Joan C. Hubbard, firstname.lastname@example.org, is a Professor of Business Administration at the University of West Georgia. Charles W. Hubbard HUBBARD@CC.Clayton.edu is a Professor of Marketing at Clayton College and State University and a partner in the Eagle Consulting Group..
INTRODUCTION AND PURPOSE
The collapse of Communism and the Union of Soviet Socialist Republics ended a myriad of restrictions to international trade in Russia. Since the iron-curtain came down, interest in the untapped economic markets of Russia has risen, and an influx of foreign investors are now hoping to tap into the 150 million-strong Russian market. The increase in economic activity has brought with it a rise in crime, rampant corruption, arbitrary taxes, and other problems. In many cases, the infrastructure of Russia seems ill-prepared for the capitalistic expansion taking place.
This paper presents an in-depth analysis of the various economic markets available to foreign investors in Moscow. In it particular emphasis is given to the following topics:
1. The current social and political climate of Russia;
2. The existing markets and competition in Moscow;
3. The legal factors that affect the formation and operation of a business;
4. Potential capital and investment markets and the potential problems that may arise in the course of breaking into the Muscovian market.
BACKGROUND OF BUSINESS IN RUSSIA
A variety of factors combine to make starting a new business in Russia unlike any other business undertaking.
One cannot evaluate the business climate in Moscow without considering the geography of Russia. Even after splintering into 16 different nations when the Soviet Union collapsed, Russia is the largest country on Earth. Unfortunately, much of it would be considered uninhabitable by many Westerners. It is a land of extremes that encompasses nearly every climatic type, from arctic to sub-tropical.
The capital city of Moscow lies in the heart of European Russia, with a latitude roughly equivalent to that of the Hudson Bay in Canada. First mentioned in Russia chronicles in 1141, the city had a population of approximately 10 million in 1995 (Microsoft Bookshelf, 1995)
The enormity of the country, as well as its climate, combine to make a business trip to Russia quite an adventure. Very few paved roads exist outside Moscow, thus much traveling must be done via dirt road or on a train. Westerners used to the relative ease of getting about in their own countries may find these a considerable inconvenience.
In 1917, the Communists took over a country that was, in many ways, a hundred years behind its European neighbors. Approximately 70 years later, they gave up a country almost as far behind. During the Soviet years, the Russian economy was based upon Communist models of efficiency. Unfortunately, the collective farms and other Soviet plans never performed as expected. A well-known example of this inefficiency was the fact that private garden plots (one of the only Communist concessions to privatization), while only a tiny fraction of the farmland in Russia, accounted for a large percentage of fresh vegetables available in its markets.
Dissatisfaction among its citizens grew during the Eighties despite Mikhail Gorbechev's attempts at "perestroika" (openness). The Soviet Union was officially dissolved, and the Communist "experiment" came to an end on December 31, 1991. [Microsoft Bookshelf, 1995]. Russia's Democratic "experiment" is now underway.
It should not be forgotten that Russia went from centuries of Imperial rule under the Czars to decades of Communist control. Never in Russian history have the people shouldered the responsibility for so many of their own decisions as they do today. Until now, democracy and the free-market have been virtually unknown to the Russians.
Political Climate in Russia
Analysts and investors are surely concerned and interested in the outcome of a presidential election in the United States. They are interested in the political leanings of the candidates and what effects their policies may have on the economy. Despite this, there is never really any concern that the election may result in total political, economic, or social upheaval. Compare this to the recent elections in Russia.
Boris Yeltsin, the only president Russia has known since the breakup of the Soviet Union, was severely challenged by a communist candidate. This candidate promised to re-institute many of the communist systems that Yeltsin had dismantled during his tenure. Outsiders wondered, with more than casual concern, what would happen if the communist was victorious.
This concern manifested itself in many ways, including a sharp decline in the Russian stock market, and a decline in foreign investment. Keeping in mind that peaceful exchanges of power have been a rarity in Russian history, the world looked on anxiously to see if it could be done.
Yeltsin was ultimately victorious, and a sigh of relief rippled through the Russian economy. In fact, the ripple was more of a tidal wave, as the market saw a whopping 170 percent gain from March to June [Podplatnik and Skatershchikov, 1996, 1]
Russia may have dodged the proverbial bullet, but it is inevitable (considering Boris Yeltsin's health, perhaps sooner than later) that an exchange of power will take place. As frightening as it may seem, there are doubts that any formal procedures exist for transferring power in one of the world's mightiest nations. Only time and successful elections are likely to convince the world the the new Russia is a stable political entity. (Perhaps in the late 1700's, similar thoughts were entertained regarding that formal British colony now called the United States of America.)
Political Climate in Moscow
In 1992, Boris Yeltsin appointed Yuri Luzhkov the Mayor of Moscow, and in the words of Alessandra Stanley in the New York Times, "he has been running it as his personal fief ever since" [Stanley,1996a, 1] Luzhkov is an enormously popular mayor with a reputation as a man who gets things done. He was re-elected, receiving 90 percent of the vote. The newly renovated churches and other successful projects are a testimony to his can-do spirit [Stanley, 1996b]
Luzhkov's efforts may seem overzealous at times. He has been known to fine merchants whose store windows are ugly, and order the police to pull over cars that show "technical disrepair or blemishes" [Stanley, 1996a, 1) Despite these eccentricities, he has proven himself to be committed to urban renewal, a champion of Moscow's reemergence, and an early favorite of the people to succeed Boris Yeltsin in the year 2000 elections.
Crime and Corruption
Crime is rarely a "new" occurrence and, despite the standard "party line," the Soviet Union was hardly less plagued with crime than the West. As a journalist from the Moscow Times explains, "Even during the Brezhnev era, as soon as the private wealth began accumulating in the recesses of the shadow economy, the predators appeared." [Bernstein, Gubsky and Yudin, 1995).
Unfortunately, as wealth has moved out of the shadows, so has an even more prominent criminal element. According to studies performed at the beginning of the Yeltsin presidency in 1994, "all retail stores, restaurants, cafes, kiosks, clothing markets and auto importers, along with 70 to 80 percent of privatized enterprises and commercial banks, were making protection payments to criminal gangs" [Bernstein, et al., 1995]
On July 16, the latest crime bill was signed into law in Moscow. While it may contain measures to assist in dealing with small-time criminals, experts doubt it will have much effect on organized crime. As Lt. Col. Sergei Adzhigev, the chief of Police Station Number 69 in Moscow, stated, "the guy who sits deep in the hole only sees the edges. It's not what the person looking down from the mountain sees. But from my perspective, nothing has changed, and nothing is going to change any time soon." [Stanley, 1996b, 3]
According to many experts, dealing with the problem of "protection" is one of the gravest problems facing Westerners in Moscow. The consensus seems to be, "be prepared." Many Western corporations working in Russia have reduced their risks by organizing their own highly professional security teams. Businesses, they say, should follow common sense standards: Keep a low profile, advertise carefully, be cautious in banking activities and choose employees carefully. Nonetheless, some may still find it necessary to succumb to the pressure. According to the American Chamber of Commerce, a recent anonymous survey of 130 foreign firms in Moscow found that 19 had been offered "protection," but only one admitted making payments. [Bernstein, et al., 1995] This of course begs the question, how many chose not to admit it?
In this environment, even the well connected are not immune. Organized crime in Russia may be unavoidable, but it is manageable. If knowing is half the battle, then even the savvy Western business may find its hands full when dealing with Russian corruption. ["Coping with the Mafia," 1994]
EXISTING MARKETS AND COMPETITION
The vast economic reforms that have taken place in Russia over the past few years have created many opportunities for foreign investors. In order to examine which markets are most attractive to enter, it is helpful to analyze the market demand for various goods and services, as well as the extent to which that demand is being satisfied by current supply. Those markets which feature a high demand and a relatively limited supply offer strong opportunities for success for those firms which enter the market and provide the sought-after goods or services. This section will analyze and discuss markets that fulfill this criterion. Firms electing to do business in these promising areas can expect to experience outstanding financial rewards.
Office Furniture Market
Office furniture is one type of product that has been in great demand over the past few years. In modern Russia, businesses start and go out of business every day. This instability has made the Russian citizen hesitant to do business with many companies. One way companies try to alleviate this fear of instability is by equipping the office with prestigious furniture. This show of prosperity seems to instill confidence in the customer. [Soskin, 1995a]
In the old Soviet system, there was very little demand for nice office furniture. Offices were equipped with standardized, utilitarian furniture. Because of this lack of demand, no Russian companies manufactured high-quality office furniture. Although domestic companies are trying to enter this new market, they have met with little success due to their inability to produce furniture of a quality comparable to that of imports. Therefore, Russian companies continue to look to foreign vendors to supply this type of furniture.
Although considerable competition is present, this market is far from being saturated. Because of these factors, the business of selling foreign-produced office furniture in Russia is attractive to enter.
Another good strategy for capitalizing on this high demand for furniture would be to form a joint venture with an existing Russian furniture producer. Several possible advantages to this approach exist. Domestic producers usually have a skilled workforce and are knowledgeable about local preferences. The only things they lack are financial backing and state-of-the-art equipment. Many key mechanical components and synthetic finishing materials are not produced in Russia. An American company able to furnish these needed components could experience a rapid return on its investments. [Soskin, 1995b]
Another area of opportunity is computers. The demand for computers and related products is one of the most rapidly growing sectors in Russia. It is estimated that by 1997, 27 million computers will be in the Russian market. [Parshukova and Weaver, 1995] The computer field encompasses both software and hardware. The hardware side of the market has been more fruitful than the software. Because of this, more firms have focused their attention to the sale of hardware. Although the hardware section has received more consideration, firms should not be discouraged from attempting software distribution.
Moscow is one of Russia's major computer-oriented cities. The Russian government determined that development of a free enterprise economy was unattainable without complete computerization of their system. During 1994 and 1995, the government developed a federal program for computerization of its agencies and public institutions to support implementation of economic and political reforms. ["Computer Peripherals,"1995] Now approximately one-third of the computers are purchased through a government agency [Parshukova and Weaver, 1995]
In recent years, a surge in demand for name-brand computers and related items has been satisfied with imports. According to some experts, imports have provided up to 90 percent of the supply of computer monitors. [Parshukova, 1995b] By 1994, the share of name-brand products increased to 20 percent of total computer sales, then rose to between 25-35 percent in 1995. [Minkevich, 1995] With this type of growth, firms could easily profit from targeting name-brand products.
Hardware sales: A hardware firm would have many options to consider in Moscow. Such options would consist of selling printers, monitors, adapters, hard-disk drives, uninterruptable power supplies, and modems/fax-modems as they are all in high demand. An expansion in computer owners has increased the number of buyers of hardware products. Local hardware companies in Russia are mainly computer assemblers. Their business is increasing along with their need for hardware. A firm could capitalize by specializing in wholesaling hardware to these companies.
Software sales: Examining the software side, companies should use caution. With the growing demand for computers, the demand for computer software has grown as well. But the most common means of distribution of software has been illegal copying (piracy). Although the percentage of pirated software dropped by four percent, from 98 to 94 percent in 1995, computer piracy remains a major concern for U.S. companies. [Parshukova, 1995a] Few firms have concentrated on targeting software sales for this reason. However, increased demand for name-brand computers should start to curb this frenzy of piracy. Most name-brand computers come with pre-installed software that spurs owners to purchase legal updated versions of the software. [Minkevich, 1995]
Companies offering after-sales service, along with quality products will reap rewards from their labor. End-users are realizing the importance of quality computers to meet their needs. With the number of purchasers of computers increasing every year, firms should recognize the vast opportunity available.
The telecommunications market is another area that has yet to be developed to its full potential. In fact, the demand for quality communications far outstrips the available supply. The infrastructure of telecommunications is outdated and unable to supply the Russian people with adequate service. Because of this, the Russian level of performance in telecommunications is far behind that in much of the industrialized world. Only about 60 percent of every 100 people in Moscow have access to a phone, while as few as one in 1000 have access in some remote areas. [Malkov, 1995b] Waiting time for telephone installation can range from one to 12 years, and even those lucky enough to obtain a phone can successfully complete inter-city calls only five percent of the time. [Malkov, 1994] Given the importance of telecommunications in developing the new economy, the need for improved telecommunications service is readily apparent.
Cellular phone communications: The rapid economic changes in Russia have dramatically increased the demand for mobile communications. One segment that has expanded the market is cellular phones. Prior to 1992, no cellular service existed in Russia. ["Cellular Telecommunications Equipment," 1995] With the introduction of cellular phones, there has been a strong demand for cellular service representatives.
Paging communications: Paging communications has become the fastest growing telecommunications business in Russia. This swift growth is due to the fact that paging services are available at a lower price than are other mobile communications options. The potential is great for larger numbers of customers than are currently using paging services. In Moscow, currently 25,000 people subscribe to paging services, but various sources estimate a potential 200,000 to 300,000 subscribers. [Malkov, 1995a] This enormous potential should give firms an incentive to increase their presence in selling paging services.
One factor that has kept telecommunications from reaching its full potential is that the price for paging in Russia is still high compared to other countries with established paging services. In order to reach the full potential of subscribers, a decrease in prices accompanied by high-quality service must be introduced. Therefore, a foreign firm able to provide lower prices and quality service will be in a good position to capitalize on the large demand.
The aforementioned markets are only a select few of the numerous and promising opportunities available to companies willing to enter the Russian market. Currently many markets exist in Russia in which the supply is inadequate to meet the growing demand. Those companies that establish themselves in these markets can expect prosperity for years to come.
LEGAL FACTORS CONCERNING FORMATION AND OPERATION
Many legal factors affect the formation and operation of a business in Moscow, ranging from finding a location to registering with the Russian government. When entering the Moscow market, the first problem that will be encountered is finding a good location to establish a business. Foreign investors might want to find a Russian real estate agent to help search for a good location. After deciding which area to set up the business, the investor must consider and understand zoning restrictions that may apply. Due to different levels of taxation, setting a business up in some areas costs more than in others.
Steps to Set Up a Company
The Russian government has established a set of steps that foreign investors have to follow before they can begin to operate their business. The first thing that must be done in order to set up a business is to register the company as a business involving foreign investment. Registration can be administered by the Chamber of Commerce, Moscow Registration Chamber, and other organizations that have this role. If the planned investment exceeds 100 million rubbles, a separate notification or registration with the Russian Government is likely to be necessary. ["Russia: Economic," 1996] Documents required by the Russian government usually request information as to the field of activity or operation in which the business intends to engage. The documents also require information about the number of people involved and the size of the investment.
Laws Concerning Operation
Investors must also be aware of and follow laws concerning the operations of their business. The logistics of opening an office in Russia are no different in principle from those than in any other place: get oriented; make initial contacts; find an office and a place to live. [Steffens, 1996c] Probably the most important thing will be to make contacts. In Moscow, different laws can affect decisions, decrease efficiency, and slow operations; therefore, making contact with lawyers who understand these areas of law and making contact with the U.S. Business Network in Moscow is very important. Additionally, contacts with any Russian companies, Russian lawyers, and Russian accountants will help familiarize the investor with different accounting requirements and other business-related laws. By understanding the Russian tax laws, inadvertent violation can be avoided.
Investors should then concentrate on protecting their business by adopting a trademark. The Law on Trademarks, Service Marks, and other Signs of Trade was adopted on September 23, 1992, and it recognizes the use of trademarks. Applications for trademark registrations are filed with the State Patent Agency. ["Russia: Economic," 1996]
Next, the company must register for tax inspection. Financial and commercial activity will be audited for taxation purposes. Any accounting and reporting has to be conducted within the rules and regulations of the Russian Federation, and foreign investors should consider obtaining legal help to clarify these rules and regulations concerning tax laws. Foreign businesses are required to submit balance sheets with their currency converted into the ruble. Since the investor's company will be a resident company, which includes 100 percent wholly owned subsidiaries and joint ventures, it will be permitted to have a ruble account and a hard currency account in Russia. ["Trade Overview," 1996] Foreign investors may also convert rubles to dollars through authorized banks or through currency exchanges if they have a signed contract for the import of goods or equipment for hard currency. ["Operations," 1995] After exchange regulations are satisfied, profit generated in the foreign currency may be repatriated after taxes are paid. ["Russia: Economic," 1996]
The company will also be subject to many different tax laws, including taxes on imports and exports. An import duty or tariff, Value Added Tax, and an Excise Tax are some of the taxes on imports that the company will face. Customs procedures are constantly being revised and need to be followed closely by U.S. exporters. Unfortunately, although companies may follow the letter of Russian import regulations, receiving authorities will often give conflicting accounts of present requirements. If exporting, the company will have to sell 50 percent of its export earnings to one of the interbank currency exchanges and then pay taxes on the earnings. Russian customs authorities will require supplementary documentation, such as a copy of the contract between the exporter and the coassignee, before allowing the shipment to enter Russia. [Steffens,1996a] The Valued-Added Tax is applied to nearly all goods imported into Russia. It usually has a standard rate of about 20 percent, and import rates usually range from about 5 percent to 35 percent and sometimes even higher. [Robinson, 1996] For example, the excise tax on goods considered to be luxurious, such as cars, jewelry, alcohol, and cigarettes, has reached as high as 250 percent. ["Operations,"1995] However, tax laws and tariffs are still changing and evolving.
Legal practices in Russia can be quite a culture shock to a foreign investor. Several commercial and legal commentators have noted that Russians and Russian firms sometimes have a rather different view of the "contract" than do foreign firms. ["Russian Trade." 1996] One important thing to remember when considering doing business in Moscow is that contracts are not taken as seriously as they are in the United States. Usually, when contracts are disputed in the courts, less weight is given to the written document compared to the weight given to any oral agreements that might exist. Contracts serve more as a statement of mutual intentions rather than as a strict legally binding document.
If any disputes should arise, Russia's form of dispute resolution and alternative dispute resolution methods will need to be studied to get an understanding of how it could affect business operations. Usually when a dispute arises between a company and the government in Moscow, arbitration by the Russia Federation will be used. The arbitrators will review any international laws and treaties that may have an effect on bringing about a reasonable decision. However, maintaining a good relationship is more important to Russian firms than the fulfillment of a contract. [Raisner, 1996] It is advised that when foreigners are looking for legal counsel, they should be very careful because the attorney-client relationship in Russia is not characterized by the degree of trust that Western lawyers usually maintain.
Investment in Moscow and in Russia as a whole is being stimulated by its government. A Bilateral Investment Treaty and Trade Agreement between governments was established to try to reassure U.S. investors operating in Russia that investing in Russia is both safe and profitable. The Treaty permits total ownership of a business and states that if the business's capital exceeds 100 million rubles, foreign investors might get to exempt registration with the Russian Agency. [Steffens, 1996b] Some decrees were also issues to simplify the process of registration. For example, President Boris Yeltsin attempted to simplify the process of business registration in Russia by requiring business to make an official application and to submit, either in person or by mail, the following: a) the company's foundation documents; b) documents of incorporation (notarized by a notary public); c) a receipt of fee paid to the Russian Government; and d) proof that more than 50 percent of the company's charter has been paid ["Russia: Economic," 1996] Also, according to the Decree, companies whose start up is 500 million rules or above must register with the Anti-Monopoly Committee. ["Russia: Economic," 1996]
Restraints Affecting Business
Once the investor has properly established the business and followed all the necessary steps, the operation of a business in Moscow must be understood. One factor that might have an effect on a business' operations is the complicated advertising laws. Until now, advertising has been relatively free of government control. However, the growth of advertising since the collapse of the Soviet Union has been remarkable. It has gone from an estimated $250 million to $900 (U.S) million. ["Advertising Overview," 1966]
The restraints on advertising in Russia are closely related to those of the United States. Some differences that exist are the ways in which the Russian government would look at an advertisement. For example, use of the radio, television, video, and cinema products, and also printed materials cannot make a deliberate attempt to draw the attention of the consumer by "implying" something. Advertisements have to be readily understandable. ["Text," 1996] Unlike the way some advertisements are presented in the U.S., the brief display of a product across the television screen is a violation of Russian advertising law.
With such restraints on how a business can promote its product, incorporation into the market would be fairly difficult, especially if a competing company has been in the current market for a while. In Moscow, and in all of Russia, people have very strong brand loyalty to certain brands, even if the brand is of poor quality. Companies such as Philip Morris have complete control over their markets. They really do not have to make great improvements on their products because the people in Russia are unchanging in their taste. ["No Rush," 1995]
FINANCE AND INVESTMENTS IN MOSCOW
In the course of setting up a business enterprise in Moscow, an investor should explore the vast array of financing and investment opportunities this market provides. The current privatization and deregulation programs of the Russian government have opened avenues for obtaining public and private sector financing for the business entrepreneur. To present a better understanding of this concept, the Russian financial markets will be analyzed, focusing on the following as they relate to establishing viable economic sectors:
3. Investment and Banking
4. Government Policies and Its Effects on the Economy
After communism collapsed, the Russian government sought to open its market to local and foreign investors by selling shares in important industries. Decades of totalitarian rule had destroyed any knowledge of democratic capitalism in Russia, and the government was now faced with the task of extolling the benefits of its privatization programs in order to win public support. In Moscow's evolving business markets, investors are now given unprecedented leeway in owning property, controlling companies, directing management, and determining compensation and tenure of employees, without the previous requirement of multiple government clearances. [Sorenson, 1992] Russia set about privatizing its major industries in two phases: the voucher privatization phase and the capital investment phase. These phases were introduced to help win the support of foreign governments and investors for Russia's emerging markets.
Voucher Privatization: Beginning in the Spring of 1992, the voucher privatization program was aimed primarily at transferring the ownership of State enterprises into private hands without the need to infuse additional capital. The redistribution process began with the government issuing to investors vouchers with a face value of 10,000 rubles to be used to purchase company shares or to invest in capital funds operated by private entrepreneurs. As a result, more than 30,000 enterprises have gone public, most joint-stock ventures, with about 100 million investors participating in its first two years. [Smirnoff, 1994]
Capital Investment Phase: The second phase of the program was designed to consolidate the efforts of the voucher privatization by helping attract new capital to local enterprises. [McCarthy, 1995] The ability to obtain capital funds is an important consideration for firms hoping to set up in Russia, and the success of this program has significantly contributed to the sustained influx of business into Russia.
With privatization and industrial restructuring, firms would have to be productively efficient to remain in the market. Newly privatized firms operating on limited equity and loans have had to cut operating costs and lay off workers in order to remain competitive and solvent.
The resulting wave of retrenchments is relatively new to Russia, and it has led many to call for a return to communist rule, under which jobs were assured despite a lack of productivity. This was possible because most companies were subsidized by the State. The privatization process has remained the only vehicle in place to transfer ownership to the private sector in Russia. The program has encountered several problems, including the low face value of the vouchers, unrealistic formulas and valuation methods, and the growing black market; however, it has succeeded in opening new avenues of business financing and investments, as is described in this article. [Smirnoff, 1994]
Financing and Capital Formation
An important factor to consider in seeking business financing in Moscow is the form of business enterprise an investor plans to establish. In recent years, joint-ventures have increased, largely because of the smaller degree of liability involved since investors share business responsibilities with their partners. Many foreign investors, including the McDonald Corporation and Polaroid Pictures, have opted for joint-ventures with Russian nationals to limit their liability in the event of huge losses. Obtaining financial resources has proven very difficult in Moscow, as few banks are willing to lend to firms not yet established in the local market. Very few credit houses and venture capitalists operate in Russia. As a result, foreign firms have resorted to using short-term financing provided by government agencies, as well as foreign loans. These loans have proven to be a disadvantage because of excessive interest rates lenders charge in order to cover a high rate of inflation and the risks associated with the doing business in Moscow.
To alleviate the problems of financing and cash management, the Russian government has in recent years put in place fiscal and monetary policies aimed at influencing the money market. Also, many foreign governments, understanding the huge potential for their exports in Russia, have instituted loans and grants to indigenous firms as an incentive to enter the Russian market. An example of this is the $2.5 billion set aside by the U.S. government-sponsored Overseas Private Investment Corporation for loans to American companies venturing into doing business in Russia. [Lancer, 1995] With careful planning and due consideration of banking and financing options, a firm can benefit from the limited financial resources available to investors in Russia. However, only firms with the financial capabilities needed to pursue long-term market investments will be the most productive.
Investment and Banking
The trend of the Russian financial and securities markets are greatly influenced by changes in both the exchange rate of the ruble and the government's financial-stabilization policy. Surprisingly, privatization vouchers issued by government have become relatively independent of the influence of the currency market. With sales of over $4 billion in the second quarter of 1995 alone, these vouchers have become the most attractive instrument to investors. [Voevodskaia, 1995]
The steady depreciation of the ruble has proven to be a deterrent to investment, and many prospective investors, scared of losing all their profits due to the the constant dismantling of exchange rate controls, have opted to stay out of Russia until financial stability can be anticipated. The exchange rate of the ruble to the U.S. dollar has also been on a continual decline, reaching a low of 4950 rubles to a dollar in December 1995, as shown in Figure 1.
The Yearly Rate of Exchange
Source: Market Research Reports, National Trade Data Bank (1995)
The Russian central bank, however, hopes that by implementing its refined financial-stabilization policy, the problem of the rapidly increasing rate of "monthly" inflation will be alleviated. (See Figure 2.)
The Monthly Rate of Exchange
Source: Market Research Reports, National Trade Data Bank (1995)
Short-term profitability has traditionally been the main incentive for foreign investors. In this regard, there has been a general tendency for foreign entrepreneurs to look first at those regions and industries that provide a quick pay off on investment in hard currency. They have found, as a general rule, that patience leads to profits in Moscow. [Zhuplev,1994] The key investment industries with relatively high yields in Russia include the oil and natural gas industry, communications, mineral extraction, manufacturing, and construction industries. Risk factors such as price volatility, political instability, less liquidity, and the significantly smaller market capitalization of securities plague the market in Russia. [Elgin, 1996]
Russia's future economic potential for international business will be based largely on its wealth of natural resources and untapped territories. The lack of proper banking infrastructure and the fledgling financial markets in Russia have made banking in Moscow very difficult, leading many foreign companies and even some Russian businesses with foreign investments to open accounts with foreign banks outside Russia. The inability of local banks to handle large credit transactions in foreign currencies and the severe liquidity crisis presently facing local banks have posed problems to foreign investors. With the improving economic prospects in Russia and the recent lifting of restrictions on foreign bank participation, major international banks, including Chase Manhattan Bank, Citibank, and Barclays of London, are seeking licenses to operate in Moscow.
Government Policies and Its Effects on the Economy
In recent years, the Russian government has set about liberalizing its business laws to encourage foreign investment. New regulations introduced to relax the stringent measures on foreign investors, coupled with the stable democratic political system, have succeeded in attracting entrepreneurs, with many experiencing huge growth.
In 1994, the Russian government, in meetings with leaders of major Western corporations, introduced legislation giving a five-year tax break to foreign investors with a guarantee that tax legislation would remain stable. [Huckstered, 1994] Laws enabling foreign companies to open investment accounts and current accounts in local banks have also been passed, and the government's application to join the Organization for Economic Cooperation and Development (OED), a move that requires it to remove all restrictions on capital flows in its economy and guaranteeing free international transfer of interests and dividends on capital invested in Russia, is seen as an incentive to increased foreign participation in the local economy. These measures are evidence of the of the Russian government's resolve to foster closer cooperation with the international community and have acted as a stimulant for foreign investment in Russia. [Raneko and Nikolayeva, 1996]
For additional information, see a list of tips for investors on doing business in Moscow in Appendix A.
Summary, Conclusions, and Recommendations
Great changes have taken place in all aspects of Russian life since the collapse of the Soviet Union. Despitei instability, the Russian marketplace is very active. The Russian government is putting much effort into encouraging trade and foreign investment, including constant revision of the laws and manipulation of the tax code. These efforts have succeeded; so the economy has been steadily growing.
The growing economy has opened many markets within Russia that were previously closed. Its wide-open markets have lured an increasing number of foreign investors to test the waters, but investors have experienced a wide variety of challenges, including rampant corruption, high tariffs, and insufficient communications and infrastructure.
While the potential difficulties may be discouraging to some potential investors in Moscow, an increasing number are choosing to invest in Russia.
From information provided in this article, the following conclusions can be drawn:
For investors to be successful in Moscow and, indeed, throughout Russia, they must realize that long-term financing and investments will enable them to obtain the full benefits of their investments.
Russia's privatization programs have made available various private and government financing opportunities in Moscow. Investors must work towards making proper use of these opportunities.
Investors with capital to risk should consider the Russian market. They should the observe the following guidelines:
Investing in Moscow is a complicated, potentially profitable move. While it may present significant gains in the short-run, long-range investing is a risky venture and should only be attempted after careful examination of the potential risks.
Note: If some of the URLs linked to below cannot be accessed by clicking on them, try typing in the URL yourself, leaving out all the address after the first backslash and access the desired page at this site from the page reached in this way.
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"Cellular telecommunications equipment," (It Market No. 111090289) [On-line] Washington, D.C., National Trade Data Bank (1995).
"Coping with the Mafia," Business Eastern Europe (October 24, 1994), 1-2.
Elgin, P., "Russian Roulette: The New Emerging Market," Pension Management (1996), 32(6), 4-6.
Hockstader, L., "Russian Premier Vows Tax Incentive to Lift Sagging Foreign Investment," The Washington Post (June 28, 1994): A19.
International Trade Administration,"Advertising overview: Russia,"(IMI950417) Moscow, Russia, Market Research Reports, (1995).
Lancaster, D. and Alex Knaster, Global Finance (1995), 9(6), 29.
Llaurado, J., "Highlights: Opportunities for improving the Russian Environment," Environmental Management (1995), 6(5), 4-6.
Malkov, Y., "Paging Telecommunications Equipment," (It Market No. IS9412.042), [On-line] Washington, D.C.: National Trade Data Bank (1994).
Malkov, Y., "Telecom Sector Profile," (It Market No. 961010.120), [On-line] Washington, D.C., National Trade Data Bank (1995a).
Malkov, Y., "Telecom Services Infrastructure," (It Market No. IS9509.577), [On-Line] Washington, D.C., National Trade Data Bank (1995b)
McCarthy, D., "Diamonds and rust on Russia's Road to Privatization: The profits and pitfalls for Western managers," Columbia Journal of World Business (1995),30(3), 56-69.
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Tips for Investors Doing Business in Moscow
The following are important tips for investors when doing business in Moscow:
Making contact: Serious investors should always appear in-person for business transactions. Russians are not used to the fast-paced, over-the-phone business practices of the West. The telex, fax, and even the telephone are relatively new technologies in this country, and there are instances where genuine business correspondence has been ignored because it went over and electronic medium.
Ethical Dilemmas: Corruption is becoming the norm in Russia's evolving business environment. The growth of the mafia, and local street gangs has produced a wave of extortion and murder. Solicitations of bribes and kickbacks are commonplace, but investors are advised not to give or take bribes, as it is a criminal offense.
Patience: Investors are advised to be patient. Russia has an extensive bureaucratic system, and the transactions that normally take a week in Western nations could drag on for months. The key is for investors to stay abreast of government regulations and try to establish long-term relationships. Personal contacts go a long way in speeding up the bureaucratic wheels.
Flexibility: Russia is presently going through an economic and cultural revolution in which lessons in capitalism are in equal parts economics and culture. Investors should try not to overestimate the business literacy of their Russian partners because this may lead to misunderstanding, frustrations, and undue delays.
Expenses: Moscow is widely regarded as the most expensive city in the world, surpassing Tokyo, Hong-Kong, and Singapore. Business expenses are extremely high: a reasonably-priced dinner costs between $40-$100 per person, while a modest hotel accommodation costs between $200-$500 a day. [Llaurado, 1995]
Caution: Moscow presently does not offer the legal safeguards and protections found in many Western markets; investors should be wary of how and with whom they do business. Russia is, however, in the process of setting up its own Uniform Commercial Code to govern business laws.
Quality Control: Maintaining quality standards is a difficult task facing businesses operating in Russia. Local producers often sell adulterated products in trying to curb rising costs. Investors should inspect their purchases before accepting delivery.
Photo Credit: (McDonalds in Moscow) Andrey Sebrant - http://gomoscow.miningco.com