#11
The Russia Journal
October 26-November 1, 2001
Opportunity knocks for foreign investors in Russia
By JIM BALASCHAK

(The writer is chairman of AmCham in Russia and a partner in charge of consulting for Deloitte & Touche C.I.S.)

For the American business community, now is the time to start investing in Russia. The Communists are no longer a force, the Yeltsin system of oligarchs controlling the government has been dismantled, and President Vladimir Putin is further consolidating power through the broad coalition of centrist parties in the Duma.

The spring session of the Duma passed 140 bills, which is more than any session since its creation. In face of market realities, the government took practical steps this year to back and enact market reforms, and this can be seen as a vital signal to investors to return to the Russian market. These new laws covered, to mention a few key areas, tax, pension and legal reforms, a new labor code, laws on currency control, money laundering and investment, and at last a start on banking regulation.

Of course, we are all greatly pleased by the reduction in the corporate profit tax from 35 percent to 24 percent. Are all the reforms perfect? No, but we have a momentum in the right direction, demonstrating that the administration’s policies are more than idle talk.

Economic and Trade Minister German Gref has been busy as well, and real transformation is beginning to take place in the state-owned monopolies. The move to break up and privatize state assets reaffirms the pragmatic, steady course pursued by the Putin team. Putin has approved long-term restructuring and privatization plans for RAO UES, one of the world’s largest power systems, and MPS, the railways monopoly.

Moreover, the government is slowly starting to exert its control over Gazprom, the state-owned company that is a government within a government and dominates the Russian economy. The appointment of Alexei Miller as president of Gazprom is a positive sign, and I believe we can see Gazprom added to the list for reform next year.

The economic program submitted by Gref almost two years ago is well under way and is proceeding better than expected. Currently, the land code is sitting on the president’s desk for signature. This has been the most controversial of all the measures, and the fact that it has proceeded is noteworthy in itself. Although it does not deal yet with farmland, the mere reality that land can be bought and sold in Russia is monumental, and Gref plans to submit legislation on farmland early next year. Of course, the Communists opposed land reform emotionally, but were not a factor.

Work also continues on judicial reform, and the Federal Securities Commission is issuing new guidelines on corporate governance.

For all the criticism of Central Bank head Viktor Gera-shchenko, he has done fairly well at managing liquidity and the money-supply growth in the period since the August 1998 financial crisis. Through ruble-strenghening policies (taking into account inflation), and using deposits and bonds as a substitute for open market transactions, the Central Bank has managed the money supply with not too much restriction, matching the continued improvement of the internal economy. In addition, the bank has built up nearly $40 billion in hard-currency reserves – or 300 percent more than three years ago.

The Federal budget for 2002 is going through its final changes, and it appears that 2002 will again result in a balanced budget for the third straight year running, although the surplus next year will be smaller than this year. The only troubling factor here is that on the spending side next year there seems to be less strict control. But it does demonstrate that reduction in personal (Russia has a flat personal tax rate of 13 percent) and corporate tax rates leads to more compliance and more revenues; and tax revenues again exceeded government targets this year.

So where are we now? Economic performance in 2001 will see GDP growth of about 5.5 percent after growth of 8.3 percent in 2000. The effects of the structural "bounces" due to the devaluation of the ruble in 1998 and the export growth due to high commodity prices have run their course. We are at another stage of development of the Russian economy. Domestic consumption and internal demand continue to become a larger part of the GDP. Because of this internal position, external factors are becoming less influential on the Russian economy.

The near-term outlook is for continued and sustained growth, most importantly since the internal market economy has developed. While the decline in the 1990s was due to the destruction of the old system, a real market has emerged today where there are choices, demand/supply decisions are made and capital is free to move. Capital flight has been reduced and barter is now less than 5 percent of trade.

So what should the budding foreign investor do? To get started, you need to learn as much as possible about the environment – including guidance in the legal framework – for operating in Russia. The environment is, and will continue to be, difficult for the near term. Bureaucracy and corruption exist. Learn as much as possible from your contacts, partners, and distributors. Do your homework, understand your market and speak with those with experience and a deep understanding of Russian business culture.

There are numerous investment prospects in Russia, and the window of opportunity is currently wide open.

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