As I plan for the year ahead I am trying to form an opinion of what may be some of the dominant themes for 2019 and beyond. It is proving to be somewhat harder than in previous years and more than anything I feel greater uncertainty than usual about the forces that will come to bear on the Russian economy and property markets over the short and medium term.
The broad factors and direction is reasonably clear. However, in 2018 the largest effects came from unexpected events, specifically the sanctions imposed or proposed during the year. There is every likelihood that in 2019 our greatest challenges will also come from geopolitical factors which are not yet clear.
Last minute inclusion: since writing the blog events have unfolded centring around BVCP. Without making any comments about the specifics, which I am not privy to in any event, this is entirely the kind of political uncertainty which makes outside investors nervous and which, at the very least, delays investment decisions.
Nevertheless, particularly when forming valuation opinions, it is important to have a good handle on the fundamentals. So, my thoughts on dominant themes are laid out below…as usual, not in any particular order:
This surprised to the upside last year with the government’s initial forecast for GDP growth coming in at 2.3%. The economy, at its core, seems to be in fine fettle, but with a higher base effect, a drag from external factors and the increase in VAT likely to affect consumption, growth is likely to be slower in the short term. So far this GDP growth has not had any significant flow through into take up and rent rates in the occupational markets, perhaps, in part, because of the uncertainty levels referred to above.
The first 6 months of 2019 may see GDP growth below 1%, but I expect it to pick up from there so that we will see full year growth of between 1.3 and 1.5%. For 2020 expect to see GDP growth above 2% and in the medium term the trend growth rate should certainly be above 3% – perhaps from 2022 onwards. A significant driver of this will be:
Putin’s “May decrees” identified a number of national initiatives. Concrete plans for investment into these are likely to be finalised during the first half of 2019, with capital being deployed from then on. This will be a mixture of government funds and encouraged activity from the private or quasi private sector. The most significant areas of investment will be the following:
- Education; and
The investment itself will add to GDP growth and will also increase the potential of the economy. The plans for infrastructure, roads and digital will have the most significant effect for the property markets and are likely to have a sustained, longer term impact.
The ruble exchange rate has decoupled from the oil price and is now more reactive to sentiment generated by sanctions (or even the threat of sanctions, as occurred on 14th February). All things being equal I expect the ruble to stay stable and to trade in a relatively tight band of 65-67 vs USD this year. More sanctions events would have one off effects on the rate. In the medium term, Russia’s growth will put appreciative pressure on the ruble, this will allow the Central Bank of Russia more space to deal with:
The CBR has reinforced its independence and has strong credibility. The policy rate movements have been more a response to exchange rate fluctuations as much as a tool to target inflation. Higher inflation (see below) and some ruble weakness means that the CBR may well tighten the policy rate in the first half of the year – out to 8%. I expect any movements in H1 to be reversed in the second half of the year, and that the policy rate will resume its downward trajectory in 2020 and 2021. I still expect that we reach 6% over the next couple of years. This will be positive for economic activity and also for property investment. Lower borrowing costs will bid up capital values of commercial property.
As expected there has been an uptick in inflation, due to the increase in VAT at the start of 2019, and the weaker ruble in the final few weeks of 2018. This is a shortish term effect and will fade throughout this year. I expect inflation around 5% this year, falling back to 4% in 2020. The significance of this for policy rates has been discussed above;
Retail has been a major driver of growth in the last couple of cycles and the Russian consumer has proven often to be very resilient. At least in the short term this story seems to have run out of steam and I expect real growth in retail spending to be at best marginal this year, with an increased focus on the economy end of the market. In the medium term, as inflation falls back, and the effect of the VAT increase dissipates, expect growth in consumption to re-establish itself. As a counter-point to this though, e-commerce remains in its infancy in Russia. As this develops the market will not be immune to the global trends in the demand for, and use of, physical retail space. However, these considerations currently seem further in the future for the Russian market due to the overall penetration of modern retail stock.
Oil / Budget
I have often said that predicting the oil price is a mug’s game – so here it goes! There is likely to be continued heightened volatility in the oil price with large moves in response to, even fairly small, news items or data points. Last year saw a low of around $50 and a high above $85 per barrel for Brent. As I write the price is just over $65 and that is probably a good as guess as any for the average level this year. This is a strong positive for the budget, with fiscal discipline meaning that the breakeven price will probably be around $49 per barrel. An increasing budget surplus will allow the government more room for investment in the national programmes as highlighted above.
JLL’s Head of Research in Russia (Olesya Dzuba) has done an excellent piece on the likely trends for the property markets this year [insert link]. I will just reiterate that all sectors are characterized by low supply, increasing take up and falling vacancy rates and are now starting to get tight. Rental rates will pick up this year across the board and that growth is likely to accelerate, as there is a broader understanding of how tight the markets actually are.
I reiterate my oft repeated view that the warehouse market will be the most dynamic. The government investment in infrastructure, roads and digital initiatives will all help the sector. Although growth in retail spending will not be as dynamic this year the growth of e-commerce and different routes to market will all be strongly positive. Rents and capital values are overdue significant appreciation.