Business Environment: Russia Euromonitor International 13 April 2010
Despite the economic recession of 2009, a recovery is expected in 2010. The business environment remains challenging due to over-regulation, lack of reform, insufficient public investment and corruption. The delay in WTO accession is the biggest challenge for foreign trade. The tax system remains complicated and tax evasion is widespread. Skills shortages are felt in many sectors and the labour force is shrinking. Consumer markets offer many opportunities as competitiveness is still low. Chart 1 Ease of Doing Business 2010: Regional overview Doing Business 2010, World Bank Ranking covers the period from June 2008 through to May 2009. The ease of doing business index ranks economies from 1 to 183. For each economy the index is calculated as the ranking on the simple average of its percentile rankings on each of the 10 topics covered in Doing Business 2010, i.e. exclusive of the electricity pilot data. The ranking on each topic is the simple average of the percentile rankings on its component indicators. A high ranking on the ease of doing business index means the regulatory environment is conducive to the operation of business. Rankings from 1-61 refer to easy, from 62-122 refer to moderate and from 123-183 refer to difficult. (<a href="http://www.portal.euromonitor.com/portal/presentations/ee-final.pdf" target="_blank">click here</a> to view map in detail.) 1. ECONOMIC STABILITY Recession ends but long-term problems persist The stability of the Russian economy has been seriously challenged as a result of factors such as the global economic crisis 2008-2009, international oil price volatility, corruption and lack of economic reform. Following the turbulent transition of the 1990s, the economy grew at a healthy pace in the 2004-2008 period, at an average rate of 7.0% per year in real terms. In 2009, a major contraction of 9.0% in real terms took place, however a recovery is expected in 2010, thanks largely to Russia's energy and raw materials exports.
Chart 2 Chart 1: FDI intensity and FDI flows 2003-2008 Euromonitor International from International Monetary Fund (IMF), International Financial Statistics and World Economic Outlook/UN/UNCTAD/national statistics The governance of the Russian economy continues to pose major challenges for investors, undermining the confidence of foreign businesses operating in the country. Heavy regulation, lack of reform and persistent corruption and favouritism are among the main problems for investors. Nevertheless, the vast and underdeveloped consumer markets in many sectors, low labour costs and the country's huge resource base continue to make Russia an attractive location for investment. Foreign direct investment (FDI) inflows continued growing in 2008 despite the economic downturn, reaching US$70.3 billion, and can be expected to continue growing over the coming decade. The World Economic Forum's global competitiveness index ranked Russia 63rd out of 133 countries for 2009-2010, which represented a significant decline compared to the country's ranking of 51st in the 2008-2009 report, largely due to the tougher economic conditions both domestically and internationally. In 2009, Russia was ranked 146th out of 180 countries in Transparency International's corruption perception index, as problems with corrupt officials at all levels of government persist and no significant measures to tackle corruption have been implemented. Chart 3 Chart 2: Corruption perceptions index rank in selected countries 2009
Global rank out of 180 countries Transparency International Transparency International s Corruption Perception Index ranks 180 countries by their perceived levels of corruption, as determined by expert assessments and opinion surveys annually. 2. EASE OF DOING BUSINESS Lack of reform creates a challenging business environment The World Bank's Ease of Doing Business 2010 report ranked Russia 120th out of 183 countries, a small drop compared to the 2009 ranking of 118th. The conditions for starting a business deteriorated significantly between the 2009 report and the 2010 report, as Russia dropped from ranking 88th to ranking 106th out of 183 countries. This was due to the lack of reform in terms of the time and number of procedures required for setting up a business in the country: while many countries have simplified and streamlined the process, it takes 9.0 procedures and 30.0 days in Russia to open a business. This compares unfavourably to an OECD average of 5.7 procedures and 13.0 days. However, the cost of starting a business in Russia is low: only 2.7% of per capita income, compared to an average of 8.3% of per capita income in the Eastern Europe and Central Asia region. However, Russia has achieved a major improvement in rankings for the ease of accessing credit. The sources of credit have expanded significantly in the last decade, with foreign investment in the banking sector improving competitiveness and service. The World Bank's Doing Business 2010 report ranked Russia 87th out of 183 countries, compared to 109th in the 2009 report. Both the depth of credit information and the coverage of the population by private credit bureaus have improved. In 2010, 14.3% of adults were covered by private credit registries. Registering a property has become easier with the introduction of new documentation requirements such as cadastral passports. It takes 6.0 procedures, 43.0 days and costs 0.1% of the value of the property to register a property in Russia. Closing a business takes 3.8 years in Russia and costs 9.0% of the value of the estate. In the Eastern Europe and Central Asia region, on average, it takes 2.9 years to close a business and resolving a bankruptcy costs 13.5% of the estate. Claimants can expect to recover 28.2 cents on the US dollar from an insolvent business in Russia, compared to 68.6 cents on the US dollar in OECD countries. However, some reforms have been introduced in Russia, including a modified insolvency law which introduced professional qualification standards for administrators and regulation of their compensation. Russia's information communication technologies (ICT) industry has seen rapid development since 2000 through foreign and domestic investment and due to strong traditions in technology education, providing the sector with a skilled and affordable labour force. The extensive involvement of the state in the sector, inadequate communications
infrastructure outside of the main urban areas and widespread copyright infringement are the major challenges for the ICT industry. Table 1 Table 1: Ranking in Doing Business 2009-2010 Indicator Doing business Doing business Change in rank 2009 2010 Ease of doing business 118 120-2 Starting a business 88 106-18 Dealing with Construction Permits 182 182 0 Registering Property 49 45 4 Getting Credit 109 87 22 Protecting Investors 88 93-5 Enforcing Contracts 19 19 0 Closing a Business 92 92 0 Doing Business 2010, World Bank (1) Rankings are based on data sets across 183 countries. Doing Business presents quantitative indicators on business regulations and the protection of property rights that can be compared across 183 economies. (2) Ranking for each year covers the period June-May of previous year. 3. GOVERNMENT REGULATIONS AND TRADING ACROSS BORDERS WTO accession still pending due to lack of reform While foreign and domestic businesses are officially treated equally in many sectors, favouritism is widespread and there is a lack of transparency. For example, tenders for public works have often been criticised. Foreign investment is limited in sectors which are considered strategic. This includes security and defence, media, telecommunications and the mining industries. Trade relations with Russia are rendered riskier due to the country's still on-going negotiations regarding World Trade Organisation (WTO) membership. While Russia needs the reassurance WTO accession provides to trade partners, the government has been slow to implement the necessary reforms and remove trade barriers including various protectionist measures. Poor intellectual property protection, barriers to agricultural products and subsidies to state-owned enterprises are among the major challenges still to be resolved before Russia achieves compliance with WTO standards. In the World Bank's Doing Business 2010 report, a standardised shipment of goods to export requires 8.0 documents, takes 36.0 days and costs US$1,850 per container, compared the OECD average of 4.3 documents, 10.5 days and US$1,090 per container. To import, a standardised shipment of goods requires 13.0 documents, takes 36.0 days and costs US$1,850 per container, making Russia one of the most complex markets to import goods into compared to most economies in the Eastern Europe and Central Asia region. Chart 4 Chart 3: Trading across borders global ranking 2010
Global rank out of 183 countries Doing Business 2010, World Bank (1) Data covers period June 2008 May 2009. (2) Rankings are based on data sets across 183 countries. 4. TAXES Tax system remains complex According to the World Bank's Doing Business 2010 report, the average enterprise in Russia needs 320 hours per year to prepare, file and pay or withhold its taxes and contributions, compared to a regional average of 336 hours per year in Eastern Europe and Central Asia and 194 hours per year for OECD countries. Complex rules and cumbersome bureaucracy make the tax system difficult to deal with. Chart 5 Chart 4: Total tax rate and number of hours to prepare, file returns and pay taxes 2005-2009 Doing Business, World Bank
(1) Total tax rate measures the amount of taxes payable by the business in the second year of operation, expressed as a share of commercial profits. The taxes included are profit or corporate income tax, social security contributions and other labour taxes paid by the employer, property taxes, turnover taxes and other small taxes (such as municipal fees and vehicle and fuel taxes). (2) Data for each year covers the period June-May of previous year. In Russia, tax collection remains problematic due to the existence of a vast informal sector: estimates put the size of the informal economy at around 40.0% of GDP. Tax evasion by both individuals and businesses is very common and corruption among tax officials is widespread. Value added tax (VAT) in Russia is set at 18.0%, with a reduced VAT rate of 10.0% applied to some children's products and foods. Cuts in VAT rates to 12-13% have been discussed by the government since 2008, however changes still have not been implemented as of March 2010. In January 2009, the corporate tax rate was reduced from 24.0% to 20.0%. Russia is party to 72 double tax treaties which prevent double taxation by offsetting tax payable in one country against tax payable in the other. Russia's government introduced plans to introduce tax breaks for private equity investors in early 2010, in an effort to facilitate the creation and survival of start ups and venture capital projects. If implemented, the tax break will apply to stakes of over 10.0% held for more than five years. Chart 6 Chart 5: Corporate income tax rate in selected countries 2009 % Doing Business 2010, World Bank (1) Data covers period June 2008 May 2009. (2) Tax rate refers to mandatory contributions that a medium-size company must pay or withhold in a given year in Russia, as well as measures of administrative burden in paying taxes. (3) The corporate tax rate in Russia was reduced to 20.0% in January 2009. (4) The corporate tax rate in Kazakhstan was reduced to 20.0% in 2009 and 17.5% in 2010. 5. LABOUR AND SKILLS Skills shortages and demographic crisis are major challenges Skills shortages are a persistent problem for investors in Russia, due to lack of reform and a shortage of funding in the education system, with both secondary and higher education establishments outside of major urban centres such as Moscow and Saint-Petersburg in poor shape. While government spending on education has increased by an average annual rate of 21.6% in the 2004-2009 period in real terms, this was from a low base and many education establishments remain under-funded and staffed by under-paid and under-qualified teachers. Thus, despite the high number of secondary school graduates and the high adult literacy rates (99.6% in 2009), sectors such as information and communications technology (ICT), business management and medicine suffer from a shortage of labour force with adequate skills.
Labour costs in Russia are fairly low. In 2009, the minimum monthly wage stood at RUB 4,330 (US$136). This, however, was higher than in many peer economies including Ukraine (US$80.2), while labour productivity has remained low due to obsolete manufacturing and management practices and poor infrastructure, as well as limited opportunities for continued qualification and re-qualification. Personal income tax is set at a flat rate of 13.0% for residents (for individuals spending at least 183 days in a given tax year in Russia) and 30.0% for non-residents. The unemployment rate, which had declined from 7.8% of the economically active population in 2004 to 6.3% in 2008 soared again in 2009, to 8.3%. The actual unemployment and under-employment problem in Russia is likely to be much greater, with youth unemployment especially high and employees at crisis-hit enterprises often forced to accept unpaid leave or reduced working hours. Chart 7 Chart 6: Unemployment rate, economically active and employed population 2004-2009 Euromonitor International from International Labour Organisation 6. CONSUMER MARKETS AND DEMOGRAPHICS Many opportunities for marketers despite low and uneven disposable incomes Russia's consumer markets are vast and still fairly undeveloped compared to Western markets, creating numerous opportunities for investors, despite the low disposable incomes and the concentration of wealth in major cities. The savings ratio has remained fairly stable in the 2004-2009 period, reaching 12.1% of disposable incomes in 2009, as more consumers have been able to save a proportion of their growing incomes. Consumer spending has increased at an average annual rate of 11.9% between 2004-2008 in real terms, but declined by 5.8% in 2009, reaching 53.6% of GDP in 2009 compared to 47.5% of GDP in 2004. Expenditure on transport, communications and health goods and medical services saw the fastest growth between 2004-2009, by 134%, 89.3% and 84.8% in real terms, respectively. This reflected the changing consumer behaviour of many Russian consumers, growing disposable incomes and the adoption of more Western-style preferences and lifestyles. While the global economic crisis of 2008-2009 affected consumer confidence negatively, the quicker than expected recovery of the economy is likely to boost spending in 2010 and 2011 and Euromonitor International forecasts consumer expenditure to rise by 3.6% and 4.8% respectively in real terms. Per capita annual disposable income reached RUB169,083 (US$5,324) in 2009, lower than most Central and Eastern European countries but higher than ex-soviet republics such as Ukraine (US$1,695), Belarus (US$2,958) and Kazakhstan (US$3,645). Consumer credit availability has increased significantly in the past decade due to the rapid development of the financial sector, and while the economic crisis led many banks to tighten lending conditions, the
already fairly strict regulation of consumer credit prevented any significant increase in bad credit from taking place. Consumer credit is likely to see healthy development in the short and medium term as a growing number of Russian consumers gain access to banking services. The major long-term challenge for Russia's labour force is the country's serious demographic crisis. The population has been declining since 1995 and will continue declining through to 2020, dropping from 142 million in 2009 to 139 million by 2020. With Russia's labour force shrinking and ageing at a rapid pace, it is becoming increasingly difficult to develop the labour skills needed to sustain economic growth. Chart 8 Chart 7: Consumer expenditure by sector 2009 % of total consumer expenditure Euromonitor International from National statistical offices/oecd/eurostat