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Russia and the WTO: The Private Equity Outlook

Russia’s ascension into the World Trade Organization signaled an expected, but nonetheless major, opening of the Russian economy. Russian membership in the WTO will dramatically lower tariffs for both Russian exports and imports into Russia. These developments, coupled with Russia’s growing middle class, global engagement through the 2014 Winter Olympics and 2018 World Cup, and market reforms, seemingly transform Russia into a hotspot for private equity investment.[1] However, the actual picture is far from rosy. Despite ending its holdout as the last G20 nation not in the WTO, Russia will continue to challenge private equity investors through both structural and legal barriers.

Many forecast the effects of Russian membership to be similar to those of China’s. After joining in 2001, China’s exports rapidly grew and its economy adjusted to meet the rising global demand for cheap Chinese exports. But simply put, Russia is not China. Though Russia’s economy is also based on exports, these exports are often commodities rather than cheap products buoyed by low wage costs. Additionally, state ownership and interventionism remains the norm in the attractive commodity sectors, meaning that Russia will be slower to adapt new reforms to compensate for the opening of its markets. [2]

This is particularly significant for private equity companies aiming to invest in Russia. While barriers to foreign investment in the crown jewels of the Russian economy (oil and gas companies) are unlikely to be removed, more foreign investment could flow into Russia’s manufacturing sector. Between 2007 and 2011, the manufacturing sector accounted for 51% of investment projects and 92% of job creation. Other similar sectors, such as the industrial and food sectors, also attracted a high number of projects and significant foreign investors. With newfound access to European markets, these sectors should experience an influx of private equity investment in the near future. [3]

Despite Russia’s economic structural limitations, private equity investors remain confident in Russia’s future growth. [4] The main reason for this confidence is Russia’s growing domestic market. Due to rising wealth levels, about 25% of Russia’s population now calls itself middle class. [5] This is a stark contrast to the oligarch-driven wealth gap that typified Russian society in the 1990’s and early 2000’s. Russian companies, already experiencing a trade surplus, will look to capitalize on the growing middle class rather than exporting to new markets. However, the specter of European competition in Russia’s markets will necessitate expansion and an influx of both domestic and foreign private equity.

While economic forces have seemingly aligned to attract investors, Russia’s culture of bureaucratization and corruption continues to ward off private equity. Additionally, the politicization of Russia’s economy also creates a major barrier for American companies. Currently, the US and Russia do not have normal trade relations due to the Jackson-Vanik Amendment, thus the US is precluded from using WTO mechanism to challenge Russia’s higher tariffs on American goods. Strict government regulation of foreign investment and corruption at all administrative levels further complicates private equity investment in Russian companies. However, investors who have already successfully navigated these barriers remain confident in future growth. For new investors, the risks may be justified by the increasing rewards of Russian companies expanding inward to a robust domestic market.

[1] Positive Outlook for Russian Investment as it Joins WTO , Ernst & Young Emerging Markets Center (Sep. 7, 2012), http://emergingmarkets.ey.com/positive-outlook-for-russian-inward-investment-as-it-joins-wto/

[2] Matthew Philips, Don’t Get Too Excited About Russia’s WTO Deal, Bloomberg Businessweek (Aug. 22, 2012), http://www.businessweek.com/articles/2012-08-22/dont-get-too-excited-about-russias-wto-deal

[3] See note 1, supra.

[4] Lena Smirova, Russia Climbs Up Investment and Business Climate Rankings, The Moscow Times (October 25, 2012), http://indrus.in/articles/2012/10/25/russia_climbs_up_investment_and_business_climate_rankings_18629.html

[5] See note 1, supra.

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Nikolai Karetnyi

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