By the end of 1999, St Petersburg had overcome the crisis of the previous year that affected the entire Russian economy. The years 1999 to 2005 brought steady growth in business activity in the industrial, investment, construction, transportation and communications sectors. Investment has been most heavily concentrated in property development, which last year attracted 36% of the total.

The residential property market is likely to increase its share in the coming years, following last June’s amendment of the law on land distribution. The availability of new residential housing is expected to contract by 10% to 15% this year, compared with 2005. Meanwhile, figures for the first quarter show an increase in average property prices from $1113 to $1134 per square metre (m2).

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The amended law, which cuts red tape to encourage more developers to participate in the market, allows construction companies to select building and refurbishment sites on their own and prepare documents for tender. Previously, only the St Petersburg City Hall could initiate the preparation of tender documentation.

Transport accounted for 19% of last year’s investment, followed by 15% for manufacturing, 10% for housing and power infrastructure, and single-digit shares for telecommunications, education and science, retail, heritage and others.

Growth continues

Last year, St Petersburg’s economy grew by 7%, compared with 5% for Russia’s gross domestic product. FDI, excluding portfolio investment, was up 43% to $1.417bn. “As the economic situation continues to improve, foreign investors are showing more interest in this region,” says Stanislav Denisenko, senior manager and head of the legal group at KPMG in St Petersburg.

“Moscow is saturated and international companies are looking at regional expansion in Russia. Moscow is also a more expensive place than St Petersburg to set up, labour tends to be more expensive and there is a lack of suitable office space.

“The city has jumped on this opportunity and, through governor [Valentina] Matviyenko’s efforts, the atmosphere has become a lot more investor friendly and less bureaucratic. With the formation of a special investment committee, most problems can be solved by telephone. They have developed the procedure of priority investor, for instance in the case of Toyota, and the government is prepared to assist these companies at all stages of the project.”

Strong on marketing

A prime example of Ms Matviyenko’s aggressive marketing activities was this year’s agreement with Shanghai Overseas Enterprises Corporation (SOEC) for the $1.25bn Baltic Pearl development, a 500-acre development project in the south-west of St Petersburg. The project, which includes developing the swampy district’s infrastructure and constructing about 1.8 million m2 of residential and commercial property, includes the construction of electricity lines, water and gas pipelines and roads, which are now non-existent in the Krasnoselsky district. SOEC is putting the project out to tender for international contractors.

Mr Denisenko says that projects of this type are easier to execute in St Petersburg than elsewhere in Russia. “Land issues are not such a problem here as in Moscow, where there is a great deal of reluctance to grant ownership rights to private sector investors,” he says. “There is a lot more land in private hands in St Petersburg. The proximity of Finland, which is only a couple of hours’ drive away, and less than that to Estonia, gives the city another natural competitive edge.”

Ralf Wagener, managing partner at Ernst & Young, St Petersburg, says that although the bulk of Russia’s economic activity is focused on Moscow, with St Petersburg in second place, in terms of dynamics St Petersburg is becoming a promising place for the future. FDI plays a bigger relative role in the city’s economic life than in Moscow’s.

“One of the attractions of St Petersburg from a foreign investor’s point of view is the quality of life,” he says. “It is a more European city than Moscow and a short distance from Finland, and therefore the EU.”

Tax breaks

Mr Wagener plays down the importance of tax breaks for potential investors, which he says were more important in the 1990s. “This is now less of an incentive because businesses established here are experiencing very high rates of growth,” he says.

“Nevertheless, the city plans to introduce tax concessions for major investments with a capital outlay of more than Rbs3bn ($112m) over a three-year period.”

Some tax breaks are already on the agenda. As of this year, the city government introduced a profits tax concession. For companies investing in fixed assets, the rate is reduced to 15.5% if the amount exceeds Rbs150m, and to 13.5% if it is more than Rbs300m. For companies engaged in certain areas of activity, such as the production of computers, telecommunications and medical equipment, the rate is reduced to 13.5%. The law also stipulates that property tax for companies investing at least Rbs150m in fixed assets is set at 1.1% of net book value of the respective land assets.

St Petersburg plans to set up a technical innovation special economic zone (SEZ) on two sites, to accommodate companies engaged in high-tech activities, as well as design and research. Companies that set up operations in the SEZ will pay a 14% maximum rate of tax, compared with the standard 26%, and will enjoy duty-free import rights.

Building pitfalls

However, investors should be aware of some of the pitfalls of building plant facilities in these newly developed industrial areas. “There are some infrastructure problems for investors,” says Mr Wagener. “Electricity is a major concern for greenfield sites. This is more an issue of connections than availability of power, as the grid is very old and obsolete.”

Although the law does not establish any restrictions on foreign participation in the privatisation process, with the exception of certain strategic sectors such as defence, the institution of the golden share remains on the books. This constitutes a special right of the Russian government, on a federal level, to participate in the management of a joint stock company created as a result of privatisation, including the right to veto decisions taken by shareholders at the annual general meeting.

Fighting corruption

Corruption remains an unpleasant fact of life in St Petersburg, as it is in the rest of Russia, although the authorities are taking steps to address it. “Under the Soviets, a box of chocolates would do the trick,” says a European businessman in St Petersburg. “The stakes were raised after the fall of the communist regime, when payments of perhaps $1000 started to change hands. Now $5000 would be more realistic and it could be a lot more, depending on the nature of the project and the number of permits required.”

Currency regulations constitute a potential pitfall for the unwary and the government imposes stiff penalties for the violation of these laws. Foreign investors are strongly urged to seek out reliable legal advice to ensure that they are in compliance with requirements. Foreigners need to monitor the currency regulations carefully because they change frequently in the Russian Federation.

All transactions conducted in the country must be in roubles, although agreements may refer to the rouble value equivalent in foreign currency. Cash in advance, now the preferred method of payment in high-risk parts of the world, is the ideal, though not the competitive, way to make sure investors get money for their goods. Experienced hands advise that exporter and customer should agree the payments process from the outset, and that methods may change as the relationship develops. Costly, complex confirmed letters of credit may be replaced by cheaper open account trading in the light of a deepening relationship with a customer.

Licensing rules

The general rules concerning the need to obtain a Central Bank licence are also rather fluid. Given the city’s fast growth and investment potential, a number of foreign law firms have opened branches in St Petersburg to service new and existing clients, and to shield their customers from the vagaries and pitfalls of the currency regulations and other areas of bureaucracy.

“We opened last year to take advantage of the city’s big potential,” says Paul Tumminia, counsel at Chadbourne & Parke. “For years, St Petersburg was viewed as a distant cousin of Moscow; however, our strategic move was based on good practical business sense. As for the local legal structure, people are becoming more comfortable with the commercial arbitrage system.

“Disputes are resolved relatively quickly and St Petersburg, as well as the Leningrad Oblast, has created a hospitable environment for investment, which was not the situation in the 1990s. The proof is the large number of foreign companies coming into the local market.”

In the past couple of years, foreign companies that were already established in the Russian market, plus many newcomers, have been piling into St Petersburg and the Leningrad Oblast in a wide range of sectors. PepsiCo spent $25m on a production and warehousing facility, Bosch

und Siemens is building a €500m domestic appliance factory and ZAO Knauf is setting up a €60m gypsum board factory, to name a few projects by US and European investors. Siemens has also signed a €276m contract with the state-owned Russian Railways to supply eight fast trains to run on the Moscow-St Petersburg route. The new rolling stock is due to be delivered late next year.

BAT, Coca-Cola, Electrolux, Gillette, Heineken, Hitachi and Sumotomo are some of the large multinationals that have established a presence in St Petersburg in the past few years. The Leningrad Oblast has attracted international investors like Henkel, Ikea, Kappa Packaging, Kraft Jacobs Suchard and Nokian Tyres.

Big on cars

The automotive sector ranks as one of the biggest drivers of FDI growth, to the extent that St Petersburg and its surrounding region are being enthusiastically hailed as the ‘Detroit of the East’. The first of the international majors to set up an assembly plant was Ford Motor Company.

In 2002, the US auto giant launched its $150m Leningrad Oblast plant, which recently started production of the new generation Ford Focus, the company’s top-selling vehicle in Europe (also produced in Spain and Germany). Within one year it had cornered 10.5% of the Russian market. The addition of second and third shifts, upgraded equipment and the establishment of a central parts depot have increased the total investment to $200m.

Ford subsequently announced its decision to increase capacity of its Russian facility by 50% to raise capacity from 40,000 to 60,000 vehicles a year. “Russian consumers have demonstrated a huge desire for the new Focus,” says John Fleming, Ford Europe president. “Even though other auto makers have followed us into the market, Ford remains the biggest global car investor in the country, something we intend to build on in the future.” The plant expansion entails an outlay of $30m.

The Japanese were not slow to jump on the bandwagon: Toyota finalised its decision to build a $200m St Petersburg factory with an initial production capacity of 50,000 units. The first line of production will be the Camry, a mainstream seller in Russia. The European Bank for Reconstruction and Development is expected to make a further investment in the plant. The Japanese car manufacturer already sells nearly 50,000 vehicles a year in the Russian market, including the Corolla, Lexus, RAV4 and Land Cruiser brand vehicles.

Foreign players

The entry of foreign auto makers has gathered momentum this year, thanks to major investments announced by Nissan and General Motors. Nissan Motor Company

CEO Carlos Ghosn signed a memorandum of understanding with Ms Matviyenko to build a $200m assembly plant in St Petersburg. Production is scheduled to begin in 2009 and when fully operational, the plant will employ 750 people with a planned capacity of up to 50,000 cars a year. The plant will produce at least three different models specifically adapted for the Russian market.

Nissan’s sales in Russia have steadily increased from 28,436 units in 2004 to 46,485 units last year. Russia will be the first European market to offer the Infiniti luxury brand, with a planned launch for this autumn.

The latest arrival is General Motors, whose $115m St Petersburg plant is expected to start production in the fourth quarter of 2008. “We completed this deal in record time,” says Heidi McCormack, GM’s Russian-based director for new business development. The US company has come in under Russia’s Regulation 166, which sets a requirement for building at least 25,000 units a year. Candidates who meet the requirements can import parts to assemble complete vehicles.

“We looked at 19 locations in Russia to build this plant and settled on St Petersburg purely for logistics reasons. The seaport is a huge advantage, as this is the least expensive way to ship parts and equipment.” GM will produce two vehicles, the Captiva Chevrolet SUV and its main bread-and-butter model, a mid-sized Chevrolet saloon car.

“We found the people here incredibly motivated and anxious to attract investment,” says Ms McCormack. “We haven’t yet encountered any difficulties in finding skilled labour. There is virtually no unemployment in the city, but with a population of almost five million, I don’t see this as a problem. We intend to employ 700 people and we can train them from the ground up.

“Attitude and enthusiasm are more important to us than work skills, and we are very satisfied with what we have found.”

ST PETERSBURG: INVESTMENT BY INDUSTRY, 2005

Source: St Petersburg administration

 

ST PETERSBURG: INVESTMENT BY COUNTRY, 2003

Source: St Petersburg Committee for External Relations and Tourism