GROUP 12GROUP 12

What is FDI ?

• Definition : Definition : "Direct investment refers to investment that is made to acquire a "Direct investment refers to investment that is made to acquire a lasting interestlasting interest in an enterprise operating in an economy other than that of in an enterprise operating in an economy other than that of the investor, the investor's purpose being to have an the investor, the investor's purpose being to have an effective voiceeffective voice in the in the management of the enterprise." management of the enterprise."

• Type of FDI:Type of FDI:

– Greenfield InvestmentGreenfield Investment

– Mergers and AcquisitionMergers and Acquisition

• From investors point of viewFrom investors point of view

– Resource Seeking ( Natural or HR)Resource Seeking ( Natural or HR)

– Market seekingMarket seeking

– Efficiency seekingEfficiency seeking

– Strategic-asset seekingStrategic-asset seeking

• From Host Country’s point of viewFrom Host Country’s point of view

– Improving quality of infrastructureImproving quality of infrastructure

– Develop local skills, tech and local learningDevelop local skills, tech and local learning

– Ensure stable & conducive overall macro and regulatory environmentEnsure stable & conducive overall macro and regulatory environment

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About Russia

GDP:2.3 Trillion $ (6th)GDP growth:.4.3% (2011)

Inflation:3.7%24% increase in Foreign TradeExchange Rate:1$=23.6 Ruble

Labor Force:75.55 Million (Agr:10%,Industry:31.9%,Services:58.1%

Unemployment Rate:6.3% (2012)

GDP:2.3 Trillion $ (6th)GDP growth:.4.3% (2011)

Inflation:3.7%24% increase in Foreign TradeExchange Rate:1$=23.6 Ruble

Labor Force:75.55 Million (Agr:10%,Industry:31.9%,Services:58.1%

Unemployment Rate:6.3% (2012)

• The Russian The Russian Federation stretches Federation stretches across Eurasia from across Eurasia from Eastern Europe to Eastern Europe to the Pacific coast. the Pacific coast. Even after the Even after the collapse of the collapse of the Soviet Union, Russia Soviet Union, Russia remains the largest remains the largest country in the world country in the world in terms of territory.in terms of territory.

About Russia

• Russia is the world's largest country in terms of territoryRussia is the world's largest country in terms of territory

• Unique Geographic Position with worldwide sea routes and rail Unique Geographic Position with worldwide sea routes and rail and road transitsand road transits

• Vast natural resourcesVast natural resources

• 32% of explored world reserves of natural gas (1st place)32% of explored world reserves of natural gas (1st place)

• 35% world gas production and exports (1st place)35% world gas production and exports (1st place)

• 23% of explored world reserves of coal (1st place)23% of explored world reserves of coal (1st place)

• 23% of world forest resources (1st place)23% of world forest resources (1st place)

• Technologically advanced research and production capabilities.Technologically advanced research and production capabilities.

• A highly educated workforce, and world-renowned human capitalA highly educated workforce, and world-renowned human capital

• A consumer market of approximately 143 million.A consumer market of approximately 143 million.

• About 73% of the population lives in urban areas. 13 cities have a About 73% of the population lives in urban areas. 13 cities have a population of over 1 millionpopulation of over 1 million

Case StudyCase Study

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Case Study

• Five years after the launch of economic reforms in 1991 Five years after the launch of economic reforms in 1991 designed to transform Russia's lumbering state-directed designed to transform Russia's lumbering state-directed economy into a modern market system, Russia was economy into a modern market system, Russia was experiencing unprecedented capital flight. experiencing unprecedented capital flight.

• In 1996, some $22.3 billion left the country, most of it In 1996, some $22.3 billion left the country, most of it illegally. In contrast, a mere $2.2 billion in foreign illegally. In contrast, a mere $2.2 billion in foreign investment flowed into the country. investment flowed into the country.

• According to data from the European Bank for According to data from the European Bank for Reconstruction and Development, between 1989 and Reconstruction and Development, between 1989 and 1996, foreigners invested just $5.3 billion in Russia, 1996, foreigners invested just $5.3 billion in Russia, compared to foreign investment of about $11.5 billion in compared to foreign investment of about $11.5 billion in another much smaller former Communist state, Hungary.another much smaller former Communist state, Hungary.

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Case Study

• Complex & Changing Tax Code:Complex & Changing Tax Code: Often at the expense Often at the expense of foreign companies. of foreign companies.

• Weak and untested contract safeguards Weak and untested contract safeguards

• Endless regulationsEndless regulations

• Favoritism:Favoritism: A playing field made uneven by trading and A playing field made uneven by trading and tax favors granted by the Russian government to Russian tax favors granted by the Russian government to Russian companies companies

• Manipulations:Manipulations: Privatization of several large-scale Privatization of several large-scale companies has seen the majority of stock sold to companies has seen the majority of stock sold to incumbent managers and employ ees for a fraction of the incumbent managers and employ ees for a fraction of the price the stock could fetch on the open marketprice the stock could fetch on the open market

• Foreign investors not allowed to bid for certain assetsForeign investors not allowed to bid for certain assets

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Russia Needs Capital

• To upgrade its crumbling infrastructure, which is suffering from To upgrade its crumbling infrastructure, which is suffering from years of neglect and mismanagement under communismyears of neglect and mismanagement under communism

• Russia has the largest oil and gas reserves in the world and it is Russia has the largest oil and gas reserves in the world and it is finding it difficult to get these reserves out of the ground and to finding it difficult to get these reserves out of the ground and to the international marketthe international market

• Russian oil output plummeted after the collapse of the Soviet Russian oil output plummeted after the collapse of the Soviet Union from 569 million tons in 1988 to 305 million tons in 1996. Union from 569 million tons in 1988 to 305 million tons in 1996.

• In an attempt to reverse this slide, the government of Boris In an attempt to reverse this slide, the government of Boris Yeltsin in November 1997 announced that Russia's oil and gas Yeltsin in November 1997 announced that Russia's oil and gas industries were open to foreign investment.industries were open to foreign investment.

• Among other things, the decree signed by Yeltsin allowed Among other things, the decree signed by Yeltsin allowed foreign investors to buy 100 percent of Russian oil companies.foreign investors to buy 100 percent of Russian oil companies.

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Case Study - UpdatesCase Study - Updates

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Case Study Update

• Fall of Soviet union in 1991Fall of Soviet union in 1991

• TransformationTransformation from socialism, central planning, government from socialism, central planning, government control to market determined prices & privatization undertaken control to market determined prices & privatization undertaken by then President Boris Yeltsinby then President Boris Yeltsin

• Increased budget deficit:Increased budget deficit: Amidst extraordinary political Amidst extraordinary political resistance by rent seekers, ranging from old state enterprise resistance by rent seekers, ranging from old state enterprise managers to novel oligarchs, Russia had an average budget managers to novel oligarchs, Russia had an average budget deficit of 9 percent of GDP from 1993 until 1998.deficit of 9 percent of GDP from 1993 until 1998.

• Financial Crash:Financial Crash: The lasting excessive budget deficit inevitably The lasting excessive budget deficit inevitably caused Russia's horrendous financial crash in August 1998 with caused Russia's horrendous financial crash in August 1998 with both a default on treasury bills and a huge devaluation. Half of both a default on treasury bills and a huge devaluation. Half of Russia's banks went out of business. Russia's banks went out of business.

• Many foresaw the end of Russia's market experiment. Many foresaw the end of Russia's market experiment.

• Economic slump and Political Turmoil Economic slump and Political Turmoil under Yeltsin’s economic reformsunder Yeltsin’s economic reforms

• GDP contracted 54%, industrial activity GDP contracted 54%, industrial activity reduced by 45%reduced by 45%

Yeltsin Era 1991-1999

Source: Russia Economic Survey – ( US- Russia Business Council)

Putin’s Era – 2000 to 2008

• New era of political stability to push forward New era of political stability to push forward economic reforms (tax reforms, elimination of economic reforms (tax reforms, elimination of red tape, privatization of agricultural land)red tape, privatization of agricultural land)

• On average GDP growth rate of 6.5% since 2000On average GDP growth rate of 6.5% since 2000

Source: Russia Economic Survey – ( US- Russia Business Council)

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Foreign Direct Investmentin Russia, USD billion

26.726.7

2006

FDI Inflow In Russia

Summary

• Russian economy has Russian economy has overcome crisis overcome crisis of 1998-99of 1998-99

• Russia has Russia has paid off biggest share of foreign debtpaid off biggest share of foreign debt

• Reduce presence of OligarchsReduce presence of Oligarchs in politics and consolidate energy sector in politics and consolidate energy sector with higher govt controlwith higher govt control

• As on date Russia is As on date Russia is 44thth largest FDI destination largest FDI destination in Europe behind UK, in Europe behind UK, France and GermanyFrance and Germany

• Number of Number of FDI projects in Russia grew by 18% FDI projects in Russia grew by 18%

• Moscow is ranked 7Moscow is ranked 7thth in top 10 cities for FDI in Europe in top 10 cities for FDI in Europe enhanced by enhanced by SEZ within the region, tax incentives, easy access to real estate and lower SEZ within the region, tax incentives, easy access to real estate and lower VAT on importsVAT on imports

• Russia now enjoys “The Four Fives”: Russia now enjoys “The Four Fives”: 5 percent unemployment, 5 5 percent unemployment, 5 percent inflation, a 5 percent current account surplus, and a 5 percent percent inflation, a 5 percent current account surplus, and a 5 percent economic growth forecast for 2012. economic growth forecast for 2012.

• In addition, Russia enjoys In addition, Russia enjoys foreign currency reserves of $500 billionforeign currency reserves of $500 billion..

• Real incomes for Russians are up 11 percent Real incomes for Russians are up 11 percent and retail sales are up 7 and retail sales are up 7 percentpercent

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Question 1

• What were the effects of Yeltsin’s What were the effects of Yeltsin’s economic reforms from socialism, economic reforms from socialism, central planning, government central planning, government control to a market determined control to a market determined prices & privatization ?prices & privatization ?

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Yeltsin’s Economic Reforms - Reality

• The crisis turned out to be a The crisis turned out to be a ‘Blessing in Disguise’‘Blessing in Disguise’. In effect . In effect Russia's financial crash completed the market transformation. Russia's financial crash completed the market transformation.

• 3 vital fiscal reforms undertaken3 vital fiscal reforms undertaken

• Slashed Public Expenditure:Slashed Public Expenditure: As financing out of tax revenues As financing out of tax revenues was no longer available, the budget deficit had to be eliminated. was no longer available, the budget deficit had to be eliminated. From 1997 until 2000, the government slashed public From 1997 until 2000, the government slashed public expenditures by 14 percent of GDP and abolished subsidiesexpenditures by 14 percent of GDP and abolished subsidies

• Reinforced central state power:Reinforced central state power: The federal government The federal government could undertake a radical centralization by shifting revenues from could undertake a radical centralization by shifting revenues from the regional governors to the federal government. the regional governors to the federal government.

• Reforms:Reforms: The newly strengthened state could beat the The newly strengthened state could beat the weakened oligarchs. The government started applying the tax weakened oligarchs. The government started applying the tax laws to big enterprises, especially the oil and gas companies, laws to big enterprises, especially the oil and gas companies, which had previously enjoyed individually negotiated taxes.which had previously enjoyed individually negotiated taxes.

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Question 2

• Was Putin effective into leapfrogging Was Putin effective into leapfrogging Russia on the progressive path as Russia on the progressive path as statistics reveal ?statistics reveal ?

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Back To Old Ways

• After initial good work, post 2003 Putin's economic policy changed After initial good work, post 2003 Putin's economic policy changed track track

• He ousted his reformist Prime Minister, Mikhail Kasyanov, and chief He ousted his reformist Prime Minister, Mikhail Kasyanov, and chief of staff, Aleksandr Voloshin, relying ever more on his of staff, Aleksandr Voloshin, relying ever more on his croniescronies from from the St. Petersburg KGB. the St. Petersburg KGB.

• The signal event was the The signal event was the confiscation of the Yukos oil confiscation of the Yukos oil companycompany. . In 2003,Yukos was Russia's largest and most successful In 2003,Yukos was Russia's largest and most successful company, but Putin clamped down on it ruthlessly and lawlessly, company, but Putin clamped down on it ruthlessly and lawlessly, engineering its confiscation. engineering its confiscation.

• Renationalisation:Renationalisation: The Yukos affair started a wave of The Yukos affair started a wave of renationalization. State enterprises have been buying big, renationalization. State enterprises have been buying big, successful private companies either at a high prices in voluntary successful private companies either at a high prices in voluntary deals, accompanied by rumours of sizable kickbacks, or the sales deals, accompanied by rumours of sizable kickbacks, or the sales are forced and the prices are low.are forced and the prices are low.

• Despite promises made by Putin to join WTO by 2003, he has Despite promises made by Putin to join WTO by 2003, he has dodged the issue all these yearsdodged the issue all these years

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Politicization of Business

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Instances of corruption

• Royal Dutch Shell,Royal Dutch Shell, Europe's largest oil company, in 2006 ceded control Europe's largest oil company, in 2006 ceded control to to state-run OAO Gazpromstate-run OAO Gazprom of its biggest project in the country, the $22 of its biggest project in the country, the $22 billion Sakhalin-2 oil and gas development, amid threats by regulators to billion Sakhalin-2 oil and gas development, amid threats by regulators to revoke the permits on environmental grounds.revoke the permits on environmental grounds.

• Russian health officials last year warned Russian health officials last year warned NestleNestle, the world's largest food , the world's largest food company, that it was violating safety rules at its Russian plants. It was a company, that it was violating safety rules at its Russian plants. It was a move to favour local rivals or extort moneymove to favour local rivals or extort money

• IkeaIkea, among Russia's largest foreign investors—had ploughed some $4 , among Russia's largest foreign investors—had ploughed some $4 billion into the country since opening its first store in 2000. Samara billion into the country since opening its first store in 2000. Samara regional authorities, they say, are regional authorities, they say, are creating artificial obstaclescreating artificial obstacles, such as , such as a requirement that the mall be able to withstand near-hurricane force a requirement that the mall be able to withstand near-hurricane force winds, even though there's no history of such weather conditions therewinds, even though there's no history of such weather conditions there

• Wal-Mart Stores and CarrefourWal-Mart Stores and Carrefour, the world's two biggest retailers, quit , the world's two biggest retailers, quit the Russian market after saying they could not repeat the success they the Russian market after saying they could not repeat the success they had had in other countries due to bureaucracy and corruption. Both had had in other countries due to bureaucracy and corruption. Both companies are expanding in China and Brazil.companies are expanding in China and Brazil.

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Risks - Investors’ opinion

Source: questioning of foreign investors «Russia as an object of investments», polled in 2005 г. by FIAC

Assessment Of Putin’s Term

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Assessment of Putin’s Tenure

• Russia has gone through 4 major developments in the eight years Russia has gone through 4 major developments in the eight years (2000-2008)(2000-2008)

• 1st1st, Russia's GDP has grown year on year. , Russia's GDP has grown year on year. Russia economic growth Russia economic growth attributed to exploitation of its natural resources. Growing revenues attributed to exploitation of its natural resources. Growing revenues not on account of increased production but increased pricesnot on account of increased production but increased prices

• 2nd2nd, the country has moved from being partially democratic to , the country has moved from being partially democratic to authoritarian rule by Freedom House (2007) standards. authoritarian rule by Freedom House (2007) standards.

• 3rd3rd, it has stayed equally corrupt according to the measurements , it has stayed equally corrupt according to the measurements by the World Bank (2007), the European Bank for Reconstruction by the World Bank (2007), the European Bank for Reconstruction and Development (2007) and Transparency International (2007), and Development (2007) and Transparency International (2007), while corruption has abated elsewhere (see also Anderson and Gray while corruption has abated elsewhere (see also Anderson and Gray 2006).2006).

• 4th4th, it has politicized the business. Legacy image of the ‘cold war’. , it has politicized the business. Legacy image of the ‘cold war’. Intimidating its neighbors after they elected pro-western Intimidating its neighbors after they elected pro-western government - Cut Gas taps to Ukraine, Georgia & doubled the gas government - Cut Gas taps to Ukraine, Georgia & doubled the gas prices to Belarusprices to Belarus

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2008 - 2012

• In 2008 In 2008 Dmitri Medvedev, a former , a former Gazprom chairman and Putin's head chairman and Putin's head of staff, was elected new President of Russia. of staff, was elected new President of Russia.

• President Dmitry Medvedev preached a sensible program for Russia's President Dmitry Medvedev preached a sensible program for Russia's modernization for the last four years though he never could do much to modernization for the last four years though he never could do much to implement it.implement it.

• Putin comes back in 2012 amidst voices of rigged campaignPutin comes back in 2012 amidst voices of rigged campaign

• Putin’s credibility is low and there is widespread discontentPutin’s credibility is low and there is widespread discontent

• Putin’s position is precarious and will now return to the reform program Putin’s position is precarious and will now return to the reform program he adopted in 2000, which emphasized market deregulation and judicial he adopted in 2000, which emphasized market deregulation and judicial reform. reform.

• Signing of WTO accord after 18 long years of debate is the amongst the Signing of WTO accord after 18 long years of debate is the amongst the 11stst things he has done after getting elected. How much of it does he things he has done after getting elected. How much of it does he adhere to remains to be seen.adhere to remains to be seen.

• As the skilful politician he is, one can expect Putin will take the air out of As the skilful politician he is, one can expect Putin will take the air out of the protests by carrying out the necessary liberal economic and legal the protests by carrying out the necessary liberal economic and legal reforms while maintaining authoritarian powerreforms while maintaining authoritarian power

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Question - 3

• What are the pre-conditions to What are the pre-conditions to favorable FDI ?favorable FDI ?

• Political stabilityPolitical stability

• Tax administrationTax administration

• Access to financeAccess to finance

• An open economy plus access to promising marketsAn open economy plus access to promising markets

• Clear-cut guarantees of property rights Clear-cut guarantees of property rights

• Infrastructure – electricity, road, rail, airports, waterInfrastructure – electricity, road, rail, airports, water

• Labor lawsLabor laws

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Effectiveness of governments in promoting foreign direct investment?

Effectiveness of governments in promoting foreign direct investment?

Base: 134 respondents

Source: questioning of foreign investors «Russia as an object of investments», by FIAC

Question - 4

• What were the reason for China’s What were the reason for China’s success in comparison to Russia ?success in comparison to Russia ?

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Reasons for China’s success

• China avoided Russia under Yeltsin’s ad-hoc ‘big China avoided Russia under Yeltsin’s ad-hoc ‘big bang’experiment which market capitalism which resulted in rise bang’experiment which market capitalism which resulted in rise of powerful oligarchs ,corruption and loss of state revenueof powerful oligarchs ,corruption and loss of state revenue

• One notable theory is that decentralization of state authority One notable theory is that decentralization of state authority allowed local leaders to experiment with various ways to allowed local leaders to experiment with various ways to privatize the state sector and energize the economyprivatize the state sector and energize the economy

• Economic reforms introducing capitalist market principles began Economic reforms introducing capitalist market principles began with with

– The decollectivization of agriculture, The decollectivization of agriculture,

– The opening up of the country to foreign investment, and The opening up of the country to foreign investment, and

– Permission for entrepreneurs to start up businesses. Permission for entrepreneurs to start up businesses.

• Farmers were able to keep the land's output after paying a share Farmers were able to keep the land's output after paying a share to the state. This move increased agricultural production, to the state. This move increased agricultural production, increased the living standards of hundreds of millions of farmers increased the living standards of hundreds of millions of farmers and stimulated rural industryand stimulated rural industry

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• The second stage of reform, in the late 1980s and 1990s, The second stage of reform, in the late 1980s and 1990s, involved involved

– The privatization and contracting out of much state-owned industry The privatization and contracting out of much state-owned industry andand

– The lifting of price controls, protectionist policies, and regulations, The lifting of price controls, protectionist policies, and regulations, although state monopolies in sectors such as banking and petroleum although state monopolies in sectors such as banking and petroleum remainedremained

• Deng created a series of Deng created a series of special economic zonesspecial economic zones for for foreign investment that were relatively free of the foreign investment that were relatively free of the bureaucratic regulations and interventions that hampered bureaucratic regulations and interventions that hampered economic growth. These regions became engines of economic growth. These regions became engines of growth for the national economygrowth for the national economy

• China's success is also due to the China's success is also due to the Export-led growth Export-led growth strategystrategy

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Reasons for China’s success

Key Results For China

• Economists estimate China's Economists estimate China's GDP growth GDP growth from 1978 to from 1978 to 2010 at 9.5% a year. 2010 at 9.5% a year.

• Average wages rose Average wages rose six fold between 1978 and 2010six fold between 1978 and 2010

• Absolute poverty declined Absolute poverty declined from 41% of the population from 41% of the population to 5% from 1978 to 5% from 1978

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Thank YouThank You

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