Russian Economic Forcast in 2010

Last week while attending the 2009 International Investment Forum in Sochi, Russia, I managed to obtain a glimpse of where the Russian economy is heading for 2010 and beyond.

The aim of my visit to the Russian resort city on the Black Sea, was to participate in the Forum in order to have a clear view of the opportunities that the Krasnodar region and Sochi will offer for a business client. Of interest was the short term / mid term construction developments and opportunities in the Krasnodar region linked to the Sochi Olympics in 2014.

Prime Minister Vladimir Putin, opened the forum’s first session where he participated in a forum discussion along with Jeffrey Immelt, the Chairman & CEO, of General Electric; John Mack, Chairman of Morgan Stanley; and the founder and President of Texas Pacific Group Investment Fund, David Bonderman which represents the largest private equity investment firm in the world.

Putin made several announcements regarding new mechanisms for economic recovery to attract investments in the construction of infrastructure, power stations, roads, railroads and residential housing. He also announced the lowering of interest rates at the central bank.

Morgan Stanley’s CEO remarked that since the crisis, there are $5 trillion in the US and $7 trillion in Japan now waiting on the sidelines. As this money moves into the investment market, Russia will be a “huge benefactor of that capital.”

Because of the rising BRIC (Brazil, Russia, India & China) economies, the CEO of General Electric announced that already 80% of their operations are outside of the U.S. which partly includes Russia. The CEO’s presence in Russia was an initiative to further increase GE’s presence in Russia to take advantage of Russia’s vast opportunities.

Most of the above mentioned forum participants noted a reduction in corruption and an increase in transparency, specifically in the Krasnodar region. Krasnodar Governor Tkachev was congratulated for his efforts to improve the business climate in Krasnodar.

According to public information, the Russian government conservatively estimated last year that the 200 construction projects for the 2014 Olympics would cost $12 billion. The state promised to inject up to $7.5 billion, with the rest coming from the private sector. With the accounting of ruble losing against the dollar, the total amount has been reduced to $9.2 billion. The government estimates at least $2.5 billion will be invested by the private sector in Sochi alone.

According to the Forum organizers, 112 agreements amounting to €13.8 billion were signed at the forum:
- 64 agreements among them to the amount of €8.4 billion were signed by 11 Russian regions.
- The Governor of Krasnodar signed 35 agreements amounting to €4.4 billion.
- Krasnodar Region presented 1,500 investment projects totaling €27 during the forum

I also got the chance to meet privately with officials from the Construction Department of the region of Krasnodar, where much of the construction is ongoing. They also noted that there are opportunities in this region that are unrelated to the Olympics in infrastructure, logistics, and agriculture. International contractors are welcomed and needed to assist the local construction sector.

According to the Krasnodar officials, decisions can be and are made locally. I also heard from some other Russian government officials that they are encouraging the decision making process to take place locally and to not rely on the government or Moscow.

One of the complaints among Russian business participants was regarding business credit and financing. Russian banks were previously charging interest rates as high as 20% . One such critic of doing business in Russia was German Gref, Chairman of Sberbank. However, Putin replied back to Gref that the banks should lower their rates eventually down to 6% embarrasing the head of Russia's largest bank. According to one of my contacts at U.S. EXIM Bank, some previous recipients no longer need to rely on U.S. export products due to their success in Russia. However, foreign companies selling U.S. content in Russia can rely on U.S. EXIM products to reduce risk utlizing some of the stronger local Russian banks. As of this week, the Central Bank of Russia announced it will slash its rates to 10% and further rate cuts are predicted to follow.

Driving along the road from the Sochi seaside to the Krasnaya Polyana Olympic village where I was staying, there was much evidence of extensive construction, new roads, tunnels, bridges, power plants/electrical lines, and the beginning construction of a high-speed rail. Also interesting was the evidence of opportunities in the Krasnodar region not related to the Olympics. Besides the need for affordable residential housing, roads and infrastructure, Krasnodar offers tremendous opportunities in wine production, agriculture and timber.

Interestingly, other regions within and outside of Russia were also being promoted at the Investment Forum from Armenia, the Crimean region of Ukraine, Kalmyk Republic, and Caucuses.

I also heard from other Russian businessmen who reported movement in the construction sector was starting up again in the Moscow and St. Petersburg regions due to government intervention during the economic crisis.

In conclusion, Russia offers tremendous opportunities in construction, agriculture and infrastructure development which will offer long-term opportunities for investors. The forum portrayed optimism that Russia and the neighboring region will be a magnet for investment as the global economy recovers. Already Russia is in 5th place for foreign direct investment inflows according to the U.N. Conference on Trade and Development only behind the U.S., France, China, and Britain.

Despite the global economic fallout, Pepsi, Boeing, and John Deere have announced substantial large scale investment plans in Russia for 2010. As energy prices stabilize to normal levels, and demands increase on Russian commodities from China and India, new opportunities will open up in 2010:

• New wave of privatization – Experts predict that since the economic crisis, over 50% of the Russian economy is at least temporarily under state control. As major developers and retailers went bust and construction projects came to a halt, Russia’s top largest banks were forced to step in and take stakes in these indebted companies converting more debt into equity. However, experts believe this is a short-term trend. Recent government announcements indicate a new wave of privatization is taking place as the government offers stakes in these companies to private investors in order to close the gap on the deficit and to avoid heavy reliance of energy prices to maintain normal levels in the state coffers. This trend is also expected to follow with a new wave of mergers and acquisitions as private investors take advantage of lower prices, especially in the real estate sector.

• Krasnodar Region – Sochi will host the 2014 Winter Olympic games marked by heavy investment and construction of the Krasnodar infrastructure systems, Casinos and Black Sea resort developments.

• Energy – Russian oil production output this year has reached record highs since the fall of the Soviet Union. Russia’s Gasprom reports that gas exports to Europe have finally stabilized since the last year’s gas issues. Merrill Lynch Russia predicts oil will rise to $82/bbl before the end of 2010.

• Agriculture and Forestry Sectors – Russia, Ukraine and Kazakhstan contain the world’s largest land areas for agriculture and forests. At the height of last year’s economic crisis, Russia reported the largest grain harvest since 1990. This sector continued to grow in 2009 and vast untapped lands will attract even further agricultural development.

The presence of Morgan Stanley, GE and other US heavy weights support this conclusion. TRP

The Chicken or the Egg - A Free Market System or Democracy?

As I am writing, the Western media is focused on the Russian elections. In the U.S. in particular, the coverage is spun to show that the elections are proof Putin is dominating all aspects of Russian life and stifling what was left of a once emerging democracy. What is often not mentioned is that the opposition movement to Putin or "Other Russia" relies on the outlawed "National Bolshevik Party" movement for its boots on the streets in anti-government demonstrations and rallies. A prominent component of the "Other Russia," the National Bolsheviks share more in common with the radical leftist organizations that often battle with riot police in the capitals of numerous Western countries than any peaceful democratic movement. Interestingly, statements from the U.S. State Department constantly scold Russia for rolling back democracy. No wonder why the average westerner already is convinced that Putin is restoring the Soviet Union!

Despite all the alarm over democracy in Russia, the fact remains that capitalism is alive and well according to all the economic data which strongly contradicts suggestions of a return to Soviet style socialism. Is the widespread popularity for Putin in today's Russia a result of everyday Russians being nostalgic for a return of the Soviet Union? The answer is no. Anyone who has been in the Soviet Union or the "democratic" Russia under the chaotic 1990's knows that Russians do not wish to turn the clocks back to either period. Today, even in smaller cities, one can see for themselves an emerging middle class that spends their leisure time in newly built shopping malls while the number of automobile owners is rising. Evidence of this fact is by the sheer number of retailers opening up businesses throughout Russia (including Siberia) and the arrival of Western auto manufacturers who are setting up plants in Russia in order to keep up with the demands of the Russian consumer. Even Ford has entered the Russian automobile market while its factories in Detroit are on the brink of bankruptcy.

In summary, there are many factors that demonstrates that the Russia of today is quite different from the previous Soviet one. Among these factors are private ownership, freedom to practice religion, and other freedoms that were previously banned but encouraged in today's Russia. And thanks to Putin's reforms, Russia has begun to reduce its size of government and implement a 13% flat tax to the envy of many pro-business economists in the United States! Although one can argue on how democratic Putin's Russia is or isn't, one thing is for sure, Russia is embracing free market policies that are certainly more liberal than currently in the United States.

By no means is Russia yet an ideal place of opportunity as compared to the United States, it is however on the right path. Let us not forget that before there was a United States, colonists lived under the authoritarian rule of the English King. Thanks to the ingenious American Founding Fathers, the United States was ushered into history on the foundations of free market principles. Today the Founding Fathers would gasp at the size of the current U.S. government and how intrusive Washington has become.

During the Cold War period, Ronald Reagan often cited that economic prosperity taking place outside the walls around the Soviet Union would eventually help defeat Communism. He argued that the Soviet government had an ineffective economic system that was doomed to fail and of course he was right. Eventually Moscow could not control the millions of people trapped behind the "Iron Curtain" when they realized that on the other side was a better life awaiting. By the end of the Cold War however, the West and in particular the U.S., squandered the opportunity to help lead these peoples to real prosperity. Rather than allow the newly freed peoples of former Soviet republics, and other former communist countries the opportunity to pull themselves up by the boot straps, the Euro-Atlantic alliance decided instead to divide and conquer them. Firstly this was tested when a newly united Germany took center stage in the international arena leading a united Europe to recognize the independence movements in Slovenia and Croatia thus breaking up Yugoslavia - the most multi-ethnic country in Europe, and certainly the least autocratic of their communist neighbors. Next, was to foment revolutions in governments that may lean towards Moscow. As some of these former communist countries embraced Europe and the United States, they received the coveted title of being "pro-Western, regardless if they are genuinely democratic or try to implement real capitalism. In other cases, the pro-Western politicians came from the same government that was previously subsidized from a bankrupt Moscow. These pro-Western countries simply swapped their allegiances and began taking handouts from Brussels and Washington. The irony however, was that instead of embracing the free market reforms that Reagan advocated for the peoples within the Iron Curtain, a new European Union emerged that absorbed some of these former communist regimes morphing into a new super state. Today, the EU micromanages the European economy while its ineffective beau racy will soon rival the managed economy of the Soviet Union!

By the time Vladimir Vladirmirovich Putin became the president of the Russian Federation, the Russian economy was in a shambles while its former communists neighbors where enjoying growing prosperity after their governments sold off state assets. This initial period of privatization allowed a quick influx of hard currencies to enter their economies as Europeans and other foreign investors began to snap up state run enterprises. However, as these countries become integrated into the European bureaucratic apparatus, Brussels can now dictate how these countries must run themselves rather than allowing the market to drive the economy. For example, the EU can tell the Poles how they should label and define vodka rather than allowing the Poles themselves. There is no question that much of the former communist bloc has benefited by the technical know how and investments from Europe after the USSR collapsed. Even the intent and idea of uniting the European markets is novel at least in theory. But in any case, EU expansion is running out of steam as is evident of the status and performance of newly admitted EU members Rumania and Bulgaria, more evidence that it is not EU membership alone the magic wand that can bring about economic prosperity but rather real free market implementation.

Case in point is the once former Soviet republic Moldova. Moldova is officially an independent country no longer under Moscow's rule. However, the Transdniester region of Moldova (predominately Russian speaking area) separated itself from the central rule of Chisinau, the capital of Moldova. Moldova receives backing and support from the United States, NATO and the EU. Moldova also has started the path to the necessary reforms for EU accession. Why that Moldova is then is one of the poorest countries in Southeastern Europe? Across the Dniester River, one can look at a contrasting picture when you consider the breakaway Transdniester Region. This area which is de facto independent of the "pro-Western" government in Chisinau is experiencing high economic growth while attracting outside investment. Today rosy economic reports are coming from Tiraspol, the capital of Transdniester. Since they have also adapted an even smaller flat tax than Russia, reduced government bureaucracy, and created a more business friendly environment than is the case outside of Transdniester, this region will ironically be better off without EU's intrusion. Could this serve as a new model for other former communist countries who may grow tired of a stagnant EU?

Always follow the money. Signs already may suggest that "pro-Western" countries may again swap allegiances as Moscow grows prosperous. The vehemently pro-Western government of Georgia is facing stiff opposition and growing street protests. In Serbia, where the U.S. is the largest single investor in that country, may soon see Russian capital flowing in. Especially with the fate of Kosovo-Metohija and the U.S. attempts to centralize Bosnia, Serbia may soon realize it could benefit from a closer relationship with Moscow. Next door to Serbia, the Serb Republic within Bosnia Herzegovina is also enjoying support from Moscow to counter attempts by the U.S. to integrate the Serb entity into a Muslim dominated centralized state. If this trend continues, the Serb Republic could also follow the "Transdniester Model" to build a more prosperous free market outside of Sarajevo and U.S. control. Even the new pro-business government of Poland is pledging to strengthen Moscow - Warsaw ties, and I predict that if Russia continues its economic success, more of her neighbors will try to get into the action.

Throughout the world one can find examples of how the free market can win. While the U.S. wastes its time on trying to build democratic institutions in Iraq, it should instead focus on building a free market there first. While factions butcher each other in that country, Iraq's other oil rich neighbors Saudi Arabia, Kuwait, United Arab Emirates, etc., enjoy unprecedented prosperity and relative stability while being ruled by undemocratic monarchs. Even U.S. ally Egypt is faced with a similar situation of trying to build a free market system before it can democratize. Although some of Egypt's opposition faces a similar fate to Russia's opposition, Cairo has enacted reforms to cut taxes and encourage a free market. Should Egypt's President Mubarak lose his grip on power, the Muslim Brotherhood will surely win elections and establish an Islamic regime in Cairo creating more instability in that already volatile region.

Time will tell which side will win as the war between socialism under the guise of democracy, versus free market capitalism continues to wage for hearts and minds throughout emerging markets. If the West, i.e. European Union continues to embrace "socialist democratic" policies, it will too implode like the USSR. Will the peoples of Europe and especially former communist countries benefit from a chaotic but democratic Russia or a stable free market one?