A litany of bad news stories emerged from Russia in 2008, not least of which was the conflict in Georgia, which appears to have driven a further wedge between Russia and the West. The BP-TNK affair – in which the unease over the joint venture between oil giant BP and a group of Russian oligarchs intensified – is still causing ructions, and recent global turmoil in the financial markets – let alone an end to the relentless upward march of commodity prices – is starting to be felt by Russian businesses and consumers. And yet, as an inward investment destination, Russia remains an important market full of potential – albeit one whose risk/reward profile is altering.

“Russia, along with the other CIS countries, enjoys the unique distinction of providing long-term strategic investors with the opportunity for near-total market share,” says one analyst. “For so long,” he points out, “even the most basic retail products were denied to consumers. Outside of large cities, that absence is still all too present, and it will be filled, come what may.”

Star performers

New consumers need access to funds, cars and accommodation, so it is no surprise that by sector, the food and tobacco, financial services, real estate, consumer products and automotive industries have been the star performers. They are represented by such companies such as Germany’s retail and wholesale group Metro, Swedish home furnishings giant IKEA, Turkish conglomerate Koç, as well as Raffeissen, Volkswagen, General Electric, Ford and Siemens.

Russian businesses also need Western technology in order to meet demand. Opportunities in Russia lie in the very fact that the country is “in a state of profound capital renewal”, says one analyst, and its burgeoning businesses have a huge demand for heavy plant machinery and electricity generating equipment.

The path has not been smooth – any illusion that transition would be incident-free was shattered long ago. But perceptions of the direction in which Russia is heading have significantly worsened. Andy Summers, president of the American Chamber of Commerce in Moscow, recollects that in late May and June last year, BP’s difficulties with its TNK-BP joint venture spurred a flurry of calls to his office from potential Western investors (from Europe and the US) in joint ventures who had “justifiable concerns”.

BP chairman Peter Sutherland accused AAR, co-owners in TNK-BP, of “1990s-style corporate raiding” tactics as the AAR oligarchs tried to wrestle greater control over the company, the headquarters of which were repeatedly raided by Russian security services.

In late July, Russian prime minister Vladimir Putin drove down the share price of metals company Mechel when he complained at an industry conference that the company was overcharging domestic consumers of steel and mining. Stocks in Mechel, which is listed on the New York Stock Exchange, plunged by 40%. Mr Putin’s remark that unless Mechel chief Igor Vladimirovich Zyusin (who was sick on the day of the conference) recovered soon, “we might have to send him a doctor”, sent “chills down the spine of anyone with a sense of historical irony”, says Mr Summers.

Russia’s August conflict with Georgia – and occupation of Georgian territory outside the ‘breakaway republics’ – also hit hard. “I was contacted by a number of companies which had approved significant increases in investment into Russia, and also by companies who were potential new entrants. They were asking me, ‘is this the right time to be going in or should we wait?’” says Mr Summers.

Many of those have almost undoubtedly chosen to wait – the vast majority of sectors are now experiencing a slowdown. “Customers cannot get access to the funds they need. The banks have either stopped lending or raised interest rates to levels that customers cannot afford,” he says. That means a freeze on car sales and a freeze on construction projects.

Deals on hold

It is an observation confirmed by Sergei Voitishkin, head of mergers and acquisitions at the Moscow office of law firm Baker & McKenzie, who has seen a number of big deals put on hold in recent weeks. “The immediate issue is simply that buyers and sellers just cannot agree on a price. There is a lot of volatility at the moment and Russian companies don’t have a clear understanding of where things are going,” he says. “In the long term, this crisis will make companies leaner and create efficiencies, but that is looking at things strategically – over the next three or five years.”

But as one analyst points out, the real point is not that the risks have increased so much as that the rewards have gone down. Investors have always had to battle with bureaucracy, lack of transparency in government decision making and an unreliable judiciary, and what Mr Voitishkin calls “sophisticated investors” are able to take those kinds of issues in their stride.

One such ‘sophisticated investor’ argues that the upside was that, in comparison to the rest of the BRICs (Brazil, Russia, India and China), the investment environment was “incredibly stable” and that corruption in Russia is “pervasive, minimal as a cost of doing business, and remarkably orderly”. He acknowledges that the “wild card” factor of unpredictable presidential intervention – as per the Mechel affair – might be frightening but suggests that it was anything but unintentional: “It is part and parcel of the current regime that they do thump the markets at regular intervals, which gives them an opportunity to trade it. [Mr Putin’s] wasn’t just an off-the-cuff remark.”

And even some of the corporate ‘victims’ of recent events have not done so badly, all things considered. Christopher Granville, formerly chief strategist and political analyst at UFG (now Deutsche Bank’s Russian brokerage operation) and currently analyst at Trusted Sources, points out that BP, which made an £8bn ($11.75bn) investment in TNK in 2003, has received the same back in dividends in just five years – not an unhealthy return.

Russia will always have its champions, and optimists will always rightly draw attention to its size, its mineral wealth and its unrealised potential – just as pessimists will flag up problems with corruption and bureaucracy. Its ruling regime, however inimical to the Western notion of a liberal democracy, has at the very least demonstrated its proclivity for ensuring its own continuity, contributing to an environment that is generally knowable, if punctuated by short-lived but unpredictable events. In the current global investment climate, the merits of those characteristics should not be under-estimated.