Global foreign direct investment: the case of Russia

1. Global foreign direct investment: the case of Russia Laza Kekic - Regional Director, Central and Eastern Europe Economist Intelligence Unit Moscow, July 1st 2003

2. World FDI inflows (US$bn)

3. FDI in eastern Europe • FDI into the transition region bucked worldwide trend of stagnant or declining inflows in 2002 • Record total of over US$32bn, despite weak OECD growth and difficult financing conditions. Increased relative attractiveness of the region compared with most other emerging markets; • Further sales of state assets; • Cost-cutting pressures on Western companies • FDI key driver of investment growth, rapid structural change and competitiveness in central and east European economies

4. A “wildly optimistic” forecast for FDI into the transition economies 1996-2000, beg. 1996

5. The medium-term future: more of the same • Continued steady increase in inflows • Share of Poland, Hungary and Czech Republic in regional total to decline (to 40% of total) • FDI/GDP averages just over 3% of GDP • Some CIS energy producers major attraction • Catch-up in reforms, performance and FDI by some previous laggards

6. FDI inflows into the transition economies (US $m)

7. Foreign direct investment inflows US$m

8. FDI inflows and stocks

9. The baseline outlook--getting by • Political stability • Putin persists with reforms, although implementation remains difficult • Medium-term external environment is relatively favourable • Macrostability preserved • No 2007-08 “succession crisis” • Authoritarian trends held in check • External debt managed successfully • Oil prices remain near US$20 pb

10. Russia’s long-term growth prospects • Scope for catch-up (+) • Demographics (-) • Skills endowment (mixed) • Geography (-) • Infrastructure (-) • Institutions (-) • Regulation (?) • Macro policies (+) • Max 3.5% growth (if no “Dutch disease”)

11. Catch-up prospects • Russia GDP per head (at PPP), 2002: US$7,590 • Index, EU-15=100: 29.2 • Index, US=100: 20.8 • Best-case scenario: • Russia’s catch-up time with long-term growth of GDP per head of 3.5% per year (assumes EU and US growth at 2% per year): • with EU average: 85 years • with US: 108 years

12. The baseline outlook and growth • Not enough for sustained, very fast growth • Long-term growth determinants--Russia has too many minuses • Domestic underpinnings for sustained fast growth are weak • Hypothesis: • Russia needs massive infusion of foreign capital, technology and management practices to try to break long-term growth bind

13. Main determinants of FDI • Market size GDP • Expected market growth • Natural resources endowment • Labour costs • Distances/proximity to markets • Agglomeration effects (FDI clusters) • Overall business environment • Policy towards FDI • Exchange rate variability • Regional integration

14. EIU Findings • Traditional determinants still very important (market access, wage costs, natural resources) • Relative immunity of FDI to financial crises • Importance of geographic distances • Strong regional integration effects • High degree of sensitivity to policy and business environment

15. EIU business environment rankings model • Model measures the quality or attractiveness of the business environment and its key components • Opportunities for and hindrances to business in 60 countries (over 95% of global FDI and GDP) • Ranking of a country’s overall position and ten categories • The model uses quantitative data and forecasts, business surveys and expert assessment • Main criteria used by companies to formulate their global business strategies and investment location decisions • The overall scores (on a 1-10 scale) and rankings are based on the scores for 70 indicators

16. Political environment political stability political effectiveness Macroeconomic environment Policy towards private enterprise & competition Market opportunities Policy towards foreign investment Foreign trade & exchange controls Taxes Financing The labour market Infrastructure Business environment model

17. Business environment scores and ranks

18. Russia’s business environment

19. Russia’s business environment • Comparative strengths • Labour market • Market opportunities Comparative weaknesses • Institutional ineffectiveness (bureaucracy, corruption, rule of law) • Infrastructure • Overall policy towards private enterprise • Financial sector

20. Factors underpinning FDI forecast • Macroeconomic stability • Low corporate tax rate; further tax reforms • Further trade and exchange rate stabilisation • Reduction in regulation, bureaucracy; some decline in incidence of crime and corruption • Preservation of political stability • Steady institutional improvement • Infrastructure upgrades • But overall attitudes (especially at grassroots) to FDI remain ambivalent--main barrier

21. Medium-term FDI projection • Expected improvement in overall business environment • with: • Improvement in most areas of the business environment • Maintenance of competitive labour costs • Consistent with average FDI inflow of up to US$10bn per year in 2003-07; about 2% of GDP--but still well below potential and requirements

22. Some issues for discussion • Could future FDI into Russia be even stronger? • How sensitive to Russo-Western political relations? • FDI and EU membership - how high are the costs of exclusion? • How much does eastern Europe feature in MNE global strategies? • Choosing a regional destination - safe versus risky strategies