Wednesday, December 22, 2010

From BRIC to BIC? Is Russia worth the emerging market status?

It took me a while to get back behind my desk and write for this blog. Too many projects have diverted some of my attention elsewhere although the topics over which to share my humble views are a lot.

Numerous times over the past few weeks I had the opportunity to share with clients, investors and friends alike my negative opinion about Russia's future economic outlook.
I went back to substantiate some of my qualitative comments with data gathered from the recent World Economic Forum report.
The data from the report is not encouraging, following is a summary that I have provided in an earlier post:

Russia: 63th position, same as last year. After the significant slide of the previous year, Russia maintains its position. While infrastructure, health, education and technology improves significantly other components of the index suffer. The major area of concern highlighted in the report are market competitiveness and efficiency of the goods markets. Competition is hindered by inefficient anti monopoly laws and restrictions on trade and foreign ownership. One of the main issue highlighted further in the report remains the weak institutions that translate in weak property rights (126th rank) and weak corporate governance standards (119th rank).

In spite of the large amount of natural resources available for development the country doesn't seem to be able to attract large amount of foreign capital due to poor market efficiency and regulatory frameworks able to give proper guarantees to foreign investors. 

Further to the contingent stagnant situation I believe there are some more fundamental weaknesses of the system that is worth outlining:
  • very negative demographic trends;
  • limited communication skills in the international arena as most of the business people tend not to be able to speak basic English.
  • weak and non competitive SME sector
The first is the most worrisome of the trends. It has been recognized by the local government as a serious problem and some measures have been taken to stimulate the natality rate.
Low birth rates and abnormally high death rates caused Russia's population to decline at a 0.5% annual rate, or about 750,000 to 800,000 people per year from the mid 90s to the mid 00s.
The population peaked in 1991 with 148,689,000 and it is now at 141,927,000 as of January 1, 2010.

The language aspect is more difficult to quantify in its impact but in my opinion remains an important one. While the Indian subcontinent for example presents clear difficulties in regulatory frameworks and infrastructure among others remains a lot more dynamic and integrated with the global economy due to the pervasive use of the English language among the average business person.
On the other hand Russia remains insulated as most of the business people, even of young age, are barely able to speak basic business English.
Russians have developed their own set of social network website separate from the rest of the world: Vkontakte ( and they are trying to develop their own set of domain names in cyrillic: Russian domain names
In a world where being connected and communication is the underlying basis for all business it is hard to imagine how big is the cost of this type of "isolation".

The SME sector is undersized for this nation as the entrepreneurial class has only a very brief history. During the entire Soviet Union time there was a systematic dismantling of the entrepreneurial spirit and only after the break up and the savage deregulation following SMEs have found a reason to exist. 
In both emerging markets and developed countries SMEs often tend to be the most resilient during an economic downturn as well as a consistent source of innovation. Without such developed strata of companies combined with some of the difficulties outlined above the Russia economy appears lacking a necessary component to long term prosperity. Please note that to support the claim above according to the latest World Bank's survey (Doing Business, 2009) Russia ranks 120 out of 181 economies in 'ease of doing business'.

Overall, my position remains that given the existing economic issues and moreover due to the long term demographic trends currently in place Russia no longer belongs to the emerging market economies in spite of the large natural resources available on the territory.

Too many changes are to be applied at the same time to reverse the situation. It would be at least necessary to create a more favorable set of predictable rules to favor and regulate foreign investment in the country such to develop and modernize further the natural resources industries.
Swift and deep additional efforts are to be made to integrate additional foreign workers in the country to be able to reverse some of the underlying demographic trends and more importantly collect the related taxes.

As many friends and clients come from this beautiful country I hope to assist to a swift reversal of such trends.