The unfolding Russian invasion of Ukraine jeopardises the fate of almost $500bn in accumulated foreign direct investment (FDI) as the sweeping sanctions promised by the US, EU and UK risk cutting out western companies active in the region. 

Accumulated foreign investment in Russia, which tracks the stock of active FDI interests in the country in any given year, stood at $446.7bn at the end of 2020, according to Unctad data. 

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Despite the sanctions imposed in the wake of the 2014 crisis in Crimea,  Western investors make up the bulk of the inward investment that flows into Russia every year. On average, investors from OECD countries made up about 80.8% of the FDI projects announced in Russia since 2014, according to figures from foreign investment monitor fDi Markets. 

Sector-wise, Russian real estate has traditionally been the biggest magnet of FDI, followed by oil and gas, and a several industrial sectors, including food and beverages and automotives, as foreign firms locally manufacture goods bound for the Russian market and the Commonwealth of Independent States region. 

The fate of this investment now hangs in the balance as Western allies threaten to cut out Russian banks from the European and US financial markets. This would de facto prevent companies from processing most of their cross-border trade and investment in and out of the country, similar to the reality in other heavily sanctioned countries, such as Iran. Signs of outflows appeared when the news of the invasion broke, with the Russian MOEX equity index plummeting by the most on record to about 50% below the high recorded in October 2021. 

“We will freeze Russian assets in the EU and stop the access of Russian banks to European financial markets,” said Ursula von der Leyen, the president of the European Commission, in a press conference on February 24

“These sanctions are designed to take a heavy toll on the Kremlin’s interests and their ability to finance war,” she continued. “We will target strategic sectors of the Russian economy by blocking their access to technologies and markets that are key for Russia.” 

Analysts note that these sanctions will be “very problematic” for foreign businesses with dealings in Russia, particularly if the country’s largest banks such as VTB and SpareBank are included.

“There will be a major operational hurdle to be able to conduct business. It’s very difficult to understand how financial payments will be processed [if these banks are sanctioned],” says Livia Paggi, the head of geopolitical risk at GPW Group. 

Given that a lot of multinationals have exposure to Russia, notably through fossil fuels and commodities like wheat and palladium, Western politicians face a balancing act between harsh sanctions and managing supply of resources from Russia. 

The recent invasion is expected to lead most companies with investments in Russia or Ukraine to put any additional plans on pause.

“There are clearly significant reputational risks associated with investing in an international pariah state or a country occupied by a foreign power,” says Hugo Brennan, the head of research for Europe, the Middle East and Africa at Verisk Maplecroft.

Western investors are also cautious of other existing risks to investing in Russia, such as corruption and a lack of confidence in its legal system. This was illustrated by the conviction of the country’s largest investor Michael Calvey back in August 2021

But onlookers expect the sanctions will lead the Russian economy to become even more dependent on China. The two countries recently issued a joint statement about a “new era” of international relations after Xi Jinping and Vladimir Putin met during the Beijing Winter Olympics.

“Chinese firms are unlikely to have the same reservations when it comes to investing in Russia, particularly in the natural resource sector,” says Mr Brennan. “Russia’s decision to invade Ukraine will be sure to accelerate Moscow’s ‘Pivot to the East’.”

The outlook is equally grim for the accumulated stock of FDI in Ukraine, which stood at $48.9bn at the end of 2020, Unctad data show, as the prospect of Russian occupation, or a raging war would equally demand a pricey toll on civilians and businesses alike.   

“There certainly is worry among global investors as to the scale of Russia’s actions and some businesses who are physically operating near the east of Ukraine will be keen to hedge risk and freeze any new FDI plans at least for the short term,” says Klisman Murati, the CEO of Pareto Economics, a London-based consulting firm.

Ms Paggi notes that there is also now significant security risk for staff working at multinationals in Ukraine: “Staff on the ground will need to be evacuated from Ukraine which is a real operational disruption.” 

While analysts expect a significant curtailment of FDI flows to Ukraine, the ability of foreign companies to divest will be limited in certain sectors, particularly in less agile operations such as oil drilling or logistics.

Even for more mobile sectors, businesses face significant risk. Ukraine has recently benefited from an influx of foreign software companies, with a record number of greenfield investments into its technology sector during 2021, according to fDi Markets. 

Ms Paggi says that foreign tech companies are unlikely to want to exit Ukraine due to the attractiveness of the market and its talent, but will face a more difficult operating environment.

“Tech companies will be thinking about blackouts and whether you can have an independent internet after a Russian invasion,” she says, noting that some of these tech companies are likely to also be caught up in their partnerships with any sanctioned Russian banks.

As foreign companies with operations in Ukraine and Russia weigh up the implications of the military action and associated sanctions, war has cast dark shadows on both countries’ economic and investment outlook. 

“Russia’s invasion of Ukraine will likely cause multinational firms to push the pause button on any decision to invest in either country,” says Mr Brennan.