In 2018, we talked with a person from one of the Chinese asset management companies who had come to Moscow for a conference. He was surprised that the Russian equity market was not popular among Russian people. He said that in China you could discuss equity investment ideas with a taxi driver. He tried it with several taxi drivers in Russia and found they were not interested in the subject. Now, a couple of years later, some Russian taxi drivers have started to ask for advice about books or courses that could help them earn money from investing in Russian stocks.
Indeed, millions of Russian people have already started to invest in Russian equities. Since the end of 2018, the number of individual broker accounts has risen 3.4 times and now exceeds 6.8 million. Since the beginning of 2020, net inflows from Russian individual investors into the Russian equity market have totalled USD 4.2 billion.
Further inflows potential in the long run from this type of investors is likely to be in tens of billions of USD. Russian individual investors’ equity ownership is still far below the levels of other EM countries comparable to Russia by GDP per capita. There could be USD 50 billion of further inflows if the proportion of equity investment in people’s saving reaches the level in China, which is 11%. In case Russia will reach Turkey or Brazil levels the potential future inflows could range from USD 35 to 140 billion . This is comparable to the total exposure of international investors to Russian equities of USD 107-125 billion, which represents around 70% of the Russian market free float .
Drivers of Russian demand for Russian equities
Low deposits rates and rising taxation
In past decades, bank deposit interest rates in Russia were in high single/double-digits and the resulting income was not taxed. This explains why for many years, deposits were the dominant asset class for Russian savers. However, over the last two years things have begun to change.
The average interest rate for deposits was roughly 6.8% in 2018 when we talked with the Chinese person about taxi drivers’ interest in equities. It was thus well above the inflation rate at the time, which was 4.3%. Now the average deposit rate is about 4.3%, which is its lowest for over 20 years . It is barely enough to exceed the expected inflation rate of 3.9%-4.2%. Deposits have lost much of their appeal.
The key reason behind this change is success of Russia’s policy designed to achieve macroeconomic stability. Since 2017, Russia has been living in a low inflation era. This allowed the Central Bank of Russia (CBR) to move into a rate-cutting cycle without the threat of capital outflows. Since the end of 2015, the CBR has cut its key rate by 675bp to a record low of 4.25%. The CBR continued rate cutting even during the initial Covid crisis period in spring this year. This was the first time since the dissolution of the USSR in 1991.
Deposit rates are likely to stay low for years as the current low inflation era is likely to continue. Russia needs macroeconomic stability, including low inflation, to increase investments. The Russian government said in 2018 that its long-term aim is to achieve a level of investment equivalent to 25% of GDP. There is still a long way to go – on average over the period 2015-2019, investments averaged 21% of GDP; in 2019 itself, they equated to 18% of GDP.
From 2021, the zero tax rate on income from deposit interest will no longer apply to some of the deposits. In March 2020, Vladimir Putin approved this change, saying that from the beginning of 2021 there will be a 13% tax on the interest from bank deposits larger than USD 13 000. This measure was announced as additional support for the economy to recover from the effects of the Covid pandemic. President Putin did not mention how long the measure will remain in place, so there is a possibility that the tax on interest will still apply long after the pandemic is over.
High dividend yield and potential for growth
The expected average dividend yield from Russian equities is 6.5%, considerably higher than the 4.3% average interest rate for deposits. This has also helped to shift investors’ attention to equities.
Russian companies’ average dividend yields have been growing for many years. Since the rebound after 2008, Russian GDP has been growing more slowly. During periods of slower economic growth, companies generally invest less, so a larger portion of their free cash flow is used towards dividend pay-outs. On average from 2012 to 2019, Russian GDP rose by 1.3% annually. Dividend pay-outs over the same period nearly tripled, reaching an average of 47% in 2019.
We believe there is still room for further dividend growth. Overall, the RTS index dividend yield is expected to rise 1.5 times by 2022 to 9.7% at current price levels.
Another move by the government to support investment growth was to give people a tax benefit if they invest in the securities markets.
In 2015, Russia introduced Individual Investment Accounts (IIA). IIAs allow individuals to receive tax benefits when investing in stocks/bonds and mutual funds. Simply by putting money into a Type A account for three years, individuals can have a full or partial refund of their annual income tax , even if the money is simply kept as cash. The other type of IIAs, Type B, releases investors from the obligation to pay any income tax on the earnings they make from IIA investments  . The number of IIA accounts now totals some three million. About 23% of the capital in IIAs is currently invested in equities.
Further tax subsidy innovations via IIAs will most likely lead to further inflows from individual investors.
There has been an ongoing discussion about how to make Type B IIA accounts more popular. The Central Bank of Russia has thus proposed increasing the investment limit through Type B IIAs from USD 13 000 to USD 40 000 with the possibility of partial withdrawals (which currently incurs the loss of tax benefits). This will potentially increase investment through Type B IIAs and stimulate trading interest among individual investors.
Digital services development
The main institutions that have been pushing investors toward the securities markets in recent years are banks. Banks have attracted the attention of individual investors through gamification apps, making it interesting and easy to trade securities and obtain analytical advice.
Additionally, financial institutions have significantly simplified the process of opening and operating brokerage accounts for individual investors – one can do it without leaving one’s home, which makes it more attractive for individual investors.
Inflows from Russian individual investors into the Russian equity market are likely to continue. The main factors that should support this are: 1) low deposit rates on the back of government actions to maintain macroeconomic stability; 2) high average dividend yields from Russian companies; 3) further tax subsidy innovations; and 4) improved services for investors. With potential inflows of tens of billions of USD, individual investors have the capacity to buy significant portion of the stocks currently held by international investors. This will likely increase the resilience of the Russian equity market while absorbing temporary outflows of foreign capital. We believe there will also likely be a positive effect on the liquidity of the Russian equity market.
(Please see the full version of the article with graphs in the attached pdf file.)
Authors: Egor Kiselev PhD, Head of International Business & Investment Marketing; Aleksandra Kuznetsova, Junior Investment Specialist
 We took the latest available proportion of Russian individual investors’ equity investments and adjusted it for the proportion of Chinese, Turkey and Brazil individual investors’ exposure to equities in their countries.
 According to Sber CIB research, 45% free-float is owned by the foreign funds. About 25% ownership is assumed for non-reporting organisations, such as hedge funds and sovereign funds.
 Deposits for more than one year; as at September 2020
 Up to 13% of RUB 400 000 (USD 5 000) paid contribution
 The amount transferred to the account may not exceed RUB 1 million (USD 13 000) a year and money should be kept for at least three years. Tax benefits can be received after the closure of the account.Russian individual investors source of significant inflows into the Russian equities October 2020