Thorsten Nestmann of DB Research -

Russian outward direct investment has expanded rapidly since the beginning of the decade and Russian corporations are challenging well-established multinationals. While Russian global corporate expansion is still limited to some of the largest companies in the oil, gas and metals sector, the trend to invest abroad is gradually spreading to other sectors.

The expansion of Russian corporations started in the "near abroad" market due to linkages established in Soviet times and a lack of foreign investors from elsewhere. Russian outward direct investment (ODI) activities continued in developed markets and have more recently also been carried forward to Africa. Large resource-based corporations not only dominate the Russian economy, but are also taking the lead in terms of outward investment.

Gaining access to new markets and technologies, securing raw materials and obtaining a wider range of financing opportunities are among the key economic reasons for Russian ODI. And high oil prices and the booming domestic economy will continue to boost Russian ODI in the coming years.

Search for profits

In recent years, emerging market multinationals have increasingly expanded abroad to enhance their competitiveness, ie. the ability to survive and to grow while maximising profits. This is achieved by saving costs, improving efficiency, applying new technologies as well as gaining access to new markets and resources. As a consequence, emerging markets' share in global ODI rose to 12.8% in 2006 from 10.7% in 2003. Russian corporations have played an active role in this process and Russia's ODI stock became the second largest among emerging markets in 2006.

Russian ODI has in particular been boosted by rising volumes of cross-border mergers and acquisitions. The majority of Russia's ODI is concentrated in the oil, gas and metals sector. However, companies from the telecom, financial and retail sector are also expanding abroad. To what extent these companies can be classified as "multinationals" is not clear-cut. The Boston Consulting Group, for example, includes only six Russian companies as "global challengers" based on their revenues and selected indicators such as international presence, overseas investments, etc.

In any case, unlike in China, there is no specific "going global" programme for Russian companies, although there is outspoken support by the political elite for corporates' expansion abroad. The bulk of Russia's foreign investment is accounted for by private companies and it mainly reflects economic considerations such as obtaining higher profit margins, increasing companies' growth potential and securing access to raw materials. Foreign engagement also allows access to new technologies, thereby helping to modernise the Russian economy. In addition, foreign activities, especially in developed markets, force Russian companies to increase transparency and to improve their corporate governance structures. Russian ODI flows are expected to remain high in the coming years and, in this respect, Russia is likely to remain an important player among emerging markets.

The expansion of Russian corporations started predominantly in the member countries of the Commonwealth of Independent States (CIS) in the 1990s, moving on to developed markets and continuing in Africa more recently. Russian corporations established a prominent position close to their home market due to linkages already in place in the Soviet Union as well as a lack of foreign investors from elsewhere. Armenia, Belarus and Uzbekistan have accounted for the bulk of the Russian FDI flows to the CIS. Examples of Russian investment in the CIS include state-owned energy supplier RAO UES, which has invested in energy distribution chains in Armenia, Georgia, Moldova and Ukraine. In addition, Gazprom controls infrastructure assets in Kazakhstan and Moldova. Furthermore, Russian mobile telecom services providers are competing for the leadership in the CIS, having invested $1.38bn in M&A since 2001 and accounting for 40% of the CIS cell phone market.

However, the proportion of Russian direct investment flows to CIS member states shows a downward trend: it fell to 12% on average in the period 2004-2006 from 59% in 1997-99. At the same time, the figures should probably be taken with a grain of salt, since they have been quite volatile. In 2004, Uzbekistan received 85% of total investment to the CIS, while Armenia accounted for 78% in 2005. In 2006, FDI flows seem to have been more equally distributed, with Tajikistan accounting for 39%, Kazakhstan for 33% and Ukraine for 26% of total CIS investment. In general, strong economic growth in the CIS should make them an attractive market for Russian direct investment in the future.

Russian total ODI flows have been fairly concentrated, with only two countries, Cyprus and Luxembourg, accounting for 64% in 2006. Given that these are offshore financial centres, part of these investment flows might return as investment to Russia or be redirected to other countries. Unfortunately, it's not possible to establish this from the data, which captures only the first capital-exporting action. Further insights can be gained by looking at survey data. A recent survey among the top 25 Russian multinationals shows Western Europe as the leading destination, accounting for 52% of foreign assets, followed by the CIS with 22% and Eastern Europe with 11%. As mentioned above, Africa has emerged as a new destination for Russian investors. Examples include Alrosa, a Russian state- owned diamond company controlling a quarter of the global market, which owns mining facilities in Angola, and large metallurgy companies, such as Norilsk Nickel, which hold raw material reserves in South Africa, Gabon, Guinea and Nigeria. Moreover, Russian oil and gas companies are participating in greenfield investment projects. For example, Sintezneftegas acquired a 70% stake in an oil-exploration project in Namibia in 2006. Apart from resource-based companies, Russian financial companies are also pushing into Africa and leading Russian telecommunications firms are also expected to expand in the African continent. Fuel and metal companies dominate outward investment

Large fuel, energy and metallurgy corporations have a major presence in the Russian economy, so it is not surprising to see that these sectors also dominate in terms of outward investment. Out of 108 companies with annual turnover over $1bn, 37 belong to the energy and metals sector. At the same time, fuel and metallurgy sectors accounted for about half (45%) of outward investment.

Cross-border M&A activity also shows the predominance of Russian fuel and metallurgy giants. For instance, in 2007 the Russian companies RUSAL and SUAL merged with the Swiss Glencore to create the world's largest aluminium and alumina company. At the same time, smaller players such as Novolipetsk (metallurgy) or Mirax Group (hotels) are entering the acquisition fray. The geographical distribution of M&A varies with the acquiring sector: over the past few years CIS member states have prevailed as targets in the telecoms sector, while large metallurgical companies have purchased assets in industrialised countries as well as Africa. Companies from emerging Asia seem not to be on the shopping list yet, but this may start to change. For instance Altimo, the telecom arm of Russia's Alfa Group, has stated that it wishes to establish a long-term presence in Vietnam and other South-East Asian countries.

Conclusion

Russia has become one of the leading foreign direct investors among emerging markets in the last decade. The Russian expansion abroad started in the CIS and has moved forward to industrialised countries as well as Africa. While resource-based industries continue to dominate outward investment, financial, telecom and retail trade companies are also venturing abroad. Expanding abroad provides Russian companies with access to new technologies, know-how and resources. In addition, higher revenues and lower funding costs achieved by investing abroad support the build-up of the capital stock and infrastructure investment within Russia. Thus, overseas investment will help to modernise the local economy and thereby contribute positively to long-term economic growth. We expect that Russia's ODI flows will continue to grow in the future and that Russia will remain a major source of outward direct investment among emerging markets in the coming years.

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