demand, but this in no way eliminates the significant downside risk of an oil price decline. With the Eurozone already heading into a mild recession and the possibility of global financial market contagion, a significant decline in oil prices is a real possibility. A drop in oil prices could unleash a chain reaction (see graph) that would undermine Russia’s economy and, at best, depress Russia’s GDP growth.
For MNCs, this means having contingency plans for a significant downturn in Russia over the next 6-8 months to address ruble depreciation and declining demand on the domestic market.
On the positive side, MNCs should also be prepared to take advantage of M&A opportunities as attractive local assets will be priced at a discount.
In the long term, the Russian market continues to hold significant opportunity for foreign companies, especially after the country joins the WTO later this year. However, MNCs need to account for the significant risk the Eurozone crisis is posing to Russia’s performance in 2012 and be prepared to respond to rapid changes in the market.
The criteria MNCs use to evaluate their distributors are designed to maximize the speed and breadth of initial market penetration, but over the long term incentive distributors to seek short-term gain rather than support their foreign partner in establishing a strong market presence.
Implications for MNCs:
- As a result of this evaluation process, most MNCs have developed distributor relationships that are optimal in the early stages of market entry, but over time become less useful
- However, many companies fail to upgrade and restructure these relationship to position themselves for long-term growth.
