Riccardo Orcel, deputy CEO of VTB Group and head of VTB International, gave Shannon Manders an exclusive interview on the sidelines of the bank’s ‘Russia Calling’ investment forum in October and spoke about Russia’s pivot to the East and the impact of sanctions on investment and trade flows.
GTR: There’s been much talk about Russia’s pivot to the Far East in terms of trade flows: has it actually happened yet?
Orcel: The pivot to the East has started and is becoming ever more noticeable. In recent years we have seen the governments of Russia and China, companies and investors talking about an increase in cross-border business. We have witnessed more and more deals and direct investments, but we are still at the beginning of what will eventually produce a significant growth in the volume of transactions between the two countries. Bilateral trade volumes are still just under US$7bn, but year-on-year they grew by about 30%. We expect a similar or faster growth in 2018 and beyond.
We look at this development in the co-operation between the two countries with growing interest and are building our local presence by adding resources to our offices in Hong Kong and Shanghai. We are the only Russian bank with a financial license to conduct banking operations in China and we are already a dominant player in the interbank RUB/RMB FX market and other cross-border commercial banking services.
We have had some notable successes, including arranging around 30 bond deals for Chinese clients; raising money in US dollar and CNH; advising on several cross-border M&A deals and – interestingly – often advising Chinese rather than Russian companies in cross-border investments. This is the result of our very unique regional strategy and commitment to build the premier emerging market investment bank in Central and Eastern Europe, Middle East and Africa, India and China. Our international region of operation perfectly matches the One Belt One Road (OBOR) initiative that is central to the Chinese government investment guidelines. By talking to us, Chinese companies can access an investment bank that covers all of the relevant countries and brings a unique local expertise.
Of course the pivot to the East raises the question of whether there is less trade now with western countries. Data released over the last two years confirms a significant reduction in trade flows between Russia and Western Europe, while trade with the US, although starting from a lower base, seems to be more or less stable. These changes are allowing companies from the East and other regions to give the time to allow new long-term relationships and commercial agreements to be developed, something that will be very difficult to reverse in the future.
GTR: What has been the role that sanctions have played in developing the business with China and reducing trade with the West?
Orcel: Sanctions have had an effect of accelerating the obvious synergies that already existed between the East and Russia. Business with different countries in the East was already growing due to the complementarity between the Russian economy and other countries. Russia can bring its wealth of natural resources and dynamic consumers while, for example, Chinese companies can export part of their excess capital and cost competitive products. We have several success stories in Russia with the likes of Huawei and Ant Financial, and investments made by names such as Fosun, Sinopec and China National Petroleum Corporation, among others.
GTR: The European Bank for Reconstruction and Development (EBRD) recently closed down five of its seven offices in Russia – what long-term impact does such an action bring?
Orcel: It’s unfortunate, but the Russian economy is proving surprisingly resilient and flexible in finding new sources of capital. From China to Saudi Arabia, Qatar or India, we are seeing new capital flowing into Russia in a variety of sectors from infrastructure to real estate, consumer industries and, of course, natural resources.
GTR: Where else does Russia look for infrastructure financing today?
Orcel: Some recent examples include Qatar investing in Pulkovo, St Petersburg’s Airport, a Turkish private company investing in a more regional airport and a number of Russian infrastructure PPPs, including the current Ufa road PPP alongside VTB.
In terms of infrastructure capital, banks like VTB have stepped into the void created by the smaller pool of international capital and we now have a very visible track-record of prime quality investments that we are financing and advising on such as the western high-speed diameter project in St Petersburg (the world’s largest toll road PPP), the Moscow-St Petersburg M11 motorway, and a number of regional projects such as the Kama river bridge.
GTR: Russia has been working hard to diversify its economy – what have been some of its successes?
Orcel: The energy sector remains dominant. There is a universal interest in the country’s oil reserves as Russia is among the world’s top three producers. But we often forget the much wider wealth of natural resources such as coal, nickel and copper or metals such as steel and aluminium that have seen their prices recover from the lows of two or three years ago. Diversification of the economy starts with the effort to add value to the natural resource. For example, instead of exporting oil, there is a growing effort to invest and sell its derivatives in order to shorten the value chain and increase value of goods exported. The counter sanctions imposed by Russia to the West have also had some very positive effects in allowing the domestic economy to diversify. The upward cycle in consumer demand will gain momentum as the recovery from recession gathers strength. Lower inflation and interest rates will continue supporting such demand so that, in absence of international products, people will continue to buy local ones.
GTR: Have the sanctions impacted the goods that Russian companies are able – and willing – to supply to the domestic market?
Orcel: Sanctions have generated an increase in investment by local companies to supply the goods that Russian consumers demand. The quality of Russian products is improving and for domestic companies this will be seen as a unique opportunity to develop local production while protected from international competition. Subsequently once the local products and brand is established, I am convinced we will see the same companies starting to export to neighbouring countries.
We also see international capital from the East interested in investing and taking advantage of this very special situation in the Russian market. For example, we saw Chinese and Korean companies interested in investing in the meat sector. Production in Russia has increased very rapidly and the country is becoming almost self-sufficient across all protein production from poultry to pork. I am convinced that Russia will become a net exporter of meat and other agricultural products in the very near future. This is, of course, not an easy process. Nevertheless, without competing international products, the next few years should allow Russian producers to provide very credible alternatives for consumers and build local production in several industries that an open economy made very challenging in the past.
GTR: How is the bank supporting these local companies so that they’re able to add value and export?
Orcel: At VTB we continue growing our assets and in particular we continue lending to a vibrant mid-market economy sector and its SMEs. We are very positive on the long-term trend of growing average income and spending by consumers and we want to support future market leaders and technology innovators.
GTR: What opportunities does the One Belt One Road (OBOR) bring to Russia?
Orcel: The opportunity for Russian companies in the near term is represented by the domestic market: replacement of international goods, supply of services to a growing number of consumers, investment in technologies that can add value to products before they are exported, etc. But I am convinced, as I said before, that we will see some new domestic market leaders and, given the generally low cost of production in Russia compared to many other countries, we could see a substantial pick-up in exports into other emerging economies.
As for VTB, OBOR is a great opportunity. The connectivity between countries in the region is growing and as advisor we have already helped China Merchants in making the largest ever investment by a Chinese company in Turkey with the US$940mn acquisition of Kumport. We also advised Essar of India in its US$12.9bn sale of Essar Oil to a consortium led by Rosneft and Trafigura. We have also supported several Chinese companies investing or operating in Russia, like Alipay, with whom we work in close co-operation.
Our strategy as an investment bank was already based on a regional approach that covers OBOR. The interest from China to focus on the same region means that VTB is very well positioned to help with local expertise in all these markets.
GTR: How does VTB’s interest in emerging markets as an asset class compare to other banks?
Orcel: Two years ago, in Q1 2016, in the midst of a sharp, albeit short-lived, market correction, many commentators were talking about the end of emerging markets (EMs) as an asset class and a very negative view of the business potential of EMs prevailed. We saw this pessimism and retrenching of global banks as an opportunity to invest. Given our experience and leadership position in Russia, a leading EM economy, we believed that our understanding of EMs in matters such as volatility – due to internal as well as wider factors – and our willingness to commit capital through the economic, commodity and financial cycles, provided us with the right expertise and resources to play a significant role more broadly across EMs. Our decision is proving to be the right one and 2017 will be a record year for our international business. At the end of Q3, VTB Capital was not only number one in M&A in Russia but also in CIS, CEE, Middle East and Africa and number two in India. Among landmark transactions just this quarter, we are advising CEFC China Energy on its recently announced acquisition of a 14.16% stake in Rosneft from Glencore and Qatar Investment Authority in a deal worth around US$9bn.
We are confident of the opportunity ahead of us and want to continue growing. Our business model, which combines advisory and capital markets with our willingness to commit capital, can support local players in their development and in successfully completing strategic transactions. We are expanding in many of our international offices and are very bullish for our business in Asia, Turkey, Africa and CEE.