20.01.2005

The lack of market news events is becoming as tiresome as holiday leftovers. So far, no trend has gripped either the stock or bond market in Russia with the feeling that a lot of designated emerging market money is still sitting on the sidelines. On the one hand, the EMBI+ index, and the spread of Russia’s benchmark RF30 in particular, are tight relative to US treasury yields. And, with the prospect of no less than an additional 0.75% rate increases in the pipeline in H1’05, choosing your entry points correctly is quite important. On the other hand, Russia’s stellar growth of the past 6-years is fading, even as inflation remains stubbornly high. Russian companies are not investing due to political uncertainties, and therefore foreign investors have little incentive to jump into the stock market at them moment. Especially, as it is not clear how the government will handle recent street protests over its bungled implementation of monetized social benefits.

Against this background, it is indeed comforting to us that TASS has reported that President Putin and Premier Fradkov had a working meeting to discuss the current socio-economic situation in the country. At least some people take these things seriously and are prepared to meet to talk about them. But seriously, the IIF reported that net private capital flows into emerging markets increased by 32% in 2004 to $279 billion, the highest level since the Asian crisis in 1997. China and Russia mopped up 60% and 25% of the increase. They forecast that another $276 bio will be invested in 2005 with 46% going to Asia and 37% going to emerging Europe, including Russia and Turkey. Given a lack of concrete investment targets in Russia at the moment, it is hard to identify where this money will flow at the moment.

Gazprom has announced that plans to merge with Rosneft will go ahead as planned, and that the ring-fence around shares & ADRs will shortly be lifted after that. However, we do not expect any concrete actions in this direction until after Deutsche Bank’s motion before the Texas court to dismiss the US’ jurisdiction over the bankruptcy of Yukos is heard in February. Also, the free float of the combined $100 bio Gazprom-Rosneft-Yugansk behemoth may be restricted to 25% versus the 40% previously expected by investors. We still see a lot of details on the majority state controlled company that would need to be clarified before we can recommend it to investors.

Russia has announced that crude oil export duties will be cut from $101 to $83 per tonne as of February 1st. Current estimates of Russian production are 250 mio tonnes per year or approximately 9.4 mio bpd putting it behind Saudia Arabia as the second largest producer of oil. Russia consumes a little more than 2.4 mio bpd itself and exports another 5.0 mio bpd to international markets. The balance flows to former CIS states at below market prices. Certainly more transparency would be helpful in accounting for these differences given that OPEC is intent on enforcing its own production cuts of one mio bpd, and a 2 mio bpd swing in production can significantly move the world price of oil. Especially as we head into Iraq’s January 30th elections, and expected terrorist activities to coincide with this event and of OPEC’s own meeting. OPEC would like to see a floor of $40 for oil this coming spring and summer, but one fears that a serious terrorist strike in the meantime might send prices screaming significantly above $50 a barrel again.

It is interesting to clarify one recent economic number, which was released this week. Capital inflows of $81 bio versus an expected $55 bio more than offset a record $60.3 bio November trade deficit. However, there is a de-facto tax amnesty in place at the moment, whereby US companies can repatriate foreign profits at a reduced rate of approximately 5% versus the normal 35% level of corporate tax. This has encouraged a number of large US-multinationals to move money back to head office, and may be a on- off or limited time offer that flatters the strength of inward capital flows without addressing the causes of the twin trade & budget deficits and current account which is approaching 6% of GDP.

Certainly the rally of the US dollar as a result of these inflows, and the increasing appeal of US assets due to the expectation of higher growth and interest rate differentials is a welcome respite from last year’s weakness, but if the new Bush government is unable to address these external imbalances, then we are likely to see a resumption of the dollar’s declining trend. Both India and China have been invited to attend the G7’s meetings in London in February, but as we have said before, trade alone cannot address the US’ problems, in the absence of US price indifference to imports due to over-proliferate private and public consumption. Never the less, we would welcome stronger Asian currencies as a sign of their own new found sense of self-assurance and willingness to cooperate internationally as equals as importers, exporters and domestic consumers. Only then can they really take their place at the table with the rest of the G7 nations as true equals.