RUSSIA

1. ИНВЕСТОРЫ И ДЕВЕЛОПЕРЫ НЕДВИЖИМОСТИ В РОССИИ И СНГREAL ESTATE INVESTORS AND DEVELOPERS IN RUSSIA & CIS RUSSIA РОССИЯ GRI 2011

2. Silver linings amid rising threats Ivan Tchakarov, Ph.D. +7 (495) 258 7770 x7400 itchakarov@rencap.com 2 Key Messages:1. Russia will not be immune to strengthening global headwindsFocus of vulnerability shifting to the ability to fiscally support a weakening economy No big signs of a slowdown yet, but the spill-overs will be felt in 1H2011 We see 4.1% (vs. 4.7% consensus) and 3.5% (vs. 4.4% consensus) GDP growth in 2011 and 2012 Forecasts driven by weaker investment (in 2011 and 2012) and consumption (in 2012)2. The negative impact on the economy may be cushioned by 4 silver linings Longer maturity structure of external debt More flexible exchange rate More robust reform momentum No overheating

3. Key vulnerability 2008 • In 2008, Russia’s descent from stability to ‘hot potato’ caught many by surprise. • After all, CA was in surplus, standard metrics of BS vulnerabilities were strong • Optimism among policy-makers abundant • However, the sudden calling in of short-term external loans put the private sector in a tight spot • Authorities had to intervene to backstop any major defaults • Heavily managed RUB was kept in place for too long, preventing a brisk external adjustment

4. Key vulnerability now Non-oil deficit remains far wider than target • In2008, Russia entered the crisis with a strong stock and flow fiscal position, allowing it to pursue (correctly) aggressive countercyclical policy • Now the medium-term fiscal framework adopted on July 7th throws prudency to the wind, putting in danger previously announced intention to balance the budget by 2015. • Non-oil balance to remain about -10% of GDP by 2014 • Break-even oil price at a whopping USD125bbl vs. USD50bbl in 2008 • Hence, current vulnerability has shifted from the ability to meet short-term foreign obligations to fiscally support an economy faced with heightened sensitivity to external shocks

5. Bear hug We forecast bigger slowdown in 2012 Consumption fall smaller, but more protracted • New forecasts driven by weaker investment in 2011/2012 and consumption in 2012 • Fixed investment 3.8% (vs. 6.8%) in 2011 and 4.7% (vs. 8.8%) in 2012 • Consumption 3.8% (vs. 4.1) in 2011 and 3.5% (vs. 6.0%) in 2012 • Investment growth forecast to drop sharply and immediately with a quarter lag (Q42011), remaining there for next year and with a full-year decline of 3.8% • Consumption growth takes longer to adjust with maximum impact reached after 4 quarters. • Hence, largest impact of the shock to be felt in H12012

6. Bear hug Pre-crisis GDP level reached by end-2011 Output gap to close only in 2Q2013 • The downward revision to our 2011 GDP growth forecasts is too small to change our estimates that Russia will reach its pre-crisis level of output by the end of this year • However, it will still have taken twice as long to achieve this in comparison with the 1998 sovereign crisis (14 vs. 7 quarters) • Largest impact of the shock will be felt in the first half of 2012 • At the same time, the more sizable growth revision for 2012 means the output gap will now only close in 2Q13, i.e. three quarters later than we previously estimated

7. Only minor signs of a slowdown Micro data slowing, but still very robust • Disaggregated microeconomic data does not yet signal a significant slowdown yet • In fact, data is still very robust • However, as argued above, it will take a couple of quarters for the external shock to kick-in • Recall that in 2008 major weaknesses appeared only in late 2008 and beginning of 2009, although the global crisis had been raging for some time already. • So no time to be complacent right now

8. The silver linings-less ST debt …and relative terms Foreign reserves smaller in absolute… Foreign reserve coverage of external debt has also declined… …although ST debt coverage has increased significantly

9. The silver linings-less ST debt …while private debt is yet to catch up External debt has recovered to pre-crisis levels… External bank dent is still lagging… • …while corporate borrowing has reached pre-crisis levels

10. The silver linings-less ST debt …mainly as a result of private sector deleveraging (30% to 15%) Share of ST debt has declined (23% to 12%)… Banks have been particularly active… • …but other sectors have also moved in that direction

11. The silver linings-more flexible RUB • RUB volatility has spiked recently and RUB has been the EM currency that saw the largest swings in the latest episode of mkt volatility • CBR intervened, but only in a measured fashion. This is commendable as one key lesson from the 2008 crisis was that keeping the currency heavily managed contributed to the acute fall in real GDP in 2009 • New monetary policy paradigm adopted by the CBR since the 2008 crisis will serve as an important buffer in the case of a deterioration in US and global growth prospects. • If the RUB is allowed to act as a shock absorber, it could limit the decline in GDP by almost 40% (1.50% vs. 0.89% decline in GDP) • Inflation should not suffer with a weaker RUB as the external shock is by nature deflationary More flexible RUB should not fuel inflation Fall in GDP growth 40% less with a Flexible RUB (1% decline in US growth relative to baseline)

12. The silver linings-not overheating • The economy was broadly running at potential until 2005/2006 • As oil price accelerated significantly and capital flows became abundant, the economy started growing above potential • This lead to a significant overheating around late 2007/early 2008 when the negative output gap was 7% of potential GDP • Right now the economy exhibits a positive output gap of about 1% • Hence, external shocks will have less of a potential to lead to a major slowdown/recession Fall in GDP growth 40% less with a Flexible RUB (1% decline in US growth relative to baseline)

13. The silver linings-reform drive • Twin surpluses were the name of the game pre-crisis… Federal surpluses were running at 7% of GDP while the current account surplus did not decline even during the crisis • …but the crisis is now turning the table on the current account… The current account is shrinking due to increasing import bill and broadly constant oil extraction, which constitutes large part of exports. • …and even more so on the fiscal balance. The prudent fiscal policy to save a significant portion of the oil windfall during the upswing cushioned the effect of the 10% turnaround in the fiscal position. Twin surpluses heading south

14. The silver linings-reform drive • Financing these deficits will be a key challenge... Deficits on the public and external side, exacerbated by rising health and pension obligations, will require a changed approach to attract foreign investment. • …in particular in light of allegedly unfavorable business environment. The transparency International rating of corruption in Russia fell last year from 2.2 to 2.1 on a scale of 0.0 (highly corrupt) to 10.0 (very clean), pacing Russia 154th out of 178 countries between Papua New Guinea and Tajikistan. • Russia needs to improve business climate in order to attract foreign investment and we think Kremlin may be starting to realize this... In our mind, the crisis has visibly brought a new frame of mind that is more open and welcoming to foreigners. • …and some tentative signs are already visible: • Privatization; • Reduction in the strategic enterprises list open to foreign investment; • WTO membership; • 2018 World Cup; • Accessibility to domestic bond (OFZ) market; • These reforms are under-appreciated and under-priced… The less-favorable external drop and the need to invest heavily in the decrepit infrastructure is inviting a fresh look into Russian growth prospects. • …but they will be implemented only in an evolutionary manner. We think that there is more serious underlying momentum to the current reform agenda.

15. The silver linings-reform drive • TI well-known perception corruption index asks international businessmen for their assessment of corruption whether or not they have done business there • Hence, results are vulnerable to distortions based on press portrayals of a country • The best data to assess corruption comes from surveys that ask businessmen and citizens whether they or their acquaintances have recently been asked to pay bribes • When scaled by GDP, Russia’s corruption is exactly as common as one would expect given its level of economic development How corrupt is Russia?

16. The silver linings-reform drive • According to Polity IV database, btw 1992 and 2007, Russia ranged btw 3 and 6, averaging 4.5 (Saudi Arabia was rated -10, and USA +10) • In general, higher income means high democracy, except for oil-rich countries and Singapore • Countries around Russia’s level exhibit a broad range of political regimes-from highly authoritarian Libya to the consolidated democracy of Poland • Again, Russia seems to be exactly where one would expect given its income level How (un)democratic is Russia?

17. The silver linings-reform drive • Among 28 post-communist countries for which WB publishes data, Russia had only the 14th largest fall in population btw 1989 and 2007 • If one were to exclude influx if immigrants, the fall worsens to 6.6, but still puts Russia outside the worst 10 countries. Does Russia’s demographics befit a country at war?

18. Appendix I- How important is oil? • Using statistical methods, we estimate that variations in oil prices account for a third of the variation in Russia’s GDP • What is the responseof Russia’s GDP growth to a one-standard-deviation decline in the Brent oil price (equal to $15/bbl)? • Our model indicates that economic activity in Russia responds negatively and the impact of the shock is maximized after three quarters, when the shock shaves close to 1.2% off growth. The average impact over four quarters is about 70 bpts. • The RUB could suffer as well, with the $/RUB declining by 1.2 two quarters after the shock. • The impact on the fiscal and current account is much more modest RUB could be the biggest casualty GDP growth may fall by 70bpts over four quarters if oil prices drop by $15/bbl

19. ИНВЕСТОРЫ И ДЕВЕЛОПЕРЫ НЕДВИЖИМОСТИ В РОССИИ И СНГREAL ESTATE INVESTORS AND DEVELOPERS IN RUSSIA & CIS RUSSIA РОССИЯ GRI 2011