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Putin the boot in

Over the last few years, the spotlight on Emerging Europe has been stolen by Russia. Once the 2008 presidential elections were out of the way, the market became a consensus overweight.

One of the best macro pictures in the world – strong GDP growth, diversification of the economy away from commodities, a consumption boom and growing middle class – all led to Russia acquiring safe-haven status among its regional rivals.

Central Europe was considered a boring place. We all but stopped hearing about the likes of Poland and the Czech Republic while Turkey – troubled by political turmoil and inflation – saw news headlines wipe almost 40 per cent off the market to the end of June.

This all changed overnight after prime minister Putin criticised the practices of one of Russia’s biggest steel producers. The company and the Russian stockmarket suffered heavy losses.

Now, Putin’s comments do not overly concern us, as we do not believe they were out of step with his ongoing fight against the corrupt business practices that no one denies still exist in Russia. Indeed, we would have ordinarily used this weakness as a buying opportunity. What concerns us is the public fallout between Putin and president Medvedev. If the rift continues, Russia could suffer a similar fate to Turkey and eradicate much of the gains of the past few years.

Good old Central Europe may be back on investors’ minds. If there is no proper reunion between Putin and Medvedev, then Poland, Hungary, Turkey and the Czech Republic are likely to outperform Russia significantly by the end of the year.

Russia is the biggest market in the region. The market cap of the MSCI Russia index measures $300bn – three times that of Poland and Turkey combined – but these are the likeliest recipients of the liquidity should Russia see further redemptions.

A political ban on Turkey’s ruling party, the AKP, has been avoided and although the political situation is far from being resolved, much of the perceived risk is priced in by now. The market should see interest from investors as valuations are at the bottom of their historical range while the management of Turkish companies is seasoned to deal with currency and political volatility.

One of the most impressive indicators is public sector solvency, with net public sector debt standing at around 29 per cent of GDP at the end of 2007. In 2001, it was 66 per cent of GDP.

Poland, the most politically stable major market of Emerging Europe, is seeing ongoing improvement in its earnings’ revisions. At more than 5 per cent estimated real GDP growth for 2008, it falls within the top 10 emerging market economies by growth. Domestic demand is strong, with real retail sales at 13.4 per cent year on year and unemployment set to fall to less than 8.5 per cent by the end of 2009.

The dependency of Polish exports on Germany is notoriously high and the slowing German economy poses risks to Polish growth but we believe that exposure to the domestic sector in Poland is very attractive.

The infrastructure theme is strong in Poland. Last June, construction output growth was up by 20.9 per cent year on year, reaching 18.2 per cent for the first half of 2008.

The current free float (as defined by the MSCI Poland index) market cap to GDP ratio in Poland is just 10 per cent, which is one of the lowest in emerging markets. The government is looking to privatise 740 state-owned companies by 2011 and to raise PLN30-45bn which should benefit governmental coffers and the stockmarket.

The political will to see Russia continuing its rapid growth should win over short-term personal differences but until then, we are likely to see its stockmarket giving up its leadership in favour of the rest of Emerging Europe.

Marina Akopian is a partner in Hexam Capital



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