Russia seen as needing Chinese capital

Russia is making progress on economic and market development, but it significantly lags international business best practice and is vulnerable to oil price drops.
Russia seen as needing Chinese capital

Senior public officials and financial executives highlight Russia’s development as an investment destination and hope to see more capital inflows from China. But there remain issues such as widespread corruption and vulnerability to oil price shocks.

Speakers at the AsianInvestor and FinanceAsia Russia & CIS Investment Summit in Hong Kong last week pointed to the likely benefits of Russia’s slated accession to the World Trade Organisation this month.

WTO membership will enable lowering of trade barriers and boost trade with Russia, argued Vladimir Kalinin, consul general of the Russian Federation for Hong Kong and Macau in a keynote presentation. Yet the country needs the support of investment from foreign partners such as Hong Kong, he adds.

In the following speech, Ronald Arculli, chairman of Hong Kong Exchanges and Clearing, agreed that WTO accession will represent a “milestone” in Russia’s development, noting that the country has moved from being a centrally planned economy to a more market-orientated one.

Yet the immediate direct effects of membership will be fairly modest, countered Alexey Zobotkin, head of investment strategy at Moscow-based bank VTB Capital, during his own session.

For example, the export benefits will not be hugely significant, given that Russia is a commodity-focused economy, with steel likely the only sector to benefit “on the margin”, says Zobotkin. Autos are likely to see the most significant – but staged – duty reduction (new cars from 30% to 25% immediately and to 15% in seven years’ time).

It is the structural push that will be more important, argues Zobotkin, with the main effects including more efficient allocation of resources and increased foreign direct investment. The World Bank estimates that WTO accession will add 3.3% to Russia’s baseline GDP within seven to eight years.

However, an expansion of capital stock is needed for higher productivity, notes Zobotkin, hence there is a major push to attract investment into Russia in the next few years. Inbound investment into the country is low compared to inflows into some large emerging markets, such as China.

Russia’s investment-to-GDP ratio needs to be around 25-28% in order to deliver productivity gains similar to those of developed Western nations, says Zobotkin. Hence specific investment-to-GDP targets were set out on May 7 of 25% by 2015 and 27% by 2018, up from 21% last year.

With this in mind, the government has established large-scale privatisation programmes from 2012-2016, at both federal and regional levels, with foreign companies able to participate in tenders for road construction, for example. And from 2013, there will be public audits of large investment projects.

But the country faces various challenges in achieving these aims, notes Zobotkin. For one thing, there is huge scope for improvement in public-sector governance. Embezzlement of fiscal resources at the federal level amounts to Rb1 trillion (2% of GDP) and probably at least as much at the regional and state-owned enterprise (SOE) level.

Measures have been proposed to tackle these problems, such as broad disclosure requirements for officials and SOE top management, open competition-based recruitment for civil-service positions, and regular rotation of civil-service employees between agencies.

“Given the scale of the problem, a more decisive campaign is probably needed,” Zobotkin notes. “But the direction is positive, and it’s very important that the targets have been set.”

Another issue is the country’s vulnerability to energy price falls as a result of a further global slowdown. A moderate shock (Brent averaging $95/barrel over the coming year or so) would result in GDP growth slowing from +4.4% in the first quarter (on a compound annual three-year growth rate) to around +2% in 2013. A larger shock (Brent averaging $75/barrel) may well lead to negative GDP growth, says Zobotkin.

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