Analytics, Book review, Economics, EU – Baltic States, EU – CIS, Markets and Companies, Russia

An international group of authors have made a comprehensive analyses of Russian FDI’s –outflow-inflow structures, as well as numerous problems connected with it while assessing the impact of changed international political situation on foreign firms operating in Russia. At the same time the book explores the new global situation affecting Russian investments abroad.

The book consists of an introduction, 13 chapters and conclusion, describing numerous investment relations between Russia and several foreign states, including those in the Baltic Sea area, e.g. Sweden, Finland and Estonia as well as EU, Eurasian Economic Union, some Asian and Latin American states. *)

*) The Russian Economy and Foreign Direct Investment/Eds. Liuhto K., Sutyrin S., & Blanchard J-M. - Routledge Studies in the Modern World Economy Series. – Routledge: UK-N.-Y.- 2017,- 276 pp.

Generally, FDI is an investment made by a company or individual in one country into business in another country, by way of either establishing business operations or acquiring business assets in the other country, e.g. through ownership or controlling interest in a foreign company.

In this sense, FDI is distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies. The FDI’s key feature is that it is an investment made to establish either effective control or exert a substantial influence over the decisions made by a foreign business.

FDI is made to provide added surplus and growth prospects for the investor; thus, FDI often involves both a capital investment and provision of management or technology.

Interesting as well are FDI’s methods. FDI can be made in a variety of ways, including the opening of a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company.

The threshold for a foreign direct investment that establishes a controlling interest, made by the Organization of Economic Cooperation and Development, OECD is a minimum 10% ownership stake in a foreign-based company, typically represented for the investor acquiring 10% or more of the ordinary shares or voting shares of a foreign company. However, that definition is flexible, as there are instances where effective controlling interest in a firm can be established with less than 10% of the company's voting shares.

Foreign direct investments are commonly categorized as being horizontal, vertical or conglomerate in nature. A horizontal direct investment refers to the investor establishing the same type of business operation in a foreign country as it operates in its home country (e.g. a cell phone provider based in the US opening up stores in China). A vertical investment is one in which different but related business activities from the investor's main business are established or acquired in a foreign country, such as when a manufacturing company acquires an interest in a foreign company that supplies parts or raw materials required for the manufacturing company to make its products. A conglomerate type of foreign direct investment is one where a company or individual makes a foreign investment in a business that is unrelated to its existing business in its home country. Since this type of investment involves entering an industry the investor has no previous experience in, it often takes the form of a joint venture with a foreign company already operating in the industry.

Source: http://www.investopedia.com/terms/f/fdi.asp

“Direct” issues in investments

Commonly referred to as foreign direct investment, it refers to an investment in a business enterprise in a country other than the investor's country designed to acquire a controlling interest in the foreign business enterprise. Direct investment provides capital funding in exchange for an equity interest without the purchase of regular shares of a company's stock.

The purpose of a foreign direct investment is to gain an equity interest sufficient to provide control of a company. In some instances, it involves a company in one country opening its own business operations in another country, while in other cases it involves acquiring control of existing assets of a business already operating in the foreign country. A direct investment can involve gaining a majority interest in a company or a minority interest large enough to provide the investor with effective control of the company.

Direct investment is primarily distinguished from portfolio investment, the purchase of common or preferred stock shares of a foreign company, and by the element of control that is sought.

http://www.investopedia.com/terms/d/direct-investment.asp

According to UNCTAD-2015 data, FDI is an investment aimed at “gaining effective voice in the management of the enterprise to be invested in”. The UN institutions suggested that in order to be identified as FDI investment needs to represent at least 10% of equity ownership.  

FDI’s situation in the EU

The Eurostat, statistical office of the EU, underlined that FDI stocks helped to quantify the impact of globalisation and measured longstanding economic links between countries (according to immediate counterpart criteria). The FDIs provide an indication of the relative importance of a country's economic presence abroad, or that of foreign partners in the reporting entity, measured in terms of FDI capital.

European iinbound and outbound investment flows are almost in balance. Thus net EU states’ FDI stocks in the world amounted to €6, 9 trillion (the end of 2015, up by 14.9% compared with the end of 2014). Meanwhile, global investment stocks in the EU accounts for about €5,9 trillion at the end of 2015 (+23% compared to 2014).

According to Eurostat’s January 2017 report “Foreign Direct Investment stocks at the end of 2015”, so-called Special Purpose Entities (SPEs) resident in the EU played a major role, accounting for 52.5% of the total EU FDI stocks held abroad and for 62.7% of the FDI stocks held by the rest of the world in the EU.

More than a third of EU FDI stocks are held in the USA: at the end of 2015, the US absorbed 37.2% of the total FDI stocks held by the EU in the rest of the world (€2 561 bn), far ahead of Switzerland (€829 bn or 12.0%), Bermuda (€353 bn or 5.1%), Brazil (€327 bn or 4.7%), China (€288 bn or 4.2%) and Canada (€249 bn or 3.6%).

In the reverse direction, United States' direct investors increased their presence in the EU to €2 436 bn of FDI stocks at the end of 2015 (or 41.7% of total FDI stocks held by the rest of the world in the EU). They were followed by those from Switzerland (€627 bn or 10.7%), the offshore financial centres of Bermuda (€503 bn or 8.6%) and Jersey (€227 bn or 3.9%), as well as Canada (€228 bn or 3.9%).

Source: Eurostat/6/2017; 12 January 2017 “Foreign Direct Investment stocks at the end of 2015”.

Seemingly, investment climate looks pretty good in Latvia with the total of about €10 bln in 2015. Among most active investors have been Sweden (over €2,6 bln), Netherlands (little over €1 bln, almost on par with Estonia), Russia (€1.2 bln) and, strange enough, Cyprus (€1,3 bln).

With all business activity of such states as Germany and Denmark, their investments are, correspondingly, € 0,7 and € 0,6 bln; even the UK is less, i.e. € 523 mln.

International investment climate and Russia

After reaching a peak in global rank among top FDI host-home countries in 2013 (making 5^th in the world), Russia faced a dramatic downturn in its international investments since 2014. Western economic sanctions (with all negative impact on Russian economic growth) have “most significant negative impact on Russian FDI flows”, e.g. trading with bonds and equities issued by five major Russian banks was prohibited and hence “indirect impact of sanctions” accounted for about 1-1,5% of Russian GDP in 2015 (p.269).  

Deteriorating global GDP’s rate, which since 2010 has been reduced from about 5,5% to less than 3% and is still falling cannot provide optimism in FDI in Russia. Besides, China’s slowdown and reduced commodity prices negatively affect FDI flows into Russia.

Authors conclude that all these factors prevent Russia’s FDI to resume the upward position which the country enjoined in the beginning of 2000s.      

So is the FDI situation in Russia’s neighbors: not only Russia’s investments in Europe are small, but quite surprising are modest investments in the neighboring states, e.g. Finland. Despite sanctions, Finish-Russian political relations are quite good; however, Russian investment flow in Finland account for about 1,5% of the total Finland’s FDI.     

Case studies

The book’s material can serve as good reference material for college/university students, mainly in the European economic studies. Thus, in some case studies, e.g. Arctech Helsinki Shipyard and other knowledge-driven initiatives in Finland, the authors showed the complexity of investment issues. Even foreign trade is “unequal”: Russia represented 8,5% of Finland’s foreign trade while Finland only about 2% of the foreign trade in Russia. (p.118).

Russian FDI in Estonia has been at the level of 10-25% of annual capital formation before the “sanction crisis” in the second part of 2014. Presently, there are strong signs of Nordic expansion in the Baltics: most active are Sweden (27%), Finland (23%), Holland (11%) and Norway (6%); Latvia and Lithuania are at the level of 3% each (p.123). 

Quite interesting is analysis of the US-Russia (pp. 43-59), Sweden and Russia (pp. 80-102), as well as history of Russian FDI in Estonia (pp. 122-137). 

Conclusion

Finding investors, both national and international is not an easy task: investors must be motivated though they are mostly looking for profit. However, this profit-oriented search makes recipient countries liable for providing optimal conditions and preferential circumstances compared to other places in modern globalization.

On the other hand, as is the case in Russian FDI, about half of these FDIs sooner or later are repatriated to Russia through foreign “corporate citizenship”. To deal with this, Russia has to streamline its FDI’s tax regulations.

Still important for Russian FDI is the EU’s market: in mid-2015, about two-thirds of Russia’s outward FDI ended up in one of the EU-28 states and three-quarters of investment in Russia (according to Russia’s Central Bank) has been originated from the EU. Actual correlation between inbound and outbound FDI in Russia is actually striking: $ 4,8 bln for the former and 21,6 blin for the latter! In contrast, the USA accounts only for 2% of Russian investments abroad.

Bottom-line: the book helps readers to understand Russia’s position and direction in the global investment scene. A team of almost 20 researchers by using a range of different models managed to reveal a diverse picture of Russian economy and FDIs. The book reveals a complex situation with Russian political economy through corporate investment abroad and shows possible perspectives in FDI’s development. 

Book review is prepared by Eugene Eteris, European Studies Faculty, Regional Economy & Business Department, RSU/Latvia.