VLADIMIR AND ANGELA
by Yiannis G. Mostrous
Editor, Growth Engines
June 7, 2007

The annual Group of Eight (G-8) meeting, which started yesterday in Germany, has been surrounded by high political rhetoric regarding the missile defense system the US has proposed to establish in Eastern Europe and Russia’s reaction. Yet, the most-important story should be that of the increasingly important economic/energy relationship between Germany and Russia.

German Chancellor Angela Merkel has been at times critical of President Putin’s methods of responding to what he views as threats to Russia’s security. But the fact of the matter is that the two countries (and you can count France and Italy in the mix) have become quite interdependent--a condition that should be expected only to intensify in the future.

The two main reasons for this reality are the importance emerging markets have gained economically (economic growth as well as domestic consumption) and Germany’s need for a reliable energy provider.

The importance of the emerging markets can be demonstrated through the latest World Bank figures: Consumer spending in the emerging world has been exceptionally strong in recent years, offsetting the loss of momentum in US domestic spending. The rate of US consumer spending growth declined from 5.1 percent in 1999 to an average of 3 percent during the last seven years. As a whole, emerging market consumers represent 19 percent of global consumption, as per capita incomes have been rising overall.

Europe--Germany, in particular--is a big exporter and, therefore, has been benefiting tremendously from the growth in the emerging economies. Russia was the fourth-largest contributor to Eurozone export growth in 2006. 

In regard to Germany, Russia has become a big export destination, contributing 0.8 percent of Germany’s growth rate--not much smaller than the US’ 1.1 percent contribution. But the important number here is that German exports to Russia are growing by 35.3 percent, while those in the US are growing by only 12.6 percent.

Given that Germany is the world’s major exporter and that its exports grew extremely strong at 13 percent in 2006--handily outperforming Eurozone’s export growth of 8 percent—it’s not difficult to see why a good, balanced relationship with an up-and-coming economy such as Russia is essential.

On the other hand, Russia has become very important as an energy provider for Europe--Germany in particular. The two countries have agreed to build the North-European Gas Pipeline, which will take gas straight to Germany. The project is cooperation between the two; if anything, it can guarantee more collaboration in the future.

That said, there’s been a lot of political noise in Europe regarding Russia’s commitment to energy security. Investors should disregard such noise, because it’s taking place for the simple reason that both parties (the European Union and Russia) need more time to digest and act accordingly to the latter’s economic growth and consequential importance.

On that issue, it’s been very encouraging that, in the past two weeks, officials from some of Europe’s biggest energy companies (ENI, E.ON and Gaz de France) have come out in support of strong relations.

“It is about long-term contracts, infrastructure joint ventures and asset swaps,” said Uwe Fip, senior vice president of E.ON, of those relations.

Expect a common ground will be eventually found, especially after the elections in Russia and the US are over. Political rhetoric--even on an international level--tends to increase during these times.

Long-term readers may remember that both the German and Russian markets have been long-term favorite investment destinations of mine, and they continue to be so. In regard to Germany, investors should seek exposure in domestic demand-related stocks (e.g., banks and real estate). When it comes to Russia, focus on domestic demand (especially telecoms and banks) and energy- and infrastructure-related issues (e.g., oil and metals).

© 2007 Yiannis G. Mostrous
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