Russia and Foreign Investments

Posted in Russia | 01-May-05 | Author: Dmitry Udalov

Dmitry Udalov is Editor Russia of the World Security Network and Assistant in the Department of Economics in the Institute…
Dmitry Udalov is Editor Russia of the World Security Network and Assistant in the Department of Economics in the Institute for US & Canadian Studies of the Russian Academy of Science in Moscow: "36,4 % more investments in Russia in 2004. The main investors remain Germany and the US."
In the era of globalization, it is easy to underestimate the role of foreign investments in the economy. In fact, the attraction of foreign investors was the key to rapid development in most countries. In the area of economic security, the investment climate of a country is a kind of indicator that demonstrates the sustainability of economic development.

As research has shown, the issue of attracting foreign investment is essential in post-Soviet states. Investments play an important role in modernizing post-socialist economies through introducing Western standards, attracting new technologies, personnel training, innovative management etc.

Last year, two countries headed the list of the most successful recipients of foreign investments: China and Russia. They managed to receive 30% more than the year before. The main investors in the Russian economy remain Germany, the United States, Cyprus, Great Britain, France and the Netherlands.

Foreign investments in Russian economy 2001-2004

Source: Federal Statistics Agency

There are several reasons why Russia is attractive to investors:

Immense supply of natural resources

Russia is a country rich in mineral resources such as metals, minerals, timber, oil and natural gas. Thus, raw material prices are expected to be less than in the rest of the world for decades ahead. It also has tremendous potential for agricultural development.

Vast market

The population of Russia is 3 times larger than, for example, the population of the UK. Strong internal demand for all kinds of goods and services and insufficient supply from local sources create a gap that is largely covered by imports.

Support to investors from federal and regional authorities

As Russian authorities are principally interested in attracting new investors, they place a great emphasis on developing a favorable investment climate. This includes the work of the Foreign Investment Advisory Council chaired by the prime minister and involves the participation of the largest and the most prestigious foreign investors in Russia.

Enormous investment potential in such priority areas as:

Oil, gas and petrochemicals, scientific and technical sectors, defense and conversion industries, machinery, transport and transportation, import substitution, consumer goods manufacturing, pharmaceuticals, telecommunications, general infrastructure, agriculture, food processing and distribution sectors are in need of new technology and know-how. Medical services and health are also priority areas.

Fast growth of competitive export-oriented industries

Foreign investors have the opportunity to use modernized Russian factories as producers and suppliers of competitively priced goods worldwide.

High technology niches

The conversion of military enterprises provides broad opportunities for foreign investments. These enterprises have a nucleus of highly qualified, disciplined personnel and access to modern technology and equipment. They are accustomed to strict quality control and are experienced in flexible manufacturing development, applying new inventions and scientific achievements. Russia leads the world in many areas of fundamental research and development ranging from eye microsurgery to space technology. This resource is now also available for foreign partners.

Highly educated population

There is a relatively well educated population ready to be retrained. The work force is well qualified and keen to work.

Relatively low labor costs

Labor is relatively inexpensive and supply exceeds demand. The average wage is still a fraction of that in OECD countries.

Ideal natural bridge between East and West

Russia has major transportation links that connect Scandinavia, Western and Eastern Europe with Central Asia and the Far East and is strategically located between most developed countries and emerging markets.

Extraordinary business opportunities

The synergy of all of the abovementioned factors creates an unprecedented business environment for successful investments. The average profits of foreign investors proved to be among the highest in the world.

Graph 1
The Dynamics of Foreign Investments in Russia

Source: Federal Statistics Agency

No one denies the existing obstacles for investing in Russia. The instability of the early 1990s still affects the image of Russia. The country must demonstrate a higher level of political, economic and social stability that is based upon democratic reforms and establishes a framework of law and order.

Russian bureaucracy might also prove to be a challenge for Western businessmen who decide to invest their money in Russia. One always has to take into account the additional costs caused by Russian bureaucracy. Yet many Western businessmen admit that the situation depends on the regions. Authorities of a number of regions have understood that the cost of an inefficient bureaucracy is too high, as it terrifies investors and thus can bring the region to economic stagnation. That’s why some regions have created a more favorable climate.

Culture is evidently a significant factor to take into account when making the decision to invest in Russia. The “mysterious Russian soul” so vividly described in Russian classics is not always ready to absorb everything that is brought from outside. To be successful, a businessman must possess a minimum of basic knowledge about the Russians, their preferences and dislikes. Thorough research into the cultural aspects of Russia would be undoubtedly useful for achieving high results.

Graph 2
Structure of foreign investments in Russia’s economy in 2004

Source: Federal Statistics Agency

New investments, the amount of which is growing year by year, have several important consequences that concern not only the economy but also political power and security aspects.

Russia is becoming increasingly involved in the global market. Its cooperation with the rest of the world is many times higher than in Soviet times. Having established strong economic ties with other countries, Russia will not be able to return to the so-called policy of the Iron Curtain, being separated and hostile to the rest of the world.

Secondly, intensive economic cooperation helps Russia to improve its democratic institutions. Attracting foreigners to invest in Russian businesses requires Russia to adapt to Western standards. Thus in modern Russia, business is the most significant driving force for further liberal and democratic reforms.

Exclusively for WSN: An interview with Andrey Podoynitsyn, President of the National League of Management and Investing Companies (Russia)

One of the best specialists in the field of investment business Andrey Podoynitsyn, President of the National League of Management and Investing Companies, describes to WSN readers the investment climate in modern Russia. Andrey Podoynitsyn has great experience in working with Russian investors as well as with foreign ones.

WSN: Thank you for your time and effort. It’s always a pleasure to know the opinion of a highly qualified specialist. What do you think about all those changes that Russia has gone through for the last 10-12 years, since 15 years ago no one thought of investments at all and moreover of attracting foreign investments. What has been achieved and what is to be achieved?

Andrey Podoynitsyn: "The Russian economy is ready for a great boom."
Andrey Podoynitsyn: "The Russian economy is ready for a great boom."
ANDREY PODOYNITSYN: Without going into particular detail about Russian reforms, one point is evident: The declared principles of reforms turned out to be almost opposite to their results. In the early 90s, instead of a market economy we had uncivilized chaos. Judiciary and law-enforcement systems practically disappeared. As the production process couldn’t stop, ersatz in a form of criminal bands emerged instead of governmental structures. It sounds sad but at that time, criminal groups were the only effective albeit barbarian way of business regulation. Fortunately since the mid-90s, this situation has rapidly improved. Today criminal aspects no longer dominate Russian business. The situation is not any worse than in Mexico, Brazil or other countries. Of course, many improvements must still be made until we have achieved European standards. In general, stable and understandable rules of business were established. This enables us to execute giant investments, to plan and calculate several years ahead. Businessmen needn’t worry anymore about activities that are not directly connected with business itself. Business ethics is more and more popular. Shadow salaries become open, and pension reform largely facilitates it. An extensive mortgage program is coming soon. So millions of citizens are interested in legal salaries, in paying all taxes and in having a positive credit history. It is becoming, or I would say, has already become a common practice, probably not everywhere but on a very large scale.

WSN: Still western investors are afraid of something. What do you think about the present level of cooperation between Russia and European and American investors? Why did communist China attract several times more investments than democratized Russia?

AP: A good question and the answer is evident. Despite being so “red”, China managed to provide investors with certain, understandable but stern and regimented business rules, which no one tries to change.

The establishment of such rules in Russia is its main achievement of recent years. The evidence of this is that institutional investors are starting to work in Russia. These are pension funds, insurance companies, the world's largest producers. But the first who came were large retailers: Auchan, Metro, Ikea. This business is not merely flourishing; it is experiencing an unbelievable boom, development, profits and popularity.

With a clear conscience we can invite foreign investors. We understand that Russian realities may seem different and rather peculiar to them. But judging from my own experience, after foreign companies come to Russia and work here for a couple of months, it is impossible to drive them back. Such big profits, salaries, bonuses and opportunities for further development are very difficult to find anywhere else in the world.

WSN: Let’s speak then about the relations between business and Russian state authorities. The UKOS case is the first thing many businessmen start thinking about when they hear about Russia. How would you comment on the situation with UKOS? What are your thoughts about the relations between business and government in Russia?

AP: Every situation should be studied in its context; it’s essential to know the background. Those who really want to understand the situation must examine the history of the creation of UKOS. Recently, UKOS started making colossal efforts to make its business clear and open, to introduce a Western way of management and to get rid of shadow affiliates. I’d like to point out that the political ambitions of UKOS were quite evident, particularly the political ambitions of Mr. Khodorkovsky. It’s important to emphasize that these ambitions were proclaimed in a very radical form. Thus the UKOS affair doesn’t relate directly to business and to the relations between the state and business. It was a political clash of interests. By the way, it is still not clear which side violated the rules first. If we remember the chronology of the events, it will become evident that it was not the state that provoked further actions. It is also clear that the state also wants to bring its taxation system in order.

Speaking about the relations between the state and business in general, on the one hand business and the state must be strictly separated. On the other hand, business and the state must have a constant, constructive dialog and I can admit the situation is developing in this direction. For example, the organization that I represent is one of the examples of this constructive and positive dialog between business and state. In fact our whole branch of business of investment foundations has grown from this dialog.

WSN: What does Russia expect from Western investors, and what requirements and wishes do you have?

Hard currencies ?
Hard currencies ?
AP: We don’t have the habit to define Western and non-Western investors. The aim of any investor is to minimize risks and to get maximum profits. That’s why we have only one point to make about foreign investors. They must overcome the previous negative stereotypes and labels that have been imposed by the mass media for the past 10 years. The most effective way to do this is to talk to Western businessmen who already have experience in working in Russia. When I listen to them, they seem to be greater patriots of having business in Russia than the Russians themselves. It sounds unreal, but in fact it is so. Of course, one can be skeptical when Russian businessmen or authorities advertise Russia trying to attract foreign investors; so those who have any doubts, please, go and ask your own businessmen who work in Russia. In any case, one thing is evident: Having overcome a period of economic chaos, the Russian economy is ready for a great boom that will last for years.

WSN: Still there is a problem of assets escaping the Russian economy. What is the possible development in this sphere?

AP: One tradition has been established in Russia for the last 10 years: Foreign investments are better protected from all kind of external influence than Russian investments. This habit is so strong that many assets are leaving Russia only to reappear under a Western “cover” through Cyprus, the Caimans, Luxemburg, the US, Germany etc. So Russian business is very eager to come back to Russia, as well as Western investors are ready to come here, too.

WSN: Could you describe - using the example of your company - the interaction between Russian and Western businesses?

AP: We are sure today that the real estate sector will experience a growth period for the next several years. A number of essentially important documents were adopted at the end of 2004 (Housing Code and 27 other laws). They form the legislative base of the mortgage system in Russia. All these rules will at last regulate all interaction between the state, citizens and the judicial system. This is far a higher level of judiciary regulation.

New modern buildings are to be constructed instead of archaic and aged Soviet houses.
New modern buildings are to be constructed instead of archaic and aged Soviet houses.
There are basic estimates of the need for housing in Russia. There are also fundamental estimates of Russian citizens. All these estimates say that the real estate market will not just merely develop – it will boom. Here are the figures. In Russia there are only 19 square meters per person, in Europe there are 45-50m2, and 72m2 in the United States! It is easy to understand what a long way we still have ahead of us. Constant migrations, the return of Russian speaking people from former USSR republics and the dissemination of people within the country create an enormous demand for housing. On the other hand, the dynamics of the real estate market at present shows how strong the solvent (effective) demand is. For example last year real estate prices grew by up to 40 % in Moscow, and up to 23% on average in Russia. Until now, only consumers themselves could satisfy this demand. This is a unique situation where the mortgage system satisfies 70-80% of the demand. In Russia, mortgage comprises only 1% of the real estate market. Tremendous changes are to start now!

We would very much welcome western investors, as they are the lucky owners of long-term investment resources that are only beginning to be formed in Russia. Our new project that we started this summer incorporates specialists in banking, investment and real estate. Consequently, we are the first to offer our customers the combined product in the field of real estate from consulting to the final stages. We present a combined product that includes all steps, so all risks can be minimized and the profits precisely evaluated. The consumer of our investment product doesn’t have to worry about the many technical details that might seem too difficult. To begin with we show the consumer the project of investments, we provide the results of our checks and tests, explain the situation and dynamics of the market and we evaluate risks and profits. This is our work. We are also trying to generate new innovative projects that have never been implemented in Russia before. There are a lot of extremely interesting projects from aqua parks to the construction of new cities in the suburbs of Moscow. We are 100% certain that these products will be enormously popular among consumers. Therefore, we are interested in a dialog with Western investors. The fact that risks have become easy to evaluate and profits will be higher than in Europe opens great perspectives for our cooperation.