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Russia Aims to Boost Growth by Luring More Foreign Investors
By Vladimir Todres

Moscow, March 21 (Bloomberg) -- Until the end of last year, it looked as if Russia would skirt the slowdown that pushed the economies of the U.S., Japan and Germany into recession.

The ruble's 70 percent plunge during the second half of 1998 -- after Russia defaulted on $40 billion in domestic Treasury bills -- had slashed costs for exporters and made imports prohibitively expensive. That spurred Russia's 144 million consumers to flock to local manufacturers for everything from cars to yogurt.

In 1999, oil, which makes up one-quarter of Russia's $103 billion in exports, doubled in price to $24.39 a barrel. Copper and aluminum soared. The result: Russia's gross domestic product climbed a record 9 percent in 2000, turning Russia into Europe's fastest-growing economy.

The boom didn't last. By the end of 2001, waning global demand for natural resources caught up with Russia. Oil purchases by the U.S. and the European Union fell to the slowest pace since 1984, knocking down prices 18 percent.

Inside Russia, 18 percent inflation eroded the price advantage that domestic producers had enjoyed. This year, the government expects GDP to expand 3-4 percent, a drop from 5 percent last year.

Investors say Russia needs more than a rebound in oil to avoid a further slowdown. They say the government must reduce the red tape that's discouraged new businesses and foreign investment.

Accounting Changes

They want accounting changes that benefit shareholders. And they want Russians to keep spending so the country can trim its dependence on natural resource exports.

``While strong demand from domestic consumers and current oil prices will ensure growth this year, long-term prospects depend on deep structural reforms,'' says Dimitri Chatzoudis, who manages $200 million in East European stocks at ABN Amro Asset Management in Amsterdam. ``Russians have a long way to go.''

President Vladimir Putin is pledging to lessen investors' risks. He's forcing companies to treat minority shareholders better by, for example, paying a bigger share of profit in dividends and paying them on time.

He's reforming the country's judicial system to safeguard property rights. The government set up separate courts for business disputes and is pushing a bill through the legislature to make it tougher to force a competitor into bankruptcy.

Cutting Taxes

Since he replaced Boris Yeltsin in 2000, Putin has eliminated some barriers: He's reduced the tax a company pays on its profit to 24 percent from 35 percent.

He's introduced a 13 percent flat income tax, abolishing the 25 and 35 percent brackets. And Russia now permits the sale of land that isn't used for farming and has whittled to about 100 from more than 1,000 the business activities that require government licenses.

Foreign investors are responding. On Feb. 1, Heineken NV agreed to pay as much as $400 million for the Bravo brewery in St. Petersburg. On Feb. 14, Scottish & Newcastle Plc said it would buy Finnish beer company Hartwall Oyj for $1.7 billion to target Russia and Eastern Europe.

A week earlier, Wimm-Bill-Dann Foods OJSC, the country's top juice and dairy producer, became the fifth Russian company to sell shares in New York. As of March 20, the stock had gained 20 percent.

Targeting Consumers

All three transactions targeted consumers, as investors hunted for companies making goods for the domestic market rather than those pumping oil or shipping steel slabs.

``Russian companies remain undervalued,'' says Alexander Branis, who oversees $160 million in Russian assets at Prosperity Capital Management, which had the best- performing offshore investment fund last year, according to Standard & Poor's.

Branis is investing in RAO Unified Energy System, the national power utility, and OAO Central Telecommunications Co., a phone service provider, among others.

Putin's reforms haven't wiped out all of the roadblocks. Businesses complain about a complicated tax system and corrupt officials. Last year, Putin dismissed Natural Resources Minister Boris Yatskevich.

Yatskevich had granted to a small oil producer owned by a former deputy finance minister the rights to an oil field, even though Russia's top oil companies had submitted higher bids.

`Long Way to Go'

``There's a long way to go, but what has been done is a breakthrough,'' says Anatoly Chubais, former deputy prime minister and Kremlin chief of staff, who's now chief executive of Unified Energy System.

Foreign companies already doing business in Russia are benefiting from consumers' growing incomes -- up some 20 percent last year -- and a narrowing price gap between domestic and imported goods. The shrinking price difference allows more Russians to opt for quality products from the West.

``Among all our shops, the one in Moscow is the second- best performing, after the one in London,'' says Ermenegildo Zegna, CEO of his namesake Italian haute couture company. In December, Zegna opened his second shop in the Russian capital, after Gucci, Chopard and De Grisogono did the same in the previous month.

Luxury Brands

To be sure, luxury brands are out of reach for many consumers in a country in which the average monthly wage is $139. Most Russians limit spending to such essential items as cars. Many are choosing more-expensive imports.

A Volkswagen Golf costs about $13,000 in Moscow -- four times as much as a Lada, the top-selling brand of Russia's biggest carmaker, OAO Avtovaz.

Even so, Russia imported 78,000 new foreign-made cars last year, up 70 percent from a year earlier. Volkswagen sold 7,300 of the total.

Ford Motor Co., the world's No. 2 automaker, plans to start producing vehicles near St. Petersburg this spring.

``Our business is going much better than we could hope,'' says Henrik Nenzen, head of Ford's Russian operations. He says sales in dollars quadrupled last year, though he declines to disclose the amount. ``There has been an obvious shift in Russians' buying power.''

Tapping the Russian market hasn't been easy. Ford is gearing up its plant after five years of talks. Swedish retailer Ikea spent four years arguing with government officials about customs duties and building permits before opening its Moscow store.

5 Million Customers

A spokeswoman says more than 5 million customers visited the shop last year, the most of all of its outlets.

Russian factories may not fare as well. A February Organization for Economic Cooperation and Development report found that proceeds from oil and gas have accounted for more than two-fifths of the fixed capital investment in Russia since 2000.

Without rising oil revenue, funds to modernize plants may be in jeopardy. ``If oil crashes, investment will dry out,'' says Natalia Gurushina, an economist at Deutsche Bank in London.

So far, that hasn't happened. Investment in production assets rose 8.7 percent in 2001, the government says.

Lower Petroleum Prices

Russian officials say they're making the best of lower petroleum prices. Cheaper oil will produce steadier growth, they predict, because it will force Russia to focus on making finished goods, a more stable market.

``If oil prices are too high, we won't at the end of the day make anything but oil,'' says Andrei Illarionov, Putin's economic adviser, glancing at a Cossack whip in his Kremlin office.

As investors assess Russia's merits, some companies are trying to tip the scale by adopting Western-style accounting and disclosure.

Mikhail Khodorkovsky, CEO at Russia's No. 2 oil producer, AO Yukos Oil Co., had epitomized companies' mistreatment of minority shareholders and manipulation of assets.

In 1999, Yukos changed the location of a shareholder meeting to a town 160 miles from Moscow without telling minority shareholders. The move prevented them from voting against the sale of assets to an offshore company.

Today, Khodorkovsky employs Americans as top managers and reports Yukos's results under U.S. generally accepted accounting principles.

Yukos Shares Triple

Yukos shares more than tripled in the past 12 months, giving the company a market value of $17.9 billion on March 20, the biggest of any Russian company.

Still, Yukos hasn't published the names of its controlling shareholders, let alone disclosed their past. Most other Russian companies are even less transparent.

``There are two breeds of companies: the likes of Yukos and the bunch that hasn't yet made a commitment to good management and corporate governance,'' says Coast Sullenger, who manages a 75 million-euro ($66 million) East European fund at Lombard Odier & Cie. in Geneva. ``A random stock would belong to the second camp.''

Until most companies fall into the first group, Russia won't attract the foreign investment it needs to keep growing.''