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Offshore oil platform near Sakhalin
Island: the area is the site of a
£10 billion gas liquefaction plant
being developed by Sakhalin |
FOREIGNERS HAVE BEEN eyeing Russia's wealth of natural resources and 145 million-strong consumer market hungrily for most of the past decade. But the few that attempted an investment often came away with their fingers badly burnt.
Foreign direct investment has remained stuck at about $20 to $25 a head of the Russian population. By contrast, most other countries in eastern Europe can boast per capita FDI of several hundred, if not thousands, of dollars. But on the back of stellar economic growth and a return to political stability this year the first big foreign investments have arrived since the fall of the Soviet Union.
Measuring foreign investment is difficult as so much of Russia's trade is done under the table and many of the big companies are registered offshore for tax reasons. However, even the official balance of payment statistics show that FDI was up 326% to $1.6 billion over the first quarter of this year compared with the same period in 2002 and the real figure is likely to be much higher.
FDI turning point
According to the official statistics, FDI has been stuck at about $4 billion a year for most of the past decade and despite its fundamentally improved macroeconomic health, Russia has attracted even less FDI since the 1998 crisis than it did before. All that changed this February when British oil company BP committed itself to a $6.1 billion joint venture with Tyumen Oil Company (TNK), spending as much in one deal as all the foreign investors of the past three years had spent between them.
"BP's decision was a massive vote of confidence for Russia and for the changes in the country that we have seen over the past four years," says Roland Nash, head of research at Renaissance Capital.
The BP deal was shortly followed by an announcement from Sakhalin Energy, an international consortium developing oil and gas resources on Sakhalin Island in Russia's far east, that it had raised the financing to spend $10 billion on a gas liquefaction plant. The first $2 billion of contracts have already been awarded, half to Russian companies.
These two deals alone would add up to $16 billion, the equivalent of the past four years-worth of investment put together. But little of this money will actually show up in the statistics. Typically, the new BP-TNK entity has been registered in the British Virgin Islands and will not count as domestic investment.
Most Russian deals are done this way for tax purposes and to avoid regulations covering hard currency brought into Russia. (Nearly all of Russia's stock market trades are settled in such offshore havens as Cyprus for the same reasons.)
Likewise, last year's biggest investment, UK investment management house Fleming Family & Partners' multi-billion tie-up with Russia's number two aluminium producer SUAL in 2002, also involved the creation of an offshore entity, and didn't show up in the statistics.
If these numbers are included, the real levels of investment are closer to $20 billion a year and climbing. Yet even these levels are disappointing given Russia's massive economic potential and investment remains concentrated in only a few sectors.
Prime minister Mikhail Kasyanov announced in June that Russia had attracted an official $6.3 billion of total foreign investments (including loans and trade financing) over the first three months of this year. Half of this was invested in trade and catering, while industry attracted a disappointing $1.7 billion.
Although the big-ticket items are still being done through offshore entities, the smaller investments in greenfield production facilities are increasingly coming onshore.
In the past, multinationals have set up representative offices in Russia and maybe built a packaging plant, but the bulk of their goods have been imported. With retail sales now rising by a robust 8% a year - having almost doubled in the past four years - these big companies are now scrambling to build factories in Russia to cut costs and ease distribution problems.
About a dozen new factories costing from $50 million to $150 million are either under construction or have been built in the past 18 months, mostly producing consumer goods, especially food products. Many are located in the investor-friendly Leningrad region around St Petersburg and more projects are being launched each month.
At the same time, the big retailers are now leaving Moscow and St Petersburg, the two traditional markets, to roll out distribution across the whole country. German cash-and-carry retailer Metro announced in June that it would spend $1 billion on opening 100 mega stores throughout the country. And Sweden's flat-pack furniture company Ikea, which pioneered the big retail store business, continues to sink hundreds of millions of dollars a year into new stores and furniture factories.
Foreigners are cashing in on Russia's recovery, but most of the so-called investments from the "far abroad" - countries outside the Commonwealth of Independent States - are actually trade credits boosting imports of such goods as machinery. The real money going into factories and production is actually Russian flight capital returning home.
Germany is ranked as Russia's biggest foreign investor, accounting for $8.1 billion of a total $42.9 billion accumulated by the end of 2002. Of this, though, direct investment only accounted for $1.7 billion, with the rest being in the "other" category - largely trade credits extended by the export credit agencies (and so not really investment at all).
Although tiny Cyprus ranks second in this investment table with $5.6 billion in total investment, it easily beats Germany with $3.9 billion in direct investment and only $1.4 billion in "other" investments.
Politically motivated funding
The US was the third-largest investor, investing a total of $5.5 billion, of which $4.2 billion was direct investment and only $1.2 billion was "other". But here too the numbers are distorted, as much of this so-called investment is politically motivated money funding such projects as the defence conversion programme.