The Rise of Russian Transnational Corporations

7/23/2019 The Rise of Russian Transnational Corporations

1/32Electronic copy available at: http://ssrn.com/abstract=977465

This work originally appeared in:

May-June 2007 issueVolume 2, Number 1, pp. 55-85

2007 The Geneva Post Company S.A.[Release: 19 June 2007]


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The Rise of Russian TransnationalCorporations

Klmn KALOTAY

These days, together with Brazil, China and India,Russia is referred to as one of the most dynamic sources of

outward investment. However, little is known about thecharacteristics and motivations of Russian transnationalcorporations (TNCs), sometimes called eagle multinationalsin reference to the national symbol of Russia. To what degreeare Russian TNCs special? Do they share at least commoncharacteristics among themselves?

In fact, the universe of Russian TNCs shows greatvariety when it comes to ownership structures, motivations

and strategies to invest abroad. There are, nevertheless, twocharacteristics that apply generally to them. The first one istheir leapfrogging to the global scene. The internationalexpansion of Russian TNCs in the 1990s and the newmillennium is not a simple continuation of the rather limitedinternational trading presence of the older redmultinationals. The activities of the Russian TNCs bornmostly after 1991 are broader and deeper, and notably includeproduction facilities. The other common characteristic ofRussian TNCs is their strong link with the natural resources of

Klmn KALOTAY is Economic Affairs Officer, United NationsConference on Trade and Development, Geneva, Switzerland. The viewsexpressed here are those of the author and do not necessarily reflect theopinion of the United Nations. He may be contacted at:.


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their home country. Until recently, they were all based on oiland gas, metallurgy, mining, or related activities.

The analysis of Russian TNCs is not an easy task, fortwo reasons. First and foremost, many Russian firms are stillreluctant to reveal information about their activities.Sometimes even the disentangling of outward investment fromsimple exports is a complex task. A second source of difficultyis that the topic of outward foreign direct investment (FDI)from Russia has been so far by and large under-researched bythe academic community. Hence, the possibility of comparingand contrasting different academic views on the topic isrelatively limited.

This present article attempts to provide a synthetic viewof what we know or would need to know about the RussianTNCs that emerged after 1991, while looking at thatphenomenon from the angle of what it means for expansionabroad and, whenever appropriate, for its broader political

context. It also analyses the transformation of the main driversof outward expansion from a need to reinvest private rentsderived from privatization (the main reason for investmentsabroad in the 1990s) to a need to use excess cash gained fromhigh natural resource prices (the main motive of the currentdecade). I perform those analyses by combining threeapproaches:

an empirical analysis of outward FDI;

an empirical analysis of corporate strategies; and

an analysis which follows the spirit of the new politicaleconomy approach.


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This approach is not alien to international businessresearch; examples exist from the 1970s to current times.

EVIDENCE FROM THE BALANCE OF PAYMENTS

The first key observation on the balance-of-paymentsinformation is the fact that since the start of the transition from

a centrally planned to a market economy, Russia has been alarge net capital exporter country (its FDI outflows haveexceeded its FDI inflows). Until recently, this observation wasbased on deductions from existing information and estimates,as the official statistics of the country used to register only afraction of the real outflows of the business sector. With recentimprovements in the data collection and reporting of the Bankof Russia, it is now also possible to confirm the accuracy ofpreviously made estimates. The cumulative amount of net

capital outflow by non-financial enterprises and householdsfor the period 1994September 2004 (US$ 167 billion) is byand large in line with earlier estimates for the unregistered ormis-registered FDI outflows of the country. This finding isin line with the estimate of the United Nations Conference onTrade and Development (UNCTAD) in 2002 that the capitalflight from Russia over the 1990s had been in excess of US$20 billion per year. In the light of statistics gathered at a laterstage, this amount proved to be right for various years (e.g.1996, 1997 and 2000).

Plotting the FDI inflows, the registered FDI outflowsand the estimated total FDI-type capital abroad for 19932004,Russia shows the signs of being a major source country of


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outward FDI. But the official and estimated outward FDI datagive somewhat different signals. If only the officiallyregistered FDI outflow is considered against the FDI inflows,there is a gradual shift towards a net capital exporting status(see Figure 1). Indeed, since 2002, FDI outflows exceed theFDI inflows. If the assumed FDI outflows are considered, thecountry has been a major capital exporter since the mid-1990s.The value of these outflows fluctuates sharply, and seems todecline after 2000, reflecting the efforts of authorities to slowdown and regularize the spontaneous outflows of FDI.

FIGURE 1

FDI INFLOWS, FDI OUTFLOWS, AND NET CAPITAL OUTFLOWSOF RUSSIA, 19932004

(Billions of US$)

Sources: United Nations Conference on Trade and Development,FDI/TNC database (); dataprovided by the Bank of Russia; and the authors estimates.


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These data indicate that, in global comparison, Russia is amajor source country of outward FDI. If the official outward FDIstock of 2003 (US$ 72 billion) is considered, Russia is alreadyamong the 20 most important source countries in the world,accounting for almost 1% of the global stock. This value is higherthan that of a number of small high-income countries (such asFinland, Austria, Norway or Portugal) and that of the majority ofemerging economies. In the emerging economy group, only theoutward FDI stock of Hong Kong (China) and Singapore exceed

that of Russia. Other leading emerging economies that areusually reported as new outward FDI majors (such as TaiwanProvince of China, Brazil, China, Republic of Korea, Turkeyand India) all fall behind Russia. If all the capital outflows of theenterprise sector of Russia as reported by the Central Bank hadbeen counted (US$ 169 billion until the end of 2003), Russiawould have advanced to the 14th position worldwide, ahead ofSingapore.

THE LARGEST RUSSIAN TNCS

A micro look at Russian TNCs reveals that the leadingoutward investors are big, even in global comparison. Thisanalysis uses two main data sources. One of them is theUNCTAD list of the largest (Russian) TNCs, ranked by theassets they control abroad. UNCTADs data reveal, for

example, that Lukoil, with more than US$ 7 billion of assetsabroad, would be at position 9 on the list of the top 50 non-financial TNCs from developing countries. Of the eight firmsthat are larger, two (Petronas of Malaysia and Petrobras of


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Brazil) are also oil-and-gas firms. In turn, other developingcountry petroleum companies such as the China NationalPetroleum Corporation and the Oil and Natural GasCorporation of India are smaller TNCs than Lukoil. As forNorilsk Nickel, it would be number 39 on the developingcountry list, behind Vale de Rio Doce (Brazil), for instance. Italso seems that the Russian oil firm Lukoil is moretransnationalized than its Chinese, Indian and Malaysianpeers. The difference in comparison with the China National

Petroleum Corporation is particularly striking. The oppositeobservation is true in metallurgy: there, Russias Mechel is lesstransnationalized than Brazils Vale Rio de Doce.

The UNCTAD data offer a quite accurate reflection ofthe degree of outward-investing activities. It has, however,also some shortcomings. First, there are always firmssometimes important onesfor which data are notavailable. Second, data reporting is far from beingstandardized among countries. For instance, for various

reasons, some Russian firms may have underestimated thereal extent of their assets abroad while their counterparts indeveloping countries may have overestimated them.Thirdly, due to their methodology, these data includeprominently specialized firms in transportation or trade thatare not TNCs in the usual sense: their business is bydefinition international; it does not require a home base orownership advantages; and the dilemma of trade-offbetween domestic and foreign activities does not arise.Fourthly, these data can present a mostly static picture,given the fact that the relative novelty and difficulties ofdata collection have made it close to impossible to havelonger-term historical series. Fifthly, a


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presentation of the largest players provides very important, butnot necessarily complete, information on the full patterns ofoutward FDI from Russia. For example, some case-studyevidence, using the example of Russian firms in Finland,suggests that medium-sized, small and family businesses arealso investing abroad.

A complementary way to identify outward-investingfirms is to use as a basis the most recent domestically producedExpert-400 list of the largest Russian firms, ranked by totalsales, selecting those whose presence abroad can bedocumented. This methodology is more rudimentary than theother one because it considers total transactions and not just theones carried out abroad. It nevertheless helps in identifying animportant number of Russian firms for whom presence abroad(and not just export sales) can be proven. Interestingly, 50 ofthe 100 largest Russian firms are already TNCs.

The combination of the two methodologies reveals a

series of important observations about Russian TNCs. First ofall, there are important differences in the size of the firms asmeasured by total sales. Oil-and-gas TNCs, together with theelectricity giant UES, seem to be in a different league, and inmost cases comparable to global firms. A second layer ofTNCs is still mostly in natural resources (Norilsk Nickel,Severstal, Evraz, RusAl, etc.), while the rest of the RussianTNC universe is more limited in size.

A second observation is that Russian TNCs are at very

different stages of outward expansion. That of the three oil-


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and-gas giants (Gazprom, Lukoil and Yukos), as well as someother firms (AFK Sistema/MTS, Alrosa, Mechel, NorilskNickel, RusAl and Severstal) is fairly advanced and alreadyspread to various host countries. Other firms, even such largeones as UES, have had more limited foreign operations,often confined to the Commonwealth of Independent States(CIS) only. A third observation is that at least an importantpart of the natural-resource-based Russian TNCs have basedtheir competitiveness and outward expansion on oligopolistic

or monopolistic advantages at home, and sometimes even onthe global market.

Fourth, the expansion of Russian TNCs abroad has beenrelatively recent and fairly fast. That was related to thepreferred mode of entry: mergers and acquisitions (M&As)have been by far the preferred mode of entry into foreignmarkets. To understand why Russian TNCs had to expandabroad via takeovers, one has to consider the stylized factsabout transition in Russia in the early 1990s. In the CIS, the

dissolution of the Soviet Union in 1991 took place when closeto 100% of manufacturing was State-owned and, logically,each successor State took over the control of the assets on itsown territory. That resulted in an unbalanced situation forRussian firms: they continued to have business links with thenew independent countries but without an appropriatecoordination mechanism (or an unclear one) in place. Thatresulted in a propensity for Russian firms trying to take overcontrol of firms, especially upstream, in order to get rid of thecoordination problem.

In developed markets, it was the elimination of the Statemonopoly of foreign trade that created a new situation for


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Russian firms. In order to take advantage of the direct bilateralbusiness links made possible by the liberalization of foreigneconomic relations, they had to establish presence in keyWestern markets and improve access to processing anddistribution networks. While the former, in principle, could bedone through greenfield projects, in the latter M&As have beenthe only feasible channel of quick market entry.

Russian natural-resource-based firms startedinternationalizing through exporting their products. Theprofitability of those exports benefited from the difference inprice levels between the domestic and world markets. As a nextstep, to diversify the production basis and to access foreignmarkets, Russian energy companies started acquiringcompanies abroad and establishing foreign affiliates. Theseaffiliates are also used as a means to avoid excessive exportduties and to introduce more favourable taxation planning. Theinternationalization strategies of resource-based companies,especially the State-owned ones such as Gazprom and Rosneft,

are also influenced by the course of Russian foreign policy.This is done partly through the States controlling share inthose companies, which directly affects the composition oftheir Boards, and partly through informal pressure.

A fifth observation concerns the variation of ownershipstructures. Some of the large outward-investor firms, such asLukoil, Norilsk Nickel and Mechel, are privately owned. Insome of them, foreign investors have minority holdings(for instance, ConocoPhillips currently owns 20% of Lukoil) or

50% ownership (for instance, BP owns half of TNK-BP).


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Other firms, such as Gazprom, Rosneft and UES, are majorityState-owned.

As will be discussed later, in the case of Gazprom, therise of the States share to majority is as recent as 2005. In thecase of Rosneft, there are plans to do the opposite but to retain50% plus one share in the States hands. In general, theRussian State sees these two companies as the core for apublicly owned TNC cluster to be developed in the future. Inthe literature, this cluster has been called patriots or theKremlin universe. At the end of 2004, Rosneft acquiredYuganskneftegas, the key extraction affiliate of the Yukoscompany, while in 2005 Gazprom acquired a majority share inthe privately owned petroleum company Sibneft. Recentreports indicate Gazproms interest in machinery TNC OMZ,which controls important assets in the Czech Republic.

Another possible extension of State involvement inengineering may come from automotive production, in which

the State-owned arms export agency, Rosoboronexport, tookover control of passenger vehicle producer AvtoVaz at the endof 2005. Some reports indicate that other manufacturers, suchas car maker GAZ or truck producer KamAZ, could eventuallybecome in the future merger targets for Rosoboronexport andAvtoVaz. Interestingly, the former also maintained itsambition to control more natural resources, too, via theacquisition in September 2006 of a 41% stake in VSMPO-Avisma, the worlds largest producer of titanium. If these plansfully materialize, the State-owned TNC cluster would grow

much bigger than anyone would have predicted just a littlewhile ago.


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Sixth, from the lists of the largest Russian TNCs andfrom information on their activities abroad, a combination ofmarket- and resource-seeking motives can be deduced. Thetypical Russian TNC aims, through international presence, atcontrolling the value chain of its natural resources. Within thestrategy of global reach, Russian companies continue to focus alarge part of their outward FDI in other Member countries ofthe CIS. In 20022003, 4 of the 10 top destinations of outwardFDI projects from Russia were other CIS Member countries(see Table 1).

A LOOK AT THE TOP

The patterns of outward FDI from Russia are largelydetermined by the behaviour of leading firms, such as


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Gazprom and Lukoil. The subsequent analysis provides anoverview of the main features of some of those key players.

Gazprom can be considered not just the largest Russianfirm but also probably one of the top outward investors. It isusually reported to control more than 93% of Russian naturalgas production and about a quarter of the whole worlds gasreserves. Its operations are spread globally; on theEuropean continent alone, it has operations in at least 19countries, involving natural gas distribution and processingactivities. Gazprom inherited its gas monopoly from Soviettimes. It was carved out from the Ministry of Oil and Gas in1989. It was partly privatized through vouchers in 1993. Until2004, the Government kept a 38.37% stake in the company.Foreign ownership at the same time was limited to 9% of theshares. In the late 1990s, that limit was raised to 20%.

Unlike Lukoil, which controls various extractionfacilities abroad, especially in the CIS, Gazproms international

activities focus more on export promotion (such as via long-term delivery contracts) and investment in Western Europeannatural gas processing and distribution, such as pipelines. Itsimpact on European gas consumption has been particularlystrongly felt in crisis situations such as the conflict withUkraine over natural gas prices at the end of 2005 and thebeginning of 2006. It has attempted to gain access to largeindustrial and gas-fired power generation markets in Westernand Central Europe, too, taking advantage of the liberalizationof the downstream gas market of the EU. It has often

established joint-venture marketing companies in exportcountries. Its non-core FDI includes gas equipment


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manufacturing, petrochemicals and banking. The consolidationof Sibneft into its operations should add new segments to itsoperations: petroleum extraction and refinery.

Lukoils strategy is relatively well documented, both in itsown corporate communications and through the UNCTADlists of largest TNCs. Established in 1991, transformed intoan open joint stock company in 1993 and privatized from1994 on, it carries out international exploration and productionin Azerbaijan, Colombia, Egypt, the Islamic Republic of Iran,Iraq, Kazakhstan, Saudi Arabia, Uzbekistan and Venezuela;refining in Bulgaria, Romania and Ukraine; and hasdownstream distribution affiliates worldwide in at least 15countries. It maintained its growth even in the middle of theRussian financial crisis in 1998. It may be hypothesized thatassets abroad have acted as an effective cushion against theshocks coming from upheaval in the domestic economy.

The expansion of Lukoil abroad is not just fast but also

successful, at least in terms of entering competitivedeveloped markets such as the United States. This is onceagain a proof of the global strategies of some outward-investing Russian firms. The expansion into the UnitedStates took place through the acquisition of Getty PetroleumMarketing at the end of 2000. Given the important costs ofestablishing greenfield presence, and the informal barriersto such entry by the structure of the U.S. market for thedistribution of petroleum products, this was the onlypossible avenue for Lukoils effective presence there. In

2001, in a similar move on the Canadian market, Lukoilbought the local Bitech Petroleum Corporation. On the


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other edge of the value chain, Lukoils most important strategicmove has been the acquisition, at the end of 2005, of theCanadian-based independent oil firm Nelson Resources,which operates large exploration and extraction facilities inKazakhstan.

While Lukoil and Gazprom are expanding, the third-largest Russian oil-and-gas firm and TNCand the first onebecoming fully privately owned back in 1993Yukos,disappeared from the international scene in 2006. Its ChiefExecutive Officer was arrested in 2003 and in 2005 wassentenced to nine years in prison for fraud and tax evasion,pending appeal. The authorities suggested, following an auditin 2004, that the company had US$ 28 billion in unpaid taxes.Yukos assets were seized and put on auction against the taxclaim, leading to Yuganskneftegazs acquisition by State-owned Rosneft at the end of 2004, mentioned above. At theend of 2005, Yukos still had a tax debt of US$ 6.3 billion,while also facing a new claim of US$ 3.5 billion for the year

2004.

At the beginning of 2006, Yukos still controlledimportant assets abroad. One of those assets was theMazeikiu Nafta refinery, which it acquired in 2002 inLithuania, a new Member of the EU. Another strategic assetin the new EU was a 49% stake in the Slovak pipeline operatorTranspetrol, bought in 2001. With Yukos bankruptcydeclared officially on August 1, 2006, its divestment fromabroad speeded up. In May 2006, Polish PKN Orlen signed an

agreement with the Lithuanian Government to buy themajority of Mazeikiu Nafta. This deal was cleared andapproved by the European Commission in November 2006.


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Also in November 2006, the Slovak Government took the finalsteps to buy back Yukos share in Transpetrol.

The other Russian oil-and-gas firms are lesstransnationalized. TNK-BP owns a relatively importantpetroleum refinery affiliate, as well as gas stations, in Ukraine.It also now controls Slavneft, itself the owner of a refinery andpetrol stations in Belarus. As for State-owned Rosneft, it isparticipating in upstream ventures in at least Algeria andKazakhstan. Some of these assets have been inherited fromSoviet times.

Outside oil and gas, but still in the area of mining,Norilsk Nickel is considered to be the fourth-largest RussianTNC in terms of assets abroad. Officially established as aState-owned concern in 1989 and privatized in two steps (1995and 1997) to Oneximbank, it is currently a world leader in theproduction of several strategic metals, in particular palladium,platinum, nickel, cobalt and copper. It also carries out the sales

and marketing of platinum-group metals (iridium, osmium,palladium, platinum, rhodium and ruthenium), cobalt and gold.Norilsk has been expanding abroad through a series ofinvestments into trading and mining companies such as a 51%stake in U.S.-based Stillwater Mining in 2003, a 20% stake inGold Fields Ltd. of South Africa, and the acquisition of theLondon-based metals trading company Norimet Ltd. in 2000.Norilsk Nickel is particularly active in the U.K., U.S., Swiss,Belgian and South African markets.

The product of a merger in 2000 of the aluminiumsmelters and aluminia refineries of Sibirsky Aluminium and


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Sibneft, privately owned RusAl is the worlds second-largest primary aluminium producer (behind Alcoa of theUnited States and ahead of Canadas Alcan), controlling aboutthree-fourths of the domestic and about one-tenth of the worldmarket, and the fifth-largest aluminium producer in the world.Since 2005, its official holding centre has been registered in theUnited States. It controls bauxite mining in Guinea (althoughthe form of control is not reported) and in Guyana, the latteracquired in 2004 and expanded substantially in 2006. It owns

smelters in Armenia, Guyana, Nigeria (acquired in 2006) andUkraine, and is a joint-venture refinery partner in Australia (anacquisition of 2005) and Jamaica (2004). It also has marketingpresence in developed markets.

In ferrous metallurgy, Mechel is an importantinternational low-cost steel and mining group, owning coaloperations in Kazakhstan, two steel mills in Romania and asteel product manufacturer in Lithuania. It specializes inspecialty steels and alloysin which it alone accounts for

more than half of the domestic outputand long productsinwhich it is the second-largest Russian producer (behindSeverstal). While Mechel has been known for its expertise inimproving and turning around production facilities in badshape (just like its main competitors, Russias Severstal andNetherlands-based Mittal Steel), it decided to discontinuesimilar rescue operations in Croatia, where production costswere too high.

One of Mechels main Russian competitors, Severstal,

has opted for a different internationalization strategy, focusingon assets in developed countries. Severstal is indeed one of the


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most spectacular newcomers to the international natural-resource/iron-and-steel scene, leapfrogging to a global statusthrough large acquisitions abroad after 2003. The success of itsinternationalization is due more to its management style andless to its roots in Soviet-era autarkic iron-and-steel production.The firm started operations as a State-owned steel mill (in1955). It was gradually privatized after 1993. It startedtechnological upgrading of production via a joint venture witha U.S. partner in 2001. That became the basis for expansionabroad from 2003 on.

Severstal first bought Rouge Industries in the UnitedStates in 2003, followed by the takeover of Lucchini Industriesof Italy in 2005. It also entered into a coke-producing jointventure and started to build a greenfield steel plant in theUnited States. Severstal was motivated not just by its expertisein improving the efficiency of ailing iron-and-steel productionfacilities but also by market-seeking motives: its plants in theUnited States are suppliers of major car producers.

Russias second iron-and-steel producer,Evraz Holdingstarted internationalizing more belatedly. It was reported asacquiring a ferrous alloy plant in Georgia in 2005. But itslarge expansion abroad moved forward in force only at theend of 2005, with the acquisition of the Vitkovice Steel plantin the Czech Republic. Interestingly, some iron-and-steelcompanies of neighbouring Ukraine also show interest ingaining footholds in new EU Member countries. Forexample, the Industrial Union of Donbass bought Hungarian


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steel producer Dunaferr in 2004 and won the right to bid forPolands Huta Czestochowa in 2005.

Alrosa is another important State-owned natural-resource-based Russian TNC. It produces about one-fifth of theworlds rough diamonds. It holds a 33% share in a diamondmining company in Angola, controls some production units inthe CIS, and has various logistics and distribution affiliatesabroad (for example, in Hong Kong (China), Switzerland, andthe United States). It also used to have a distribution agreementwith South African De Beers affiliate, The Diamond TradingCompany (currently under revision).

Reporting on individual investment projects abroadsuggests that some engineering firms ranked relatively low bytotal sales are nevertheless important TNCs abroad. Forexample, the Power Machines (Sylovye Machiny)conglomerate is only 86th if those total sales are considered buthas major branches in 16 countries across the globe. Some of

these engineering operations have been inherited from Soviettimes; others are recent projects. In turn, 87th-ranked OMZbecame a major international player recently, with theacquisition of the nuclear power plant equipment producerSkoda JS and the steel producers Skoda Hute and SkodaKovarny in the Czech Republic (not related to VolkswagensSkoda Auto but with similar names).

The international expansion of other Russian TNCs is,however, less pronounced. As mentioned, State-owned UES

continues focusing principally on the Russian market. It ispresent, through international consortia, in power-station and


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energy-distribution activities of some CIS countries (Armenia,Georgia, Republic of Moldova, and Ukraine). It has astrategic goal of a common CIS electricity system, a strategythat may raise political sensitivities in partner countries.Outside the CIS, its first major acquisition was that of thepower stations in Varna and Ruse, Bulgaria, announced in May2005.

The absence of technology-based companies from thegroup of Russian TNCs is particularly notable, especially inlight of the countrys defence-related R&D traditions. Inprinciple, the engineering companies Power Machines andOMZ could be treated as at least partly technology based.However, given the nature of their products, such as turbines,they are closer to the natural-resource-based universe. On thelist of the largest 100 Russian firms there are only twoaerospace TNCs (Sukhoi Aircraft and Aerospace Equipment),both of them having only small representative offices abroad.The reasons for this weakness are manifold, including the

traditional confidentiality of defence technology andgovernment regulations restricting aerospace investmentabroad, prompting firms to use more arms-length transactionssuch as exports or licensing in their international deals. Withthe lifting of some of the administrative restrictions in 2005,more aerospace firms may be expected to open offices abroad.However, they still have a long way to go before engaging indeep outward FDI.

There may be also some technology-based Russian

TNCs, particularly in information and communicationstechnology, that are relatively important international players,although they do not appear on the radar screen of the UNCTADandExpert-400 lists. The Russian anti-virus producer Kaspersky


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Lab, for example, created only in 1997, had become a globalplayer by the end of 2005, expanding to 10 foreign locationsspread across the globe (China, France, Germany, Japan,Republic of Korea, The Netherlands, Poland, Romania, UnitedKingdom and United States). This is an evolution that in therecent past was more common in Indian, than in Russian,software firms. But as data on sales are not available, the firmis not listed on the Expert-400 list. Another Russian high-technology firm,NT-MDT (Nanotechnology-Modular Devices

and Tools), created in 1993, was reported as establishing in2005 an affiliate in Ireland to carry out assembly, testing andafter-sales services as well as research and development.

Potentially, mobile telecommunications can be anotherindustry in which the strategies of Russian TNCs could becomenon-resource-based. For the time being, Russian telecomsTNCs focus almost 100% on the CIS. The largest one, MobileTeleSystems (MTS), is present in various markets, whileVimpelCom focuses on Kazakhstan, Tajikistan and Ukraine,

and MegaFon on Tajikistan. In 2005, Alfa Group (the parent ofVimpelCom) purchased a 13% minority share in TurkishTurkcell. Also in 2005, AFK Sistema (the parent of MTS) wasnegotiating its entry into an operator in India.

RELATED ISSUES

OLIGOPOLISTIC/MONOPOLISTIC ADVANTAGES

From the individual cases analysed above, it emergesthat the horizontal integration of production capacities and


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INCOME DISTRIBUTION AND OLIGARCHY

One main feature of the Russian economy makingoutward FDI possible is the high concentration of income. In2001, the Russian investment bank Troika Dialog calculatedthat around 70 large financial and industrial groups controlled40% of the Russian gross domestic product (GDP). By 2000,the Gini index for Russian society reached a high of 45.6%.The Gini index is the main measure of inequality, where 0%corresponds to perfect income equality (i.e. everyone has thesame income) and 100% corresponds to perfect incomeinequality (i.e. one person has all the income, while everyoneelse has zero income). Russias ratio of 45.6% is quite high foran economy of transition freshly emerging from an egalitariantraditionhigher than that of the United States (40.8%), andexceeded only by traditionally very unequal Latin Americansocieties such as Brazil (59.1%) or Argentina (52.2%).

With the change from a centrally planned to a market

economy, the country needed private property, and fast.The share of the private sector in the generation of RussianGDP jumped from 5% in 1990 to 70% in 1998. In Russia,however, unlike in Central Europe, inward FDI was notconsidered to be a main avenue to arrive at a private-sector-based economy, mostly for political and strategicconsiderations. Natural resources, in particular, were seen to betoo sensitive to be controlled by foreigners. From the point ofview of the authorities of that time, it was the lack of interestby foreign investors to invest massively into high-risk Russia

that prompted the pre-eminence of insider forms ofprivatization.


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While interpretations of the reasons may differ, itremains a matter of fact that for the Russian governments ofthe early 1990s, the creation of a national capitalist classseemed to be the most evident way of capitalism building. Itwas estimated that by 1998, 49% of former State property hadbeen privatized to insiders (the oligarchs), compared to 3%in Hungary and 5% in the Czech Republic. Conversely, only3% of former State property had been sold to foreign buyers inRussia, compared to 48% in Hungary and 15% in the CzechRepublic.

As a new development in the early 21st century, highnatural resource prices (especially for oil) are providingRussian firms controlling them large amounts of excess capital.Indeed, the bulk of Russian outward-investing firms are inenergy, metallurgy and mining, and these are industries thatgenerated large cash flows in the period 19982004. Overthose years, the profits of Russian corporations were estimatedto rise 2.5 times. For this excess capital, it was natural to seek

investment opportunities abroad in addition to the domesticones.

THE ROLE OF THE STATE

The role of the State is another important factor

explaining the evolution of outward FDI from Russia. Duringthe Presidency of Boris Yeltsin (19911999), most Russiangroups became privately owned. In recent times, the Stateseems to have decided, with the strengthening of itsparticipation in Gazpromit increased its stake from38.37% to 50% plus one share by paying US$ 7.14 billion in


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2005and acquisition of some privately owned assets (theacquisitions of Yuganskneftegas and Sibneft mentioned abovebeing the most salient cases) to increase its share and influencein natural resources. That influence now goes beyond the firmsthat it owns and seems to affect the strategies of some privatelyowned companies, too. Indeed, currently the balance ofinfluence between the State and the oligarchs is changing. Until1999, the latter occupied an undoubted dominant position intheir relationship. Since then, the power balance has tiltedgradually in favour of the State.

The change in the power balance between the State andthe oligarchy is rooted in Russian political and socialtraditions. In old Russia, property rights turned out to be morefragile and more relative than in Western societies. In theCzarist times, an important part of private property wasreversible and conditional on State service. Bolshevismwent even further, banning private property and making thepersons executing the ownership functions State employees

and/or managers. Although former bureaucrats and managersoften transformed themselves into owners with the help ofRussias privatization, the acceptance of such private propertyhas always remained very low.

However, increase in State power also faces importantdomestic and international constraints. The birth of capitalismhas given rise to a large number of entrepreneurs in Russia(not just oligarchs), and these entrepreneurs have a majorinterest in stable and normal property rights. In addition, an

important part of Russian business has become international,


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and partners abroad want to deal with firms embedded inWestern-type property. Finally, the forces that promote afurther disengagement of the State from direct involvement inproduction have not disappeared from the Russian politicalscene. For these reasons, while a return to Soviet times withtotal public ownership is unlikely, it is far from being settledwhere the limits of the States role will be established.

It is needless to emphasize that the final shape of therelationship between the State and large firms will have majorimplications for outward FDI from Russia. If those firms arewashed back to a State-dependent status, they will becomefollowers of the Governments foreign policy, independently oftheir ownership. The implications of such a shift forinternationalization strategies are difficult to forecast withprecision. In principle, if in issues related to expansion inforeign markets there is a conflict between private (profit) andgovernment (political) interests, the latter should prevail. It isnot clear, however, how often and how strongly such

divergences could surface. Nor is it obvious in the presentclimate of high resources rents if that would seriously affectprofitability. The impact, nevertheless, should be felt in thedirections and timing of projects abroad (with locations offoreign policy priority receiving more FDI).

From the point of view of long-term efficiency, concernscan be raised about a too-strong State and too-weak privateproperty. This can affect outward FDI in the long term, andperhaps more indirectly, but may have major ramifications

should the international context change (for example, the priceof natural resources stagnates or falls).


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For the period 19992004, relatively robust proof hasbeen found that State ownership of natural resources leads to aslowdown in output, exports and GDP in Russia, while theopposite is true for private ownership. A similar relationshipcould be detected when contrasting the performance withinRussia of industries dominated by State ownership (such asgas and electricity) with those predominantly in private hands(oil and coal).

In the light of this performance, questions can also beraised about the opportunity cost of the Government spendingon increasing participation in, say, Gazprom, Sibneft andYugansneftegas. Here, it is not the principle of Stateownership per se that could be contested. In the developingworld, many outward-investing firms, especially in naturalresources, are State-owned. One can recall the cases of theChina National Petroleum Corporation, the CorporacinNacional del Cobre de Chile, the Oil & Natural GasCorporation (India), Pemex (Mexico), Petrobras (Brazil),

Petrleos de Venezuela, Petronas (Malaysia) or Vale do RioDoce (Brazil). However, those firms are operating in a morebusiness-oriented tradition, in which the success of foreignoperations could be judged mostly on grounds of efficiency.And even in some of those firms, say Petrleos de Venezuela, arecent increase in State control (1999) resulted in a slowdownof investment in oil wells and, consequently, a one-fourth dropin output. In Russia, where the tradition of business-orientedpublic enterprises may be weaker, the risk of falling productioncould be even higher.


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TRANSPARENCY AND GOVERNANCE

In all countries of the world, the business and economicconditions of the home economy exert a major influence on thepatterns of outward FDI. In Russia, doing business has neverbeen easy, despite recent improvements. On the one hand,there have been a series of impressive measures to improve theRussian business climate, including the rationalization of taxes.On the other hand, in the case of Yukos, tax administration hasbeen used to reach certain non-economic, non-fiscal goals. Inthis contradictory business environment, some RussianTNCs still follow system-escape motivations. Asevidenced by the widespread phenomenon of capital flight, animportant part of FDI outflows appears to be motivated by thedesire of investors to diversify assets as a safeguard againstdomestic instability.

This is then linked with the phenomenon of roundtripping the transfer of funds abroad in order to bring some

or all of the investment back as FDI and claim the tax and otherbenefits offered to foreign investors. One indication of theexistence of round tripping in Russia, especially before thefinancial crisis of 1998, was a fast parallel increase in bothinflows and outflows. Another proof was the persistently highshare of offshore Cyprusa small island that otherwise has noownership advantages for its local firmsin both inflows andoutflows. Finally, the discrepancy of home and host countrystatistics also points towards the existence of round tripping. Alarge part of Russian investment into developed countries is not

reflected in host country statistics, either because theindividual transactions are too small to be registered or


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because they are transferred through third countries, typicallyoutside the area of the Organisation for Economic Co-operation and Development.

Transparency and governance are additional factorsinfluencing capital outflows from Russia. In 2002,Transparency International ranked Russian TNCs as the leasttransparent in its sample of 21 bribe-paying nations, behindChina (20th), Taiwan Province of China (19th) and theRepublic of Korea (18th). This may be also related to thesectoral composition of outward FDI: the same survey foundthat oil-and-gas was the third-least transparent industry, behindpublic works and defence only.

Low transparency at home can act as an incentive fordomestic firms to increase their presence in more transparent,and thus more predictable, locations abroad; this is theexodus side of the expansion/exodus dichotomy describedin the literature. However, on the other side of the coin, coming

from a low-transparency environment reduces the acceptanceof Russian businesses in host locations. Russian TNCs areaware of the fact that more transparency would make businesssense abroad. For that reason, they need to improve theirgovernance. Indeed, Russian corporate governance has beenfound to be improving after 1999, mostly due to theinternationalization of companies.

The business strategy of some Russian TNCs thatconsists of acquiring assets abroad through shadow

(offshore) firms instead of by purchasing shares up front in


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their own names can have opposite impacts on outward FDI inthe short and long terms. In the short term, it is increasingoutward FDI. In fact, some business people would argue thatthis is the sole, or the fastest, way to access assets abroad. Inthe longer term, however, it can reduce the readiness of hostcountries to accept Russian FDI.

In this regard, in Ukraine, the use of offshore firmslocated either in financial centres such as Cyprus and theBritish Virgin Islands, but also in the United Kingdom andthe Netherlands, by Russian TNCs to acquire assets has beenreported to be the norm. Considering the assets acquired byRussian firms through offshore companies, the real value ofRussian FDI in the country could be three times higher (in therange of US$ 1.21.8 billion) than the reported one, makingRussia the number one investor in Ukraine. According toofficial balance-of-payments reports, with US$ 543 million atmid- 2005, Russia was only the seventh source of UkrainianFDI, behind first-place Cyprus, second-place United States and

third-place United Kingdom.

In Hungary, Gazproms efforts to gain control of theplastics maker Borsodchem while using proxies such asprivately owned and Austria-based CE Oil and Gas in 2001became a strongly debated issue. That effort was at that timecountered by MOL Hungarian Oil and Gas Company, anothershareholder in Borsodchem. Nevertheless, in 2006, the CEOof Gazproms banking affiliate in Hungary, General Bankingand Trust, managed to increase his personal shareholding in

Borsodchem to 18% by using his U.K.- registered family-owned firm Firthlion. Even some non-foreign transactions,


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such as the purchase of Yuganskneftegas by the State-ownedRosneft, could follow this business style: at the auction, theassets were bought directly by the little-known Baikalfinancegroup, which was some days later purchased by Rosneft.

These low-transparency transactions raise concerns inthose host countries about intentions, although Russian expertsinsist that the funds used for those transactions are of legalorigin. It remains to be seen if in the future there will be a trendby Russian TNCs to switch away from these types oftransactions, dissipating a large part of the concerns in hostcountries.

CONCLUSION

Outward FDI from Russia is expected to stay with usand to increasingly become a global phenomenon. Some of its

features may change as Russian TNCs increasingly interactwith their global peers. It is not the home-country businessenvironment or the consequent round tripping that would makeRussia a special case compared to other large emergingmarkets. The latter phenomena have been reported for thecases of China and Brazil, too. The main difference withoutward FDI from other emerging markets lies in the fact thatRussian TNCs are mostly natural-resource-based. Russianfirms are also expected to remain focused on controlling theupstream (exploration and extraction) and downstream

(distribution) parts of their value chain together.


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The most probable scenario for the future is that RussianTNCs will marginally modify the geography of their expansionabroad. They may also end up reflecting more foreign policyconsiderations than before. In the case of the latter issue,however, one has to differentiate between firms that are by-and-large controlled by the Government (such asGazprom/Rosneft) and the ones over which its influence ismore indirect. All in all, the authorities may reserve their rightto veto the sales of strategic Russian TNCs to foreign investors,

invoking concerns either about competition or national securityor boththeir veto in the case of Siemens (Germany) bid forPower Machines in 2005 set a precedent for this.

Russian TNCs have to deal, in particular, with theirimage problem abroad. That is not an easy undertaking, as thatimage has been loaded by the influence of 74 years ofcommunism. Hence, sensitivities about Russian investment inmany countries may be higher than vis--vis investment fromother countries. It has been noted that:

Russian organizations must become more open to theoutside world. Rather than thinking of themselves asfortresses besieged by enemy armies, they need to developopen systems that benefit from give-and-take within anever-changing environment. (M. Kets de Vries andothers, The new global Russian business leaders,European Management Journal, 22(6):2004, p. 645).

In the long run, it will be the action and the impact of

Russian TNCs that will decide whether they will continue to bewelcome.

Documents

The Rise of Russian Transnational Corporations