The Russian Economy and Foreign Direct Investment

Kari Liuhto, Sergei Sutyrin, Jean-Marc F. Blanchard

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317309031
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Before the recent Ukrainian crisis, Russia was one of the main sources of foreign direct investment (FDI) outflow and one of the main targets of FDI inflow in the world. However, the events in the Ukraine, the formation of the Eurasian Economic Union, and China's growing interest in the Russian market and its natural resources have changed the picture completely.

This new book brings together an international group of contributors to present a timely and comprehensive analysis of FDI to and from Russia. The book assesses the impact of the changed international political situation on foreign firms operating in Russia, and explores how the new world context has affected Russian investments abroad. The book also considers the future relationship between Russian corporations and the EU and the USA in light of recent events. This book answers an array of key questions including: how have investments from and to Russia developed in the last 100 years; how are Russian businesses spreading to foreign countries through their indirect investments; and how is the Russian Government influencing the investments of Russian businesses abroad?

This volume is of great interest to those who study international economics, modern world economy, and FDI, as well as those interested in international investment movements and the changing role of Russia in international business and the global economy.

1 Introduction

Kari Liuhto

Russia is among the top five countries with foreign investments in the world. Russian businesses have invested especially in the neighboring countries. Russia is also an important target for foreign direct investment (FDI). American, Belgian, British, French, and German investments make up more than 90 percent of all FDI in Russia. Foreign investments contribute substantially to Russia’s total capital. In some years, foreign investments have accounted for as much as a third of the country’s total investments. Foreign banks finance businesses operating in Russia, and foreign businesses are building railways across the country, drilling oil, mining metals, and producing textiles and pharmaceuticals. The public’s dissatisfaction with the head of state and social movements have nevertheless increased, which raises the political risk for foreign businesses continuing their operations in Russia considerably.

The previous paragraph could have easily been from a report sent by an embassy operating in Russia to its home country concerning Russia’s economic situation a little over 100 years ago. The October Revolution in 1917, the founding of the Soviet Union five years later, and the country’s transition to a centrally planned economy at the beginning of the 1930s nevertheless interrupted normal economic development in Russia. With the transition to a centrally planned economy, Russia fell into a half-century of slumber from the perspective of foreign investment. The country was awoken by Mikhail Gorbachev’s reform program, Perestroika (reconstruction), towards the end of the 1980s.

Inspired by Perestroika, the Soviet Union passed a Joint Venture Act in 1987, which allowed foreign businesses to set up companies that were co-owned together with a Soviet organization. The growth of foreign investment in the Soviet Union was slow, as joint ventures had to operate in an economic system that was not designed for them. Joint ventures had no trouble finding demand for their products in the Soviet Union’s consumer market, but they struggled hard to source raw materials, as joint ventures had not been factored into the design of the country’s centralized materials distribution system, Gosplan. Legislation governing businesses and business support services were also practically non-existent.

The promising era of joint ventures ended with the sudden disintegration of the Soviet Union into 15 nations at the end of 1991. With the splintering of the country, the Soviet-era production system was also smashed to smithereens, as a result of which Russia lost approximately 40 percent of its gross domestic product (GDP) over the following five years. In order to prevent the total collapse of the country, Russian leaders were forced to build the foundations of the country’s market economy in great haste, which inevitably led to some major structural errors.

The FDI inflow to Russia remained at below $5 billion per year throughout the 1990s. However, a significant change took place in the investment inflow at the beginning of the new millennium, when the country’s extremely rapid economic growth began to tempt foreign investors to Russia. In 2000, the Russian economy grew by a staggering 10 percent.

The economic growth sparked an increase in the FDI inflow to Russia. As early as 2004, the country had an FDI inflow of more than $15 billion, and the rate of growth only kept increasing. The growth continued right up to the autumn of 2008, when the global financial crisis shook not just the global economy but also Russia. Despite the crisis, Russia still managed to attract $75 billion in FDI in 2008. As a result of the crisis, Russian GDP shrank by 8 percent in 2009, and the FDI inflow to Russia decreased slightly. However, as soon as 2013 Russia had, from the perspective of FDI, recovered from the global economic shock. The recovery was evidenced by the fact that, in 2013, Russia managed to attract almost $70 billion in FDI.

In 2014, the Ukrainian crisis boiled over, when Russia annexed the Crimean Peninsula, which had belonged to Ukraine since the 1950s, to its territory. After this, the West imposed sanctions on Russia, and Russia responded with its counter-sanctions. As a result of the sanctions, economic growth in Russia slowed even further and, finally, in 2015, Russian GDP shrank by almost 4 percent. Although the majority of the sanctions is not directly targeted at enterprise investments from the West to Russia or vice versa, they have impacted on Russia’s economic growth projections and general atmosphere of the investment climate. Foreign investors have become more cautious, and Russian capitalists no longer repatriate their capital from abroad to Russia as eagerly as they did before the overheating of the Ukrainian crisis. Clear evidence of this development is the fact that the net inflow of FDI to Russia had dropped to approximately $5 billion in 2015, when it had been more than ten times that a couple of years previously.

Similarly, in order to understand the development of Russian investment abroad, we should remind ourselves that the October Revolution in 1917 essentially cut off all investment by Russian businesses in foreign countries. Although a few dozen Soviet businesses operated outside the socialist bloc, when the Soviet Union broke up, Russian businesses’ total investments abroad amounted to less than $1 billion. In the chaos that followed the disintegration of the country, capital – including some assets of the Communist party – fled Russia through illegal channels to other countries. Russian businesses’ legitimate investments abroad nevertheless gradually began to override illegal capital flight.

More and more Western newspapers began to report on the new phenomenon: the flow of Russian capital to the West. I can vaguely remember one article from almost two decades ago. The gist of the article was more or less as follows: Five decades ago the Russians aimed to conquer the West with soldiers and tanks – now they are invading our markets with enterprises and banks.

The aforementioned article was way ahead of its time, as the 1990s were only a first taste of what was to come, as – until the beginning of the new millennium – Russia’s total foreign investments were relatively minor. In fact, Russia’s outward foreign direct investment (OFDI) stock was as low as approximately $20 billion in 2000. With increases in the prices of oil and other raw materials, Russian investments in other countries nevertheless skyrocketed, as a result of which Russia’s OFDI stock grew almost 20-fold during the first decade of this millennium. In 2013 alone, Russian businesses invested more than $90 billion in foreign countries. The figure put Russia in the top five countries with foreign investments in the world after a break of 100 years.

However, in this context, it is important to remember that a considerable share – approximately half – of Russian businesses’ foreign investments are sooner or later repatriated to Russia. Circulating capital via foreign countries back to Russia is less to do with criminal activity and more about legal tax sheltering by Russian businesses and securing capital with the help of foreign “corporate citizenship”. With the capital boomerang, Cyprus, in particular, has become a second financial home for wealthy Russians, which is why some analysts have even begun to hyphenate the country’s name in a new way as Cyp-Rus.

The majority of Russian OFDI has ended up in the European Union. According to the Central Bank of Russia, in mid-2015, two-thirds of Russia’s total OFDI is registered in one or other of the EU countries. Similarly, three-quarters of investments in Russia originate from the European Union. Even with Cyprus excluded from the analysis, the EU would still be easily the most important target for Russian investments and by far the most notable source of foreign investment for Russia. In this context, it should be mentioned that the USA only accounts officially for 2 percent of Russian investments abroad and less than 1 percent of Russia’s total inward FDI (IFDI) stock. The figures for China were at less than 1 percent, even with Hong Kong included. In addition to the EU, the USA, and China, Russian investments are also to be found elsewhere – especially in the world’s tax havens. As official statistics are only able to show development trends, a firm-level analysis is indispensable for getting a realistic picture of the movements of investments to and from Russia.

To recapitulate, Russia has, in practice, made an impressive comeback to the world’s investment arena in a quarter of a century. Russia is once more one of the most active foreign investors in the world and one of the most notable target countries for foreign investment. Its comeback is evidenced, for example, by the fact that Russia accounted for more than 5 percent of the global FDI inflow and outflow in 2013.

With the intensification of the Ukrainian crisis, dark clouds have nevertheless begun to gather on Russia’s investment horizon. The inflow of FDI to Russia has plummeted, and many Russian businesses are frantically trying to find safe places for their investments outside their home country’s borders, where they would not encounter sanctions imposed by the West. The rapid rise of China to become the leader of the global economy in a couple of decades and the founding of the Eurasian Economic Union in 2015 are, together with Western sanctions, transforming Russian’s investment projections.

The main objective of this book is, at a time of major upheaval, to increase understanding of the position that Russia will have in the global investment atlas in the future. This goal can be met by looking for answers to the following ten questions:

(1) How have investments from and to Russia developed in the last 100 years?

(2) What is Russia’s current role as a target and source of global investment movements?

(3) How is Russian investment cooperation organized at the level of individual businesses with China, the EU, the Eurasian Economic Union, Latin America, South Korea, Turkey, and the USA?

(4) How are Russian businesses spreading to foreign countries through their indirect investments?

(5) How have Russian businesses managed to use their foreign investments to gain access to Western cutting-edge know-how in the age of sanctions?

(6) How have sanctions shaped Russia’s political risk to Western oil companies?

(7) Can Russian businesses’ foreign investments be explained by means of existing FDI theories or are there special characteristics that should definitely be taken into consideration?

(8) What needs to be taken into account when analyzing FDI statistics relating to Russia?

(9) What is the role of a firm’s ownership structure when Russian businesses invest in foreign countries?

(10) How is the Russian Government influencing the investments of Russian businesses abroad?

By answering these questions, a team of almost 20 researchers strives to give readers an understanding of the direction in which Russia’s role in the global investment atlas is developing. The research team comprised experts from China, Estonia, Finland, France, Russia, Sweden, and Turkey. Each of the authors of the book has studied Russian FDI for several years. Some authors have been following this phenomenon and its varied stages since the Soviet era. It would be no exaggeration to say that, together, the research team has several centuries of experience of foreign investment relating to Russia.

In their contributions, the researchers have made use of a range of different theories in order to provide as diverse a picture of the phenomenon as possible. In addition to John Dunning’s Ownership, Location, and Internationalization (OLI) paradigm and the Investment Development Path (IDP) model, the researchers have, among others, used the following models: the equilibrium model of multinational enterprises, economic gravity model, hierarchical-wave model of spatial FDI diffusion, institutional theories, and political risk model related to FDI. The researchers have based their analyses and conclusions on materials such as statistics, press releases, and interviews with business executives.

The book is structured as follows: In Chapter 2, Jean-Marc F. Blanchard reviews global FDI trends and delves into the global factors that shape global FDI patterns. The chapter speculates about the world’s future FDI trends in general and Russia’s FDI situation in particular. In Chapter 3, Wladimir Andreff presents four historical stages related to Russian FDI. He also analyzes the role of the Russian Government in Russian OFDI.

Alexey Kuznetsov focuses on investment relations between Russia and the USA in Chapter 4. He pays special attention to FDI motives, industrial structure, and geographical division in Russia and the USA. Moreover, Kuznetsov analyzes the impact of sanctions on Russia–USA FDI flows. In Chapter 5, Sergei Sutyrin and Olga Trofimenko describe the main trends of EU investments to Russia. They aim to identify key institutional amendments in Russia and analyze whether these institutional transformations have led to changes in FDI inflows to Russia.

In Chapter 6, Torbjörn Becker investigates the investment flows between Russia and Sweden. He builds several hypotheses regarding bilateral capital flows and compares them to the actual data before concluding his contribution with some policy-relevant comments. After describing the historical development of Russian investments in Finland, Kari Liuhto and Elisa Aro analyze a knowledge-driven investment of one Russian shipbuilding company in Finland in Chapter 7. In a similar manner, Alari Purju investigates an indirect investment of a Russian ICT company in Estonia in Chapter 8. Both the contributions of Liuhto and Aro and Purju deal with motives, location, mode, characteristics, and timing behind these investments.

Given the political situation caused by the crisis in Ukraine and the related sanctions, Hanna Mäkinen and Eini Haaja study the impact of the Ukrainian crisis on the political risk faced by foreign investors in Russia in Chapter 9. More precisely, the aforementioned authors examine political risk in ExxonMobil’s investment in the Kara Sea and Total’s investment in Yamal. Chapter 10 is devoted to analyzing trends, motives, and peculiarities of Russian FDI in the Eurasian Economic Union. In this chapter, Elena Efimova and Vladimir Sherov-Ignatev investigate how well these investments fit to the explanations of classical FDI theories.

In Chapter 11, Andrei Panibratov and Liubov Ermolaeva concentrate on studying the Chinese–Russian investment relationship. These authors aim to discover drivers and special features behind this emerging investment partnership. In Chapter 12, Irina A. Korgun investigates investment cooperation between Russia and another Asian country, namely the Republic of Korea. She explains the factors behind the investment flow from Korea to Russia. In addition to statistical analysis, Korgun describes Hyundai’s investment project in Russia.

In Chapter 13, Caner Bakır and Nuran Acur identify major Turkish multinationals’ greenfield investments and acquisitions in Russia. Their chapter also offers a description of the activities of the two largest Turkish investors, namely Enka and Anadolu Efes, in Russia. In Chapter 14, Alexandra Koval deals with Russian investments in Latin America. With the help of three case studies, the chapter presents motives, barriers, and determinants of Russian OFDI in Latin America. In Chapter 15, Kari Liuhto analyzes the linkage between the ownership structure and outbound investments of ten non-financial Russian corporations with the largest assets abroad. The analysis of these corporations has major strategic significance since these ten companies cover a third of the total value of Russian FDI abroad. Sergei Sutyrin summarizes the main findings of the book and discusses the future development of the phenomenon in Chapter 16.

The chapters are written from each author’s own perspective. The researchers’ views are not always ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of Figures
• List of Tables
• About the Contributors
• Abbreviations and Acronyms
• 1 Introduction
• 2 Global FDI Trends
• 3 Maturing Strategies of Russian Multinational Companies: A Historical Perspective
• 4 Investment Relations between Russia and the USA
• 5 Do Formal Institutions Really Matter for Foreign Direct Investments to the Russian Federation? The Case of FDI Flows from the European Union to Russia
• 6 Investment Relations between Sweden and Russia
• 7 Russian FDI in Finland: Empirical Evidence from a Knowledge-Driven Investment
• 8 Russian Indirect Investment in the Estonian Information and Communications Technology Sector
• 9 Political Risk of Western Oil and Gas Investments in Russia: Review of Media Coverage on ExxonMobil and Total in the Russian Arctic
• 10 Russian Foreign Direct Investments in the Eurasian Economic Union
• 11 Outward Investments from China and Russia: The Case of the Sino-Russian Investment Relationship
• 12 Investment Cooperation between Russia and the Republic of Korea during 1999–2009: Major Trends and Main Lessons
• 13 Turkish Multinationals in Russia
• 14 Russian Outward Foreign Direct Investments in Latin America: Contemporary Challenges and Prospects
• 15 Does Ownership Matter in an OFDI Decision of a Russian Firm? The Case of Russia‖s Ten Largest Investors Abroad
• 16 Conclusion
• Index