FDI prospects for transition economies helped by the Russian Federation’s WTO accession

In economies in transition in South-East Europe, the Commonwealth of Independent States (CIS) and Georgia, FDI recovered some lost ground after two years of stagnant ows, reaching $92 billion, driven in large part by cross-border M&A deals. In South-East Europe, manufacturing FDI increased, buoyed by competitive production costs and open access to EU markets. In the CIS, resource-based economies beneted from continued natural-resource-seeking FDI. The Russian Federation continued to account for the lion’s share of inward FDI to the region and saw FDI ows grow to the third highest level ever. Developed countries, mainly EU members, remained the most important source of FDI, with the highest share of projects (comprising cross-border M&As and greeneld investments), although projects by investors from developing and transition economies gained importance.

The services sector still plays only a small part in inward FDI in the region, but its importance may increase with the accession to the World Trade Organization (WTO) of the Russian Federation. Through WTO accession the country has committed to reduce restrictions on foreign investment in a number of services industries (including banking, insurance, business services, telecommunications and distribution). The accession may also boost foreign investors’ condence and improve the overall investment environment.

UNCTAD projects continued growth of FDI ows to transition economies, reecting a more investor-friendly environment, WTO accession by the Russian Federation and new privatization programmes in extractive industries, utilities, banking and telecommunications.

FDI out ows from the transition economies also grew, by 19 per cent, reaching an all-time record of $73 billion. Natural-resource-based TNCs in transition economies (mainly in the Russian Federation), supported by high commodity prices and increasing stock market valuations, continued their expansion into emerging markets rich in natural resources. For example, TNK-BP (Russian Federation) entered the Brazilian oil industry in 2011 with a $1 billion acquisition of a 45 per cent stake in 21 oil blocks located in the Solimoes Basin.

FDI ows to transition economies are expected to grow further in 2012 and exceed the 2007 peak in 2014, in part because of the accession of the Russian Federation to the World Trade Organization and a new round of privatization in the region.

FDI ows to economies in transition recovered strongly. They are expected to grow further, partly because of the accession of the Russian Federation to the World Trade Organization (WTO).

The Russian Federation saw FDI ows grow by 22 per cent, reaching $53 billion, the third highest level ever recorded. Foreign investors were motivated by the continued strong growth of the domestic market and affordable labour costs, coupled with productivity gains. They also continued to be attracted by high returns in energy and other natural-resource-related projects, as shown by the partnership deal between Exxon Mobil (United States) and the State-owned oil company Rosneft (Russian Federation) to develop the rich, untapped reserves of the Arctic zone.

Cross-border M&As were particularly dynamic. The FDI rebound was due mainly to a surge in the value of cross-border M&As, from $4.5 billion in 2010 to $33 billion in 2011 (tables B and C), driven by a number of large transactions. The takeover of Polyus Gold (Russian Federation) for $6.3 billion by the KazakhGold Group (Kazakhstan) was the largest. Although deals in energy, mining, oil and gas tend to attract the most media attention, the consumer market was also a target for cross-border M&As in 2011. Examples of large transactions include the €835 million acquisition of a 43 per cent stake in the Russian retail hypermarket chain OOO Lenta by the buyout group TPG Capital (United States), and the €604 million that Unilever (United Kingdom) spent on the Russian cosmetics manufacturer Concern Kalina.

FDI in services remained sluggish but new impetus may come from the WTO accession of the Russian Federation. In 2011, FDI projects in transition economies rose in all three sectors of production (tables B and D). Compared with the pre-crisis level (2005-2007), the value of FDI in the primary sector increased almost four-fold; FDI in manufacturing rose by 28 per cent while FDI in services remained lower. Over the long run, however, FDI in services is expected to rise because of the accession of the Russian Federation to the WTO (box II.3). Through that accession the country has further committed to integrate itself into the global economic system, which will boost foreign investors’ condence and improve the overall investment environment.

The services sector may well replace the manufacturing sector as the engine of FDI growth, while in the manufacturing sector, domestic and foreign investors will most likely consolidate as the landscape becomes more competitive. In the primary sector, the impact on FDI will vary by industry.

Record-high FDI out ows, and not only by natural-resource-based TNCs. FDI out ows from the transition economies, mainly from the Russian Federation, reached an all-time record level in 2011 (gure C). Natural-resource-based TNCs in transition economies, supported by high commodity prices and higher stock market valuations, continued their expansion into emerging markets rich in natural resources. For example, TNK-BP (Russian Federation) entered the Brazilian oil industry with a $1 billion acquisition of a 45 per cent stake in 21 oil blocks located in the Solimoes Basin.

At the same time, the company base of outward FDI continued widening as other rms from various industries also invested. For example, Sberbank – the largest Russian bank and the third largest European one in terms of market capitalization – was pursuing major acquisitions abroad (e.g. in 2011 the bank completed the acquisition of Volksbank (Austria) afliates in four transition economies33 and four new EU member countries34). As corporate customers of Russian banks venture abroad, they demand that their banks have a local presence in host countries to help nance their activities there.

Russian technology-based rms also acquired large assets, especially in developed markets (e.g. Sky Technology acquired 10 per cent of Twitter (United States).

Box II.3.  The Russian Federation’s accession to the WTO: implications for inward FDI ows

On 16 December 2011, at its Ministerial meeting in Geneva, the WTO formally approved the terms of the Russian Federation’s entry to the WTO.a Fullling the WTO obligations will involve substantial trade and investment liberalization measures. These measures will have implications for FDI ows to the Russian Federation in all three sectors, which will be felt even more strongly after the transition to full compliance with WTO standards.

• The services sector. This sector accounts for more than 40 per cent of GDP in the Russian Federation. Liberalization will gradually open the country’s services market to foreign investors. The Russian Federation has undertaken special obligations in 11 services industries and 116 sub-industries. For example:

— In banking, foreign banks may now establish majority-owned afliates, and the threshold of foreign participation has been raised to 50 per cent (with the exception of foreign investment in privatized banks, in which greater ownership is possible).b However, even though the country has allowed the establishment of branches of international banks, they must be registered as Russian entities, have their own capital and be subject to supervision by the Russian central bank.

— In insurance, the share of foreign ownership has been expanded to 100 per cent in non-life insurance companies and to 50 per cent in the life insurance market (up from 15 per cent in both).

— In trade, 100 per cent foreign rms are allowed to participate in both the wholesale and the retail segments.

— In business services, the country has committed to market access and national treatment for a wide variety of professions. Foreign companies have been permitted to operate as 100 per cent foreign-owned entities.

— In telecommunications, restrictions of foreign participation to 49 per cent will be eliminated within four years after the WTO accession.

— In distribution services, 100 per cent foreign-owned companies have been allowed to engage in wholesale, retail and franchise activities, as well as express delivery services, including the distribution of pharmaceuticals.

• The manufacturing sector. Most manufacturing industries had been largely open to foreign investors and had already attracted a signicant amount of FDI, so accession to the WTO may not immediately have substantial FDI-generating effects. Indeed, the reduction of import restrictions and the elimination of trade-related investment measures in industries such as automobiles and food industries may reduce incentives to FDI by eroding the possibility of “barrier-hopping”. Nevertheless, over time, freer access to imported inputs could help improve the cost-quality conditions of manufacturing and increase the attractiveness of the economy as a site for efciency-oriented manufacturing FDI. Some industries that are not competitive, such as mechanical engineering, may lose FDI potential as they undergo downsizing in the aftermath of WTO accession and the end of their current protection. Industries such as ferrous and non-ferrous metallurgy and chemical products may benet from WTO accession and better access to foreign markets, but only in the long run. Metallurgy and chemicals are already competitive in world markets and operate without major subsidies.

•  The primary sector. WTO accession may beneŵt FDI in the mining sector but hinder FDI in agriculture. Foreign investors may also be attracted to export-oriented oil and gas production (within the limits of the strategic sectors law) because these activities will benet from the liberalization of markets and elimination of export quotas.

Business opportunities are expected to be more scarce in agriculture, in which output may even contract. The Institute of Economic Forecasting of the Russian Academy of Sciences estimates that the country will lose $4 billion a year in agricultural production. This estimate is based on the assumption that local production will not be able to improve productivity and competitiveness. If local producers react by modernizing successfully, the losses may be more moderate. Competitive foreign producers would still nd niche markets in food and beverages.

Upon accession, pursuant to the WTO Agreement on Trade-Related Investment Measures, the Russian Federation will be prohibited from imposing certain conditions on enterprises operating in the country, including those with foreign investments. 

Source: UNCTAD, based on Kostyunina (2012).

a  The Russian Federation will have until mid-July 2013 to ratify the accession agreement and will become a member 30 days after it noties the WTO of its ratication.

b In addition, foreign afliates in banking will be allowed to provide a variety of services, including asset management services, credit cards and other types of payments; to own and trade all kinds of securities available in the country, including government securities; and to participate in the privatization of State-owned enterprises.

For instance, the Government of the Russian Federation approved partial privatization of 10 major State-owned companies before 2013, which could bring an extra Rub 1 trillion  ($33 billion) to the State budget. The effort includes minority shares in the major oil company Rosneft, the hydropower generator RusHydro, the Federal Grid Company of Unied Energy Systems, the country’s largest shipping company (Sovcomot), Sberbank, VTB Bank, the United Grain Company, the Rosagroleasing agricultural leasing company, the oil pipeline company Transneft and the national rail monopoly (Russian Railways). In Serbia, two large publicly owned enterprises are expected to be privatized in 2012: Telekom Srbija and the catering service of the national airline, JAT. In Bosnia and Herzegovina, the Government is hoping to raise about $5 billion in 2012-2013, mainly by privatizing assets in 25 large companies included in previous privatization plans. In Croatia, the State holds a minority stake in over 600 companies and more than 50 per cent of assets in over 60 companies. Seeking to leverage increased investor attention on the back of its accession to the EU in 2013, Croatiais set to reinvigorate its privatization drive. 

Both in ows and out ows are expected to rise further. FDI ows to transition economies are expected to continue to grow in the medium term, reecting a more investor-friendly environment, WTO accession by the Russian Federation and new privatization programmes. FDI from developing countries is also expected to rise further, aided by joint initiatives to support direct investments in some transition economies. For example, CIC, China’s main sovereign wealth fund, and the Russian Direct Investment Fund (RDIF) agreed to contribute $1 billion each to an RDIF-managed fund. The fund will make 70 per cent of its investments in the Russian Federation, Kazakhstan and Belarus. 

In 2012, CIC bought a small stake in VTB Bank (Russian Federation) as part of a deal to privatize 10 per cent of the bank. However, FDI in ows in the rst quarter of 2012 are slightly lower compared with the same period in 2011.

More investments from Asia and the Russian Federation. By source, the share of transition economies in in Hows to LLDCs increased from  6 per cent in 2010 to 19 per cent in 2011 (table E). This was due to the $7.2 billion in investments (27 projects) from the Russian Federation, in which the $5 billion investment in Uzbekistan (table II.5) accounted for 70 per cent.

The Russian Federation relaxed the approval requirement for foreign acquisitions in companies that extract subsoil resources, from 10 per cent of shares to 25 per cent. e

The Russian Federation issued a decree appointing investment ombudsmen, one for each of the country’s eight federal districts. The decree states that ombudsmen are meant to assist businesses in realizing investment projects and to facilitate their interaction with authorities at the federal, regional and local levels. c

The Russian Federation amended the federal law “On mass media”. Foreign legal entities, as well as Russian legal entities that have a foreign share exceeding 50 per cent, are prohibited from establishing radio stations that broadcast in an area covering more than half of the Russian regions or in an area where more than 50 per cent of the country’s population lives. g

World Investment Report 2012:Towards a New Generation of Investment Policies

http://www.unctad-docs.org/files/UNCTAD-WIR2012-Full-en.pdf