On FT.
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INVESTING IN
Russia
FINANCIAL TIMES SPECIAL REPORT | Friday October 1 2010
A search for new sources of growth
Charles Clover
notes a shift in
aspirations from
resources exporter
to ‘knowledge
economy’
A
debate that capti-
vated Russian
intellectuals in the
18th and 19th cen-
turies has returned with a
vengeance in the 21st – does
a perpetually backward
country need to be western
to be modern?
It is an argument that
resurfaces over the centu-
ries, and has been a regular
stumbling block ever since
Tsar Peter the Great forced
nobles to shave their beards
and wear western dress.
In the 19th century, sup-
porters of parliamentary
democracy faced off against
proponents of autocracy.
Today, the elite is split
along familiar lines.
Autocracy has been
replaced by the notion of
“sovereign democracy”, a
Technophile: Medvedev has said he wants his country to become a post­industrial economic power Getty concept dreamt up by the
Kremlin that justifies con-
Russia in numbers tinued rule by quasi-author-
GDP growth (annual % change) Inflation (annual % change on CPI) Rouble versus currency basket* External debt ($bn) itarian methods. There are
the trappings of democracy,
10 20 500 such as parliament, civil
16
society, and an independent
Government
judiciary, but only in name.
14 Corporations
400 Today, just as 200 years
5 25 Banks
ago, there are those who
12
300 believe Russia must adopt
western political practices –
0 10 30
including checks and bal-
200 ances on the executive and
8 a free press – or face decline
-5 35 and eventual irrelevance as
100
6 a simple exporter of raw
materials.
-10 4 40 0 Against them are arrayed
opponents, who assert that
2005 06 07 08 09 10 2003 04 05 06 07 08 09 10 1999 2002 04 06 08 10 1994 2000 05 10
only a strong state is capa-
Sources: Thomson Reuters Datastream; Troika Dialog * Rouble per dollar (55%), euro (45%) January and September
ble of dragging a perpetu-
www.ft.com/invest­russia­oct2010 | www.twitter.com/ftreports
ally backward Russia into
the 21st century.
For the past 10 years, the
latter camp has had the
upper hand, but things may
be changing.
Since 2000 under the lead-
ership of president, now
prime minister Vladimir
Putin, the country has cen-
tralised power in an effort
to stabilise its economy,
and his success has lent
weight to those who argue
authoritarian regimes are
better modernisers.
Helped by high resource
prices, GDP doubled in 10
years. The lesson seemed
simple – the economy grew
under Mr Putin’s autocracy,
while it collapsed under
Boris Yeltsin’s democracy
in the 1990s.
But now the consensus is
shifting, as the country
struggles to learn the les-
sons of its meltdown after
the global economic crisis.
Last year, the resource-
driven Putin growth model
seemed to fail, and the
economy fell 7.9 per cent in
2009, farther than any
major emerging market.
Even though growth has
Inside this issue
Politics Charles Clover on
the Putin­Medvedev
relationship Page 2
Agriculture Grain yields
could be doubled, writes
Isabel Gorst Page 3
Financial
reforms Courtney
Weaver reports on
slow progress
Page 3
Stock
markets
Political fears
Staying ahead of Google
Arkady Volozh, founder and chief
executive of
Yandex, the
country’s top
search engine
talks to
Rachel
Morarjee
rebounded, at least tempo-
rarily, to a positive, if anae-
mic, rate, President Dmitry
Medvedev, who was all but
appointed to his job by Mr
Putin in 2008, is challenging
conventional wisdom.
A year ago, he offered an
alternative to the Putin
model of “energy super-
power”, saying Russia
needed to wean itself from
“primitive” dependence on
energy exports, adopt politi-
cal reforms and become a
truly post-industrial eco-
nomic power, by focusing
on innovation and becom-
ing a knowledge economy.
On September 10, at the
annual presidential summit
in the medieval city of
Yaroslavl, Mr Medvedev
continued on this track. In
contrast with Mr Putin’s
bullish tone on economic
recovery, he said, “Just
because energy prices have
risen and we have had a
burst of growth, people get
comfortable, but it may not
last.”
“There is no alternative
but to change the source of
our growth,” he said.
Mr Medvedev’s view has a
cast a long shadow, says
Rachel Morarjee Page 3
Oil Industry Catherine
Belton finds the sector and
finance ministry at odds
on tax Page 4
Foreign
investment
Bureaucracy
and corruption
scare
business
away, says
Neil Buckley
Page 4
lot of support from profes-
sional economists.
Yevgeny Yasin, rector of
the Higher School of Eco-
nomics in Moscow, points
out that while an authori-
tarian state capitalism eco-
nomic model works in
neighbouring China, this is
because it depends on mobi-
lising millions of rural peas-
ants every year and moving
them to the cities to work
in factories.
Today, he and other liber-
al-minded experts say
sources of growth should
depend on increasing “post
industrial” sectors of the
economy such as services
and innovation.
The Kremlin has laid out
ambitious plans to jump-
start a high technology sec-
tor, with Rusnano, the state
nanotechnology company,
and financing development
of Skolkovo, a high-tech
cluster in a Moscow suburb,
touted as “Russia’s Silicon
Valley”.
Mr Medvedev’s rhetoric
reflects a view that growth
requires political reforms:
“Only a free person, who is
unafraid of the state, una-
fraid for his property, una-
fraid for his life, can build a
truly modern economy” he
said in Yaroslavl.
While these are fine
words, most experts give
the Kremlin low marks for
implementation.
Pro-democracy demon-
strators are regularly
beaten by police, opposition
figures fear for their lives,
and Mr Medvedev, while
talking about democracy,
has increased the powers of
the Federal Security Serv-
ice, the former KGB.
Businessmen, meanwhile,
say the Kremlin has failed
Continued on Page 2
2 ★ FINANCIAL TIMES FRIDAY OCTOBER 1 2010

Investing in Russia

Two top men A search

for sources
lay markers for of growth
2012 election Continued from Page 1

to bring about effective reforms

Politics
Charles Clover considers
that most vexing question
for Kremlinologists: the
true nature of the Putin­
Medvedev relationship
to boost investment. Without
new investment and ideas, the
future is grim, with official
cious little to feed their addiction and projections showing the current
their pastime now evokes the Krem- account turning negative after
linology of the Cold War, when teams 2013, even in high-oil-price
of CIA researchers scanned the back scenarios.
pages of Pravda or the May Day parade
stand for clues as to who was in the
With roads and infrastructure
crumbling, and the lowest rate
ascendant. Today’s Kremlinologists of investment (as a percentage
tend to grasp any hint of competition
between Mr Medvedev and Mr Putin as
of GDP) of any Bric country, it
desperately needs to attract cap-
evidence that something interesting is ital, both foreign and domestic.
going on. “There is a big disconnect
Mr Medvedev, for example, talks between the optimistic state-

A
noisy media campaign in Sep-
tember to oust Yuri Luzhkov,
the former mayor of Moscow,
was the first public power
struggle to rock Russia’s airwaves in
nearly 10 years. In a sense, it was the
exception that proved the rule, remind-
ing people just how boring political life
has become over the past decade.
Not since the “information wars”
between rival oligarch groups in the
1990s has there been such a public
mudslinging.
In what some have labelled revenge
for criticism from Mr Luzhkov, Presi-
dent Dmitry Medvedev deployed a fear-
some armada of state TV channels,
accusing the mayor of everything from
corruption to being a bad beekeeper in
a two-week airwave blitz.
Mr Luzhkov’s fate was decided on
September 28 when Mr Medvedev
sacked him. Most political analysts
agree that, with the departure of one of
Russia’s last independent figures, poli-
tics might now be even less interesting,
if this is possible.
Political pluralism has never been
Russia’s strong suit, but the era of
Vladimir Putin, former president, now
prime minister, has brought political
monism to a new level: the press is
muzzled; the once proud state Duma,
or parliament, now exists more as a
lobbying body.
The single vexing political question
of the day, meanwhile, is whether
power belongs to one man, or, in the
best case scenario, two.
That conundrum – the relationship
between Mr Medvedev and his mentor
Mr Putin – represents the only unpre-
dictable, or at least unknown, element
left in Russian politics, the sum total of
the allowable spectrum for musing
about the future.
Moscow political junkies have pre-
about democratic reform, while Mr
Putin does not; Mr Medvedev says
dependence on oil exports is “primi-
tive”, while Mr Putin has referred to
the country as the “energy super-
power”; Mr Medvedev says the econ-
omy needs to be overhauled, Mr Putin
says it is “healthy”.
Whether these differences amount to
stylistic ones, or a looming split in the
political “tandem”, is hotly debated.
Many believe Mr Putin is the master
string-puller. Mr Medvedev is merely
keeping the seat warm for his mentor,
and any evidence of competition
between the two is for show. Others
believe that while Mr Putin is the more
powerful of the two, Mr Medvedev may
yet be able to mount a challenge to Mr
Putin’s dominance.
Yevgenia Albats, chief editor of The
New Times, a news magazine, is one of
those who sees real competition. She
likens Mr Medvedev’s position to that of
Mikhail Gorbachev in the 1980s, when
the latter faced down communist party
hard liners, using economic and politi-
cal reforms to create a constituency of
the liberal minded intelligentsia.
“Mr Medvedev is playing to a specific
section of the elite, who share his
views on society” she says. Without
entering into direct confrontation with
Mr Putin, she believes Mr Medvedev is
trying to make life uncomfortable for
the hardliners, by creating debate on
sensitive issues, such as police reform
and official corruption.
The 2012 presidential election is
likely to put the various Putin-
Medvedev theories to a test.
Mr Putin stood down in 2008 after his
constitutionally allowed two term max-
imum, but it is unknown whether he
plans to return to the presidency, and
it is unlikely the two would run
against each other.
Master string­puller? Some analysts believe Medvedev (left) will mount a challenge, although Putin is more powerful,
If one of the two does not announce
his withdrawal from the presidential
election in the months before
March 2012, the ensuing political
struggle could make the Medvedev-
Luzhkov brawl look like a kindergarten
spat.
Kremlin watchers note that Mr Putin
has made an effort to appear more in
the media over the past two months,
and on September 18, announced that
pensions would be increased next year,
a sure sign he has an eye on voters.
In a September meeting with the
Valdai Club, a group of western aca-
demics and journalists, he compared
himself to former US president Frank-
lin Delano Roosevelt, who was elected
to four terms in office.
But Mr Medvedev also clearly wants
a second term, and the signs are there
that he is placing markers.
In September, his press secretary,
Natalia Timakova, told a TV inter-
viewer: “The modernisation agenda
proposed by the head of state is shared
by a large section of society and the
government. Therefore achieving these
goals goes beyond the term of one pres-
idential mandate.”
Konstantin Remchukov, editor of
Nezavisimaya Gazeta, the Moscow
daily newspaper, said Mr Medvedev’s
aim in forcing out Moscow’s mayor
Getty
might have been to prove he is a politi-
cal heavyweight.
“To be taken seriously in our hierar-
chical society, you need to demolish
someone powerful,” he says.
He drew a parallel with Mr Putin’s
arrest of Mikhail Khodorkovsky, the oil
tycoon, in 2004, which confirmed him
as the all-powerful leader.
Gleb Pavlovsky, a spin doctor who
works for the Kremlin, says neither
man wants conflict: “They are hoping
the choice will be obvious.” However,
he added, it increasingly looks like it
may not be.
Which means the political scene
might yet get interesting once again.
ments from government and the
tougher reality of doing busi-
ness in Russia. Most investors
complain about corruption, red
tape and a lack of legal protec-
tion for their investment,” says
Chris Weafer, chief strategist for
Uralsib, the investment bank.
Officials privately estimate
that 60 per cent of GDP is now
produced by state-controlled
companies. A $50bn privatisa-
tion programme announced by
Alexei Kudrin, the finance min-
ister, last month, is unlikely to
change things, as no controlling
stakes will be sold.
One thing that has been
noticed, however, is the atmos-
phere at top levels of the gov-
ernment. “There is a new mind-
set that is very noticeable” says
Elena Titova, president of Mor-
gan Stanley in Russia/CIS. “It is
moving from blaming the out-
side world for problems, to the
new mindset, which is much
more open to the world and
understanding that we our-
selves have to change.”
The announcements, at least,
have been bold. Mr Medvedev
has made ending the “legal
nihilism” of the court system
one of his priorities, and
announced reforms of the
bureaucracy. In June, he tar-
geted a 20 per cent cut in civil
servants, whose numbers had
grown to enormous proportions
during the previous oil funded
decade.
He also appears to be tackling
endemic corruption in law-
enforcement structures by firing
top officials, and announced the
1.4m police force will be reduced
by more than 200,000 jobs by
2012. But the ability to carry
these reforms to completion is
still in doubt.

Multinationals Investment and reform

An ambitious reform of the
army, announced in 2008 follow-
ing the war in Georgia, seems
stuck halfway – plans to abolish
military service and create a

find new ways remain key to growth smaller, professional army ran
into budget constraints and
objections from officer corps.
Mr Medvedev attributes slow

to tackle graft
gest. “The main thing is that
Economy the economy needs a lot of reno-
vation. The level of use of
Neil Buckley finds [capacity] is very high.”
bank, calls an “exaggerated
boom-bust cycle”.
“The two most important fac-
tors influencing the economy
reform to the inertia of a lazy
bureaucracy: “I’m afraid that in
the manner of thinking of our
bureaucrats, modernisation is
just some buzzword, something

of the law firm’s Moscow office.

signs of recovery but As well as new capacity,
investment is needed to improve
are both set independently of
Russia,” says Mr Nash. “For
transitional, maybe around for
three or five years. My task is to
Corruption The highest priority of such says infrastructure is the use of existing plant. “There both the price of natural get it through their heads, so

Courtney Weaver
says few companies
are pulling out but
many are diverting
resources to other
emerging markets
When Aldo Fumagalli decided to
expand Candy, the Italian home
appliances manufacturer, into
Russia five years ago and open
the company’s first plant there,
he expected the usual instances
of bureaucracy and corruption.
What he did not expect was that
it would take weeks for the com-
pany’s trucks to even make it
across the border.
He recalls that the trucks
spent weeks circling the coun-
try, trying to find a customs
clearance point at which they
could enter.
Despite the fact that the cus-
toms system should operate as a
federal organisation, all deci-
sions are made on a local level,
explains Mr Fumagalli.
“The local level makes its own
interpretation of the law and
procedures and the document
that was good at one customs
point was not good in another.
There is no national organisa-
tion to help you,” he says.
After struggling with the
problem for weeks, he decided
to set up a division of the com-
pany in Moscow that would
have the sole responsibility of
dealing with customs clearance.
The problem was solved in days.
While the customs fiasco is
just one of many problems faced
by Candy in Russia, the com-
pany’s approach to solving it is
indicative of the new
approaches multinationals are
employing when combating
bureaucracy and corruption.
If previously they looked at
just a couple of sites before they
picked a place to build a plant,
now they are looking at upward
of five to ensure they pick a
place with local authorities that
are both receptive to the busi-
ness and practise transparency,
says Paul Melling, a partner at
Baker & McKenzie and founder
companies is “making sure the
business culture is [the com-
pany’s] ethical culture rather
than the local culture” and
avoiding instances where the
company might be thrown into
a corruption scandal, he says.
While President Dmitry
Medvedev has made modernisa-
tion and rooting out corruption
two of his biggest priorities, the
recent experiences of multina-
tionals operating there suggests
there is still much to be done.
Ikea, the Swedish retailer, has
repeatedly frozen new invest-
ment in the country while bat-
tling court cases and allegations
of corruption, while Daimler,
the carmaker, and Siemens, the
industrial group, have faced
allegations of bribery.
Even Mr Fumagalli’s Candy
has not been immune from
court cases: since opening shop
four years ago, it has dealt with
four lawsuits over issues rang-
ing from income tax to value
added tax payments.
‘Now companies are
going to other
countries in eastern
Europe first, because
there is less risk’
While the volume of court
cases is atypically high even for
Russia –“Usually you don’t have
four cases in 10 years,” Mr Fum-
agalli says – it is stories such as
these that turn multinationals –
and their investment dollars –
off Russia, says Mr Melling.
“The problem is that Russia is
competing for investments with
other Bric countries and if you
have an environment that is
seen as high-risk, then those
investment dollars are going to
go elsewhere,” he says.
Other factors are hurting Rus-
sia’s appeal, says Alex Turkel-
taub, chairman of Frontier
Strategy Group, a consultancy
focused on emerging markets.
The country has a demo-
graphic problem – its low birth
rate – while the population of
other countries is expanding, he
Aldo Fumagalli: ‘There is no
national organisation to help’
says. Simultaneously, it is no
longer viewed as a “springboard
to Eurasia” as its political rela-
tions with its former Soviet
neighbours are declining.
“A lot of companies are delay-
ing their Russia entry. Before,
you would see companies saying
they were going to Russia first
and then other eastern Euro-
pean markets. Now companies
are going to eastern Europe first
because there is less risk,” Mr
Turkeltaub says.
While few companies are pull-
ing out completely, many are
diverting resources to other
emerging markets, he adds.
Multinationals that decide to
enter the market regardless are
taking more precautions against
corruption and accepting they
might not be as successful in
the market as some of their
peers, says Mr Melling.
“[Maintaining your company’s
ethical culture] means accepting
you’re going to lose business
opportunities.”
While Moscow and St Peters-
burg bureaucrats these days are
“more sophisticated” and are
“not going to ask for $5,000 in a
paper bag”, the problem
remains, as do outsiders’ percep-
tions Mr Melling adds.
Last year Transparency Inter-
national, the international anti-
corruption watchdog, placed
Russia in 146th place beside
Sierra Leone and Zimbabwe in
its annual Corruption Percep-
tion Index of 180 countries.
“Russians get very upset
about [the ranking] and say how
unjust it is and how it doesn’t
reflect the improvements here,”
says Mr Melling.
As the Kremlin tries to
improve the business environ-
ment while working on turning
Moscow into a financial centre
and building a technology hub
in Skolkovo, it will also have to
work on improving its reputa-
tion for corruption, he adds.
“So long as this perception
exists, Russia is really going to
struggle.”
a brake on expansion
Everywhere in Russia there are
signs of recovery. The roads of
big cities are more clogged than
ever, building sites are spring-
ing back into life. But its growth
prospects look very different
from how they did during the
past decade.
The plunge in oil and com-
modity prices from mid-2008 and
drying up of credit flows hit
Russia harder than expected,
leading to a 7.9 per cent eco-
nomic contraction in 2009.
But the country’s prudent fis-
cal policy in previous years, led
by finance minister Alexei
Kudrin, had left it with a big
enough foreign reserves cushion
– nearly $600bn at their peak –
to mitigate the crisis.
It was able to slow the rou-
ble’s devaluation and so avoid a
run on the currency and banks,
fund a stimulus package, and
inject sufficient liquidity to sta-
bilise the banking system.
Yet assuming oil prices
remain at today’s $70-$75 a bar-
rel, economists now forecast
Russia’s annual growth at 3-4
per cent in coming years – a far
cry from 7 per cent it averaged
in 1999-2007.
Its growth then was fuelled in
part by rising oil and gas prices.
But a consumer boom, as real
incomes rose and consumers
started to enjoy access to goods
long denied during the Soviet
era, also played a role.
An important factor, too, was
Russia’s ability to put back into
use capacity that had been
mothballed in the 1990s, particu-
larly after the 1998 crisis. Capac-
ity utilisation increased from
about 55 per cent then to close
to 90 per cent now.
There is still scope for produc-
tivity gains and expanding the
service sector. But maintaining
growth will also require build-
ing new capacity, and removing
bottlenecks by renewing and
expanding dilapidated infra-
structure. And that, in short,
needs cash.
“Investment today is the key,”
says Peter Aven, president of
Alfa Bank, one of Russia’s big-
are so many factories that are
uncompetitive, what do we do
with them?” says Yuri Novozhi-
lov, president of state-owned
Trans Kredit Bank, which lends
to many industrial enterprises
connected to the railway indus-
try. “These factories have costs
3-4 times those of a Chinese fac-
tory. This is the Soviet legacy
we are dealing with.”
The government has identified
the investment need and taken
steps to address it. President
Dmitry Medvedev has adopted a
modernisation programme
aimed at reducing reliance on
oil and commodities and devel-
oping a more innovative, high-
tech economy.
He has also championed plans
to turn Moscow into an interna-
tional financial centre. That is
aimed not just at competing
with other emerging hubs such
as Dubai. It is also intended to
improve Russia’s ability to
channel its own citizens’ sav-
ings into investments in its
economy, and reduce its reli-
ance on international financing.
But many economists and
businesspeople are sceptical
about these initiatives’ chances
of success. Political uncertainty
ahead of the 2012 presidential
election – notably over whether
Mr Medvedev will remain in his
current job – is one factor.
Another is slow progress on
the president’s pledges to
strengthen the rule of law, and
tackle corruption widely said to
have reached record levels.
Even without reforms, 3-4 per
cent growth is not disastrous.
But it would call into question
Russia’s status as one of the
Brics – the others are forecast to
continue to grow much
faster.
Failure to reform
would leave Russia
vulnerable, too, to
what Roland
Nash, chief
strategist at
Renais-
s a n c e
Capital,
a Mos-
c o w
invest-
ment
resources and the cost of capi-
tal, Russia is a price-taker.”
Lower growth could also see
state revenues failing to grow
fast enough to meet ever
expanding social spending
needs. Previous budgetary disci-
pline was loosened ahead of the
2008 presidential election and,
together with last year’s eco-
nomic decline, pushed the
budget into deficit for the first
time in almost a decade.
Mr Kudrin acknowledged this
year that the oil price at which
the budget balances reached $95
a barrel for Urals blend – about
$100 a barrel for Brent crude.
Yevgeny Gavrilenkov, chief
economist at Troika Dialog, the
Russian investment bank,
warns that macroeconomic pol-
icy has deteriorated sharply in
recent months.
Spending has been increased
for both this year and 2011-12,
with another increase pencilled
in for 2013, resulting in a budget
deficit of about $60bn, or 3 per
cent of gross domestic product,
a year. That is modest by inter-
national standards, and Russia’s
low sovereign debt means it has
scope to borrow.
But Mr Gavrilenkov says the
change in budgetary policy is
“dangerous”, raising the “break-
even” oil price for the budget to
well over $100 a barrel.
“It is clear that raising $60bn
every year via borrowing on the
domestic market is virtually
impossible,” Mr Gavrilenkov
said in a recent report.
“It is also questiona-
ble whether the gov-
ernment will be
able to borrow
that much inter-
nationally and
keep sovereign
ratings unaf-
fected.”
Pump jacks at
an oil field:
Medvedev
wishes to
reduce
reliance on
the sector
that it is understood as inevita-
ble” he said in Yaroslavl.
Meanwhile, there is the Putin
factor. No one aside from Mr
Medvedev and Mr Putin know
the true nature of their relation-
ship, but Mr Putin is universally
recognised as being the more
powerful, despite Mr Medvedev
having the levers of constitu-
tional authority.
The real differences between
the two seem to be in nuances.
Both vow their commitment
to modernisation, but whereas
Mr Medvedev accents political
reforms and innovation, Mr
Putin talks about the energy
sector and raising pensions and
entitlements – vestiges of the
social contract of the past dec-
ade, when citizens accepted
political passivity in exchange
for improved living standards.
Western analysts remain scep-
tical of Mr Medvedev, convinced
that, despite his independent
views, he is subordinate to Mr
Putin, and that the latter will
inevitably return to power.
But predicting continuity is
not always the safe option in a
country known for political
earthquakes.
Contributors
Charles Clover
Moscow Bureau Chief
Neil Buckley
Eastern Europe Editor
Catherine Belton
Moscow Correspondent
Isabel Gorst
Central Asia Correspondent
Rachel Morarjee
FT Contributor
Courtney Weaver
FT Reporter
Ursula Milton
Commissioning Editor
Steven Bird
Designer
Andy Mears
Picture Editor
For advertising details, contact:
Samantha Lhoas
+44 207 873 3708
samantha.lhoas@ft.com
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FINANCIAL TIMES FRIDAY OCTOBER 1 2010 ★ 3

Investing in Russia

Rich soil has capacity to double yields

Agriculture
But huge investment
is needed in storage
and to improve roads,
says Isabel Gorst
Kremlin launched agricultural
reforms and sanctioned private
ownership of arable land.
Since then Agro Vista has
built a portfolio of 35,000 hec-
tares of farm land in the Tam-
bov region in the heart of Rus-
sia’s grain belt, where it grows
cereals and sugar beet and
keeps a small dairy herd.
prompting the Politburo to
deploy the Red Army to crush a
peasant revolt. After decades of
mismanagement, wheat produc-
tion fell into a decline, forcing
the Soviet Union to turn to the
US, its arch-enemy, for supplies.
As oil earnings soared after
2000, Russia launched agricul-
tural reforms aimed at overturn-
lager asked if Agro Vista was
going to export Tambov’s fertile
soil to England, stripping the
region of its best resource.
In a move to overcome local
suspicion, Agro Vista paid over
the odds for its land, most of
which had lain idle for more
than a decade and was covered
age grain field in Tambov cov-
ers about 500ha, the same size
as a whole farm in England.
Agro Vista has invested about
£20m ($31.3m) so far, buying
land and modernising its farms.
After fair weather last year, it
produced 90,000 tonnes of cere-
als, including more than 60,000
tonnes of wheat.
looking very rosy,” says Mr Met-
calfe.
However, the drought still
casts a shadow over grain farm-
ing. Planting winter wheat in
parched soil this month was “a
gamble”, with a high risk some
crops might fail for want of
moisture. Moscow has set a tar-
get to plant 18m hectares of win-
of nitrogen fertilisers produced
from abundant gas resources.
With modern equipment and
proper management, grain
yields at established farms can
be doubled; and vast tracts of
land still await cultivation.
“Our business model is based
on profitable farming coupled
with land ownership, using a

A
severe heatwave and a
drought that wrecked
more than half his
grain crop this summer
has not dulled David Metcalfe’s
enthusiasm for Russian farm-
ing.
“The drought was bad, but it
was a blip,” says the British-
born farmer. “With the right
investment and management,
the prospects for Russian grain
farming are dazzling.”
Mr Metcalfe is the head of
Agro Vista Tambov, a company
his family formed with a group
of British investors after the
During five years farming in
Tambov, the company has been
buffeted by a storm of events
that has seen wheat production
rise to record levels only to col-
lapse by a third amid the sum-
mer’s drought.
Tambov sits in the Black
Earth region, a vast swathe of
fertile land stretching from the
Black Sea to the Urals that was
the breadbasket of Europe
under the last tsar.
When the Soviets came to
power, Tambov became a centre
of resistance to Josef Stalin’s
forced collectivisation policies,
ing the legacy of collectivisation
and regaining its status as a glo-
bal power in grain.
A law sanctioning private
ownership of agricultural land
unleashed a land grab in the
Black Earth region, as Russian
and foreign investors rushed to
buy neglected collective farms.
They received a cool recep-
tion. Some investors in the first
wave were speculators with no
experience of Russia or farming,
says Oleg Betin, the governor of
the region.
Country folk were also wary
of foreigners – one anxious vil-
Fields of gold:
land is cheap
and so are
nitrogen
fertilisers from
abundant gas
resources
with forest and scrub. Even so,
the price of about £100 ($157) a
hectare was ridiculously cheap,
compared with thousands of
pounds for arable land back in
Mr Metcalfe’s native Yorkshire.
The immense scale of Russian
farming was in itself an attrac-
tion, says Mr Metcalfe. An aver-
Drought ruined more than
half the crop this summer with
the worst heatwave on record.
But the disastrous harvest
was not necessarily a financial
blow for Agro Vista. Like many
grain farmers in Russia, the
company is stockpiling in the
expectation that grain prices
will continue to rise, offsetting
losses from low sales volumes.
Prices are expected to remain
buoyant next year, ensuring
good returns for farmers that
survived the drought – if the
harvest returns to normal.
“The forward business plan is
ter wheat this year as part of a
plan to boost grain production
to 80m-90m tonnes in 2010-11 –
up from an estimated 60m
tonnes in 2009-10. But analysts
believe the goal is unrealistic
because dry weather will pre-
vent some winter wheat crops
from thriving.
Despite the immediate risks,
Agro Vista is standing by plans
to double in size, buying land
adjacent to existing farms.
When compared with York-
shire, Russian agriculture has
compelling attractions, includ-
ing cheap land and the low cost
mix of Russian and western
management skills,” says Mr
Metcalfe.
There are challenges besides
the weather. Huge investment is
needed to build storage and
improve crumbling roads.
Probably the worst problem is
bureaucracy. In Yorkshire, Mr
Metcalfe’s farm employs a single
accountant. In Russia Agro
Vista has 15, plus five lawyers
to handle the mountains of
paperwork. A security team of
40 guards has also been hired to
combat theft, mostly of grain
and fuel oil.

Foreign investors
are sceptical about
implementation
Financial reforms
Courtney Weaver
says progress is
slow on passing
and enforcing laws
When the Kremlin
announced plans three
years ago to turn Moscow
into an international finan-
cial centre, western inves-
tors turned up their noses,
citing problems ranging
from high inflation to poor
protection of shareholder
rights to the lack of laws
against insider trading.
While the financial crisis
has renewed the govern-
ment’s efforts to combat
these problems and rebuild
Moscow’s market infra-
structure, investors are tak-
ing a wary look at the
reforms made so far, and
the distance left to go.
This spring, the govern-
ment appointed Alexander
Voloshin, a former presi-
dential chief of staff and the
former chairman of Norilsk
Nickel, to head the finan-
cial centre initiative.
Alexei Kudrin, the
finance minister, promised
at the start of June that the
government would be tak-
ing “real steps” in the com-
ing months to improve the
markets environment.
Yet four months later,
little follow-up information
has been released on the
initiative and investors are
left to wonder what form
Moscow’s financial centre
will take and how improve-
ments will be made.
“[The financial centre
plan] is not a bad idea, but
the problem is that more
than a declaration is
needed,” says Yevgeny
Gavrilenkov, chief econo-
mist at Troika Dialog.
“A lot of things like [bet-
ter] rule of law, independ-
ent media and visa-free
travel are needed. The rou-
ble must also be made more
attractive which means
inflation must be lowered
as well.”
Another concern for both
investors and the govern-
ment is boosting liquidity
on the local market,” Mr
Gavrilenkov says. “If there
are still only 15 traded liq-
uid companies, it’s not
enough for a global or even
regional financial centre.”
While the list of work to
be done is daunting, inves-
tors say the country’s mar-
kets regulator should first
focus on strengthening the
law against insider trading
– passed just this year – and
creating a central securities
depositary.
The insider trading law
was years in the making
and is still a work in
progress, says Roman
Lokhov, chief executive at
Otkritie Financial Corpora-
tion, the Russian brokerage.
“It’s a very good thing
that [the law] has been
passed finally, but it would
be naive to believe you
would eliminate insider
trading by passing one doc-
ument,” he says.
The process of creating a
central securities deposi-
tary, an idea bounced
around for six years, will
also take time, Mr Lokhov
says. He suggests the gov-
ernment could draft a law
within two or three years,
yet peers say it could take
even longer.
Independently registered
companies, of which there
are about 50 in Russia,
would see their business
plunge, should independent
joint stock companies begin
registering with a central
securities depositary
instead, says Mikhail
Laufer, president of the
Depositary Clearing Com-
pany, the clearing and set-
tlement subsidiary of Mos-
cow’s RTS stock exchange.
RTS and Micex, the city’s
other exchange, have sepa-
rate securities depositaries
at present, a system that
may prevail, given how
slow the central depositary
project has been to get off
the ground, Mr Laufer says.
A proposal for a central
depositary was developed
three years ago, but cur-
rently is just three pages
long, he says.
“It’s difficult to envisage
changes when you don’t see
One­to­one: RTS and Micex, the two stock exchanges, have separate securities depositaries. Investors are pushing for one central depositary Bloomberg
any real document. We Russia could benefit from a business in London is now secrecy laws are over- services are to growth,”
have a concept and, strate- shake-up of the financial a risk,” says a western turned. says Mr Costello.
gically, it’s more or less centre hierarchy, as west- investment banker who sep- “Because of the crisis, “Moscow is not suddenly
clear, but it’s not clear how ern banks look to escape arately predicts high-earn- most regulatory regimes are going to become the next
we can achieve this.” regulation changes in estab- ing Russians will begin competing with each other Singapore and it’s not sud-
While the idea of Moscow lished cities such as London transferring funds out of to be more punitive. Here denly going to become the
becoming an international or Zurich. Switzerland back to Mos- they actually understand next Switzerland. But will it
financial centre makes “Concentrating all your cow, as the former’s bank how important financial be better? Yes.”
many investors roll their
eyes, a minority of western
investment bankers say the
concept may not be so bad.
Indeed, the idea could be
seen as a “tent pole” on
which smaller reforms can
be hung, says Jeffrey Cos-
tello, chief executive for
Russia at JPMorgan.
“We need to fix the mar-
kets; we need to provide a
central securities deposi-
tary; we need to harmonise
the security laws; we need
to fix the bankruptcy codes.
“None of these things in
isolation has enough politi-
cal support to get done,
[but] if you hang all these
projects using the financial
centre as a tent pole, hope-
fully some of them will hap-
pen,” he says.
He and peers also say

Political fears cast long shadow

Stock markets
A stable period of
global growth
might whet investor
appetite, says
Rachel Morarjee
At the beginning of 2010
investors’ expectations for
Russia’s stock market were
bullish. Most expected a
flood of IPOs and equity
capital raising by domestic
companies and to see stock
valuations to resume their
upward climb.
However, the market has
languished. As the third-
quarter earnings season
kicks off, market watchers
are asking whether this
year’s final quarter could
usher in a rally, but inves-
tors remain wary of the
shadow cast by faltering
global growth.
Chris Weafer, chief strate-
gist at Uralsib, the Moscow
investment bank. says:
“People are still fearful of a
reversal into a double-dip
recession, triggered either
by solvency problems in
Europe or a slowdown in
growth or consumer activ-
ity in the US.”
With its dependence on
exports of commodities to
global markets, investors
view the country as a high
beta play on the global
economy.
A more stable period of
global growth would whet
investor appetite for Rus-
sian stocks, analysts said.
The stock market collapse
in the second half of 2008
showed how exposed the
economy is to global trends
and investor sentiment.
“One of the main legacies
of the 2008 crisis is the real-
isation of how fragile Rus-
sia’s financial system is,”
says Mr Weafer, adding that
confidence in financial and
political stability is not
enough to lure investors
back while the world econ-
omy remains shaky.
“The fiscal position is
very strong, politically it is
stable, and valuations are
at a big discount to emerg-
ing markets but that is not
enough to attract investors
back,” he says.
However, if third-quarter
earnings do not disappoint
and there is steadier growth
from the US, investors may
become more confident
about global growth and
there could be an end-of-
year rally.
Peter Elam Hakansson,
director of asset manager
East Capital, which special-
ises in eastern Europe, says
Russia is now the cheapest
big world market and
remains misunderstood.
“The most striking way to
illustrate it is that the valu-
ations in the stock market
are no higher than they
were in 1999, in contrast to
other Bric markets,” he
says.
Price-earnings ratios in
developed markets hover
around the early teens,
while Russian companies
trade at almost half the
norm at a ratio of 7x.
The comparison with Bric
peers is stark: Brazilian
stocks trade at 13x, the Chi-
nese market at 15x, while in
India valuations are close to
20x, according to East Capi-
tal.
Mr Hakansson says politi-
cal fears cloud investors’
perceptions, despite the fact
that the economy has gone
from being virtually bank-
rupt to one of the strongest
in the world. “We think
people are too suspicious of
what is happening and con-
fusing the valuations.”
Dimitri Kryukov, founder
of Russia-focused hedge
fund Verno Investment
Management concurs, say-
ing investors’ biggest fears
are about politics and cor-
porate governance but
these are often overblown.
“A lot of these risks are
pretty easy to avoid if you
are on the ground, meet the
management and know
what is going on,” he says.
On the upside have been
the “reset” in relations
between Moscow and Wash-
ington and Russia’s sensi-
tive handling of the air
crash that killed the Polish
president and other offi-
cials in April.
The result has
been a more posi-
tive tone in arti-
cles by western
commentators,
which could ease
investors’ fears.
“During the
past few months,
we have seen
small steps
towards a
n e w ,
m o r e
posi-
t i v e
view,”
Mr Hakansson notes.
For the coming quarter,
investors will remain nerv-
ous but as the end of the
year approaches, the focus
should turn to a better 2011.
Growth remains and con-
sumer spending will proba-
bly be boosted by govern-
ment moves to support vot-
ers ahead of the 2012 elec-
tion.
Kingsmill Bond of Troika
Dialog, the investment
bank, says the best
approach is to invest in
stocks exposed to the Rus-
sian consumer. “We see the
market as split between the
stagnant government-con-
trolled sector and vibrant
companies that serve the
Russian consumer.”
Troika Dialog said in a
recent report: “High growth
sectors include retail, bank-
ing, media, airlines, broad-
band, automotive machin-
ery or restaurants, where
we expect the market to
double in size over the next
five years.”
“The key point is that
this growth should mate-
rialise even if com-
modity prices are
flat, as it is an
aspect of the
normalisation
of Russia as a
middle income
country.” the
bank said.
Chris Weafer:
‘Valuations
are at a big
discount to
emerging
markets’
4 ★ FINANCIAL TIMES FRIDAY OCTOBER 1 2010

Investing in Russia

Fundamental problems deter inf lows High­tech

Foreign investment
Bureaucracy and
corruption scare
business away,
says Neil Buckley
Much has changed since
Frank Schauff arrived in
Moscow in mid-2007 to
become chief executive of
the Association of European
Businesses, an umbrella
group representing compa-
nies and entrepreneurs.
“At that time, the general
line was: ‘We are so strong
with our exports of oil and
gas and other commodities;
we have this stabilisation
fund with hundreds of bil-
lions of dollars in – and we
don’t need too much foreign
investment’.”
Since last year’s deep
recession, the tone has
changed.
“Conversations with Rus-
sian government officials
have become much easier.
Now, you have all the talk
about modernising the
country. The discourse is
going in the right direc-
tion,” says Mr Schauff.
The message that Russia
is not just open to invest-
ment but actively courting
it is being heard even from
senior officials, such as
Arkady Dvorkovich, chief
economic aide to President
Dmitry Medvedev, and first
deputy prime minister Igor
Shuvalov.
Prime minister Vladimir
Putin, addressing foreign
journalists and at an invest-
ment forum, has spoken
approvingly of a recovery in
foreign investment so far
this year.
But investors still ques-
tion whether the country
is ready not just to change
its attitudes but address
the fundamental problems
deterring investment flows.
Officials had reason to be
blasé before the global
financial crisis. Despite set-
backs for its investment
image such as the Yukos
affair, and corporate dis-
putes entangling foreign
companies such as Telenor,
Royal Dutch-Shell and BP,
the dollars rolled in.
Organisation for Eco-
nomic Co-operation and
Development figures show
annual foreign direct
investment mushroomed
from $12.9bn in 2005 to
$75.5bn in 2008. Though it
halved to $38.7bn in 2009,
that was still the third-high-
est annual total ever.
Investment fell more
heavily in 2009, but Russia’s
performance since 2005 gen-
erally compares favourably
with Bric counterparts.
China, its population
nearly 10 times as large,
increased FDI from $33.6bn
in 2005 to $59.6bn in 2008,
though that slipped to
$48.4bn last year.
Sergei Guriev, an econo-
mist and rector of Moscow’s
New Economic School, says
moves are under way to
modernise the economy and
improve the investment cli-
mate.
He was asked a year ago
to produce recommenda-
tions on improving eco-
nomic performance. He
listed privatisation, deregu-
lation, joining the World
Trade Organization and
OECD, tackling inflation,
improving health by raising
tobacco and alcohol prices,
and ending military service.
Some progress has been
made on all of them, he
says. The commitment to
reduce the state’s invest-
ments in many big compa-
nies to a minimum control-
ling stake will increase
transparency and competi-
tion. Two commissions are
looking at cutting red tape.
‘I don’t have the
feeling we are
particularly
supported in
investing in Russia’
Mr Schauff of the AEB
also points to some concrete
steps – notably a move to
simplify the visa process for
foreign professionals earn-
ing above a certain salary.
Some critics, however,
regret that the visa regula-
tions did not extend to hold-
ers of certain advanced aca-
demic qualifications.
Mr Schauff also notes
that the visa change bene-
fits were partly offset by
introduction of import
duties for expatriates mov-
ing their belongings into
the country, saddling many
with bills of tens of thou-
sands of euros.
The authorities have
promised to remove the
duties, he says, but that
could take time.
“It shows that co-ordina-
tion between different min-
istries and agencies could
be improved.” he adds.
Some investors are also
sceptical about the extent of
changes in the environment
for investment.
Jiri Smejc, managing
partner of PPF Group, a
Czech Republic-based finan-
cial investment group oper-
ating across central and
eastern Europe, says his
organisation remains posi-
tive about Russia.
PPF has $3bn of invest-
ments there, including 100
per cent of Home Credit &
Finance Bank, a retail
bank, and a controlling
stake in Eldorado, a big
electrical retailer.
No other European mar-
ket, he suggests, can match
Russia’s scale of opportu-
nity.
He thinks “nothing has
changed” in the investment
climate in the past year. “I
don’t have the feeling we
are particularly supported
in investing in Russia,” he
says. “I don’t see any differ-
ence. But they have only
started. I think we will have
more visibility in a year.”
Like many, Mr Smejc
identifies as a priority
increasing the effectiveness
of the courts, although he
says PPF Group has had
some favourable experi-
ences with the legal system.
A further barrier consist-
ently cited by investors
remains bureaucracy – and
its inevitable corollary,
demands for bribes and
kickbacks. Until serious
efforts are made to tackle
those problems, investment
is likely to remain below its
potential.
“Everyone knows Russia
needs more investment,”
says Mr Guriev.
“But for that you need to
tackle corruption, and Mr
Putin doesn’t seem to
believe this.”
project raises
awareness
Skolkovo
Charles Clover on
plans for a research
and production hub
in a Moscow suburb
Evgeny Velikhov, one of the
Soviet Union’s greatest
physicists, sits at his desk
in a villa on the outskirts of
Moscow, surrounded by the
trappings of a 50 year
career in science – books on
non linear diffraction and
ionised plasmas.
But the elderly Mr
Velikhov has his mind on
something else: an Apple
iPad, which he has just
been given as a present. He
thinks it is a good example
of what needs to happen in
Russia.
“Look at this. It is not a
product of brilliant science.
There is no super secret
technology in here. It is a
Mr Velikhov, head of Rus-
sia’s Civic Chamber and a
supporter of the Skolkovo
project, says it is conceived,
not as a panacea, but sim-
ply a first step.
Elena Titova, president of
Morgan Stanley in Russia/
CIS, says: “It’s great to cre-
ate an island of excellence,
but the point will be to
make the excellence spread
beyond it. The most impor-
tant things have to happen
around Skolkovo, not inside
it.”
For now, many of Russia's
most skilled software engi-
neers go abroad, or work
for foreign companies at
home, because of the diffi-
culty of doing business in
their native country.
Valery Kudryavtsev,
chairman of the department
of mechanical mathematics
at Moscow State University,
is one of the world’s pio-
neers of artificial intelli-
gence and has dozens of US
patents for his Artificial

Sector and
clever gimmick. But we
have nothing like it.”
The lack of a high tech-
nology sector is particularly
galling to the country that
launched Sputnik and the
Intelligence inventions – all
owned by a US company
that funds his research and
employs his students.
“I would love to set up
such a company in Russia,

finance
first manned space flight.
But Russia’s leaders are
recognising that having
world class scientists alone
will not take it into the
ranks of global knowledge
but it would be practically
impossible” he says, adding
that it would cost hundreds
of millions of dollars.
Many of the problems
that afflict the technology

ministry at
economies. With President
Dmitry Medvedev talking
about making the leap from
an industrial resources
exporting economy to a
post industrial economy
sector are common to all
small and medium size
enterprises: bureaucracy,
corruption, inefficient regu-
lations, and lack of finance.
Serguei Beloussov, chief

odds on tax
Oil industry
Catherine Belton says
the stand­off is part of a
broader debate about
the type of economy
best for the country
based on “innovation”, the
Kremlin has resolved to
address this. ‘Now, there is
The country does not lack motivation to
brain power – pumping out
70,000 computer program- be involved in
government should collect rents
ming graduates every year,
many of whom migrate to
innovation
from natural resource wealth and Silicon Valley and other creation, which
divert funds into modernisation technology hubs.
projects. The debate was brought But what it lacks is the
is very positive’
to the fore by the global economic fusion of this brain power
crisis, which highlighted the per- with an environment for executive of Parallels, a
ils of the country’s continued commercial success. “A lot company that designs cloud
dependence on raw materials. of innovation, not enough computing software, is very
Few argue against the need to products” is how Roman familiar with the challenges
modernise the economy, but Lokhov, head of investment of being a tech business in
many in the oil industry argue banking for Moscow’s Bank Moscow.

T
he oil industry and the
finance ministry are
locked in a debate over
taxes that could shape the
economy for years to come.
The oil industry is lobbying for
a sweeping change to introduce a
profits-based system, which it
says would be more predictable
and fend off a looming production
decline by easing the investment
climate.
But the ministry is digging in
its heels and, in a bid to raise
revenues, is ending tax holidays
under the current revenue-based
regime, while raising other
charges.
Alexei Kudrin, the fiscally con-
servative finance minister, this
summer said he wanted to raise
extraction taxes on the industry
in a move that could win another
$6bn in revenues for the govern-
ment next year, while scrapping
export tax holidays for crude from
east Siberian fields and levying a
tariff of 45 per cent instead, which
could raise another $4bn.
However, this month Rosneft,
the state oil company chaired by
Igor Sechin, the powerful deputy
prime minister, began fighting
back, lobbying for tax holidays for
its vast Vankor field in east Sibe-
ria to be reinstated, as the entire
industry argues that output
growth is under threat from the
burdensome tax regime.
But as the haggling goes on, at
the heart of the stand-off is a
broader debate about what type of
economy the country wants.
It centres on the extent the
that modernisation would be best
driven by improving the overall
investment climate, particularly
for the energy industry, so the
country can harness its natural
resource advantages to drive mod-
ernisation in the rest of the econ-
omy.
The current push to raise taxa-
tion on the sector and plough bil-
lions of dollars into building a
“Russian Silicon Valley” in Skolk-
ovo outside Moscow is, for many
energy sector advocates, a waste
of money and could strangle the
oil industry as a main source of
growth.
“They are going to build Skolk-
ovo and still find themselves in
the middle of an eight lane [tech-
nology] highway in five years
time, where they are going to get
flattened,” says one expert, speak-
ing on condition of anonymity.
“China and India are just much
faster,” in the sphere of high-tech.
But Mr Kudrin, who watched in
horror as pressure on the rouble
helped shrink vast hard currency
reserves by more than $160bn at
the height of the crisis, is seeking
to levy every kopeck he can.
Although reserves have recov-
ered with the help of high oil
prices, Russia’s once flush oil
windfall funds, vital for future
pension payments, are dwindling
after anti-crisis spending.
One, the reserve fund, is down
to $40bn from a high of $142bn
before the crisis; and the other,
the national wealth fund, stands
at $85bn. “Mr Kudrin’s main pri-
ority is maximising tax revenue
Raising revenues: Putin opens a section of a new pipeline to export east Siberian oil to China
from wherever he can get it,” says
Chris Weafer, chief strategist at
Uralsib investment bank in Mos-
cow. “He knows the budget is vul-
nerable and the oil price could
collapse at any time.”
The industry, however, argues
that if the finance ministry
allowed the tax regime to shift
from its current revenue-based
‘The main priority of
Kudrin – the finance
minister – is
maximising tax revenue
from wherever he can’
model, which takes 90 per cent of
earnings from all oil exports at
prices above $25, to a profits-
based system, output would rise
and eventually boost tax revenues
as growth increased.
Russia’s oil barons also say a
profits-based system would be
more predictable than the current
ad hoc tax holidays, while the
existing regime has become unfair
after a huge rise in costs since it
was installed six years ago.
Jonathan Muir, chief financial
officer at TNK-BP, BP’s Russian
oil venture recently noted oil lift-
ing costs had soared 126 per cent
in the past four years. “This is a
huge challenge,” he says. “We
have seen free cash flows decline
by half in the past few years.”
But the finance ministry is
wary of the move to a profits-
based system, as it could motivate
oil companies both to boost costs
and to revert to the transfer pric-
ing schemes of the 1990s – that
shifted costs and profits within a
company or group to favourable
jurisdictions – thereby lowering
tax liability.
“A move to a profits-based sys-
tem inevitably means more risk
for the finance ministry than the
current production tax and export
duty formulas because they would
need to have more people to
implement the regime and rely on
companies’ profit and loss state-
Getty
ments – and it seems they are
reluctant to take on the incremen-
tal work and are also sceptical
about the transparency of costs,”
says Peter O’Brien, vice-president
of Rosneft.
“To address these perceived
risks, the industry could offer to
set up and fund an independent
body that would be a clearing
house for all cost-related data and
analysis, enabling comparability
and the setting of acceptable
transparent industry bench-
marks,” he says. “Importantly,
both sides need to move.”
In the meantime, however, the
ministry is showing little sign of
approving such a shift.
But with investment in new
fields slowing and existing fields
in west Siberia in decline, produc-
tion could fall by 30 to 50 per cent
by 2030 if the government does
not create a stable long-term tax
environment, says Sergei Vaku-
lenko, head of the Moscow office
of IHS Cambridge Energy
Research Associates, which is
advising the government.
Otkritie, puts it.
His institution has been
seeking to get its foot in the
door of this developing sec-
tor by financing tech start-
ups on a stock exchange
opened last year, the Mos-
cow based Micex Market for
Innovation and Investment.
So far, there are only five
listed companies on the
exchange, but one day, it
aims to be Russia’s Nasdaq,
the US high technology
exchange. “Its not even a
baby Nasdaq yet, but the
goal is to get there,” says
Mr Lokhov.
The government is bet-
ting that the creation of a
huge high technology cen-
tre in Skolkovo, a suburb of
Moscow, will attract foreign
investment and specialists.
Already, Cisco Systems,
the US consumer electron-
ics company, has pledged
$1bn of investment, and
Siemens, the German engi-
neering company, has said
it will take part.
But many have criticised
Skolkovo, saying it is not
what the sector needs – Ale-
ksander Auzan, an econo-
mist at Moscow State Uni-
versity, says it bears all the
hallmarks of an expensive
prestige project.
“It is just like one of
those science expositions
we had in the Soviet Union
– designed to sit there and
look pretty.”
Although his company is
based in Switzerland, its
research and development
centres in Moscow and
Novosibirsk employ 500 of
the 700 total staff. “The
company is run 100 per cent
on Russian technology” was
how he put it.
“Instead of being focused
on developing the fastest
search engine or something,
you would be focused on
making sure that you have
air conditioning in the
office, or on paying taxes or
something,” he says.
“In the UK you can get a
new CPU from the US, and
you simply receive it and
start using it. Here, you
have to go through cus-
toms, and that can take a
while. Things are not
straightforward.” However,
he says that merely by talk-
ing about the sector, the
government has started to
change the situation.
“Five years ago, most
young people wanted to be
government employees or
entrepreneurs in some very
traditional fields. They
might be a talented engi-
neer or software designer,
but they would want to
leave and open a chain of
pharmacies,” he says.
“But now, there is a moti-
vation to be involved in
innovation creation, which
is very positive. It’s already
happening.”

Hard times and hard weather boost online shopping

E­commerce
Customers like to
hunt for bargains
and this has helped
protect the sector,
says Isabel Gorst
Hard times and extreme
weather have given a boost
to online retail in Russia, as
shoppers abandon wild pre-
crisis spending and bargain-
hunt on the internet.
“The crisis did online
retailers a huge favour,
increasing the number of
value-seekers,” says Nata-
sha Zagvozdina, consumer
analyst at Renaissance Cap-
ital, the investment bank.
Glitzy shopping malls
that sprang up during the
oil boom emptied after the
financial crisis hit in 2008,
plunging the economy into
recession for the first time
in more than a decade.
The retail sector has
begun to recover this year,
but shoppers have learnt to
curb the extravagant spend-
ing that drove the longest
consumer boom in the
country’s history.
“In 2008, if people saw
something they liked – even
big luxury items – they had
to have it. But impulse buy-
ing has now gone and peo-
ple are really doing compar-
isons,” says Dale Clark,
retail and consumer indus-
try leader at PwC.
Russia’s e-commerce mar-
ket is worth some $3bn to
$4bn a year, not yet large
enough to pose a serious
threat to bricks-and-mortar
retail. But e-shops’ ability
to deliver discount goods in
a forum ideal for shopping
around has helped it sur-
vive the recession relatively
unharmed.
While most non-food con-
ventional retailers saw
sales fall in 2009, e-shops
continued to show growth,
albeit at a slower rate than
before the crisis.
An abnormally cold win-
ter followed by a record-
breaking heatwave this
summer was a boon for
e-commerce, as people
stayed at home to shop.
Internet shopping pat-
terns are similar to those
worldwide. Books are the
most popular items, closely
followed by consumer elec-
tronics, cosmetics and DIY
home improvements, says
research by PwC.
The online arms of large
bricks-and-mortar retailers
are expected to gain a lead-
ing role in the country’s
e-commerce because of the
large investments needed in
storage and distribution
infrastructure to support a
successful business.
Ozon.ru, Russia’s biggest
e-commerce company with
an annual turnover of more
than $100m, modelled itself
on Amazon, when it began
operating in 2000 and has
invested heavily in state-of-
the-art warehouse and
batching facilities.
E-shops linked into the
country’s bustling social
networking sites, have won
a strong following, helping
shoppers escape often exor-
bitant mark-ups in conven-
tional stores.
The collective buying
revolution hit this year, as
online shopping clubs, copy-
ing a US model, began pro-
viding huge discounts on
goods and services once
orders build to a critical
mass.
Pioneers such as dar-
Fishing for
bargains:
darberry.ru is
a popular
web shopping
club
berry.ru and weclever.ru
have enjoyed instant suc-
cess with deals-of-the-day
on anything from apple
strudel to yoga classes or
bikini waxes snapped up by
club members.
Domestic companies have
so far been the biggest ben-
eficiaries of growth in the
sector, but global brands
are making inroads, as they
start to take non-Latin
alphabets more seriously.
E-Bay launched a Cyrillic
version this year to com-
pete with Russia’s molo-
tok.ru web auction service
and allowing customers to
pay with roubles for the
first time.
Groupon, the fast growing
social commerce website,
bought a controlling stake
in darberry.ru as part of
an international expansion
that has taken it to 56 coun-
tries since starting business
in 2008.
Venture capital funds are
also targeting e-boutiques,
in a boost for one of the
country’s few innovative
industries. Accel Partners,
the Silicon Valley-based
fund that backed Facebook,
has invested $20m in kupi-
VIP.ru, an online shopping
club specialising in exclu-
sive fashion brands.
Limited access to the
internet has been the main
brake on e-commerce so far,
although that is set to
change.
The country has more
than 43m web users, a
penetration rate of about
30 per cent, and is one of
the world’s fastest growing
internet auditoriums ac-
cording to comScore, the US
web research company.
Online purchasing is con-
centrated in Moscow and St
Petersburg. But Bernard
Lukey, chief executive of
Ozon.ru, says internet shop-
ping will surge, as broad-
band becomes available in
the regions.
“Russia will soon have
the biggest internet audito-
rium in Europe,” he says.
Collecting payments is
the biggest challenge
e-shops face.
Few Russians own credit
cards, and those who do are
wary of using them online,
fearing cyber crime. Door-
to-door cash collections do
not work well because of
distrust of strangers.
Delivering goods to meet
tight deadlines across a
vast land mass is another
problem.
The antiquated postal
service admits it cannot
handle the surging number
of parcels dispatched by
web retailers. And when
shoppers order from abroad,
Russian customs often nit-
pick about price tags caus-
ing delays at the border.