Russia in Major Deals with Germany's Siemans

In a move to modernize the Russian economy, President Dmitry Medvedev is looking to German engineering giant Siemens.

Partnering with Siemens will be Russian Railways, which they'll work together on 22 railway switching yards throughout the country, and together produce 240 regional trains.

Siemens also landed a wind power deal where they'll install wind turbines in Russia as well.

Most products will be manufactured in Russia, Siemens said.

The deals for Siemens are reportedly worth about $2.8 billion.

Morgan Stanley (NYSE:MS) CEO Sees Fast Continuing BRIC Growth

Morgan Stanley (NYSE:MS) CEO John Mack said he sees continual growth for BRIC countries in 2010, unsurprisingly, led by China and India.

Concerning the weakest link of the four countries, Russia, Mack said, "Russia still has a very strong balance sheet and low overall leverage, which remain key advantages for the country. However, it continues to lag in investment due to the volatile macro environment and weak property rights."

Even though growth around the world will probably slow down because of China's fight with inflation from their hot urban property market, no growth in the U.S., and the European sovereign debt crisis.

Regardless of what the growth rates end up being, Mack stated that "Our expectation is that the fastest rates of economic growth this year are expected to be in China, India, Brazil and Russia."

BRICs Drive Export Demand

BRIC Driving Export Demand

With the U.S. consumers expected to hold back on spending for some time, the world continually is looking for the rebound from the BRIC countries in order to generate increasing demand for exports, which will help their domestic economies.

According to a recently released Goldman Sachs report, they assert the BRICs will account for around 50 percent of export demand as their domestic consumption grows; presumably from their emerging middle classes.

The report reiterated what we already know here, that China would perform particularly strong, more than likely accounting for 30% of the world’s consumption growth next year, which is more than the combined growth of the G3 — United States, Japan and Germany — as they slowly move out of recession.

Goldman Sachs, which dubbed the term BRIC in 2001, said the emergence of the BRIC consumer is an important development that will create demand and hence support the export markets of developed economies, and I would add that this will be going on for some time to come.

The report added that consumption in the BRIC economies would be supported by a shift in spending power from the richest countries towards a growing middle-income bloc in the emerging markets. Consumption would likely receive a further increase when the fast economic growth in China and India finally reaches their rural populations.

As these domestic economies emerge, the type of products they consume is also likely to slowly move away from low-value-added products, like agricultural goods, to those at the higher end, such as cars, office and telecom equipment.

The Goldman economists estimate that Chinese retail sales, a key indicator of consumption, rose 17.6% in the year ended June, with food and beverages products posting the biggest gains, although it remains to be seen whether this is a real rebound once their stimulus money runs it course and potential inflation arises. Retail sales in Brazil, while lower than in 2008, remained well supported and would likely increase in the third quarter as demand for commodities increase.

India does not measure retail sales, but individual components, such as vehicle sales are used to measure the consumer for consumption demand. Goldman said auto sales had increased in a big way, and were now selling quicker than before the crisis.

Russia, after years of strong growth, was the only BRIC country where retail sales growth had suffered, and is slowly losing the luster connected to being included with BRIC at this time. Sales in the year to June fell 6.72% on the back of a plunge in non-food products.

While most agree the BRIC countries will have an increasingly important role to play in the worldwide economy, not all are sure they can drive demand, but I think that's ludicrous based on China alone.

BRIC Driving Export Demand

Russia Struggling Most of BRIC

Russia continues to struggle most among BRIC nations

Some people have been questioning the continual inclusion of Russia among the BRIC economies, as they continue to underperform the rest during these difficult times, and Indonesia has been breathing down BRICs necks to be included among them. Maybe we'll begin to see it called BIIC if Russia doesn't turn things around soon.

China and India remain strong, with China projected to grow at a 8.4 percent rate and India a 6.2 percent rate. Brazil is also struggling with declines expected to come in at 1 percent, but that's no where near Russia's plunge of 8.5 percent.

Considering Brazil and Russia rely on commodities so strongly, it makes Russia's fall look even worse, based on direct comparisons.

The country’s natural comparison is with the BRIC countries — Brazil, Russia, India and China. In the first half of 2009, China and India have been surging ahead, while Russia’s GDP fell off the cliff by 10 percent.

Russia’s economy remains reliant by oil and gas, and its overall government policies depend heavily on the worldwide oil price. Three standard scenarios were formulated in the official Strategy 2020 program. The favored “innovation scenario” was supposed to generate an annual growth of 6.5 percent. It presupposed far-reaching reforms and investment in human capital, which is not a plausible option with an oil price above $60 per barrel.

The Kremlin’s negative “inertia scenario” assumed no significant reforms and forecasted an average growth of 3.9 percent a year. Such an authoritarian petrostate is likely if the oil price is $75 per barrel. In between, the Kremlin put an “energy and raw materials scenario” with 5.3 percent growth, which could be called status quo with an oil price of $60 to $75 per barrel, but such a policy is not likely to generate a high growth rate.

The the major thing to learn is that the higher the oil price is, the lower Russia’s long-term economic growth is likely to be, because the ruling elite will thrive on energy rents rather than pursue reforms or invest in human capital. The greater the corruption is, the more repression the rulers need to defend their fraudulent revenues.

Russia’s course is hard to figure out because overt economic policy changes every few months with the oil price. During the period from May to July 2008, the inauguration of President Dmitry Medvedev raised hopes that he would initiate economic and political reforms — particularly as it related to his anti-corruption initiatives — but we saw no important changes.

Prime Minister Vladimir Putin intimidated Mechel in late July, threatening to send a “doctor” to clean out the company’s problems, and the war in Georgia two weeks later augured a period of darkness and reaction. Russia’s attempts to accede to the World Trade Organization were suspended and a renationalization of leading companies became a priority.

But the devastation caused by the financial crisis and gradual devaluation allowed reformist ideas to surface again. Russia saw a renewed openness from February until May that could almost be labeled a thaw, but again no legislation was passed.

In early June, the oil price surpassed $70 per barrel, and the reactionaries got into action again. In Pikalyovo, Putin declared the not very market-oriented view that private businessmen have to produce for the sake of producing. Numerous governors threatened private enterprise owners with confiscation if they did not rehire workers and keep decrepit factories alive. Several weeks later, Putin suspended Russia’s attempted accession to the WTO and he even went on a personal tour to control sausage prices. Naturally, rumors are ripe of possible new confiscations of large corporations.

This is a terrible to run economic policy. In effect, Russia is pursuing the status quo or inertia scenario — but without the benefit of stability. With its quarterly swings in declared economic policy, the government destabilizes the business environment and fails to carry out any economic policy. Both the vagaries and passivity are dangerous to the country’s economy as is evident from the extraordinary fall in GDP. No wonder that not only China and India but also Brazil are much more successful.

Russia’s only sensible policy has been its fiscal policy with a persistent budget surplus in the good times from 2000 until 2008, which allowed it to build huge international reserves that, while reduced, remain at roughly $400 billion today. This means that Russia can safeguard itself from some fluctuations of the global financial market.

But it is not doing so. On the contrary, it is causing unnecessary domestic financial problems. The ultimate folly was Russia’s gradual devaluation during the period from November to January. Naturally, everybody speculated against the ruble, which meant that the Kremlin instigated a domestic liquidity freeze. It was probably the main reason for the excessively sharp drop in Russia’s industrial output. Amazingly, this operation is officially hailed as a success,ensuring that the danger of a continuation could persist.

The state-dominated banking system remains a disaster. The five dominant state banks are in horrid shape. The government pours more and more money into them, but it helps little as the banks lose it in short order on politically motivated, nonperforming loans. The state banks pose a threat of nationalizing big Russian companies, while they provide little credit. In effect, the Kremlin maintains a detrimental liquidity squeeze.

Senior officials interfere however they want to in big enterprises, asking them to hire more workers, to reduce prices and to expand production under threat of confiscation, further undermining the country’s weak property rights.

Gazprom appears to be the greatest management failure of them all. It is difficult to fathom how it has succeeded in scaring so many customers away in half a year that it has been forced to cut its output by 35 percent. In any other country, save Congo, such a harmful management would be fired without delay. There is no reason to expect any significant improvement as long as the managers remain the same.

Russia’s ultimate shortcoming is its pervasive top-level corruption. Remember that it has failed to extend its road network since 2000. A country that cannot build roads cannot develop much more.

There is no doubt that Russia will recover somewhat because of higher oil prices, the global recovery and recovering exports, but nothing has been done about the country’s profound structural problems, which have only been aggravated during a year of financial crisis. Worse, Russia’s economic policy is in such flux that nothing is being done. Gradually, the question is moving from complaints about how Russia is being governed to criticism that it is not being properly managed.

Russia continues to struggle most among BRIC nations

BRICS Auto Parts Focus

BRIC and Auto Parts

Globally, the auto-parts industry is running on a major flat, experiencing a blowout of demand due to production cuts at struggling vehicle manufacturers. They’re expected to slash auto-part employment in this country by more than a third this year, according to the Conference Board of Canada. But unlike Michigan’s Lear Corp., which just joined its home-state competitor Visteon Corp. in seeking Chapter 11 protection from creditors, Frank Stronach’s Magna International Inc. isn’t cruising in crisis mode. Instead, the Aurora, Ont.–based company, the third-largest and most diversified automotive supplier on the planet, is looking to feast on industry road kill.

Launched in a Toronto garage by Stronach about five decades ago, Magna hasn’t been immune to sector woes. The company, which has been forced to shutter plants and eliminate thousands of jobs, posted a net loss of US$200 million in the first quarter, when light-vehicle production in North America and Europe plummeted 50% and 40%, respectively. Sales dropped to US$3.6 billion, a 46% decline from Q1 2008 — when Magna reported a gain of US $207 million.

But Stronach’s operation, which employs 70,000 people in 25 countries, has a non-union culture, so it doesn’t face the labour cost issues that helped park General Motors and Chrysler (which jointly accounted for 30% of Magna’s Q1 sales) in bankruptcy court this year. Like Canada’s other two major sector plays — Martinrea International Inc. (TSX: MRE) and Linamar Corp. (TSX: LNR) — Magna is free to rev up M&A activity because it is fuelled by a healthy balance sheet.

Unlike the competition, however, Magna is chaired by Stronach, who controls the company via controversial dual shares that turn off institutional investors. And he is raising eyebrows by voicing a desire to shift his auto empire’s gears by ramping up assembly operations. In other words, Stronach apparently thinks it is a good idea for Magna — which currently builds outsourced vehicles at a single assembly plant in Austria — to compete head-to-head with customers in emerging and developed markets alike.

In May, Magna and Moscow-based Sberbank made a joint non-binding bid for control of Germany’s Adam Opel GmbH, the main arm of GM’s European operations. If completed, the Kremlin-controlled lender is expected to transfer its stake to Oleg Deripaska, an oligarch with auto interests, not to mention friends in Moscow, who would then open the door to a rapid Magna expansion into Russia.

The $700-plus-million Opel play isn’t the first time Magna has appeared willing to roll the dice on a major expansion of assembly operations. At the company’s annual general meeting this year, Stronach admitted the company “dodged a bullet” by losing the bidding war for Chrysler two years ago. The focus on Russia also isn’t new. In 2007, Stronach cut a deal to share control of Magna with Deripaska, who invested US$1.5 billion in the Canadian firm at the time. But the Russian’s direct involvement with the company ended late last year, when a liquidity crisis forced a sale of his equity stake.

According to Magna spokeswoman Tracy Fuerst, the “working relationship” with Deripaska’s GAZ auto-making group has remained strong. Still, Magna’s renewed focus on Russia and eagerness to compete with customers is generating mixed reviews. “Not many investors we speak with seem terribly anxious about a potential Magna-Opel tie-up,” Itay Michaeli, an analyst with Citigroup Global Markets, declared in a research note. He argues the Opel deal represents a “low-risk” investment that would, if completed, generate future goodwill with GM.

But other industry watchers see the Opel bid as a high-risk strategy, which is why 12-month analyst stock price targets are all over the map, ranging from $32.74 to $59.03. (At press time the stock was trading around $48.)

Clearly, not all of Magna’s customers are happy over the company’s play to become a full-blown automaker.

While bidding for Chrysler, Stronach could at least claim he was out to aid a troubled client. Opel, however, attracted other suitors, including Beijing Automotive Industry Holding Corp. And even if Magna doesn’t close the deal, it still threw a wrench in Chrysler’s survival plan — since the Canadian bid put Fiat out of the running, and the Italian car company had hoped to buy Opel as part of the strategy it developed when agreeing to take over the Detroit automaker. Shawn Morgan, a Chrysler spokeswoman, declined to comment on the company’s relationship with Magna. But Volkswagen has said it is watching developments with some apprehension.

Carlos Gomes, an auto-sector analyst with Scotia Capital, Magna’s focus on Russia could also prove to be riskier than deal supporters want to admit. He acknowledges that Russia has a low vehicle-penetration rate (about 180 vehicles per 1,000 people), compared with roughly 560 vehicles in western Europe, so the potential is enormous if its energy-dependent economy recovers. Still, he thinks “Russia likely has the weakest outlook among the BRIC nations because of declining population.”

Bill Witherell, an adviser to the Organisation for Economic Co-operation and Development and chief economist with New Jersey–based Cumberland Advisors, is also bearish on the Russian economy, which is projected to decline 8.5% this year. He thinks emerging-market strategists should focus on BIC economies, noting Russia — where IKEA recently suspended operations due to the “unpredictable character” of administrative procedures — sits between Syria and Kenya on the 2008 Corruption Perceptions Index.

Michael Willemse, an Toronto-based analyst with CIBC World Markets, says Magna shareholders are obviously uncomfortable with the Opel bid. But he thinks a related sell-off that weakened the share price was probably overdone. Simply put, he doesn’t believe Magna’s co-CEOs — Don Walker and Siegfried Wolf — would be willing “to inject a material amount above the original investment,” which would be inconsistent with “Magna’s desire to maintain a strong balance sheet.” If Magna’s management was blindly focused on becoming a global automaker, Willemse argues the company would have been more aggressive pursuing other deals over the past two years. But he admits there is a risk that Stronach has taken the wheel from his CEOs to drive Magna into auto-making in a major way.

BRIC and Auto Parts