Press Clippings

29 May 2004FDI in Russia: Russian business is ready for competition — but are competitors prepared to arrive? — Petr Aven, Alfa  Bank Bulletin

FDI activity has always been a crucial measure of economic performance. From a business standpoint, the size of FDI flows is a more important measure of the economic success of a country than the performance of its financial markets or declarations by its government. On the state level, FDI serves as a yardstick for a country’s integration with the international community and helps drive economic growth.

FDI inflows to Russia reached $6.8 bln in 2003, the highest level since the beginning of the post-Soviet transition period. However, diversification of FDI remains weak: while some successful projects have been launched by foreigners in the agriculture, cement and even banking sectors, this investment has generally been concentrated in a few select regions. In 2003 47% of total FDI inflows went to the City of Moscow and Moscow region, while another 30% was directed to oil-rich Sakhalin region. Not much was allocated to the rest of the country.

The declared priorities of Russian state policy are to increase living standards and boost employment, which will inevitably require greater foreign investment and more efficient allocation of investment resources. Better functioning of the state apparatus and simplification of business regulation are still prerequisites for progress in these and other areas. This has been borne out in practice: an analysis of FDI suggests that the best-governed regions, like Novgorod, have benefited from favorable attitudes among foreign investors.

The opposition among Russian businesses to such openness is largely a myth. A number of entities in the banking, insurance, food and other sectors are already sufficiently competitive to face the arrival of foreign competitors on the domestic market. It is in their best interest to support the creation of a more market-oriented environment, which would help improve domestic regulation to comply with international norms. Since 2000 Russia has seen eight IPOs, two of which — by Concern Kalina in cosmetics and Irkut in aviation manufacturing — have taken place over the past two months. Preparation for other private placements, which are expected to amount to $7 bln over the next two years, best illustrates the degree of interest among Russian companies in attracting foreign investors, as well as their desire to enhance transparency.

A comparison of Russia and other countries suggests that the scale of FDI can be much bigger. Russia’s annual FDI inflow totals just 1.6% of GDP, or $46 per capita, vs. $140 in the Czech Republic and $220 in Hungary. A comparison with other CIS countries is also not very encouraging: resource-rich countries like Kazakhstan and Azerbaijan attract on average 6% and 20% of GDP per year in FDI, respectively. Russia receives only about 1% of global FDI, even though its GDP accounts for 1.5% of global production.

European countries like Germany and France still prefer to lend to Russia rather than invest longer-term. More than 70% of financial inflows from these countries arrive in the form of loans. Meanwhile, the U. S. and Cyprus are the two largest contributors of FDI, respectively having contributed $4.3 bln and $5.0 bln to date. In terms of accumulated FDI, Cyprus even became the largest source by 2004, which signals greater confidence among Russian holders of capital in the domestic investment. This will serve as a key catalyst for foreign investors seeking opportunities in the country’s real sector.

FDI by Region, $ min, 2003

The experience of other countries shows that WTO membership plays a very positive role in terms of encouraging FDI inflows. Three CIS countries — Moldova, Georgia and Kyrgyzstan — benefited from greater FDI following WTO accession. Russian membership in the WTO, which will almost certainly take place in 2005, will boost the country’s FDI by around 1% of GDP at least. And those companies who choose to invest the earliest in Russia will enjoy a “first mover” advantage.

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