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A woman walks outside TNK-BP headquarters in Moscow, Thursday, Oct. 18, 2012. Mighty BP and its Russian billionaire partners have revealed they are in talks to sell their TNK-BP oil-production colossus to Rosneft, the state-run oil company, for about $28-billion (U.S.). BP never had an easy time in Russia. At one point things got so nasty that Bob Dudley, BP’s boss, had to flee Russia to avoid getting arrested. (Mikhail Metzel/AP)
A woman walks outside TNK-BP headquarters in Moscow, Thursday, Oct. 18, 2012. Mighty BP and its Russian billionaire partners have revealed they are in talks to sell their TNK-BP oil-production colossus to Rosneft, the state-run oil company, for about $28-billion (U.S.). BP never had an easy time in Russia. At one point things got so nasty that Bob Dudley, BP’s boss, had to flee Russia to avoid getting arrested. (Mikhail Metzel/AP)

ERIC REGULY

Despite growth, investors still see red flags in Russia Add to ...

What’s wrong with this picture? The Russian economy is one of the strongest in the world, yet foreign investors are as hesitant as ever to join the growth party. The bureaucratic maze and corruption might have something to do with it, along with heavy doses of bad publicity. Google “Russia” and “Pussy Riot” comes up a bit more often than the Kremlin likes.

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Russia, the scene of so much misery in the 1990s and some of the last decade, has escaped the European disease. The 17-country euro zone is in double-dip recession and a few countries – Greece, Italy, Portugal, Spain – are in dire shape; a Spanish bailout is almost certain. Britain, a member of the European Union but not the euro zone, is in recession. Western, southern and central Europe would consider themselves blessed if they shared Russia’s growth trajectory.

In 2011, Russia’s gross domestic product expanded by 4.3 per cent, the third-highest among the world’s biggest economies, after China and India. The jobless rate, at 5.2 per cent, is the lowest on record and half of the EU’s level. Real wages and disposable income are on the trot. National debt is relatively low and the current account, at 5 per cent of GDP, is fat and enviable. Russia seems in no danger of ejection from the exclusive club, known as BRIC (Brazil, Russia, India, China), that is supposed to keep global growth intact as the United States and Europe trudge through their vats of economic mud.

Yet Russia doesn’t get much respect from foreign investors. To be sure, investment is climbing, albeit from a low level (Russia was in recession in late 2008 and early 2009, after the Lehman Brothers collapse). Direct foreign investment into Russia grew 8 per cent in the first half of 2012, to a fairly pathetic $7.6-billion (U.S.). If foreign loans and flows into securities markets are included, the figure contracted by almost 15 per cent, to $75-billion. Worse, capital outflows have reached $348-billion since 2007, which was the last year Russia had a net inflow.

In other words, investment is nowhere near the level it should be given the health of the economy, its growth potential, the government’s desire to funnel the oil and gas spoils into economic diversification and make the country a fully paid-up member of the world economy. After almost two decades of fraught negotiations, Russia is finally a member of the World Trade Organization. The Organization for Economic Co-operation and Development is the next club it wants to join.

A tour of GUM, the airport-sized department store on Moscow’s Red Square, will tell you that foreign investors have made a splash in Russian retail – almost every store is a foreign brand, with an especially strong presence among the Italian names. But foreign companies have a middling to miniscule presence in a vast array of other sectors.

Take gold mining. The only foreign player of any size is Toronto’s Kinross Gold, even though Russia has the world’s second-biggest gold reserves, after South Africa.

Some companies that had built up industrial presences or investment portfolios in Russia are in retreat. Barrick Gold, the world’s biggest gold company, recently ditched its last Russian mining investment, a 20-per-cent stake in Highland Gold. On Wednesday, mighty BP and its Russian billionaire partners revealed they are in talks to sell their TNK-BP oil-production colossus to Rosneft, the state-run oil company, for about $28-billion. BP never had an easy time in Russia. At one point things got so nasty that Bob Dudley, BP’s boss, had to flee Russia to avoid getting arrested.

Russia knows it needs foreign investors if it is to drag its oil-based economy – unsustainable by definition – into the 21st century. Years ago, the Kremlin and the top foreign investors in Russia, including PepsiCo, BHP Billiton, Renault, UniCredit, Ernst & Young and Kinross, set up the Foreign Investment Advisory Council (FIAC). Its job is to tell the Russian government how to make Russia friendlier to investors, and the government tends to listen. “The reputation of the country is best measured by the volume of capital attracted,” Prime Minister Dmitry Medvedev said at the latest FIAC meeting, held Monday in Moscow.

While FIAC’s members report growing satisfaction with their Russian investments since 2007, they and other foreign investors always say the same thing: Russia suffers from horrendous levels of bureaucratic red tape and corruption (and shabby infrastructure). By some measures, it’s all getting worse. Transparency International’s latest list of most-corrupt countries ranked Russia 143rd, along with Uganda and Nigeria. In 1996, Russia was in 46th spot. This is not lost on Mr. Medvedev. Last year, at a United Russia party congress, he said “Everyone is fed up with corruption and the stupidity of the system.”

Corruption is an investment killer. Southern Italy hardly gets any foreign investment, in good part because it is considered a Mafia protectorate. Some academics and economists think that corruption, not high public debt, is Italy’s main economic obstacle. A country as rich and creative as Italy should be running like a gazelle. Ditto Russia. On paper, Russia looks like a dream place to invest. Fear of getting ripped off can shatter that dream in an instant. The image is probably worse than the reality – there is a lot of money to be made in Russia. But the Russian government is learning the hard way that image is everything.

Follow on Twitter: @ereguly

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