U.S. companies can win in Russia! While now capturing only a tiny share of what is demonstrating to be a solidly performing market, this article details how the U.S. can better position itself and gain competitive advantage by planning ahead and seeking accurate knowledge about this challenging and often misinterpreted, misunderstood business environment in Russia. Russia is now poised for unprecedented growth and integration into the world economy and Americans are losing out by overlooking its potential. If we forge ahead, undaunted by misinformation and stereotypes, and guided by a careful study of economic data and forecasts with an understanding of key trends and issues, we are in a solid position to contain risks and enhance our probability of gain. On top of that, if we calculate into our strategic planning process knowledge of how the Russians themselves are planning for their own economic, political and social future, then we utilize an even greater and superior methodology to guide our business investments and operations in Russia. So let’s look at some specifics!
Evaluating 2012 and What’s Ahead
The year 2012 was a respectable year for Russia by any standard. The economy grew at an average rate of 3.5 percent; unemployment posted at a decent rate of 5.4 percent, wage growth or real income showed growth at 8.8 percent and inflation at 6.6 percent, impressive considering that from 2000-2010, inflation was averaging nearly 13 percent. Russia’s middle class continued to grow, thrive, and engage in consumer purchasing in the many new malls that have sprung up in Moscow and around the country. The 2012 budget did not run a deficit, finances remained stable, and currency reserves grew. Tax policy and administration has remained predictable and competitive over the last decade, with a flat tax rate of 13 percent.
Russia ended the year with a budget surplus and almost no public debt, a significant current account surplus and large international currency reserves. However growth began to slow by the end of the year, as problems in agriculture continued, with the drought situation further highlighting its high dependence on food imports which historically have been problematic.
It is of interest that in the Russian Investment Managers Report to the Directors of JPMorgan Russian Securities in late October 2012, the managers concluded that the risk/reward profile of Russian securities is advantageous for investors. They noted many developments already highlighted in this article, and in addition that the ruble appreciated by 4.5 percent vs. the U.S. dollar in nominal terms, a reflection of the strength of the current account due to ongoing high energy prices. Importantly, the report noted that 2012 was the first year for a dividend yield of 3+ percent for the Russian market, putting it on even footing with other global emerging markets for the first time in history. Russia, they believe, represents an important source of returns for investors.
Russia Stacks Up Quite Well
There is no doubt that relative to Europe and the U.S., Russia stacks up quite well. While Russia is projected to grow at a slow, but steady rate of 3.6 in 2013, other economies are shrinking. The Spanish economy is projected to contract by 1.5 percent and Italy by 1 percent. The German bright spot is only expected to grow by 0.6 percent. The U.S. economy is projected to grow at 2 percent. European economies at best are stagnant if not shrinking over the next several years. At an unemployment rate of 6 percent, Russia looks a lot better than that of Spain’s, over 24 percent and with France and the UK at over 8 percent. Russia’s 8 percent of debt to GDP compares well to that of Italy at 123 percent of GDP and UK at 88 percent. The U.S. debt to GDP ratio is 106 percent, while U.S. national debt totals $16.4 trillion. While crushing debt is a handicap for Western economies, lack of debt offers Russia a distinct advantage in the future.
WTO Accession a Major Gain for Russia in 2012
Many U.S. business deals transpired in 2012, including the ExxonMobil-Rosneft deal for exploration of the Arctic shelf; a continuation of Boeing’s aircraft sales in Russia, and ExIm Bank’s agreement with Russia’s largest bank, Sberbank, to finance up to $1 billion in exports to Russia.
But the most important development with implications for American companies was that finally, after a prolonged effort since its application was first submitted in 1993, Russia gained accession to the World Trade Organization (WTO). On August 22, 2012, Russia became the 156th member. This means that Russia’s trading policies will comply with WTO rules, regulations, norms and standards followed by all member nations, and is expected to significantly enhance Russia’s integration into the global trading regime, helping not only Russia but expanding trade with other member countries. Some analysts estimate that Russia’s involvement in the WTO can stimulate trade and investment to the tune of tens of billions of dollars a year.
Also of significance was the repeal of the Jackson-Vanik Amendment, the U.S. trade act of 1974, which restricted most favored nation status and normal trade relations through linkage with Jewish emigration from the Soviet Union. This signified the removal of a significant historical barrier, although the U.S. continued to trade with Russia through an exception to Jackson-Vanik granted annually by every president since 1992. One important aspect of the repeal is that U.S. companies will see reduced tariffs on goods exported to Russia. For examples, duties on power and hand tools would decrease from 9.3 to 6.8 percent. Tariffs on medical equipment would be capped at 7 percent, down from 15 percent. Duties on aircraft engines would go down to 5 percent from 10 percent. American sales to Russia can well soar with such improved favorable terms.
Unfortunately, the victory for American business was clouded by passage on the same day of the Magnitsky bill, which punishes Russians for allegedly having played a part in the death of Sergei Magnitsky, by denying visas to those responsible to the U.S., freezing their assets and imposing other stipulations seen by Russians as interference in their domestic affairs. In retaliation, in late December 2012 President Putin signed the Dima Yakovlev Law, which bans the adoption of Russian children by U.S. citizens starting January 1, 2013 and other sanctions against the U.S. Nonetheless, entry into the WTO and repeal of Jackson-Vanik can be seen as the removal of significant barriers for American companies in the Russian marketplace.
The World Bank has projected a 3.6 percent growth rate for Russia’s GDP in 2013. I believe that we can reasonably expect the general trajectory of positive domestic economic growth and innovation to continue, along with increasing global economic integration. This is not to underestimate problems and criticisms that are well known, both by Russia and the world. These include the need for economic diversification and growth of small business, improving public administration and allowing greater freedom of expression and dissent and addressing corruption, lack of transparency and weak rule of law. Many allege that Putin is suffocating the country by letting state corporations ravage the economy and deepening the gap between haves and have nots. Others anticipate slowdown and stagnation in 2013.
All in all, it comes to whether you see the Russian glass half empty or half full. If you see the glass half empty, you will focus on the weaknesses, problems, shortcomings and doomsday predictions. If you see the glass half full, you will focus on change, promise, optimism and challenge.
I look at how far the country has come from the collapse of the Soviet Union, with all of the challenges of literally starting all over. Seen in this light, where Russia is today is nothing short of amazing, all problems notwithstanding. I look at Russia also in terms of how it stacks up against other countries and the domestic challenges we all face in the post-2008 economic downturn. I believe there is undeniable opportunity for the U.S. in Russia and with Russia’s entry into the WTO and repeal of Jackson-Vanik, American companies are better positioned than ever to make significant gains in Russia.
More on Russia into the Future
There are many ways that Russia is positioning itself for a better future. A recent Wall Street Journal article detailed how Russia is encouraging Moscow companies to list through the Moscow Exchange, demonstrating their renewed pro-business attitude and Moscow’s goal to become a major financial center. Russia is actively planning for accession into the Organisation for Economic Co-operation and Development (OECD), now that they have achieved membership in the WTO. Early this year, Russia’s First Deputy Foreign Minister Andrei Denisov met with OECD Secretary General Angel Gurria, during a working visit to Moscow. The talks affirmed a mutual interest in the accession and the importance of Russia’s participation in the organization. The parties discussed what practical measures were expected from Russia for it to gain entry. Prime Minister Medvedev has also indicated that Russia has formulated a roadmap to achieve this goal.
The OECD was established in 1961 to coordinate the economic processes of member states. There are 34 members including the U.S., Canada, Japan, Australia and the countries of the European Union, who account for over half of global GDP. Communist countries traditionally did not belong so if Russia were to join, it’s another benchmark development for Russia’s integration into the global economy.
Russia’s Own Silicon Valley: Skolkovo
Understanding the need for business innovation, Russia established its own Silicon Valley, known as the Skolkovo Innovation Center. Primarily funded by the government, Skolkovo’s mission is to promote research and development in IT, energy, nuclear technologies, biomedicine and space technology. Another example is the formation of Titanium Valley, a special economic zone in the Urals. This endeavor hopes to increase the productivity of titanium in such industries as aircraft, auto, shipbuilding and medicine. Participating companies include Nokia, Rolls-Royce, Goodrich and Boeing.
Russian Foreign Direct Investment in U.S.
An often overlooked trend is Russia’s foreign direct investment into the U.S. economy. Severstal, a Russian steel company, has invested approximately $3 billion in two U.S. operations, in Dearborn, Michigan and Columbus, Mississippi. Similarly, another Russian company, Evraz, took over the steel industry in Pueblo, Colorado and now owns Rocky Mountain Mills. Evraz has invested in new equipment in order to upgrade productivity and output. A third, Rusnano, is investing in high tech American companies by opening a branch in Silicon Valley in March 2011. Rusnano is known to have invested in top U.S. biotech companies, which will now operate out of the Skolkovo Innovation Center in Moscow. Rusnano has also invested in a 30 percent share of a Colorado-based producer of biochips for drug tests. There are numerous other examples of Russian investments in the U.S. economy, from steel to biotech and more.
Americans Achieving in Russia
Moving in the other direction, there are likewise many examples of successful American investments in the Russia. In recent years they include Chevron’s investment in the Caspian Pipeline Consortium, which initially stood at $800 million. It is expected to invest another $810 million to increase the output of oil to 1.4 million barrels of oil daily. Ford Motor built a production plant in Elabuga in 2011 and in 2012 had increased vehicle sales in Russia by 11 percent. Ford opened five new dealerships in Russia in the last quarter of 2012, totaling 120 dealerships in 79 Russian cities. Anticipating the 2014 Olympics in Sochi and other growth markets in Russia, Coca-Cola opened a new plant in 2011 in Rostov-on-Don, costing $120 million, as part of a $3 billion investment plan in Russia for 2012-2016. Pepsico in 2011 acquired a two-thirds stake in Wimm-Bill-Dan, Russia’s second largest food and beverage company for $3.8 billion. The list goes on and on.
In 2012 U.S. exports to Russia totaled $9.5 billion, and imports totaled $27 billion, leaving the U.S. with a trade deficit with Russia of $17.5 billion. Major U.S. exports to Russia included machines, including engines and pumps, vehicles, aircraft and spacecraft, mean products, medical and technical equipment and electronic equipment. Major U.S. imports from Russia are primarily in natural resources. These include oil, iron and steel, gems and precious metals, inorganic chemicals, fertilizers, aluminum and nickel. This structure of trade has been repeated for years, and follows a traditional pattern of developed nations with Russia, the exchange of raw materials for sophisticated manufactured goods and high tech equipment. But as William Cooper from the Congressional Research Service points out, trade turnover is minor relative to the size and potential of both countries. Russia accounted for 1.6 percent of U.S. imports and 0.6 percent of U.S. exports in 2011, and the United States accounted for 3.3 percent of Russian exports and 5.3 percent of Russian imports. Russia was the 31st largest export market and the 14th largest source of imports for the United States in 2011.
Sochi Winter Olympics and World Cup in Moscow
Russia is actively preparing for two prestigious international events in its future, the 2014 Olympics in Sochi, February 7-23 and the FIFA World Cup in 2018. The Winter Olympics will be the first held in the Russian Federation, and the first since the USSR 1980 Olympics in Moscow, which was boycotted by the U.S. Undertaking this task will be Dmitry Chernyshenko, the president of the Sochi 2014 Olympic Organizing committee. It is being financed with a combination of private sponsorships and government funding. The games are expected to cost anywhere from $18-30 billion. There is a huge infrastructure renovation underway, including projects such as hotels, new sports venues, new railroads and light rail, a new terminal in the Sochi airport, enhanced power stations and telecommunications, and modernizing the city of Sochi.
The 21st FIFA World Cup in 2018 will be held in Moscow. This prestigious soccer tournament will involve 32 national teams, including that of the host nation. This will be the first time Russia hosts the tournament. Russia is also to become the largest nation geographically to host the World Cup. The bidding process was intense, with Spain/Portugal and Netherlands/Belgium also in contentious competition. Russia plans to build 10 new stadiums. Soccer matches will take place in cities across Russia. To support the event, Russia will waive the visa requirement for tourists coming to Russia for the games!
Group of Twenty and Group of Eight
Finally, this year Russia assumes the rotating chair position of the Group of Twenty. Twenty finance ministers and Central Bank governors from the top twenty major economies in the world are expected to participate. The annual summit of the group will be held in St. Petersburg in September 2013. Russia continues an active role in the Group of Eight, which brings together eight of the world’s top economies and governments (U.S., France, Germany, Canada, Italy, Japan, UK and Russia) to discuss global issues on an annual basis. Russia became an official member in 1997 when it first participated in the summit meeting in Denver, Colorado.
Russia’s Development Strategy to 2020 – The Concept
Having looked at some facts and details about Russia’s economic performance and what’s ahead in its future, it’s useful to step back and embrace a broader conceptual perspective. Companies can benefit by having a broader perspective on the day-to-day happenings of the economy by evaluating the body of Russian information about how Russia is positioning itself for economic performance. You can find many clues and insights into the direction of the Russian economy, and a whole range of other reforms in civil society and politics.
Planning ahead for Russia comes naturally. Following a long tradition of planned, command economics during the years of the Soviet Union, where Five-Year Plans for socialist development were the norm for over seventy years, Russia under President Vladimir Putin and Prime Minister Dmitry Medvedev has a planning process with goals in place.
Companies can learn by adopting the Russian way of thinking about how it intends to move ahead. What are the main components of Russia’s economic development aspirations? Where would Russia like to be ten and twenty years from now? What are the chances of achieving these goals? Is Russia’s performance today consistent with what it says it’s going to do in the future? Definitely, there is something to be gleaned from this approach, one that is often overlooked in traditional American corporate strategic planning and overseas risk assessment.
Russia’s overarching growth strategy was first comprehensively presented by President Vladimir Putin in February 2008 in a speech to the State Council entitled “Russia’s Development Strategy to 2020,” popularly known as Strategy 2020. The cornerstone philosophy of the plan is for strong state support to protect the national interest. The main strategic goal is to transform Russia into one of the major leaders of the global economy and successful integration into major global institutions such as the WTO and OECD. The means to do this include an emphasis on modernization through science and technology, stable growth of the economy, contingent on expanding industrial production, GNP, personal income and the middle class. President Putin once said, “I am confident that the new growth model should center on economic freedom, private property and competition. We need honest competition to revive our economy.”
Very specific goals and indeed ambitious goals have been set—they include improvement in areas of rare earth metals, biotech, genetic engineering, information technology and urban construction. Russia also committed to creating 25 million new high productivity jobs by 2020, and enhanced investment in aerospace and the Arctic. Overall, the plan targets Russia to become one of the world’s 5 top economies, with an annual growth rate set between 5-6 percent. Analysts can remain current on latest developments by regularly reviewing business writings, speeches by public officials, reports by investment houses and other Russian source material.
What Russia’s ambitious development strategy in its conceptual form tells us is this—Russia has no intention to turn back the clock either to communism or weak and untested models of economic development. Nor is complacency, mediocrity or business-as-usual acceptable. The Russians are determined to grow competitively and command respect and admiration for their national achievements and secure a role as a major world leader. They yearn for, and in fact demand recognition. They aim to place science, technology, research and advanced thinking at their doorstep in a quest to achieve their goals.
Part of their strategy is to work with international institutions to normalize relations as an active participant and leader in groups such as the WTO, OECD, G20 and more. It includes a domestic reform process to strengthen the rule of law, legal and law enforcement institutions and their own variant of democracy.
It’s clear to me that what the Russians want and how they intend to achieve it is out there in print in the public domain for all to read and know about. We can take it upon ourselves to see if there is a consistency between what they are saying they hope to do and what they are doing. It can be tremendously useful for business researchers to look at Russia in this light to help with their own planning process. Further, I think if we ask the question has Russia’s growth trajectory and current outcomes remained consistent with the projections and goals set in 2008 and since, the answer is yes, and there is compelling reason it will remain consistent into the future.
Russia will always present an especially unique environment for foreign investors: its potential is so great; while its risks, uncertainties and problems can be seen as overwhelming. Therefore superior planning and fact gathering, in a solid analytical framework are required to stay on track, and hence the ability for accurate knowledge and forecasting becomes all the more pressing.
This article concludes that Russia is on a consistent and positive growth path for the future, despite obstacles, barriers and shortcomings. American companies, equipped with the right strategy and risk management plan and knowledge can succeed and thrive in Russia.
Deborah A. Palmieri, Ph.D. is a business specialist on Russia. She is the Honorary Consul General of Russia in Colorado and President and Founder of Deb Palmieri Russia LLC, a consultancy. Contact Dr. Palmieri at 1552 Pennsylvania Street, Denver, CO 80203 or 720-980-4829 or Deb@DebPalmieriRussia.com. Special thanks to Keith Detweiler, student intern from University of Colorado Boulder for research support for this paper.