Issue No.29, Volume 1
The Russian economy has been hit by the ruble’s depreciation, declining oil prices and sanctions from Western countries. Moscow believes funds from Asia would help change the situation. The deputy mayor of Moscow went to Hong Kong to negotiate transportation junction projects and financial cooperation, and Russian enterprises are actively inviting investment from China.
December 16, 2014 has been described as “Black Tuesday”.
At 1:00 am on December 16, 2014, the Russian Central Bank announced a big interest rate increase of 6.5%, from 10.5% to 17%, which is the biggest increase in sixteen years. Russia expects this to stimulate the market’s demand for rubles.
Though the exchange rate of rubles to US dollars went up slightly, by 6%, in the morning Russian local time, it declined rapidly, by 19%, later the same day. Compared to the exchange rate in June 2014, the exchange rate has declined by 91%, making the ruble the currency with the worst performance in 2014.
The main reason for the exchange rate’s rapid decline on the same day that the interest rate was increased is because investors had lost confidence in the Russian economy. The large interest rate increase didn’t stimulate the market’s demand for rubles, but made investors think the Russian economy was in crisis and cashed the capital calculated in rubles, thus causing the sharp drop in the exchange rate.
In fact, investors’ confidence in Russia has continued to decline. According to data from the Russian Central Bank, the net capital outflow of Russia in the first nine months of 2014 was USD 85.2 billion, an increase of USD 44.1 billion compared with the same period in 2013, an increase of 39%. Anton Siluanov, Russia’s finance minister, predicts the total net capital outflow of Russia in 2014 to reach USD 130 billion.
The ruble’s depreciation is also closely related to the drop in oil prices. Regarding the fluctuation of Brent Oil prices, the average price per barrel dropped from USD 108.70 in 2013 to USD 60 (as of December 16, 2014), which is the lowest in five years. Currently oil exports account for 39% of Russia’s exports, while exportation makes up 28% of Russia’s GDP. Therefore, the drop in oil prices deals a huge blow to the Russian economy, which relies heavily on oil exports.
While Russia was in the awkward situation of currency depreciation, the EU and US each imposed new economic sanctions against Russia. The EU Council approved a bill to prohibit investments from EU companies into Crimea on December 18, 2014. Later, the US and Canada announced the launch of new economic sanctions against Russia, aimed at the Russian national defense industry and the restriction of energy technology exportation to Russia, respectively.
Early in July 2014, the US launched a third round of economic sanctions against Russia, prohibiting American banks and investors from providing four large Russian companies loans for a period exceeding 90 days. In August 2014, the EU imposed sanctions against Russia in terms of financial transactions, weapon sales, and providing energy technology.
Defending against crisis with construction investment
When the Russian economy was besieged on all sides, Moscow’s government thought Asia might bring some changes to the local economy. In recent days, Sergei Sobyanin, Mayor of Moscow, reiterated in the fourth Moscow City Forum that despite of the ruble’s depreciation, falling oil prices and sanctions from Western countries, the government will continue an expansion project in the capital to construct a “New Moscow”. He emphasized that “construction investment can defend against crisis on any level”, that the city government intends to change the image of the high cost of doing business in Moscow and will provide 8 million square meters of commercial service land for investment from local and overseas investors.
This “New Moscow” project will not only expand the city’s area to 2,500 square kilometers, which is 2.5 times Moscow’s original city area, but also transform the city into a multi-center city. The new district plan includes the administrative organization of the federal government.
Marat Khusnullin, the deputy mayor, said at the Forum that the city government intends to attract oversea investors to invest in Moscow expansion projects, construction of transportation infrastructure, industrial areas and the Moscow River, etc.
In order to attract Asian investors, Khusnullin attended the MIPIM Asia in Hong Kong and promoted the transportation junction project, an estimated value of USD 40 billion. He said: “The New Moscow Development Project is a project that the city government will give priority. To promote the implementation of the project, the city government plans to use appropriations from the federal budget to encourage domestic private investment and cooperation of overseas investors. The city government would like to provide the most ideal investment environment and customized investment programs for investors who plan to invest in Moscow’s development.”
Khusnullin described the development model of the Moscow transportation junction project as similar to Hong Kong’s Subway-Estate model. He said the city government intends to cooperate with Hong Kong Subway and he said “the experience of Hong Kong Subway is of great reference value to the development of the city of Moscow”. At the same time, he said the city government had invited the Hong Kong Institute of Architects to participate in the planning of the Moscow Transportation Junction Project.
Apart from the construction of transportation infrastructure, Khusnullin believes that Hong Kong plays an important role in Chinese-Russian financial cooperation. He noted that some Russian banks, i.e. VTB Bank and Gazprombank, plan to open offices in Hong Kong because RMB trades could be carried out in Hong Kong, the international financial center.
According to a report from the South China Morning Post, four Russian banks plan to issue dim sun bonds with an estimated value of 2.5 billion RMB (about USD 400 million) in Hong Kong, i.e. bonds issued in Hong Kong but denominated in Chinese RMB.
Eddie Astanin, Chairman of National Settlement Depository of the Moscow Exchange Group, mentioned during an interview that in the past even though some Asian investors wanted to invest in Russia, they had to go through intermediaries located in London (for example, some global custodians, brokers and investment banks). Russians would like to establish a relationship with the financial institutions and investors to avoid the intermediaries. He also hoped to strengthen the cooperation between Moscow and Hong Kong at the level of company listing, offshore RMB trades, etc.
In addition, the Moscow City Government also aims to increase revenue from the local tourism industry. At the summit “It’s Moscow’s Time”, an officer of the city government said that a total investment of 19 billion Euros (about USD 23 billion) would be used to make Moscow into an international tourism destination. The plan includes large-scale restoration of historic sites. Currently the Chinese make up the largest percentage of tourists visiting Moscow. According to a research report recently published by the City Intelligent Statistics Center, Moscow is the world’s fourth most popular city for Chinese travelers, with the number of Chinese visitors reaching 276,000, behind New York (646,000), Los Angeles (570,000) and Sydney (380,000). Depreciation makes Moscow a relatively cheap tourist destination.
The ruble’s depreciation also benefits some Russian companies
A weaker ruble not only benefits foreign travelers but also some Russian companies. Metalloinvest is one of them. Andrey Varichev, CEO of Metalloinvest said that 95% of the company’s cost was calculated in rubles, while almost 70% of the revenue was connected to the US dollar. Therefore, the ruble’s depreciation brought certain positive impacts to their financial performance.
Also, Metalloinvest was not impacted by the earlier economic sanctions from Western countries. According to the Financial Times, Metallionvest announced it received USD 1 billion in financing when the EU and US launched the first round of economic sanctions against Russia. And some European banks also were involved in this transaction, including Deutsche Bank, Internationale Nederlanden Groep and Societe Generale.
Andrey Varichev said the sanctions made Western banks alarmed with Russian companies, that it was completely expected, however, the banks that have funds and would like to continue cooperating with Russia would only turn to the loan granted to Russian companies that were not on the list of sanctions.
Although the company’s business was not dragged down by a weakened ruble and Western sanctions, Varichev paid attention to the risk of an unstable foreign exchange market. He said, “Because of the unstable foreign exchange market, diversifying the currency risk is a matter of course. We are considering using RMB to settle when providing products to China, purchasing equipment, doing debt financing, etc.”
Some Russian companies also turned to financing from Asian countries before Western sanctions. In 2012, the Russian electricity company TGC-2 established a joint-venture company with China Huadian Corporation to build a power plant in Yaroslavl, northeast of Moscow. TGC-2 announced that the project received a loan of USD 190 million from the Industrial and Commercial Bank of China and another loan of USD 210 million would follow. Because 85% of the project funds were provided by China (70% from the loan of the Industrial and Commercial Bank of China; 15% from China Huadian), this project was described as“the only energy project in Russia in which a Chinese enterprise invested directly”.
TCG-2 signed a framework agreement with China Huadian in November to strengthen the cooperation in Russia, including the modernization of the power generation equipment in northern Russia. CEO Andrey Varichev said that Chinese enterprises would not only provide funds to Russian enterprises but would also be reliable partners. “Two elements makes Chinese enterprises in the energy industry reliable: First is technology. Chinese technology is developing rapidly, not only approaching the international level but also being cost-effective; Second, the Chinese have a sense of discipline in work,” he said.
However, it is not always a smooth road for Chinese enterprises investing in Russia. Even though Russia’s ranking has risen from 64 last year to 62 in the global business operation environment ranking published by the World Bank, the ranking did not include data from the second half of 2014. Facing increased construction costs due to fluctuations in the ruble, two Chinese companies constructing the new railway branch lines for Moscow, China Railway Construction Corporation Limited and China International Fund Limited, decided to postpone the plan.
Varichev used the energy industry as an example to point out that a certain amount of differences in technical standards and regulations between China and Russia exist. He said,“Russian standards focus too much on the planning of how to address unexpected events. Therefore, the enterprises find it very difficult to reduce the cost of constructing the energy plant as they would do in Europe or China. Russian engineering standards also demand very high metal density.”
Earlier Moscow wanted to cooperate with China Wanda Group to build 100 million square meters of real estate in the Russian capital. However, both parties failed to reach an agreement when Wanda Group wanted to use RMB and rubles for payment of the project. It seems there is still a long way to go for Russia to strengthen business and economic cooperation with Asia, even if Asia might bring some changes to Russia’s economy.