The Russia BRIC: Low Taxes the Key to Investment Diversity

The emerging economies of Brazil, Russia, India and China, or BRIC bloc of countries, represent 40 percent of the world’s population and together, a growing economic force. Chris Devonshire-Ellis is traveling to the four BRIC nations to observe the impact these countries are having on one another, and the impact they are having on the world. In this second article he focuses on the largest of the four, Russia.

By Chris Devonshire-Ellis

MOSCOW, Oct. 7 – Russia has long been thought of as purely an energy play due to the massive reserves of oil and gas the country possesses. However, as the country continues to recover from the enormous upheaval from the collapse of the Soviet Union, foreign investors are increasingly finding in Russia an increasingly buoyant market led by new consumers as wealth now starts to permeate further across and deeper into its society.

The current downturn aside, Russia’s investment credentials are robust. The country possesses the third largest foreign exchange reserves in the world, has budget and trade surpluses and a growing and increasingly affluent middle class. The Russian government, with an eye on improving infrastructure, has provided a “stabilization fund” of some US$255 billion to be spent on improving the condition of domestic roads, transportation and related constructions, especially outside the main cities over the next five years.

Importantly, given the state of the global economy, and the inherent problems within the American banking system, Russia’s Central Bank has sufficient funds to support the entire Russian banking system. Signs of the global downturn are negligible in Russia, and consumers are feted with a wide variety of domestic and imported goods. The Economist magazine predicts GDP growth of around 8 percent annually for the next three years, with private consumption growing at 10 percent annually.

Government concerns over unemployment are also well under control at 6 percent, while public debt is low at 1 percent of GDP. Foreign currency reserves too are high at some US$550 billion, all pointing to a healthy economy with strong fundamentals – a fact realized in the five years up to 2009 when major Russian companies profits grew at rates of 30 percent annually. That has taken a hit with global demand declining, however the domestic market remains strong.

Low tax rates have helped, corporate income tax is low at 20 percent, while individual income tax is at just 13 percent, making the prospect of both success and yields highly attractive. Growth now is centering on a number of industries; sectors in food and beverage, retail, consumer goods, banking, real estate, construction, mobile communications, aerospace, mining, automotive, pharmaceuticals and IT are all to the fore in the development of the foreign direct investment in the country.

However, concerns remain over issues of transparency and corporate governance, and a large, off the books, black economy is still highly evident. That goes hand in hand with corruption, and remains Russia’s biggest weakness. A 2007 study by Against Corruption, a Russian NGO, estimated that some quarter of all money earmarked for state expenditure is stolen, while 28 percent of Russian businesses said some form of fiscal corruption had affected them. That is echoed by the PricewaterhouseCoopers Economic Crimes Survey, which ranks corruption globally. Its most recent findings found that global corruption affected 43 percent of all businesses; in Russia the figure was 59 percent, up by over 10 percent in two years.

There are concerns over sustained growth also. The United Nations has reported that Russia’s population is shrinking, and has fallen by 7 million people since 1993, with a further 11 million people to be lost to the total population by 2025. With a current population of some 142 million, such shrinkage could result in labor shortages, slowing economic growth in the longer term and an increasing social burden of an aging population. Parts of Russia’s rural areas are already facing depopulation, and while this has been balanced by an influx of immigrant labor, concerns remain over the long-term impact it may have. However, opportunities remain in this, Russia is overhauling its health system, and an increasing awareness of lifestyle changes, promoting health are being put in place to counterbalance traditional problems such as alcoholism and Russia’s relatively high mortality rates.

The government is also slowly weeding out previous, inefficient state owned businesses left over from the Soviet days, and encouraging reeducation and redeployment of workers to modern industry. Russia’s domestic political risk profile is expected to continue moving in tandem with the overall economic environment, and political dynamics, especially related to policy certainty and social stability, look set to continue improving. This has already been reflected in short-term political risk ratings (STPR) for Russia, which have recently been upgraded. Russia’s business environment is hampered overall by poor infrastructure, rising state protectionism in the energy industry and weak institutional development, however there are signals that the government is taking these issues seriously. The government is also involved in an ongoing privatization program, Russia’s Economic Development Minister Elvira Nabiullina announced plans this week to sell off some 450 state owned enterprises and government held stakes in ports and airports in moves that are expected to attract significant interest, especially in the southern-based ports that service Europe.

Like all emerging markets, Russia has its development issues. However, with a young, determined government in place (albeit with limited acknowledgment of democracy), the country looks set to continue robust GDP growth as its infrastructure requirements and a rising, consumer lead middle class drive the nations prosperity forward. Russia remains a viable and indeed desirable destination both for growth in domestic consumption, and for the manufacturing of products to sell onto the European and ex-Soviet markets.

Comments are welcome

Next week: India

Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates and lived in China for 21 years. He is now based in Mumbai. The firm is currently evaluating establishing a presence in Russia, while Asia Briefing will be adding Russia Briefing to its catalog of titles in the near future.