This is bne's Russia chairman’s newsletter, a selection of forward looking stories on development in eastern Europe and the region. Feel free to request topics or ask questions: editor@bne.eu

Contents: Top Story Putin launches All Russia Popular Front party, elected leader Russia’s WTO accession fails to bring any benefits Politics – the good Business ombudsman Titov’s business amnesty to go into effect Reshuffle of Cabinet an attempt to inject some fresh policy ideas to spur growth Kremlin critic Navalny to run for mayor with fugitive economist’s Guriev’s help Mikhail Prokhorov's Civic Platform decides not to run for Moscow mayor Russia amends foreign investments law Latest Moscow demonstration small and quiet Politics – the bad Federation Council passes anti-gay, anti-foreign adoption and blasphemy bills Russian Election Monitor Golos Suspended for 6 Months

Politics – the ugly Ex-deputy fined just 0.007% for $467m property scam Polls, mood, sociology Sberbank CIB Ivanov consumer confidence tracker flat in May Finance executives pessimistic over business climate Strikes ineffective in Russia says poll Russians dislike the USA, better disposed to Georgia, Belarus is the favourite Hard for Russians to Say What They Take Pride In - Poll 21% of Russians worry about environment Over half of Russians think conditions to start private business poor 41% of Russians see Putin as ideal leader Almost half of Russian students want to emigrate

Banks and Finance CBR to keep its de jure independence, no growth goal mandate Russia’s corporate lending rate down again, but retail lending rate grows Share of bad consumer loans has been growing since 2012 Customs Union scams lead to capital flight and tax evasion Capital outflow doubles on month in May Putin says offshore zones are used excessively, use G8 chairmanship to tackle SME leading up 17%, Putin to support with new measures Russian bank profit for January-May 2013 decreased 6.1% year on year to RUB391.2bn due to tougher provision requirements Economics President Putin's Budget plan to 2014-16. Things picking up? Economy passes bottom Russia’s IP contracted 1.4% year-on-year in May Russia’s retail trade growth down to 2.9% in May Loss-making firms' share in Russia falls to 65.2% January-April Russia records budget surplus in 5M13, deficits end of year and in 2014-16

Russia's MinFin considers budget maneuver for 2014-16 Russian demographics reach western European levels in leading cities Ruble hammered 1H13, to recover in 2H13 depending on capital flight Economists have another stab at estimating the size of the grey economy State Property Agency cuts privatisation programme Russia’s tariff growth cap to lower inflation and support the economy in the medium term ECM IBS Group Luxoft successfully completes IPO Brutal sell off – Russia, Brazil lose most Cash positions of GEM funds close to post-crisis lows Government waters down SOE dividend policy VTB trumps Baring Vostok in Russian buyouts without raising funds Online retailer KupiVIP plans to make IPO on NYSE in 2015 Lenta supermarket chain picks banks for IPO in 2014 DCM Big outflows hit bond market Russian Railways sells second infrastructure bond

Sectors Russia’s housing construction puts in solid growth Russia’s defence sector to grow by half Cargill opens $40m chicken processing plant in Russia Russia’s subsidized car loans could resume in July Russia has largest shale oil reserves Gazprom to launch LNG plant near St Petersburg in 2018 Russia to give additional RUB40bn to farmers each year to 2020

Top Story Putin launches All Russia Popular Front party, elected leader The All-Russia People’s Front (ONF) held its first congress in June and made Putin leader by popular acclaim – ie there was suitably enough no vote. The movement is technically not a political party, but clearly is an organisation designed to replace the widely unpopular ruling United Russia party. ONF, as it is known in Russian, aims to be a nationwide platform for grassroots activists “with a constructive agenda.” Putin has already suggested that ONF champion his call for setting up a consumer monitoring body that will hold companies and services to account in the interest of the consumers. It is also clearly designed to take some of the wind out of the opposition’s sails. The group’s preliminary mission statement listed a set of populist- measures that will “put pressure on the authorities … and provide constant feedback to the president.” It has also done work on the proposal for a luxury tax on expensive cars; began a campaign against golden parachutes for employees of state-owned enterprises; called for the introduction of school uniforms in state schools; and amendments to the law on fishing. The explicitly pro-Putin group, boasts a membership of 2,500 organizations,

but has never officially registered as a movement. 56% of Russians are aware of ONF, according to a poll in June, up 9% from a month earlier, according to a study by state-run pollster VTsIOM, presented Monday. Half the respondents were indifferent toward the group, while 29% approved of it and 9% disapproved, according to the poll. Russia’s WTO accession fails to bring any benefits It took Russia 18 years to get into the World Trade Organisation club, but one year after accession most Russian businesses are starting asking why they bothered. None of them are reporting any economic benefits and several important sectors are actually a lot worse off. And if anything the simpler trade rules have actually made Russia’s relations with the rest of the world worse, not better. That is the conclusion of several surveys and reports issued on the anniversary of Russia’s accession to the global trade club on August 22. At the time Russia’s membership was hailed as a real step forward in modernising the Russian economy and a badly needed goad that would force the Kremlin to push ahead with reform and diversification. However, it seems that the benefits, if any, will arrive much further down the road. “The majority of Russian businesses have felt little or no change following Russian accession to the WTO in 2012, Global Council, a consultancy belonging to Peter Mandelson, a former British politician and EU commissioner for trade, said in a report released at last week’s St Petersburg International Economic Forum. “The Russian authorities expect that the impact of new competition will begin to be felt after three to five years, but the full impact

could take much of this decade to emerge.” In spring 2013, the Strategy Partners Group (part of state owned banking giant Sberbank) surveyed 2,000 owners and top managers of Russian companies with annual turnaround of more than $100m. More than half of them expected a positive impact of WTO accession on the Russian economy immediately following accession, but now more than 50% think that there has been no impact at all, with 32% thinking that the impact was negative. This result was backed up by a separate survey conducted by the Association of European Business, although with the caveat that these foreign businessmen, as opposed to their Russian peers, remain <a href="http://www.bne.eu/archive_story.php?id=5101"> optimistic about the benefits from the club’s membership </a>in the medium term: two thirds of the AEB’s members report no change in their business from the WTO accession. Indeed the one place where the WTO accession did have an impact was in the agricultural sector – and that was extremely negative. Russia is phasing in the compliance to the WTO rules over eight years, with the most vulnerable sectors, like automotive, required to meet the new rules last. But with agriculture all the restrictions were dropped from day one. “WTO entry has to some degree exposed a lack of price competiveness and a dependence on state support. The pork industry in particular has felt the impact of a reduction in in-quota tariffs to zero by some Russian companies,” says Global Council. These problems are already causing a backlash in the Duma where

companies are lobbying for some more protection, or at least compensation. Opposition lawmakers from the Just Russia party (that voted against WTO accession) said on June 20 that Russia has lost “billions of dollars,” for WTO accession due the cut in import tariffs and lost business for domestic companies. The comments were made at a government committee session and attended by groups lobbying on behalf of engineering, agriculture and clothing industries. However, the Kremlin roundly ignored their complaints. "The WTO is bringing us into an [economic] depression," Konstantin Babkin, the head of harvester producer Rostselmash, said during an emotional speech, adding that his industry is amongst the hardest hit by the lower tariffs that has opened Russia up to cheaper imports; milk imports alone have grown 17 in the last year, making Russia the biggest fresh milk market in Europe. He Babkin has also threatened to challenge the accession in the constitutional court on the grounds that Russia still doesn’t have a representative office at the WTO headquarters. The government is very unlikely to go back on the WTO accession, which was personally championed by Russian President Vladimir Putin. However, the Kremlin has got itself into hot water with the EU by imposing administrative barriers on the more sensitive sectors. The European Union has threatened sue Russia after it imposed an auto recycling fee on foreign, but not domestic, car makers in an effort to protect its domestic manufacturers. On the other side of the coin Russian producers have taken advantage of the opportunities nominally freer trade with the rest of the world they now enjoy. Moreover, several

commentators say there is a serious lack of Russian lawyers that are au fait with WTO rules and Russia has not brought a single case in the WTO to protect the interests of its own manufacturers in other markets. “Many Russian businesses do not fully understand the implications and potential benefits of WTO membership in terms of a more level global competitive playing field. This has often encouraged a defensive position in which WTO entry is seen as something for which industry must be compensated with domestic protection or subsidy. In some cases, the Russian government seems to see the problem the same way,” says Global Council. “Both in government and in the private sector, the first year of Russian WTO membership has highlighted a clear shortage of qualified experts on WTO law and procedures.” The WTO birth problems has been a disappointment but some analysts say that they are symptomatic of a more general reduction in Russia’s competitiveness in the global market place that has caused Russia economy to close even more dramatically than was expected at the start of this year. “The WTO accession has done little good to the economy so far. Instead, Russia has to spend more resources protecting the uncompetitive sectors of the domestic economy than it benefits from through its exporters having access to international ones. Coupled with the cooling off of the commodity markets these factors suggest that no breakthrough can be expected over the next year, at least,” say analysts at Uralsib. Still, the majority of commentators still believe that the WTO accession was an important step for Russia and that in the long-term increased competition will benefit the country and its economy. The point of increasing the

competition is that domestic firms will have to work harder and better to stay in front, but for this to work they actually have to make the effort. At the moment most companies and several elements in government are still looking backwards at the loss of their easy life behind protective barriers rather than looking forward to the benefits easier access to bigger markets.

Politics – the good Business ombudsman Titov’s business amnesty to go into effect Putin backed June 22 the proposal to amnesty thousands of jailed Russian entrepreneurs, urging the parliament to pass a law on it before August. Around 13,000 people convicted for economic crimes could be released from prisons, and up to 100,000 have their records cleaned or cases against them dropped. About 3m businessmen were convicted of various crimes in Russia over the past decade, according to governmental. Criminal prosecution in Russia is routinely abused for extortion or as an illegal means of resolving business disputes.

Boris Titov

Reshuffle of Cabinet an attempt to inject some fresh policy ideas to spur growth Putin’s reshuffle of Russia's top economic officials in June has been designed to stave off looming stagnation. The newly appointed Economic Development Minister Alexei Ulyukaev comes from the central bank, but is facing an uphill struggle as Russia's economic growth slows amid sliding commodity prices. Ulyukayev is likely to devote more attention to stimulating private investment and cooperate more closely with the financial sphere. He also may face obstruction from his predecessor, Andrei Belousov, who is the latest minister to be transferred to the so-called shadow government of advisors around Putin as his chief economic advisor. Belousov replaces Elvira Nabiullina, who goes from Putin’s economic advisor to head the Central Bank. She is also thought to be close to Putin and a more pro-growth governor. This rearrangement reflects an attempt to find new sources of economic growth, according to chief economist at Alfa Bank Natalya Orlova. However, the changes demote prime minister Dmitry Medvedev even further as Putin is gathering more allies to himself and promoting the active and effective policy makers to his own administration rather than leaving them in government under Medvedev who is nominally responsible for this work.

Kremlin critic Navalny to run for mayor with fugitive economist’s Guriev’s help Russian anti-corruption activist Alexei Navalny will stand as an opposition candidate in Moscow’s mayoral race this September. The one time Kremlin advisor, economist Sergei Guriev who fled to Paris in June fearing arrest, will support him. The other opposition parties have decided to unite behind Navalny. The combination is somewhat embarrassing for the Kremlin, especially Guriev’s apparent “defection” for the want of a better word. Three Opposition parties - RPR-PARNAS, People's Alliance and December 5 - have decided to pool efforts in the election and concurrent the election to the Moscow Duma. Navalny chances of success are slim. The police have already raided his mayoral campaign offices as of July 1 for “starting his campaign too soon.” Secondly, despite his high international profile, Navalny is not very popular amongst ordinary Russians as we have written here in the past issues. Incumbent acting mayor Sobyanin is actually fairly popular amongst Muscovites and should win the election comfortably. The independent Levada Center pollster reports that about 3% of Muscovites would be willing to vote for Navalny, versus 45% for Sobyanin.

Mikhail Prokhorov's Civic Platform decides not to run for Moscow mayor Kremlin insider and oligarch Mikhail Prokhorov said that his Civic Platform will not run the mayoral election. Prokhorov is looking for an opening to get into politics and has the nominal blessing from the Kremlin as a “pro-business” candidate that could steal votes from the genuine opposition that draws on its support from middle class Russians. However, Prokhorov seems to be struggling to get any traction and is not seen as creditable. He appeared on the street at various opposition rallies, but has failed to stand for any office presumably afraid of a humiliating defeat. His refusal to stand in the Moscow mayoral elections will only weaken his position further. Still, Prokhorov would still come second to Sobyanin with 12% of the vote if he were to stand, according to the Levada-Centre – four times more than Navalny.

Prokhorov at the December 2011 demo

Russia amends foreign investments law Russia's amendments to the law on foreign investments to boost foreign investments Amendments to the law on foreign investments in Russian strategic companies approved by the State Duma in the first reading in May will destroy administrative barriers and facilitate an inflow of funds from abroad the government hopes. The amendments to the law provide for a cancelation of a repeated approval procedure: if a foreign investor owns 75% of shares in the subsurface use sector, it will not have to ask another permission to invest additional money. One of the key changes applies to food products. The initiators of the amendments propose to exclude the manufacture of, for example, cheese, cultured milk, juices, bakery products, beer and other products from strategic types of activity. Transaction in these sectors will not be subject to control by the governmental commission any more Latest Moscow demonstration small and quiet A protest held on the public holiday “Russia Day” on June 11 drew between 6,000 and 10,000 marchers, one of the smallest marches to date, and passed off quietly. The march to Bolotnaya, the scene of the first demos in 2011, was held to call for the release of those protestors arrested last year on May 6, which ended in a bloody melee and 650 detentions. Twelve people are currently on trial, and another 16 under investigation.

The opposition claim that the violence was instigated by the police (with some justification). The demo shows the protest movement has lost its momentum and that street protest as a mechanism to pressure the Kremlin, has run its course. Putin admits lost control over monopoly spending, orders the creation of public control over their spending Putin ordered the government to create a mechanism of public control over the formation and implementation of natural monopolies’ investment programmes in mid June. The proposals are due to be submitted by 1 September 2013. The investment programs of the natural monopolies continue to increase yet there is a limit on how much can be financed from tariffs without affecting industrial growth. The state has already limited tariff growth for the next few years to hld down inflation. Tariffs for the gas, electricity and railroad industries are now comparable with those in the US. Gazprom in particular has been singled out as culprit and in the midst of out of control spending.

Politics – the bad Federation Council passes anti-gay, anti-foreign adoption and blasphemy bills Russia’s upper house of parliament signed off on the three controversial bills on June 26. Russian President Vladimir Putin is expected to sign all three bills into law in July. Putin said the anti-gay law did not violate the rights of sexual minorities and was, in fact, designed to “protect” Russian children. Sexual minorities, he said, “are full-fledged members of our society and are not being discriminated against in any way.” However, the wording of the “non-traditional sexual relationships” bill is so vague that it may enable individuals to be implicated for even telling children that gay people exist. The “non-traditional sexual relationships” bill sets out jail terms of up to 90 days and maximum fines of 1m rubles ($30,000) for promoting such relationships in the media or on the Internet. Under the bill to safeguard religious faith, anyone who commits an offensive act during a religious ceremony would face a fine of up to 300,000 rubles ($9,000) and up to 200 hours of compulsory community service. Moreover, for an offense at any holy site, the punishment would be up to five years in jail, a maximum fine of 500,000 rubles and up to 400 hours community service.

Blasphemy bill in effect from July despite fact most Russians don’t go to church, read bible The controversial legislation that introduces tough penalties for offending believers' feelings is set to come into force in July after State Duma Deputies approved a number of amendments to the bill. Hefty fines and possible prison sentences for offenders from both Russia and abroad are included in the legislation, RIA-Novosti reported Tuesday. A opinion poll conducted by FOM earlier this year showed that 45% of all Russians believed that offending religious believers’ feelings should be a criminal offense. 22% said it should not be a crime, and 33% could not answer the question. However, while about 64% of Russians identify themselves as belonging to the Russian Orthodox Church, 52% said that they have never read the bible. Another 24% said that they are rare church-goers, and 28% hardly ever pray, according to poll results released by the country’s Public Opinion Foundation (FOM). The FOM results showed that there are more non-believers in Russia (25%) now than in the US back in 2005, when just 6% of Americans said they were not religious. The total number of all Russians surveyed who believe in the universe's divine origin was some 46%, while in the US that figure was 80%.

Russian Election Monitor Golos Suspended for 6 Months The Russian Justice Ministry has suspended the activity of independent election monitor Golos for failing to register as a "foreign agent.” Golos, which has been active in publicizing violations in federal and regional elections in recent years, was fined 300,000 rubles ($9,000) in April for failing to register as a "foreign agent." It was the first NGO to be penalized under the new law. The ministry issued a suspension order

halting the NGO's operations until December 25. Legislation that came into force in November obliges all non-governmental organizations in Russia to register as "foreign agents" if they are involved in any kind of political activities and receive funding from foreign sources. Golos has been prohibited from holding public events and will have its bank accounts frozen, except for contract settlements, compensation for losses, and the payment of fines, the Justice Ministry said in a statement.

Politics – the ugly Ex-deputy fined just 0.007% for $467m property scam Vasily Dupak, a former lawmaker from the United Russia party in the Moscow Regional Duma, has been fined just 0.007% of the value of the $467m worth of real estate he was found guilty of stealing. Dupak was also given a six-year suspended sentence with a five year probation period as well as the 1m ruble ($31,000) fine.

Polls, mood, sociology Sberbank CIB Ivanov consumer confidence tracker flat in May The Sberbank CIB Ivanov consumer confidence tracker showed no change in the consumer confidence index in May. The overall score staying at –8% in May after declining from –4% in January to –8% in March. This corresponds with stability in the macroeconomic indicators that most tightly drive consumer behavior: inflation and unemployment. The main findings of our survey were: • Only 20% of respondents think that

this is a good time for big-ticket purchases, but a surprising 44% still plan to change their car within the next two years.

• Some 10% of respondents’

companies are increasing headcount, while 50% are either laying people off or not replacing resignations with new hires. Some 37% of respondents are concerned about being fired.

• The savings ratio (defined as the

share of income saved monthly) is around 10.8% but higher for upper-income respondents. The same income dependence is true for relative accumulated savings.

• The Ivanovs spend 40% of their

income on food, 16% on utilities, 11% on clothing and 7% on servicing debt.

• Respondents’ wage growth lags

behind official statistics, staying virtually flat year-on-year (while the State Statistics Service shows an

11.8% year-on-year increase in April).

• Consumers are becoming more

price-sensitive: 57% of respondents consider price attractiveness as a key factor in whether and where they make purchases, compared with 46% in January.

Finance executives pessimistic over business climate Less than half of Russia's senior financial professionals polled believe that their company's business prospects have improved since last year, according to the results of a survey carried out by EuroFinance. The survey shows that only 46% of treasurers and CFOs are optimistic about the current business climate — a 3% decrease over last year's number. Strikes ineffective in Russia says poll The number of Russians considering strikes as the only way to resolve disputes has gone down in the past years, while the number of skeptics grew considerably. In 1989 17% respondents considered strikes to be the only way to have their demands met and only 11% expressed the same stance in June 2013, according to the Levada Center. Russians dislike the USA, better disposed to Georgia, Belarus is the favourite Russians think the USA is the most hostile country to Russia, but call Belarus their best friend, according to the Levada Center. Belarus topped the list of five best friends and allies of Russia (46%) in the May poll. Kazakhstan ranked

second (31%), China third (20%), Ukraine fourth (16%) and Germany fifth (14%). Belarus and Kazakhstan held the same positions (34% and 28% correspondingly) last year, while Germany ranked third (17%), China fourth (16%) and Ukraine (13%) The United States has become the most antagonistic country (38%) in Russians' eyes. Georgia comes next with 33% (35% and 41% correspondingly in 2012). Latvia (21% vs. 26% last year), Lithuania (17% vs. 25%) and Estonia (16% vs. 23%) are the other top opponents. It appeared that Russians are disposed better towards the European Union: there were 61% of likes and 23% of dislikes. Hard for Russians to Say What They Take Pride In - Poll It is difficult for Russians to name the country’s achievements of the past 10-15 years that they take pride in, according to a poll by VTsIOM. Top of the list was they are proud of Russia winning the bid to host the 2014 Winter Olympics, which will be held in the Black Sea resort of Sochi (7%). 6% of pollees praised sports victories (unchanged from 2005). 6% said they take pride in increasing living standards and economic growth (5% in 2005), and 5% were glad that the country’s international influence was strengthening (2% in 2005). 3% said they are proud of a peaceful situation in Russia. 3% praised army revival (unchanged) and 2%, technological development (unchanged).

42% said there was nothing to be proud of (37% in 2005), and 19% said it was difficult to answer the question (36% eight years ago). 21% of Russians worry about environment About 21% of Russians are “seriously worried” about environmental issues in their country, according to a survey by the Levada Center pollster said the figure is 4% points less than during its previous poll on the issue held last year. Almost 62% of respondents, however, are convinced that polluted environment has a negative impact a person’s health. Over half of Russians think conditions to start private business poor In the last four years Russians have become more dissatisfied with the local conditions for private business, according to Russian Public Opinion Research Centre. In 2009, 44% of the citizens polled considered the conditions to be poor, but today the percentage is up to 55%, reads centre's research seen by Interfax. Poll results show that residents of small towns and villages (62%) are more likely to have a negative view, together with the 35-44 age range (63%). In the two capitals every second (50%) person polled was critical about the business climate in the country. A fourth of respondents said conditions for developing private business in their area were good, compared to 30% in 2009.

In cities with a population of over onem, 36% of those polled said conditions were good along with 34% of respondents in big cities and 31% of 18-24 year olds. 41% of Russians see Putin as ideal leader A poll found that 41% of Russians think President Vladimir Putin is an ideal or “close to ideal” of a president, according to independent pollster the Levada Center. Overall, 64% of respondents said they approved of the president’s work. Of the 41% of people who consider Putin an ideal leader, 6% said the current president had no faults at all. 46% of those polled disagreed that Putin was an ideal leader, while stopping short of calling him a bad leader. 61% agreed that he had an inherently good strategic vision for the country’s problems; and 45% said they believed that the president was attentive to the needs of citizens. Despite all this in March, another poll conducted by the Levada Center revealed that only 22% wanted to see Putin re-elected when his term ends in 2018. Almost half of Russian students want to emigrate Nearly half of Russian students (45%) and some 38% of businessmen would like to leave Russia, according to a survey by the Levada Center. However, these figures are not too shocking and indeed lower than similar surveys on emigration desires in many EU countries.

A total of 22% of all respondents in the poll said they want to emigrate from Russia to other countries, not including the former Soviet states, while some 70% said they plan to stay in Russia, according to the survey. Last year, a similar survey by the pollster indicated the same number of people said they were thinking of leaving Russia, while some 9% said they often thought of doing so. The urge to leave is strongest among residents of Moscow and other large cities (27%) and those who supported Russian billionaire Mikhail Prokhorov (38%) at the presidential polls and, perhaps oddly, supporters of Vladimir Zhirinovsky, leader of Russia's nationalist LDPR party (30%). Actual emigration from Russia is very low and in single digits.

Banks and Finance CBR to keep its de jure independence, no growth goal mandate The government has decided against giving the Central Bank of Russia (CBR) a broader mandate to support the economy and so have ensured its independence. This idea originated from the Ministry of Economy and was construed as a way for the CBR to be more aggressive during episodes of economic softness. The Ministry of Finance (MinFin) has been firmly opposed to this idea and has argued that there should be a clear delineation of responsibilities for economic growth and inflation with regard to economic policy-making in the country. A more explicit mandate for the CBR to target GDP growth would have militated against its primary objective to bring sustainably lower levels of inflation. The keeping of de jure independence, however, may not mean full de facto independence. However, this government decision should alleviate fears that incoming CBR Governor Elvira Nabiullina will be more prone to yield to pressure from the political establishment. Russia’s corporate lending rate down again, but retail lending rate grows Pressure on banks is increased again in May after corporate loans fell again, retail lending grew, but retail deposit growth remain flat month-on-month. The corporate lending rate further slid to 10.1% from 10.2% in April, while

retail increased to 25.7% from 24.4% in the previous month. Retail deposit rates (excluding on demand deposits) stayed flat at 8.2%, while corporate increased to 5.7% from 5.6%. Corporate lending rates keep moving down under the pressure of low demand and expectations of potential rate cuts in the autumn.

Share of bad consumer loans has been growing since 2012 As many as 24.5% of Russian borrowers owe money to three or four banks, the Equifax credit bureau said in June. In 2007, only 4% of borrowers fell into that category, while in April 2012 that figure stood at 21.1%.

The number of people owing money to five or more different banks before the crisis was 0.1%. Unsecured loans, the driving force behind growth in the banking sector, are expanding mainly among lower-income borrowers. The proportion of defaulted retail loans in the total amount owed by households to banks has been growing and reached 11.8% as of May 1, 2013. The regulator's says the proportion of overdue loans has been rising since beginning of 2012 mainly due to "other consumer loans" composed of credit cards for the most part. Despite the increase in the proportion of defaulted loans, the proportion of bad loans (overdue by 90 days and more) remains rather low at 5% as of May 1, 2013. Customs Union scams lead to capital flight and tax evasion The Central Bank of Russia reported a scam where Russian firms pay fake bills for imports from Belarus or Kazakhstan to a third-country bank account. The CBR forged invoices for non-existent imports from Belarus were worth $15bn last year against total capital outflow from Russia of $54bn. There are no similar estimates for Kazakhstan. The elimination of customs inspections at common borders has meant that banks are no longer verifying the deals from customs documents. The exporting of capital using the new ruse has largely replaced other informal capital export channels.

Capital outflow doubles on month in May Net private capital outflow from Russia was twice as large in May as in April, the central bank’s First Deputy Chairman Alexei Ulyukayev said at the St. Petersburg International Economic Forum. The capital outflow was at $8.0bn in May, up from $3.5–4.0bn in April and $7.8bn in March, according to estimates from the Economic Development Ministry. The CBR does not expect the outflow to exceed $10bn for the year if oil prices remain at around $97 per barrel, it said earlier. The Economic Development Ministry expects the capital outflow to amount to $30–35bn in 2013, but may revise the forecast in August. Putin says offshore zones are used excessively, use G8 chairmanship to tackle The Kremlin is cracking down on the use of offshore havens in its fight against corruption and capital flight. Putin ordered the Federal Financial Monitoring Service to work out an anti-money laundering program. “After consolidating the regulatory and legal framework … we should prepare the national control program on money laundering, tax evasion and ‘deoffshorisation’, as was done in other countries,” President said. Putin recommended that the service cooperate with the central bank. Russia will also use its 2014 leadership of the G8, a group of the world’s eight richest countries, to push for international regulation of offshore tax havens.

Putin argued that in order to tackle offshore zones – which he called a threat to “fiscal sovereignty” – regulations need to be drawn up and enforced not only by national governments, but at an international level as well. Putin said in the middle of June that offshore zones are used “excessively” by Russian companies during a meeting with young representatives from G20 countries. “It's like a Russian matryoshka doll," he said. "It is unclear what is at the end of it.” This in effect is the Kremlin’s first attempt to impose some sort of capital controls over movement of money into and out of Russia and the threat that these controls could be extended beyond the Duma deputies and state officials is one of the main drivers of the current capital flight, running at $25bn in the first quarter of this year. SME leading up 17%, Putin to support with new measures Total loans granted by banks to small and medium-size business (SMEs) increased 17% in 2012 year on year to reach over RUB4.5 trillion. This is 6% higher than the result of lending to big business (up by 11%), Expert RA reports. SME lending is expected to continue growing in 2013 The Russian government will expand the range of guarantees for SMEs Putin said at the St. Petersburg International Economic Forum. “The availability of banking loans is the most important factor of business and investment activities. The issue is the most urgent for SME, and here a whole set of measures should be taken. They involve the improvement

of mechanisms of the banking system’s refinancing, steps to develop competitiveness in the banking sphere, and the expansion of state guarantee tools for SME,” Putin said. The government will continue creating tax allowances for investments. Russian bank profit for January-May 2013 decreased 6.1% year on year to RUB391.2bn due to tougher provision requirements Assets increased 1.8% mainly due to the on-going growth of banks' loan portfolios. Analysts say that the decline in bank profits is quite expected and explain it by the contribution of profits to provisions and by a much slower growth rate of lending in 2013 compared with the last year. Andrei Klapko, an analyst at Gazprombank, says that the profit decreased "not least because of Sberbank which had low contributions to provisions last year and started charging provisions aggressively this year." Sberbank's provisions increased 270.2% over the period January-May 2013 year on year and reached RUB42.8bn. Effective March 1, 2013, the Bank of Russia toughened the requirements for provisions. The minimum provisions for probable losses were doubled: to 1% for old loans and to 1.5% for new ones.

Economics President Putin's Budget plan to 2014-16. In the middle of June Putin laid out his budget goals that run thru the three-year plan to 2016 that reflects the austerity that is being imposed on the Russian budget thanks the domestic and global slowdown. On the one hand, Putin said the budget is designed to boost flagging growth. On the other, he admits that the budget has to stay within the new strict budget rule. This can be done by prioritising expenditures, lowering the transfer to the State Pension Fund, postponing the rearmament programme and improving spending efficiency. This tactical planning has to coincide with the long-term budget strategy to 2030 that is due to be prepared by the end of summer. Pension reform. The ultimate goal is a lower transfer from the budget to the pension system. The president highlighted the necessity of having a transparent pension formula and asked for a scheme to be defined for how the National Welfare Fund might be used to cover any pension system deficit. Social taxes are to be maintained at the current level. Importantly, Putin is considering granting newcomers on the labour market the right to choose the level of contribution to the funded part (whether to leave it at 6% or cut it to 2%). This is a major concession to early decisions to raid the pension fund for investment money. Now the worker has the right to opt out of this raiding.

Rearmament programme. The state-run rearmament programme might be partly postponed (by 2-4 years, according to recent comments by Minister of Finance Anton Siluanov), but the total sum planned is to remain intact (RUB 23-25tn for 2011-30). Regions. As of next year, all regions in Russia are to adopt 3-year budgets and open them to public (for the first time ever). This implies regional public finances becoming more transparent and bodes well for the plan of regional authorities attracting more investments. Infrastructure projects. Putin urged infrastructure investment to be increased as an additional source for boosting growth. Funding money is to be accumulated in the pension system and the NWF. He stressed the importance of a guaranteed payback on investments and the involvement of private capital (mainly through PPP). Things picking up? Economy passes bottom The great debate in Russia is if growth has stalled or if the economy is only going through a “soft patch” at the moment. GDP growth fell to 1.6% in the first quarter (revised up from the initial estimate of 1.1%) and industrial production growth seems to have stopped completely, while domestic fixed investment growth is actually negative. Inflation at 7.4% is still too high. But according to the RenCap-NES leading GDP indicator’s final estimate of 2Q13 GDP growth is 2.2% year-on-year. This is up from the 1.5% projected in May.

Some of the pick up will be due to base effects. 1H12 had a very high base, with GDP growing at 4.5%, while 2H12 was a low base, with growth of only 2.6%. Second, the Ministry of Agriculture expects the 2013 harvest to be bountiful, amounting to an estimated 95mnt of grain. This would represent a significant 30% increase on the 72mnt of harvest last year, leading to a slower pace of food, and overall, inflation. Finally, the decelerating pace of consumer inflation will also increase the real purchasing power of consumers, leading to expectations of more robust consumer spending in 2H13. Inflation was over 7% in the first half, but is expected to fall to 6% or less in the second half. All together Rencap is predicting growth of about 3% for the year, up from 2.4% that the government is

predicting and 2.8% Bloomberg consensus. Rosstat reaffirmed its preliminary estimate that the economy decelerated to only 1.6% year-on-year growth in 1Q13 -- the lowest since 2009 -- from 2.1% year-on-year growth in 4Q12. The extraction and utilities segments where the biggest drags on the economy, while the fastest recovering sectors were finance (up 12.3% year-on-year), fishery (8.7%) and real estate (7%). Real estate was the main growth driver, accounting for around 10% of GDP, while the share of the other two growing segments is rather small and make little difference to the economy as a whole. Growth will be domestically oriented. The beginning of the year was very weak but we expect the situation to improve gradually.

Russia’s IP contracted 1.4% year-on-year in May In the otherwise improving economic story industrial production remains the bugbear. IP basically came to a standstill in May and this is connected to the low levels of corporate borrowing, the shrinking levels of capital investment and the on going capital flight. IP growth plunged 1.4% year-on-year in May, the second lowest reading since the crisis, according to Rosstat. This came below Bloomberg expectations of 0.6% year-on-year growth and even below VTB’s downbeat forecast of -0.8% year-on-year. The key drag on IP growth was shrinking manufacturing output, that dropped 4.4% year-on-year with output of cars declining a sharp 18.1% year-on-year (almost fourfold the -4.8% year-on-year in April) and growth in the production of construction-related materials deteriorating significantly. The recovery in IP year-on-year growth in April-March turned out to be short-lived and May’s result was the worst manufacturing output result since October 2009.

Russia’s retail trade growth down to 2.9% in May Despite a pick up in consumer borrowing in May retail trade also continued to slow on the back of the general economic down turn. Retail sales were down to 2.9% on the year in May from 4.1% on the year in April and 4.4% on the year in March. The Economic Development Ministry revised down in April its forecast for the country's retail trade growth in 2013 to 4.3% from 5.4%. In 2012, Russia's retail trade rose 5.9%. Loss-making firms' share in Russia falls to 65.2% January-April The share of loss-making companies in Russia decreased 1.9%age points on the year to 65.2% in January-April, the Federal State Statistic Service said in a statement on Thursday. The net profit of all organizations except banks, small enterprises, insurance companies and public service firms fell to RUB2.032tn from RUB2.877tn in the same period a year ago. Russia records budget surplus in 5M13, deficits end of year and in 2014-16 The Russian budget returned to a surplus in 5M13 after falling into deficit in the first quarter. The Finance Ministry reported a surplus of RUB128.4bn or 0.5% of GDP for 5M13 after initially reporting a deficit of RUB75.6bn (or 0.4% of GDP) for 4M13. Both revenues and expenditures declined month-on-month in May due to the long holidays.

Revenues fell 20.4% month-on-month to RUB890bn, as oil & gas revenues dropped 10.3% month-on-month to RUB523.7bn, with the average Urals price practically unchanged month-on-month in May. The share of oil & gas revenues grew to 59% from 52% in April. Non-oil & gas revenues contracted 31.5% month-on-month to RUB366.5bn, mainly due to lower tax collection. The Finance Ministry currently expects a budget deficit of 0.6% of GDP in 2013, or RUB400bn. Revenues may be lower than expected this year, due to weak profit tax collection and VAT credit to state companies, which completed large investment projects recently. Also the government has dramatically revised back its privatization plan: it had budgeted for RUB300bn, but cut this to RUB190bn and analyst say it will be luck to get RUB60bn. Russia's federal budget will run a deficit of about RUB400bn in 2014 too and RUB500bn in 2015 and 2016 each, Russian Prime Minister Dmitry Medvedev said at a meeting of the Governmental Committee for Budget Drafting.

Russia's MinFin considers budget maneuver for 2014-16 Due to the slower growth in nominal GDP and lower tax revenues, budget revenues and expenditures growth were revised significantly downwards. As additional expenditures expected over the next three years are almost fully accounted for by the already signed state obligations on arms purchases, salary payments and government programmes, MinFin is considering budget manoeuvres to allocate expenditures in the most efficient way:

• a lower transfer to the State Pension Fund;

• 5%-cut in spending outlays for

state procurement; and

• postpone the military rearmament programme beyond 2016.

The debates are not finished yet. The next date to watch is 4 July when another government meeting on the budget is to be held. Russian demographics reach western European levels in leading cities Maternal mortality in Russia has fallen by 55% since 2005, Prime Minister Dmitry Medvedev said and is on a par with that in western Europe in the leading regions. In 23 regions, the maternal mortality figures have fallen to the level of West European countries. Medvedev linked the positive dynamics to a state program to build 23 perinatal centers and a program to improve the supply of equipment and medicine to maternity centers.

Birth rates in Moscow are also rising steadily. A record 130,000 boys and girls were born in Moscow last year, says Acting Moscow Mayor Sergei Sobyanin in June. “That's a 20-year record.” All in all the birth rate in Russia is up 30% since 2007, Russian Minister of Labor and Social Protection Maxim Topilin said in late June, partly due to the introduction of the so-called “maternity capital” on January 1, 2007. All women who gave birth to their second child after January 1, 2007 are eligible for a government-issued benefit of almost 409,000 rubles (about $12,600), which is not paid in cash but is given as a credit to be used to improving housing, children’s education or contributed to a pension. The biggest problem remains the shrinking number of young people in the population. In 2012 there were 31.6m people in the 15-29 age group down from 32.4m in 2011, and 33.7m in 2009. Young people’s share of the population has fallen to 22% in 2012 from 23% in 2011 and 24% in 2009, according to Rosstat. Ruble hammered 1H13, to recover in 2H13 depending on capital flight The ruble has lost about 7.2% vs the dollar in May, and may approach the

RUB32.5-33.0/$1 level in the near term. The scope for the rouble/basket rate to move towards 37.0 (currently 35.0). Ruble has fared better than other EM currencies: the Polish zloty has lost 9.6% vs the dollar so far in May, the Hungarian forint 9.7%, the Czech koruna 7.4%, the South African rand 9.1% and the Turkish lira 4.9%. The currency is helped by the fact that the Russian consumer has gained in maturity and no longer reacts to currency weakening by running to the bank to convert roubles into FX deposits. Analyst see potential ruble appreciation in the second half of the year. If Europe starts emerging from recession later this year, that will support commodity prices and help reduce capital outflows. The big unknown is what rate the capital flight will run at and clearly it is running at a rate higher than the government would like to see. Capital flight has intensified since the start of the year, with $37.8bn leaving the country in 5M13. The Economy Ministry said that capital flight doubled month-on-month in May to $8bn; this is consistent with the recent ruble weakness.

Economists have another stab at estimating the size of the grey economy According to the Finance Minister the budget loses $90bn in taxes annually as businesses hide up to 20% of GDP (approximately $400bn) in the shadow economy. That Russia has a sizeable grey or shadow economy is not at all in doubt. How big is the figure is anybody’s guess. At one end of the scale is the estimate by the Research Institute Global Financial Integrity which has evaluated Russia's shadow economy at 46% of GDP or $900bn. According to the World Bank estimates Russia's shadow economy is 3.5 times larger than in other G8 countries. But then that reference figure is also a best guesstimate. State Property Agency cuts privatisation programme Russia’s State Property Agency has worked out a revised privatisation proposal. The government now plans to retain control over Rosneft, RusHydro and Zarubezhneft, (50.1% by 2016-20) as opposed to the full exit envisaged before. The same is planned for VTB. On the other hand, the State Property Agency included Rostelecom into the privatisation programme with a full exit by 2016.

The privatisation plans for Transneft and Inter RAO are unchanged. The state wil exit Rosnano by 2017 vs. 2016 as per the SPA proposal (a minor delay). Aeroflot – to leave a blocking stake by 2016 vs. full exit as per the SPA proposal. Alrosa – to leave a blocking stake by 2016 vs. full exit as per the SPA proposal.

Russia’s tariff growth cap to lower inflation and support the economy in the medium term Tariff growth might be capped by consumer inflation ... On Friday, President Vladimir Putin said that regulated tariff growth should not exceed the previous year’s consumer inflation; the changes are to be implemented in 2014 and will last for five years. The reduction in tariff growth has been discussed several times in the past few years, but this time restrictions on tariff growth appear feasible. According to the Economy Ministry’s estimates, lower tariffs will have a relatively small effect on state companies’ investment programs, provided that they improve efficiency. In order to boost efficiency, Putin proposed the introduction of efficiency evaluation procedures for the management of large state companies.

He also promised to reduce administrative barriers for banks, which should help lower commercial loan rates and thus support credit growth. CBR will only cut key rates in September, not earlier Epectations of a growth-boosting rate cut have been fading and now are not expected until the autumn, according to Deputy Economic Development Minister Andrei Klepach, speaking on

the sidelines of the St. Petersburg International Economic Forum. The ministry expects consumer price inflation to rise in July due to a planned increase of natural monopolies’ prices and believes that the bank’s key rates need to be reduced, Klepach said. “I think, by autumn (the bank cuts its rates).” On June 10, the central bank kept its refinancing rate unchanged at 8.25% for the 9th consecutive month.

ECM IBS Group Luxoft successfully completes IPO IBS Group’s subsidiary, Luxoft that handles the company’s international business, got its IPO on NASDAQ away on June 26. Russian IPOs are relatively rare, but clearly a window has opened and several have got away recently and more are in the pipeline. The IPO offered attractive alternative exposure to the Russian IT industry and highlighted investor interest in the sector. IBS is the main force in software engineering in the CIS but since 2000 its international business has been growing fast and mostly done via the subsidiary Luxoft. The IPO was intended to crystalise the differences between the two companies and separate out the international form the domestic/regional business to make it easier to raise money and plan. The company placing 4.1m class A shares at $17/share in the middle of the $16-18/share range.

The price implies a discount of 11% to analyst’s fair valuation of $19/share implies $585m pre-money and post-money valuation of $555m. The IPO proceeds of $69.6m will be split between Luxoft and its main shareholder, IBS Group. Luxoft’s free float comprises 12.6% of its total capital prior to the execution of the over-allotment option. Brutal sell off – Russia, Brazil lose most Russia and Brazil running neck and neck for highest fund outflows from equity markets in June In the week leading up to June 12, Russia recorded unprecedentedly large losses when compared with GEM equity fund flow records. Russia’s aggregate outflow totaled $524m, which is the single largest weekly loss since October 5, 2011, when the RTS Index reached the

trough of the cycle and marked its lowest level since 2009. The RTS was trading around 1250 at the end of June, well down on the 1490 it finished 2009, the most painful crisis year. Most of the outflows in the Russian equity space are due to institutional funds exiting the most liquid stocks. Russia’s outflow comes to $1,079m YTD, making it one of the worst performers among emerging markets after Brazil (outflows of $1,915m) and China. Cash positions of GEM funds close to post-crisis lows GEM funds have reduced cash levels in their portfolios close to post-crisis lows, according to the EPFR Global data to 2.4% of their portfolios, below the 12-month average of 2.6%. Historically, the cash level has been an accurate fear indicator in the GEM universe. GEM fund managers have become fairly complacent in their positioning. In the post-2009 crisis years, the Russian stock market produced positive returns only when inflows into Russia-dedicated funds outpaced those into GEM funds.

Government waters down SOE dividend policy After ordering state-owned companies to pay at least 25% of their profits out as dividends, the state has watered down the policy. Minister of Finance Anton Siluanov said in June that the government has decided to set dividend policies for state-owned companies individually, taking into account the specifics of their situation. Several companies, notably Gazprom, have ignored the order and claim their need the money for inbvestment programmes. Banks as well have claimed they are a special case and need the money to boost capital ahead of the Basel III rules. VTB trumps Baring Vostok in Russian buyouts without raising funds VTB Capital acquired Tele2 Russia, the fourth-largest wireless operator in Russia, for $3.6bn this quarter, pushing its private-equity total to about $5bn since VTB Group Chief Executive Officer Andrey Kostin created the unit five years ago. That surpasses the $1.8bn that Baring Vostok has spent of the $3.7bn raised for five funds since 1994, according to the company’s website.

Regulations similar to the U.S.’s Volcker rule will eventually be applied in Russia, making VTB’s current model unsustainable, according to VTB bankers. The rule would ban proprietary trading at banks and limit how much of their own money they can invest in private equity and hedge funds. Online retailer KupiVIP plans to make IPO on NYSE in 2015 Russian fashion clothes retailer KupiVIP will make an IPO on the New York Stock Exchange in 2015, CEO Oskar Hartmann said on Wednesday. "We are keeping our plans on going through with the IPO. We have two years left to prepare - and we will prepare. We want to be completely ready by the end of 2014, and the IPO itself will be made in 2015," Hartmann said, cited by Prime. In mid-2012, the company said it planned to make an IPO within two years. Lenta supermarket chain picks banks for IPO in 2014 Russian hypermarket chain Lenta, part-owned by private equity firm TPG TPG.UL and Russia's VTB Capital, has selected banks for IPO next year. The banks chosen are JP Morgan Chase & Co, Credit Suisse, UBS, Deutsche Bank and VTB.

DCM Big outflows hit bond market Russia saw its losses quadruple to $309m from the previous $86m in mid June. Yields soared from 4% for semi-sovereign to over 6%. Most of the outflows came from active and retail funds. Russia was the worst performer in the GEM fixed income space as tracked by EPFR Global. The total outflow from GEM fixed income funds totalled $2,326.47m in the week of the worst sell off in mid June, versus $1,423m in the week leading up to June 5. Russian Railways sells second infrastructure bond Russian Railways set the first coupon rate for the second tranche of RUB25bn worth of infrastructural bonds at 8.4% annual on June 26. Bids for 15-year bonds were accepted on June 24. The placement by public subscription was scheduled for June 27. The underwriter is VTB Capital. The first tranche of infrastructural bonds worth RUB25bn maturing in 30 years was placed by Russian Railways early June, the first coupon rate being 8.2% annual. Russian state-run bank Vnesheconombank (VEB) said it will buy the whole of the 2nd, 25bn ruble tranche of Russian Railways 15- year infrastructure bonds.

Sectors Russia’s housing construction puts in solid growth Residential real-estate deliveries have been growing strongly in the 5M113, up by 11%, according to Rosstat. Total deliveries were 17.5m sqm in 5M13, up 10.9% year-on-year. Housing construction grew 9.8% year-on-year to 3.4m sqm in May 2013. The recovery of the real estate sector is a very positive sign as together with consumption and investment it is one of the three big drivers of the Russian economy. (Consumption is rising, btu investment is falling). The Russian government aims to bring the total volume of housing construction to 120m sqm by 2018 and 140m sqm by 2020 (approximately one sqm per capita), which implies the residential real-estate sector must post a 10.7% CAGR over the next five-seven years. Recent data suggest the residential real-estate sector is on track to meet these ambitious goals. Russia’s defence sector to grow by half Russia’s defence output may grow by 50% in 2014-2016 according to Deputy Economic Development Minister Andrei Klepach. Putin has pledged to bring defence spending up to over 3.4% of GDP or some RUB700bn to rearm the country and also as an economic stimulous plan.

Cargill opens $40m chicken processing plant in Russia Cargill has officially opened its first chicken processing facility in Russia at its complex in Efremov. The facility represents a further investment of $40m at the company's industrial complex, located 300 kilometres south of Moscow. The facility will predominantly supply McDonald's restaurants in Russia. Russia’s subsidized car loans could resume in July As part of the Kremlin’s efforts to kick start the stalling economy it is toying with the idea of resuming the subsidise on car loans from July. The program would continue until the end of 2014 and would apply to loans for purchases of cars costing less than RUB700,000 ($22,000). The program would apply to both cars and light commercial vehicles that are produced in Russia and are imported. Measure could increase demand by 200-250,000 cars, which is around 7-9% of the market volumes. Russia has largest shale oil reserves Russia has the world’s largest identified shale oil resources, with the United States and China second and third, the US Energy Information Administration (EIA) said in June. Russia boasts 75bn barrels of technically recoverable shale oil resources, followed by the United States with 58bn barrels and China with 32bn barrels, the EIA report says. Russia’s richest shale oil source is the Bazhenov formation in West Siberia with total reserves estimated at 1.24

trillion barrels, of which only 74.6bn barrels are currently considered as technical recoverable. Gazprom to launch LNG plant near St Petersburg in 2018 Russia’s Gazprom will launch a liquefied natural gas (LNG) plant in the Leningrad Region in 2018, the company said in June “We are currently considering two possible locations, where the LNG plant will be constructed. The first stage of it will be launched at the end of 2018,” Gazprom said. The projected capacity is up to 10m tonnes annually. Russia to give additional RUB40bn to farmers each year to 2020 The Russian government will grant farmers RUB40bn of additional support every year until 2020 expanding the program to RUB1.51 trillion, Agriculture Minister Nikolai Fyodorov said in June. “But this is the minimum sum because we need to add the resources of the regional budgets. Moscow cannot be the only responsible body for agriculture, for how the countryside is developing,” Fyodorov said. “If we direct, say, 2 trillion rubles to this program from the federal budget until 2020, they must also contribute about 1 trillion rubles.”