Investment Rating for Russia`s Regions, 2002-2003 - Russian News

Expert RA has completed the eighth annual rating of the investment climate in Russia’s regions

Adding up Regional Strategies
Russia will never accomplish the national task of doubling the GDP unless similar ambitious goals are also set at the regional level. Today, less than a forth of Russia’s regions are ready for such a task.
Data and methods
The two general components determining a region’s attractiveness to investment are investment risk and investment potential.
The Investment Rating Results
The investment climate in Russia is stabilizing. The number of marginalized regions is declining and the number of “middle-class” regions is growing. The difference between Moscow and St. Petersburg and outlying suburbs is shrinking Only smaller regions, the autonomous ethnic federation subjects, are exceptions to these general positive trends.
Investors, Politicians, and Bureaucrats
Officials make all the difference, especially when it comes to investment climate. However, the opposite is also true: the electorate’s mood depends heavily on the conditions the region has created for investors.
The Wave Effect
Investment climate is not only defined by local authorities. It is also defined by neighboring regions. The Russian investment climate gets increasingly worse as one moves east and south. The waves of economic development expand in concentric rings from Russia’s investment core.
Investment Climate, Strategy, and Regional Administrative Efficiency
Here are some of the views of several participants in the conference held in October 2003 in Moscow, Russia’s Regions: from Survival to Prosperity. New approaches to improving investment climate and increasing economic growth.

Russia will never accomplish the national task of doubling the GDP unless similar ambitious goals are also set at the regional level. Today, less than a forth of Russia’s regions are ready for such a task.

The results of the first three quarters of 2003 seem to indicate that last year’s recession is over. However, only a move to an investment-based development approach will ensure stable growth. Every country has its own way of interpreting this approach. At the same time, the experience of other countries demonstrates that certain economic relationships must almost always be present:
- investment should equal 20-25% of the GDP (the level of capitalization);
- direct foreign investment should be no less than 15-17% of the total domestic investment;
- fixed asset depreciation should not exceed 30-35%.

In other words, it will not be possible to double the GDP at the national level unless Russia sees a stable influx of significant amounts of investment, according to our estimates at least $1.11 trillion, including at least $170 billion in direct foreign investment for 2004-2013. This means that the overall amount of investment in fixed assets must double and the amount of foreign investment must quadruple compared to the average yearly investment rates of 1995-2002. (See Table 1 and Chart 1)

How do the regions figure into this context? This remains unclear. In 2002 the majority of Russia’s regions had yet to achieve any significant increase in their rate of economic growth. Compared to 2001, the regions where industrial production declined already number nineteen. Only two out of 89 regions demonstrated the coveted 7% increase in their GRP over the last five years. There is still hope that the situation is actually a bit better than it seems. The State Statistics Committee has yet to release its data on gross regional products for 2001-2002.
Twelve regions have already achieved the necessary level of capitalization (the general range ran from a hopeless zero to an excessive 65%, a serious call for concern). Things look a bit worse in terms of foreign investment, as only five regions were able to attract the necessary proportion of foreign investment.
Thus, investors will make all the difference, especially as the international investment market is looking up for Russia, despite the YUKOS Affair. Russia’s recent investment-level rating will also make it more attractive to foreign capital.
But are regional authorities ready to take advantage of this chance for renewal through investment, which could even go as far as to “reindustrialize” Russia?
In this year’s rating we did not merely attempt to evaluate the investment climate in various regions in order to guide investors; we also determined the efficiency of regional administrations and their efforts to reduce investment risk and bring investment to their regions.

Our years spent observing investment processes in Russia’s regions has led us to make two conclusions. The first seems banal at first glance: it is impossible to significantly improve the investment climate without developing a strategy for social and investment development of Russia’s regions and municipalities. When even the municipalities in a region have an investment strategy or development program, things are far better for both investors and regional authorities.
While this first conclusion may seem banal, the second is almost paradoxical: only about two dozen regions (less than a forth!) have any kind of strategy. The remaining regions have put no effort at all into moving toward investment-based development. We have tried to figure out what unites these twenty more progressive regions. It turns out that they all have the same problem. Before adopting new strategies, all these regions experienced a decline in investment. It seems that everyone else is waiting for the other shoe to drop.
According to the Ministry of Economy and Development, the strategies and programs of eight regions have already received federal approval, including those of Kabardino-Balkaria, Mari El, Khakasia, Krasnodar and Stavrovol Territories, and Voronezh, Rostov, and Tula Provinces. The strategies and programs of Bryansk, Ivanov, Kaluga, Kursk, Novosibirsk, and Tomsk Provinces are currently under review. Khabarovsk Territory, and Yarslavl, Penza, Perm, and Vladimir Provinces, as well as a variety of other regions, are now working on strategy documents.
Why have these strategy documents, once so unusual for Russia, become so significant? Most likely because by working on strategic plans and programs, the regional administration systematizes its information about the region and increases its understanding of the current situation. Often, officials only find out how things actually stand by creating such a document. As a consequence, afterwards they make better founded, more correct administrative decisions regarding investment policy.
In addition, strategy is an important factor in increasing a region’s attractiveness to investment. It simplifies negotiations with investors significantly. Based on strategy documents, investors can determine the region’s strategic development goals, its resources and potential, its priorities and areas of economic growth, and the measures the region is taking to implement this strategy, including investor benefits. Investors can evaluate the region’s market and imagine their place in it and their business prospects. For this reason, it is no coincidence that major investors began to call on Yaroslavl, Ivanov, and Penza Provinces the moment they heard that their administrations were developing strategy documents.
Moreover, the moment regions developed and began to implement strategies and programs, 80% of them lowered their investment risk back in 2002-2003. They increased their ranking in terms of risk, moving up one spot (Kaluga and Penza Provinces) or as many as sixteen (Udmurtia and Novosibirsk Province). Yet among those without strategies only 47% regions were able to lower their investment risk.

The two general components determining a region’s attractiveness to investment are investment risk and investment potential.

Investment risk represents the likelihood of the loss of investments or income from investments. The integral risk evaluation consists of seven different risk types (see Table 3). A region’s rank in terms of each kind of risk is determined according to its relative deviation from the Russian national average risk, which equals one.
Investment potential takes macroeconomic characteristics into account, such as the geographical concentration of industrial facilities, consumer demand, and other factors. The aggregate investment potential of a region consists of eight individual potential factors (see Table 6), each of which in turn is defined by an entire group of indicators. Each region’s potential ranking depends on a quantitative estimate of its potential as a portion of the total potential of all 89 Russian regions.
The general indicators for potential or risk were calculated as the weighted totals of the individual potential or risk factors. Indicators were totaled, each according to its own weighted coefficient. A region’s final ranking was calculated according to the total weighted sum of the individual factors. As a result, each region has a qualitative rating in addition to its rank, reflecting how great investment potential is and how great the risk to investment in that particular region.
Regions are also divided by their overall potential and risk into twelve groups (Table 2, Chart 4, and Map 1). According to research results, all regions fall into the following categories:

High potential – moderate risk (1B) - 4 regions.
High potential – high risk (1C) - 1 region.
Average potential – moderate risk (2B) - 15 regions.
Average potential – high risk (2C) - 5 regions.
Low potential – minimal risk (3A) - 1 region.
Reduced potential – moderate risk (3B1) - 27 regions.
Reduced potential – high risk (3C1) - 5 regions.
Insignificant potential – moderate risk (3B2) - 16 regions.
Insignificant potential – high risk (3C2) - 11 regions.
Low potential – extreme risk (3D) - 4 regions.

This year, no regions fell into the 1A (maximum potential – minimal risk) and 2A (average potential – minimum risk) categories.
The changing conditions for investment in Russia and changes in the format of available data demanded that we make several adjustments to our calculations of individual risk and potential factors. This primarily affected our estimates of crime-related risk, which caused the greatest changes in regions’ ratings. First, the new Criminal Code introduced in the middle of 2003 has a milder interpretation of when legal violations are subject to criminal prosecution. This led to a dramatic decrease in the number of reported crimes in almost all regions and to substantial reshuffling of crime-related risk ratings. Secondly, an indicator of violent and extremely violent crimes was reintroduced as a criterion for determining the extent of crime in a region.
When evaluating legislative risk, free economic zones were attributed substantially less significance as a result of their minor importance for investors. Limits set on investment in formerly state owned or soon to be privatized companies were also given less significance.
The results of elections for regional leaders that had been held before this rating was published were taken in consideration when evaluating political risk.
The former indicator of social risk, the cost of a fixed group of goods and services, was replaced by the cost of the minimal amount of basic food products.
Finally, the institutional potential indicator for the first time takes into account the number of entrepreneurs who are not operating as official legal entities.
The weighted contribution of each component in aggregate potential or integral risk, originally estimated by means of surveys of experts from Russian and foreign investment and consulting companies and firms, saw no substantial revisions.
To compare the amount of domestic capital investment with direct foreign investment, domestic investment was converted into hard currency equivalents at the dollar exchange rate of the corresponding years.

The investment climate in Russia is stabilizing. The number of marginalized regions is declining and the number of “middle-class” regions is growing. The difference between Moscow and St. Petersburg and outlying suburbs is shrinking Only smaller regions, the autonomous ethnic federation subjects, are exceptions to these general positive trends.

The smaller regions, as a rule, are not able to properly reduce their investment risk. Their administrations, as a rule, are less efficient (see Table 8). This is especially apparent in regions’ average risk. While in 2001 the index of integral risk per region (excluding Chechnya) was 1.102, in 2002 it was 1.122 and has now reached 1.131. This is the highest level since 1997 (Chart 2). (According to our methodology, the average risk for the country overall equals one. This means that that an increase in the average per-region risk can only occur due to an increase in high-risk regions.) average investment risk in Russia

Nonetheless, over the past year, the integral risk index only grew in 42 federation subjects, as opposed to 47 in 2001-2002. Yaroslavl and Novgorod Provinces stayed in the highest category of regions with minimal risk and were joined by Belgorod Province and, after a four-year hiatus, St. Petersburg. On the other hand, Moscow Province fell from this category, as did Moscow city for the first time in the history of Expert RA’s ratings. The lack of a law governing investment activity was one of the most significant factors for Moscow’s fall; 80 other federation subjects already have such a law. Mayor Yuri Luzhkov only gave the city government the order to draft such a law in March 2003.
The number of “marginalized” regions is declining steadily – i.e. the regions with extremely high risk or very low potential. It often seems easier to start from scratch than to perfect something. As a consequence, many regions are creating a fairly satisfactory investment climate and joining the “middle class.” Further progress will require qualitative administrative reform and the development and implementation of an investment strategy. Few seem up to the task.
In terms of the rating, this process is reflected in increases in the popular 3B1 category, the “middle-class” regions with reduced potential and moderate risk (Chart 3). There are now 27 such regions, as opposed to 24 in last year’s rating. Competition for investment between regions falling in the 3B1 category is particularly stiff.

This year saw less frequent “migration” of regions between rating categories. While last year, 19 regions changed their risk or potential categories, only 14 did so this year. Those regions who moved up, the leaders of this year’s rating, by improving both risk and potential include Belgorod Province, which went from 3B2 to 2A, and Buryatia, which moved from 3C2 to 3B1 (Table 2, Chart 4, and Map 1). Only 9 regions improved their risk and potential index, as opposed to 11 in the last rating (Chart 5). At the same time, fewer regions saw an increase in risk and a decrease in potential, only 28 as opposed to 31 last year. This further confirms that the investment climate is “averaging out” in the overwhelming majority of smaller regions.

In the investment risk rating there occured significant changes. Fisrt of all, there appeared a new leader - Yaroslavl province that has been constantly reducing its investment risk during the last for years and for the first time it became leader (Table 3). In the second plece, regions has been reshuffled again. These shifts are accounted bu changes in the criminal risk, namely by the way crimes are registered now. Because of that Astrakhan and Tyumen provinces have improved their integral risk significantly. Most of all investment risk has deteriorated in Tver province, not only becouse of the situation with the governor, but also due to the criminal and financial risk aggravating (Table 4). The increasing investment risk in St. Petersburg province is connected with the criminal risk worsening, as well as ecological and social risks. And the catastrophic increase of risk in Nenetsky AO is accounted by the whole bunch of negative factors (all risks, except plitical and ecological). (Table 5)
One of the most notable results of the rating was the substantial decline in position of two of the biggest economic centers in Russia, Moscow and St. Petersburg (Table 6 and Map 2). However, this does not necessarily mean that city officials and entrepreneurs have let things slide. It indicates that other regions are outpacing them in terms of growth (as position is determined relative to national averages). The investment potential of the regions closest to Russia’s two biggest cities, Moscow and Leningrad Provinces, grew particularly rapidly. If one compares this trend with historical developments in Western Europe and the US, it appears to be the natural result of the exodus to the suburbs of businesses or facilities that are inefficient, inappropriate to an urban setting, and require more space, such as wholesale trade, rail transport, and aviation. These businesses and companies either close down or restructure, or move their business to nearby suburbs. They are replaced by technologically advanced small and mid-sized firms, office centers, expensive hotels, boutiques, entertainment facilities, and sports and health clubs.
Regions’ progress in terms of increasing potential was less significant, as demonstrated by the limited number of regions belonging to the most dynamic in improving investment potential (Table 7). The leader is this area, Bryansk Province, improved its potential by increasing the number of people with higher education involved in investment. To all appearances, this is related to defense companies getting back to work. The increase in investment potential in Chechnya resulted from a minor economic revival and the introduction of accounting practices for a range of investment climate indicators.
The top six regions kept their leading positions in terms of potential, and all in all the top ten regions for investment, despite some minor shifts in position, remained the same.

Officials make all the difference, especially when it comes to investment climate. However, the opposite is also true: the electorate’s mood depends heavily on the conditions the region has created for investors.

Investment climate is in many ways determined by the structure of a region’s entire bureaucratic machinery, even down to the municipal level. In certain regions this machinery requires up to two years to approve an investment project. While they wait, investors lose more than time and patience; they also lose significant amounts of money (in part due to “lubrication” of the corrupt bureaucratic machinery). However, there are also regions (such as Novgorod Province) where the entire bureaucratic procedure related to investment takes only two weeks. Unfortunately, due the lack of information on how the bureaucratic machinery of all Russian regions operates forces us to limit ourselves to circumstantial evaluations of officials’ efficiency in the area of investment.
Investment is the final step resulting from years of effort to create a positive investment climate, as reflected by our ratings. Thus, if we evaluate officials according to the compound criterion of “conditions created and results achieved” (Table 8), the most efficient administrations are in St. Petersburg, Moscow city, Krasnodar Territory, Tatarstan, Moscow Province, Bashkorostan, and Yarslavl, Samara, and Novgorod Provinces. The least efficient bureaucrats work in Tuva, Dagestan, Ingushetia, Bryansk Province, the Jewish Autonomous District, and a handful of the smaller autonomous districts.

Elections results present yet another piece of circumstantial evidence regarding officials’ effectiveness. We have noted a correspondence between the results of efforts to improve investment conditions and the likelihood of reelection.
Though too little time has passed to say for sure, this prediction appears to be a self-fulfilling prophecy. The heads of the regions with the most promising outlooks (for example, the governors of Leningrad Province, Belgorod Province, and the president of Mordovia) were reelected by a wide margin in the very first round of elections.

Investment climate is not only defined by local authorities. It is also defined by neighboring regions. The Russian investment climate gets increasingly worse as one moves east and south. The waves of economic development expand in concentric rings from Russia’s investment core.

Regions with the best investment climates are for the most part concentrated in European Russia. The Northwest, Central, and Privolzhsky Federal Districts have particularly favorable climates. Almost two thirds of Russia’s investment potential is concentrated in these regions, and investment risk per region is lower than the national average. As one moves further east and south, the investment climate grows gradually worse, as overall potential decreases and risk increases (Charts 7 and 8). In the Far Eastern Federal District, average investment risk per region is almost 1.5 times greater than in Northwestern Russia, while in the Southern Federal District, it is 1.6 times greater.

Russia’s investment core, as revealed by last year’s rating, lies between Moscow and St. Petersburg and has yet to gain a sufficiently stable and favorable investment climate. Its center has shifted to the northwest and to St. Petersburg, as the attractiveness to investors of Moscow city and Moscow Province has declined. Tver Province has fallen out of this core group, and investment risk in Leningrad Province has increased dramatically. At the same time, the investment climate in Vologda and Yaroslavl Provinces has increased significantly.
Improvement to the investment climate in Russia has taken the form of gradually decreasing concentric rings moving out from the center of the investment core to the periphery. This is demonstrated by the significant improvement in investment climate in the regions lying near the investment core, such as Belgorod, Nizhegorod, and Kostroma Provinces and Tatarstan. In order for this wave of increased investment attractiveness to reach further into the periphery, new sub-centers and investment cores, regions with minimal investment risk, need to form. Tatarstan is the most likely candidate for this role, as it had a minimal risk in the 1998 and 1999 ratings. Other possibilities include Krasnodar Territory, Bashkortostan, and Nizhegorod, Rostov, Samara, Perm, and Tyumen Provinces.

Here are some of the views of several participants in the conference held in October 2003 in Moscow, Russia’s Regions: from Survival to Prosperity. New approaches to improving investment climate and increasing economic growth.

Vladimir Blank, Deputy Executive Chair at PSB (Industry and Construction Bank) and former Vice-Governor of Pskov Province:

- The main limiting factor to regional development is the efficiency of administrative teams and company owners. It is ridiculous that people at the helm ask whether the region really needs a strategy. This only happens because local administrations don’t really understand what they are administering. For this reason, many “strategies” merely preserve the ratios and relationships that already exist in the region.

- Yaroslavl Province is a great example of a region struggling to survive without natural resources. The provincial administration and local companies developed a group of effective managers during the era of post-Soviet reform. This is how we managed to maintain production potential. The function of regional authorities is to remove via legislation all barriers in investors’ way and to simplify bureaucratic procedures. Yaroslavl Province strategically supports strong and profitable companies, not weak ones.

- Doubling the GDP to a significant extent will not rely solely on Moscow, but will involve every region in Russia. Yaroslavl Province gives us an excellent example of successful development. The provincial administration spent several years working strategically. The financial indicators of local companies have improved, real incomes have increased, and the region has balanced its budget. These changes have allowed Yaroslavl Province to achieve an A-level credit rating with a very positive outlook from Expert RA-AKM.

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