Available Finance and the Chance of a Rate Cut are Positive Signals for Market

The economy is increasingly dependent on the oil price to support fading growth but real estate continues to benefit from a strong consumer market and potential for greater mortgage lending.

Tom Mundy

National Director, Head of Research

Jones Lang LaSalle, Russia & CIS

The year 2013 has been a difficult one for emerging markets. Equities have shed some 12 percent so far and debt  fared hardly better. The average yield on 10-year EM government debt has expanded by some 100 basis points since Ben Bernanke proposed tapering off quantitative easing. EM bond funds have seen 14 straight weeks of outflows. Such an extended run on debt has not been seen since the global financial crisis in 2008.

Russia has not been immune. Equities are down 12 percent this year, though this looks respectable compared to India and Brazil which are both down over 20 percent. In line with EM peers, debt has suffered too. The benchmark Russia 30 sovereign debt has traded up to 4.4 percent versus 2.6 at the start of the year with, of course, most of that jump coming after Bernanke's QE tapering comments.

The ruble is holding up a little better. Undoubtedly the conflict in Syria and the threat of Western military intervention has been the anchor, rather than any positive domestic growth driver. Fortunately with the average price for Brent through August at over $110 a barrel and little near term hope for resolution to Syria's troubles, this position is unlikely to change any time soon.

Nonetheless Russia is in a precarious position. The oil price cycle of the last decade has been an important factor in the growth in the Russian economy, but provides no guarantee for the future and Russia can no longer rely on the factors from which it has benefited over the past 10 years.

Apart from oil, the other factors that have supported the country's economic boom are: the massive growth in private sector debt which has funded investment by Russia's largest companies; the growth in capacity utilization by Russian companies after the economic woes of the Yeltsin years; a switch to a 13 percent income tax rate which has been hugely positive for the State's tax revenues and, importantly, growth in per capita income which was heavily impacted after the 1998 ruble default.

There appears to be ready access to financ- ing for large deals... you have some strong positives.

The momentum of these other drivers has faded and this is evident in the economic dynamics this year. Despite the stellar oil price the economic ministry recently downgraded its full year GDP growth forecast from 2.4 percent to 1.8: better than Europe, but a long way from the nearly 9 percent growth levels before the crisis. The Russian economy appears to be stagnating and the country's current weak manufacturing profile and low levels of investment growth have combined with a soft external environment — particularly demand for Russia's exports — to push down expectations for Russian growth further and further.

This brings us to the exception that is the real estate market. Perversely this low growth environment is contributing to a pretty robust backdrop for the sector. In the first half of this year, Russian real estate investment grew by 31 percent compared to the same period of 2012, with total investment volumes at $3.7 billion, with the majority of activity in the office and retail segments. This included record high investment volume of $2 billion in the first quarter, and second quarter investment volumes of $1.7 billion — very close to the record levels seen in the first half of 2011.

Russian borrowers also have access to financing and, assuming no inflation shocks, the Central Bank has room to move rates down from the current level of 8.25 percent. A move during the autumn is not impossible and developers are willing to bet that with the country's growth profile as precarious as it is there is little or no chance of a rate hike from the Central Bank in the foreseeable future.

Indeed there appears to be ready access to financing for large deals. In the first half of this year the number of deals over $300 million accounted for 12 percent of the total number (61 percent of the total investment volume for the period) — pretty much double that of the same period last year.

Combined with this, even if GDP growth is sluggish, the consumer is still a powerful force with the average Russian devoting an astonishing 60 percent of their private spending to retail. Add to this the fact that Russian mortgage penetration has barely taken off and you have some strong positives.