Foreign Direct Investment in Russia


Term Paper, 2006

25 Pages, Grade: A-

Anonymous


Excerpt

TABLE OF CONTENTS

Introduction

1 FDI during the period of transition: a failure or success?

2 Spatial and sector distributions of FDI in Russia

3 Factors behind investment performance of Russia

Conclusion

References

Introduction

Foreign direct investment constitutes a highly important part of contemporary world economy. Globalization of international economic relations have led to the situation in which many countries face the necessity to compete with each other and, thus, to enhance their competitiveness through attraction of foreign capital. FDI in this respect appears to be the most desirable option for many economies, as they are more stable than other forms of investment. For the developing and emerging markets they provide specific opportunities, such as

- integration into the global economy,

- enhancement of the aggregate rate of investment,
- transfer of soft technology (management, organization, sourcing and marketing),
- development of patterns of networking and subcontracting with other firms in the host country[1].

Currently, there is a debate among researches on the relationship between foreign direct investment and crucial economic indicators, such as output growth, accumulation of human capital stock, higher productivity rates, etc. According to the most widespread point of view, inflows of foreign direct investments are deemed to improve economic growth and restructuring of the host countries. However, the empirical literature has not proved this opinion, since in many countries with high rate of FDI other economic indicators appear to be worse than in those which accept less inflows. Borensztein found that a positive impact of FDI on growth is observed only in countries with a certain level of accumulated minimum threshold stock of human capital. Blomstorm, on his part, stated that FDI positively influenced growth only in the ‘low quality data’ countries[2]. Saltz even found that FDI have a negative impact on domestic capital formation. Naurto F. Campos and Yuko Kinoshita argue that the discrepancy between the authors appears to be a result of the fact that the former tended to equate FDI to technology transfer while in most countries and regions of the world FDI encompasses arrangements that goes well beyond pure technology transfer.

However, even taking into consideration different results of the studies provided by the authors, it is evident, that some more developed fast growing countries tend to export FDI more than import, while the others, which import more, show very modest achievements in economic growth (the examples are Bolivia and Papua New Guinea with FDI inflows of nearly 2% of GDP)[3]. Transition economies, in this respect, can be viewed as a unique case. On the one hand, according to Naurto F. Campos and Yuko Kinoshita, they possess some kind of ‘enabling environment’ that is lacking in many developing economies, and thus ‘present an excellent testing ground for the impacts of FDI on growth’[4]. On the other hand, all these countries encounter many problems, as they develop in specific environment, characterized by strong influence of the Soviet past. In certain cases distortions, inherited from the past (such as lack of entrepreneurial culture, sluggishness of the transformation of legal system, etc.), can slow down, or even eliminate improvements, associated with the FDI inflows to the country.

Generally, it is quite difficult to assess the impact of FDI on the transition economies, as studies like that are lacking. In Russia it is even harder to find information, which is due to the fact that economic growth was not characteristic to the country for the whole decade. However, the success or failure of FDI within the country is largely attributed to the success or failure of the transition process and vice versa, which means that FDI is obviously interrelated with other economic indicators. The United Nations Economic Survey[5], for instance, views success of many CEE countries in attracting FDI primarily as a consequence of macroeconomic stabilization. However, while observing the failures with FDI of the CIS countries, it involves such explanatory factors as political instability and unfriendly investment environment, which relate more apparently to the sphere of decisionmaking.

Taking into consideration highly controversial character of the subject, in this paper I will try to find out the factors behind investment performance of the country during the period of transition, and, thus, answer the question of why Russia attracted such a small amount of FDI since the beginning of the transition process. Starting analysis from the observation of foreign investment profile of the country after the dissolution of the Soviet Union, I will then look at major determinants of FDI inflow to the country as well as factors of their spatial and sectoral distribution within the state.

Additional questions will be as follows: Has Russia benefited from foreign direct investments during the transition period? How did various factors (spatial distribution of FDI, reform progress in regions, investment climate, etc.) influence its effectiveness? Answering these questions I will embark on different approaches toward the assessment of the FDI effectiveness, and then refer to the analysis of sectoral and spatial distribution of FDI within Russia.

Trying to answer the main and additional questions, I will involve some comparisons from other transition economies, such as Poland, Czech Republic, Hungary, China.

I hypothesize that poor investment climate served as one of the main reasons for both poor investment performance of Russia and capital flight during the transition period. Thus I suppose that the determinants of bad investment performance and capital flight out from Russia significantly coincide. The paper will largely focus on assessment of the environment for FDI in Russia during the period of transition and the contemporary period. It will also raise some questions about the factors that might be strongly discouraging for the enhancement of FDI in Russia[6].

1 FDI during the period of transition: a failure or success?

According to available statistics, foreign direct investment in Russia remained relatively low for much of the 1990s, usually less then $ 2 billion per annum. Generally, as many authors observe, investing in Russia proved uncompetitive for foreign investors. Russia attracted $10.3 billion worth of FDI in the period 1994-1999 that is on average $1.7 billion per annum. After the 1998 crisis the FDI even declined[7].

The OECD report states that the cumulative figure for FDI in Russia from 1991 through the end of 2001 represents $18.2 billion, or only 5 percent of domestic fixed capital formation. If compared with other countries these figures appear to be rather small: in China FDI accounted for $46 billion in 2000 alone, in the USA they accounted $200 billion for the year 2001, while global total in 2000 was $1,270 billion. The level of FDI in Russia is also very low relative to other transition countries in the region: on a per capita basis, cumulative FDI in Russia is 15 %, compared to 84 % for Poland, 118 % for the Czech Republic and $221 for Hungary[8]. At the same time Russia appeared to be the leading investor in the CEE region, providing about 75% of the regional outflows.

However, according to Ditlbacher, Fidrmuc, Walter, and many other authors, interest in Russia as a destination for investments has been steadily growing, and in spite of the fact that FDI levels have remained relatively low for much of the 1990s, usually little over $2 billion per annum, recently the inflows have increased – including returning flight capital from Cyprus and elsewhere – and there are prospects for higher FDI in future[9].

In 2005 the amount of foreign investments into the Russian economy doubled as compared to the previous year. Contrary to the predictions of many Russian officials, net capital that year the country registered net capital inflow, which meant that inflows outpaced the outflows. FDI jumped from $12.8 billion in 2004 to $17.8 in 2005. UNCTAD explains this positive shift primarily by two reasons: high oil prices and the appearance of Chinese capital inflows. Other sources, trying to explain such an unpredicted rise of inflow, add to the reasons the massive borrowing of Gazprom (over $13,1 billion from a consortium of foreign banks) to purchase Sibneft[10], the deal, which had a huge effect on statistics, preventing a net inflow from being negative.

However, the growing level of inflows in 2005 significantly coincided with other positive economic indicators in Russia and the rise of FDI throughout the world (in 2005 – $ 897 billion, which is 29% higher than during the previous year).

illustration not visible in this excerpt

According to the UNCTAD data, the largest investor in Russia has always been the United States providing a share of 20% of the Russian FDI stock (in 2001 and 2002). According to the OECD report, the largest investor in Russia by the end 2000 in cumulative terms was Germany (17,1 percent), the United States (15,6) and Cuprus (14.9 percent). Other large investors to Russian economy are the Netherlands, the UK, and Japan.

It is interesting that Cyprus, which has never been a particularly active investor on the world scene (according to UNCTAD (2003) the outward FDI stock of Cyprus was $731 million whereas the inward stock was much higher - $4827), during many years provided nearly the same amount of FDI to Russia, as the United States. The study of Pelto, Peeter Vahtra and Kari Liuhto shows that by July 2003 the investment stock from Cyprus to Russia was $ 6 606 million. Of these, $ 4432 million were direct investments, making Cyprus the main source for FDI to the Russian economy with a 20-% share of the Russian total inward FDI. Thus, during the first half of 2003, the FDI stock of Cyprus exceeded that of the USA[11].

The fact that Cyprus has been one of the main investors to the Russian economy for many years, and at the same time one of the main destinations of Russian FDI, gives an opportunity to suggest the return of Russian capital. In this respect, the study of Elina Pelto, Peeter Vahtra and Kari Liuhto, suggests that Cyprus’s FDI that are declared in Russia, are actually not of Cypriot origin, but most likely originate in Russia. This transfer of funds abroad in order to bring them back, partly or wholly, as FDI, and obtain the tax and other benefits offered to foreign investors is known as a phenomenon of ‘round tripping’, that is connected to Russian capital flight. Generally, the share of Cyprus in the Russian inward FDI is strikingly large, considering that Cyprus has a population of only 750000 and does not play active role as a Russian regular trade partner.

The phenomenon of ‘round tripping’ is characteristic not only to Russia, but also to some more developed countries (as, for example, China). However, for Russia, which, unlike China, has been characterized by slow growth of foreign investment, this phenomenon proves to be particularly harmful. As it is exemplified in literature, Russian investors tend to diversify themselves through both visible and hidden channels into offshore investments. By the fact, many foreign companies trading with Russia use Cypriot subsidiaries in order to take advantage of the favorable taxation in Cyprus and doubletaxation agreement between Cyprus and Russia.

Table 1 – The Structure of Accumulated Foreign Direct Investment to the Russian Economy[12]

illustration not visible in this excerpt

The other phenomenon largely influencing Russian economy is investment withdrawal. Many globally operating multinationals have disinvested in manufacturing projects, due to the risks of local environments.

Generally, low levels of FDI in Russia, as well outflows of capital and disinvestments are commonly used to illustrate the unsuccessful investment performance of the country during the period of transition. However, so that to understand whether the FDI story was a success or failure, we must also try to answer the question of whether Russia benefited from foreign direct investments during the transition period, i.e. have those amounts of FDI which Russia received, a “success story”?

If we look at the share of output of foreign owned firms in total output, we will see that it significantly increased during the period of transition (being around 2-3 percent in the beginning of the 1990s, it has grown up to 6-10 percent).

Figure 2 - Share of Output of Foreign Owned Firms in Total Output (%)[13]

illustration not visible in this excerpt

While comparing the productivity of foreign and Russian owned firms, Yudaeva K., Kozlov K., Melentieva N. and Ponomareva N. found that the former are more productive than the latter, as they have advantages on access to technologies and better management[14]. In spite of the fact that involvement of foreign capital had negative effect on firms in vertically related industries (hence, negative effect for the suppliers), it was shown that Russian economy benefits from foreign direct investment both directly (by receiving money) and indirectly (through spillovers to domestic firms). Liudmila Bzhilianskaya[15] while observing a case study of foreign direct investments in the Science-Based industries of Russia, also found positive effects of transfer of management and marketing skills and hard technology.

Most studies in the field insist on the positive potential of foreign direct investments in Russia. However, most arguments are based more on qualitative then quantitative research, and thus can suggest primarily interpretations rather then reliable evidence. Unfortunately, it is also hard to find studies explaining unsuccessful experience, exemplified by disinvestments in Russia. If such studies were found, the answer to our question would be clearer.

[...]


[1] David A. Dyker, Foreign Direct Investment in the Transition Countries: A Global Perspective, in Foreign Direct Investment and Technology Transfer in the Former Soviet Union’, ed. By David A. Duker, Edward Elgar 1999.

[2] Foreign Direct Investment As Technology Transferred: Some Panel Evidence from The Transition Economies, by Naurto F. Campos and Yuko Kinoshita, The Manchester School Vol 70 No.3, June 2002, pp. 398-419

[3] Liberalization of capital flows

[4] Foreign Direct Investment As Technology Transferred: Some Panel Evidence from The Transition Economies, by Naurto F. Campos and Yuko Kinoshita, The Manchester School Vol 70 No.3, June 2002, pp. 398-419

[5] FDI and the Macroeconomy in the Transition Economies, Background Paper for Special Session ІІІ on FDI and the Restructuring of the Transition and Emerging Economies, prepared by Economic Analysis Division UN/ECE, December 6-7, 2000 // http://www.unece.org/press/specialevent/00rcmfd_documents/Ffdjoe.pdf

[6] Following Russian legislation, we can define FDI as purchase of at least 10 percent of shares in a Russian firm.

[7] On the Determinants of Capital Flight from Russia, by Marcella Mulino, in AEJ March 2002, Vol. 30, No. 1

[8] ‘Attracting Foreign Direct Investment For Russia’s Modernization. Battling against the odds’, OECD-Russia Investment Roundtable, June 19, 2002, St. Petersburg, Russia // http://www.dundee.ac.uk/cepmlp/journal/html/vol12/article12-1.pdf

[9] ‘The Great transformation: Russia’s Return to the World Economy’, Paul Hare, Mark Schaffer, Anna Shabinina, Centre for Economic Reform and Transformation, Heriot-Watt University, January 2004, A report for Media Strategy on Foreign Direct Investment in Russia // http://www.dundee.ac.uk/cepmlp/journal/html/vol12/article12-1.pdf

[10] Shaun Walker, ‘A Reverse in Capital Putflow’, Russia Profile, Feb 17, 2006 // http://www.russiaprofile.org/business/2006/2/16/3271.wbp

[11] ‘Cyp-Rus Investment flows to Central and Eastern Europe – Russia’s Direct and Indirect Investments via Cyprus and CEE’, Elina Pelto, Peeter Vahtra, Kari Liuhto, Turun Kauppakorkeakoulu, Turku School of Economics and Business Administration, Electronic Publications of Pan-European Institute, 2/ 2003 // http://www.tukkk.fi/pei/verkkojulkaisut/Pelto_Vahtra_Liuhto_22003.pdf

[12] Pelto E., Vahtra P., Liuhto K., Kauppakorkeakoulu T., Cyp-Rus Investment flows to Central and Eastern Europe – Russia’s Direct and Indirect Investments via Cyprus and CEE. <em>Turku School of Economics and Business Administration, Electronic Publications of Pan-European Institute, 2/ 2003, p.12</em> // http://www.tukkk.fi/pei/verkkojulkaisut/Pelto_Vahtra_Liuhto_22003.pdf

[13] Yudaeva K., Kozlov K., Melentieva N., Ponomareva N., Does Foreign Ownership matter? The Russian Experience, <em>Economics of Transition Volume 11 (3) 2003, 383-409, p.389</em> //http://www.gdnet.org/pdf2/gdn_library/awards_medals/2004/r_m/fdi/does_foreign_ownership_matter.pdf

[14] Yudaeva K., Kozlov K., Melentieva N., Ponomareva N., Does Foreign Ownership matter? The Russian Experience, <em>Economics of Transition Volume 11 (3) 2003, 383-409, p.389</em> //http://www.gdnet.org/pdf2/gdn_library/awards_medals/2004/r_m/fdi/does_foreign_ownership_matter.pdf

[15] Bzhilianskaya L. Foreign Direct Investment in the Sciencebased Industries of Russia, in Foreign Direct Investment and Technology Transfer in the Former Soviet Union’, ed. By David A. Duker, Edward Elgar 1999.

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Details

Title
Foreign Direct Investment in Russia
Grade
A-
Year
2006
Pages
25
Catalog Number
V356292
ISBN (eBook)
9783668436947
ISBN (Book)
9783668436954
File size
731 KB
Language
English
Tags
foreign, direct, investment, russia
Quote paper
Anonymous, 2006, Foreign Direct Investment in Russia, Munich, GRIN Verlag, https://www.grin.com/document/356292

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