Russian Roulette: the challenges of investing in Russia

After all but deserting Russia, foreign businesses are cautiously returning to take advantage of a weak currency. Foreign direct investment (FDI) has increased in 2016, recovering significantly from the nadir of 2014-2015. However, they face significant challenges not experienced by domestic firms. Rampant corruption, a weak economy and strong anti-West sentiment mean that foreign direct investment has still not returned to 2013 levels.

Vladimir Putin at the World Trade Center, Moscow © N.Androsov / Shutterstock

Opportunities
The rapid fall in the value of the rouble (RUB) has become an advantage for firms interested in outsourcing manufacturing as well as foreign currency investors. Before the country’s worst currency crisis since 1998, production costs could be higher than those in the U.S. or Europe. The 35 per cent devaluation against the U.S. dollar means that foreign currency investors have a much higher purchasing capacity and production costs are much more affordable.

For example, in 2016, Swedish retailer Ikea, U.S. food manufacturer Mars Inc., U.S. pharmaceuticals giant Pfizer Inc. and Korean Samsung Electronics Co. significantly increased their activities in Russia, taking advantage of cheaper labour costs.

The Russian government is attempting to attract more foreign investors into the country, with the cabinet recently discussing the possibility of tax breaks for companies considering increasing their capital expenditure. There are also more than 20 special economic zones in Russia, variously focused on industry and production, logistics, technology and tourism.

Challenges
On the other hand, the fate of Western companies in Russia seems heavily dependent on the geopolitical situation. Ikea, for example, has previously warned that it would suspend all activities in Russia after a series of lawsuits over alleged tax evasion, though the company continues to argue that it has paid its taxes in full.

Around the same time that the U.S. and E.U. imposed sanctions on Russia, the state food regulator recommended a ban on some food sold by the U.S. chain McDonald’s

When the U.S. and E.U. imposed sectoral sanctions on Russia following the latter’s intervention in Ukraine and annexation of Crimea in 2014, Russia reacted by imposing counter-sanctions on agricultural produce and food coming from the European Union. At around the same time, the state food regulator recommended a ban on some food sold by the U.S. fast-food chain McDonald’s and then temporarily closed twelve outlets.

In September 2014, shortly after the closures of McDonald’s restaurants, the Saint Petersburg offices of the Finnish dairy company Valio were raided by armed special forces on the dubious grounds that a Dagestani criminal group had been using one of the company’s bank accounts to launder money. This was particularly notable given that 17 per cent of Valio’s profits in 2013 were from its sales in Russia, making the company highly vulnerable to Russia’s counter-sanctions; indeed, in 2016, the company had to shut down one of its facilities in the Finnish city of Tampere as a direct result of Russian sanctions.

 

The sanctions and counter-sanctions are not the only example of how antagonism between Russia and the West can affect businesses. In 2015, France and Belgium seized Russian assets after an international court of arbitration ordered the Russian state to pay compensation to shareholders of the oil company Yukos after the company was broken up and nationalised. Russia refused to recognise the ruling and rapidly adopted a law allowing the seizure of assets of foreign states on Russian territory in response to the confiscation of Russian assets in Europe.

In the early days of Donald J. Trump’s presidency of the U.S., it appeared that he would likely push for closer relations with Russia and possibly the removal of sanctions. However, following the U.S. missile strike Syrian military air base in April, relations have rapidly soured, and it is likely that U.S. firms will be targeted for invasive inspections or even suspension of business in Russia.

Both President Vladimir Putin and his predecessor Dmitry Medvedev – who served for one term between Putin’s second and third terms – have identified corruption as a major disincentive for FDI. Both presidents have launched anti-corruption campaigns and introduced a variety of anti-corruption laws. Until recently, however, only lower-level officials were targeted while high-ranking politicians were spared scrutiny. Putin’s anti-corruption campaigns also seem to disproportionately target his critics.

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