THE Western European view of Russia has not moved with developments in the country since the crash of 1990. To the Western media, Russia remains a kleptocracy run by the mafia. It is seen as secretive, corrupt, plutocratic, hugely unequal and unjust.
Yet the challenges that Russia faces are not unique in the world of emerging markets – look at Saudi’s vulnerability to swings in commodity prices; Mexico’s income inequality and plutocracy; Malaysia’s political jackbooting; and Argentina’s corruption and recent property grab. Russia’s challenges are entirely consistent with the level of its affluence and stage of economic and political development. And while Vladimir Putin’s re-election is widely considered regressive, we see it as the beginning of another cycle of transformation of the world’s largest country into the vibrant economy it deserves to be.
To understand why, we must appreciate one very important and obvious correlation. The staying power of Russia’s ruling regime is determined by its ability to raise living standards by generating economic growth. In 2012, the traditional sources of that growth are all but gone.
Today the ruble is fairly-valued; there is scant room for production growth in the extractive industries; the oil price is unlikely to rise fast from here, and, even if it does, it would not be good for Russia anyway.
Putin must therefore find new sources of growth to lift GDP and diversify away from a dependence on commodities which currently controls Russia’s fortunes and make it vulnerable to market gyrations.
Putin has, therefore, no choice but to engage in dynamic policy action. This is what we think he will do:
■ A Kremlin privatisation programme, the largest in the world, will increase productivity sharply. The over-expanded Russian state has become a hindrance to growth. It must be pruned.
■ Red tape will be cut and regulation improved to support business, especially small and medium-sized firms, by streamlining taxation, providing investment incentives and, inevitably, tackling corruption. Putin will know that corruption is best tackled from below, rather than top-down where it is usually most entrenched.
■ Putin will preside over one of the largest-ever infrastructure cycles – about $1 trillion (£616bn) – which will lift potential GDP by at least 1-2 per cent a year, upgrading Russia’s dilapidated infrastructure and generating mass employment. This will create an entirely new value chain of companies and huge wealth on the stock market, judging by the precedents of China, India, Malaysia, Chile, Singapore, and more recently, Brazil.
■ The floodgates to foreign portfolio and direct capital will be opened to generate high growth in investment. The local corporate bond market attracted institutional flows never seen before after its infrastructure was upgraded to world-class level in 2011. Only 4 per cent of it is owned by foreigners; getting to 20 per cent – the median in emerging markets – means $50bn annual inflow for a few years. This will reduce the cost of financing and increase return on investment.
■ He will dramatically improve corporate governance. Ossified and corrupt managers will be replaced by professionals with strong track records. Cash, previously stolen, hoarded or wasted in dubious capital expenditure will be returned to shareholders via buybacks and dividends.
■ Lastly, Putin will put in place a comprehensive pension reform, ensuring that a domestic investor base is built, smoothing asset market volatility.
In 1990, the Russian economy had a $2.9 trillion output, second only to the US. Today, the Chinese economy is more than three times larger than Russia’s, which has slipped to ninth position. Putin’s measures will mimic the steps that made China what it is today and provide exceptional opportunities in the next few years.
Russia looks like many other countries of the same level of development – governed by a system that is part democratic, part authoritarian; informed by partly-free media; and powered by an economy tied to the commodity cycle.
To the savvy investor, however, Russia is a treasure trove of opportunity which is likely to translate into some of the best investment returns in the world. This will be the true rebuilding of a superpower. Russia 2.0 starts now.
Plamen Monovski is chief investment officer for Renaissance Asset Managers.