The 12 months between mid-1998 and mid-1999 were pretty unpleasant for the markets of Eastern Europe...
The 12 months between mid-1998 and mid-1999 were pretty unpleasant for the markets of Eastern Europe. Collapsing oil prices and economic mis-management resulted in Russia defaulting and devaluing in August 1998. This was then followed by a sharp economic slowdown in the EU with disastrous consequences for the economies of Central Europe.
Fortunately as day follows night the outlook for the region has changed utterly since last summer. Soaring oil prices, the competitive benefit of the devaluation of the rouble and the end of Yeltsin's tired administration have transformed the outlook for Russia, while the powerful economic recovery in the EU has provided a significant boost to the exporting countries of Central Europe.
The key question for investors is will this continue? The current outlook for Russia is more positive than at any time since the fall of the Soviet Union in 1991. Russia's dependence on natural resource exports, for so long a weakness, is likely to be a strength over the next 18 months as strong global growth keeps commodity demand high and OPEC's recent deal keeps oil prices locked in a $20-$25 per barrel range. This is likely to allow Russia to generate a current account surplus of 10-15% of GDP in 2000. GDP growth has also resumed, and we expect 4-6% this year.
However, without structural reform this cyclical economic recovery is likely to prove unsustainable. The almost complete absence of structural reform under Yeltsin has left Russia a weak and inefficient country. The election of Vladimir Putin is likely to make a crucial difference in this regard.
Putin has almost a perfect c.v. for successfully designing and executing a reform programme. His experience as deputy mayor in the reformist St. Petersburg administration between 1992-96 and his close links with liberal economists suggest he knows exactly what needs to be done. He has already stated that tax reform, land reform and a restructuring of the bloated civil service will be his priorities.
He will be helped in this regard by the result of last December's Duma elections, which resulted in a non-communist majority for the first time since 1991.
If Putin succeeds, or begins to succeed, the re-rating potential for the Russian market is substantial. Russia trades on a P/E of 6.5 times 2000 earnings and assets remain at a 90% discount to international comparisons. We are overweight this market.
We are also positive on Central Europe. Hungary, Poland and the Czech Republic are essentially geared plays on the EU economy, in much the same way as Mexico is on the US. In 1998-99 this was bad news. Over the next three years we think this linkage will prove to be extremely beneficial.
Martin Taylor is a fund manager at Baring Asset Management
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