- - Thursday, January 21, 2016

Why are international companies still doing business in Russia? Moscow’s economic headlines have been downbeat for a year and a half, as the country has been hit by falling oil prices, Ukraine-related sanctions and currency devaluation. Moreover, Russia has long been reputed to be a challenging place to do business.

To answer that question, it is worth recalling why international firms chose to invest in Russia in the first place. Russia has a wealth of natural resources well beyond oil and gas and a talented pool of engineers, mathematicians and scientists. Its market of 140 million consumers is underdeveloped and yet still one of Europe’s largest in sectors from mobile phones to autos. Bloomberg ranks Russia as the world’s 12th most innovative economy, placing it in the top 10 for the number of domestic high-tech companies and top five for percentage of the labor forces with advanced degrees. Russia’s economy nearly doubled in size between 1998 and 2008, and much of that growth was consumer-driven. Most international companies entered the Russian market before 1998 and their investments were strategic with long-term time horizons. Investors saw both the immediate opportunities and difficulties in the 1990s, as well as the obvious potential for the future — for example, as part of a global supply chain connecting Europe and Asia. Many of the same international businesses entered the Ukrainian market at the same time, seeing a promising future there as well.

The past 18 months have been trying for business in Russia. The numbers speak for themselves: GDP contracted last year by nearly 4 percent; the ruble lost more than 40 percent of its value; and the annualized rate of inflation edged up to 13 percent. Foreign direct investment was down by two-thirds, and capital flight increased in 2015. International businesses have suffered as a result, particularly in consumer-driven sectors and extractive industries. The continued decline in oil prices and ruble depreciation have dampened the outlook for the economy in 2016. Nonetheless, the rate of decline of major economic indicators has slowed and policymakers see the economy adapting to a lower oil price environment. Both private and government economists forecast a return to very modest growth in 2017 even with oil below $40 a barrel.

Throughout this difficult period, there have been some positive signs in Russia’s economic policies. The Central Bank moved to a free float of the ruble and rejected capital controls. The Russian government continued its multiyear effort to improve Russia’s position in the World Bank’s Doing Businesses rankings. Russia continued its upward climb and was top-ranked among the BRICS countries for the first time this year. At the same time, some Russian anti-crisis measures have raised concerns, most notably the emphasis on import substitution, counter-sanctions on Western foodstuffs and new limitations on foreign participation in government tenders. As former WTO Director General Pascal Lamy recently noted, Russia’s import substitution policy is likely to create greater inefficiencies and result in lower-quality, higher-cost goods for Russian consumers absent competition from high-quality foreign goods.

Russia’s biggest economic policy challenges, however, remain unanswered: What is to be done to reach sustained growth in the 4 percent to 5 percent range needed to take the country to the next level. In other words, what will it take to encourage new investment, retain talent and resume expansion of Russia’s middle class? Will the role of the state be reduced in the economy? Will rule of law and protection of property rights be strengthened? These are key concerns for Russians themselves to decide. In this regard, it is important to put the current difficulties into perspective. Sanctions have had a significant impact, particularly regarding access to global capital markets, but the drop in oil prices hurt Russia’s economy more. The policy decision to allow the currency to float helped to soften the blow. Moreover, Russia’s economic slowdown actually predates the events of 2014. Its GDP fell from 4.5 percent in 2011 to 1.3 percent in 2013 despite oil prices at more than $100 a barrel. The reason is underlying structural issues and imbalances. Given that the global commodity supercycle is clearly over and a return to $100 a barrel oil is highly unlikely, those long-standing structural issues remain key to restarting growth.

There’s an open debate in Russia about the economic way forward. Prime Minister Dmitry Medvedev laid out a solid set of ideas late last year, advocating more competition, human capital development, support for small business, and greater efforts to attract foreign capital and technology transfer. The international business community would welcome these initiatives and supports other Russian calls for structural reforms, including moving ahead on planned privatizations, increased property rights protections, and pension reform.

It is encouraging that the Russian government has been open to discuss streamlining bureaucratic and regulatory burdens on businesses through the Foreign Investment Advisory Council and other fora. On many of these issues, the U.S.-Russian Business Council, which I head, is working with like-minded Russian business groups, including Business Russia and the Russian Union of Industrialists and Entrepreneurs, and with the American Chamber of Commerce in Russia, to advance shared commercial objectives. At a time of heightened political tensions, business-to-business dialogue is especially important to keep channels of communication open between Russians and Americans.

At the same time, international business is complying fully with the legal requirements of Ukraine-related sanctions as well as with applicable Russian laws and regulations. The business community appreciates the U.S. government’s willingness to discuss companies’ sanctions concerns to the extent possible and the U.S. government’s considerable efforts to synchronize sanctions with the EU. The maintenance of a level playing field and equal market access vis-a-vis European and Asian competitors remains a key concern of American firms.

The bottom line is that Russia’s high-risk, high-reward economy of the early 2000s has hit a structural slump compounded by external shocks. The economic contraction has been prolonged and a return to real growth depends in part on the Russian government’s policy choices. Still, international businesses are realistic about short-term prospects, and American member companies of the U.S.-Russia Business Council remain committed to their Russian partners, customers and employees through this tough time. The reason is simple: The fundamental factors that brought them into the Russian market in the first place haven’t changed. Russia has the natural and human resources to be globally competitive; international business can offer the capital, technology and project management expertise to help fully develop Russia’s potential. Moreover, the presence of world-class firms in Russia brings to the market a commitment to the rule of law, international standards, equal employment opportunity, environmental protection, and other proven best practices. Disengagement is not an outcome that benefits Russia’s or the United States’ commercial interests.

Without minimizing today’s very real and daunting challenges, I still think it is fair to say that a prosperous, modern and competitive Russian market economy would benefit both Russians and Americans; it would offer a better foundation for overall U.S.-Russian relations; and it would foster increased global ties to help us all better manage the politically and economically turbulent world in which we live.

Dan Russell is president and CEO of the U.S.-Russia Business Council.

The US-Russia Crosstalk is a joint initiative of the Kommersant newspaper and Valdai Club in Russia and The Washington Times and Center for National Interest in the United States aimed at fostering a dialog on strategic engagement between the two countries.

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