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Global foreign direct investment: the case of Russia Laza Kekic - Regional Director, Central and Eastern Europe Economist Intelligence Unit Moscow, July.

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Presentation on theme: "Global foreign direct investment: the case of Russia Laza Kekic - Regional Director, Central and Eastern Europe Economist Intelligence Unit Moscow, July."— Presentation transcript:

1 Global foreign direct investment: the case of Russia Laza Kekic - Regional Director, Central and Eastern Europe Economist Intelligence Unit Moscow, July 1st 2003

2 The Economist Intelligence Unit Who is the Economist Intelligence Unit:  The business information arm of the Economist Group (includes the Economist magazine).  Provider of economic, political and business analysis and forecasts; macroeconomic and industry data; daily briefings; custom publishing. Users: Thousands of executives engaged in cross- border business. Location: headquarters in London; offices in 31 other locations.

3 The Economist Intelligence Unit Mission: To provide executives with timely and reliable analysis for making successful global decisions. Resources:  More than one hundred in-house analysts (London, New York, Hong Kong) and over 500 external contributors across the globe.  For Eastern Europe and Russia: based in London, staff of 15--EIU’s largest regional team. Extensive coverage and forecasts of economic, political and business developments for all 27 East European countries.

4 Global FDI and Russia  The global and regional context  FDI in Russia: the record so far  The potential role of FDI in spurring long-term Russian growth  The EIU’s business environment model and FDI forecasts

5 The global and regional context  Global FDI quintuples between 1990 and Reaches peak of US$1.4trn in 2000, but plummets in , driven by slump in M&As.  Bursting of the stock market bubble, geopolitical uncertainty and the weak global economy accompanied by drop in global FDI to estimated US$580bn in  Inflows in the developed world fell by an estimated 27% in 2002 to US$375bn, their lowest total since This followed a 53% decline in  Decline concentrated in US and UK (US$140bn total drop on 2001).

6 Expected recovery  FDI flows into developing world hold up  Further shrinkage in global FDI early 2003 But, stabilisation in second half of 2003; slow recovery from 2004  Recovery in global FDI: trend towards better business environments; progress in regional integration; industrial consolidation; sharper global competition; opportunities in emerging markets.  FDI flows to China in 2002 a record total of US$53bn. High FDI flows to China will be sustained in the coming years.

7 World FDI inflows (US$bn)

8 FDI in eastern Europe  FDI into the transition region bucked worldwide trend of stagnant or declining inflows in 2002  Record total of over US$32bn, despite weak OECD growth and difficult financing conditions. Increased relative attractiveness of the region compared with most other emerging markets; Further sales of state assets; Cost-cutting pressures on Western companies  FDI key driver of investment growth, rapid structural change and competitiveness in central and east European economies

9 A “wildly optimistic” forecast for FDI into the transition economies , beg. 1996

10 The medium-term future: more of the same  Continued steady increase in inflows  Share of Poland, Hungary and Czech Republic in regional total to decline (to 40% of total)  FDI/GDP averages just over 3% of GDP  Some CIS energy producers major attraction  Catch-up in reforms, performance and FDI by some previous laggards

11 FDI inflows into the transition economies (US $m)

12 Foreign direct investment in Russia  Extremely low FDI inflows so far, far below potential  The missing ingredient from Russia’s recent economic successes  Inflows average a mere US$2.7bn per year in  Estimated “foregone FDI” in this period: US$10bn per year (if Russia had had same business environment and willingness to sell state assets as in east central Europe)

13 Foreign direct investment inflows US $m

14 FDI inflows and stocks

15 Russia and the transition region Russia, % shares in regional totals, 2002 GDP (at market exchange rates): 35.4% GDP (at PPP exchange rates): 37.6% Population: 35.2% Exports: 32.8% Inward FDI stock: 11.7%

16 Features of FDI in Russia  Regional concentration--two thirds of stock in Moscow(44%), Sakhalin (14%) and Saint Petersburg (8%)  Transport and communications dominate (25% of 2002 stock), then fuels and petrochemicals (19%) and food industry (15%)  US and “Cyprus” main investors--about 20% each of end-2002 stock of US$20.4bn (Goskomstat) ...but overtaken by UK in 2003 (BP-TNK and Shell Sakhalin); over US$10bn in total

17 The role of FDI in Russia  Recent big FDI deals--a harbinger of things to come?  How much does it matter? Does Russia need large- scale FDI?  Economic growth since 1999 averages 6.4% pa; acceleration of growth in first half of 2003, to above 7%  Putin wants 7%-plus growth; doubles incomes in a decade ….but, is high growth sustainable?

18 A mixed picture I The good news  Increased monetisation of the economy; reduced barter; decline in government arrears  Decline in capital flight  Recent evidence of some improvements in business environment  Effectiveness of institutions improves slowly  Despite ups and downs, relations with the West remain essentially cooperative  Eventual WTO membership

19 A mixed picture II The bad news  Few signs of industrial restructuring  Very weak banking sector  Still overall unfriendly business environment (tax regime, regulatory framework, crime and corruption,property rights protection)  Demographic trends  Political-business links in the regions  Capacity constraints  Overdependence on energy sector

20 The natural resource curse High oil prices help state finances and boost short- term growth, but also: lead to real appreciation crowd out the non-oil sector weaken the urgency to reform No natural-resource dependent market economy has grown fast in the last half- century

21 Dependence on energy sector In 2002, energy accounted for: almost 20% of GDP 55% of export revenue up to 40% of fiscal revenue 50% of industrial investment For every US$1 change in the international oil price: US$1bn change in federal budget revenue US$300m change in regional budget revenue US$2bn change in export revenue

22 Reform--an uphill task Reform may also be stymied by the enormity of outstanding tasks  increase competition  sustain macroeconomic stability  reform monopolies and banking system  cut tax burden, simplify the tax regime and reduce general government spending  reform of housing sector and utilities  upgrade regulatory framework; fight crime/corruption  reform the military

23 Continued reform is likely but will face familiar obstacles:  public hostility  vested industrial interests  regional obstruction  inefficient bureaucracy  difficulty of building and sustaining reformist coalitions  Overdependence on presidency--weak political development

24 The baseline outlook--getting by  Political stability  Putin persists with reforms, although implementation remains difficult  Medium-term external environment is relatively favourable  Macrostability preserved  No “succession crisis”  Authoritarian trends held in check  External debt managed successfully  Oil prices remain near US$20 pb

25 Russia’s long-term growth prospects Scope for catch-up (+) Demographics (-) Skills endowment (mixed) Geography (-) Infrastructure (-) Institutions (-) Regulation (?) Macro policies (+) Max 3.5% growth (if no “Dutch disease”)

26 Catch-up prospects Russia GDP per head (at PPP), 2002: US$7,590 Index, EU-15=100: 29.2 Index, US=100: 20.8 Best-case scenario: Russia’s catch-up time with long-term growth of GDP per head of 3.5% per year (assumes EU and US growth at 2% per year): with EU average: 85 years with US: 108 years

27 The baseline outlook and growth  Not enough for sustained, very fast growth  Long-term growth determinants--Russia has too many minuses  Domestic underpinnings for sustained fast growth are weak Hypothesis: Russia needs massive infusion of foreign capital, technology and management practices to try to break long-term growth bind

28 Main determinants of FDI  Market size GDP  Expected market growth  Natural resources endowment  Labour costs  Distances/proximity to markets  Agglomeration effects (FDI clusters)  Overall business environment  Policy towards FDI  Exchange rate variability  Regional integration

29 EIU Findings  Traditional determinants still very important (market access, wage costs, natural resources)  Relative immunity of FDI to financial crises  Importance of geographic distances  Strong regional integration effects  High degree of sensitivity to policy and business environment

30 EIU business environment rankings model  Model measures the quality or attractiveness of the business environment and its key components  Opportunities for and hindrances to business in 60 countries (over 95% of global FDI and GDP)  Ranking of a country’s overall position and ten categories  The model uses quantitative data and forecasts, business surveys and expert assessment  Main criteria used by companies to formulate their global business strategies and investment location decisions  The overall scores (on a 1-10 scale) and rankings are based on the scores for 70 indicators

31 Main features  Estimates for historic and forecast periods  Based on EIU forecasting models and assessment by a network of hundreds of in- house country experts and external contributors  High correlation with recorded FDI inflows across countries  Good forecasting record

32 Business environment model  Political environment political stability political effectiveness  Macroeconomic  environment  Policy towards private enterprise & competition  Market opportunities  Policy towards foreign investment  Foreign trade & exchange controls  Taxes  Financing  The labour market  Infrastructure

33 Business environment scores and ranks

34 Russia’s business environment

35 Comparative strengths  Labour market  Market opportunities Comparative weaknesses  Institutional ineffectiveness (bureaucracy, corruption, rule of law)  Infrastructure  Overall policy towards private enterprise  Financial sector

36 Factors underpinning FDI forecast  Macroeconomic stability  Low corporate tax rate; further tax reforms  Further trade and exchange rate stabilisation  Reduction in regulation, bureaucracy; some decline in incidence of crime and corruption  Preservation of political stability  Steady institutional improvement  Infrastructure upgrades  But overall attitudes (especially at grassroots) to FDI remain ambivalent--main barrier

37 Medium-term FDI projection Expected improvement in overall business environment with: Improvement in most areas of the business environment Maintenance of competitive labour costs Consistent with average FDI inflow of up to US$10bn per year in ; about 2% of GDP--but still well below potential and requirements

38 Some issues for discussion  Could future FDI into Russia be even stronger?  How sensitive to Russo-Western political relations?  FDI and EU membership - how high are the costs of exclusion?  How much does eastern Europe feature in MNE global strategies?  Choosing a regional destination - safe versus risky strategies

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