Russia, where are you headed to?

The current situation in Russia, Ukraine and Crimea is striking straight to Russia’s most vulnerable spot in the international economy: the country’s trustworthiness as a safe investment destination. The investment climate has taken quite a blow due to the recent events. Growing consumer markets, bigger middle-class, increasing of the disposable income and availability of skilled labor force made Russia the 6th most attractive investment destination in the world in year 2012 (E&Y Attractiveness Survey 2013). Foreign investors have created a large amount of jobs to Russia and especially to the production sector. The reformation of Russia’s economy has not, however, played out as hoped: bureaucracy and high corruption levels still trouble the country and its economy. Modernization of industry, investments to the future technologies and transition from commodity dependence to diversification of the economy have progressed extremely slowly despite the large foreign currency reserves and enormous income from energy exportation. WTO membership has not eased the trade much: Russia wishes to interpret the conditions of the membership in its own favor. In addition, the protectionism i.e. favoring Russian companies and defending the rights of Russian citizens has risen to the surface lately.                                                              

Will Russia’s development in global economy end to these geopolitical conflicts due to the takeover of Crimea? Is Russia choosing the path of economic isolation? Russia’s economy started to slow down already last year – will the recession deepen even more if foreign companies will freeze their investments or start to retreat from Russia? Germany halted a 100 Million Euro arms trade, Stockmann has frozen its plans to expand to major Russian cities (TE no. 11, 21.3.14), just to mention a few examples. The possible economic sanctions from Russia’s biggest trading partner EU and Russia’s counter sanctions will strike straight to the core of business. Have the openness and reformation policies that were started over 20 years ago been forgotten completely? Because of these questions the Russia strategies and SWOT-analyses of Finnish companies will be rewritten. It will take years to gain back the confidence of the foreign investors. Country risk has gained a whole new meaning.

Finland’s situation in the crisis

Crimea’s gas, oil and natural resources are vital for Russia, and the true reason for intervention in the area. It is important for Russian economy to keep the oil price high: approximately 50% of the budget income consists of energy export taxes and approximately 80% of export earnings consist of oil and gas revenues. Wars in Middle East have almost doubled the oil prices. Time will show what measures Russia will make in order to maintain the current price level of oil also in the future. In its energy policies Russia is heading east: Russia will double its exports of oil and gas to Asia within the next 20 years. From year to year Russia has been within Finland’s three main trading partners. Last year Finland’s exports to Russia were about 10% and import approximately 20% of the total exports and imports. Almost 80% of Finland’s imported gas comes from Russia; even though the number for electricity is only 5%. It would be the time to start considering other countries where energy could be imported, as well as finally start investing in the energy self-sufficiency of Finland.

The big negative effects are on the retail sector. The purchasing power of Russian citizens has declined considerably due to the slowing down of the economic growth as well as the depreciation of ruble (over -20%). Shopping tourism has reduced in Finland, and particularly in South Karelia. The effects can be seen in the stores and in the streets. Still last year the area received a record-breaking amount of travelers, 2.5 million people (TAK). Tax-free trade reduced by 25% in Finland last year, and the growth of invoice-trade does not change the whole picture that much. Trade sanctions might reduce the amount of tourists even more. In the logistics point of view, the ending of TIR-handling on the Vaalimaa border after 21st of April makes the operations of exporting companies more difficult. The WTO-membership does not seem to limit Russia’s actions.

The Finnish companies operating in Russia face a two-way effect: retail companies like Stockmann, SOK and Kesko suffer from the weakness of Ruble since the exported goods are now over 20% more expensive than last year. The focus has to be turned on local products, which will not meet the quality of the Finnish products. The winner in this situation are those companies that have their sales contracts in Euros and expenses in Rubles. Also the Russian oil companies will benefit from the situation.

The mistrust on Russia has increased the outflow of capital from the country to record-breaking levels (70 Mrd Euros) during the first quarter of the year. That is a lot to deal with for the last three quartiles.

Pirjo Karhu
CEO, Centre d' Expertise Oy


A version of this blog entry has been published also in a member magazine of Hämeen Venäjän kaupan kilta ry, magazine no. 2/2014.