Russian Economy: Signs of Thawing

After the traditionally long and harsh Russian winter, spring is finally in the air in Moscow. And perhaps on the economic front, too, things may finally be looking up, after months of pain caused by the global financial crisis.

Russia is still hurting badly, of course. In recent months industrial production has been plummeting: down by 13% year-on-year in February, after a 20% plunge in January. This year the government expects Russia's gross domestic product will shrink by 2.2%, a significant turn for the worse following years of high growth, averaging 7% to 8% per annum. Many industrial enterprises are still in dire straits. A $1 billion bailout of Avtovaz (AVAZ.RTS), Russia's largest carmaker, on Mar. 30 was just one recent reminder of the huge social and economic challenges caused by this widespread industrial distress.

Yet despite these continuing problems, there are also some surprising signs of optimism. One rough-and-ready indicator of financial confidence, visible at exchange kiosks on every street corner, is the ruble exchange rate. Just a couple of months ago, the plummeting ruble was a phenomenon to behold. Despite pumping in around $200 billion to defend it, the Russian Central Bank was unable to prevent it from losing a third of its value.

Yet over the past couple of weeks the ruble has been firming up, gaining around 7% since its nadir in February. That's a vote of confidence in the central bank's new currency corridor. True, the ruble's recent buoyancy has a lot to do with the current weakness of the dollar. But the mood is noticeably calmer than a few weeks ago, when Russians couldn't rush fast enough to convert their savings and salaries into dollars. One result of this new financial stability is that the Russian central bank has hinted at cuts in interest rates.

A Lightening Mood

Of course, what matters even more is the performance of the real economy. But here, too, not everything may be quite as gloomy as recent production falls imply. Surveys of business confidence show that the mood among Russia's businesses is now slowly improving. One key survey, the VTB Capital Purchasing Managers Index, reached its highest level for five months in March.

True, at 42.0 points, the index is still below the 50 mark, which is the divide between contraction and expansion. But an industrial rebound may now be imminent, says Vladimir Salnikov, a researcher into industrial trends at Moscow's Centre for Macroeconomic Analysis & Short-Term Forecasting. "There are a lot of short-term factors which will probably stop acting in the next two to three months," he says. For example, many companies suspended production temporarily to clear surplus inventories.

Meanwhile, corporate announcements about acquisitions and expansion plans, conspicuously absent for many months, now seem to be returning to the news columns. A $1.9 billion acquisition by Russian oil company Surgutneftegaz (SNGS.RTS), which acquired 21% of Hungarian refiner MOL (MOLB.WA) on Mar. 30, is only the most high-profile example.

Foreign investors also appear to be once again setting their sights on the Russian market. On Mar. 31, French engineering concern Alstom (ALSO.PA) announced it was acquiring a 25% + 1 share stake in Transmashholding, Russia's largest producer of railway locomotives. (The sales price will depend on Transmashholding's financial results over the next three years, but it is likely to be hundreds of millions of dollars.) Despite the economic contraction, Alstom evidently sees long-term opportunities in a country that has huge needs to upgrade its transport network. In terms of physical output, Transmashholding is already the largest rolling stock producer in the world.

Multinationals Marching In?

Meanwhile the Russian press reports the U.S. fast-food chain Burger King (BKC) is on the brink of entering the Russian market, where it is already actively recruiting staff. That's an especially bold step, when you consider that archrival McDonald's (MCD) already has a massive presence in Russia. Such rumors suggest that multinational investors, who had frozen their overseas expansion plans during the crisis, are now mulling the post-crisis opportunities in emerging markets like Russia.

It is, to be sure, very early days. There's still plenty that could go wrong. The most serious risks relate to the Russian banking sector, where the share of bad loans—already around 10% of banks' portfolios—is set to rise sharply. The result is likely to be a serious shakeout, with many smaller banks expected to fold. That process will need to be carefully handled, if it is to avoid sparking bank runs and a systemic financial panic.

Even more depends on what happens to the global economy, which is crucial for the recovery of Russia's commodity exports. The recent stabilization in Russia largely reflects the similar mood now observable in Western economies. But despite the first tentative signs of improvement, it would be hard to argue that anyone yet has a clear idea of how and when the global crisis will end.

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