« OECD Investment Policy Reviews OECD RUSSIAN FEDERATION O Investment PROGRESS AND REFORM CHALLENGES E C D Policy Reviews Despite a wealth of investment opportunities, the Russian Federation has attracted relatively In v little foreign direct investment (FDI) and has experienced large-scale capital flight. This e s phenomenon results from sectoral restrictions on foreign investment and from important tm RUSSIAN FEDERATION institutional factors which also affect domestic businesses. e n t P Russia has made significant improvements in its business environment since the last o decade, adopting laws to protect the property and other rights of investors, and establishing lic PROGRESS AND REFORM y institutions needed for a market economy to function. Russia has also signed investment and R CHALLENGES double-taxation treaties with OECD members and other countries. e v ie w In 2001, the OECD published The Investment Environment in the Russian Federation: s Laws, Policies and Institutions, in which it made proposals for building on these positive R developments and further improving policies towards foreign investment. U S S The 2004 Investment Policy Review of the Russian Federation evaluates the progress made IA N since the publication of the 2001 study and offers policy options designed to improve F the investment environment further. These include relaxing remaining restrictions on FDI E D in several sectors of the economy, continuing efforts to simplify and make administrative E procedures more transparent, and ensuring compliance with federal laws and regulations at R A sub-federal government levels. T IO N This Review is part of the OECD’s ongoing co-operation with non-member economies around P the world. r o g r e s s a n OECD's books, periodicals and statistical databases are now available via www.SourceOECD.org, d our online library. R e fo This book is available to subscribers to the following SourceOECD themes: r m Finance and Investment/Insurance and Pensions C Transition Economies h a lle Ask your librarian for more details on how to access OECD books on line, or write to us at n g [email protected] e s www.oecd.org ISBN 92-64-01849-2 20 2004 07 1 P -:HSTCQE=UV]Y^Z: OECD Investment Policy Reviews Russian Federation PROGRESS AND REFORM CHALLENGES ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT Pursuant to Article 1 of the Convention signed in Paris on 14th December 1960, and which came into force on 30th September 1961, the Organisation for Economic Co-operation and Development (OECD) shall promote policies designed: – to achieve the highest sustainable economic growth and employment and a rising standard of living in member countries, while maintaining financial stability, and thus to contribute to the development of the world economy; – to contribute to sound economic expansion in member as well as non-member countries in the process of economic development; and – to contribute to the expansion of world trade on a multilateral, non-discriminatory basis in accordance with international obligations. The original member countries of the OECD are Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The following countries became members subsequently through accession at the dates indicated hereafter: Japan (28th April 1964), Finland (28th January 1969), Australia (7th June 1971), New Zealand (29thMay1973), Mexico (18th May 1994), the Czech Republic (21st December 1995), Hungary (7th May 1996), Poland (22nd November 1996), Korea (12th December 1996) and the Slovak Republic (14th December 2000). The Commission of the European Communities takes part in the work of the OECD (Article 13 of the OECDConvention). Publié en français sous le titre : Fédération de Russie Progrès et enjeux de la réforme © OECD 2004 Permission to reproduce a portion of this work for non-commercial purposes or classroom use should be obtained through the Centre français d’exploitation du droit de copie (CFC), 20,rue des Grands-Augustins, 75006 Paris, France, tel. (33-1) 44 07 47 70, fax (33-1) 46 34 67 19, for every country except the United States. In the United States permission should be obtained throughthe Copyright Clearance Center, Customer Service, (508)750-8400, 222 Rosewood Drive, Danvers, MA 01923 USA, orCCC Online: www.copyright.com. All other applications for permission to reproduce or translate all or part of this book should be made to OECD Publications, 2, rue André-Pascal, 75775 Paris Cedex 16, France. FOREWORD Foreword R ussia and the OECD have been co-operating in a wide range of policy fields that are critical for economic development. Investment policies are among the most fundamental, and our co-operation has allowed the Russian Government to draw on the OECD investment instruments and the experience of OECD member countries as it formulates these policies. In2001, the OECD published The Investment Environment in the Russian Federation: Laws, Policies and Institutions, which described the legal and regulatory framework for foreign investment and analysed the key issues and options for building in Russia an attractive enabling environment for investment. Since then the Russian Government has made important changes in many policies that affect foreign investment, including taxation, foreign exchange regulation, corporate governance and reporting standards, land law, and customs procedures. This study documents this progress and Russia’s efforts to meet international standards, including those of the OECD investment instruments. Russia continues to need more investment and further improvements in the investment environment are possible. The Review examines, for example, the scope for relaxing remaining restrictions on FDI in sectors such as financial services and energy, rules on foreign participation in privatisation of corporations and measures to ensure greater local compliance with federal laws and regulations. I am happy to notethat the study has benefited from numerous contributions and comments from senior government officials and experts in the Russian Federation. The Review has given us a unique opportunity to learn about the fascinating process of Russia’s transition to a functioning market economy. I would also like to thank OECD member country experts and members of the business community in Russia for their contributions which ensured that this Review is well grounded in their experience of policy-making and doing business. The OECD looks forward to building on the2004 Investment Policy Review to continue its close co-operation with the Russian Federation. Donald J. Johnston Secretary-General RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004 3 FOREWORD O n behalf of the Ministry of Economic Development and Trade of the Russian Federation, I should like to greet all those who will be using the Russian Investment Policy Review prepared by the Organisation for Economic Co-operation and Development. In the past two years the Russian Federation has managed to make considerable progress in its institutional reform in terms of both creating a favourable environment for entrepreneurship and improving the quality of existing market institutions. Positive dynamics of the key macroeconomic indicators are yet more proof of that. The Government of the Russian Federation has been pursuing a policy of improving conditions for foreign investment, creating economic incentives to attract investment resources from abroad and strengthening enforcement. Efforts to improve the transport infrastructure, to open up markets consistently for foreign participants and to liberalise the currency legislation are integral components of this policy. Also worth mentioning is a more active policy of the regional authorities aimed at attracting foreign investment. The Russian economy and, primarily, its manufacturing sector, have a great investment potential due to a number of Russia’s competitive advantages vis-à-vis other countries that are recipients of foreign investment. The current policy of the Government of the Russian Federation to improve the investment climate for both foreign and domestic investors is aimed at the efficient utilisation of such opportunities. Let me express my gratitude to the Organisation for Economic Co- operation and Development and the authors of the Review of the Russian Investment Policy for the work they have done and express my hope for further co-operation. German O.Gref Minister of Economic Development and Trade Russian Federation 5 RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004 NOTE BY THE EDITOR Note by the Editor T his report was prepared in support of an Investment Policy Review of the Russian Federation by the OECD’s Investment Committee held in Paris on 14June2004. The Russian delegation to the Review was led by Deputy Minister of Economic Development and Trade Saveliev, accompanied by Central Bank First Vice-Chairman Kozlov and high level officials of other agencies. The material for this report was assembled by Eva Thiel and Kenneth Davies in the Investment Division of the OECD Directorate for Financial and Enterprise Affairs, with input from its Corporate Affairs, Anti-Corruption, Financial Affairs and Competition Divisions and from the Centre for Tax Policy and Administration, the Economics Department and the Directorate for Food, Agriculture and Fisheries. The cut-off point for information in this report is 16August2004 and, in relation to foreign exchange regulations, 14June2004. The preparation of the report and the Review are the result of active co- operation and close consultations with the Ministry of Economic Development and Trade, the Central Bank and other agencies of the Russian Federation. They also benefited from comments by delegates to the OECD’s Investment Committee and input from representatives of the private sector, in both Russia and in OECD Member countries, including the law firm Salans, Ernst & Young and the Foreign Investment Advisory Council. This report was prepared as part of the OECD Investment Committee’s work programme and co-operation with non-members. It is published under the authority of the Secretary-General. 6 RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004 TABLE OF CONTENTS Table of Contents Chapter 1.Progress and Prospects................................................................... 9 1. Russia needs more foreign direct investment................................... 10 2. Recommendations in the2001 OECD study...................................... 13 3. Recent progress and remaining challenges....................................... 14 4. Policy options for further reform......................................................... 16 Chapter 2.The Pattern of Russia’s FDI Inflows.............................................. 21 1. FDI inflows fluctuate at a fairly low level........................................... 22 2. Main sources of FDI inflows to the Russian Federation: OECD countries and Cyprus................................................................. 24 3. Uneven geographical distribution of FDI in Russia........................... 25 4. Sectoral composition of FDI: prominence of extractive industries...... 26 5. Low level of Russia’s FDI inflows in comparative perspective........ 28 Chapter 3.Progress Since the2001 OECD Study: Selected Areas............... 31 1. Tax reform and tax incentives for foreign investment.................... 32 2. Reforming foreign exchange legislation............................................. 36 3. Improvements in corporate governance............................................ 38 4. Regulatory reform.................................................................................. 41 5. Land reform............................................................................................ 51 Chapter 4.Addressing Remaining Non-discriminatory Barriers to Investment.................................................................................... 59 1. Enforcement and coherence in implementation.............................. 60 2. The challenge of corruption................................................................. 62 3. Corporate disclosure............................................................................. 62 Chapter 5.Relaxing Discriminatory Restrictions on Foreign Direct Investment............................................................................. 67 1. Restrictions on Land Ownership......................................................... 68 2. Financial services.................................................................................. 69 3. Foreign ownership restrictions in other sectors............................... 77 4. Reciprocity condition for foreign participation in telecommunications......................................................................... 78 5. Energy sector.......................................................................................... 80 RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004 7 TABLE OF CONTENTS Annex A. Statistical Tables and Figures........................................................... 87 Annex B. Measuring Capital Flight from Russia............................................. 90 Annex C. Russia’s Bilateral Investment Treaties and Double Taxation Agreements................................................... 93 Annex D. Responses to Questionnaire on Investment Conditions in North-West Russia......................................................................... 97 Annex E. Credit Ratings..................................................................................... 104 Bibliography......................................................................................................... 106 Glossary................................................................................................................ 110 Boxes 2.1.Sources of Russian FDI data....................................................................... 23 3.1.List of Developments in the Tax Area During2003................................. 34 3.2.The OECD Principles of Corporate Governance....................................... 39 3.3.Main features of amended legislation on corporate governance......... 42 3.4.Federal regional policy coherence for acquisition of real estate.......... 52 3.5.Agricultural land rights............................................................................... 54 Tables 2.1. Cumulative foreign direct investment flows into the Russian Federation up to end-2003. . . . . . . . . . . . . . . . . . . . . . 24 2.2. Cumulative foreign direct investment flows from the Russian Federation up to end-2003. . . . . . . . . . . . . . . . . . . . . . . . . . 25 2.3. FDI by Federal District, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 2.4. Composition of FDI inflows into the Russian Federation, January-September2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 2.5. FDI inflows to Russia and Central European OECD members, 1994-2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 2.6. FDI inflow per head in Russia and Central European OECD members, 2002. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Annexes A.1. Top 12recipients of FDI among subjects of the Russian Federation, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 A.2. FDI inflows to Russia and China in the early years of opening to foreign investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 A.3. Cumulative FDI inflows to the Russian Federation from selected OECD countries, 1994-2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 C.1. Russia’s Bilateral Investment Treaties (BITs) . . . . . . . . . . . . . . . . . . . . . 94 C.2. Russia’s Double Taxation Treaties (DTTs). . . . . . . . . . . . . . . . . . . . . . . . 95 Figure A.1. FDI inflows into Russia and China, 1994-2002. . . . . . . . . . . . . . . . . . . . 88 8 RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004 ISBN 92-64-01849-2 Russian Federation Progress and Reform Challenges © OECD 2004 Chapter 1 Progress and Prospects RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004 9 1. PROGRESS AND PROSPECTS 1. Russia needs more foreign direct investment The Russian Federation, the world’s largest country, with a land area of 17million square kilometres and a population of 144million, has attracted relatively little foreign direct investment (FDI). This modest performance of Russia in attracting FDI is particularly evident in comparison with other transition economies in Europe, which have received far more FDI, adjusted for population, and have also exhibited a positive correlation between FDI inputs and GDP growth rates. By the end of2003 Russia had recorded a cumulative inflow of USD 26.1billion, less than half China’s annual inflow for2003 alone, and far below comparable absolute figures for the Czech Republic and Poland. Divided by population, the resulting figure is much lower than the per capita FDI inflows recorded during that time by all four Central European OECD member countries, which were, like Russia, transition economies. Low FDI inflows are a problem in Russia because the country suffers from a low rate of capital investment which restricts its economic growth potential. Gross fixed capital formation fell from a third of GDP in1989 to 14.4per cent in1999 and has since recovered to 17.9per cent in2002. This figure is not far behind those in more developed countries, such as OECD member countries (21per cent in2002), but is much lower than those in countries at a comparable stage of economic development which are enjoying robust growth, such as China (42.2per cent in2002) or Malaysia (43per cent in the years preceding the1998 Asian economic crisis).1 At the same time, the saving rate has fallen steadily from 35per cent in1989 to 21per cent in2002.2 However, since capital formation has fallen faster than savings, the savings: investment ratio has remained above 100per cent during the transition to market economy, matching continued current- account surpluses. The problem has been not merely a lack of domestic savings to fund investment as a lack of confidence of Russian investors in the Russian business environment, as indicated by the substantial capital flight that has occurred during most of the period. This outflow suggests that a range of domestic investors prefer to operate in the business environment in other countries, indicating that the Russian investment environment may also not be sufficiently competitive to attract adequate inflows from abroad. This judgment needs to be tempered by the 10 RUSSIAN FEDERATION – ISBN 92-64-01849-2 – © OECD 2004