Investor, Go Home!
Last week the Russian government introduced for discussion in the State Duma legislation entitled "Concerning the Realization of Foreign Investments in Commercial Organizations of Strategic Importance for Russian National Security" that would limit the participation of foreign investors in 39 different industries. One of the reasons for the legislation is the unregulated flow of foreign investment, which has turned into one of the most important factors in inflation. This runs directly counter to the fiscal authorities' main goal for this year, which is curbing inflation.
A Flood of Investment
In 2006, according to the Bank of Russia, the volume of direct foreign investment in the Russian economy was $31 billion. If another $40 billion in portfolio investments is taken into account, then the overall volume of foreign investment in Russia in 2006 could be estimated at $70 billion. In the first half of 2007, according to data from the Ministry of Economic Development, the net flow of foreign investment into the Russian economy reached $11 billion, while direct foreign investment accounted for another $14.1 billon. The reason for the interest in our economy among foreign investors is obvious: prices for energy products are continuing to grow. On June 18, for example, the global price of Brent oil exceeded $75 per barrel. Over the first half of 2007, oil has appreciated on the world market by more than 25%. Such blistering growth rates cannot help but attract profit-hungry investors from all over the world.
In Russia, however, only a narrow segment of the crude materials sector and a handful of successful metals ventures, machine works, and retail enterprises interest foreign investors. Until recently, a large part of the Russian economy remained untouched by the general flood of external investment, and as a result, a serious investment imbalance developed in the economy. In order to redress that imbalance, between 2002 and 2007 the government enacted numerous rules and regulations that often contradicted each other and that served only to further muddy the waters. The recent legislation prepared by the Ministry of Industry and Energy, entitled "Concerning the Realization of Foreign Investments in Commercial Organizations of Strategic Importance for Russian National Security," is intended to make the rules of the game apparent to everyone and to impose order on the situation once and for all.
The restrictions will affect 39 industries that are considered strategic or related to classified government information. This is the first time that a full, exhaustive list of strategic industries has been compiled. Incidentally, classified government information was also referenced as the grounds for stripping foreign companies of their licenses to develop Russia's oil and gas fields (these industries are not on the list). The legislation will finally bring clarity to this issue. In controversial situations, however, no one is prohibiting potential investors from appealing to a specially-created government commission that is required to return its verdicts within six months.
The legislation treads on the toes of the interests of foreign companies hoping to work on the development of Russian oil and gas fields, and a negative reaction was not long in coming. On July 11, the European Parliament approved a report entitled "Prospects for the Internal (EU) Gas and Electricity Market," which says that no third-party countries should be allowed to purchase energy infrastructure in the EU unless these countries are prepared to reciprocate by opening their own markets. The author of the report, European Parliament vice president Alejo Vidal-Quadras, believes that Europe is too heavily dependent on supplies of energy from Russia and Algeria: "Let's say that Gazprom wants to buy infrastructure in Europe. This can be done only on the condition that Russia opens up [its] market to European companies."
Currency Control
The main beneficiary of rising crude prices on the world market is, of course, Russia's stabilization fund. On July 14, Russian Prime Minister Mikhail Fradkov signed another government resolution increasing export tariffs. According to the document, as of August 1, 2007, the duty on crude oil will rise from $200.60 to $223.90 per ton. The export duty on light petroleum products and liquefied hydrocarbon gases will increase from $147.50 to $163.20 per ton, and on dark petroleum products, it will increase from $79.40 to $87.90 per ton. The lion's share of these customs duties will be directed into the stabilization fund, meaning that this money will have almost no effect on the current state of affairs in the Russian economy.
However, the possibilities for increasing export duties and channeling funds into a piggy bank located outside the country's borders are limited. Oil and gas extraction companies will still turn a profit, and these profits, with prices rising worldwide, will begin to exert more and more noticeable inflationary pressure on the economy. The possibilities for channeling them into investment projects within the extraction sector are limited, since the volume of funds that the government leaves in the hands of these companies is insufficient for the realization of large projects. It is possible that the introduction of restrictions on foreign investors will be accompanied by a loosening of restrictions on domestic investment.
For the time being, companies in the raw materials sector are being obliged to sell their currency proceeds and lower the exchange rate of the dollar. In 2006, the dollar slid 9% against the ruble, and it has declined by almost a further 4% in the first half of 2007, driven partially by the overall tumble of the American currency against other world currencies. In analyzing the exchange rate of the dollar against the euro, the conclusion could be drawn that the exchange-rate inflation of the euro over 2007 and the first six months of 2007 is unfavorable thus far. However, the euro's behavior is linked with an unprecedented strengthening of the European currency (in the period under consideration, the euro was worth between 1.27 and 1.33 USD on the world market). In Russia, the relationship between the dollar and the euro ventured outside the limits set by the world market fairly often, since the supply of dollars in the country consistently exceeds demand.
Planning for the Future
The Russian Central Bank also has its oar in the water when it came to the weakening of the dollar and the strengthening of the ruble: the bank has been using the strengthening of the ruble as a means of fighting inflation. By throwing dollars into the market and buying up rubles, the Central Bank held down ruble inflation, and so far this scheme has succeeded. However, the strengthening of the ruble by 9% in a year means that imports are becoming significantly cheaper than domestically-manufactured products. Russian companies are finding it harder to export their products, since the excessive strengthening of the ruble is undermining their products' competitiveness. This is affecting all exporters, including exporters of raw materials. In addition, the Russian population is encountering greater difficulties in acquiring durable goods such as housing, since the dollar price of such goods is growing disproportionately.
The powerful influx of currency investment is becoming an inflationary factor in itself, as foreign investors arrive in Russia with their pockets full of currency, most often dollars. Even if they sell this currency directly to the Central Bank instead of on the stock market, the volume of rubles issued by the Central Bank will grow. In order to absorb these excess rubles, the Russian Ministry of Finance is continuing to issue federal loan bonds, while the Central Bank issues OBR bank bonds. On July 16, Russian Finance Minister Alexei Kudrin announced that the total volume of domestic borrowing will be 305.9 billion rubles in 2007, almost 8 billion more than was originally expected.
The government is introducing a few changes in its economic plans for this year: on July 16, deputy prime minister Alexander Zhukov announced that in 2007 the growth rate of GDP and industrial manufacturing in Russia would exceed 7.0%. In his opinion, total inflation in the third quarter of 2007 will correspond to the level of the same period in 2006 – 7.2%. So far, however, the government is not planning to revisit its predictions for annual inflation this year and expects that the final number will not exceed the 8% target set at the beginning of the year.
The World Bank is partially in agreement with this prediction: in its report from July 17, the bank confirmed the prediction that Russian GDP growth will hit 7%, but it indicated that annual inflation in Russia will be no less than 9% by the end of the year. After all, according to data from the Russian Ministry of Economic Development released on July 10, inflation since the beginning of the year is already 6%. Thus, the government is faced with trying to rein inflation in to around 2% in the second half of 2007. The task will be difficult, but it is not entirely impossible: in the second half of 2005, annual inflation was 2.8%, and in the same period of 2006 it was 2.4%.
It is generally thought that curbing inflation should not be an end in itself. It is possible that the government, in order to fulfill its anti-inflationary goals, has decided to go the road of limiting investment in the raw materials sector and to put a stop to the pumping of the domestic market full of excess dollars. If this is so, private investors should jettison their dollar assets.
What will happen to the dollar by the end of the this year?
Pyotr Neimyshev, a senior currency dealer at MDM Bank: "The fall of the dollar on the external currency market is tied to the negative news coming out of the US real estate market, sufficiently controlled inflation in the US, and relatively high inflation over the first few months of the year in Great Britain and the Eurozone. This gives grounds to suggest that the Federal Reserve will not raise dollar interest rates, while the Bank of England and the European Central Bank will resort to raising interest rates soon. In conjunction with this, the English pound rose to a level of 2.05-2.055, and the euro to 1.38-1.383. The ruble ahs also strengthened against the dollar…to a level of 25.4-25.45 rub/$.
In our opinion, this movement of the dollar cannot have a long-term, chronic character. Within a month or two, we are certain that the market will be fluctuating within the range of 1.34 to 1.37 to the euro and 2.01-2.04 to the pound. Moreover, by the end of the year we see the dollar strengthening against these two [currencies] to 1.32 to 1.3 and 2 to 1.98, respectively. With regard to the ruble, inflation in our country could oblige the Russian Central Bank to embark on some further strengthening of the ruble…we believe that the range of fluctuations in the near future (one to two months) will be 25.4-25.8 rub/$. The future entirely depends on the policies of the Central Bank."
Alexei Kitaev, financial department director at BIN Bank: "The sharp drop of the American dollar on the global currency market at the beginning of July was caused by negative information coming out of the mortgage credit market in the US and, in addition to that, to unfavorable macroeconomic statistics. The combination of these factors allowed the single European currency to reach a new historic maximum, exceeding the $1.38 mark.
Tendencies in the global currency market are also being reflected in the ruble/dollar pair. In only the last two weeks, the American currency has lost more than 1.1% against the Russian [currency], and since the beginning of the year the ruble has strengthened by more than 3.3%. The Russian Trade and Economic Development Ministry's official prediction for 2007 for the exchange rate of the dollar is 25.8 rubles at the end of the year, but the trend in the exchange rate of the dollar does not inspire optimism among investors. In the future, the ruble/dollar pair is going to depend greatly on the situation in the global currency market and will fluctuate until the end of the year in the range 25.0-25.8 rub/$. The Central Bank is also likely to strengthen the ruble if inflation is higher than planned."
Pavel Lukyanov, a leading analyst at Soyuz Bank: "It is difficult to point to a single reason for the falling exchange rate of the dollar that, on July 18, led to the euro/dollar pair reaching a historic maximum of 1.3833 during morning trading. Most likely, the strong fall of the dollar exchange rate that took place at the beginning of July, when the pair was still trading at 1.362-1.363, was the result of a convergence of short-term factors and the weakness of various US economic indicators, such as retail sales (a drop of 0.4%) or median personal consumption expenditures (0.1%). In addition, we cannot fail to note a gathering strong trend in the market that appeared as the result of a large number of bids for the purchase of the American currency. The current dynamic of the euro exchange rate with regard to the dollar appears sufficiently certain, and no technical levels where there could be a "stop" are expected in the near future. However, we believe that the mixed character of US macroeconomic statistics means that federal interest rates will not be lowered before the end of the year, which will serve as a life preserver for the dollar, and we do not expect a dramatic fall of the American currency relative to the current level. In our opinion, at the end of 2007 the euro/dollar exchange rate will be 1.36-1.39, which will mean a ruble/dollar exchange rate of around 25.4-25.6."
Vladimir Kravchuk, an analyst at Alfa Bank: "The basic conclusion that we've come to as a result of a special analysis of the ruble/dollar trends and cycles that are dominating the market is that the mid-range tendency to decline will remain. As was expected, the basic catalyst and driver [of this decline] was the fall of the dollar exchange rate against the euro, and the Russian Central Bank did not play sufficiently aggressively against the trend, allowing the ruble to strengthen against the US dollar. However, numerous special leading economic indicators show an approaching correction in the direction of an upswing capable of changing the short-term trend on the market. It seems to me that the future growth of the euro/dollar pair without a preliminary deep correction is unlikely; this should support the US dollar against the Russian ruble. Thus, our mid-range prediction for the exchange rate of the dollar is 26.295 rubles."
Vladimir Rozhankovsky, a senior analyst at the investment company Bars Finance: "The old dynamic of the dollar is the commitment of the US Federal Reserve to an exchange rate that weakens the America currency with the goal of increasing the competitiveness of the American economy, and, as a consequence, pushing down the US trade deficit. What is new in the dynamic of the ruble and the dollar is the position of the Russian Finance Ministry with regard to the strengthening of the ruble as a means of fighting Russian inflation, as Alexei Kudrin proclaimed more than a month ago. As a result, the Central Bank has stopped participating in currency trading, and the enormous numbers of petrodollars flowing into the currency market have had to provide their buyers with an additional discount. As a result of these two factors, external and internal, working in tandem, the dynamic of the strengthening of the ruble against the dollar will significantly overtake the dynamic of the weakening dollar against the euro. We see the dollar at 25.30-25.35 rubles by the end of the year."
Cumulative Currency Inflation
Month |
Cumulative Exchange Rate Inflation in USD, annual %
|
Cumulative Exchange Rate Inflation in Euros, annual % |
| 38718 |
1,2 |
0,9 |
| 38749 |
1,3 |
2,9 |
| 38777 |
2,5 |
2,5 |
| 38808 |
4,2 |
0,4 |
| 38838 |
5,2 |
-0,8 |
| 38869 |
5,4 |
0,7 |
| 38899 |
5,7 |
0,6 |
| 38930 |
6 |
0,4 |
| 38961 |
5,9 |
1 |
| 38991 |
5,9 |
1,1 |
| 39022 |
7,8 |
-0,2 |
| 39052 |
7,5 |
-1 |
| 39083 |
-0,1 |
0,5 |
| 39114 |
1,1 |
0,1 |
| 39142 |
1,6 |
-0,6 |
| 39173 |
2,7 |
-1,5 |
| 39203 |
2,1 |
-0,9 |
| 39234 |
2,7 |
-0,7 |
|
July 2007 (prediction): 3.8, -2.7
Cumulative Ruble Inflation, According to Data from the Russian Trade and Economic Development Ministry
| Month |
Cumulative Exchange Rate Inflation in Rubles, annual % |
| 38718 |
2,4 |
| 38749 |
4,1 |
| 38777 |
5 |
| 38808 |
5,4 |
| 38838 |
5,9 |
| 38869 |
6,2 |
| 38899 |
6,9 |
| 38930 |
7,1 |
| 38961 |
7,2 |
| 38991 |
7,5 |
| 39022 |
8,2 |
| 39052 |
9 |
| 39083 |
1,7 |
| 39114 |
2,8 |
| 39142 |
3,2 |
| 39173 |
4,1 |
| 39203 |
4,7 |
| 39234 |
5,9 |
|
July 2007 (prediction): 6.2
Dollar Exchange Rate Set by the Russian Central Bank
| Date |
Ruble Exchange Rate, per $ |
| 38728 |
28,482 |
| 38735 |
28,269 |
| 38742 |
27,989 |
| 38749 |
28,13 |
| 38756 |
28,252 |
| 38763 |
28,184 |
| 38770 |
28,19 |
| 38777 |
28,121 |
| 38784 |
27,994 |
| 38791 |
27,992 |
| 38798 |
27,702 |
| 38805 |
27,801 |
| 38812 |
27,692 |
| 38819 |
27,679 |
| 38826 |
27,567 |
| 38833 |
27,424 |
| 38840 |
27,242 |
| 38848 |
27,035 |
| 38854 |
27,02 |
| 38861 |
26,987 |
| 38868 |
26,984 |
| 38875 |
26,733 |
| 38882 |
27,083 |
| 38889 |
27,045 |
| 38896 |
27,033 |
| 38899 |
26,9423 |
| 38906 |
26,8781 |
| 38913 |
26,9631 |
| 38920 |
26,9122 |
| 38927 |
26,8718 |
| 38934 |
26,771 |
| 38941 |
26,793 |
| 38948 |
26,7364 |
| 38955 |
26,7998 |
| 38962 |
26,7542 |
| 38969 |
26,7625 |
| 38976 |
26,7667 |
| 38983 |
26,6712 |
| 38990 |
26,7799 |
| 38997 |
26,8102 |
| 39004 |
26,9314 |
| 39011 |
26,851 |
| 39018 |
26,7884 |
| 39025 |
26,7007 |
| 39032 |
26,6195 |
| 39039 |
26,6888 |
| 39046 |
26,5199 |
| 39053 |
26,2465 |
| 39060 |
26,2356 |
| 39067 |
26,3298 |
| 39074 |
26,2941 |
| 39081 |
26,3311 |
| 39092 |
26,4465 |
| 39095 |
26,577 |
| 39102 |
26,5075 |
| 39109 |
26,5575 |
| 39116 |
26,48 |
| 39123 |
26,3473 |
| 39130 |
26,2358 |
| 39137 |
26,2474 |
| 39144 |
26,174 |
| 39151 |
26,2086 |
| 39158 |
26,0476 |
| 39165 |
26,0109 |
| 39172 |
26,0113 |
| 39179 |
25,9252 |
| 39186 |
25,8286 |
| 39193 |
25,724 |
| 39200 |
25,7446 |
| 39207 |
25,7691 |
| 39214 |
25,8594 |
| 39221 |
25,8492 |
| 39228 |
25,9152 |
| 39235 |
25,8983 |
| 39242 |
25,9247 |
| 39249 |
25,9558 |
| 39256 |
25,9356 |
| 39263 |
25,8162 |
| 39270 |
25,7305 |
| 39277 |
25,4936 |
|
Euro Exchange Rate Set by the Russian Central Bank
| Date |
Ruble Exchange Rate, per euro |
| 38728 |
34,335 |
| 38735 |
34,294 |
| 38742 |
34,393 |
| 38749 |
34,049 |
| 38756 |
33,854 |
| 38763 |
33,573 |
| 38770 |
33,583 |
| 38777 |
33,329 |
| 38784 |
33,478 |
| 38791 |
33,521 |
| 38798 |
33,617 |
| 38805 |
33,398 |
| 38812 |
33,612 |
| 38819 |
33,578 |
| 38826 |
33,77 |
| 38833 |
33,959 |
| 38840 |
34,254 |
| 38848 |
34,543 |
| 38854 |
34,616 |
| 38861 |
34,676 |
| 38868 |
34,636 |
| 38875 |
34,539 |
| 38882 |
34,057 |
| 38889 |
34,03 |
| 38896 |
34,048 |
| 38899 |
34,2383 |
| 38906 |
34,3421 |
| 38913 |
34,1488 |
| 38920 |
34,0332 |
| 38927 |
34,1084 |
| 38934 |
34,2508 |
| 38941 |
34,2039 |
| 38948 |
34,3162 |
| 38955 |
34,2019 |
| 38962 |
34,2668 |
| 38969 |
33,9887 |
| 38976 |
34,0446 |
| 38983 |
34,1525 |
| 38990 |
33,9783 |
| 38997 |
33,99 |
| 39004 |
33,8393 |
| 39011 |
33,9048 |
| 39018 |
33,9677 |
| 39025 |
34,1075 |
| 39032 |
34,238 |
| 39039 |
34,1216 |
| 39046 |
34,3937 |
| 39053 |
34,8186 |
| 39060 |
34,8356 |
| 39067 |
34,6526 |
| 39074 |
34,7082 |
| 39081 |
34,6965 |
| 39092 |
34,4862 |
| 39095 |
34,3136 |
| 39102 |
34,4173 |
| 39109 |
34,3176 |
| 39116 |
34,469 |
| 39123 |
34,3015 |
| 39130 |
34,4555 |
| 39137 |
34,392 |
| 39144 |
34,4816 |
| 39151 |
34,4564 |
| 39158 |
34,6563 |
| 39165 |
34,6751 |
| 39172 |
34,6861 |
| 39179 |
34,7812 |
| 39186 |
34,9177 |
| 39193 |
35,0387 |
| 39200 |
34,9972 |
| 39207 |
34,9609 |
| 39214 |
34,8585 |
| 39221 |
34,8706 |
| 39228 |
34,8041 |
| 39235 |
34,8177 |
| 39242 |
34,778 |
| 39249 |
34,6698 |
| 39256 |
34,79 |
| 39263 |
34,715 |
| 39270 |
34,9575 |
| 39277 |
35,1072 |
|
Maria Glushenkova and Pavel Chuvilyaev
All the Article in Russian as of July 23, 2007
|
