RS Main Russia is still attractive to investors

Russia is still attractive to investors

August 2011

Foreign investors are willing to put up with traditional problems

There is still no answer to the question of why investment outflow from Russia still continues despite the more than attractive conditions, such as high oil prices. Speaking at the recent International Economic Forum in Saint Petersburg the head of VTB24 and the former Minister of Finance of the Russian Federation Mikhail Zadornov assumed that perhaps the business community does not entirely trust Russia’s legal and administrative systems. Nevertheless foreigners remain optimistic and are still willing to invest in Russia.

‘The fact that capital continues to flow out of Russia despite the current oil prices means that business does not entirely trust the Russian judicial system and that the state must protect the property rights of businesses and individuals who have assets in Russia,’ Zadornov stated during the forum. According to him, there is nothing new about the influence of the upcoming elections on the outflow of capital. Thus 2000 and 2003 were not the best years for the Russian stock market either. However, the fact that despite the oil prices being at a level of US$ 115-120 per barrel of Brent capital continues to flow out of Russia means that business still does not entirely trust the country’s legal and judicial system. ‘The essential things that business needs are property rights and state protection of these rights, regardless of whether we are talking about a 15-hundred sq.m piece of land, an apartment, a small business or a multinational corporation,’ noted the head of VTB24. And no distinctions must be made between foreign and Russian proprietors, he said. Zadornov also noted that the International Energy Agency and leading global banks that have strong commodities teams are predicting oil prices of US$ 120-130 per barrel for next year. However it is unclear whether this will improve the situation with investments in Russia.

The essential things that business needs are property rights and state protection of these rights, regardless of whether we are talking about a 15-hundred sq.m piece of land, an apartment, a small business or a multinational corporation

It should be noted here that First Deputy Chairperson of the Central Bank of Russia Aleksey Ulukaev previously reported that in 2011 the outflow of capital in Russia is expected to remain at a level of US$ 35 billion. Current statistics seem to confirm these predictions; in May net outflow of capital from Russia slowed down to US$ 7.8 billion and in April it was down to US$ 5 billion. At the same time Vice Prime Minister, Minister of Finance of Russia Aleksey Kudrin believes that at the end of the year the total net outflow of capital from Russia may be below the Central Bank’s forecast of US$ 30-35 billion.

Experts are having quite a bit of disagreement about what it is exactly that influences the decisions of investors. Thus, Director of the Financial and Economic Expert Examination Department of 2trade.ru Dmitry Pushkarev is sure that corruption in Russia is on the rise. ‘An administrative secondary structure has been created that businesses are finding it more and more difficult to support with every passing year,’ he noted, ‘at the same time nothing has really been done about corruption, it’s just that now access to the right place or resources is ten times as expensive as it used to be. Plus there are purely financial reasons; western countries offer businesses a more comfortable environment to operate in. For example in Germany loans are offered to growing businesses at an annual rate of 4%, in the US at 5.6%, in Japan at 6.2% while in Russia the lowest rate you can get is 15%. So corporations are transferring their assets abroad, get loans against them and grow their business there.’ In addition to that, the statistics cited in the media are in all probability only the tip of the iceberg and in reality a lot more capital is leaving the country. Summing up, Pushkarev noted that at the end of the day the main reasons why businesses are choosing to invest elsewhere are corruption and bureaucracy.

In the meantime polls of investors produce rather paradoxical results; most of them view both the current situation and the short term prospects for their businesses in Russia as positive. And as for the ever present corruption and bureaucracy, they are willing to accept them as unavoidable overheads of running a business in Russia.

One of the authors of a study commissioned by the Association of European Business (AEB) explained that they polled the top managers of companies that are members of the Association. Although, General Director of GFK-Rus Alexandr Demidov complained that only a fifth of the 500 members were polled, i.e. about 100 managers. According to him the companies and managers that participated in the poll represented such countries as Germany (12%), France (11%), UK (10%), the Netherlands (10%), US (10%), Sweden (9%), Finland (6%), Switzerland (6%), Austria, Italy and Russia (with 4% each) and others (13%).

These companies primarily operate in consulting (24%) and financial services (14%), the automotive industry (10%), mechanical engineering, construction and retail (10% each).

Most of the respondents cited market volume (71%), and upward market trends (49%) as the main reasons for entering the Russian market. These most important criteria satisfy the expectations of AEB members; 75% of the companies are happy with the prospects of their business in Russia.

According to Demidov, AEB members are getting more optimistic, however strange it may seem. ‘Our study has shown that in 2010 70% of our respondents (managers of AEB member companies) had their sales in Russia increased and only 13% experienced a slump in sales,’ he noted, ‘ Another curious fact is that increased investments, sales and profits are expected in 2011 by 72%, 79% and 71% of the respondents respectively. And a third paradox is that in addition to the ever present corruption and bureaucracy, European business people also cite lack of qualified personnel as a hindrance to their expansion in Russia.’ The paradox of this last statement, Demidov explained, is that availability of qualified personnel is also cited by European business people as one of the reasons why they are choosing to enter the Russian market. ‘I think the explanation here is that in general the Russian population is more qualified than in other countries and Europeans are drawn here by that fact but when it comes to filling specialised expert positions there is a shortage,’ he assumed.

Most of the respondents cited market volume (71%), and upward market trends (49%) as the main reasons for entering the Russian market. 75% of the companies are happy with the prospects of their business in Russia

Independent experts explain these paradoxes by the fact that basic, i.e. primary and high school, education remains at a comparatively high level in Russia while at the same time the prestige and quality of specialised technical education has been declining in recent years. ‘There are many factors that are at play here but the main negative influence is that the state is not participating in any way in the planning and support of higher education and specialised technical education schools, which is creating lots of problems’, believes Aleksey Kozlov, Deputy Director of Department for Trade and Sales of Stock at UFS Investment Company, ‘As a results we have a shortage of human resources’.

At the same time, Alexander Demidov also notes that there is a certain degree of ambiguity. ‘For example, when it comes to public statements European business people have a habit of making general statements about corruption, bureaucracy and excess government regulation while behind the scenes they confess to having problems with customs and ambiguous tax laws,’ he explained, ‘the same terms that they are used to in Europe have a completely different meaning in Russia which leads to unintended errors for which, business people believe, they get fined too harshly. At the same time most business people presume that investments in Russia are going to increase, although Europeans are now looking beyond Russia at the Asian markets’

Steven Jennings, Executive Director of the Renaissance Capital investment group, believes that today Russia has all the right conditions for investments while twenty years ago investments in Russia were near impossible. ‘Russia is trying to expedite the privatisation process,’ he noted, ‘Some serious steps were made towards creating an international financial centre in Moscow, which should allow foreign companies to work there. There are several more industries attractive to sectors, such as natural resources as well as services and industry. I think that in the past ten years Russia has opened its strategic sectors to foreign investments’.

Sergey Kulikov,
Exclusively for Russian Survey RS