Russia economics: FDI gets real

By bne IntelliNews March 1, 2006

Alex Fak -

Foreign direct investment (FDI) statistics in Russia can always be relied upon to support both the optimists and pessimists. And it's no different this year: on the one hand the quality and distribution of FDI improved last year, but in absolute terms there is still not enough of it.

In 2005, Russia attracted $13 billion worth of FDI, some 39% more than in 2004, according to the stats agency Rosstat. This equals, to the last penny, the increase in FDI the year before, which indicates that the robust growth direct investments may be sustainable.

More importantly, FDI is becoming more diverse, increasingly flowing into sectors other than oil, and regions other than Moscow.


And it is becoming, in a sense, truly “foreign.”

For the first time Cyprus has been knocked off the top spot of the country with the most accumulated stock of FDI in Russia, replaced by the Netherlands. Cypriot money is seen as shorthand for Russian capital flight flowing back home. “As the economy progresses, more and more investments coming in are not just flight money coming back but investments by real companies," said Peter Westin, chief economist at MDM Bank in Moscow.

Dutch projects, for instance, included Heineken's purchase of three Russian breweries and Royal Dutch Shell's explorations in Sakhalin - all examples of “real” FDI.

Another feature of FDI last year was foreigners' willingness to plough their profits back into Russian projects. Reinvestment of earnings probably doubled last year, according to the Central Bank of Russia (CBR), which keeps a different set of FDI numbers to Rosstat. “The significant increase in reinvested earnings is an encouraging sign of growing confidence in the economy,” said Yaroslav Lissovolik, chief economist at Deutsche UFG.


In terms of regional distribution of FDI, though, the news is more mixed. “We have entered the second phase of FDI - the regional expansion," says Westin. "Companies already established in Moscow and St Petersburg are now investing in the regions.”

Indeed, the share of foreign investment going to Moscow and the surrounding region has halved between 2002 and 2004, from 53% to just 28%, though it appears to have swung back a bit last year.

Looking at the data another way, however, one finds that more than three-quarters of all FDI in the first nine months of 2005 went into just two geographical areas: Moscow (including the surrounding region) and Sakhalin.

Lissovolik attributes this to "cumulative causation" - regions which have accumulated significant investments tend to attract even more. It also has to do with what Lissovolik calls a "legal chaos" at the regional level.

Much regional legislation contradicts federal laws; meanwhile, local political kingpins with their own business holdings are often wary of foreign competition.


Perhaps the greatest surprise in FDI this year has been the swing in dominance from fuels to manufacturing.

Whereas in 2004 fuel and raw material extraction made up 43% of FDI inflows while manufacturing attracted 31% of inflows, last year the situation flipped, with $6 billion, or 46% of total FDI, going into manufacturing and just 30% into fuel and raw material extraction. In absolute terms, FDI in manufacturing doubled.

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