Marilen Cawad
12/01/2005
Until recently, capital from the United States represented the second largest inflow of foreign direct investment (after Germany) into the Russian economy. But as the new century dawned, the U.S. gradually yielded its position to a number of European countries. By the end of March 2005, the largest investors were Cyprus ($12 billion); the Netherlands ($9.8 billion); the U.S. ($4.2 billion); Germany ($2.1 billion); and the UK ($1.4 billion). Most of these investments went to the fuel, food, trade, catering and transport sectors, which is reflected in the American companies that have made major inroads into Russia, including Exxon Mobil, Chevron Texaco, Boeing, United Technologies, Ford, General Motors, International Paper, Caterpillar, Procter & Gamble, Mars and Phillip Morris.
The real story behind Russian FDI, however, is not which countries it draws from, but rather how little of the global share it has managed to draw at all. Keith Bush, research director of the U.S.-Russia Business Council, says the paucity of its investment can be attributed to many factors, including political instability during the Yeltsin era; a capricious, changing and exorbitant tax regime; lack of commercial infrastructure; limits on foreign banks; and constant changes in legislation affecting foreign investors.
The ongoing reform of public administration in Russia, aimed at substantial reduction of the government’s intervention in the economy, has reversed the negative trends of the 1990s. Since 1999, the average GDP growth rate has been approximately 6.4 percent per year in real terms. In 2004, Russia achieved its sixth consecutive year of stable economic growth.
Another positive sign is that the growth is spread broadly across many relatively new industries, meaning that growth in traditional sectors is kick-starting growth in new sectors, such as retail, insurance, communications services, branded consumer durables, hospitality services, personal care and fitness services and real estate development.
To support the growing economy, Russia has a strong demand for capital
goods: Nearly half of its imports consist of machinery and equipment. Its second
and third largest import groups are food products and chemicals.
“The
opportunities for business expansion seem almost unlimited here,” says Lance
Pilant, one of the directors for the Moscow branch of a multinational commercial
real estate agency. Originally from Missouri, Pilant moved to Moscow in
the mid-1990s to head the logistics and industrial property division of DTZ
Zadelhoff Tie Leung International Property Advisers. He represents and gives
advice to foreign investors looking for properties to rent or purchase as they
expand their operations in Russia.
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| “You have to be friends with your counterparts, which means tremendous amounts of travel, dinner, vodka, banya and conversation.” |
Imports
The Russian government, in the interest of improving the climate
for foreign investment, is working to liberalize its business laws. “Customs
formalities have been simplified, and a new Customs Code has been implemented to
better correspond to the interests of exporters and importers,” explains Andrey
Dolgorukov, Russian trade representative to the U.S. The new Customs Code, which
took effect on January 1, 2004, essentially reduced the time limit for customs
clearance of goods from 10 days to three. In addition, customs clearance fees
have been reduced, and fees for customs certificates and permissions have been
removed.
Foreign Exchange Regulations
In 2003, a new federal law entitled Foreign
Exchange Regulation and Foreign Exchange Control was passed, which eliminated
state intervention in the foreign exchange market. The law also eliminated the
limits on foreign currency operations between residents and nonresidents. It
allows residents to open accounts in foreign banks, if the banks are domiciled
in member states of the Organization for Economic Cooperation and Development or
of the Financial Action Task Force.
Tax Reform
Tax reform is another strong indicator of the Russian
government’s desire to eliminate excessive administrative barriers for business.
In the last five years, Russia introduced a flat income tax rate of 13 percent
(earlier, Russia had a progressive income tax, which started at 12 percent);
reduced capital gains tax from 36 percent to 24 percent; and reduced the maximum
rate for the Unified Social Tax from 35.6 percent to 26 percent (this tax is
paid by employers, and its rate depends on the number of employees and their
wages). In addition, the government reduced the value-added tax rate from 20
percent to 18 percent and removed a sales tax collected by regional authorities.
Legal Issues
Other factors to consider when setting up a business in
Russia are bureaucracy and security concerns (see “Traveling Wisely,” page 96).
Establishing a presence in Russia and protecting a company’s interests, assets
and personnel often require the assistance of local experts. “The rule of law as
we know it in the U.S. does not exist there,” says Gene Smith, president of
Smith Brandon International, a Washington, D.C., company that collects
intelligence and information for U.S. and foreign corporations that are actively
engaged in global business operations. Smith says legal remedies for fraud,
recovery of civil damages or reimbursement for business losses in Russia are
spotty. A new venture that encounters a problem with a bounced check, for
instance, may find that payment will not be received for months because of the
lengthy legal process involved. Smith advises Americans to use a Russian legal
counsel, whether or not affiliated with a major international law firm. “They
will know how to best address the ever-changing Russian legal system,” she adds.
Financing Options
Obtaining financial resources can be very difficult in
Moscow because of a dearth of both credit houses and venture capitalists. In
addition, banks are unwilling to lend to firms that are not yet established in
the local market. As a result, foreign firms have resorted to using short-term
financing provided by government agencies, as well as foreign loans.
Unfortunately, these loans often carry excessive interest rates to cover high
inflation and the risks associated with doing business in Moscow.
Local Resources
Foreigners often hire the services of Moscow consultants
who are familiar with the language, customs, political system and bureaucracy.
“In Russia, relationships come before results,” says Julia Karpeisky, an
interface consultant who builds and manages relationships with foreign partners
and represents the American partners in face-to-face meetings with the Russians.
“You have to be friends with your counterparts, which means tremendous amounts
of travel, dinner, vodka, banya [sauna] and conversation,” she says. This makes
doing business in Russia an expensive undertaking both in terms of time and
money. Karpeisky founded JMK Contact 10 years ago to assist U.S. companies doing
business in the former Soviet Union. Aside from being an interpreter, she helps
her clients in developing strategies and bringing deals to closure.
Interpreters (oral language converters) and translators (written text
converters) are both essential to establishing a presence in Russia and are not
interchangeable. “You may incur a serious liability if you do not hire a
competent, professional interpreter,” points out Karpeisky, who has served as
interpreter for the chairman and CEO of Exxon Mobil. She adds that while the
younger generation of Russians is fluent in English, at the highest level of
business and government they still prefer to speak their own language.