Russia Direct sat down with Andrei Yakovlev, Director of the Institute for Industrial and Market Studies at the Higher School of Economics, to discuss the impact of economic recession and political uncertainty on Russia’s investment climate.
It remains to be seen to what extent the economic crisis will affect Russia's investment climate in 2016. Photo: RIA Novosti
Heading into 2016, the focus of Russia’s economic leaders has been the stabilization of the economy and the attraction of new foreign investment. However, 2016 has started with bad news for Russia.
Despite the rosy forecasts of the Russian authorities and their assumption that the economic crisis in the country had reached a bottom, the reality turns out to have been more pessimistic, as indicated by the drop in oil prices and the fall of the Russian currency and main stock indexes in early Janaury.
On Jan. 21 the ruble fell to more than 85 against the U.S. dollar and about 93 against the euro following the decline of oil prices.
Thus far, attracting new investors has been the far more difficult task, given the overhang of Western sanctions and the impact of Russian foreign policy moves on the broader economy. Other external factors – such as volatility of oil prices – also play a role in shaping how foreigners perceive Russia’s investment climate.
With this mind, Russia Direct recently sat down with Andrei Yakovlev, Director of the Institute for Industrial and Market Studies at the Higher School of Economics, to discuss the impact of economic recession and political uncertainty on Russia’s investment climate.
Russia Direct: What are the major trends in the investment climate in Russia today and how have they been evolving since last year?
Andrei Yakovlev: One of the trends is the massive departure of big foreign companies from Russia. However, it was not the case in the beginning of the year, as indicated by the result of our research on the activity of the Associations of Foreign Business in Russia that brings together companies from different countries. This spring and summer, foreign companies were very hesitant about investment and discouraged by sanctions, but they said that they wanted to keep working in Russia because they find its market very promising. But the unpredictability of the Kremlin’s policy will force them to give up: They just find it easier to leave the assets, which they invested in Russia, and do business elsewhere, unfortunately.
RD: What kinds of companies are usually leaving?
A.Y.: One of the most recent examples is Toshiba, which reportedly was going to leave. Even though the company denied this afterwards and claimed that decreasing its activity in Russia was not related to Russia’s currency volatility, such a trend is commonplace in Russia. In 2015, a series of foreign companies, including the famous Finnish retailer Stockmann, have announced plans to close their business in Russia. For example, in the beginning of this year, the famous producers of cars such as Opel, Chevrolet and Honda stopped selling their cars to Russia because of the difficulties with sales there. Likewise, Ford is also about to close its plants in Russia.
RD: Nevertheless, some giants like the American aviation giant, Boeing, are still committed to doing business in Russia because of social responsibility to their employees and the desire to save their robust ties with Russia. Why?
A.Y.: Regarding Boeing, as I understand, Boeing has a branch in Russia, which is incorporated in their broader organization and which targets the global market, not the Russian one. So, it is a bit different case. When I am talking about large-scale departure of foreign companies, I mean those ones that come to do business in Russia and target Russian customers. They are facing difficulties. Especially, it refers to the companies with low level of localization: The significant part of their production is made from imported materials and components. Amidst the ruble devaluation, their market is shrinking a great deal. So, the situation is very complicated.
RD: Despite sanctions, the plight of the ruble and economic recession, Russia improved its record in global investment and doing business indexes. How can you account for this contradiction?
A.Y.: You know, paradoxically even the Bloomberg index demonstrated that Russia improved. Russia’s positions in the World Economic Forum's index improved from 67th to 53th between 2012 and 2015, with more modest results in the Bloomberg's Best for Doing Business ranking: Russia moved from the 48th to 43rd position between 2012 and 2014.
However, the nuance is that the authors of these rankings look at things from the macroeconomic point of view. From this standpoint, the labor force became significantly cheaper. Despite the fact that the Russian market itself has been significantly shrunk, there is still an increase in the possibilities to export from Russia or organize production targeting external markets. In addition, property in Russia is comparably cheaper now in general.
So, it seems to be the time to invest in Russia, if we are talking about the property and construction business. However, the obstacle is unpredictability. The macroeconomic record is not so bad, but rather stable: inflation is not so high; yes, the currency rate is changing very quickly, but it is common not only for Russia, but also for other countries as well. In addition, in fact, some industries and economic sectors benefited from devaluation.
Regarding Russia’s improved record in Doing Business, the Russian government launched the program in 2012, which required from federal and regional agencies to improve economic indicators. However, these indicators are purely technical in their nature and this is the problem.
RD: Do you mean that they are misleading?
A.Y.: Well, usually I am using a metaphor to clarify this idea. For example, we have a color television and its sound is adjusted very well, but the picture remains bad. Those with myopia might finally feel better because the sound got better, but, in general, the television does not work well: the problem remains unresolved. At any rate, the ranking is a sort of formal tool, needed for certain goals. People who use these rankings are aware of this.
RD: So, there is no reason to brag about Russia’s improved records in Doing Business and other rankings.
A.Y.: Yes, it is definitely too early to brag about it, because there is not only the lack of foreign investment in Russia, but also Russian investors themselves are leaving the country. The level of capital outflow is still high. Last year it was about $150 billion, this year $60 billion is expected to leave. But given the oil price, which is twice lower than it was last year, the capital outflow is almost the same.
RD: The oil prices continue to fall and nobody would dare to predict the future scenario. How can this instability affect Russia’s investment climate?
A.Y.: Taking into account that oil prices weaken the ruble, the investment climate is suffering. In the times of high oil prices, there were much more investment just because higher oil prices led to increased demand (and thus wages and consumption) in Russia’s domestic market in the mid-2000s. Those investors who came to Russia during the oil boom, they are leaving Russia’s market now.
RD: Recently, the Russian president reiterated the idea of improving the investment climate in Russia during his annual press conference with journalists. However, his rhetoric seems to be declarative in its nature, given the fact that the Kremlin’s political moves contradict the very idea of investment attractiveness. Take for example, the adoption of the law on the priority of national law over international court rulings. Foreign investor might meet with skepticism because they need legal guarantees, the rule of law, which Russia lacks, according to them. So, to what extent does politics affect investment in Russia?
A.Y.: Yes, this is unfortunately the reflection of a very strong contradictory nature of Russia’s domestic policy, when foreign policy dominates the economy. The problem is aggravated by the lack of consistency in what is happening in Russia’s foreign policy, because if investors could understand its logic, they can be more confident in making economic decisions.
The recent example of such inconsistency is the Kremlin’s response to Turkey’s downing of the Russian jet: sanctions and other economic measures. I see such response as inadequate for business because it leads to the situation of total unpredictability of what the authorities can do next week. Investing in such atmosphere is highly difficult, because business is used to assessing risks: low risks, associated with low yields, and high risks, which are usually associated with high yields.
Yet, we are currently in the situation of uncertainty, not risks. Risks differ because they are possible to measure, while unpredictability is impossible to assess. And this bring about a sort of torpor among investors, because we can rhapsodize about investment climate and improve our technical indicators in global investment indexes, but as long as there are uncertainty and lack of consistency in the Kremlin’s policy, all efforts to improve technical indicators of business will be futile.
RD: But there are companies that prefer to stay in Russia regardless of unpredictability, recession and sanctions. How can you explain it?
A.Y.: First, some companies invested a lot and they cannot give up. For them it is easier to decrease their activity or accept partial losses, because they find Russia promising over the long-term and hope that its market will allow earning much more in the future.
At any rate, such companies have input costs, and, thus, they will have output expenses, if they are going to leave. So, if they are going to come back, they will face new input costs at any case. They just weigh all pros and cons and try figure out in what situation their losses will be bigger.
Our surveys with foreign investors who decided to stay in Russia indicate that there are many arguments in favor of Russia. Its market remains attractive to some investors over the long-term because of several reasons. First, Russia has a great deal of natural resources, so if we take a wider horizon (not two-three years, but 15-20 years), it will be a big advantage, as, at least, seen by a potential foreigner investor, given that today mineral resources are increasingly shrinking.
Second, the Soviet economic legacy and distorted economic structure inherited from Soviet time helped to save some economic niches, in the framework of which an effective company can see two-fold growth during many years. Some foreigners see and appreciate this.
Read Russia Direct's new report: "The Magnetic Push and Pull of the Russian Economy"
The third reason is the size of the Russian economy: even though it was devaluated because of the weakening of the ruble and low oil prices, it does matter. If Russia was a big country with a small economy in the 1990s, it became a big economy with a huge market in the 2000s. This market structurally differs from the ones of developing countries, and in a better way.
What do I mean? Russia has a higher level of urbanization (more than 70 percent), with urban people being well-educated and affluent in comparison with India’s or China’s citizens. They have certain standards of consumption. This market brings together decent customers and comparably decent goods. Foreign investors take this into account.
Another point mentioned is related to the level of education in Russia. Investors find it attractive, when the level of education among the population is high enough, because it makes possible to establish more complicated and effective production facilities than would be the case in other developing countries.
Based on these reasons, some foreign investors are still interested in working in Russia. However, this primarily refers to Western investors. Yet there are also Chinese investors, which we interviewed. And they are increasingly investing in Russia, unlike the Western ones. Yes, they are not pleased with Russia’s current economic situation, but politically, Chinese see and appreciate Russia’s pivot to the East, because, any attempts of China to invest in Russia’s big strategic fields were blocked previously, in the 2000s. In contrast, now the vector is definitely changed: although Russia-China ties are not so close as the Kremlin expected initially after the confrontation with the West, there is a positive trend.
RD: What investment sectors are most promising for foreign investment from your point of view?
A.Y.: Domestically, there is growth in the agricultural and food industry despite the country’s economy falling 4 percent. Obviously, this sector won from macroeconomic changes and, particularly, from devaluation and embargo imposed by Russia on European food. This embargo was a political signal that the government will support the agriculture sector, because previously the authorities were not too enthusiastic in responding to the requests of the agriculture lobby. Despite unpredictability, agriculture is facing a sort of economic boom.
Those sectors that have export potential are also among winners: metallurgy, which is now in a much better shape than it was two or five years ago, or the chemical industry, which is also seeing positive dynamics. Those who are ready doing business in the times of political uncertainty can get good yields. After all, Russia’s assets at stock exchange are very cheap in the current situation; the cost of these assets is determined by political risks, of course.
RD: To what extent can Russia’s innovations attract investment today, given a lot of buzz around them?
A.Y.: Generally, despite all this political turbulence, there are positive shifts in higher technical education, because the government launched many encouraging programs in the mid-2000s, which are bringing certain results, when we see the increase in links between fundamental science and industry, when projects with commercialization potential are emerging and technology transfers are becoming reality.
This process is happening independently from geopolitical instability. There are some results, some potential. No wonder: the government spent a great deal of money on this. However, the question is to what extent it is promising. Anyway, there are many risks because it happens in Russia, where technology transfer and commercialization facilities are not completed and requires a lot to be fully implemented.