1. Slide 1 | October 2010 | Russia: Poised for Growth, but Constrained by Policy October 2010 Evgeny Gavrilenkov, Chief Economist Russia: Poised for Growth, but Constrained by Policy

2. Slide 2 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Russia’s growth model should undergo uneasy transformation amid institutional constraints  In the aftermath of last year’s correction, Russia’s growth is moderating after a period of overheating and excessive borrowing. Nonetheless, growth is expected to be rather strong this year – Russia’s GDP can expand around 4- 5% and our outlook has not changed since mid-2009, however recent changes in budgetary policy reduce optimism.  The State Statistics Service is now transitioning to a new base year (2008 instead of 2003). This means that data for 2010 and preceding years are often incompatible and thus should be treated cautiously. Statistical errors were already too high last year, which means that even last year’s numbers are suspicious.  Last year’s economic performance may have been better than the State Statistics Service reported. This is because monetary and financial indicators, which indirectly point to where the economy is heading, look very encouraging since 2Q09 (including 1H10).  Russia did not face any serious budgetary constraints, but rather institutional constraints.

3. Slide 3 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Statistical revisions were significant in the case of industrial output and are yet to come for GDP Source: State Statistics Service Revised industrial output figures, y-o-yGDP growth breakdown, 1H10, y-o-y Source: State Statistics Service GDP 4.2%4.2% Agriculture 1.8%1.8% Fishing 8.0%8.0% Raw materials extraction 8.4%8.4% Manufacturing 14.4%14.4% Supply and redistribution of electricity, gas and water 6.8%6.8% Construction -3.9%-3.9% Retail 1.7%1.7% Hotels and restaurants -1.4%-1.4% Transport and communication 9.5% Finance -4.3% Real estate -1.0%-1.0% State administration, military, social services 1.9%1.9% Education 0.4% Health care -0.3% Housing and social services -19.0% Net taxes on products7.7%7.7%

4. Slide 4 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Russia’s economy will expand around 4-5% in 2010 * State Statistics Service (first estimate) ** State Statistics Service (second estimate) *** Troika estimates Source: State Statistics Service; Troika estimates 20082009 * 2009 *** 2010 GDP5.6%- 7.9%-7.0%5.0% Consumption8.6%- 5.4%-3.2%3.1% Household consumption10.8%10.8%-8.1%-8.1%-5.0% 5.0%5.0% Public sector consumption2.9%1.9%2.0% 1.0% Consumption of other sectors-1.4%-1.8%0.0% -1.0% Gross investments10.5%10.5%-37.6%-30.0%18.0% Fixed capital investments10.4%-18.2%-17.0% 3.0% Changes in stocks11.5%11.5%––– Net export of goods and services-35.5%58.0%34.0%-2.0% 2009 ** -7.9%-7.9% -5.1%-5.1% -7.7%-7.7% 2.0%2.0% -1.4% -37.4% -15.7% – 56.6%

5. Slide 5 | October 2010 | Russia: Poised for Growth, but Constrained by Policy “But actually, he thought as he re-adjusted the Ministry of Plenty’s figures, it was not even forgery. It was merely the substitution of one piece of nonsense for another.” (George Orwell, Nineteen Eighty-Four) Source: State Statistics Service RetailServicesHousehold consumption Real disposable incomes Real wages 1Q0817.2%7.4%14.6%14.6%7.5%13.4% 2Q0814.9%5.4%12.1%12.1%5.7%12.5% 3Q0915.0%5.1%11.2%4.5%12.2% 4Q088.7%1.8%6.2%6.2%-6.9%5.0% 200813.5%4.8%10.7%1.9%11.5% 1Q09-0.1%-0.9%-2.6%-2.6%0.7%-0.8% 2Q09-5.6%-4.7%-7.5%3.4%-3.9% 3Q09-9.2%-6.4%-10.8%-3.4%-3.4%-5.2% 4Q09-6.1%-4.4% -9.4%8.2%8.2%-0.7%-0.7% 2009-5.5%-4.3%-7.7%2.3%2.3%-2.8%

6. Slide 6 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Following the crisis, the Russian economy looks healthier, but risks of derailment cannot be ruled out  Last year, Russia was able to deflate not only the financial bubble, but the consumption bubble as well. Monthly growth, which resumed from 2Q09, moderated but looked healthier and more balanced.  Since April-May 2010, almost all y-o-y indicators have turned positive. Even though y-o-y and m-o-m growth numbers are still incompatible for some economic indicators, the growth this year looks robust. According to official statistics, investment was up 10.9% in August (2.8% in 8m10 and 1.3% in 7m10) and retail up 6.5% (4.3% in 8m10 and 3.9% in 7m10). According to revised figures, industry grew 9.2% y-o-y in 8m10. There is an acceleration of growth on the demand side and a deceleration of supply, implying more imports.  Annual nominal wage growth fluctuated around 10% in 1H10 and also moderated relative to the pre-crisis overheated years, which resulted in disinflation in 1H10 and July (5.5% y-o-y). Wage growth accelerated in recent months, which, combined with drought and some negative shifts in monetary and fiscal policy, triggered acceleration of inflation in August-September. Nonetheless, y-o-y inflation will be a bit lower in 2010 compared with 2009.

7. Slide 7 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Industrial output has been recovering m-o-m since February 2009, Jan ’06 = 100% Source: State Statistics Service

8. Slide 8 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Russia’s nominal GDP (in dollar terms) correlates with the oil price Source: State Statistics Service, Troika estimates 2009 2010

9. Slide 9 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Source: State Statistics Service, Troika estimates Rising oil price and expanding foreign borrowing failed to accelerate Russia’s growth: in principle Russia can grow at any oil price

10. Slide 10 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Retail was booming due to foreign borrowing, which stimulated imports Source: State Statistics Service, Central Bank, Troika estimates Acceleration due to borrowing

11. Slide 11 | October 2010 | Russia: Poised for Growth, but Constrained by Policy After a short correction a year ago, consumption is rising steadily, while household debt shrank Source: State Statistics Service, Central Bank, Troika estimates Growth accelerated amid excessively rapid expansion of credit

12. Slide 12 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Bonds were replacing loans in banks’ portfolios Source: Central Bank Bonds and loans in banks’ portfolios

13. Slide 13 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Russia is returning to a more balanced model of economic development after several years of overheating Source: State Statistics Service, Troika estimates

14. Slide 14 | October 2010 | Russia: Poised for Growth, but Constrained by Policy New equilibrium: Since 1999, South Korea’s growth has moderated after decades of unbalanced investment-led growth Source: National statistics, Troika estimates

15. Slide 15 | October 2010 | Russia: Poised for Growth, but Constrained by Policy China: a balance is yet to be found… Source: National statistics, Troika estimates 2008 2009est 2006 2003 1999 1996 1993 1992 1990 1987 1980 1984 1986 1981 1978 -5% 0% 5% 10% 15% 20% 25%30%35%40%45%50%55% Investments/GDP GDP, y-o-y ?

16. Slide 16 | October 2010 | Russia: Poised for Growth, but Constrained by Policy GDP per capita in the former Soviet republics in 1991 and 2009, $ Source: IMF

17. Slide 17 | October 2010 | Russia: Poised for Growth, but Constrained by Policy GDP per capita in the former Soviet republics in 2009 and external borrowing Source: IMF, CIA, national banks

18. Slide 18 | October 2010 | Russia: Poised for Growth, but Constrained by Policy In uncertain times, economic performance is affected by government policy more than before  In addition to monetary policy, which has improved since the Central Bank abandoned exchange rate targeting in February 2009, fiscal policy looked less generous in 1H10, which was extremely positive. For the first time ever, expenditures were not expected to rise in 2010 and beyond – a major disinflationary factor. Recent decisions to inflate budgetary expenditures accompanied by sporadic intervention by the Central Bank on the forex market are dangerous.  On the back of rapidly rising budget expenditures, inflation remained high in preceding years, while the former did not encourage economic growth. Russia needs to balance the budget in the years to come in order to secure growth. As the breakeven oil price reached $95/bbl last year, the budget’s dependence on the oil price should be reduced, but the government has no plans to do so.  Apart from external risks, Russia’s major internal risk is excessive dependence of the budget on the oil price. Budgetary spending was raised this year amid an improved external environment and better performance of the domestic economy. The risk of further increases in 2011 and beyond still exists. The proposed budgets for 2011-12 look excessively generous while borrowing plans seem unrealistic.

19. Slide 19 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Budget revenues fell in 2009, but not as much as the government expected, R bln... Note: The government initially forecast revenues in 2009 at R6,713.8 bln. In 7m10, revenues reached R4,659.2 bln, while the deficit was R538.8 bln. Source: Finance Ministry 200520062007200820092010E Total revenues5,1276,2767,7799,274 7,338 7,784 Profit tax378510641761 195 – Social tax268316405507 510 – VAT1,4721,5112,2622,1322,050 – Raw materials extraction tax8551,0941,1231,605 982 – Export duties1,3521,8961,8352,8592,042 – Import duties271342488626467 – Other5336081,0267841,092–

20. Slide 20 | October 2010 | Russia: Poised for Growth, but Constrained by Policy … but expenditures increased massively, R bln Note: The government initially planned expenditures in 2009 at R9,845.2 bln. Source: Finance Ministry 200520062007200820092010E Total expenditures3,5144,2815,9837,5679,660 10,212 State administration501530812835829 839 National defense5816828321,0411,188 1,264 National security4505506678361,005 1,096 National economy2493456931,0251,651 1,583 Housing sector753295130152 198 Education162212295355418 433 Medical care, sport88148197278352 341 Social policy178201214294324 329 Transfers1,2461,4991,9002,6753,594 3,633 Other52627999147496

21. Slide 21 | October 2010 | Russia: Poised for Growth, but Constrained by Policy A larger government and a budget deficit in Russia usually mean worse economic performance Source: State Statistics Service, Finance Ministry, Troika estimates

22. Slide 22 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Government interventions were inflationary: public consumption shrank in real terms Source: State Statistics Service Deflator for public consumption remained higher than for other elements of GDP Source: State Statistics Service Public consumption to GDP ratio shrank in real terms, its contribution to economic growth diminished

23. Slide 23 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Due to increased expenditures, the breakeven oil price climbed close to $100/bbl Urals Source: Finance Ministry, Troika estimates Breakeven oil price, $/bbl Urals Federal budget expenditures exceed pre-crisis level Source: Finance Ministry, Troika estimates

24. Slide 24 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Finance Ministry has become too generous: planned expenditures tend to grow November 2009, R bln Source: Finance Ministry 20092010E2011E2012E2013E Revenues 7,336.07,783.88,843.89,502.710,378.9 Expenditures 9,662.210,212.410,658.011,237.312,174.9 Deficit of the federal budget -2,326.2-2,428.6-1,814.2-1,734.6-1,796.0 % of GDP-5.9%-5.9%-5.4%-5.4%-3.6%-3.1%-2.9%-2.9% 20092010E2011E2012E2013E Revenues 7,336.07,783.88,617.89,131.79,983.9 Expenditures 9,662.210,212.410,385.110,844.611,749.1 Deficit of the federal budget -2,326.2-2,428.6-1,767.3-1,712.9-1,765.2 % of GDP-5.9%-5.9%-5.4%-5.4%-3.6%-3.1%-2.9%-2.9% August 2010, R bln September 2010, R bln 20092010E2011E2012E2013E Revenues 7,336.06,950.08,077.08,549.09,147.6 Expenditures 9,662.29,886.99,857.49,895.610,078.7 Deficit of the federal budget -2,326.2-2,936.9-1,780.4-1,346.6-931.1 % of GDP-5.9%-5.9%-6.8%-3.6%-2.4%-1.5%

25. Slide 25 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Sources of deficit financing, R bln

26. Slide 26 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Source: Central Bank, Troika estimates Source: Central Bank Voluntary reserves have increased sharply in 1H10 Central Bank deposit and bond rates Voluntary reserves increased as the Central Bank offered an attractive risk-free rate

27. Slide 27 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Banks’ voluntary reserves are not inflationary if real rate on household deposits is positive Source: Central Bank, Troika estimatesSource: Central Bank Growth in real deposit rate stimulates increase in deposits Money supply and bank reserves, R bln

28. Slide 28 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Central Bank absorbed previously extended loans, R mln Source: Central Bank

29. Slide 29 | October 2010 | Russia: Poised for Growth, but Constrained by Policy M2 declined in nominal terms, but started to rise in February 2009, a sign that the economy is recovering (R bln); a sort of “currency board” regime is seemingly over: money is becoming endogenous ($ bln) Source: Central Bank, Troika estimates

30. Slide 30 | October 2010 | Russia: Poised for Growth, but Constrained by Policy The ruble has appreciated since February 2009 after the Central Bank stopped targeting the exchange rate, which became more volatile; the Central Bank’s role as lender of last resort grew in importance Source: Central Bank, Troika estimatesSource: Central Bank

31. Slide 31 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Historical exchange rate and oil price: new regime emerges as the Central Bank reduces interventions Source: Central Bank, Bloomberg, Troika estimates 20 23 26 29 32 35 38 20406080100120140 $/bbl Urals R/$ Exchange rate regime since February 2009

32. Slide 32 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Two regimes of targeting: currency first, money market second Source: Central Bank Volatility high on the money market, low on the forex market Volatility high on the forex market, low on the money market

33. Slide 33 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Nominal interest rates declined, but may go up again Source: Central Bank, State Statistics Service

34. Slide 34 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Real rates have grown due to decelerating inflation, but will go down as inflation accelerates Source: Central Bank, State Statistics Service Based on y-o-y inflation

35. Slide 35 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Annual inflation has been slowing more rapidly, but started to accelerate in August Source: State Statistics Service, Central Bank Annual inflation versus refinancing rate Source: State Statistics Service, Central Bank, Troika Monthly inflation

36. Slide 36 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Source: Central Bank, State Statistics Service No obvious correlation between inflation and money supply No stable correlation between inflation and the exchange rate The direct impact of monetary factors on inflation is not obvious, irrespective to whatever lags are used

37. Slide 37 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Source: Central Bank, State Statistics Service There has been a sort of inverse correlation between money supply growth and inflation

38. Slide 38 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Source: Central Bank, State Statistics Service The correlation existed before 2009……but increased in 2009-10, when real interest rates became positive Money supply dynamics affect changes in inflation (acceleration or deceleration)

39. Slide 39 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Mcap and the money supply drift together Source: Central Bank, State Statistics Service, Bloomberg

40. Slide 40 | October 2010 | Russia: Poised for Growth, but Constrained by Policy

41. Slide 41 | October 2010 | Russia: Poised for Growth, but Constrained by Policy Research Department+7 (495) 258 0511 Head of ResearchPaolo Zaniboni+7 (495) 787 2381 Strategy Chief StrategistKingsmill Bond, CFA+44 (207) 583 3257 StrategistAndrey Kuznetsov+7 (495) 933 9844 Oil and Gas Senior AnalystOleg Maximov+7 (495) 933 9830 AnalystValery Nesterov+7 (495) 933 9832 AnalystAlex Fak+7 (495) 933 9829 Utilities Senior AnalystAlexander Kotikov +7 (495) 933 9841 AnalystIgor Vasilyev+7 (495) 933 9842 Assistant AnalystAndrey Trufanov+7 (495) 258 0511 Telecoms, Media and IT Senior AnalystEvgeny Golossnoy+7 (495) 933 9834 AnalystAnna Lepetukhina+7 (495) 933 9835 Metals and Mining Senior AnalystSergey Donskoy, CFA+7 (495) 933 9840 Senior AnalystMikhail Stiskin+7 (495) 933 9839 AnalystIrina Lapshina+7 (495) 933 9852 Assistant AnalystStanislav Ermakov +7 (495) 258 0511 Manufacturing AnalystMikhail Ganelin+7 (495) 933 9851 Financials Senior AnalystAndrew Keeley+7 (495) 933 9845 AnalystOlga Veselova+7 (495) 933 9846 Consumer Senior AnalystVictoria Sokolova+7 (495) 933 9836 AnalystMikhail Krasnoperov+7 (495) 933 9838 Real Estate AnalystIgor Vasilyev+7 (495) 933 9842 Chemicals Senior AnalystMikhail Stiskin+7 (495) 933 9839 AnalystIrina Lapshina+7 (495) 933 9852 Transport AnalystKirill Kazanli+7 (495) 933 9853 Small and Mid Cap AnalystMikhail Ganelin+7 (495) 933 9851 Assistant AnalystIvan Belyaev +7 (495) 258 0511 Market Analysis AnalystNadezhda Kireeva+7 (495) 933 9855 Economy Senior economistAnton Stroutchenevski+7 (495) 933 9843 Fixed Income Head of FI ResearchAlexander Kudrin+7 (495) 933 9847 Senior AnalystAlexey Bulgakov+7 (495) 933 9866 AnalystEkaterina Sidorova+7 (495) 933 9849 AnalystStanislav Ponomarenko+7 (495) 933 9857 Ukraine StrategistRoman Zakharov+38 (044) 207 3780 EconomistIryna Piontkivska Senior AnalystYevhen Hrebeniuk Senior AnalystIvan Kharchuk AnalystAlexander Tsependa AnalystMaria Repko Kazakhstan AnalystZaurbek Zhunisov AnalystAinur Medeubayeva Senior Management Chairman of Board of Directors and CEO, Troika DialogRuben Vardanian Chief Business OfficerJacques Der Megreditchian Head of Global MarketsPeter Ghavami Chief Economist, Managing DirectorEvgeny Gavrilenkov