RISK IS A NOBLE THING
Svetlana Pinkovskaya, economics columnist of Rotary Digest.
By 1994 the economic situation in Russia could be characterized as follows.
The volume of industrial production in 1991/94 decreased by 54%, manufacturing industry has decreased even more significantli. The greatest recession occurred in mechanical engineering, in the production of construction materials and light industry. In turn this process led to a deeper structural reorientation of our economy for exporting raw resources, with a simultaneous growth of import dependence.
The social sector is characterized by a deterioration of the standard of living.
Real incomes of the population in 1994 were 40-45% of the 1990 level, which resulted in a demand decrease in the home market. It dropped by 60-65%.
By 1994, Russia which had been a raw material resources giant, with a huge but in effective manufacturing industry, turned into a raw material giant. In 1995 and 1996 this process developed further, as evidenced by the data on the state of economy by early 1997.
Thus, in 1996, Russia was still in the state of depressive stabilization. The volume of gross domestic product reduced by 6%. According to some analysts, pre-conditions for economic growth have taken shape in the economy. But the results of development in the first quarter of 1997 show that this can be considered only theoretically. In reality, the government could not solve the grave situation (with businesses and the crisis in financial sector,) all of which resulted from the tough financial and credit policy which was drop in aimed at curbing inflation.
In 1997 the estimated rate of production in industry will be about 8% of its 1990 lerel.
Electric power production, fuel inductry, ferrous and non-ferrous metallurgy will remain more favourable areas for development.
The situation in chemical and oil-technical industry will remain difficult. In these sectors of industry the decline rate was higher than in the oil industry complex - about 11%. This was due to the decrease in exporting because of the change of the economic situation in the world market, and a further reduction of demand on the home market.
The main reason for this was the diminished demand on the home front due to the continuing crisis in investments. Another unfavourable factor is low the competitiveness of the products of most enterprises, due to the disparity with world standards. On the whole in 1997 a change in these sectors is unlikely. Some enterprises will stabilize their position it new technologies and higher labour standards are adopted.
The high rate of decline will continue this year in light industry because of low competitiveness of their products compared to similar imported goods, and because of the limited buying capacity of the population. From the point of view of attracting invesiment this branch is quite promising. The return on the investments in this sphere is not more than three years. Besides, on one hand a low saturation of the home market with quality goods for moderate prices, and on the other hand low satisfaction of the populations demand for these goods, a quick market for light industry goods can be quarinteed.
Another quite attractive sphere for investments is the services sptene. The rate of development of the share of services of the total volume of the GDP is steadily increasing. In 1996 this amounted to 3.8%. Compared to developed countries, the share of services in the GDP is low, so it is highly probable that this sphere, especially those sectors which are connected with the market, will develop.
An assessment and forecast of the economic development of Russia for 1997 show that a substantial improvement is unlikely. Quick and high profits from investing in the Russian economy cannot be expected either.
It is interesting to consider strategically prospective spheres for investments. Here the information from the World Economic Forum and the International Institute of Management and Development (Lauzanne, Switzerland) may be quite useful.
These organizations rate the competitiveness of cantrie in the international economy. Russia's competitiveness was assessed for the first time in 1995. It placed last (48th).
Scientific-technical potential and labour resources were marked in the rating as the strongest points of the Russian economy, and the role of the state in the economy, the on system of management and the credit-financel sphere were marked as the weakest.
Competitive branches of Russia's economy are aerospace, instrument making, shipbuilding, and some other sub-branches of military-industrial complex.
The government is attemoting to support and develop these branches. But, from the point of investments, the branches of fuel-power complex will remain attractive in the neart Puture. This can be explained by the demand for the products of these branches in the foreign market. Telecommunication and communication also present opportunity for investment at present. This sector of Russia's economy is going through the period of growth now.
Big hopes for the stabilization of the economic situation and the beginning of growth are count ring on the changes, in taxation and tariff policy of the government. The Taxation Code is slated to appear not later than early 1998. It will lead to the simplification and reduction of the size of taxes imposed on manufacturers.
As for the tariff policy, it is proposed thet manufacturing tariffs are which excluded will benefits the population in electricity and transport.
Financial Market of Russia
A private investor or a legal person may have several ways of investing money; government securities, shares of enterprises and separate investment projects.
The market of government securities, as everywhere in the world, is the least risky. Its economic situation and profitability are closely connected to the political situation in the country in general, and to the financial policy, in particular. Opposite to this, the home market of government securities has been the most profitable instrument of investing money until recently.
This was closely connected with the aims of the government's financial policy. These securities were used as an instrument for the redistribution of the money supply for social needs and consumption. But due to this situation, new and serious problems arose in the sphere of investment.
The market of government securities is represented by government treasury bonds (GTB) and bonds of the federal loan (BFL), whose profitability at the beginning of 1997 reached 30-38% per year. Until recently they have been the most profitable financial instruments.
During some periods of 1996 with the fluctuations in the political sphere (election of President and his illness last year), market speculations caused the profitability of these securities to rise 150-200% per year. But this profitability was naturally connected to a high degree of risk.
S.Dubinin, Chairman of Central Bank, believes that the profitability of the GTB market should exceed the annual inflation rate by 4-5% only. That is the government and the Central Bank (CB) are planning the state bonds profitability to be not higher than 20% per year. A 15% tax on the profit from the operations with these securities was also introduced in January 1997.
In 1996 foreign investors got access to the GTB market and strongly influenced the profitability of these securities. Russian investors regard them as strong competitors. Their share of participation in this market is estimated by specialists as 20-25%. The peculiarity of foreign investors in the GTB market is that they prefer, in conditions political stability, to buy GTB of all series, and keep them until repayment. As foreign investors are non-residents, the profitability for them was 25% per year, but at the end of 1996 it fell to 13%.
Another financial instrument on the Russian securities market are the bonds of the government savings and loan (BGSL). The profitability of these bonds, as well as of GTB-BFL, fluctuat under the influence of political events. At the beginning of the year the BGSL interest rate was 72%. In June, before the elections, it rose to 164%, and by the end of the year it fell to 32.66%. In early 1997 the profitability of BGSL was 33% per year.
According to the Ministry of Finance, this rate may well correspond to the market conditions and fulfil the requirement to decrease profitability set by the government. In 1997 the Ministry of Finance is planning to maintain the profitability of BGSL a little higher than the inflation level. The most probable profitability of these securities will be within the range of 25-30%.
The Ministry of Finance plans to extend the borrowing time both on BGSL and other securities, and this year already the bonds of savings and loan are likely to be distributed with the term of circulation as long as two years.
The warrant period will be extended to a minimum six months, that is, the income on BGSL will be paid not every quarter, as it is done now, but twice a year.
Other financial tools whose profitability greatly exceed inflation are shares of privatized enterprises. Experts on the financial market emphasize that the value of the growth of portfolios made up of shares of different enterprises ranged in 1997 from 50 to 150% per year, while some participants succeeded in earning 90-100% per year in foreign currency.
With a few exceptions, dividends on shares of enterprises are not high at present. Therefore the main aim of purchasing them, especially by foreign investors, is strategic: the purchase of property which will grow in value with time.
Many analysts forecast success to the stock market already in 1997. First of all, it will be due to the fact that in 1996 Russia was awarded a credit rating. This considerably increasel the attractiveness of Russian shares for foreign investors. During 1996, Russia held the highest position in the list of developing markets. The value growth of Russian shares was 142%.
The stock market is developing and this, in turn, favours the attraction of foreign investors. In 1996 there were practically no legal problems in the work with shares, the sabmission time for shares by private investors and receiving money from these operations decreasal to 2-3 days. All the questions connected with corporate shares are controlled by the Law entitled "On Securities Market".
A considerable revival of the stock market is possible with the continuing privatization of enterprises, which will lead to the expansion of the market. But now, in the opinion of foreign investors working on the Russian market, it is not ready for big sums of investments. They believe that the growth of the market is also restrained by an imperfect market infrastructure.
Shares presented on the world securities markets as American depository receipts (ADR) are in the biggest demand. These are the shares of LUKoil, Mosenergop, Purneftegasp, Surgutneftegas. The shares of these corporations are leaders on the market. In 1996 they gave from 163% per year in foreign currency (LUKoil) to 440% (Surgutneftegas).
According to the estimation of experts working on the share market there are three major groups enterprises with the highest attractiveness for investors.
Shares of enterprises the so-called "blue counters" form the first group. These are highly liquid shares of the leaders of national industry released in big quantities into free circulation. They are the most sensitive to political fluctuations, legislative changes and the policy of the Central Bank.
The main conditions of joining the group of "blue counters" are the following:
First, the enterprise must represent one of the largest national monopolies (fuel-power complex, communication, transport) or a financial-industrial group. At present there are the following financial-industrial groups on the Russian market: "ONEKsim", "Menatep", "Alfa", "Incombank", "Rossijsky Credit", "Gasprom" and "LUKoil". Second, the firm must take care of the development of the market of these shares.
At present the group of "blue counters" includes the shares of seven enterprises: "UPS of Russia", "Mosenergo", the LUKoil company, "Norilsky nickel", "Rostelecom", "Surgutneftegas", "Gasprom".
Their profitability index during 1996 doubled on the average.
The second group includes shares of enterprises with a high growth potential. These shares are of interest from the point of medium-term investing.
As a rule their issuers are enterprises involved in the sphere of interest of financial-industrial groups and monopolies.
The third group includes shares of enterprises in branches of growth where a revival of the economic situation can be observed. At present these branches are energetics and telecommunications.
They may be interesting to potential investors because of their transparency, and investing in them has comparatively low risk.
At present both Russian companies and about 60 foreign firms work on the Russian stock market. Their investment share in Russia does not exceed 6-7% of the total assets. These stocks form their portfolio both of state securities and shares of the first and the second echelon. As a rule foreign investors keep shares in these portfolios for 3-5 years, because investments into these securities are considered to be strategic.
Foreign shares which are controlled by Russian companies function on the stock market more successfully. This is explained by the fact that Russian specialists feel better about the specificity and peculiarity of situations both in the economic and political areas. This allows them to control the investment portfolios more effectively and minimize the risks.
The market of investment projects has been developing successfully lately. It is mainly aimed at the direct investments of foreign capital into the Russian economy.
Still, most specialists note that the existing market is imperfect due to the shortage of real and well-grounded projects. Besides, many of the authorities of enterprises are not ready to work with investments.
The main problem here is the disparity between the expectations of western investors and their Russian partners. The Russian partners usually consider investments as a certain charity action, with no obligation for them to report back to the investors on the aims and ways of their spending.
Second, the shortage of information about Russian companies and the disparity between the Russian system of book keeping and accounting and the world standards present a big problem. The Russian accounting system, in the opinion of western specialists, does not give a qualitative characteristics of business. Different algorythms on similar directions of assessing the activities of enterprises do not give foreign investors a real picture of these companies'. For the same reason it is difficult to assess the reality and the expected effect of the proposed investment project.
Third, the guarantee mechanism for medium-term and long-term investments is absent.
All this makes the investment of capital into concrete investment projects rather risky.
On the whole, if a foreign investor wishes to invest into a certain project, he should take into account the following:
Big projects have, as a rule, a long term of recoupment and can be attractive only from the strategic point of view. They are of interest from the point of view of strengthening their positions for the future. Such projects need considerable money and the company which works on the project should be in a position to influence the economic situation. It is possible to fulfil these conditions only being in close interaction with the authorities. At present long-term projects can become real only if their aims join those of federal or regional development programs.
From the point of view of profits from investments projects with the recoupment term of up to 3 years are of more interest. It is important to note that these should be the projects for the enterprises of those sectors where the market for the products is guaranteed. At present there are several such branches ( see the table). The communication and telecommunication branches may be of interest for investors due to the following:
Their quick development results from a number of reasons. The level of their development does not correspond to the world standards. But if the country enters the world market as an active partner it should possess a suitable level of information support. This conditions and guarantees quick development of telecommunication and communication in the nearest years.
Another category of attractive sectors are the ones which guarantee a market for their products. These are food and chemical industries, production of construction materials and pulp-and-paper industry. The interest in the latter two branches is explained by the low price of raw materials.
The application of modern technologies at the enterprises (mainly medium and small ones) of these branches will allow them to obtain (given low primary investments) rather high profits, and to enter the world market.
The main act regulating the activities of foreign investors on the Russian market is the Law of the Russian Federation: "On foreign investments in the Russian Federation", which came into effect in 1991. At present there are a great many additions and amendments to it. In the first quarter of 1997 provisions to the Law were introduced which concerned preferential tariffs and tax exemptions for foreign investors, large-scale investments ( of more than USD100 mln), priority branches, industries and kinds of activities, and depressive regions.
The state is carrying on an active cooperation in the investment sphere on the world level. For example, cooperation is developing with the Organization of economic cooperation and development attached to the UNO, with some countries (France, Germany).
On the whole the volume of investments in 1996 was USD 6 bln, among them direct foreign investments - USD 2 bln.
In non-production branches, the volumes of foreign investments are growing in financial - credit activities, suchas insurance and pensions.
The main share of foreign investments - about 70% - is in the Central region as before, in other regions it does not exceed 5-6% .
The most active investors are the USA, Holland, Switzerland and Great Britain.