Why investing in Russia is a risky business

Russia has never been a country easily understood by outsiders. Winston Churchill described it as “a mystery, shrouded in a mystery,” and today’s investors are likely to agree with him.

Many investors still have trouble getting rid of the memory of the communist era in the Soviet Union, even decades after the collapse of the Soviet Union in 1991. The prosperous period that followed was short-lived, replaced by repressive government and crony cultural capitalism.

  • Russia has huge natural wealth in oil, gas and minerals, including diamonds.
  • Corruption and lack of transparency are major obstacles to business.
  • Its dependence on oil makes it vulnerable to commodity price fluctuations.

Russia’s prosperity

Russia’s transition from a communist world power to an emerging economy is not easy for its citizens. It was not until 1998 that the Russian ruble depreciated due to the economic crisis and its economy began to grow.

Over time, its growth rate has put it on par with other major emerging markets such as Brazil, India and China. Its economic size is different from those of these countries: Russia ranks 11th among the world’s economies in terms of gross domestic product.

The country’s major stock markets have shown steady growth. The much-watched comprehensive index MOEX Russia Index fell to around 570 points in early 2009 along with most of the world’s indexes. Since then, it has been climbing steadily, reaching below 3,200 by the end of February 2021.

It is still possible to generate a return on investment in Russia. The trick for investors is to understand Russia’s challenges and opportunities.

As a reasonable measure of the personal wealth of ordinary citizens, Russia’s per capita GDP is about one-third of that of EU countries.

Russia’s challenge

Russia ranks 9th among the most populous countries in the world, with approximately 146 million. Many of them have increased their incomes in the past decade and spend more and more of their income on luxury goods, services and holidays.

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However, the country’s reputation as a safe haven for oligarchs has not been underestimated. According to the latest data provided by the World Bank, its per capita gross domestic product (GDP) is a reasonable measure of the prosperity of a country’s citizens, and it was US$11,585 in 2019. This is below the level of many countries previously under Soviet rule, including Croatia, Estonia, Lithuania, Poland, Slovakia, and Slovenia. (The per capita GDP of the European Union was 34,913 U.S. dollars and that of North America was 63,343 U.S. dollars.)

Russia seems to perform relatively well during the COVD-19 pandemic in 2020 and 2021. A report by the World Bank estimates that due to fiscal, monetary and social policies, its economy will shrink by 4% in 2020, which is lower than earlier forecasts, which will help control the cost of economic disruption.

Russia’s natural resources

Russia’s greatest attraction to investors lies in its abundant natural resources. Oil and natural gas play an important role in the Russian economy in terms of domestic production and exports.

According to data from the US Energy Information Administration, as of 2017, Russia is the world’s largest producer of crude oil and the second largest producer of dry natural gas. Russia is also involved in the energy industry through a number of important joint ventures in Africa and other energy-producing regions.

Its continued dependence on oil makes its economy vulnerable to fluctuations in global oil prices.

Mineral wealth

But oil and gas are not the only abundant natural resources in Russia. This country sits on trillions of dollars in minerals. It claims to be the source of 83% of gold exported to Europe. It is also considered to have the largest diamond resource in the world.

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Having said that, energy and minerals are a blessing, and misfortune is a blessing. Russia’s heavy dependence on resources is a risk. When you invest in Russia, you must keep in mind the direction of commodity prices.

human capital

Russia also has abundant human resources.

Its educational tradition is excellent in mathematics and hard science, as well as in language. It produced a large number of smart workers. Russia has a staggering 99% literacy rate, and about half of its citizens have received secondary education.

Russian corruption

Russian politics may be the biggest investment risk.

Take Yukos as an example. It can be said to be one of Russia’s largest and most successful oil companies. In 2003, its chief executive Mikhail Khodorkovsky clashed with President Vladimir Putin. The Russian court found him guilty of fabricated charges and sentenced him to eight years in prison. Yukos was forced into bankruptcy, and some of it was sold to Putin’s allies for a fraction of its actual market value. Yukos’ shareholders lost in that matter.

The notorious example is a while ago, but there is no evidence that a substantial change has taken place since then.

Obstacles to doing business

“Corruption seriously hinders companies from operating in Russia or planning to invest in Russia. High-level and small-scale corruption is common, especially in the judicial system and public procurement,” Risk and Compliance Portal compiled for 2020 The Russian business profile points to the resources maintained by GAN Integrity.

Russia sometimes makes it difficult for foreign investors to operate in an environment without bureaucratic pressure. The police raided BP’s Moscow office in 2008, trying to persuade shareholders to sell their shares in a joint venture between the British oil giant and the Russian oil producer TNK.

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Other global operators, including Carrefour and De Beers, have withdrawn from business in Russia. The Russian government has a record of exerting pressure on foreign energy companies as part of its efforts to consolidate control of the country’s largest and most important hydrocarbon deposits.

Due to continuing concerns, companies that pride themselves on ethical business practices, such as Swedish home furnishing giant IKEA, have announced the suspension of investment in Russia.

Ranking Russian corruption

In the 2020 Corruption Perception Index of the anti-corruption organization Transparency International, Russia ranks 129th out of 179 countries, tied with Azerbaijan, Malawi and Gabon. (The United States is ranked 25th.)

According to the Corruption Perception Index, Russia has many obstacles to fair and effective business practices. Even Iran, Libya, and Pakistan are considered to be less corrupt.

It is safe to say that corporate corruption and lack of transparency are the main risks faced by Russian investors.

Bottom line

When they look for investment opportunities around the world, investors need to understand the country risks that may threaten their investments. High returns come from high-risk investments, and emerging markets are likely to be a place to look for returns better than developed countries.

Although Russia offers high returns, it is dominated by energy companies, the regulatory status is still evolving at best, and political risks are greater than elsewhere.

This is a distinctive feature of investing in Russia. The risks and potential rewards are high.

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