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Onward, Comrades! 5 Priorities for a Resurgent Russia

Neil Dwane | 02/03/2017
View of Russian skyline

Summary

One hundred years after the Russian Revolution, the tsars and the USSR may be gone, but Russia itself is alive and well. With the US becoming more isolationist, Russia has a chance to revise its standing with the US and EU – but this time, as an equal.

Key takeaways

  • President Putin sees the USSR’s collapse as one of the world's greatest disasters, and he is using his country’s proud national identity to re-establish its prominence not militarily, but economically
  • Five priorities for the new Russia: turning around its economy, transforming its energy sector, flexing its geopolitical muscle, dealing with its demographic issues and locking down its leadership
  • With reduced legal protections for international investors, many Russian assets will stay cheap, but Russia and many CEE nations offer sovereign debt with attractive yields

As Russia commemorates the 100th anniversary of the Russian Revolution, a major geopolitical event that shaped much of the 20th century, it is easy to imagine its citizens taking stock of what went right and what went wrong since the 1917 uprising. From our perspective, we see at least three enduring legacies from the past 100 years:

  • The failure of communism. After the tsars were overthrown, Russia pursued a path to communism that was ideologically appealing yet economically unsustainable. Even China, long ruled by its Communist Party, seems to have found its capitalist heart.
  • Major military-industrial successes. Russia’s World War II defeat of Nazi Germany in the Ukraine came at a horrific cost and is still generally under-appreciated by the West. After the war, the Union of Soviet Socialist Republics’ technological feats in the space and nuclear races still rank among the 20th century’s defining scientific achievements.
  • The systemic misallocation of resources. As the Cold War raged, Russia kept its huge energy sector going to feed its defence efforts at the expense of its other markets and industries. Unable to keep up with the United States’ 1980s-era “Star Wars” spending, the USSR eventually collapsed.

Russia on the rebound

Yet even though the Soviet Union rose and fell during the past 100 years, Russia itself is alive and well today. President Vladimir Putin – who has described the USSR’s collapse as one of the world's greatest disasters – is using his country’s sense of history and proud national identity to re-establish its prominence not militarily, but economically. Russia retains a great deal of influence over the "Stans” of Eurasia and other neighbouring countries, and it can still exercise its might even though it has been weakened by sanctions. With the US becoming more isolationist under US President Donald Trump, and with China’s influence rising in the East, Russia sees an opportunity to revise its standing with both the US and the EU – but this time, as an equal.

Five priorities for the new Russia

So how will Russia celebrate its centenary with its Mr Putin at the helm, and what will its new goals be? Here are five issues worth watching:

1 Turning around the economy

Many European countries – especially Italy, France and Germany – are keen to normalize trading relationships with Russia. Sufficient rapprochement would particularly benefit the economies of Central and Eastern Europe, which remain troubled by migration issues and the European Union’s austerity measures.

Although Russia’s economy is overly reliant on commodities, rising oil and gas prices could be an accelerating story in 2017. If additional government revenue slows Russia’s two-year recession, consumer confidence and investment could rise as interest rates fall and the rouble strengthens. But without help from oil prices, Russia’s economy should remain relatively dull, and weaker oil prices could create trouble in the coastal and interior regions. This is because Russia’s economy is highly regionalized, with more than one-fifth of its wealth generated in and around Moscow. The central government may face regional resentments as it makes a tough choice between implementing additional austerity measures and reducing military spending.

2 Transforming the energy sector

Allianz Global Investors has been constructive on energy prices for some time, given the global factors of constrained supply and rising demand. If prices climb, Russia should see not only more government revenue but also more investment, as efficiencies developed in the US shale industry are put to work in Siberia’s vast energy fields; the Bazhenov Shale alone is the size of the US! Still, Mr Putin will take pains to make sure the new Russia avoids the fate of the Soviet Union, so we expect him to move away from energy and revitalize the formerly strong industrial, space and technology centres that once competed with the US. Much of this can be accelerated with eager investment from Italian, French and German companies that have long-established ties to Russia.

3 Flexing its geopolitical muscle

The West is still struggling to recognize how badly Russia wants to be a major player on the global stage. For its part, the US and Russia are fast becoming “frenemies”: Mr Putin has celebrated Mr Trump’s presidential victory, and Mr Trump has expressed his admiration for the Russian leader. At the same time, there is growing scrutiny of pre-election contacts between their administrations and Russia’s election-hacking efforts, and Russia still must navigate sanctions placed on its intelligence agencies on the eve of Barack Obama’s exit from office. With its vast size, Russia can be engaged in many world theatres, though Crimea and Ukraine are its highest priority. If Mr Trump were to ease sanctions there, further rapprochement could be possible.

Syria, on the other hand, is of little strategic value to Russia; it merely offered an opportunity for a little muscle-flexing as the US prevaricated. While it is unclear how this conflict will be resolved, particularly with ISIS in the mix, the Middle East is another story. The battle for Mosul in Iraq rages on, and the regional Sunni vs Shia struggle could last another 25 years – with long-term repercussions for Eurasia as the conflict resonates across Islamic regions from central Africa to China.

Mr Putin may also forge closer ties with China, potentially to the detriment of the US. Both Russia and China face growing threats from radical Islam, and Russia should find it easy to support China’s "One Belt, One Road" initiative, which aligns with its own economic prosperity. Elsewhere in the region, Mr Putin is trying to clear up historical legacy issues in Asia, including its disputes with Japan over Pacific islands.

4 Dealing with demographics

Russia will face a dramatic demographic crisis in its next 100 years. The consequences of a rapidly ageing society, low fertility rate and low life-expectancy rate are palpable. Change will require more than mere legislation, yet change is essential to the future health, prosperity and credibility of the nation. Russia’s government is facing intense pressure to fix these social issues – pressure that would re-intensify if the price of oil were to fall again.

5 Locking down leadership

Russia has always prospered under strong leaders, but it isn’t entirely unclear in which direction the Kremlin is headed. In late 2017 or early 2018, Russia will hold its first presidential elections in five years. Mr Putin has spent much of his time in office extending his rule, using sleight of hand from allies, but he now seems uneasy of his own political security; he has been removing any potential opposition to his authority and appointing not just loyalists, but people with no political identity or heft. These “political purges” – permitted under the pretence of fighting corruption – seem similar to what President Xi Jinping has been doing in China ahead of his reappointment in late 2017. Will Mr Putin continue with his reign or will Russians wish to rejuvenate the presidency? This question will remain critical over the next few months.

Revolutionary reflections

One hundred years after the February revolution, Russia remains as Churchill once described it: “a riddle, wrapped in a mystery, inside an enigma”. In the short term, there are questions about Mr Putin’s strategy: Is he sincerely looking for a reliable, strong global partner in Mr Trump, or is he reckoning for a distracted US and a destabilized Europe to provide him with room to pursue his own agenda? Either way, Russia has serious domestic problems – including financial inequality, mass immigration and high unemployment – that echo the environment that gave rise to populism in the West. So while there may not be a new revolution during the centenary of the last uprising, unless Russia begins to re-define its future and its purpose for the post-Putin world, there may well be one on the horizon.

Key considerations for investors

  • Many Russian assets are cheap and are set to remain so, since legal protections are not truly afforded to international investors.
  • However, a lowering of trade and political tensions would offer European companies significant new market opportunities.
  • Sovereign-debt issues from Russia and many CEE nations offer attractive yields in US dollar and local currency terms, and their underlying economies have the potential to achieve the living standards of their EU cousins.
  • With Eastern Europe thawing, European investors once again have access to an interesting emerging market that offers growth potential at a time when de-globalization and trade frictions are causing sluggishness elsewhere.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

119763

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Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.

4 Keys to the G20 Summit

Neil Dwane | 14/03/2017
Currency data

Summary

With America's leadership waning, the G20's role as a central institution for global co-operation is more important than ever. While this week’s meeting might not produce concrete actions, participants will address tough issues like protectionism, trade imbalances, currency manipulation and financial-market regulation.

Who's leading the world now?

As Germany prepares to host this week's G20 meetings in Baden-Baden, one question will hang over this spa town like a cloud: "Have we left the world order that lasted 70 years under Pax Americana?" As the group looks for answers, its discussions and eventual pronouncements on four topics will be significant.

1. Protectionism

The forces that helped US President Donald Trump rise to power have not been placated by his election. The changes expected to be made to US trade policy are being echoed around the world by anti-globalization politicians and voters. Indeed, it speaks volumes that China's president, Xi Jinping, is expected to be the meeting's most vocal supporter for global free trade. Unlike at previous G20 summits, we don't expect to see any unashamed celebration of free trade at this year's meeting. Instead, participants will unite under the banner of "fair globalization" in a bid to signal that a new form of collaboration is possible.

2. Trade imbalances

Because of its high trade surplus, Germany is facing reproach from G20 members running trade deficits – which not only includes members in Europe, but the United States as well. It is therefore quite conceivable that Germany will issue cautious signals about increasing government spending in areas such as defence that could lower the trade imbalance.

3. Currency manipulation

While connected to trade surpluses, no large country meets all of the US government's formal criteria for currency manipulation. What's more, Germany is a euro-zone member and therefore somewhat shielded from these accusations. As such, these discussions may be heated, but they are not likely to produce any concrete sanctions. China, however, will remain under careful scrutiny.

4. Financial-market regulation

Establishing a global framework for the smooth functioning of financial markets is crucial for creating a level playing field for the international banking sector. Yet if there is no agreement among G20 members, Europe's banks will suffer more than their US counterparts. This seems particularly relevant given the United States' current flirtations with deregulation, including a possible repeal of the Dodd-Frank Act.

The G20's role in a fractious world

In conclusion, the meeting will reflect a world of increasing geopolitical confrontation. And while concrete actions will be few and far between, the willingness of participants to break with consensus will be significant. Nevertheless, in an increasingly fractious world, the G20 will be more important than ever in its function as a centre for co-operation.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

124100

Expert-Image

Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.
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