Financial Five O’Clock: Russia’s Investment Projects Analysis

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Financial Five O’Clock: Russia’s Investment Projects Analysis

On June 26, 2012, Gradient Alpha held a financial Five O’Clock about Investments in Russia 2012: performance in the first half year and future forecasts in Swissôtel Krasnye Holmy. In an informal atmosphere, Andrey Murga, a State Duma Deputy; Pavel Gagarin, Chairman of the board of directors of Gradient Alpha; Laurent Wyart, Vice President of Le Cercle Kondratieff, of the French Association of Economists, had a cup of tea with journalists.

Is the WTO that awful?

Andrey Murga, a State Duma Deputy, member of State Duma Committee for Financial Markets analysed the prospects for domestic business in the light of Russia's entry into the World Trade Organization (WTO). During the coming days, the 18-year battle for Russia to be admitted to the WTO will come to an end. Mr. Murga said that the organisation that consists of about 150 countries and none of them have ever left it, thus the benefits from WTO membership are obvious for him for the long term prospects of the Russian Federation.

“For the business community it provides new opportunities and prospects of entering new markets, the reduction (and in some cases, removal) of export duties, access to cheap foreign financial resources, goods and components”, the State Duma Deputy said. However, he admitted that the WTO accession does not only give new opportunities related to foreign economic activity, but also a boost to the domestic market. Not all domestic enterprises survive the competition from foreign manufacturers with reduced taxes on imports of foreign goods.

Pavel Gagarin, Chairman of the board of directors of Gradient Alpha, suggested that in these circumstances the tax burden on Russian business will inevitably increase, consumer prices will grow and the rouble will weaken. “If the budget is replenished by the customs duties in the volume less than before, and that customs is not able to comply with the plan to raise revenue, another budget making structure, Russian Federal Tax Service, will have to work much more actively. Thus, in the short and medium term budget losses from WTO accession will be compensated by taxpayers”, said Mr. Gagarin. “Tax rates may or may not be increased, but the procedure for collecting taxes will clearly be tightened, otherwise they will not increase the collection rate. Any student studying economics can calculate how much the price of a carton of milk increases due to intensification of the tax burden on business by 10%. But tax authorities have no time for that kind of calculation, they have to fulfil the plan for tax collection by any means”.













“In order to reduce the negative impact from Russia's accession to WTO, most federal laws have been enacted and will be enacted by the State Duma taking this fact into account”, assured Andrey Murga. “The government has taken preventive measures as well. According to the Ministry of Economic Development, the conditions of Russia's accession to WTO are best compared to those that other countries have. After the ratification of the membership protocol, import duties will be reduced gradually. Farmers experience the heaviest concerns in connection with Russia's accession to the World Trade Organization. However direct state subsidies to the agricultural sector will not be allowed, during the transitional period support measures will apply. In 2013-2014 the volume of investments in agriculture will at least be the same. The WTO accession is not that awful if the government is quick, at protecting and regulating its markets; and this is possible without violation of international agreements”.

Thus, in the opinion of the Deputy, Russia's accession to the WTO promises to be shock therapy for the Russian economy, and the positive effects of this step should overwhelm any negative ones. Working in a tough competitive environment should become a push to the development of Russian business, improving productivity and quality, thus cleansing the market of inefficient enterprises. “If, for example, we can buy potatoes of better quality at half the price than our domestic potatoes, then maybe we need to do something else, and produce something else to focus on cutting-edge areas where we are truly competitive?”, concluded Andrew Murga.

Risks determine attractiveness

Pavel Gagarin, Chairman of the Board of Directors of Gradient Alpha, presented the results of a survey Investment in Russia 2012: attractive industries, promising regions, key trends, conducted as a part of international practical conference East + West = Invest. Gradient AlphaInvestments Group arranged this event.

The survey involved 311 participants: seekers of investments (68%), investors (26%), representatives of investment companies and experts (11%). They represented various sectors of economy: agriculture and the food industry; innovation; construction; manufacturing; trade; the hotel business; restaurants and tourism; transport; communications and electric power. Most participants represented Moscow, Central Russia, Europe and the USA. This data, though not intended to be absolute, but possesses certain objectivity and representativeness.

"The last thing the foreign investors want to invest in is land and property, even in Moscow and the Moscow region, for them it is incomprehensible and scary”, told Mr. Gagarin. “They also distrust the annexed territories, with all the bureaucratic hurdles and regulatory complexity common for the capital, apply to them as well. And it is not known whether the law On the town-planning complex of Moscow will apply to the annexed territories in the form it operates today in the capital, or not”, said Mr. Gagarin. “The point where the interests of investors and managers and owners of companies coincide is manufacturing and industry. Representatives of the real sector need investment to modernise the existing production, introduce new technologies, open new production lines, it is the least risky area, not too interesting for the raiders and corrupt law enforcement officers, supported by the state, and with more affordable loans. Also investors have to open their production branches and representative offices in Russia to circumvent the import replacement policy of the Russian authorities, which actively continues despite the accession to the WTO. It is easier to start such business from scratch in special economic zones, than to revive old enterprises burdened with debts and other obligations, the worn-out infrastructure, different risks and unseemly ‘case records’.”













Another trend in the preferences of foreign investors is to invest a relatively small amount of capital (less than 10 million euros, or better yet, less than 1 million euros) in several projects and receive the return within one to two years. The most popular form of investment project implementation, according to the survey participants, is a joint venture with a co-investor or investment seeker. For seekers it is related to the need to draw the missing funds, and for investors that are capable to fund the project(s) independently and the need to diversify risks. It is safer to invest available resources separately i.e. 30% in three different projects than to fund any one project by 100%. So investors are more willing to give money if you sit “in the same boat” to implement a project.

“It is a paradox but Moscow is a difficult city in Russia to do business, but at the same time it is the most attractive. Of course, this is due to the fact that most survey participants are Moscow citizens, who, on the one hand, are well aware that business conditions in the capital are far from perfect, but on the other hand, they are well aware of the opportunities and problems, as well as how to avoid the pitfalls. As for foreign investors, they are also afraid to invest in projects farther than 50 kilometres from the capital for the following reason: working in the regions is easier, but you completely depend on specific leaders in the regions. In the federal centre there is no such dependence on "human factors", but there is dependence on the system, and it is easier to adjust to the system than to a man, says Pavel Gagarin.

According to the survey only every sixth manager or owner of companies and every tenth investor are ready for a partnership between the government and private sector. Representatives at all levels and branches of government claim that the budget cannot afford to implement large-scale infrastructure projects without the participation of business, but during the implementation of PPP projects the investor does not feel secure. State policy in this area is unclear, the state offers do not seem to be well elaborated. According to specialists of Gradient Alpha there are less than 300 PPP projects implemented in Russia at the present time, though the potential is four to five times higher.

So, in terms of foreign and Russian investors, as well as managers and owners of companies, our market is a priority considered to be attractive and promising, but the risk management is in the forefront of ‘heightened risk zones’. That risks and opportunities to minimise them determine the attractiveness of industries, facilities, regions and forms of implementation for investment projects.

“As a result of contact with foreign investors it is possible to make a kind of rating of their perception of investment risk in Russia, said Pavel Gagarin. In the first place there are tax risks, however it is not about high tax rates, but about unfair taxation. The second and third reasons share bureaucratic and administrative risks, related to prolongation of the time required to receive permits, constantly changing conditions of its reception and regular correction of the “game’s rules”. In the fourth instance there are the legal risks. Foreign investors assess the legal environment of business as ‘legal chaos’, referring to the conflict between federal and local laws, the lack of uniformity in enforcement, the lack of federal laws On Public Private Partnership, On Holding Companies, On Project Financing, as well as laws of the city of Moscow On Public Private Partnership in Moscow and On investment activity in Moscow.

Western investors require

Laurent Wyart, Vice President of Le Cercle Kondratieff, of the French Association of Economists, General Director of XPM CIFAL Russia spoke at financial five o'clock with a report European companies investing in the Russian economy: expectations, requirements and prospects. The businessman made it clear that in the time of crisis, the euro zone foreign investors do not even think to implement large-scale investment projects comparable to Danone, they are postponed until better days. However the work of Le Cercle Kondratieff shows that small and medium businesses in European continues still have an interest in investing in the Russian economy, particularly in the agricultural sector, consumer market and in IT-projects. Mr. Wyart has agreed with the results of Gradient-Alpha’s study: Western business is really  only interested in quick-payback projects that are beginning to return investments within one or two years after the start of their implementation. Planning for more than five years in Russia is impossible.

“But if we talk about projects in the field of public-private partnership, and its form as work in the Russian special economic zones, it is important to determine clear conditions of business for many following years, specify the interest of private investors, expressly determine the governmental guarantees to business, define specific conditions of entry and exit of foreign businesses in the projects, added the Vice-President of Le Cercle Kondratieff.A foreign business would be interested in long-term tariff setting, it gives better guarantees of return on investment and allows you to understand what you can expect, and for how long. Only in this case it would be interesting for both foreign and Russian companies to participate in PPP projects”.

Among other obstacles to foreign business investment in the Russian economy Laurent Wyart identified the following. “When I see how Russian companies optimise customs duties and taxes on import and export using ‘fly-by-night’, I do not understand how one can invest in such companies. When I go into the details of Russian holding businesses and realise that the relations between owners and managers of such holdings are informal, and ‘shell’ companies are used in such relations, I cannot see the point where financial resources may be applied, and I have doubts about the return on investment. Despite all the difficulties, to attract foreign investment Russian companies should switch to international financial reporting standards, transform informal holdings in the form acceptable to investors, make holdings transparent and thus resistant to risks. Companies should ‘whitewash’ themselves of complexity, as it is the only way to become a reliable and safe partner for foreign companies, which have always been particularly picky in choosing companions”, Mr. Wyart recommended to the Russian seekers of investment.