Russia Country Market
Insights and Opportunities
Foreign Investment Sector
Overview: The investment climate in Russia has strengthened in recent years and now presents many promising investment opportunities. Russia recognizes foreign investment’s critical role in the country’s economic development and is trying to encourage foreign investment by establishing special economic zones, high-technology parks, special tourist regions, and export zones on both federal and regional levels. Capital account liberalization assisted in raising net inflows to Russia from $40 billion in 2006 to $82 billion in 2007. However, Russia was one of the countries most adversely affected by the financial crisis starting in 2008, with 2009 GDP dropping by 8.7%. From 2004-2008, foreign direct investment (FDI) inflows picked up substantially, rising to over $62 billion in 2008. However, because of the economic crisis, FDI inflows decreased from $40 billion during the first half of 2008 to $16 billion in the same period of 2009. The crisis also caused a net capital outflow of $130 billion in 2008, and for the first three quarters of 2009 Russia had a net outflow of over $60 billion. In the last quarter of 2009, the flow reversed direction, and the Central Bank estimates net capital outflow for all of 2009 went down to $42 billion.
The investment climate has been undermined by the slow pace of structural reforms and the government’s ever-increasing role in certain sectors of the economy, notably gas and energy. Other government actions have had adverse effects on the investment climate, such as the apparently politically motivated investigations into businesses (e.g., the TNK-BP oil and gas joint venture, the Mechel coal company, and the investment fund Hermitage Capital Management) and a reluctance to allow foreign investors de facto unfettered access. Rule of law, corporate governance, transparency, and respect for property rights, including intellectual property rights, have improved over the years but remain key concerns for foreign investors. Possible liabilities associated with existing operations (especially environmental cleanup) and inadequate bankruptcy procedures are also factors in the decision to invest. In short, while there is strong interest, many U.S. companies remain cautious about investing in Russia.
There is a legal structure in place to support foreign investors, although the laws are not always enforced in practice. The 1991 Investment Code guarantees foreign investors rights equal to those of Russian investors, although some industries have limits on foreign ownership. The 1999 Law on Foreign Investment also affirms this principle of equal treatment. Unfortunately, corruption plays a sizeable role in the judicial system, and the sanctity of contracts is not always upheld.
Numerous laws have been amended in the past decade that serve to increase investment opportunities in specific industries. In 2003, Russia enacted several amendments to the insurance law that liberalized the market, effectively allowing any foreign insurer to set up life insurance operations in Russia as long as the company has an office in the EU via which the investment was made. Since 2005, Russia has introduced several pieces of legislation that have offered reduced customs and tariffs rates on automobile parts to encourage foreign automobile corporations to begin manufacturing their products in Russia. In the spring of 2005, President Putin announced four National Priority Projects in health, education, housing, and agriculture. These projects, which aim to tackle some of Russia’s most pressing social and economic needs, provide investment opportunities in sectors such as medical equipment manufacturing, agricultural equipment sales, and housing construction. The 2009 budget for the projects was RUR 450 billion ($15 billion), notably more than the 2008 budget of RUR 330 billion ($11 billion).
Russia’s government officials have repeatedly stressed the need for foreign investments, especially those aimed at developing Russia’s high-tech sectors, as one of the prerequisites for Russia’s successful economic recovery after the economic crisis. At the same time, the government adopted new policies aimed at more effective control over foreign investments into so-called “strategic sectors” of the Russian economy. In May 2008, then President Putin signed into law the “Strategic Sectors Bill.” The law, which grandfathered already completed acquisitions, specifies 42 activities that have strategic significance for national defense and state security and establishes an approval process for foreign investment in these strategic areas. According to the law, investors wishing to increase or gain ownership above certain thresholds need to seek prior approval from a government commission headed by Russia’s Prime Minister. With investment down in 2009, this commission has not been active enough yet to get a good sense of its function. But foreign investors fears that the approval process might be non-transparent and burdensome, and that the law could be used to restrict foreign investors seeking to invest in Russia’s strategic sectors.
Russia’s government also tends to favor direct cash injections and joint ventures with local entities, especially state-owned entities, and particularly in Russia’s “strategic sectors.” The energy sector is the most prominent of these; the government continues to tighten its grip and typically limits foreign companies to minority stakes (20 to 25%) in larger projects. In December 2008, a resolution was passed that increased the duty on most imported vehicles from 25% to 30% and imposed a prohibitive duty on cars older than five years. This move was perceived as a means of helping local auto manufacturers weather the financial crisis. Less critical sectors, such as consumer products, are relatively unrestricted.
Between 2003 and 2009, the share of the private sector in GDP decreased from 70% to 65%, according to the European Bank for Reconstruction and Development. Roughly three quarters of the economy has been privatized to date, although the government continues to hold significant blocks of shares in many privatized enterprises. The economic crisis had an adverse effect on the privatization process. However, the government announced in November 2009 that it plans to privatize at least 14 strategic enterprises, among them Russia’s largest shipping company Sovcomflot and multiple ports that handle large amounts of crude oil and assets. In total, Russia’s government expects to receive RUR 77 billion ($2.7 billion) from the privatization of state enterprises in 2010.
Treatment of foreign investment in new privatizations is inconsistent and is likely to remain so. Often, foreign investors participating in Russian privatization sales are confined to limited positions and face problems with minority shareholder rights and corporate governance. Potential foreign investors are advised to work directly and closely with appropriate local, regional, and federal ministries and agencies that exercise ownership and other authority over companies whose shares they may want to acquire.