Foreign direct investment “took a break”

newsletter 01/06/2016

Despite the ongoing recession for the second year, namely the 5th consecutive quarter, sanctions and general decline in business activity, Russia does not give up the idea of hosting the major international economic forums. In the current challenging to business environment, especially with Western partners, the country aims to attract investment. The largest of the upcoming events is XX jubilee St. Petersburg International Economic Forum (SPIEF), which will be held in June 16-18, 2016.

Retrospective analysis of attracted foreign capital dynamics is of particular interest today, especially in view of the known complications (see Picture 1). Currently, in addition to sanctions, there is a "recommended" ban by a number of foreign countries’ authorities to support contacts with Russian counterparties and government agencies. This applies to the largest foreign companies and the banking sector.

It must be said that in many respects the sanctions policy has its negative consequences: according to the results of 2015 the volume of foreign direct investment (hereinafter - FDI) was "modest" 4,8 bln USD, the lowest level since 2002. The reduction of funds involved to the level of 2014 amounted to more than 78%. In comparison to the "pre-crisis" 2013, the investment "collapsed" by 93%. In the previous crisis of 2009 investment totaled now unattainable 36,6 bln USD.

At a non-comparable scale and structure of the economy compared to 2002, the current situation with investment obviously was caused by external administrative reasons, little conjugated with free market rules, capital flow and fair competition.

Total volume of accumulated foreign direct investment for the whole monitoring period (according to the Bank of Russia) since 1994 to 2015 reached 513,9 bln USD.

Dynamics of foreign direct investment in Russia from 1994 to 2015, bln USDPicture 1. Dynamics of foreign direct investment in Russia from 1994 to 2015, bln USD

Change in the regional structure of FDI origin (see Picture 2) is also interesting. From 2007 to 2013 in the period prior to sanctions and deterioration of relations with the West, the highest total amount of FDI stock fell on Cyprus, the Netherlands and Luxembourg.

Regional structure of accumulated FDI origin for 2007-2013, % of total volumePicture 2. Regional structure of accumulated FDI origin for 2007-2013, % of total volume

After the worsening of the Russian geopolitical relations with Europe and the United States, the origin of FDI structure has reversed. At the end of 2014-2015, 28% of the total FDI stock came from the Bahamas island state, 16% from the British Virgin Islands, the territory which are not subject to the EU directives (see Picture 3). The Republic of Cyprus has lost its role of leading country of FDI origin in the Russian Federation.

Regional structure of accumulated FDI origin for 2014-2015, % of total volumePicture 3. Regional structure of accumulated FDI origin for 2014-2015, % of total volume

If we examine the structure of accumulated FDI by sectors (see Picture 4), it is possible to identify the most attractive segments of the Russian economy to foreign capital. In the period of 2010-2015 after the crisis of 2008-2009, the majority of investment came in the wholesale and retail trade; financial and insurance activities and manufacturing. The leading export-oriented industry – mining - received only 14,6% of the total FDI accumulated in the last 6 years.

Common myths that "the Russian oil industry will not survive without western investment", or that "Russia produces nothing and invest nothing except the primary hydrocarbon feedstock" do not stand up to facts-based criticism.

Sector structure of accumulated FDI origin for 2010-2015, % of total volumePicture 4. Sector structure of accumulated FDI origin for 2010-2015, % of total volume

In monetary terms, the volume of accumulated FDI for 2010-2015 in wholesale and retail trade reached 64,7 bln USD; 51,6 bln USD in financial and insurance activities, and 46,8 bln USD in manufacturing (see Table 1).

Table 1. Total volume of accumulated FDI by sectors for 2010-2015, bln USD

Business activity typebln USD
1 Wholesale and retail trade 64,7
2 Financial activities, insurance 51,6
3 Manufacturing 46,8
4 Mining operation 35,8
5 Other services 14,3
6 Construction 12,7
7 Real estate 8,9
- Others 10,2

Most of FDI in manufacturing (see Table 2) for 2010-2015 are focused on investment in production of coke and petroleum products (20,9 bln USD). Thus, investment in companies producing products with high added value are comparable to investment in the whole sphere of mining (35,8 bln USD).

Chemical production ranks second in attractiveness for foreign investors and accumulates 5,4 bln USD.

Table 2. Total volume of accumulated FDI in manufacturing industry for 2010-2015, bln USD

Sectors of manufacturing industrybln USDShare, %
  Manufacturing industry, including: 46,8 100
1 Production of coke, oil products and nuclear materials 20,9 44,6
2 Chemical production 5,4 11,5
3 Production of food products, including beverages and tobacco 4,9 10,4
4 Manufacture of vehicles and equipment 4,2 8,9
5 Manufacture of other non-metallic mineral products 2,8 6,1
6 Manufacture of electrical equipment, electronic and optical equipment 2,6 5,5
7 Manufacture of machinery and equipment 1,9 4,0
8 Manufacture of rubber and plastic products 1,3 2,7
9 Processing of wood and manufacture of wood products 1,1 2,4
10 Pulp and paper industry; publishing and printing 0,9 1,9
11 Metallurgical manufacture, manufacture of fabricated metal products 0,5 1,0
12 Other manufacturing 0,3 0,6
13 Textile and clothing manufacture 0,1 0,3
14 Manufacture of leather, leather products and footwear 0,0 0,1

Among the most attractive RF subjects the first place is obviously taken by Moscow, which attracted 57% of all FDI for 2011-2015, that is 115,1 bln USD in monetary terms. This fact is not surprising: according to the Information and analytical system Globas-i, 1,1 mln of a total 4,8 mln active legal entities are registered in Moscow on May 1, 2016.

On the second place with a considerable gap from the capital is Tyumen region (without Autonomous Okrugs) with 29,3 bln USD invested in it.

Saint-Petersburg closes the top three. The city on the Neva received 15,4 bln USD over the past 5 years.

Currently, the Russian business has developed mainly at the expense of its profit, which reduces in companies focused on domestic demand. This is connected with the decrease in consumer activity.

Artificial restriction of capital movement laws will lead to underfunding of potentially attractive sectors of economy bringing high rate of return to the Western investors. Being apparently for a long time under sanctions, and taking into account the impossibility of attracting domestic credit at low interest, Russia may face problems in the future. In order to avoid strengthening the negative trends it is necessary to continue to attract investors from other markets and loosen monetary policy by increasing the stock of money and reduction of interest rates.

In addition to the macroeconomic instruments, Russia can rely on attracting investment through the issuance of sovereign bonds. This has just occurred in late May 2016. For the first time since the introduction of the sanctions the country has placed its Eurobonds in the amount of 1,75 bln USD. 1,2 bln USD were purchased by foreign participants, and the Russian banks bought about 550 mln USD. Experts originally anticipated limited demand among foreign investors due to the fact that the transaction involved no foreign banks, as well as considering the fact that the calculations on the bonds will pass through Russia, not through leading international companies. However, the total volume of order book (demand) amounted to about 7 bln USD. Thus, Russia's return to the international capital market can be considered as quite successful.