- The document discusses Russia's heavy dependence on oil and gas revenues, which leaves its economy vulnerable to global economic cycles. Structural reforms are seen as necessary to diversify the economy and attract more foreign investment. - Russia has among the lowest levels of foreign direct investment as a percentage of GDP among transition economies. Low FDI is attributed to poor corporate governance, transparency and protection of property rights. - While Russia faces challenges, small incremental reforms could significantly improve its investment climate and economic prospects. The potential upside for investors remains large.

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– Second level
LOOKING DOWN THE TRACK
• Third level
– Fourth level
» Fifth level
Understanding the ways in which the
political climate and changes in
Russia will impact investors both
local and foreign
Winning Moves, Winning Strategies

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SPEAKER
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– Second level
• Third level
– Fourth level Alexei Yazikov
» Fifth level
Head of Research
Aton Capital
Winning Moves, Winning Strategies

3. Oil or Nothing: Oil is the lifeblood of the Russian
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economy
Oil & Gas contribution to budget revenues Ave. annual net FDI as % of GDP, 1994-2010, BRIC countries ($bn)
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Budget ($bn, LHS)
Oil (% of total, RHS)
O&G (% of total, RHS) GDP ($bn, LHS)
Oil (% of total, RHS)
O&G (% of total, RHS)
500
– Second level
42%
47% 47%
41%
48% 46% 46%
45%
50% 3,000
10.0%
10.9% 10.6% 12%
400 37% 40% 2,500 8.7% 10%
• Third level
8.3% 8.1%
7.6% 7.8% 7.5%
2,000 8%
300 30%
– Fourth level 1,500 6%
200 20%
» Fifth level 1,000 4%
100 10% 500 2%
0 0% 0 0%
2005 2007 2009 2011E 2013E 2005 2007 2009 2011E 2013E
Source: Bank of Russia, EBRD, Aton estimates
• Russia’s economy remains heavily dependent on the Oil & Gas sector – over the last six years the sector accounted
for 44% of federal budget revenues and 9.4% of GDP. This leaves Russia exposed to the global economic cycle and
boom-bust periods
• In 2003-08 the country experienced one of the fastest 5-yr periods of growth ever, but in 2009 it recorded one of
the largest slumps in economic activity in the world. While Russia currently seems to be in good shape, the
situation could quickly deteriorate as the current financial crisis escalates
• Downbeat forecasts for oil production growth in the coming years underline Russia’s economic vulnerability
Winning Moves, Winning Strategies

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Structural reforms are necessary
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– Second level
• Third level
– Fourth level
» Fifth level What causes frustration or anxiety in your life?
• With rising budget spending on the agenda (in both the run- Unreasonably high cost of living 67
up to the elections and their aftermath), the fiscal deficit is Low availability of medical services 53
likely to rise significantly Widespread corruption 49
High level of crime 48
• Russia’s next president will inevitably shift his focus towards Influx of Migrants 41
the nation’s economic performance as the main determinant Deplorable state of education system 39
Moral decay of society 39
of popular support Weak protection of property 36
• Without deep structural reforms and modernisation, Russia’s Limited career opportunities 35
State of pension system 35
economic prosperity will be at risk Increasing intolerance in society 27
• Reforms are therefore not dependent on the political will of Absence of an independent judiciary 26
the ruling elite: they are a practical necessity. Any pragmatic Growth of Russian nationalism, xenophobia 16
leader needs to accept the path of reform or face the risk of Authoritarian regime 15
Restriction of media freedom 14
popular unrest. Source: Levada Centre, Novaya Gazeta
Winning Moves, Winning Strategies

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Net FDI remains very weak
Russia: gross and net FDI, 1994-1Q11 ($bn) Net FDI into transition economies 1994-2010 ($bn)
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80 140
70
– Second level
120
Net FDI Gross FDI
60
100
50
40 • Third level
Total gross FDI in the period:
80
30 $274bn
– Fourth level
Net FDI – $37bn
60
20
10
» Fifth level 40
0 20
-10
0
Turkmeni…
Russia
Lithuania
Croatia
Hungary
Romania
Estonia
Latvia
Belarus
Bulgaria
Slovenia
Slovakia
Kazakhstan
Czech Rep
Armenia
Georgia
Ukraine
Poland
Albania
Azerbaijan
Kyrgyzstan
-20
1Q11
1997
1994
1995
1996
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
• FDI is vital for an economy in transition: it brings considerable benefits such as the transfer of technology and
management know-how as well as potential access to export markets. FDI can help close the technology gap with
developed countries. FDI has also been a major component of success for countries that have been able to
diversify away from natural resource dependence (Sweden, Finland, Canada, and to some extent Australia).
Winning Moves, Winning Strategies

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Russia’s FDI is one of the lowest
Net cumulative FDI per capita 1994-1Q11 ($bn) Average annual net FDI as % of GDP, 1994-2010 ($bn)
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8,000 12%
7,000
6,000 – Second level 10%
8%
• Third level
5,000
4,000 6%
3,000 – Fourth level 4%
2,000
1,000
» Fifth level 2%
0
0%
Turkmenis…
Belarus
Slovenia
Georgia
Ukraine
Albania
Romania
Poland
Hungary
Estonia
Lithuania
Kazakhstan
Croatia
Azerbaijan
Russia
Kyrgyzstan
Armenia
Latvia
Slovakia
Bulgaria
Czech Rep.
Turkmenistan
Belarus
Slovenia
Georgia
Russia
Ukraine
Albania
Poland
Estonia
Lithuania
Romania
Croatia
Hungary
Kazakhstan
Czech Rep
Latvia
Azerbaijan
Kirgizstan
Slovakia
Bulgaria
Armenia
Source: Bank of Russia, EBRD
• Political risks, poor investment climates and widespread corruption were the key contributing factors to low FDI in
the region. Nevertheless, Kazakhstan and Azerbaijan have been more successful in attracting FDI with investment
climates little better than Russia’s.
• Low FDI can be partly explained by the fact that most investments were geared towards domestic consumption –
this differs significantly from foreign investments into EU accession countries.
Winning Moves, Winning Strategies

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FDI: Russia not solid BRIC
Net cumulative FDI per capita 1994-1Q11, BRIC countries Avg. annual net FDI as % of GDP, 1994-2010, BRIC countries
($bn) ($bn)
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1,800
1,566
4.0%
1,600
3.5%
– Second level
3.5%
1,400
3.0%
2.1%
• Third level
1,200
2.5%
1,000
830
– Fourth level
2.0%
800
1.5%
600
» Fifth level 1.0%
0.7%
400
258
0.2%
200 87 0.5%
0 0.0%
India Russia China Brazil Russia India Brazil China
Source: Bank of Russia, EBRD
• In our view, the main reason for low FDI comes down to poor corporate governance: transparency and protection
of property rights are the keys to attracting FDI. While many would argue that Russia is hardly unique vs its peers in
terms of weak governance, a state-dominated economy and other socio-economic issues, the figures above speak
for themselves.
• In one of its reports, the OECD rightly noted that if a country wants to attract foreign investment, it needs to make
its investment climate and business environment attractive for domestic players as well.
Winning Moves, Winning Strategies

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Which side of the Master on?
Net FDI in BRIC countries 1994-1Q11 ($bn) Annual net private capital outflow, 1994-2010 ($bn)
1,200
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82
1,000 41
– Second level
50
800
0
600 • Third level -50
-14
-4
-24 -18 -22 -21 -25
-15 -8
-2 -9 0
-22
400 – Fourth303
level Total Net Outflow 1994-2011
-57 -49
-100
$300bn
200
37
103 » Fifth level
-150 -134
0
Russia India Brazil China
Source: Bank of Russia, EBRD
• Capital flight remains an issue for Russia with the net total outflow amounting to over $300bn since 1994.
• While portfolio investors were putting money into Russia in the first half of this year, domestic businessmen were
actively taking money out, de-facto selling their own country. This can serve as an ‘insider trading’ test for the
attractiveness of Russia and poses the question to potential investors – which side of the trade do they want to be
on?
Winning Moves, Winning Strategies

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• In many respects, Russia now resembles the classic
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business case of a large struggling company where the
absence of a coherent strategy and eternal conflicts of
– Second level interest between board, management committee and
the remaining stakeholders lead to the lack of
• Third level cooperation between divisions, inefficient use of
– Fourth level available resources, poor corporate governance, high
» Fifth level staff turnover and shambolic financial performance.
• While this description may be dispiriting, even small
incremental changes in the way the company
(country) is run can have a disproportionate effect on
its investment attractiveness and hence its market
capitalisation.
• Therefore, we continue to believe that the ‘upside’ for
Russia’s stock remains huge and this alone justifies the
risk of an investment.
Winning Moves, Winning Strategies