Doing Business in Russia in Times of Sanctions

Business in Russia

Yesterday I was invited to speak at the HLB conference in Munster, Germany on the topic of Doing Business in Russia in Times of Sanctions. Below you find the text of my presentation.

This morning, I want to discuss with you subject of: doing business with Russia in times of sanctions. My name is Gerard Uijtendaal and I am HLB Eurasia leader and a partner in HLB Energy Consulting in Moscow. As you might realise, I am not Russian, I actually come from the Netherlands. I moved to Russia 13 years ago.

For this discussion today, first of all I am going to make a distinction between trade and investments. My focus is on investments, where foreign companies are really investing directly into in our situation Russia. Of course trade is very important, and substantial between Russia and Europe, my focus is mainly on foreign direct investments.

Gerard Uijtendaal
LinkedIn

So, can we do business (i.e. can we invest) in Russia?

The answer is very clear, yes, you can. There are sanctions, there are limitations, but in most cases, if you study the sanction regulations carefully, assuming that you are not a bank and assuming you normally do not business with olicharchs who are closely connected with the Kremlin, or in the Crimea I would say: do not listen to the politicians who are claiming that Russia is in a depression, and that investments are dead. I will come back to that in a minute.

I always say: Capital does not play politics.

Important to understand that Foreign Direct Investments (FDI) are long term. First of all, it takes them a long term to plan, then to implement, and then to make a return on investment. So, in general is what we see that our clients are looking for the long-term perspectives, not for short term opportunities. Long term, Russia was and still is an attractive market, with a large consumer market with increasing spending power, well educated workforce, available resources etc. The economy is growing, although not as fast as before and certainly not as strong as in the EU at this moment, but there continuous growth projection. Furthermore, the oil prices, always strongly related with the Russian economic health, is going up and this is very good news for the Russian budget.

Then why should you consider to invest in Russia, when so many think this is a very bad idea?

First of all, politics and sanctions are implemented short term, and often without a view how to exit them, or for how long. Also, politics will lift sanctions, eventually. But this is for long term investment decisions just one of the criteria in the risk assessment. Important, indeed, but not the only factor. Just one in many.

According to the Financial Times FDI report 2018, Russia is ranked as the second country in Europe in terms of capital investments into Europe, with a market share of 9% and US$ 15.9 billion in 203 projects in 2017. This is an increase of 2% compared to 2016. So it shows that, although the first sanctions were imposed in 2014, capital does not play politics. Companies will continue to invest in long term opportunities. Most people are surprised when I tell them this. This ranking proof that Russia is still an interesting place to invest.

Secondly, Investors also look at what they call Country Risk Premium. They take this into account when calculating the potential long term return on investments. And what do we see here? Also that Russia is not ranked as a much higher risk country. Basically, the Country Risk Premium is the extra return on investment that investors would like to receive to cover additional risk. To give you an example: The country risk premium for Germany is zero: no extra risk. The country risk premium for Italy: what do you think? 2.19%. Another country: Ukraine. 10.4%. And Russia? 2.54%. So the financial market see the risk for investing in Russia slightly higher than for example Italy.

Thirdly, the response that I get from my foreign clients is that profit margins in Russia are higher than in other countries. There are various reasons for that, but in general I believe that this is because the management practices of international companies are much better and sophisticated than these of local companies. Russia has a large management problem, which also shows in very low labor productivity. Foreign investors, bringing their best practices with them, are so much better in management.

Long term outlook:

Sanctions, contra-sanctions, new trade wars and tariffs are the last symptoms from politicians trying to prevent a trend that nobody can reverse: globalisation. The world is becoming more and more globalised, and companies are getting strategically prepared for that. Short term barriers trying to stop free flow of capital will increase short term return on investments for these companies that are able to overcome them, and giving long term global investors actually a premium on their strategy. Russia is uniquely positioned between Europe and Asia. Europa has a difficult relationship with China. Where as the Chinese are very active investors in Europe, and especially in logistics and high tech, European companies are struggling to understand how to deal with China. The answer lies in Russia: this is where East and West will meet and Russia will become to play a pivotal role in the relations between Europe and China. Long term, this is what companies are investing in.

Russian-German-EU relations

Germany is a very open economy, and German companies have always been very open in their trade and investments abroad. That is why relatively, Germany has so much multinational companies’. But also middle sized companies, often generations-long family owned, have great internationalization strategies and we see them actively investing in Russia. First of all we see investments in agro-technology. Think of animal feed, seed, crop protection, technology for agriculture, horticulture, etc. EU companies are very active in these fields. Secondly, EU has great engineering capabilities, not only in water management, but you can see this also broader in architecture, waste management, urban planning etc. Many EU companies are successful in these fields in Russia. Thirdly, Russia is in dire need of new technologies. Where as Chinese companies, having the same need, are actively buying foreign companies to get access to new technologies, we do not see that strategy at Russian companies. This means that there is an interesting market in new technologies in Russia supplying all kinds of industries from oil and gas to automotive. Smaller, innovative EU companies see opportunities here.

I will give you some examples. One of my client is a family owned, third generation, producer of animal feed. After having worked with their very reliable distributer for more than 10 years, they decided jointly to build an animal feed mill. This became so successful that they decided to build a second one, and by now they are one of the largest animal feed producers in Russia. Interestingly, their main competitors are all foreign owned.

Another example: French fries are imported and this is becoming a problem under the so called contra sanctions. So producing locally is important. Unfortunately, there are no potato growers in Russia that grow the special potatoes that for example McDonalds needs to make its French Fries. So in a joint venture between a large Russian agricultural conglomerate and a Dutch fries manufacturer, they are currently building a gigantic French fries factory, some 300 KM south of Moscow.

My third example: the oil and gas industry is under sanctions in respect to delivering them technology for drilling in the artic. This is knowledge that Russian companies do not have. However, most suppliers of technology are from the US and find it really difficult to secure if products will be used for ‘normal’ use, or for drilling in the artic. So most of them decided not to continue to supply at all. My client has seen this potential and is very well able to supply the oil and gas industry with technology, without breaking sanctions.

Of course you need to be careful. Siemens was confronted with a large problem when they realised that gas turbines they delivered to their joint venture partner ended up in Crimea, which is part of the sanctions.

Problems

Off course there are structural issues with investing in Russia. An unclear rule of law, difficulties obtaining finance for investments, corruption and bureaucracy are mentioned most often. Companies that have a global strategy understand these issues and have means to mitigate these. I would not recommend Russia as your first country for your international expansion, but for the experienced companies, the issues in Russia are not more or less than for other countries they are investing in.

My conclusion:

Russia is not for the faith-hearted, unexperienced investor. But if you have a high risk appetite, a good risk management system, and if you can mitigate the risks, Russia can be a very rewarding country to invest in. We have many European clients who are very successful in Russia, also in times of sanctions.

View for more information our Russian Desk page.