Mixed Messages From The Kremlin

As Putin tries to win back foreign investment, nationalist forces seem to be pushing it away

Is it safe to invest in Russia? That question is resonating in boardrooms across the U.S. and Europe. Last year's renationalization of the Yukos oil company cast a chill on the country's investment climate. Still, many reasoned that once the Kremlin wrapped up its messy campaign against Yukos, the outlook for foreign companies would improve. Alas, nothing in Russia is ever that simple.

The good news is that President Vladimir V. Putin has been on a mission to win back investor confidence. At a Mar. 24 meeting with leading Russian businesspeople, he vowed that the state has no plans to renationalize their properties. He repeated the message a few days later, in a speech at Germany's Hanover Trade Fair on Apr. 10, also attended by Chancellor Gerhard Schröder. "We well understand that the prospects for growth and diversification of the national economy depend on the level of economic freedom in the country and on the ability of the state to guarantee favorable, transparent, predictable conditions for conducting business," said Putin.

The bad news is that no sooner does Putin say one thing than his underlings do another. Just one day after the Hanover speech, TNK-BP Ltd., a Russian oil company 50% owned by Britain's BP PLC (BP ), revealed it had been hit with a $936 million bill for back taxes dating from 2001, when the Russian partner in the venture, TNK, took advantage of tax havens that were then widely assumed to be legal. The belated tax bill was all too reminiscent of the tactics used to dismember Yukos, whose key production assets were confiscated by the state in order to settle old tax claims.

Two days later investor sentiment sustained another blow. Russia's antimonopoly commission blocked a $320 million bid by German engineering giant Siemens (SI ) for 74% of Power Machines, Russia's largest producer of electricity-generation equipment, citing national security concerns. (Power Machines also makes components for nuclear submarines.) However, in the weeks leading up to the decision, ministers made conflicting statements about whether the deal should be allowed, adding to the sense of the government being in disarray and lacking direction. "There are no clear signals or control from on top," says Al Breach, head of research at Moscow investment bank Brunswick UBS. "Putin is also looking increasingly isolated from the whole agenda."

Adding to the confusion is the fact that, in other areas, Russian investment is surprisingly robust. Data show that foreign direct investment (FDI) reached a record $9.4 billion last year -- a 39% increase over 2003. This year it is off to a strong start, with $5.4 billion in FDI recorded in the first quarter. Recent weeks have seen a spate of sizable deals. In March, Coca-Cola Co. (KO )acquired Russia's largest juicemaker, Multon, for an estimated $600 million. Alcoa Inc. (AA ) bought two Russian aluminum smelters for $257 million in January. And just last month, British electronics retailer Dixons Group PLC announced that it had acquired an option to buy Russia's largest electronics retailer, Eldorado Group, paying $190 million for a 10% stake by 2008. If Dixon decides to acquire the entire company by 2011, it will pay an additional $1.71 billion.

For many international companies Russia's gravitational pull is simply too strong to resist. "There are only two to three growth markets available to American blue chips, and Russia is one of them," says Andrew Somers, president of the American Chamber of Commerce in Moscow. "Plus Russia has a huge population." Coca-Cola Hellenic Bottling Company, the Coke subsidiary producing in Russia, logged double-digit growth in sales volumes in 2004. Compare that with Coke's flat or low single-digit growth in markets such as the U.S. and Europe.

Russia, though, would be harvesting even more foreign capital if it weren't for the Kremlin's schizophrenic behavior. Measured as a share of gross domestic product, Russia's FDI take remains disappointingly low compared with that of other emerging markets. Moreover, when it comes to strategic sectors of the economy, particularly natural resources and defense-related industries, advocates of a more protectionist and nationalist economic policy are gaining influence. That puts them at odds with more liberal government officials.


The enduring suspicion is that members of the nationalist camp are acting on behalf of local business interests. "The Russian presidential administration [is] hoping for higher [foreign] investment. I think they are sincere. But maybe the incumbent players are not so happy," says Andrea Clavarino, general director of Coeclerici, an Italian mining company. It had been planning to bid more than $8.5 million for a coal-mining license in the Kemerovo region in Siberia until the tender was mysteriously postponed just 24 hours before it was to take place, on Apr. 7. Government officials would not comment on the reason for the cancellation.

Faced with such vexing ambiguity, many foreign companies with a Russian presence are still upbeat about the market. TNK-BP is downplaying the implications of the tax claim, saying it is a preliminary assessment. "It's not something that's going to break the company," says Peter Henshaw, TNK-BP's vice-president, who believes the bill can be negotiated down. Henshaw does complain, however, that new regulations governing foreign access to natural resources, still in draft form, "are insufficiently clear on what the policy will be." For example, the draft law fails to define the "strategic" oil fields that will be out of bounds for foreigners.

Foreign investors also know that with Russia, patience can pay off. After several years of lobbying by foreign carmakers, Moscow is expected this month to abolish tariffs on imported car parts despite vocal opposition from local manufacturers. The move should boost foreign investment in Russia's car industry. Volkswagen and Toyota Motor Corp. (TM ) are among the international manufacturers that may now consider setting up production there. "We are very glad," says Vanessa Levy, spokeswoman for the local subsidiary of Renault, which inaugurated a $230 million plant near Moscow in April. "Clearly lower taxes help foreign investors invest in Russia."

Seasoned Russia hands are also less bothered by the Kremlin's conflicting signals than they are by everyday operational concerns. Andreas Romanos, chief executive of the Association of European Businesses, which represents European investors in Russia, says his members are more likely to grouse about longstanding problems, such as routine bureaucratic hassles, than about the Yukos affair or any increase in the Kremlin's interference in the economy. The single most common complaint: Russia's negative image abroad. "Headquarters thinks Russia is this wild place where the government steals your money, which we know isn't the case," says Romanos. Well, Russia is a wild place. But it's not lost to capitalism yet.

By Jason Bush in Moscow

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