Russia Attracting More Western Companies

Where's Russia headed? One good place to get an answer was the just-concluded St. Petersburg International Economic Forum, which followed the strained G-8 meeting in Germany. According to Russian Economics Minister German Gref, upwards of 10,000 people from over 60 countries participated in the Forum, which this year was also done in partnership with the World Economic Forum -- otherwise known as Davos.

I attended the forum and chaired the session on energy. I have subsequently been asked to answer some significant questions.

What is the outlook for the Russian economy? What is the investment environment like currently?

The political tensions, suspicion, and tough rhetoric between Russia and the United States and other members of the G-8 that were so apparent prior to that summit were mostly marked by their absence at the St. Petersburg Economic Forum. The commodities mainly evident in these very warm days and long white nights were optimism and confidence.

With just nine months to go until the Russian presidential election, this presumably last Forum for St. Petersburg-native Vladimir Putin underlined the growth story in Russia under his presidency. Since he took over at the tail end of an economic crisis in 2000, the size of the Russian economy has quintupled. It's the tenth largest economy in the world, and some are estimating that it will be the fifth by 2020 or before. It also has the third largest financial reserves of any country.

On the other side, worries center on the extent of vulnerability to lower energy prices, volatility in the Russian stock market, uncertainty from domestic politics during an election season, and what some say is the stalling of needed reforms.

How is Western business looking at the Russian economy?

There was a strong sense among Western and specifically American companies of not wanting to be left out. After all, the Russian economy is now bigger than Brazil's or India's. As one American put it when we were talking after a session, "For many years, the 'R' seemed to be missing from BRIC. No longer.

Now American companies are scrambling to put their Russia strategy together. They may still worry about the risks, but the opportunity is so much bigger." A number are already there, of course, ranging from Boeing to Procter and Gamble.

Rising income is particularly what the business community is seeing. It's estimated that 25 to 30 percent of the population is now at least in the "consumer class," if not necessarily "middle class."

That's a lot of spending power and a lot of new demand. Last year, it was said, a million cars were sold in India -- and two million in Russia. This optimism is certainly very different from what one encounters in more political circles.

You were the chair of a panel on energy at the conference. Do you anticipate more western involvement in Russia's oil industry or less?

The Putin Administration continues to be intent on revising to one degree or another the oil and gas deals that were done in the middle 1990s. The actual rewriting varies from one deal to the next. So you don't see the same kind of enthusiasm in energy that is evident in other sectors.

There's a lot of uncertainty, frustration, and pessimism about policy, decision-making and about the role of foreign capital in the energy sector. Also, exploration and development costs have been rising substantially in Russia, as elsewhere, but, at least in the mature region of West Siberia, this goes unrecognized by the very high tax rate.. Yet the resource potential is so great that the major companies can't easily stand aside.

There are two critical things that they are waiting for, both of which are promised by the end of the year. One is the definition of "strategic sectors" and how those sectors will be managed -- in which oil and gas are at the top of the list.

The other are the "rules of the road" for exploration and development in the off-shore and Artic, which will be high cost, challenging technically, but are very high potential.

What is the outlook for Russian oil and gas production? Are there any big changes underway?

For most of this decade, it was the dramatic growth in Russian oil production that, on a net global basis, balanced out the rapid growth in Chinese oil demand. Today, Russia is the world's largest producer of oil, but growth has slowed very substantially, and the future growth rate will be very sensitive to tax rates, costs, and regulation.

How do fluctuations in oil and gas prices affect Russia?

To understand Russia's position today on oil and gas, you have to go back to the collapse in 1998. The current leadership never wants to be in the position it found itself when oil prices collapsed back then.

The Russian government, led by finance minister Alexei Kudrin, has constructed a fiscal regime intended to insulate the economy from any future shocks. That means large government reserves and an oil stabilization fund that together, today, exceed $600 billion. This gives Russia two or even three years of protection against a downturn.

At the same time, these reserves have helped to keep down inflation and prevent the currency from appreciating more than it has. Kudrin certainly gets much credit inernationally for the management of Russia's fiscal position.

The bottom line is that Russia has very strong finances today, although there will be greater pressures to spend in an election year. As one of the senior officials put it in a private session, "At a time of high oil prices, we must resist all the temptations to spend."

Still the debate will continue as to how sensitive the Russian economy is to any downturns in oil prices. About 20 percent of GDP is accounted for by oil and gas export revenues, although obviously the indirect impact is a good deal larger.

Russia's economy has boomed under President Putin. What changes do you foresee from your discussions with business leaders when there is a change in leadership?

With perspective, one would say that, from an economic point of view, Putin's program has been directed to stabilization and restoring growth -- and restoring the state -- and state direction over the economy.

The macroeconomic results, as we heard at St. Petersburg, would never have been anticipated by either optimists or pessimists when he came to power. As a prominent American international financial figure put it when we were talking as the conference ended, "No one could have thought in 2000 that this was possible."

Putin's two most likely successors each scoped out at the conference the future emphasis from their current portfolios. First Deputy Prime Minister Sergei Ivanov pointed to aviation, shipbuilding, information technology, nanotechnology, space and nuclear power.

The Russian government is consolidating those sectors to make them internationally competitive. First Deputy Prime Minister Dmitri Medvedev pointed to the "national projects" for which he's responsible -- spending on human capital, and reconstruction in health, education, housing, agriculture. With Russia's population shrinking and ageing, pensions are a very big issue; and a second oil fund, this one specifically for pensions, is in the works.

The buildup to last week's G8 saw some harsh words between Putin and President Bush over an antimissile shield with an ultimate effort to compromise. Is there a change in attitutude toward the U.S. among business leaders? is there a change in the way Russia is treating U.S. business?

Issues like missile defense and domestic politics were not much on the agenda -- except for the appearance of the Serbian prime minister on one plenary, apparently to register Russia's position on independence for Kosovo.

And of course there was much discussion about the controversy around energy issues. It was notable to see that the third speaker on one of the plenaries with President Putin and President Nazarbayev of Kazakhstan was Professir Francis Fukuyama of Johns Hopkins University talking about "trust" and "transparency."

And there was some interesting discussion at senior levels about "Russia's brand." Rule of law and contracts got a fair amount of attention, but that is because this conference was about trade and investment.

From the Russian side, despite some some political ripostes, the forum was mostly about doing business. Putin several times cited the surge of capital inflows into Russia -- and outward investment from Russia. The perspective was summed up by one of the senior people in a meeting with non-Russian CEOs. "Come to Russia with your capital, your money, your technology," he said. "We're delighted to see you here."

This time -- in contrast to earlier years -- he was talking to an audience that seemed quite interested in taking him up on his invitation. Perhaps the mood was captured by another senior figure when he, as almost an afterthought, told the same audience, "We're very business-oriented nowadays." There was a suggestion that perhaps this person himself was a little surprised to find himself in that position.

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