Russia: 20 Years of Change

8/6/2019 Russia: 20 Years of Change

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RUSSIA:20YEARSOFCHANGECOLLAPSE,RECOVERYANDTRANSFORMATION JANUARY2011

TROIKA DIALOG 3

Key Themes


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TROIKA DIALOG 4

Twenty years of change

To coincide with Troikas 20 years in Russia, we bring together data to illustrate the spectacular amount of

change that has taken place as Russia has moved from bankrupt communist empire to cashrich capitalist state.

From this, we highlight 10 themes relevant to the market.

The end of the Soviet Union.

The creation of a market economy.

Collapse and recovery.

Macroeconomic stabilization.

The evolution of a middle class.

Adoption of developed market tools.

Global integration.

The move to the East.

The resurgence of the state.

Relative decline.


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TROIKA DIALOG 5

The end of the Soviet Union

Borders of Soviet Union and modern Russia

BA L T I CS E

A

B L A C K

S E A

CA

SPIAN

SEA

ARALSEA

B A R E N T S

S E A

SEA OFAZOV

KA

RA

SE

A

L A P T E V

S E A

A

RC

TI C O C

EA

N

E A S T

S I B E R I A N

S E A

B

E

R

I

N

G

S

E

A

S E A

O F

O K H O T S K

P A C I F I C

O C E A N

WH

I T E S EA

Moscow

BELARUS

U K R A I N E

POLAND

SW E

D E N

N O R W AY

F I NL

AN

D

T U R K E Y

I R A Q

I R A N

TURKMENISTAN

UZBEK

ISTAN

K A Z A K H S T A N

PAKISTAN

M O N G O L I A

C H I N A

R U S S I A

D.P.R.OFKOREA

REP.OFKOREA

AF G

HA

N IS T

A N

R.F.1

23

4

ROMANIA

5

6

7

8

9

J

A

P

A

N

DENMARK

NOVAY

AZ E

MLY A

SVA L

B AR

D St.LawrenceI.

Vol g

a

Kama

Sev

.D

vi na

Don

Pechora

Ob

Irtysh

Ob

Tob

ol

Ye n

i sei

Yen

isei

Lena

Indig

ir

ka

Kolyma

Amur

Am

ur

Len

a

Tallinn

Vilnius

Minsk

Kyiv

Chisinau

Baku

Yerevan

Tbilisi

Ashgabat

Dushanbe

TashkentBishkek

Riga

Astana

1. ESTONIA

2. LATVIA

3. LITHUANIA

7. AZERBAIJAN

8. TAJIKISTAN

9. KYRGYZSTAN4. REP. OF MOLDOVA

5. GEORGIA

6. ARMENIA

Source: Troika

Number of Russian nuclear warheads

0

2,000

4,000

6,0008,000

10,000

12,000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: Wikipedia

While not strictly a market theme, it was of course the political changes that set in place the environment that

made possible what followed. The end of the Soviet Union saw a major fall in the size of the territory and population controlled by the

Kremlin. In 1991, the Soviet Union had a population of 293 mln; in 2011, Russia has a population of

142 mln, less than half the level of 20 years ago.

The period has also seen a dramatic reduction in the size of the military complex. This can be illustrated by thefall in the number of nuclear warheads, from over 10,000 to under 3,000 (and falling) as the tensions of the

Cold War fell away.


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TROIKA DIALOG 6

The creation of a market economy

Private sector share of GDP

0%

20%

40%

60%

80%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: EBRD

Russian domestic gas prices as % of US prices

0%

15%

30%

45%

60%

75%

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: Troika estimates, Bloomberg

The period saw the formation of the building blocks of a market economy, with radical change across the board.

Privatization and the reduction of state control. The private sector share of GDP went from negligible to 65%today.

The introduction of free market prices. First of all with Gaidars famous rapid price liberalization, and then withthe increase in utilities tariffs and the slow reduction in state subsidies, a process that is still ongoing.

The setting up of the necessary legal and tax infrastructure, and the formation of capital markets.

The more efficient use of resources, especially energy resources. So, although Russia produces no more coalor oil than in 1990, it exports considerably more as domestic energy consumption has fallen by 33%.


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TROIKA DIALOG 7

Collapse and recovery

Index of real Russian GDP

0%

20%

40%

60%80%

100%

120%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: State Statistics Service, Troika estimates

Russian oil production, mln bpd

0

2

4

68

10

12

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: BP

The period is conventionally divided into two main parts, with a coda at the end: 199198 collapse;19992008 rapid recovery; 200811 crash and recovery.

This dynamic can be seen not just in real GDP, electricity production and housing construction, but also in oilproduction, the grain harvest, and even birth and death rates.

The key driver of this was commodity prices, arguably responsible for the parlous position of the Russian statein the 1990s, the final coup de grace in 1998 and the miraculous recovery thereafter.


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TROIKA DIALOG 8

Macroeconomic stabilization

Russian inflation*, yoy

1%

10%

100%

1,000%

10,000%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

* log scaleSource: State Statistics Service

Government debt/GDP

0%

40%

80%

120%

160%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: Central Bank

The start of the period saw economic chaos as the country struggled with the legacy of the Soviet Union amidlow commodity prices. Inflation was over 1,000%, and the savings of the middle class were wiped out.

There was a second bout of turmoil after the 1998 default as inflation spiked, the ruble fell sixfold and muchof the banking sector went bust.

Significant structural reform and higher commodity prices then enabled the government to create andentrench macroeconomic stability. Government debt/ GDP fell from nearly 100% to just 9% today, inflation

fell to single digits, forex reserves rose from under $10 bln to $500 bln today, and M2/GDP rose from around

10% to nearly 40%.

From this followed a huge appreciation in the real value of the ruble, which rose from 13% of its PPP fair valueto 66% today. This transformation has underpinned many of the domestic stories in Russia in the last decade.


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TROIKA DIALOG 9

The evolution of a middle class

Annual consumption per person, $

0

1,500

3,000

4,500

6,000

7,500

9,000

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Nominal PPP


Proportion of the population earning over $6,000in PPP terms per annum

0%

15%

30%

45%

60%

2004 2005 2006 2007 2008 2009 2010 2011


A propertyowning, educated and moderately welloff middle class has emerged thanks to Soviet education,the transfer of property rights over most of Russias 50 mln dwellings to those living in them, the rebalancing

of the entire economy from investment toward consumption, and the recent growth in wealth.

Consumption has increased spectacularly, from under $1,000 per capita for most of the 1990s to nearly$6,000 today. This has set the scene for an explosion in sales of consumer goods beer sales are up nearly

sixfold since the mid1990s, and the amount of modern format retail space has increased at least twentyfold

since the early 1990s. Russia has become Europes largest volume market for most consumer goods.

According to data from the LevadaCenter, 65% of the population has middle class consumption habits, andwe estimate from State Statistics Service data that 55% of the population will have PPP income per head of

over $6,000 this year, the traditional threshold for the emerging market middle class.


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TROIKA DIALOG 10

Adoption of developed market tools

Credit and debit cards in Russia, mln

0

30

60

90

120

150

2001

2002

2003

2004

2005

2006

2007

2008

2009

10m10


Mobile subscribers, mln

0

50

100

150

200

250

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

2011E

Source: AC&M

Russia was very fast to adopt developed market tools and techniques once macroeconomic stabilization had set in.

Examples of this are the rise of a real domestic banking sector (loans and deposits rose from $50 bln in 2001to $600 bln today), the adoption of credit and debit cards (nonexistent in the early 1990s, 11 mln in 2001,

and 138 mln today), the building of modern retail format supermarkets, containerization, warehousing,

offices, advanced recovery techniques in the oil sector, digitization of the telecoms sector, and so on.

More recently, the adoption of mobile phones (with 220 mln subscribers, Russia is the largest market inEurope) and the internet has been rapid.

This process is still ongoing. Entrepreneurs are today seeking to apply developedmarket techniques to theagricultural and construction sectors, and many areas remain where we believe there can be a major impact.


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TROIKA DIALOG 11

Global integration

Exports and imports, $ bln

0

100

200

300

400

500

600

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Exports Imports


FDI, $ bln

0

20

40

60

80

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E


Russia has integrated far more with the rest of the world, leaving behind the autarchy of the Soviet Union.

Total foreign trade has increased sixfold since the early 1990s, from just over $100 bln per annum to nearly$800 bln at present.

Real export volumes have more than tripled since 1991 (and more than doubled since 1995) as Russia hasreduced some of its excessive use of energy and exported the surplus. Oil exports are up by 70%, gold

production by 59% and copper production by 67% from 1991.

FDI has gone from $12 bln a year in the early 1990s to $40 bln a year at present, and is matched by outwardFDI of the same order.

People are able to travel abroad with much greater frequency, and a much wider group of Russians has

traveled the world.


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TROIKA DIALOG 12

The shift to the East

The share of Asia in Russian trade

0%

10%

20%

30%

40%

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Exports Imports

Source: State Statistics Service

Energy links to the East

PAKISTAN

C H I N A

NEPAL

NORTHKOREA

SOUTHKOREA

MONGOLIA JAPAN

KAZAKHSTAN

UZBEKISTAN

TURKMENISTAN

KYRGYZSTAN

TAJIKISTAN

AFGHANISTAN

IRAN

AZERBAIJAN

ARMENIA

GEORGIA

RUSSIA

U.K.

LATVIALITHUANIA

UKRAINE

BELARUS

FINLAND

SWEDEN

NORWAY

DENMARK

ESTONIA

R U S S I A

OMAN

U.A.E.Oil pipelines in operation

Oil pipelines in construction and design stage

Gas pipelines in operation

Gas pipelines in construction and design stage

Source: Institute of Energy Research of the Russian Academy ofSciences, Troika estimates

The period has seen the start of a shift in Russias focus to the East, with a final resolution of the border withChina and a major drive for additional infrastructure to link the two economies.

The two key hydrocarbon projects are the ESPO and the Altai gas pipeline. Russia now has active or underconstruction enough capacity to send a quarter of its hydrocarbon exports to Asia, while at present it exports

less than 10% of hydrocarbons to Asia, and only minimal amounts went there in 1991.

Imports from Asia have increased to over a third of total imports, more than double the level in the early 1990s.


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TROIKA DIALOG 13

The return of the state

Oil price required for fiscal breakeven, $/bbl

0

20

40

60

80

100

120

2003 2004 2005 2006 2007 2008 2009 2010 2011E

Source: Central Bank, Troika estimates

Russias ranking on the Corruption Perception Index

0

30

60

90

120

150

180

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: Transparency International

After a weak period in the early 1990s when it ran a huge budget deficit, the state has returned in force.

The number of state employees has more than doubled from 0.7 mln in 1991 to 1.7 mln today. Meanwhile,the state has reasserted its dominance over the economy and its power to tax and control the countrys raw

material wealth. As an example of this, the percentage of Russian oil production controlled by the state has

risen from 7% in 2003 to at least 36% today.

Meanwhile, corruption has deteriorated considerably. In 1998, Russia ranked 76th in the world for corruptionperception according to Transparency International. That has now fallen to 154th in the world.

And as a result of higher state spending, the breakeven level for the oil price has risen dramatically. In the early1990s it was $2030/bbl; today it is over $100/bbl. For all the considerable achievements elsewhere, this

implies a dangerous degree of dependency on external variables.


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TROIKA DIALOG 14

Relative decline

The share of Russia and China in global GDP*

0%

4%

8%

12%

16%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

China Russia

* GDP in PPP terms

Source: IMF

Russias share of global gas production

18%

20%

22%

24%

26%

28%

30%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP

The relative decline of Russia in global terms is quite notable.

Russia's share of global GDP has fallen from 4% to 3% as the share of population has fallen from 3% to 2%.

Russias share of global gas production has also fallen from 29% to 18% as the country has failed to keep upwith global developments.


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TROIKA DIALOG 15

Macro Changes


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TROIKA DIALOG 16

GDP

Index of real Russian GDP

0%

20%

40%

60%

80%

100%

120%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011


Russian GDP, $ bln

0

500

1,000

1,500

2,000

2,500

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

GDP PPP

Source: IMF

Real Russian GDP is the clearest example of collapse and recovery. As the old system gradually collapsedduring the 1990s, real GDP fell, reaching a nadir in the financial crisis of 1998 that was 43% below 1990.

Thanks to devaluation, reform and the recovery of commodity prices, real GDP then grew rapidly for a decade.

However, in real terms, GDP in 2011 will be only 14% above that of 1991.

Thanks to real ruble appreciation, GDP in dollar terms is dramatically higher, increasing from under $100 bln in1992 to $1.6 trln this year; and as a result of global inflation, Russias PPP GDP has doubled over the period.

Russias share of global GDP has declined from over 4% to around 3%, in a similar manner to the UK.


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TROIKA DIALOG 17

The ruble and inflation

Russian inflation, yoy, log scale

1%

10%

100%

1,000%

10,000%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


Ruble exchange rate as % of PPP

0%

15%

30%

45%

60%

75%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: IMF

The early 1990s saw financial chaos, inflation peaking at over 1,000%, the nominal ruble falling fromR0.20/$1 to R5.00/$1 and the populations savings being destroyed as a result.

The financial crisis of 1998 saw another bout of high inflation, and another huge fall in the ruble/dollar rate toR30/$1.

Inflation did not fall sustainably below 20% until 2002, and only recently has it fallen below 10%.

Real ruble appreciation since 1999 has underpinned much of the rerating of Russian domestic assets. In 1993and again in 1998 the ruble traded at just 13% of its fair value in PPP terms, while at present it trades at 66%.


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TROIKA DIALOG 18

Privatization

Share of private sector in GDP

0%

20%

40%

60%

80%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: EBRD

Percent of population employed by stateenterprises

0%

15%

30%

45%

60%

75%

90%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008


The last 20 years have seen private ownership replace state ownership.

According to data from the EBRD, at the start of the period only 5% of the economy was in private hands.Thanks to the very ambitious privatization program launched by Gaidar, some 70% of the economy was in

private hands by 1997.

The State Statistics Services data indicate that the percentage of those working for state enterprises has fallenfrom over 80% to around 30%.

Meanwhile, the government has started to set up the legal and institutional infrastructure to sustain thistransformation.


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TROIKA DIALOG 19

Government revenues and expenditures

Fiscal revenues and expenditures as a % of GDP

0%

5%

10%

15%

20%

25%

30%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Revenues Expenditures


Fiscal balance as a % of GDP

12%

8%

4%

0%

4%

8%

12%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

2011E


At the start of the period, the government was weak, with revenues that in 1993 and in 1998 amounted toonly 10% of GDP.

Huge fiscal deficits of up to 10% of GDP characterized the early 1990s, while most of the 2000s saw largesurpluses.

It is notable that the recent fiscal deficit is dramatically lower than that faced in the early 1990s.


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TROIKA DIALOG 21

Reserves and M2

M2/GDP

0%

10%

20%

30%

40%

50%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011


Russian forex reserves, $ bln

0

100

200

300

400

500

600

700

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011


When the reformers took power in 1992, Russia had forex reserves sufficient for only a few months ofimports, and throughout the 1990s, reserves remained low.

At the start of the period, monetization was very low, and in the 1990s barter was often used. However, asforeign reserves increased, so did the domestic money supply, and M2 is now nearly 40% of GDP.

As commodity prices rose in the 2000s, the government was careful to husband the reserves, and has been

able to build up foreign reserves of $500 bln, the third largest in the world.

SS 20 S O C G CO S CO S O O 20


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TROIKA DIALOG 22

The structure of GDP

Russian savings and investments/GDP

0%

10%

20%

30%

40%

50%

60%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Savings Investments


Index of real retail and real investment spending

0%

50%

100%

150%

200%

250%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Investments Retail


The period has seen a sustained decline in the savings rate, in response to macroeconomic fragility, highinflation and low interest rates. At the end of the Soviet period, savings rates were over 50%, but they have

now fallen to below 30%.

Investment/GDP has seen the typical pattern of collapse and recovery. It fell from 24% in 1992 to 14% in

1999, rising back to 22% in 2009.

And the economy has shifted dramatically away from investment (which in real terms is at only just half of itslevel in 1990) and toward consumption, with real retail spending nearly 2.5 times the level in 1990.

RUSSIA 20 YEARS OF CHANGE COLLAPSE RECOVERY AND TRANSFORMATION JANUARY 2011


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TROIKA DIALOG 23

Trade

Exports and imports, $ bln

0

100

200

300

400

500

600

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Exports Imports


Index of export volumes

0%

100%

200%

300%

400%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E


There has been a secular increase in trade. The start of the period saw total annual exports plus imports of justover $100 bln, and during the 1990s, they never exceeded $200 bln.

However, the early 2000s saw a spectacular increase in trade, reaching $900 bln in 2008 and likely to beonly a little lower this year.

The key driver has clearly been commodity price increases. However, export volumes have also increasedmarkedly, up more than threefold in the period.

There have been two main drivers to higher export volumes. On the one hand, Russian domestic consumptionof energy (above all) fell in response to higher prices and more market efficiency. On the other hand, greater

global demand and investment were able to stimulate growth in overall production in certain areas, such as

gold or copper production.

RUSSIA: 20 YEARS OF CHANGE COLLAPSE RECOVERY AND TRANSFORMATION JANUARY 2011


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TROIKA DIALOG 24

Capital flows

Current account, $ bln

25

0

25

50

75

100

125

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E


Capital flows into Russia 19942010, $ bln

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Exports

Imports

Incomes

received

Inc

omespaid

FDI

Other

investmentin

Russia

In

vestments

abroad

Capital

outflow

FX

reserves

acc

umulation


For most of the 1990s, Russia struggled to run a current account surplus. In 1994 it was $8 bln, but by 1997,it had fallen to zero.

However, devaluation in 1998 and the commodity price increases thereafter radically changed the position,and Russia has run large current account surpluses since 1999.

Over the period, Russia has sold some $3.3 trln of exports and imported $2.3 trln of goods. As most othercapital flows balance, the remaining $1.0 trln can be shown to have gone half into forex reserves

accumulation and half into capital outflows.



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RUSSIA:20YEARSOFCHANGE COLLAPSE,RECOVERYANDTRANSFORMATION JANUARY2011

TROIKA DIALOG 25

FDI

FDI into Russia, $ bln

0

20

40

60

80

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E


Russian investment abroad, $ bln

0

10

20

30

40

50

60

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


The huge increase of both foreign FDI into Russia and Russian investments abroad is indicative of globalintegration.

At the start of the period, FDI was running at $12 bln per annum. Now it is at nearly $40 bln per annum, as aseries of major foreign companies have moved into the Russian market, including almost all of the worlds top 100

by capitalization. Whether it is Danone, Carlsberg or Unilever in the consumer sector, BP, Total or Schlumberger in

the oil sector, or HP, Microsoft and Cisco in the tech space, the lure of Russia is too great to be ignored.

This FDI has been nearly matched by Russian investments abroad, where the track record has been, to put itmildly, rather mixed.



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RUSSIA:20YEARSOFCHANGE COLLAPSE,RECOVERYANDTRANSFORMATION JANUARY2011

TROIKA DIALOG 26

Consumption

Annual consumption per person, $

0

1,500

3,000

4,500

6,000

7,500

9,000

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

Nominal PPP


Real wages and disposable income

0%

25%

50%

75%

100%

125%

150%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Real disposable income Real wagesSource: State Statistics Service

At the start of the 1990s, annual consumption in dollar terms was well under $1,000, and throughout the1990s, it rarely exceeded this level. It has risen to nearly $6,000 today.

Real wages and disposable income have seen a fall and recovery in a similar way to GDP. However, as a resultof the rebalancing of GDP toward consumption and away from investments, they are now markedly higher

than in 1990.



27/54

,

TROIKA DIALOG 27

The Russian middle class

Share of the population earning over $6,000 PPP

0%

15%

30%

45%

60%

2004 2005 2006 2007 2008 2009 2010 2011


Share of the population with middleclassspending patterns

0%

20%

40%

60%

80%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Lower middle class Middle class

Source: LevadaCenter, Troika estimates

The period has seen the rise of the Russian middle class, assisted by the effective transfer of all housing assetsinto the hands of the people living in them at the start of the 1990s. The other great Soviet contribution to the

formation of such a class was the excellent education levels inherited from that period.

Traditionally, a level of around $6,000 per capita in PPP terms has been seen as the emerging market threshold

for a middle class. The number of people in Russia that meet this definition has grown from well under 20% ofthe population for most of the 1990s to around 55% this year.

Data from the LevadaCenter on spending habits shows that 64% of the population now has sufficient incomefor food, clothing and some discretionary items.

Selfdefinition is one of the other key determinants of middleclass status. Surveys differ, but an average ofaround 75% of the population considers themselves as belonging to the middle class.


28/54



29/54

TROIKA DIALOG 29

Capital markets

RTS Index

0

500

1,000

1,500

2,000

2,500

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: Bloomberg

Russian daily equity trading volumes, $ mln

0

2,000

4,000

6,000

8,000

10,000

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: Bloomberg, Troika estimates

The Central Moscow Stock Exchange was registered in November 1990, and Troika Dialog was founded onJanuary 18, 1991. In 1992, voucher schemes were launched, and the market was off.

Capital markets saw spectacular growth after a bumpy start. The RTS, launched in 1995 at 100, fell to 38points in October 2008, but is now trading at over 1,800.

There has been a huge increase in trading. Volumes for much of the 1990s were under $100 mln a day (and

much less after crises); today they are in the region of $5 bln a day.

Large domestic bond markets have arisen, and today are over $100 bln in size.



30/54

TROIKA DIALOG 30

Demographics

Fertility rate: babies per woman

1.0

1.2

1.4

1.6

1.8

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


Life expectancy in Russia, years

55

60

65

70

75

80

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Average Males FemalesSource: State Statistics Service

The fertility rate has also seen collapse and recovery. It finished the 1980s at over 2.0 children per woman, fellto under 1.2 in 1999, and has now risen back to 1.5.

Life expectancy has seen a similar collapse, falling from nearly 70 to under 65 in 1994, before rising back tonearly 70 again today.



31/54

TROIKA DIALOG 31

Population

Russian population, mln

130

133

136

139

142

145

148

151

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: IMF

Russia's share of global population

2.0%

2.2%

2.4%

2.6%

2.8%

3.0%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: IMF

The population has fallen from 149 mln in 1991 to 142 mln today, a decline of some 5%.

However, as a result of rising populations elsewhere, Russias population has fallen from around 3% of globalpopulation to around 2%.

Given that the Russian Empire in 1900 apparently ruled over some 10% of the global population, this is adramatic longterm decline. It should thus drive a radical change in strategic thinking by Russia and the West

about the countrys place in the world, as outlined by Dmitri Trenin. Regrettably, however, old Cold Warwarriors continue to fight the last war and ignore this new reality.



32/54

TROIKA DIALOG 32

Energy usage and pollution

Index of energy consumption per unit of real GDP

60%

70%

80%

90%

100%

110%

120%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP, State Statistics Service

Russian CO2 emissions, mln tonnes

1,400

1,600

1,800

2,000

2,200

2,400

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP

Energy consumption has fallen 25% from 850 mln toe in 1991 (around half that of the US at the time andmore than China) to 635 mln toe in 2009. It is the sale of this spare energy at high prices that has

underpinned the resurgence of the country.

Energy consumption per unit of real GDP has fallen 33% as some of the Soviet dinosaur industries were closeddown.

As a result, Russia, nearly alone among major counties, has seen a sharp fall in CO 2 emissions (down 33%),albeit from a high base.



33/54

TROIKA DIALOG 33

Corruption

Transparency International Corruption PerceptionIndex Russia's global ranking

0

30

60

90

120

150

180

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Note: The lower the number, the better.

Source: Transparency International

Control over corruption Russia's globalpercentile

0

5

10

15

20

25

30

1996 1998 2000 2002 2003 2004 2005 2006 2007 2008

Note: The higher the number, the better.Source: World Economic Forum

We lack statistics from the early 1990s, but those that we do have indicate that corruption has deterioratedover the last decade.

Transparency International data show that Russia has fallen from the 76th position globally in 1998 to the154th over the last decade.

The WEF measurement of control over corruption indicates that corruption got worse in the aftermath of the1998 crash, improved after 2000, and then deteriorated again after 2005. The data ranks each country by its

global percentile, with 100% being the best. The latest data has Russia at the 15th percentile, while Brazil is

at the 58th and China at the 41st.

As we have argued for some time, Russia is in an anomalous position to have so much corruption amid such

high levels of wealth, education and internet usage. This is thus an area where we expect change.



34/54

TROIKA DIALOG 34

Government size and spending

Number of government officials in Russia, mln

0.0

0.3

0.6

0.9

1.2

1.5

1.8

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


Oil price required for fiscal breakeven, $/bbl

0

20

40

60

80

100

120

2003 2004 2005 2006 2007 2008 2009 2010 2011E


We have seen a secular rise in the number of government employees, from just 0.7 mln in 1991 and 1.1 mlnin 2001 to 1.7 mln today.

This is symbolic of the huge increase in government spending and, as a result, in oil price dependency.

In the early 1990s, the breakeven oil price (the price at which the fiscal budget balances), was around$2030/bbl. This has risen inexorably, and now stands at over $100/bbl this year.


35/54



36/54

TROIKA DIALOG 36

Agriculture

Russian agriculture

0

30

60

90

120

150

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Land farmed, mln ha Grain crop, mln tonnes


Land yield, tonnes/ha

0.0

0.3

0.6

0.9

1.2

1.5

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


In 1991, Russia farmed 116 mln ha of land. The move to profitbased farming and the lack of capital meantthat the area farmed fell continually until 2008, stabilizing at just under 80 mln ha.

However, the total grain crop has not fallen to the same degree. With the exception of the poor harvest in2010, there has been a 50% increase in yields. In 199194, they averaged 0.8 tonnes/ha, and in 200609,

they averaged 1.2 tonnes/ha. Recent years have seen a large number of Russian and foreign entrepreneurs enter the agriculture sector,

brining new equipment, knowhow and capital, and forming giant farms capable of transforming the space.



37/54

TROIKA DIALOG 37

Banks

Loans and deposits, $ bln

0

150

300

450

600

750

2001

2002

2003

2004

2005

2006

2007

2008

2009

10m10

Loans Deposits


Credit and debit cards in Russia, mln

0

30

60

90

120

150

2001

2002

2003

2004

2005

2006

2007

2008

2009

10m10


Russias modern banking history begins only after the sector was largely wiped out in 1998.

Since 2000, there has been a spectacular increase in both deposits and loans, with the former largely trackingforex reserves. They have each grown from around $50 bln to around $600 bln today.

The credit card industry has taken off in a similar way. Negligible in the early 1990s, there were only 11 mlncards in 2001, but there are nearly 140 mln credit and debit cards today.



38/54

TROIKA DIALOG 38

Cars

Russian automobile fleet, mln

0

10

20

30

40

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009E

2010E


Car sales, mln

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2004 2005 2006 2007 2008 2009 2010E 2 011E

Source: Ernst & Young, PricewaterhouseCoopers, Vedomosti,Association of European Businesses, Troika estimates

In 1991, there were just 10 mln cars on Russia's roads; today there are nearly 35 mln, a statistic endured eachday on Moscows trafficclogged roads.

In 2008, the sale of cars in Russia challenged Germany for the top market in Europe. This year, around 2 mlncars will be sold.

There has been a transformation of the car fleet as foreign brands have flooded into the country, forcingdomestic producers to upgrade their quality.



39/54

TROIKA DIALOG 39

Coal and steel

Coal production and consumption, mln tones

0

30

60

90

120

150

180

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Production Consumption

Source: BP

Russian steel production, mln tonnes

0

20

40

60

80

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


There has been a secular decline in consumption of coal, from 165 mln tonnes in 1991 to 83 mln tonnes in2009.

As with many other sectors, there was also a collapse and recovery in production of coal and steel.

As a result, exports have increased significantly.



40/54

TROIKA DIALOG 40

Consumer

Russian beer sales volumes, mln hl

0

20

40

60

80

100

120

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


Modern retail selling space, mln m2

0

3

6

9

12

15

18

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


Consumer markets have seen spectacular growth from a low base in both volume and value terms as incomeshave risen and consumer goods have become more widely available.

The industry at the forefront of the change has been brewing, as the purveyor of a lowprice item.Consumption rose nearly sixfold from 20 mln hl in 1996 to 116 mln hl in 2007 as foreign brewers broke into

the country and established production and distribution networks deep into the hinterland.

We have seen similar developments in many consumer goods markets, from chocolate to fruit juice to babyfood. Manufacturers have also increasingly set up factories inside Russia to produce locally.

The organized retail sector has also seen necessary and spectacular growth over the period. From tinybeginnings in the 1990s it has now risen to operate 16 m2 of space, and is still growing fast. The amount of

choice now available is dramatically different to the deficit days of the early 1990s.



41/54

TROIKA DIALOG 41

Consumer discretionary

International flights, bln passengerkm

0

20

40

60

80

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: Transport Clearing Chamber

Washing machine sales volumes in Russia, mln

0

1

2

34

5

6

7

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

Source: Euromonitor

Higherticket consumer discretionary goods have also seen a tremendous increase in spending.

Washing machine sales in 1998 were under 1 mln, but by 2010 had risen to 6 mln, and were by far thelargest market in Europe.

In the early 1990s, international flights were only 30 bln passengerkm. With wealth and curiosity, this hasdoubled to over 60 bln passengerkm, and we expect much growth yet to come.



42/54

TROIKA DIALOG 42

Electricity

Electricity generation in Russia, TWh

800

850

900

950

1,000

1,050

1,100

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP

Electricity price, $/MWh

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


Electricity generation is the typical story of collapse and recovery. Once more it is worth noting that totalgeneration is below that in 1991, and that the efficiency of energy use per unit of GDP is low in Russia even

today.

The introduction of market prices has seen dramatic increases in the cost to businesses and households. Theaverage price has risen from $7/MWh in 2000 to nearly $30/MWh today.



43/54

TROIKA DIALOG 43

Fixed line telecoms

Fixed lines in Russia, mln

26.8

33.134.7

36.538.4

40.842.9 44.2

45.2 45.5 45.4

51%

64% 67%

70%74%

78%82% 85%

87% 87%90%

0.0

10.0

20.0

30.0

40.0

50.0

1995

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

0%

20%

40%

60%

80%

100%

Total fixed lines in service Penetration, % of households (rhs)

Source: State Statistics Committee, ITU, Troika estimates

Digitalization of fixed lines

0%

20%

40%

60%

80%

1995

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: State Statistics Committee, ITU, Troika estimates

The fixed line telecoms sector is a good example of the adoption of existing technology in a system whereconsumers had the power to demand it.

In the early 1990s, as can be well attested by those of us who had to endure it, there were few digital lines tospeak of. By 2009, some 80% of lines were digitized.

The number of fixed lines also increased markedly, from 27 mln in 1995 to 45 mln by 2007.



44/54

TROIKA DIALOG 44

Gas production and exports

Gas production and consumption, bcm

200

300

400

500

600

700

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


Source: BP

Russian gas exports, bcm

0

50

100

150

200

250

300

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: Gazprom

Gas has been a sector where government control has thus far shielded it from the deep changes that we haveseen elsewhere.

Production and consumption held up better than most other areas in the 1990s, but are still down over theentire period. Exports have risen, but this is in part a result of reexporting Central Asian gas, where the

margins are lower.



45/54

TROIKA DIALOG 45

Gas pricing and global production share

Russian gas production as a % of global

18%

20%

22%

24%

26%

28%

30%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP

Russian domestic gas prices as % of US prices

0%

15%

30%

45%

60%

75%

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: Troika estimates, Bloomberg

Most worryingly, there has been a secular decline of Russias share in global gas production as the country hasfailed to capitalize on its enormous gas resources as rapidly as the rest of the world.

Meanwhile, there has been secular growth in domestic prices toward international levels. In 2000, Russiangas was sold domestically at the (now) mouthwatering price of $10/mcm, 9% of the erstwhile US price.

Today, the gas is sold at around $80/mcm, more than 60% of the US price.


46/54



47/54

TROIKA DIALOG 47

Mobile and broadband

Mobile subscribers, mln

0

50

100

150

200

250

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

2011E

Source: AC&M

Broadband household penetration

0%

5%

10%

15%

20%

25%

30%

2002 2003 2004 2005 2006 2007 2008 2009 2010

Source AC&M, Troika estimates

The mobile sector is an excellent example of Russia being a late starter but having the education and wealth tochallenge European levels of penetration.

There are 220 mln mobile subscriptions in Russia today, making it the largest market in Europe.

Equally, broadband penetration has increased rapidly to over 25% and is still rising fast.



48/54

TROIKA DIALOG 48

Nonferrous metals

Russian gold production, tonnes

0

50

100

150

200

250

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: GFMS, Troika

Russian copper production, kt

0

200

400

600

800

1,000

1,200

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008E

2009

2010E

2011E

Source: CRU

The nonferrous metals sector has seen more growth than the energy sectors or the ferrous metals space,perhaps because of the more advantageous taxation regime and a lower starting point.

We estimate that gold production increased 59% from 146 tonnes in 1992 to 232 tonnes today, and thesector has laid the foundations for much higher production levels than this.

Copper production has increased 67% from 0.7 mln tonnes in 1991 to 1.1 mln tonnes expected this year.



49/54

TROIKA DIALOG 49

Oil production and exports

Russian oil production and consumption, mln bpd

0

2

4

6

8

10

12

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


Source: BP

Russian oil net exports, mln bpd

0

2

4

6

8

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP

Oil production has seen the typical pattern of collapse and recovery. Production was 1112 mln bpd in Soviettimes, had fallen to 9.3 mln bpd in 1991, and the trough came in 199699 when it was just over 6 mln bpd.

Thereafter, devaluation, new ownership and the adoption of new extraction techniques have led to arenaissance of the sector, which in 2010 produced 10.1 mln bpd.

Domestic consumption of oil fell from 5 mln bpd to under 3 mln bpd as a result of higher domestic pricing andthe shutting down of some valuedestructive heavy industries.

As a result, Russias net oil exports have increased spectacularly, surging 70%, from 4.3 mln bpd to 7.3 mln bpd.



50/54

TROIKA DIALOG 50

Oil global share and state control

Russian oil exports as a % of global

0%

4%

8%

12%

16%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BP

State control of Russian oil production

0%

10%

20%

30%

40%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: Troika estimates

The recovery of Russias share of global oil exports is in contrast to gas. In 1991, Russia made up 13% ofglobal oil exports; this fell to 9% in the mid1990s, and has now recovered to 13%.

The state control of oil production fell consistently from 100% to a trough in 2003 of 7%. It then rose againafter the YUKOS affair, and we now estimate it at a very conservative 35%.



51/54

TROIKA DIALOG 51

Real estate

Housing completions, mln m2

0

15

30

45

60

75

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009


Moscow housing prices, $/m2

0

1,500

3,000

4,500

6,000

7,500

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: www.irn.ru

Housing construction has seen a similar pattern of collapse and recovery. The total housing built fell from50 mln m2 in 1991 to 30 mln m2 in 2000 before bouncing back to 60 mln m2 today. Given the stilllow level

of housing per capita in Russia, we expect this to rise further.

Meanwhile, housing per capita has risen 36% from 16 m2 in 1991 to 22 m2 today, and the freshdevelopments are visible in new suburbs, which have sprung up around every major Russian city.

There has been a secular rise in other areas of real estate construction. Office construction, for example, rosefrom 0.9 mln m2 in 2000 to 7.7 mln m2 in 2009.

There was a massive (and arguably excessive) increase in real estate prices after economic stability returned in2000. The price of Moscow apartments has increased from under $1,000/m2 in 2000 to $4,500/m2 today.


52/54

Chairman of Board of Directors and CEO,

Troika Dialog Ruben Vardanian

Chief Business Officer Jacques Der Megreditchian

Head of Global Markets Peter Ghavami

Chief Economist,

Managing Director Evgeny Gavrilenkov


53/54

Research Department +7 (495) 258 0511

Head of Research Paolo Zaniboni +7 (495) 787 2381

Strategy

Chief Strategist Kingsmill Bond, CFA +44 (207) 583 3257

Strategist Andrey Kuznetsov +7 (495) 933 9844

Oil and Gas

Senior Analyst Oleg Maximov +7 (495) 933 9830

Senior Analyst Alex Fak +7 (495) 933 9829

Analyst Valery Nesterov +7 (495) 933 9832

Utilities

Senior Analyst Alexander Kotikov +7 (495) 933 9841

Analyst Igor Vasilyev +7 (495) 933 9842

Assistant Analyst Andrey Trufanov +7 (495) 258 0511

Telecoms, Media and IT

Senior Analyst Evgeny Golossnoy +7 (495) 933 9834

Analyst Anna Lepetukhina +7 (495) 933 9835

Metals and Mining

Senior Analyst Sergey Donskoy, CFA +7 (495) 933 9840

Senior Analyst Mikhail Stiskin +7 (495) 933 9839Analyst Irina Lapshina +7 (495) 933 9852

Assistant Analyst Stanislav Ermakov +7 (495) 258 0511

Manufacturing

Analyst Mikhail Ganelin +7 (495) 933 9851

Assistant Analyst Ivan Belyaev +7 (495) 258 0511

Financials

Senior Analyst Andrew Keeley +7 (495) 933 9845

Analyst Olga Veselova +7 (495) 933 9846

Consumer

Senior Analyst Mikhail Krasnoperov +7 (495) 933 9838

Assistant Analyst Artur Galimov +7 (495) 258 0511

Real Estate

Analyst Igor Vasilyev +7 (495) 933 9842

Chemicals

Senior Analyst Mikhail Stiskin +7 (495) 933 9839

Analyst Irina Lapshina +7 (495) 933 9852

Transport


Small and Mid Cap


Assistant Analyst Ivan Belyaev +7 (495) 258 0511

Market Analysis

Analyst Nadezhda Kireeva +7 (495) 933 9855

Economy

Senior Economist Anton Stroutchenevski +7 (495) 933 9843

Fixed Income

Head of FI Research Alexander Kudrin +7 (495) 933 9847

Senior Analyst Alexey Bulgakov +7 (495) 933 9866

Analyst Ekaterina Sidorova +7 (495) 933 9849

Analyst Stanislav Ponomarenko +7 (495) 933 9857

Assistant Analyst Boris Krasnenkov +7 (495) 258 0511

Ukraine

Strategist Roman Zakharov +38 (044) 207 3780

Economist Iryna Piontkivska

Senior Analyst Yevhen Hrebeniuk

Senior Analyst Ivan Kharchuk

Senior Analyst Sergey Nevmerzhitsky

Analyst Alexander Tsependa

Analyst Maria Repko

Kazakhstan

Analyst Zaurbek Zhunisov

Analyst Ainur Medeubayeva


54/54

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Russia: 20 Years of Change

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