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The Impact of Russia’s WTO Accession
on Russian Outward Foreign Direct Investment71
Introduction. Russia commenced its accession negotiations with the World Trade Organization (WTO) more than 10 years ago. “The accession process begun in early June 1993 when Russian government submitted its application to the WTO. … In initial stages, however, Russian government did not prioritize the WTO accession when conducting its policy. This can be explained by the transition challenge the country was facing. The 1998 financial crisis put pressure on Russian authorities to resolve the vulnerable and urgent state of the economy and not much attention was given to the WTO issue. The turning point came with the election of President Putin who announced WTO accession as one of the goals of his presidency. … However, in spring of 2006 Russia still remains in negotiations with the WTO for its accession which makes it the last big country and an important international trade player not in the WTO.” (WTO, 2006, 2-3).
Table 1
The Russian economy in the global economy
of the world total
Population in 2005 (est.) 2.2%
GDP at PPP in 2005 (est.) 2.6%
Exports in 2005 (est.) 2.4%
Imports in 2005 (est.) 1.2%
Inward FDI stock in the end of 2004 1.1%
Outward FDI stock in the end of 2004 0.8%
Sources: UNCTAD 2005; CIA 2006.
Russia has concluded its bilateral negotiations with all the WTO members. Even if Russia’s WTO membership is in the horizon, we are not fully aware of the exact timing of Russia’s WTO membership. Another issue hindering the writing of this report is a paucity of earlier analyses linked with the impact of Russia’s WTO membership upon outward foreign direct investments (OFDI). There are several articles on the possible impact of Russia’s WTO membership upon inward foreign capital flows, but the authors were unable to find any report or even an article explicitly dedicated to the analysis of the relationship between Russian WTO membership and the country’s OFDI.
Due to the absence of any earlier writings on the topic, this article is based on the authors’ earlier reports concerning the Russian OFDI. The authors have carried out several reports and articles on the topic since the beginning of the decade (Liuhto 2000/2001; Liuhto and Jumpponen 2001a/b, 2003a/b; Vahtra and Liuhto 2004). The WTO impact was approached by means of studying earlier reports on the Russian WTO accession process and conducting some interviews within Russia and elsewhere in Europe.
The remainder of the article has been structured as follows: Chapter 2 summarises the recent development of Russia’s OFDI. Chapter 3 aims at anticipating the impact of Russia’s WTO accession on Russian OFDI flows.
The recent development of Russia’s outward foreign direct investment. Russian outward foreign direct investments have grown rapidly during recent years. In the first quarter of 2006, outward investments from Russia increased by 60% compared to the corresponding period a year earlier. During the first three months of this year, Russian outward investments totalled some USD 10 billion. These investments were mainly targeted towards the USA and the Virgin Islands (Bank of Finland 2006b).
The total amount of the Russian OFDI, i.e. the OFDI stock, exceeds USD 100 billion. With such an OFDI stock Russia ranks as 15th in the world. Although Russian investments abroad are still somewhat negligible compared to those of the world’s leading investors, OFDI growth in Russia is among the highest in the world.
When analysing the total amount of the Russian capital abroad, one should keep in mind two issues. First of all, it is widely agreed that the actual figures regarding the total amount of Russian capital abroad are considerably higher than suggested by the recorded OFDI statistics. According to the Central Bank of Russia (2006), net capital outflow by non-financial enterprises and households from Russia amounted to USD 181 billion between 1994 and 2004. According to the European Commission (2004), the non-recorded capital flight from Russia totalled USD 245 billion in 1992-2002. When the registered OFDI and the capital flight are calculated together, Russia ranks among the 10 largest investors and capital exporting countries in the world (Kalotáy 2006). Secondly, Russian enterprises have invested substantial amounts of capital abroad through third countries and offshore locations (Pelto et al. 2003).
The majority of the Russian OFDI is carried out by large conglomerates in the natural resource-based industries, such as oil, natural gas, and metals. The companies operating in the so-called new sectors of the economy, for instance telecommunications, have become increasingly active in pursuing foreign investments.
The increase in exports and OFDI growth are closely connected. This is also the case in Russia. Russian exports have grown some five-fold since 1992 and the Russian OFDI stock has increased even faster. In 1995 the Russian OFDI stock was USD 3 billion, whereas today it is over 30 times higher (Figure 1).
Figure 1
Russia’s OFDI and foreign trade turnover in 2000-2004, USD bn
Sources: Central Bank of Russia 2006; Goskomstat 2006.
It is evident that the growth in the Russian OFDI is strongly related to increasing export revenues. The largest Russian exporters also happen to be mostly the main investors abroad. Among Russia’s top 10 foreign investors, seven are natural resource-based companies (Table 2).
Table 2
Russia’s top 10 companies ranked by foreign assets as of the beginning of 2005, USD mn
| Company | Industry | Assets | Sales | ||
| | | Total | Foreign | Total | Foreign |
| Gazprom72 | Oil and natural gas | 104 982 | … | 36 422 | 16 149 |
| Lukoil | Oil and natural gas | 29 761 | 10 663 | 33 845 | 26 428 |
| Norilsk Nickel73 | Non-ferrous metals | 13 632 | 2 618 | 7 033 | 5 968 |
| Russian Aluminium (RusAl)74 | Non-ferrous metals | 11 500 | 2 165 | 5 450 | 4 440 |
| Mobile TeleSystems | Telecommunications | 5 581 | 1 214 | 3 887 | 995 |
| VimpelCom75 | Telecommunications | 4 780 | 852 | 2 147 | 45 |
| Severstal | Ferrous metals | 5 919 | 666 | 6 648 | 3 954 |
| Yukos76 | Oil and natural gas | 18 514 | 607 | 16 566 | 12 546 |
| Rosneft | Oil and natural gas | 25 987 | 319 | 5 275 | 3 438 |
| OMZ77 | Heavy engineering | 901 | 347 | 524 | 272 |
Sources: Company information, authors’ calculations
One should pay attention to the fact that the number of enterprises operating outside these natural resource-based industries, telecommunications in particular, is strengthening among Russia’s main outward investors. The telecommunications companies were responsible for the bulk of the largest acquisitions conducted by Russian corporations outside the natural resource sector in 2004-2005 (Table 3).
Table 3
The largest foreign acquisitions by Russian companies in 2004-2005
| Acquiring company | Target company | Country | Type of assets | Share, % | Value, USD mn |
| Lukoil | Nelson Resources | Kazakhstan / Canada | Oil exploration & production | 100 | 2 000 |
| Norilsk Nickel | Gold Fields Ltd | South Africa | Gold mining | 20 | 1 200 |
| Severstal | Lucchini Group | Italy | Steel products | 62 | 574 |
| RusAl | Queensland Alumina Ltd | Australia | Alumina refinery | 20 | 460 |
| VimpelCom | Kar-Tel | Kazakhstan | Telecommunications | 100 | 425 |
| Evraz Holding | Vitkovice Steel | The Czech Republic | Steel products | 100 | 287 |
| VimpelCom | Buztel and Unitel | Uzbekistan | Telecommunications | 100 | 275 |
| Lukoil | Teboil and Suomen Petrooli | Finland | Petroleum marketing | 100 | 270 |
| Lukoil | - | The USA | 795 petroleum stations from ConocoPhillips | 100 | 266 |
| VimpelCom | Ukrainian Radio Systems | Ukraine | Telecommunications | 100 | 254 |
| MTS | Uzdunorbita | Uzbekistan | Telecommunications | 74 | 121 |
Sources: Numerous company and media sources, authors’ calculations.
Russian metal producers have become notably active in conducting investments abroad. Russia’s major steel producers (particularly Severstal and Evraz Holding) and non-ferrous metal producers (particularly RusAl and Norilsk Nickel) are among the leading enterprises worldwide, with strong ambitions to expand internationally. As Russia’s WTO membership draws closer, we expect the number of mergers and acquisitions (M&As) in Russia to increase considerably, adding to the international focus of Russian companies.
We estimate that the EU accommodates over a third of Russia’s OFDI stock, and the share of the CIS is around a fifth. Another major recipient of Russian investments is the USA, with an estimated share slightly less than that of the CIS (Kalotáy 2003; Vahtra 2006).
The recent investment trend by Russian companies indicates that the share of the CIS countries is rapidly growing. The aforementioned observation is also supported by the UNCTAD (2005) data on cross-border mergers and acquisitions. Measured by the number of M&A deals, over half of the Russian purchases have taken place within the CIS.
For many Russian companies, the CIS region has been the first step in their internationalisation path. These Russian natural resource-based companies already hold a strong grip on some particular segments of the CIS markets and they have since progressed and moved their focus beyond the CIS. The manufacturing and telecommunications companies have more recently entered into their first investment projects in the CIS region.
The CIS markets are at least as strategic as are Western markets for Russian companies. On many occasions, the energy and infrastructure assets controlled by the Russian companies in the CIS are controversial, due to their political nature. In addition, the Russian companies tend to be the dominant players in several CIS markets, whereas in developed economies they often possess less significant leverage in their respective industries.
To sum up, the recent development signifies both the geographical and the sectoral extension of the Russian OFDI. Additionally, the majority of Russian companies’ foreign M&As have taken place during this millennium, clearly indicating the growing international activity of Russian firms.
The impact of Russia’s WTO membership on the Russian outward foreign direct investment. Russia’s WTO accession has a modest direct impact on the Russian OFDI78. In this context, one should bear in mind that Russia no longer has significant controls over their OFDI and capital exports, and therefore, one may argue that the direct impact of Russia’s WTO membership on the Russian OFDI is rather minimal. We believe that the implementation of the full convertibility of the rouble has stronger impact on the Russian OFDI than the WTO membership per se79.
Despite the fact that the WTO membership does not directly affect Russia’s OFDI, one may argue that the WTO membership indirectly and positively influences the Russian OFDI. One may find at least two significant ways, in which membership indirectly affects the investment outflows from Russia.
Firstly, WTO membership obviously has an influence on the Russian export structure, i.e. in the long-term, WTO membership aids Russia in reducing its natural resource dependency. As outward investment tends to follow export flows, one may assume that the structural change in exports would also change Russian OFDI from their current natural resource-dominated outward investments towards more knowledge-based investments. Here, one should stress that such an indirect impact is to happen in the long term, rather than immediately after Russia’s WTO accession.
Secondly, one should stress the fact that a certain relationship between inward FDI and outward FDI exists. As the Russian WTO membership is likely to increase FDI inflows80, one may also anticipate that the growing FDI inflow affects the FDI outflows in three major ways: 1) increasing FDI inflow leads to growing FDI outflows already in the medium-term, 2) the access of Russian companies, service and energy companies in particular, becomes easier in the developed West, and 3) the Russian national image as a foreign investor undergoes an improvement.
Increasing FDI inflow leads to growing FDI outflows already in the medium-term: via increasing inward FDI Russia receives modern managerial know-how and advanced technologies, and hence, Russian firms are able to produce more competitive products. Due to the spill-over effect of this inward FDI, other Russian companies not receiving foreign investment may also upgrade their competitiveness. In other words, the inward FDI leads to an enhanced learning curve, not only in those companies with foreign capital but also in other companies, co-operating with foreign-owned firms.
Possessing more competitive products, the Russian corporations are able to increase their market shares in the domestic markets and increase their exports, and hence, improve their financial position. Through a better financial position, Russian firms have an enhanced possibility to conduct investments, both domestically and internationally. It would come as no major surprise, if Russia’s WTO membership would strengthen Russia’s OFDI towards the CIS, as membership improves the competitiveness of Russian firms, making them much more competitive than their rivals within the CIS region.
The access of Russian companies, service and energy companies in particular, becomes easier in the developed West81: the internationalisation of Russian banks would benefit from WTO accession, as their operations will become more transparent. With increasing transparency, Russian banks will be better received on the financial markets of the developed West. Most probably, Russian banks will focus on serving their Russian clients abroad, i.e. the Russian banks will probably follow their current clients overseas. The aforementioned internationalisation strategy is supported by earlier empirical findings (Liuhto and Jumpponen 2003a).
One may also assume that the access of the Russian companies towards European energy markets will become less constrained. Consequently, Russia’s outward investments in energy companies within the EU will doubtlessly increase, as there would be less political space for the EU member states to protect their domestic energy markets.
The WTO membership is to bring higher natural gas and electrical energy prices within Russia herself. Higher domestic prices, i.e. subsequent increased revenues, are likely to boost the investments of Russian energy companies in both the domestic market and abroad.
The Russian national image as a foreign investor undergoes an improvement: at the moment, a vicious circle related to Russian outward investors is in existence. Some EU countries, particularly the former socialist states, have been extremely concerned about the growth of Russian investments in their countries due to the assumed political leverage of the Russian State. This has resulted in various restrictive measures towards Russian investors.
In order to avoid this rather negative national image, Russian corporations have invested via front companies based in other countries, such as Cyprus, Switzerland, Ireland, and Luxemburg, in order to obscure their true identity. As these identity changes have usually been detected, these indirect investments have not built trust, but on the contrary, mistrust has deepened. Their WTO membership may offer one crucial way to break the vicious circle and gather Russian corporations into the fold of the most respected investors of the world.
It seems likely that through Russia’s WTO membership, Russia’s outward investments via other countries will be reduced and the transparency of the Russian OFDI will be improved. More transparent investment would be a desired outcome for both Russia and the recipient countries. Moreover, WTO membership would help Russia fight against capital flight and money laundering, and correspondingly, the host countries would be more assured regarding the true identity of the investor.
To conclude, Russia’s WTO accession does not have significant direct impact upon Russian outward direct investment. Despite the situation that no significant direct gains are to be achieved, membership will create an indirectly positive effect on the Russian OFDI. Despite WTO membership not bringing a direct and immediate positive impact on the Russian OFDI, one should keep in mind that WTO membership would augment economic restructuring in Russia. Brisker economic restructuring is necessary, since Russia cannot rely on its natural resources for ever82.
References
Alfa Bank 2004. FDI in Russia: Russian business is ready for competition – but are competitors prepared to arrive? Press Clippings 29.5.2004.
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Bank of Finland 2006a. BOFIT Weekly 20, 19.5.2006 < i/bofit/>
Bank of Finland 2006b. BOFIT Weekly 21, 26.5.2006 < i/bofit/>
British Petroleum 2006. Statistical Review of World Energy 2006.