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FT REPORT – INVESTING IN RUSSIA: Corruption complicates an image problem

By Catherine Belton and Neil Buckley, Financial Times

Deteriorating political relations with the west have had little impact on bullish attitudes among corporate investors in Russia – but those not yet in the country are significantly more cautious about the country’s prospects.

A survey of 106 foreign companies investing in Russia and 51 “potential” investors this year found 82 per cent of existing investors were moderately or highly satisfied. Only 7 per cent of respondents to the survey, conducted for the Foreign Investment Advisory Council (or FIAC, a forum including senior business figures set up to foster dialogue with the government) were dissatisfied.

More than half of current investors said returns on investment in Russia were higher than in other emerging markets, with only 39 per cent saying risks were also higher. But, among potential investors, a mere 18 per cent said they believed returns would outstrip those elsewhere, while 59 per cent believed it was a riskier place than other emerging markets. Perhaps the most striking difference, however, was in answers to the question of whether Russia had the ability to become “one of the premier countries in the international market”.

Among current investors, 69 per cent believed it did; only 39 per cent of potential investors agreed. One message was clear: Russia has an image problem.

Red tape, corruption and selective interpretation and application of laws were again listed by investors as the top three investment barriers. An overwhelming 72 per cent named combating bureaucracy and graft as the one area the government should focus on to improve the investment climate.

Two other recent reports portrayed Russia in a negative light. The World Bank last week placed it 106th out of 178 countries, 10 places lower than the year before, for ease of doing business, citing slowing reforms and government complacency fostered by oil revenues.

A day later, Transparency International said Russia had slipped from 126th to 143rd out of 180 countries in its annual Corruption Perceptions Index, tied with Indonesia, Gambia and Togo

But Russia also scores highly among current investors on measures such as its highly educated workforce and growing consumer spending power – a message that does not always seem to be getting across to those outside the country. “There is no clear state communication policy,” says Alexander Ivlev, FIAC co-ordinator and a partner at Ernst & Young in Moscow. “There’s a lack of co-ordination between the presidential administration and the government.”

Muhtar Kent, president and chief operating officer of Coca-Cola, is typical in saying his company remains highly positive about Russia – and plans $1.5bn of further investment there in the next five to eight years, doubling its total investment to date. He adds that companies themselves could do more to highlight Russia’s advantages. “We certainly feel that, as investors in the country, we have a role to play in improving the image of ‘brand Russia’,” he says.

High-profile disputes, such as Royal Dutch-Shell’s problems with its Sakhalin-2 energy project, or TNK-BP’s battle with Gazprom over the east Siberian Kovykta gas field, inevitably skew investors’ perceptions.

Mr Ivlev says the Russian authorities’ robust yet indirect tactics do not help. With Sakhalin-2, the authorities used legal action over environmental infringements as a lever to force renegotiation of a 1990s deal that even many independent observers agreed was bad for Russia.

“But in the majority of disputes [with foreign investors], they find a resolution and the resolution is acceptable for both parties,” adds Mr Ivlev. Analysts say the prices paid by Gazprom to take control of Sakhalin and Kovykta were broadly fair.

Peter Hart, whose firm Peter D Hart Research Associates carried out the investor survey, says negative perceptions could be overcome if the government improved communications, modified some of its behaviour, and tackled the red tape and corruption problems named by investors. “They can correct it. This is something totally in their power.” he says.

Some factors, however, are outside the state’s control. The government is facing the first test this decade of the economy’s resilience to external shocks amid the global credit squeeze following the US subprime mortgage lending crisis.

Until now, President Vladimir Putin’s government has thrived amid a beneficial external environment as global oil prices soared along with the appetite for risk. Foreign borrowings have climbed since Russia lifted currency restrictions last year and the cost of capital fell. In the banking sector, foreign borrowing more than doubled to reach $140bn over the past year.

Economists and bankers now warn Russia faces a tricky task of readjusting to the sudden dearth of easily available foreign funds. “The Russian economy has become very dependent on external financing,” says one senior Russian banker. “I anticipate that a lot of companies are not ready to repay their debts this year.”

Russian companies and banks must repay $35bn in foreign debts in the last six months of 2007. The Central Bank, flush with more than $400bn in hard currency reserves, has been preparing to stem a potential liquidity crunch this autumn as repayments loom, boosting the list of bonds it will accept for repo operations to total Rbs1,400bn.

Economists and bankers say that, even if defaults are avoided, Russia could face slowing growth if the credit squeeze continues and companies cannot access funds for expansion plans.

Most believe the impact is likely to be limited. But the senior banker sounds a warning that, if it lasts until the end of the year, Russia’s running rate of growth could, at least for a while, halve to about 3.5 per cent – its slowest this decade.

Published: Oct 02, 2007

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