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European Business Correspondent Eric Reguly (Fred Lum/The Globe and Mail)
European Business Correspondent Eric Reguly (Fred Lum/The Globe and Mail)

Sanctions erode Russia's improved business practices Add to ...

Russia has raised its hand, extended the middle finger and thrust it toward the face of the West. The message: Go ahead and hit us with your sanctions, we don’t need you, we have the East.

It’s a defiant strategy that may work for a while. As the Western-imposed economic sanctions start to bite, China, Saudi Arabia and the Gulf States may fill the investment gap left by European and North American companies as they shy away from Russia or avoid boosting their Russian investments. But in the long run, it is Russia that will lose, not because it needs Western investment so much, but because it needs Western-style corporate governance and transparency.

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Every significant Western investment in Russia, from Kinross Gold’s mines to General Electric’s aircraft leasing business, helps to boost overall investment, accounting, patent protection and legal standards within Russia.

To be sure, the improvements have been slow and sporadic, and foreign investment horror stories still abound. But there’s no doubt that the investment climate in Russia for foreign companies is better than it was 10 or 20 years ago, when the casino mentality prevailed – I win, you lose – and corruption was rampant. Russia’s entry into the World Trade Organization in 2012 and its effort to join the rich countries’ club, the Organization for Economic Co-operation and Development (OECD), have helped to raise Russian standards (the OECD suspended Russia’s membership talks after the Crimea foray).

If Russia kisses off the West and turns to the East, the pressure to improve standards will only drop. Sovereign and private investors from China and elsewhere in Asia are not as demanding as their European and North American counterparts. If the pressure to improve corporate governance standards evaporates, Russia will go backward, eventually making it harder to attract Western investment.

Since Russia seized Crimea, triggering the sanctions against dozens of officials and businessmen close to President Vladimir Putin, the Kremlin has urged a Go East strategy. In May, Russian energy giant Gazprom, the biggest single seller of natural gas to Europe, signed a long-term, $400-billion (U.S.) deal to supply gas to China.

Later the same month, Vladimir Yakunin, president of Russian Railways, one of the biggest transportation companies in the world, with 880,000 employees, lashed out at the West for imposing sanctions on him and the other boys in Mr. Putin’s sandbox. The sanctions, he said, will force Russia to turn East. “We can aim at reaching a new level of relations with our friends in China, South Korea, Japan, the Pacific countries, Latin America and so on,” he said in an interview with the Moscow Times at the St. Petersburg International Economic Forum, the investment conference that was boycotted this year by more than a few Western companies.

Canada’s Kinross, one of the world’s largest gold companies, is a fine example of a foreign investor using its muscle, goodwill and patience to improve investment standards in Russia to protect itself and make it safer for other investors to wade into the Russian market.

Kinross is the only foreign gold miner in Russia and one of the few foreign companies of any description to operate without foreign partners. It is also the only Canadian company on the Russian Prime Minister’s Foreign Investment Advisory Committee. Kinross’s two Russian mines, Kupol and Dvoinoye, have sucked up about $2-billion in investment, accounting for more than a fifth of the company’s global portfolio.

In 2011, Kinross commissioned a “white paper” on mining development in Russia that government officials have taken seriously. The 72-page document contains dozens of references to “transparency” and “corporate governance,” noting that “the improvements necessary in taxation, capital markets reform and government bureaucracy to encourage a successful mining sector would benefit all industries.”

It’s unlikely that the sanctions will trigger Kinross’s withdrawal from Russia, although the company is nervous that any retaliation against the West would add a big layer of misery to its Russian operations. Kinross is, after all, the face of the West in the domestic mining industry.

The sanctions have already been tightened up once and could be tightened again. They could last years, forcing Western companies to reassess their Russian investments and Russian companies to retreat from Western markets. Already, a few Russian initial public offerings on the London market have been put on hold, presumably because of the East-West tensions over the Ukraine crisis. Russian companies that list on Western exchanges have to meet international disclosure standards. If fewer of them make the jump, corporate Russia in general would become less transparent.

The sanctions won’t punish the Russian economy in the near term, even if they will make life uncomfortable for a few of Mr. Putin’s cronies. Business with the East will be pursued as Western investors pull back, or are in effect ordered to do so. Goodbye Western-style corporate governance. As imperfect as it is, Russia needs it.

Follow on Twitter: @ereguly

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