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January 2007

Kari Liuhto
A FUTURE ROLE OF FOREIGN FIRMS IN RUSSIA´S STRATEGIC INDUSTRIES
Electronic Publications of
PanEuropean Institute, 1/2007

Download the publication in PDF format.

A summary of the strategic policies in Russia

The invisible implementation of the strategic policies started soon after Putin was elected as president in the year 2000. However, these strategic policies did not receive much public attention until April 2005, when President Putin gave his annual address to the state. Thereafter, many observers have wondered which sectors, which natural resource sites, and perhaps which individual companies will be excluded, either partially or completely, from the foreign investments. At the end of 2006, the situation is still without its final answer, as the corresponding laws have not been passed yet, but evidently they will be signed during 2007.

Since one cannot understand Russia’s strategic agenda only by reading the relevant laws, one should search for the underlying rationale behind the strategic thinking from elsewhere. One way to go beyond the official façade is to analyze Russia’s key industries in terms of their importance for national security and economic security. Using these two dimensions, the Russian economy can be divided into four sectors: 1) The militarily sensitive sector; 2) The economically sensitive sector; 3) The top sensitive sector; and 4) The nonsensitive sector.

The militarily sensitive sector is highly strategic for Russia’s national security, just as the economically sensitive sector is highly strategic for the country’s economic functioning. The top sensitive sector stands for those industries which are highly strategic for both national and economic security. On the contrary, the sensitive sector has lower strategic importance in both of these dimensions.

The top sensitive sector is formed mainly by those industries, which are either explicitly named in the subsoil law or they are otherwise on the Kremlin’s watch list. The defense industry automatically belongs to the military sensitive sector, but also some civilian industries, such as telecommunications, have certain characteristics which lift them into the military sensitive sector. Banking and insurance are the backbone of the economy but as they are not highly sensitive in terms of military security, they can be regarded as belonging to the economically sensitive zone. Consumptionrelated industries are the core
of the nonsensitive area.

Should the strategic policies strengthen in Russia, the following analysis conducted by the OECD (2006b, 6) is easy to agree with: “The expansion of state ownership overall must be regarded as a step back. The Russian state’s track record as an owner of industrial and financial companies is poor. The corporate governance of many statecontrolled companies is problematic and state interference in the operations of such companies often distorts the development of the companies themselves and the markets they operate. The expansion of state ownership in important sectors will probably contribute to more rentseeking, less efficiency and slower growth. The trend towards greater state ownership should be reversed in order to improve performance and reduce opportunities for corruption and rentseeking.

At the same time, more needs to be done to strengthen the corporate governance of those companies that remain in state ownership, especially as regards transparency, and to provide for a clearer separation between the state’s roles as owner and regulator in those sectors in which it fulfils both roles.” The position of foreign companies in the four sectors of the strategic governance matrix differs a lot. The sensitive sector contains an extremely high political risk for foreign firms.

Correspondingly, foreign investments in the nonsensitive zone do not face any direct political interference, though administrative abuse may still be frequent, i.e. foreign operations in the nonsensitive sector face only a business risk with nonfederallyorchestrated administrative harassment. In the militarily and economically sensitive areas, a foreign firm faces varying levels of political risk depending on the lobbying power of the Russian competitor.

Should the strategic policies strengthen, it would probably lead to a weakening position of foreign firms in industries outside the nonsensitive sector, and a lowering of foreign investments in the sensitive industries. However, the faster FDI growth in the nonsensitive industries compensates for the lowering FDI in the sensitive zone, and therefore, the overall FDI inflow continues its growth, at least in medium term.

Download the publication in PDF format.


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