This may sound strange, but governors are responsible for economic and investment growth in Russia. They are furthermore directly-not indirectly-responsible.
Usually no one mentions the legal aspect of this matter. Article 114 of the Constitution of the Russian Federation, stating the functions of the federal government, mentions policy—budgetary, social, environmental, and even demographic policy—but says not a word about the economy or investment. The task of developing this policy is also not part of the president’s duties or those of the Federal Assembly. That is, unless the president, in accordance with the same Article 114, were to issue a decree forcing the government to develop and implement investment policy. However, there has been no sign of a decree like this. Thus, in general there are really no grounds to accuse federal authorities of pursuing exclusively fiscal goals. The Constitution does not charge regional authorities directly with taking care of the economy. However, Article 73 of the Constitution states that “within the confines of the jurisdiction of the Russian Federation and the authority of the Russian Federation over objects under the joint jurisdiction of the Russian Federation and Russian Federation subjects, the Russian Federation subjects shall enjoy the full extent of state power.”
Moving on from these formal observations, the regional heads are perhaps the only link in the chain of authority determining the fate of the investment climate. At least, statistics from the last seven years of ratings testify convincingly to this fact.

The investment climate in Russia today is governed by two interrelated trends: a growing differentiation between regions and the formation of an investment core.

Regional authorities have yet to take full advantage of their simplest and most effective resource, the formation of a regulatory base that would benefit investors.

Of the eight governors whose regions have seen a systematic worsening of the investment climate, only two or at most three have a chance at re-election.

Table 1: Basic Parameters of Investment Development in Russia
Table 2: Russian Regions Divided by Investment Climate Rating, 2001-2002
Table 3: Investment Potential of Russian Regions, 2001-2002
Table 4: Russia’s Most Dynamic Regions in Terms of Investment Potential
Table 5: Regions with the Least Total Investment Risk
Table 6: Investment Risk in Russian Regions, 2001-2002
Table 7: The Most Dynamic Regions in Terms of Change in Investment Risk
Table 8: Regions with Greatest Integral Investment Potential 
Table 9: Regions with Different Investment Climates by Federal Administrative District, 2001-2002
Table 10: Long-Term Stable Trends in Investment Risk
Table 11: The Relationship between Investment Climate and Time in Office of Regional Leaders
Table 12: Likelihood of Re-Election for Current Executive Heads of Federation Subjects

Map 1: Investment Climate in Russia’s Regions, 2001-2002
Map 2: Changes in Investment Potential and Risk between 1997/98 and 2001/02

Results of the Ratings

Centrifugal Forces. In 2001-2002, the difference between Russia’s regions grew. While after the 1998 Crisis, they fell onto the same risk-potential plane, now differences between them have started to grow (Chart 3). Thus, in the previous regional rating the maximum risk was 2.8 times higher than the minimum (the Republic of Ingushetia versus Novgorod Province; Chechnya was not included in the rating). This year, however, they differ by 3.2 times (the Koryak Autonomous District versus Novgorod Province). In terms of the differences between investment potential, in the last rating Moscow exceeded the Koryak Autonomous District by 296 times, while this has now grown to 333 times. In other words, the rich are getting richer.
Only five regions, predominantly large and medium-sized ones such as Moscow, Leningrad, Yaroslavl, and Tula Provinces, and the Khabarovsk Territory, qualitatively improved their standing in the investment ratings. At the same time, 14 regions (the largest among them being Krasnoyarsk Territory, Primorsky Territory, and Volgograd Province) fell into a lower ratings class (Map 1). The most notable change in ratings was Belgorod Province, which went from the elite of class 2A (minimum risk-moderate potential), and the number of regions in the most crowded 3B1 class (low potential-moderate risk, basically the ratings’ “middle class”) fell from 30 to 24, returning to its level in 2000 (Table 2 and Chart 4).

The fact that the number of regions with minimal investment risk grew compensates in part for this bad news. Moscow Province joined class 1A (high potential-minimum risk), and Yaroslavl Province rose to class 3A (low potential-minimum risk). Orlov Province and Tatarstan both have a strong chance to rejoin the regions with minimal investment risk (Tatarstan left their ranks back in 1999).

Yet another reassuring fact is that the change in the general geography of investment (Charts 5, 6 and Map 2). A comparison of changes in the investment climate in 2001-2002 versus 1997-1998 shows improvements in the overall distribution picture. While previously most regions saw a simultaneous rise in both risk and potential, the largest group in the current rating is made up of regions where risks are declining, but so to is potential.

The formation of a Russian “investment core.” A new aspect of regional investment development is the dramatic improvement of the investment climates in the regions lying between Moscow and St. Petersburg. Previously we singled out these two poles of investment attractiveness, Russia’s two biggest cities, which led the pack. Now contiguous regions—Moscow and Saint Petersburg Provinces—have joined the two loners. These two poles border on satellite regions with minimum investment risk (Map 1), namely Yaroslavl and Novgorod Provinces. They form a sort of “investment backup” for implementing projects, which for various reasons (high real estate costs, bureaucratic foot-dragging, environmental requirements, etc.) would be impractical or difficult to do in the big cities and their surrounding provinces. Novogorod Province has already been taken over by investors, in particular foreign investors, but Yaroslavl Province has for the first time in seven years been able to present itself to investors as one of Russia’s best regions for investment. Also taking into account the fairly high investment ratings of Tver and Volgoda Provinces, we can see the formation of an investment core along the axis of the E95 Highway. This core is ringed by several less attractive regions, extending via Vladimir and Nizhegorod Provinces, through Chuvashia and Tatarstan to the east.
The eight regions belonging to the “investment core” have about a third of Russia’s total investment potential, and their share has been rising steadily over the past several years. Here is also concentrated the majority of Russia’s institutional (53%) and innovation (46%) potential (Chart 7).

In the last three years, the core regions’ share of other resources like labor, financial, and consumer potential has grown substantially and grown in all the areas most valued by investors, particularly Western ones. If we also add in their low level of risk, then the fact that foreigners are paying more attention to the core regions makes complete sense. These regions’ share of foreign direct investment (FDI) has been growing each year and has already reached almost 47% (Chart 8). At the same time, the expansion of domestic capital out of the two urban centers to the periphery has reduced the core’s share in overall capital investments.

Investment Climate Components

The current rating confirmed our conclusion that attractiveness to investors is a conservative characteristic that is extremely difficult to increase. As a rule, the basis of much of a region’s potential depends on the natural resources at local authorities’ disposal.
As a result, the top five regions with the greatest potential remained on top, and those in the top ten did not change (Tables 3, 4, 5). Only Samara (from 8^th to 6^th) and Nizhny Novgorod (from 9^th to 8^th) Provinces rose in the ranks.
The most significant changes, as in the past, occurred in the middle of the table. The regions there differ little in terms of their overall investment potential.
Risk, however, is often the result of the local administration’s activities. The top ten regions with minimum investment risks changed insignificantly, but in a systematic way. Novgorod Province managed to keep its position as number one in terms of investment risk, though second-place Moscow closed some of the gap (Tables 7, 8, 9). For the first time in the history of the ratings, Leningrad Province reached the top ten. The Nenets Autonomous District also became one of the leaders. Kalingrad Province and Krasnodar Territory fell out of the top ten. Belgorod and St. Petersburg lost ground, while Yaroslavl and Moscow Provinces improved their standings. The difference in the risk level between the regions is minimal, a few ten-thousandths of a percent (0.0006). Among the larger regions, Moscow, Samara, Sverdlovsk, and Irkutsk Provinces had the most success in lowering their risk for investors.
However, the regions with limited investment potential proved the most dynamic. If local governments take a series of steps to improve the investment climate, the results can be seen quickly and lead to a reduction in risk. The regions that rose in the rating like Leningrad, Ivanov, Vladimir, Ryazan Provinces and particularly the Nenets Autonomous District (where almost all factors determining risk improved) support this thesis.
In addition, investment risks in small regions are subject to various factors that have little effect on larger regions. An example of this is the significant increase in investment risk in smaller regions near the Russian border. Out of the 12 regions that fell into the worst rating category due to increased risks, nine are located along the border and are on narcotics smuggling routes. The most alarming situation emerged in Saratov Province, where in the last year all risks, with the exception of political ones, increased. Not long ago (in 1998 and 2000), this province was one of the top ten regions in Russia in terms of investment risk.

The ratings showed that the most effective element in investment policy is the creation of a regulatory basis for investment activity and the development and implementation of a long-term investment strategy. This approach gives the maximum result in the minimum amount of time.
The first step in this direction, as a rule, is passing regional laws on investment activities. At present, such laws haven’t been passed (or are not made public information, which is all the same for investors) in Moscow City, the Yamalo-Nenets, Taimyr, Aginsky-Buriat, and Chukotsky Autonomous Districts, in the Karachay-Cherkess Republic, and in the Jewish Autonomous Province. The investment advantages of the first two regions are well-known and for the time being they don’t need to worry about special laws to attract investors. The consistent extremely low ratings of the remaining regions can be explained to a great extent by the lack of any initiative on the part of regional authorities to create a good investment climate for the entire history of the ratings. It is telling that five of the six “passive” regions in 1999-2001 had elected new leaders.
At the other end of the regulatory spectrum are regions where not only has regulatory legislation been passed and put into effect, but where it is constantly being perfected and amended as conditions change. In the period from September 1, 2001 to September 1, 2002, laws on investment activity were amended in 30 regions.
The federal government’s tough fiscal policies require regional authorities to seek new forms of investor support. One of the latest innovations in this area is the complete or partial payment of interest on loans acquired in the process of investment projects in the region, as well as decreasing rent for land. At present, Novgorod, Yaroslavl, Belgorod, Kaliningrad, Astrakhan, and Kemerovo Provinces, Komi Republic, Altai Republic, and the Krasnoyarsk Territory have all paid interest on investment projects. In the majority of regions, which take these steps, a good investment climate has already been established.
An important factor in attracting investors is how prepared a region is to accept investment. This refers to the existence of catalogues of investment projects and land registries of investment sites (in the rating these are included in the evaluation of legislative risk). More than two thirds of all regions have investment project catalogues (though in part these are brochures created as a formality and lacking any information helpful to decision-making). However, the creation of investment site registries has just begun. According to our information, this work has been conducted or is being conducted in Saint Petersburg, Novgorod, Yaroslavl, Orenburg, Kaliningrad, and Ivanovo Provinces and in Krasnodar Territory.
Finally it is absolutely necessary to develop a regional investment strategy. The basis of this document must be realized independent of the personality of the regional leader in power at the given moment. This significantly lowers investment risk. However, so far not a single Federation subject has its own investment strategy. Moreover, the only areas, according to our information, with any sort of long-term, complex plan or program for socio-economic development are Tatarstan, Bashkortostan, Karelia, Murmansk, Saint Petersburg, Novgorod, Vladimir, Yaroslavl, Nizhny Novgorod, Penza, and Samara Provinces.

One of the main reasons behind this change is the insufficiently slow restructuring of the economy. More than half of production capacity at many Russian companies was obsolete and worn out (sometimes from the very moment it was put into production). According to our estimates, immediately after the 1998 Crisis domestic manufacturing had a significant reserve of unused capacity, which allowed for a 22-25% increase in production. Now that reserve has been used up, just like the potential of a cheap ruble.
Only investment double or triple today’s levels will give a new impulse to the Russian economic development. However, the basic data on Russia’s investment development demonstrate that just the opposite is occurring (Table 1). In 2001 the growth rate of investment in fixed assets fell, and the amount of foreign direct investment (FDI) declined by 11.1% overall. Thus, while in 1999 ten regions saw a decline in production, in 2000 only Kalmykia and the Aga Buriat Autonomous District saw declines. In 2001 11 regions again saw declines, and in 2002 this number had growth to 28.
The steadily increasing depreciation of fixed assets in the Russian economy testifies eloquently to the investment deficit. In other countries, on the contrary, development encouraged by investment usually leads to a lower rate of depreciation and a dramatic influx of FDI (the share of this kind of investment reaches 25-35%). For precisely this reason when many talk about attracting investment, they usually mean attracting the cautious and finicky foreign investor. This kind of investor does not want to come to Russia, no matter how much Russians invite him to investment forums and conferences, of which there were more than 70 held in this year alone.
Foreign direct investors are again losing interest in Russia. They are frightened away by the infamous investment climate. In spite of all attempts to the contrary, foreigners don’t seem to appreciate Russia’s economic accomplishments in the past few years.
An excellent example of this is Russia’s position on international national (country) ratings of comparative attractiveness to investment. Unlike the Soviet Union, which in 1988 Euromoney Magazine rated 17^th right after Italy and Taiwan, Russia can’t seem to get out of the tail end of the first hundred countries (Chart 1). Worst of all, there seem to be no signs of any movement in that direction.
By comparison, according to Euromoney’s evaluation of September 2000, Kazakhstan was 81^st in the world, in September 2001 76^th, and by March 2002, it was already 70^th (the leader among CIS countries). Russia for the same period not only yielded to Kazakhstan and Azerbaijan (95^th), but also notorious Papua New Guinea (89^th).
The international rating agencies have also shown Russia no mercy. At least, not one has seen fit to include Russia in its investment level ratings. As a result, Russia is losing out in the competitive battle on the world market for direct investment not only to China and the countries of Eastern Europe and the Baltic, but also to its more dynamic neighbor to the south, Kazakhstan.
At the same time, it is not fair to say that the international business community has not noticed Russia’s huge potential. According to AT Kearney’s Foreign Direct Investment Confidence Index (which reflects how leaders of major transnational corporations view the feasibility of purchasing or setting up businesses in a certain country), Russia is 17^th out of 60 countries. This means that foreign investors would like to put their money in Russia. However, existing conditions still prevent them from making the decision to do so.

The attractiveness to investors of Russia’s regions is determined by two basic characteristics: investment risk and investment potential.
The amount of investment risk indicates the likelihood of losing investments and the revenues from these investments. Integral risk is made up of seven types of risk (Table 6). A region’s rank by each risk type is determined by ranking the regions according to the significance of investment risk, the relative deviation from the Russian nationwide average risk level (taken as a unit of measurement).
Investment potential reflects basic macroeconomic characteristics such as the density of production in the area, local consumer demand, and other factors. The total investment potential of a region consists of eight separate indicators of potential (Table 3), which are in turn determined by an entire group of factors. A region’s rank according to each potential type depends on quantitative evaluation of the size of its potential as a percentage of the aggregate potential of all 89 Russian regions.
Overall indicators of risk or potential were calculated as the weighted total of the separate types of risk or potential. These indicators were tabulated, each with its own weighted coefficient. The region’s final rank was calculated according to the size of weighted sum of the individual indicators. As a result each region was given not only a rank, but a quantitative evaluation reflecting the size of its investment potential or risk.
The ratings themselves divide the regions up into 12 groups according to their total potential and integral risk (Table 2,  Chart 3, and Map 1). According to the results of our research, all regions fell into the following groups

• Maximum potential, minimum risk (1A);
• High potential, moderate risk (1B);
• High potential, high risk (1C, no region fell into this group in the current rating);
• Average potential, minimum risk (2A, no region fell into this group, either);
• Average potential, moderate risk (2B);
• Average potential, high risk (2C);
• Low potential, minimum risk (3A);
• Reduced potential, moderate risk (3B1);
• Reduced potential, high risk (3C1);
• Negligible potential, moderate risk (3B2);
• Negligible potential, high risk (3C2);
• Low potential, extreme risk (3D).

This year, our methodology underwent several changes, allowing us to evaluate the investment climate under current conditions more precisely.
The factors used to calculate crime-related risks were adjusted to a certain extent. The “number of murders and attempted murders” was exchanged for a more representative factor in our opinion, the number of serious and extremely serious crimes. The abstract “economic crimes” was replaces by “crimes connected to the use and sale of narcotics.”
We included new tendencies in investment regulation in our calculations of legislative risk, such as strategies and long-term programs for economic or investment development in the region, investment project catalogs and investment site registries, and budget subsidies for interest on loans taken out by legal entities from commercial banks for investment purposes.
Lastly, we succeeded this year in giving separate ratings to all provinces, territories, and autonomous districts in the Russian Federation. In accordance with Article 5 of the Constitution, all federation subjects are equal in terms of rights, but nonetheless the State Statistics Committee and a variety of other federal agencies include data on the autonomous districts (and even their budgets) in information on the territories and provinces they were part of in 1993. Separating out data for the autonomous districts benefited Tyumen Province most of all and allowed it to take its proper place among Russia’s regions in terms of investment risk and potential ratings.
To compare the amount of Russian domestic investment with foreign direct investment, the former were converted into their hard currency equivalents using the exchange rate from the corresponding year.
Main sources of information: data from the State Statistics Committee, the Ministry of Finance, the Ministry of Economic Development and Trade, the Central Bank, the Ministry of Taxation and Duties, the Ministry of Natural Resources, The Russian Government Center for Economic and Market Trends, the Consultant Plus-Regions Database, and Expert RA Rating Agency databases. We furthermore used other information the administrations of individual federation subjects provided at our request or published online.
We determined the contribution coefficient of each component in the overall potential or integral risk by surveying experts from Russian and foreign investment and consulting companies and firms in 2001 and 2002. Experts from many companies participated in the survey, such as BKG Management Consulting, The Boston Consulting Group, the Russian Development Bank, Alfa Bank, ROEL Consulting, Kirovsky Zavod, the German Manufacturing Development Institute (BFA), Permskie Motory, and Nizhnekamskneftekhim. For the first time, directors of regional investment departments were invited to participate as experts. Survey results showed that in the post-Crisis period, investors’ ideas regarding investment attractiveness and the importance of various separate factors changed noticeably (Chart 2). Changes in experts’ evaluations of risk can be explained by the fact that the majority of Russians have a low standard of living while government assistance is constantly shrinking. Due to these factors, experts placed increasing significance on social and crime-related risks.
As in previous surveys, experts are least concerned with environmental risks and most concerned with legislative risks. Experts saw regional regulatory measures related to investment an increasing important risk. This confirms the great influence of regional authorities’ activities on the investment climate.
According to experts, Russia’s regions are important to investors first and foremost as a source of quality human resources and consumer markets. To a great extent, experts placed increasing significance on the institutional potential supporting market function. This demonstrates that Russia has progressed to a more civilized market based on a deeper division of functions between manufacturing and services.
A region’s internal financial potential continues to lose significance. Companies and consumers continue to lack resources, and budget resources are losing their regulatory role in the investment process. Under current conditions regional authorities can only attract investors by subsidizing interest on loans and lowering land rent. The majority of regional budgets are not in a position to provide financial guarantees to investors or form collateral funds.