Three years ago, Russia-hating Senator John McCain insulted the country's escape from Soviet Communism by calling it a "gas station masquerading as a country." His comments were at least partially true. Russia is a commodities economy, and oil and gas dominates the country's budget. For the past decade, Russia has been trying to move away from its oil dependence. Goldman Sachs thinks they've finally done it.
So, sorry Senator...Russia is much more than a gas station.
Earlier this year, in fact, its biggest toy store chain, Detsky Mir, raised $355 million in an initial public offering on the Moscow Stock Exchange.
The Russian economy is increasingly becoming self-sufficient and less oil-price dependent, Goldman analysts led by Geydar Mamedov wrote in a report from their Moscow subsidiary dated July 5. Goldman and archrival J.P. Morgan became two of the top three firms with the most M&A deals in Russia so far this year. VTB Capital was also tops.
Russia's Finance Ministry’s focus on capping state expenses and making the tax system more efficient is translating into higher non-oil revenues in the budget. This is designed to reduce the state’s dependence on oil prices and cuts the break-even oil price for the budget. The impact of oil price shocks on domestic inflation, and the ruble should decline sharply in the years ahead, says Mamedov.
Russia had to redo its budget in 2014 when they priced oil to average out at $80, instead it was more like $60. They were forced to do the same in 2015 when they based oil prices on $60 per barrel for their budget. The cuts impacted military spending, but were also felt in poorer parts of Russia still reeling from the break up of the Soviet Union and back-to-back recessions.
Russia's budget revenues in the first quarter are up 30% year over year and 10% on the quarter, so this country is not going broke. (Sorry, Senator.) Oil and gas revenues are up 53% this year and non-energy-related revenues are up 15% yearly and 12% quarterly, which is more than can be said about oil. It is worth noting the dynamics in non-energy revenues of the budget, which are rising thanks to domestic demand and fights against tax evasion.
The Finance Ministry’s “budget rule” -- set to be made official in 2018 -- requires all state revenues when the oil price exceeds $40 a barrel be transferred to the reserves fund, rather than used to increase spending. By putting the money away, instead of counting on it for government spending programs, it reduces Russia’s dependence on oil revenue and domestic economic activity becomes less oil-price driven. Goldman analysts believe the new budget rule should also lower the impact of oil prices on the ruble, as the Ministry of Finance will likely look to buy currency in exchange for these excess oil revenues. Given that the state receives in excess of 80% of the marginal oil revenue from the energy sector, these cash flows will insulate the balance of payments from the direct impact of a change in oil prices. The piggy bank will be fuller.
See: Hedge Funds Have Given Up On Russia -- Forbes
The Senate Wants Full-Blown Russia Sanctions -- Forbes
A Look Inside The Senate's Crazy Russia Bill (Which The House Rejected) -- Forbes
Recent data points show Russia rebounding slowly. The increasing competitiveness of domestic goods and services is driving economic growth, Goldman analysts believe.
"Energy is our least preferred sector," says Mamedov. "But within the global energy universe, Russian oil companies remain strongly positioned, given low costs, high free cash flow, low leverage and huge reserves with production growth potential."
Renaissance Capital in Moscow estimates that foreign investors pulled $83 million out of the Russian stock market in five days ending June 28. Outflow has been ongoing since early February. It reached a three-year high in June, according to EPFR Global in Cambridge, Mass.
