The Economy and Investment Climate in Russiain English
The Economy and Investment Climate in Russiain Russian
Primer on U.S. Foreign Direct Investment Regulationin English
Primer on U.S. Foreign Direct Investment Regulationin Russian
The 7th Annual AmCham Investment Conference:
The Economy and Investment Climate in Russia
Wednesday, March 1, 2006
Radisson SAS Slavyanskaya Hotel in Moscow
During AmCham’s 7th Annual Investment Conference held March 1 in Moscow, business leaders cited economic indicators supporting the growing attractiveness of Russia as a prime investment destination: currency reserves of approximately $200 billion, planned IPOs in 2006 of more than $20 billion, and rising personal incomes of the population.
Representing a cross section of industries also benefiting from a 50 percent increase in foreign direct investment into Russia in 2005, corporate leaders from international and Russian companies delivered a consistent message: Opportunities abound in Russia, but more transparency and predictability are needed to improve the investment climate and maintain economic growth.
“Sustainable GDP growth in wealthy countries is directly related to the volume and sustained inflow of foreign direct investment,” Andrew Somers, president of the American Chamber of Commerce in Russia, noted. “Numerous independent studies have confirmed this phenomenon in part because foreign direct investment has a multiplier effect. That is to say, FDI is a significant driver of GDP growth, which in turn drives further FDI into the economy.”
“Equally important are the concurrent effects of FDI, namely transfer of business and ethical values, creation of jobs and tax revenues – all of which contribute to further growth,” he concluded.
Top business leaders delivered their overall positive message to an audience of about 250 fellow business people, U.S. and Russian government representatives and press.
Expanding Opportunities for Investment and Russia’s Economic Future
Speakers: Andrew Somers, president of the American Chamber of Commerce in Russia; Kirill Androsov, deputy minister for Economic Development and Trade; William Burns, U.S. ambassador to the Russian Federation; Trem Smith, chairman of the American Chamber of Commerce in Russia’s board and president, Chevron Neftegaz Inc.; and Charles Ryan, chief country officer and chief executive officer, Deutsche Bank in Russia.
Noting the number of companies with significant Russian investments represented at the conference, Deputy Minister for Economic Development and Trade and keynote speaker Kirill Androsov focused on three strategies designed to attract further investment to Russia: the Investment Fund, the Law on Concessions and special economic zones. The latter two – designed to support large infrastructure projects and promote technology/light manufacturing development, respectively – have been of particular interest to international businesses, which helped pump the record levels of investment into diverse industries throughout Russia in 2005.
“Most boats are rising across this vast society,” said U.S. Ambassador William Burns. “The real question before us at the beginning of 2006 is whether the Russian economy will do as well as it is capable of doing, whether it will use the progress of recent years not as a cause for complacency, but as a basis for a truly bold effort to build transparency and predictability and diversity into its economy.”
Trem Smith, chairman of the American Chamber of Commerce in Russia’s board and president of Chevron Neftegaz Inc., explained that growing economic diversification is being reflected in AmCham’s membership. “The story is very simple. The member companies in the American Chamber of Commerce now are over 800. Growth has been between 4-10 percent per year throughout the membership categories, not just in the blue chips. (It is) primarily in smaller companies, which is a very important component in any kind of economy that’s attempting to grow and sustain that growth,” he said.
Economic diversification is also reflected in official statistics, said Charles Ryan, chief country officer and chief executive officer of Deutsche Bank in Russia. “(There) is an increase in employment. The only way this is possible is if we are seeing an increase in employment in small businesses, and particularly in the services. It’s an incredibly healthy sign given some of the restructuring that’s going on in the heavy industry in the country,” he said.
Another healthy sign, Ryan explained, was the growing number of IPOs in Russia. In 2006, experts estimate the net value of IPOs will be $22 billion – up from less than $1 billion in 2004.
“It’s a good time for Russian companies to go to capital markets,” he said. “And what is particularly encouraging is what they are planning on doing with the (raised capital).”
Indicators Good, But Red Tape Needs to be Cut
Speaker: Evgeny Yasin, director of the Expert Institute
Evgeny Yasin, director of the Russian Union of Industrialists and Entrepreneurs’ Expert Institute, delivered a mixed message on the strength of the Russian economy, emphasizing economic achievements, but drawing attention to potential weaknesses.
Large cash reserves, conservative fiscal policy and the continuation of record prices for hydrocarbons, the country’s chief export, will allow Russia to maintain annual growth rates of 4.5-5.5 percent during the short term. According to The Economy and Investment Climate in Russia, a report compiled for the conference by the Expert Institute, the American Chamber of Commerce in Russia and Ernst & Young, economic growth was based on cash inflows from exports, promoting growth in liquidity, domestic investment and consumer demand due to increased real incomes and availability of consumer loans.
Better sovereign ratings for Russia by global investment agencies also are helping draw more investments. Year-end results for 2005, in fact, show a positive inflow of private capital, albeit small, after large outflows in 2004.
Yet, despite the solid numbers, macroeconomic indices point to slowing growth, notes The Economy and Investment Climate in Russia. Growth rates in 2005 slowed in the extractive industries, which have been key to Russia’s recent economic success. Whereas the value of exports in 2005 increased 34.6 percent, physical output increased only 4 percent. Additionally, as the ruble strengthens, consumers are buying imports, which are cheaper than domestically produced products.
“As you know,” Yasin said, “high oil prices were good for Russia until a certain point. Now they are becoming more and more of a problem, because it is increasingly difficult to place this money effectively to serve the interests of the Russian economy. The strengthening of the ruble will continue, and it will be harder and harder to fight inflation.”
Annual inflation, 10.9 percent for 2005, remains well above planned estimates, but “considering the concrete environment in (Russia), this isn’t a bad indicator,” Yasin remarked.
While some headway was made in administrative reforms in 2005, “little noticeable progress in reducing economic barriers” has been made, analysts from the Expert Institute noted in the conference’s report. Russia was ranked 75 of 117 by the World Economic Forum’s global competitive rating in 2005, indicating continuing problems in its business environment.
Driving Growth in Key Market Segments
Speakers: Chris Israel, international IPR enforcement coordinator, U.S. government; Andrea Martinelli, country manager, METRO Cash & Carry, Russia; Clyde Tuggle, president, Coca-Cola Russia, Ukraine, Belarus; Andreas Ridder, managing director, CB Richard Ellis, Central and Eastern Europe; Robert Fernandez, managing director, J.P. Morgan Bank International; Eric Franke, first vice president, Mobile TeleSystems; Dmitry Loschinin, CEO, Luxoft; and Mikhail Krasnov, president, Verysell
According to data released by the United Nations Conference on Trade and Development, FDI flows to Russia doubled in 2005 from its 2004 level – from $12 billion to $26 billion – and found their way to various sectors. Alcoa acquired two Russian aluminum fabrication plants for $257 million, Coca-Cola purchased Russia’s second largest juice producer for a similar dollar figure. Heinz entered into a joint venture with Russia’s largest sauce maker; and Yum! Brands made a significant investment into Rostik Restaurants Ltd.
Consumer demand continued to grow in 2005 and, according to Kommersant, retail trade turnover grew nearly 12 percent for the year.
With 22 stores in Moscow, St. Petersburg and 14 regions, Metro Cash & Carry is one of the largest foreign retailers already working in the country. Based on current trends, it has plans to open eight additional stores in Russia each year. During the past four years, it has invested EUR 600 million into its Russian operations.
“Right now, for Metro Cash & Carry International, Russia is probably the (most important) project in the world,” declared Metro’s country manager for Russia, Andrea Martinelli.
The major hindrances to growth, he noted, were an absence of infrastructure, the low quality of local suppliers, and an inflexible labor code.
As real estate prices continue to climb in Russia, Moscow has emerged as the third largest agency market in Europe. Yet, the market is only one-fourth the size of Austria’s, said Andreas Ridder, managing director of CB Richard Ellis’ Central and Eastern European operations.
“The office agency market in Moscow has caught up extremely fast and in an impressive way. (Its) market turnover and annual demand stands now at about 1 million square meters, and this is the third largest agency market in Europe already, after London and Paris. So, that’s quite an enormous achievement already in a very few years,” he said.
Representing one of the companies making significant direct investments in Russia during 2005, Coca-Cola’s Clyde Tuggle, president of its operations in Europe, was bullish on the Russian market.
“I think the simple way of putting this country and this business into context for the global Coca-Cola business is to say that Russia represents arguably the single best opportunity for our business to create value over the long term, perhaps, anywhere.”
Its purchase in 2005 of the second largest Russian juice producer, Multon, was one of its largest acquisitions worldwide. Over the past five years, the juice market in Russia has grown 20 percent.
While 2005 witnessed continued rapid growth in the banking industry and the adoption of a national depositor’s insurance program, a more quiet revolutionary change is taking place as well.
“The environment in Russia is ideal for what we do,” said Robert Fernandez, managing director of J.P. Morgan Bank International. “You have enormous companies that engage in strategic transactions both in Russia and abroad, and (have) enormous capital expenditure programs. All of this leads to mergers and acquisitions advice, leads to capital raising, and it leads to risk management.”
Focusing on the impact of IPOs as part of the process of raising capital, Fernandez continued, “When you go from a private to a public company, you are committing to a completely different standard of behavior in the way you conduct business.”
It is this commitment to international corporate management standards, says Fernandez, which will have the lasting and most profound impact on business in Russia.
Information and Telecommunications Technologies
With the adoption in 2005 of a law creating special economic zones, Russia is striving to attract more investment into its domestic high-tech development industry. Four of six newly established special economic zones are designed specifically to lure such industries to begin or expand operations in the country.
Yet, even as the country establishes these new zones, one of its most famous companies, MTS, is already facing a rapidly maturing market.
“Twelve years ago, I worked with mobile companies that were very happy to see one thousand subscribers here in Russia. A subscriber had to contribute about $4,000 just to get a mobile phone and start his subscription. Penetration at that time was maybe even lower than 1 percent. These times are gone,” said Eric Franke, first vice president of Mobile TeleSystems.
Across the CIS, MTS has more than 60 million subscribers and 28,000 employees, and in Russia is facing a penetration rate approaching 100 percent in the $10 billion market.
“2006 is the last year where we will see substantial growth,” Franke said. “We are looking at a market where each of us will have to fight – fight for growth and give offerings that are different and better than our competitors.”
While information technology companies are not facing the same rapidly maturing market as telecommunication firms, they are facing the same type of competition, but from other emerging markets such as China and India.
“Outsourcing is the most rapidly growing IT field, with an average rate of more than 30 percent,” explained Dmitry Loschinin, CEO of Luxoft, a Russian company founded in 2000 with 50 employees and which now has 1,500 employees and nine offices. His stiffest competition comes from India, whose own high-tech outsourcing industry earned $17 billion last year.
Loschinin commented that for Russia’s own outsourcing industry to develop, it needs to receive much of the same type of state support as those in China and India receive.
“This support is provided at different levels, including through special tax regimes for companies that work in our sector, through special programs that support the industry, and through the development of infrastructure that allows companies like ours to develop and grow effectively,” he said.
Continuing, he added, “For small companies to be able to grow and to represent (Russia) effectively, serious efforts and support will be required. If such support materializes, the industry will become a growth point in the Russian economy.”
Mikhail Krasnov, president of Verysell, another home-grown IT company focusing on systems integration with revenues of $400 million last year, repeated the same sentiments, adding that the tax regime needs to take into account the different needs of the IT industry, which relies on human resources and not raw materials.
Further contributing to the overall problem of further growth in the IT sector is the weak protection of intellectual property. This lack of protection is not only hampering a final bilateral agreement between Russia and the U.S. on Russia’s entrance into the World Trade Organization, it is also working to the detriment of the domestic economy.
"Intellectual property supports (the U.S.’s) ability to remain a global and competitive economy, to focus on innovation, to diversify our economy,” explained speaker Chris Israel, international IPR enforcement coordinator with the U.S. government. “Industries that are intensive and focused on intellectual property account for about half of all our exports. They account for about 18 million jobs in the United States and most of these jobs are extremely well paying jobs in very dynamic and growing industries.”
Foreign Direct Investment
Speakers: Richard Brody, president, United Technologies International Operations – Russia; Alexander Livshitz, managing director, International & Special Corporate Projects, RUSAL; Bill O’Rourke, president, Alcoa Russia; and Kris Sliger, executive vice president, Strategy/New Business Development, TNK-BP.
Returning to remarks made by Deputy Minister for Economic Development and Trade Kirill Androsov, the final panel of the 7th Annual Investment Conference focused on possible revisions to Russia’s foreign direct investment regulations.
“Russia today is going through a review of its FDI strategy, including imposing possible restrictions. This comes at the very time when liberal-economy societies – such as the U.S. and U.K., which generally encourage FDI – are reacting negatively to certain foreign acquisition attempts in both countries,” AmCham President Somers said. “This phenomenon reflects the complexity of the task which the Russian government has set for itself in determining the parameters of FDI in strategic sectors.”
Representing the largest domestic aluminum company and the third largest in the world, Alexander Livshitz, managing director of International & Special Corporate Projects for RUSAL, presented a viewpoint on investment from a domestic company’s perspective.
“What does RUSAL expect from the government of the Russian Federation?” he rhetorically asked. “RUSAL wants to have what Alcoa (the world’s largest aluminum company) is getting from the government of the United States. We don’t need anything more.”
Enumerating his desires, he listed predictability in government actions, in inflation rates and exchange ratios.
“I could multiply the list of wishes. They have one thing in common: Business does not seek money from the government; it does not seek preferential treatment. What it wants is more certainty, more stability in the decisions made by authorities,” he concluded.
Richard Brody, president of United Technologies International Operations – Russia, further underlined the need for clarity. “We believe that the general lack of clarity and the specific restrictions on foreign investment have limited Russia’s ability to maximize the development of the civilian industrial high technology sector and probably more important, they put Russia at a significant competitive disadvantage relative to other emerging economies that have already established clear frameworks,” he said.
While Russia did attract significant sums of FDI in 2005, it is “a miniscule share of the total global foreign direct investment flow of almost $900 billion,” Kris Sliger, executive vice president of Strategy/New Business Development for TNK-BP, said. “Clearly, Russia is not attracting its fair share or its proportional share of foreign direct investment relative to the economic power that Russia has.”
In order to maintain current levels of production in the oil and gas industry, Russia needs to invest in its infrastructure and to begin developing greenfield production projects. To attract that investment, its policy toward FDI needs to be clear and evenly applied to all participants, he concluded.
Providing another perspective, Bill O’Rourke, president of Alcoa Russia, spoke about his company’s landmark deal to acquire two aluminum manufacturing plants.
“By our measures, the restrictions in Russia are generally no more extreme than we have found in other countries and other jurisdictions. In Russia, the government approval process took time and effort, but we found the inquiries to be appropriate and thorough,” he noted.