By Simon Pirani
Russia’s minister of economic development and trade, German Gref, talks exclusively to Emerging Markets about an economy in flux
EM: Do you think there is a danger of a bubble in the Russian capital markets?
GG: The Russian stock market grew by 83% last year and by 30.5% in the first two months of this year. In this respect Russia is the “absolute champion”. In terms of market capitalization, Russia is now moving into the group of countries, such as South Africa and Thailand, characterized as a “large volatile bubble” – where capitalization has grown by 200% but share prices undergo rapid vacillations. By February this year, the capitalization of the Russian market reached $604 billion, or 79% of GDP.
The growth of the Russian market has been conditioned by the successes of oil, metals and other natural resources stocks. The market is growing for sound objective reasons but, at the same time, is subject to speculative vacillations. Rising oil prices and the increasing flow of funds into emerging markets mean that the capitalization of Russian companies could grow still further.
Russian shares really are not cheap. But it is premature to talk about a bubble, since Russia is still cheaper than analogous emerging markets. The Russian market is also supported by a stable political situation, balanced macroeconomics and high oil prices.
It is worth looking at companies’ underlying numbers (asset values and real reserves), comparing them with current share prices and taking investment decisions on that basis. There are bubbles on the market for Russian paper – companies that are overvalued, and those that are fundamentally undervalued. It is this latter group that may perhaps be the source of further increases in the Russian market indices. So the problem of a bubble does exist, but considering that the Russian economy as a whole is undervalued, this is a problem not of the whole market but of particular companies.
EM: In your report to the government on March 2 you expressed concern about the low level of investment in processing industries, the poor competitiveness of those sectors and the resulting high level of imports of manufactured goods. What should be done, and what will be done, to tackle these problems?
GG: The growth of investment in fixed capital in Russia is stable. It hasn’t fallen below 10.5% annually for many years. But the other side of the coin is that this investment is a small proportion of GDP – about 16% – at a time when the economy faces a difficult task of replacing outdated equipment as quickly as possible and introducing new technology into production. That is the first requirement for making domestic industry more competitive.
However, businesses that seek to improve the quality of their products by introducing new technology usually have insufficient means to do so. The banking sector and the stock market are not effective as financial intermediaries. So it is left to those who can to issue domestic bonds or raise funds on the international markets. Foreign direct investment doesn’t play a substantial role, either: its share is 5.3%. It is not surprising that the state budget accounts for a big proportion, 19%, of investment in fixed capital. I can’t say that that is right and proper in a market economy, but it is a fact. So companies have to fall back on their own resources, which comprise 47.5% of investment capital. We are in a vicious circle.
In response to these problems, the government has hopes for private-public partnerships to support innovative infrastructure and social projects, all of which urgently require investment. We understand that significant investment is required by the state. But the state will participate in such projects as a co-financier with private capital, which will in turn make the use of state funds more effective.
EM: Are you satisfied with the progress of negotiations on Russian entry into the WTO?
GG: I am satisfied with the results, but not with the pace. If we look at what we have achieved in recent years in this respect, it is clear that Russia could already be a WTO member now. The changes to Russian legislation in accordance with WTO norms and rules are practically complete. But the process of joining the WTO doesn’t depend only on the Russian side, but to a large extent on the political will of our partners in other countries. This is where the process is being delayed.
We have said, and say again, to our partners: Russia won’t join the WTO “on any terms”, that is, with conditions that exceed the requirements met by other WTO members. That is unacceptable. Russia’s responsibilities under WTO rules – on import tariffs, on agriculture, on access to the market in services, on systemic issues – will be set in accordance with the real state of the Russian economy and its prospects of steady development.
EM: The issue of opening Russia’s banking and financial services market to branches of foreign-owned institutions has become an obstacle to concluding a bilateral agreement with the US. Why is this an important issue of principle for Russia?
GG: This is one of the most sensitive issues in the negotiations. It relates to foreign competition and economic security. Our proposals to the WTO proceed from the principle of guaranteeing equal opportunities to Russian and foreign bankers and insurance companies on the Russian market. We welcome foreign investment in our banking system and we are ready to offer banks with foreign participation the standard conditions that apply in the national market. But we are not going to create a situation whereby after, and as a result of, our joining the WTO, our national service providers are in a less favourable situation in their own country than their foreign competitors. Opening the market to direct subsidiaries of foreign banks would produce just such a result.
EM: Can you see a way to resolve this issue?
GG: We believe, as we always have, that in negotiations there are no insoluble problems. We see our aim as to create the conditions for Russian participation in the all-round trading system of the WTO, under which the government will be able to take well-prepared and timely decision on the possibility of granting access to direct subsidiaries of foreign banks to the Russian market. Our financial system must approach this decision in a smooth, evolutionary way, without any further shocks.