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Financing the Russian Economy: Future opportunities and challenges

Steven Fisher Managing Director, Citibank ZAO, Russia. Financing the Russian Economy: Future opportunities and challenges. February 2008. Russia is a BRIC Leader. Notes: (1) 2007 Nominal GDP; Source: EIU. (2) 2007P GDP growth; Source: EIU. (3) Market Cap as of December 2006 from Factset.

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Financing the Russian Economy: Future opportunities and challenges

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  1. Steven FisherManaging Director, Citibank ZAO, Russia Financing the Russian Economy: Future opportunities and challenges February 2008

  2. Russia is a BRIC Leader Notes: (1) 2007 Nominal GDP; Source: EIU. (2) 2007P GDP growth; Source: EIU. (3) Market Cap as of December 2006 from Factset. (4) 2001–2006 Market Volume; Source: SDC – Any Involvement. (5) 2001–2006 Equity offerings – Equity and Equity Linked. (6) 2006–2007YTD IPOs as of 17 September. 2

  3. Exceptional Strength in Intellectual Capital Leads BRICs in Human Development Index Highest Literacy Rate among BRICs Rank Russia (65) 99.6 Russia Brazil (69) China 90.9 China (81) 86.4 Brazil India (126) India 61.0 0 0.2 0.4 0.6 0.8 1 0 20 40 60 80 100 120 Leader in Higher Education 3 Sources: UNESCO, OECD, Economist

  4. Russia’s Economy is larger than India, Brazil, South Korea Forecast to jump to top 6 player by 2020 GDP 2007E 2020 4 Source: EIU

  5. Leading Energy Position is Key Economic Driver Ranking for FCY and Energy Reserves Foreign Currency Reserves Oil (Proved Reserves) Natural Gas (Proved Reserves) Source: EIU Source: BP research Source: BP research 5

  6. Russia – Already Major Equity Market, Potential is Big 30 Companies with Market cap. >=US$6bn New Listings Will Bring More Sector Diversification Sector Breakdown, by Market Cap (MSCI) Leading EM Equity Market Improving Risk Profile Source: S&P Sovereign Ratings History Since 1975; Fitch – Complete Sovereign Rating history; Bloomberg Source: MSCI, Citi, 18 October’ 07. Source: Bloomberg, 19 October 2007. 6

  7. Russia Update: Stronger and More Stable • Average real GDP annual growth rate since 1998 - 6.9% • GDP grew from $200 billion in 1999 to $1.2 trillion in 2007 • Personal consumption rate more than doubled since 1999 • Total Central Bank reserves: $483 billion • Stabilization Fund: $121.7 billion • Public Sector Debt: declined from $152 billion in 1998 to $37 billion in 2007 • Due to become the 8th-largest economy in the world in 2007 (using purchasing power parity exchange rates) Since the 1998 financial crisis, Russia’s economy has stabilized and greatly expanded After 7 years in office, Putin’s approval ratings are higher than ever at 80%, though public trust of leaders in general is low An unprecedented majority of the public report they are more or less happy with life, and optimistic about the future Source: The Economist Intelligence Unit Russia Country Data Annual Time Series, 2007 7

  8. Rank City Population Rank City Population MOSKVA (Moscow) 8,297,000 Novokuznetsk 564,000 1 26 St Petersburg 4,678,000 Penza 528,000 2 27 Novosibirsk Ryazan 1,400,000 528,000 3 28 Nizhny Novgorod Orenburg 1,358,000 523,000 4 29 Ekaterinburg Naberezhnye Tchelny 1,267,000 521,000 5 30 Samara 1,165,000 Lipetsk 519,000 6 31 Omsk Tula 1,153,000 506,000 7 32 Kazan Tyumen 1,092,000 502,000 8 33 Ufa 1,088,000 Kemerovo 492,000 9 34 Chelyabinsk Astrakhan 1,084,000 482,000 10 35 Perm Tomsk 1,014,000 481,000 11 36 Rostov-na-Donu 1,003,000 Kirov 466,000 12 37 Volgograd Cheboksary 992,000 459,000 13 38 Voronezh Ivanovo 903,000 459,000 14 39 Krasnoyarsk 876,000 Bryansk 455,000 15 40 Saratov Tver 875,000 451,000 16 41 Tolyatti Kursk 720,000 440,000 17 42 Ulyanovsk 668,000 Magnitogorsk 427,000 18 43 Izhevsk Kaliningrad 654,000 425,000 19 44 Krasnodar Nizhny Tagil 640,000 393,000 20 45 Yaroslavl 614,000 Murmansk 379,000 21 46 Khabarovsk Ulan-Ude 609,000 370,000 22 47 Vladivostok Arkhangelsk 607,000 365,000 23 48 Irkutsk 591,000 Kurgan 364,000 24 49 Barnaul Smolensk 580,000 351,000 25 50 Beyond Natural Resources: Consumer Boom Presents New Opportunities The emerging Russian middle class of 30 million is set to become one of the largest in the world…Russian consumers tend to be early adapters of new technology with discerning tastes… Spotlight on Rising Russian Middle Class • 12th-largest retail market in the world, to become 9th-largest by 2010 • Expanding to provincial cities 2007 1990 Russia’s cities are growing, and 14 cities have populations near 1 million Source: Russian Ministry for Economic Development & Trade, http://www.economy.gov.ru, accessed 24th July, 2007 • 60% of FDI into Russia is now in the non-natural resources sector • Russia ranked the second most attractive retail market in the world after India* • 35 years after Pepsi and 17 years after McDonald’s entered the market, many iconic brands are starting to follow suit (Campbell’s, Starbucks) • Key growth sectors include autos, construction, luxury goods, hospitality, advertising, banking and professional services * AT Kearney 2007 Survey 8 Source: City Mayor’s Statistics http://www.citymayors.com/features/euro_cities1.html

  9. FDI Rates and IPOs: Buoyant Regional Opportunities Russia leads the way in attracting FDI in the region, followed by the Saudi Arabia and Turkey, despite concerns over corruption and ease of working in the business environment 2000 2001 2002 2003 2004 2005 Russian Federation 2,714.23 2,748.29 3,461.13 7,958.12 15,444.37 14,599.61 United Arab Emirates (514.56) 1,184.32 1,306.69 4,255.96 8,359.43 12,000.00 Turkey 982.00 3,352.00 1,137.00 1,752.00 2,837.00 9,681.00 Ukraine 595.00 792.00 693.00 1,424.00 1,715.00 7,808.00 Poland 9,343.00 5,714.00 4,131.00 4,589.00 12,873.00 7,724.00 Romania 1,037.00 1,157.00 1,144.00 2,213.00 6,517.00 6,388.00 Egypt 1,235.40 509.90 646.90 237.40 2,157.40 5,375.60 Saudi Arabia 183.00 504.00 453.00 778.46 1,942.00 4,628.00 Kazakhstan 1,282.52 2,835.00 2,590.22 2,092.03 4,112.60 1,738.40 Foreign Direct Investment (US $MM) 2006 Eastern Europe Private Sector in GDP (in per cent) 28,700 8,300 20,100 5,200 14,000 11,400 10,000 18,300 6,100 Source: European Bank for Reconstruction and Development, EBRD Transitions Report 2006, accessed 27 August 2007. www.ebrd.com. Source: United Nations Conference on Trade and Development (UNCTAD), Foreign Direct Investment Database, http://stats.unctad.org Accessed on 17 October 2007 IPOs in the Region (July 2006- July 2007) 9 Source: Thompson Financial SDC Platinum , accessed 1stJuly, 2007

  10. FDI in Russian Federation 1994-2007, forecast 2008-09, USD bn 10

  11. There are Still Challenges to Doing Business in Russia Russia retains many of the complex bureaucratic procedures present in many post-communist countries World Bank Ease of Doing Business Indicators (Ranking of 175 Countries) Ease of Doing Business Rank Source: World Bank Doing Business Indicators 2007, accessed on 27 September 2007. www.doingbusiness.org. Transparency International Corruption Perceptions Index 2007 (+/- change from 2006) • In recent years, Russia’s bureaucracy has expanded and its corruption ranking has declined (worsened). Government has set fighting corruption as key priority. Source: Transparency International, Corruption Index 2006. Accessed on 29 August 2007. 11

  12. One of the Largest Underbanked Markets in the World. Improving Risk Profile Bank Assets / GDP, 2006 Standard and Poor’s Rating Source: EIU Source: S&P Sovereign Ratings History Since 1975 • Consumer banking market growth at 50+% per annum • SME untapped by international players, 50+% growth • Competition for Top Tier corporate names increasing 12

  13. 200 200 1000 RTS Index Brazil 5yr CDS (Ba1/BB+) Brazil 5yr CDS (Ba1/BB+) S&P 500 900 175 175 Bombay SENSEX Mexico 5yr CDS (Baa1/BBB+) Mexico 5yr CDS (Baa1/BBB+) Shanghai 800 SOAF 5yr CDS (Baa1/BBB+) SOAF 5yr CDS (Baa1/BBB+) 150 150 Brazil BOVESPA 700 Russia 5yr CDS (Baa2/BBB+) Russia 5yr CDS (Baa2/BBB+) 125 125 600 Price (bps) Price (bps) 100 100 500 Percent Increase since Jan 2002 400 75 75 300 50 50 200 25 25 100 0 0 0 Jan Jan - - 07 07 Mar Mar - - 07 07 May May - - 07 07 Jul Jul - - 07 07 Sep Sep - - 07 07 Nov Nov - - 07 07 Jan Jan - - 08 08 Jan 02 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Strong Fundamentals Despite Market Turmoil Comparative CDS Spreads Equity Market Performance Russian Credit Overview Russian Equity Market • Over the last few years, Russia’s equity markets have shown stunning growth with the RTS Index growing by nearly 900% since 2002 • While easily outperforming indices from developed markets, Russia’s performance has even dwarfed other fast-growing emerging markets such as India, China and Brazil • In line with the developments in the credit markets, equities have similarly seen a difficult start to the year. • However, Russia’s solid fundamentals and further upward potential are expected to mitigate any potential risk-aversion • Despite the widening credit spreads since H2 2007, the year has been very strong for Russia in terms of both issuance volumes in the syndicated loan and Eurobond markets • Although appetite for EM debt has been affected by the deteriorating credit environment, a large pipeline of both bonds and loans from investment-grade names will keep supply strong into 2008 13

  14. 250 250 1yr CDS 1yr CDS 1yr CDS 1yr CDS 3yr CDS 5yr CDS 200 200 7yr CDS 10yr CDS 10yr CDS 10yr CDS 10yr CDS 150 150 Price (bps) Price (bps) +106 bps 100 100 +97bps +88 bps +79 bps +62 bps 50 50 0 0 Jan Jan - - 05 05 Jul Jul - - 05 05 Jan Jan - - 06 06 Jul Jul - - 06 06 Jan Jan - - 07 07 Jul Jul - - 07 07 Jan Jan - - 08 08 Russian Sovereign CDS Levels Source: Bloomberg as of 31.12.2007 14

  15. Value 100 No. of deals 87.9 90 80 70 60 US$ billions 50 40.1 38.2 40 30 20 15.0 153 132 112 8.3 10 74 62 0 2003 2004 2005 2006 2007 120 120 47.2 Oil & Gas 12.7 100 100 20.4 Metals & Mining 6.8 80 80 10.6 Basis Points Finance 12.4 60 60 1.2 Utility & Energy 40 40 0.4 0.4 20 20 Telecoms 2.2 2007 8.0 0 0 Other 3.6 2006 4Q98 4Q98 4Q99 4Q99 4Q00 4Q00 4Q01 4Q02 4Q02 4Q03 4Q03 4Q04 4Q04 4Q05 4Q05 4Q06 4Q06 4Q07 4Q07 A excluding ACQ A including ACQ BBB including ACQ BBB excluding ACQ Russia FCY Loan Market Update Russia Loan Market Volumes • 2007 was a record year for syndicated loans, the total more than doubling to US$87.9bn • The big driver behind the substantial increase were capex and acquisition related financings in the Oil&Gas and Metals & Mining sectors • Hence, Oil&Gas as a sector represented with US$47.2bn, 53.7% of total volumes or an increase of 3.7x vis-à-vis 2006 • However, on the back of recent market dislocation and a huge pipeline of syndicated loans out of Russia, pricing has slowly started to creep upward Volumes By Sector EMEA Pricing Trends 15

  16. 40,013 45,000 Russia Kazakhstan 140 35,397 27,730 30,000 80 40,000 Ukraine Others Finance Oil & Gas 120 76 35,000 No Deals 121 70 Metals & Mining Others 25,000 100 21,229 30,000 No Deals 60 97 63 15,887 Issuance Volumes (US$ - million) 80 25,000 20,000 50 11,138 20,000 60 Issuance Volumes (US$ - million) 13,587 15,000 40 8,055 54 15,000 8,580 46 40 30 6,505 32 10,000 29 10,000 20 20 24 5,000 5,000 16 10 0 0 2003 2004 2005 2006 2007 0 0 2003 2004 2005 2006 2007 Bank/Finance Bank/Finance Energy/Oil/Gas Energy/Oil/Gas State Authority/Government State Authority/Government Telecoms/IT Telecoms/IT Local authority Local authority Metals/Mining Metals/Mining Others Others 100% 90% 80% 70% 60% 50% Russian Bond Issuance (%) 40% 30% 20% 10% 0% 1997 1997 1998 2001 2001 2002 2002 2003 2003 2004 2005 2005 2006 2007 Russian Eurobond Market Overview CIS Eurobond Volumes Russia Eurobond Volumes Russia Eurobond Volumes by Sector (%) • Despite the difficult market conditions since the summer’s credit woes, issuance volumes in 2007 have surpassed the previous year’s record levels • Since the difficulties in the credit markets started only investment grade names, with the likes of TNK-BP on Oct. 3rd (US$1.7BN 5 & 10-year dual tranche), Gazprom on Oct. 17th (€1.2BN long 10-year benchmark) and VTB on Oct. 25th (US$2BN 2 & 5-year dual tranche) were able to print in H2 2007. • Since Gazprom’s issue in October last year, only Sovereign credits (Ukraine, City of Kiev) have been able to raise funds on the primary market • Although a large pipeline is expected for 2008, this large supply is partly mitigated by the redemption of nearly US$2bn coming due in the next 4 months in CIS 16

  17. M&A Activity in Russia Historic M & A Volumes Overview • Total US$ value of M&A Transactions grew from US$ 58 bn in 2006 to US$ 129 bn in 2007 • In 2006 the average deal size was US$ 90 mm, this grew to US$ 152 mm in 2007 • The average deal size for 2007 was greatest in Utilities where the average deal size was US$ 463 mm, this compares to US$ 93 mm in 2006 • In 2006 the average deal size was greatest for the Oil and Gas, US$ 181 mm compared with US$ 390 mm for 2007 • This year deal volumes have reached US$ 16 bn so far • Despite the financial crises, deals are still being done • So far Oil and Gas has been the biggest M&A sector, capturing around 45% of the deal flow Sector Split – 2006 (US$ mm) Sector Split – 2007 (US$ mm) 17

  18. M&A Activity in Russia Top 10 M&A deals - 2007 Transaction Announcement Sector Acquiror Name Nation Value of Transaction ($mil) Acquisition Technique % of Shares Acq. RN-Razvitye Russian Fed 7,608 Privately Negotiated Purchase / Auction 9.44 Mar 07 Oil and Gas OAO Rosneft Apr 07 Oil and Gas EniNeftegaz Italy 5,835 Privately Negotiated Purchase 20 Gazprom Neft LionOre Mining May 07 Mining OAO MMC Norilsk Nickel Russian Fed 6,287 Tender/Merger 100 May 07 Oil and Gas LLC Neft-Aktiv Russian Fed 6,814 Divestiture / Auction 100 Yukossibneft Oil -Lot 10 May 07 Oil and Gas LLC Neft-Aktiv Russian Fed 6,407 Divestiture / Auction 100 Yukossibneft Oil -Lot 11 Yukos Oil Co Certain Assets May 07 Oil and Gas OOO Paran Russian Fed 3,877 Divestiture / Auction 100 Jul 07 Power Generation Shareholders Russian Fed 12,382 Divestiture / Spinoff / Privatization 100 HydroOGK Jul 07 Power Distribution RAO Unified Energy Russian Fed 4,172 Self-Tender / Tender Offer 7.43 RAO Unified Energy System Sep 07 Power Distribution E ON AG Germany 3,947 Privately Negotiated Purchase / Privatization 47.43 OGK-4 Golden Telecom Dec 07 Telecoms Vimpel – Communications Russian Fed 4,232 18

  19. Innovative Approach to Corporate Finance Management Traditional Economic Development Scheme “Growth->Optimization->Cost-Saving->Investment” Turned into “Growth/ Investment->Optimization/ Cost-Saving” in Russia Russia Economic Development Product Fin. Markets Corporates Growth/ Investment Funding, Leasing Short term FX & Money Market/ Stock Exchange/ Bond Market Funding/ Funding/ Funding Optimization/Cost-saving Hedging, Insurance Long term FX & Money Market/ Derivatives Market Hedging/ “Alternative Funding”/ Risk Management • New Methods of funding introduced, e.g. Synthetic RUR Funding -> USD Libor Linked Loans + Cross Currency Swap -> Synthetic Fixed RUR Funding • Market Indices introduced: Derivatives Market and Money Market Benchmark (MosPrime) Becoming More Important • Local Derivatives Law in place: All Long-Term Derivatives Were Previously Booked in London – Starting This Year Local Law Supports Derivatives ( Local ISDA under Development) • Investor base diversification (Samurai bonds) 19

  20. Key drivers for the Russian economy in 2008 remain positive • Clarity on the political front.The future configuration of power in Russian has finally been clarified. We believe that it indicates reduced political risks and therefore consider it positive for the Russian market • Macro story is still highly appealing. Russian economy has stayed immune to the global liquidity crunch, as evidenced by continued strong rates of GDP expansion. The current positive macroeconomic trends in Russia to continue in 2007-08, backed by favourable external economic conditions, in particular resilient oil price, which should support further growth, a stronger ruble and falling inflation • Strong investment and consumption growth. • Market is defensive to global slowdown. One of the positive attributes of the Russian market is that it is less exposed to a slowdown in the global, and especially the US, economy – unless that slowdown leads to sharply lower oil prices. Even one of the more exposed sectors, Russian banks, is unlikely to get into significant trouble over the global credit crunch due to massive central bank and government ability to provide liquidity if needed. 20

  21. Risks for the Russian Economy in 2008 • Global sentiment. In some ways, Russia is more integrated than ever into the global financial system, global concerns about subprime, credit and debt can have an impact on the Russian market. A bigger risk is a global economic slowdown resulting in reduced demand on commodities (above all oil) • Rouble strength. Better-than-expected performance on the current account side and strong inflow of private capital combined with an attempt of the CBR to ease inflationary pressures may result in a rouble appreciation ahead of the market expectations. This will put further pressure on margins of commodity exporters • Cost inflation. Inflationary pressures are unlikely to ease in 2008, supported by wage increases, government spending, tariff increases for natural monopolies and global price increases. These may result in rising operating costs and capex overruns for Russian companies 21

  22. Longer Term: Key Questions for the Russian Economy Future investment and long-term growth in Russia will be dependent on: • Further reforms progress. “Reform vs. Stability?” • Productivity and Efficiency of Russian enterprises vs. the world competition and WTO • Diversification of Russian Industry • Addressing the demographical challenges • Declining population • Limited skilled professionals force • Low mobility • Promotion of Rule of Law, Decreasing Corruption • Investment into infrastructure • Accelerating the growth of the Russian smaller and medium sized (“SME”) enterprise sector • Growing middle class and its positive effects • Food! 22

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