German expert praises comeback of Russian stock market

Andreas Männicke, born in Hamburg in 1955, is a founding member of KREMLIN AG and Beteiligungen im Baltikum AG. Both companies, which are listed on German stock exchanges, invest locally in listed corporations, respectively in Russia and in the Baltic states. Mr. Männicke advises funds as well as financial holding companies that want to invest in Eastern Europe. He is also managing director of ESI East Stock Informationsdienste, an online platform and print service covering Russian and Eastern European stock markets, which publishes the investor newsletter 'East Stock Trends.' He spoke to Modern Russia about the comeback of the Russian stock market and long-term prospects for foreign investors in the Russian economy.

You say the Russian economy is experiencing a comeback. What indications are there of this, and what are the reasons for it?

In contrast to many other countries, Russia’s state budget was not turned upside down by the crisis, thanks to oil revenues which allowed the Russian government to introduce large-scale welfare programs. Consumer demand, which amounts to 30 percent of the Russian gross national product, developed positively in the wake of an increase in real incomes. This was particularly beneficial to large retail chains like X5 Retail Group and Magnit, whose stock I also recommended in my stock exchange newsletter ’East Stock Trends.’ Following the recession of 2009, the Russian economy was able to recover and reach GNP growth of 3.6 percent in 2010 mainly due to high commodity prices and a robust consumer demand. The fact that Russian banks did not collapse in 2008-09, but on the contrary started to make profits again, thereby contributing to the stabilization of the Russian financial system, was also important. Inflation was kept to single digits in 2010 despite the wildfire crisis, which can be regarded as a success.

The rise in foreign direct investments (FDI) as well as the growing number of important joint ventures over the past year is another sign of investor confidence. For example, Pepsi Cola made the biggest foreign direct investment in its history in Russia by taking over Wimm-Bill-Dann despite prophecies of doom. The projected tie-up between Rosneft and BP also shows that Russia still appeals to major foreign corporations regardless of the bureaucratic hurdles. Of course, the Russian government needs to fight corruption more effectively and guarantee legal security for foreign investors. The easing of tensions in Russia’s relations with NATO and the U.S., which had worsened after the war in Georgia, contributed to the improved sentiment of foreign investors.

However, many industrial facilities and nuclear power plants - currently a sensitive issue - are outdated and Russia’s infrastructure often does not meet western standards. This is why the modernization campaign supported by President Medvedev is urgently needed. However, the situation also offers new opportunities for international cooperation that are useful for all parties involved.        

What are Russia's main strengths compared with other emerging markets?

First of all, the country’s vast natural resources are a fundamental strategic advantage, especially at a time of dwindling supplies of raw materials. Many industrialized countries like Japan and Germany do not possess these assets, while Russia is far more politically stable than other emerging markets that do have considerable raw material resources. Russia is a very reliable partner as far as energy issues are concerned. Furthermore, the Russian education system is more advanced than that of other emerging markets and the large number of young gifted Russian scientists could be helpful for modernization. 

Similarly, Russia has a higher literacy rate than many emerging markets. Certainly it could do more to promote its human capital, a step which facilitated Germany’s role as one of the world’s leading economies. But Russia already welcomes the contribution of western know-how to its own production process and acknowledges that the productivity of many state-owned enterprises can be improved considerably. I regard this as a great opportunity for intensified international cooperation with strategically important partners and western universities in future. I see great potential for synergies between Germany and Russia in the economic sector which could counterbalance the huge economic growth in Asia.        

Russia's stock market has outperformed most of its Western and emerging market competitors in the past two years. What are the prospects for Russian stocks in the short and medium term?

To a great extent, this depends on whether (and what kind of) external shocks influence the Russian stock market in the next few years. The past few weeks have shown how fast international stock markets react to shocks like a nuclear disaster in Japan or a war in Libya. Therefore, we continue to live in times of insecurity and a “black box” due to “black swans,” which can shake the world stock exchanges at any time. Looking at the stock market in Moscow in isolation, I would assess the medium and long term prospects as positive. In this regard, the further development of commodity prices is very important for the Moscow’s stock market. Should a “double dip” occur as a consequence of the nuclear disaster in Japan, a new financial crisis in Europe or a Jasmine Revolution in China or Saudi Arabia, Russia would also be negatively affected despite rising oil prices.

Considering the huge deficits of important industrialized countries like the U.S., UK and Japan, let alone the ‘PIGS’ states, there is likely to be monetary turmoil in the future. In Europe, analysts are already asking whether the Euro will collapse. However, the U.S. dollar will probably also face stability problems in the future due to the U.S. national debt and trade balance deficits.

Russia and China justifiably want to introduce the ruble and the yuan respectively as the world’s reserve currency. But the Russian stock market is still heavily dependent on foreign venture capital and stock market prices are just a statement of cash flow. If there is an outflow of venture capital for whatever reason, prices will fall on Moscow’s stock market as well. Conversely, they will increase if more foreign venture capital flows to Russia. Assuming that there will be no external shocks, I expect that the Russian stock market will continue to significantly outperform established world stock markets while offering annual returns of 10-20 percent. 

Which sectors and industries offer the most promising prospects for investors?

As long as commodity prices continue to increase, the raw materials sector will be one to watch due to its low rating. Apart from oil and gas, I would also recommend coal and fertilizer producers as promising areas for investment. Moreover, there are several growth sectors that are promising in the medium term like IT, logistics, telecommunication, retail and banking.

Russia has the second highest growth rates in the Internet sector after China, as well as the longest duration of time spent on websites, which is beneficial to companies like Mail.ru and Yandex. In the telecommunications sector a spurt of growth could be encouraged by the use of the new 4G and broadband technologies, which however, would have to be pre-financed with big investments.

Furthermore, the construction sector will probably gradually recover due to necessary infrastructure investments in the run up to the 2014 Winter Olympics and the football World Cup in 2018. The modernization of Russia’s transportation system by expanding the road and rail networks should certainly constitute part of the modernization campaign as well. Russia has to catch up in this field as it has missed out on a lot of opportunities in past years.

Also, the automotive sector has good prospects, with several promising international joint ventures on the horizon, though these will only bear fruit in a few years’ time. As we know, car production plants in Russia are outdated and the technology lags behind western standards. International cooperation could be a chance for Russia to catch up in this sector in a few years, and could make Russia one of the leading car markets in the world. I wonder when the first electrically powered car will be driven in Russia.

The high-tech sector is another branch that will probably cause a sensation in a few years, provided that Russia can successfully pool foreign capital and know-how. A good start in that respect was made by establishing the new Skolkovo research center near Moscow. Furthermore, I expect a quantum leap - and perhaps even a lead position for Russia - in the field of nanotechnology as the country has already performed remarkably in this sector.   Unfortunately, nanotechnology stocks are currently not yet tradable and it will take a little while for progress to show.               

Although a key asset, some also regard Russia's energy resources as a potential obstacle as the country tries to diversify and modernize its economy. What is your view on this and how can the energy sector contribute to Russia's modernization?

Everybody in Russia is aware that the raw materials sector and the sale of oil and gas in particular make the biggest contribution to Russia’s revenues. It would be desirable for Russia to use oil revenues  for the promotion of alternative energy, but Russia still has far too few solar and wind power plants, while energy efficiency is not yet sufficiently supported either politically or  financially. It may not be in the interest of the Russian oil and gas lobby, but the government could certainly push for this by offering certain tax incentives in the field.

However, energy companies themselves should also recognize the signs of the times and invest more money in alternative sources of energy. Further incentives for the promotion of innovation in the field of energy efficiency would also be reasonable. In addition, energy companies should intensify their financial contribution to the development of Skolkovo as they might benefit from innovations in the medium term.

Last, but not least, the modernization of Russia’s production plants would have ecological benefits. Emission trading could provide incentives in this field and Russia could simultaneously contribute to international climate protection efforts. Russian oil and gas companies should take the old BP slogan as their guiding principle: “There is much to be done – let’s get at it!”