Investing in Russia

European Business Club, Investing in Russia Conference, Brussels

02 October 2001

I am very pleased to have the opportunity to address this forum today. I congratulate Seppo Remes and the European Business Club on your efforts to spread the word about the changing business environment and investment opportunities in Russia. I have always found the European Business Club an important source of advice and direct experience of the challenges facing business in Russia. We are privileged to have Vice Prime Minister Kristienko with us today: his personal commitment to this event underlines the important role your organisation plays in the EU-Russia dialogue on these issues. As we prepare for tomorrow’s summit with President Putin, I am sure that your discussions today will provide illuminating insights and ideas about the future direction of reform in Russia.

Russia is a European country with enormous potential. Potential for economic development and prosperity, for intellectual creativity, for research, for innovation and the application of new ideas. Thanks to efforts on both sides, we have made huge strides in recent months in transforming EU-Russia relations from a series of ritualistic meetings and declarations towards the sort of genuine strategic partnership to which we are whole-heartedly committed. The recent tragic events in the US have underlined how the whole international community needs to stand together in the face of new threats to our shared values. Russia has impressed many by her willingness to set history aside and to align herself solidly with the international coalition against terrorism. I hope this also opens the way to a peaceful resolution of the conflict in Chechnya.

Terrorism will naturally be a central theme of the EU-Russia summit tomorrow. But we also have an important economic agenda on the economic side of our relationship. And it is the questions on this agenda that are probably most relevant to all of you today.

The title of this forum is "Invest in Russia". Sadly, Russia still experiences difficulties when it comes to attracting investment. Levels of investment in Russia have been disappointing by comparison with other transition economies, with foreign direct investment averaging $20 a head between 1994 and 1999 (Hungary attracted over ten times this amount in the same period). The mismatch between Russia’s potential and its ability so far to attract productive investment is striking. One reason is that the investment climate has been characterised by uncertainty; many investors have had their fingers burnt by uneven application of unclear legislation. Moreover, there are few incentives to invest and in some sectors of the economy like banking or insurance foreign investment is deliberately limited by Russian legislation. A symptom of this poor investment climate is the vast quantity of Russian capital - up to $25 billion each year - which has fled abroad since 1991.

Lack of investment has a number of consequences. The average age of capital stock in today’s Russia is over 25 years. In the gas sector, for example, this has led to diminishing volumes of gas extraction each year since 1991. As reserves become less accessible, ever more complex technology is needed to reach and exploit them. Know-how is expensive. Machinery breakdowns and bottlenecks are an economic drain across all sectors of the economy. Lack of investment has also prevented the diversification of Russian exports and prevents Russia from gaining a competitive edge in European or global markets.

The scale of required investment is staggering. Russian estimates suggest that at least 10 to 12 billion euros is needed annually to put Russia onto a sound economic footing. I’m not suggesting the picture is all doom and gloom: investment has picked up in the past year or so largely through the re-investment of their own profits by companies, together with some returning flight capital. However, foreign direct investment has so far been slow to follow. And that has an important role to play. Because as well as providing an additional source of investment, FDI also offers direct access to modern management skills and production technologies, which will in many cases not be otherwise available.

So, Russia needs to attract more capital and more know-how. Easy to say. But Western companies will not come to Russia simply because the European Commission says they should. We cannot direct investors to Russia. Investment will need to be attracted, by providing an appropriate climate How to bring this about? The basic requirement is an open, rules-based society.

The first priority therefore is to maintain the pace of reform. Russia has made great strides over the past 18 months, in building up the political will to develop and then implement sweeping market reforms. This determination deserves our congratulations and support. The impression is of a country with new direction, ‘under new management’. Most impressive, perhaps, has been the government’s efforts to put in place a full market economy on the basis of a completely reformed judicial system.

At the same time, much remains to be done, with some reforms still on the drawing board and others on the statute book but not yet in place on the ground.

The necessary elements include:

• Improved corporate governance, with legislation to define and enforce property rights, especially those of minority shareholders. The draft Corporate Conduct Code is a step in the right direction;

• reasonable, transparent and predictable tax laws;

• open registration of real estate;

• speedy bankruptcy procedures;

• a high level of protection of intellectual property rights.

To have their full impact these changes will need to be accompanied by improved accounting rules and practices, including disclosure of share ownership, the absence of which currently provides a disincentive to enter into joint ventures with Russian companies. Bureaucratic interference and corruption remain major problems, as does the extent, whether perceived or actual, of activity by organised criminal gangs in the Russian economy. Judicial reform and cutting through red tape is the way to tackle this and we are ready to offer assistance. Moreover, the adoption by Russia of global trading rules under the WTO and full implementation of the PCA should do much to boost confidence among European traders and investors alike.

The EU and Russia have a shared interest in being reliable and good neighbours. Our past and our futures are intimately bound together. We need to draw maximum benefit from our potential to our mutual advantage – Russia’s immense resources on the one hand; the EU’s huge market, investment and human and technical capital on the other. Trade and investment should fuel our relationship.

Our theoretical interdependence is not yet matched by a strong and balanced commercial relationship. One point – as I have said - is that investment is too low. Another, that Russian exports are not sufficiently diversified, but are dominated by gas and oil, as well as by basic manufactures relying heavily on subsidised energy.

At the Summit tomorrow, we shall discuss the first steps towards creating a common European economic space. This will allow us to assess where we want to take our strategic relationship over the next 5 to 10 years and beyond. It represents a truly European choice for Russia. For the best part of a century, artificial dividing lines have kept Russia on a different track from the rest of Europe. Our tracks are now converging. In the coming months, the EU and Russia will – I hope - draw up a blueprint for close economic integration between Russia and the EU.

This should be based on the wider goal of extending key parts of the EU single market to Russia. If this dialogue can deliver results, it will help create the right legal climate for both EU and Russian investors. Alignment with internal market rules would also bring significant benefit to Russia and the EU, in terms of making sure Russia is able to take advantage of the opportunities created by EU enlargement. It would certainly inject much-needed confidence into Russia’s legal system and help Russia to compete with the candidates for EU accession states in attracting investment.

There is no panacea. We in the EU have learned a lot from the process of building up our structures and from our mistakes. The diversity of our continent is to be celebrated; we cannot and should not try to standardise every corner of Europe. It’s not a matter of imposing EU legislation word for word on Russia but of offering a model for economic and legislative integration.

We are creating a new EU-Russia High Level Group to oversee the preparation of the concept of the common economic space. This new body, established under our existing Partnership and Co-operation Agreement, will provide an opportunity to bring high-level political attention to issues that have in the past got stuck in bureaucratic working groups. It will also provide a sort of umbrella over the growing number of sectoral areas where our dialogue is intensifying across the whole spectrum of our economic relations.

Perhaps the most important of these is the trade agenda as we work to help Russia prepare for membership of the WTO. This is an ambition we strongly encourage, although there can be no quick political fixes and there are many important legal and technical challenges for Russia to address. Similarly, we are keen to intensify our relations in the area of science and technology and are interested to pursue Russian suggestions for closer co-operation on satellite communications and navigation systems like the EU Gallileo project.

One of the potentially most attractive sectors for investment is energy. The Summit tomorrow will adopt a report drawn up by EU and Russian experts which will provide a clear set of short and medium term objectives for co-operation. We want to turn the dialogue into a real partnership. The further improvement of the investment climate in Russia is central. This means setting up a better legal framework through Production Sharing Agreements and creating a system to resolve disputes, in particular between investors and the authorities. Other means to encourage the financing of key investments will also be explored. We have already identified some projects of particular common interest. Our task is to improve further the security of oil and gas supplies, on a fully commercial basis. The reform and modernisation of Russia’s infrastructure and the development of the EU’s integrated energy market are the processes driving this initiative.

Equally, as President Prodi highlighted at the last EU-Russia Summit earlier this year, there is more we can do to realise the potential of the euro, Europe’s single currency, that will become a material reality in the majority of member states at the end of this year. Already widely traded on financial markets, the euro will increasingly have consequences for businesses operating in Russia. I know that the European Business Club is particularly active in raising awareness in Russia of the need for effective and timely business preparations as well as of the opportunities the euro will bring. The euro will benefit Russian companies and traders through an increase in economic stability and therefore prosperity in the euro-zone. And conducting business on the EU market in a single currency will also significantly reduce exchange rate fluctuations, and the risk for Russian business. It should therefore naturally become the "currency of choice" for our trade relations and offers an attractive alternative to the dollar for official reserves and commercial transactions.

In conclusion, the breadth and depth of EU-Russia relations is clear. They have come a long way since our first agreement of 1989. The world is a different place. The EU has become involved as a major actor where previously it was hardly involved at all in such areas as justice and home affairs and security co-operation, on which it now works with Russia. EU-Russia initiatives are underway to improve the investment climate, further economic and legislative integration, develop a strong energy partnership and boost scientific and technological co-operation. We are using Tacis to support legal and administrative reform, underpin Russia’s WTO membership bid and help Russia deal with the social consequences of transition.

Russia and the EU are working together to increase peace, prosperity and stability on the European continent. We have a shared interest in working together for a brighter European future.