Russia’s FDI Outlook Grim, with No Chinese Rescue in Sight
(Russia Matters – russiamatters.org – Nicholas Trickett – July 11, 2019)
Nicholas Trickett is editor in chief of BMB Russia and an associate scholar with the Foreign Policy Research Institute. He specializes in the domestic and international political economy of the Russian energy and infrastructure sectors and Russian foreign policy, and is currently finishing an MSc in international political economy at the London School of Economics.
Since its annexation of Crimea in 2014 Russia has seen foreign direct investment decline significantly. Western sanctions meant to punish Moscow’s muscular takeover of Ukrainian territory have certainly done their part to scare away foreign investors, but they were only one driver of the drop in FDI; others include the 2014-2015 oil price plunge, domestic economic policy since Crimea and a weak economy long plagued by structural problems, not to mention a global economic environment less favorable to investment in emerging markets. Chinese investment—despite record-high trade between the two countries—is not making up for the shortfall and, as Russia’s investment climate continues to deteriorate, alternative sources of FDI aren’t forthcoming, notwithstanding a large spike in the first half of 2019. With the cash pie much smaller, and increasingly concentrated in state hands, competition among interest groups in Russia has gotten more vicious, with their lobbying further undermining policy coherence. Western money is not doing the talking in Moscow these days, so it seems, paradoxically, that by imposing sanctions on Russia the U.S. and its allies may have whittled away an instrument of leverage they once had.
Crunching the Numbers
While exact numbers can be hard to nail down due to different methodologies, all estimates of Russian FDI in the past five years show the trendlines pointing south. Based on official Central Bank statistics,1 FDI stood at roughly $22 billion in 2014 and dropped to $8.8 billion for 2018. These figures include reinvested earnings—a contentious way of counting often seen as a means of inflating figures, since it includes money made in Russia and transferred offshore before returning as investment. However, the Central Bank likewise calculates FDI without reinvested profits2; by that method, FDI in 2018 was in the red, with a net outflow of $6.5 billion, the worst showing since at least 1997, according to the RBC news agency. The Institute of International Finance, a global association of banks, reportedly found that between 2015 and 2018 Russia ranked last among 23 emerging market economies in terms of true FDI (i.e., without reinvested earnings), averaging only 0.2 percent of its GDP annually—worse even than Nigeria, a fellow petro-dependent state faced with a simmering insurgency.
Russia’s poor showing for FDI doesn’t come in a vacuum: The IIF assessment noted that FDI to emerging markets in general “has fallen to its lowest in 20 years, with little prospect of improvement,” according to Reuters. While the institute’s chief economist said the drop reflects the end of a long-running trend to globalize manufacturing, a more recent cause lies in U.S. economic policies, including a stronger dollar—which can make investing in poorer countries less profitable—and the Trump administration’s tariff wars, which have stirred up investor uncertainty worldwide.
Finally, most figures for FDI to Russia are imprecise because of the nature of corporate finance and taxation. In a pattern similar to the confusing “revolving door” of Russian businesses’ earnings, many rich companies are headquartered in one country but have subsidiaries in other jurisdictions with more favorable tax laws and use those to make their investments. Hence, the billions invested by Chinese entities in Russian liquified natural gas projects may not appear in the Central Bank statistics as Chinese FDI, because the companies transferring the money are registered in Singapore, the British Virgin Islands or elsewhere. Likewise, the first half of this year saw a large spike in FDI—$11.6 billion, up by nearly 40 percent year on year—but the reasons are not yet clear: This may be more Russian money coming back to the country from tax havens, or perhaps other accounting trickery. Nonetheless, for an illustration of trends, here is a table of the top 12 sources of FDI to Russia in 2013 and 2018, plus Cyprus.3
FDI to Russia (equity only, without reinvested earnings), blns of USD
|British Virgin Islands||1.45||.174||20|
Sanctions: Part of a Noxious Brew
When Western sanctions were first imposed in 2014, they coincided with the collapse of oil prices—down by more than 60 percent between mid-summer and the end of the year—and the two together accelerated capital flight. The sanctions negatively impacted Russian businesses’ access to credit, forcing companies to recalibrate how to finance operations in an atmosphere of heightened uncertainty and making them less attractive to investors. The shifting oil markets, meanwhile, hit the ruble exchange rate—heavily dependent on oil price changes—and Central Bank interest rates. By the end of 2014, a record-breaking $151.5 billion had left Russia, triple the net outflow of the year before. This pushed the ruble’s value down even further; the Central Bank was forced to let the currency float and raised key rates to 17 percent. As borrowing became more expensive and uncertainty rose, there was little reason for investors to leave their money in Russia.
The double whammy of sanctions and oil market chaos continued to undermine FDI for the next couple of years. The Obama administration expanded sanctions to prevent foreign banks from doing business with sanctioned individuals and entities in Russia and halted the provision and refinancing of dollar-denominated obligations, further raising the risks for investors. As oil prices slumped below $30 a barrel, the ruble reached a historic low against the dollar in January 2016. With the reduced access to dollars, ruble exchange rates became even more important to investors. But the Central Bank had to delay interest rate cuts, making borrowing within Russia still more expensive. One pair of researchers estimated in 2015 that the oil price shock had done triple the damage to Russian economic output as sanctions had.
Today, sanctions are seen as a permanent feature of the operating environment in Russia, and Western businesses see no end in sight to pressure on their interests in the country, particularly since there aren’t any significant domestic U.S. constituencies opposed to sanctions. In the summer of 2017 the U.S. Congress passed more stringent financial restrictions on firms operating on the Russian market, turning Obama-era sanctions from executive orders into public laws and expanding congressional control over the sanctions process. With this, businesses saw the picture get bleaker, as sanctions legislation is notoriously difficult to repeal.
Domestic Policy Problems and ‘Autarkic Drift’
One point worth repeating is that Russia’s economic problems predate the sanctions. Growth had stalled by 2013—when oil was still riding high, above $100 a barrel—sapped by an outdated economic model, weak legal protections, “strategic nationalization,” pernicious corruption and ruble volatility. Sanctions have merely exacerbated these structural challenges.
Russian policies adopted in response to the sanctions have further degraded the investment climate, with various lobbies scrambling for preferential outcomes, and have compounded the operating risks investors face in Russia. Now, for example, in the interest of protecting firms under sanctions, Moscow is allowing companies and banks to “classify” various types of data in order to avoid secondary U.S. penalties. Sanctioned banks can hide who sits on their leadership boards so as to avoid scrutiny. The Federal Anti-Monopoly Service is going so far as to keep secret all deals with a majority participation from banks, firms and individuals under sanctions. This makes it increasingly difficult for investors to know who their partners are, creating additional legal uncertainty.
Moreover, now that foreign investment is greatly diminished, large-scale spending relies almost totally on the state and state banks, moving the country toward an increasingly closed economy. This has fueled fights among various powerful blocs over funneling state spending into preferred projects. The infighting, in turn, shapes policy in unpredictable ways, often leading toward less coherence and more inefficiency in sectors from energy and metals to agriculture. One field of battle is the state-run VEB.RF, a national development bank for channeling government money to infrastructure and other public-good-type projects, which has become something of a substitute for FDI.
Last month’s St. Petersburg International Economic Forum, or SPIEF, only seemed to highlight the Russian economy’s increased insularity. Despite a record volume of agreements at this year’s forum, they had little to do with encouraging foreign investment. A review of the publicly available agreements reveals that most of those concerning investment decisions were linked to the so-called national projects, state spending mandated by President Vladimir Putin’s decrees of May 2018. In short, SPIEF was fruitful for Russian businesses seeking state money and a few key foreign firms working on national projects.
This drift toward autarky seems to have diminished Western leverage in Russia and raised the risks for foreign investors. The highest-profile example of this has been the arrest of American investor Michael Calvey and the scandal around his private equity firm, Baring Vostok. The Kremlin’s failure to resolve the situation despite widespread, vocal support for Calvey among senior Russian officials, prominent Russian business executives and foreign investors has exposed the limits of Western financial clout: Patrick Pouyanné, CEO of France’s oil giant Total, reportedly called for the release of Calvey’s partner Philippe Delpal in a one-on-one meeting with Putin in late April; Russian courts still refuse to release him, and the Kremlin does not appear to be doing anything to help.
China’s Not Coming to the Rescue
Increasingly close ties between Moscow and Beijing—including bilateral trade over $100 billion in 2018—have long stirred hopes in some quarters that Chinese investment would come pouring into Russia, but this has not happened. With its highly globalized economy, China remains a skeptical investment partner, as its business community struggles to find returns on the Russian market. Though China’s overall investments have risen, the only significant multi-billion dollar projects in which major Chinese firms take part have been Novatek’s Yamal and Arctic LNG projects. (These investments, as noted above, are registered through offshore vehicles, so China does not appear in official statistics as their point of origin.) China’s turn away from the acquisition of shares in oil giant Rosneft has likewise signaled concerns about getting too close to state-owned firms in Russia. And the Russian Far East, though it’s resource-rich and just over the border, attracted only 2 percent of the $140 million of FDI China officially put into Russia in 2017. China’s presence at SPIEF only served to emphasize the point: Despite a delegation upward of a thousand people, Chinese investors made no major commitments; oil and gas field operator Neftegazholding closed a framework agreement with a Chinese engineering firm, but nothing approaching an investment decision.
- See “Direct Investment in the Russian Federation” > “Flows by Type of Investment.”
- See “Direct Investment in the Russian Federation” > “Flows by Instrument and Partner Country” (“Equity” tab).
- Cyprus is included as a leading destination for offshore Russian wealth. Although no longer among the top 10 sources of FDI to Russia, it often ranked there prior to its own banking crisis in 2013 and it had an outsized impact on 2018 FDI figures, according to the Central Bank.
[featured images are file photos]
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