Vol 1 (2004) - Issue 3

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SMEs Entering Russia: The Economic and Political Climate

There has never been a better time to invest in Russia, almost regardless of the sector one operates in. The last five years, since the crash of the rouble in August 1998, have seen steady year-on-year growth of between 4 and 7%; inflation has fallen from 36% in 1999 to an estimated 13% now; and imports have risen by approximately 65% during the same period. That the picture is so comparatively healthy has something to do with the high price of oil in recent years, but most believe that the underlying trends are towards real stability.

One clear result of this macroeconomic development is a steady rise in living standards, most prevalent in Moscow but increasingly discernible in major cities elsewhere. Average disposable income in Moscow is something in the region of USD550-650 per month, and some 2 million Muscovites now earn more than USD20,000 a year.

That the average Russian is much better off than ever before has prompted a significant expansion of the retail market. Consumer spending is estimated to have reached somewhere around 250 billion dollars in 2002, and to be growing at between 15 and 20% per year. The retail market accounts for about 75% of this sum. In 2002 retail spending grew by 14% in nominal terms; this year growth is expected to be between 16 and 17%, resulting in a market worth some 140 billion dollars.

So market conditions are good, and many western companies have been taking advantage of them. The last year has seen some highly significant deals involving Russian and western companies. BP invested some USD6.75 billion in the oil company TNK, creating Russia’s third largest oil company, TNK-BP (many wondered how you could spend six billion dollars and still have your name come second). At the other end of the chain, Bentley opened its first dealership in Moscow, which is said to have immediately become its busiest in Europe, and Ikea opened its first superstore, also in Moscow and always busy. And the investment has not all been one-way. For the first time Russian companies have been making significant investments outside Russia: Norilsk Nickel, for instance, the country’s largest precious metals group, bought a controlling stake in a US palladium producer earlier this year - the first time the Russians have taken control of a US listed entity. And recent weeks have seen a Russian businessman increase his stake in the UK-Dutch steel producer Corus.

Economically, then, everything in Russia looks as rosy as it ever has done. Politically, things are a little more complicated. As anyone who has read a single copy of the Moscow Times will have learnt, every act has a political dimension in Russia; and while much of the economy can now operate without direct political interference, no business operating there can afford not to monitor political developments in Moscow and locally. Business is still definitely political, as Mikhail Khodorkovsky knows and many of his peers increasingly fear. And in the eyes of many observers, the only thing that might get in the way of Russia’s economic advancement at the moment is the uncertainty created by political instability of any kind.

This is a particularly striking truth for any small or medium-sized business looking to forge or develop a presence in Russia. For large businesses with a fairly short-term view (the banks) recent events are unlikely, they believe, to affect equity or debt prices significantly over the whole of the next twelve months; and long-term businesses (natural resources companies) many of which have made considerable commitments to Russia, see the Khodorkovsky affair as likely to prove only the smallest of blips in the country’s progress over the next twenty years. Whether these businesses are right is another matter, but for a moment this is an accurate statement of the general view.

In this light, the Khodorkovsky affair should be of real interest to everybody else for three reasons: because however it turns out it will have reconstituted the political and business landscape in a way more striking than at any time since Yeltsin stood on a tank outside the White House in 1991; because it is the first sign of marked potential instability affecting business conditions since the devaluation of the rouble; and because for small businesses even short-term changes in policy or even political atmosphere can seriously affect revenue and stability. SMEs, in short, cannot afford to be nonchalant.

On my trips to Moscow in recent months, Russian businessmen have talked of little else but Khodorkovsky; and the reason it is so important to them is that they feel that it could presage some huge change in the way business in Russia operates.