National rating agency “Expert RA” has completed the ninth annual rating of the investment climate in Russia’s regions

Investment paradox
There has appeared a phenomenon of risk division in Russia: investment risks are being transferred from the federal level to the regional one
Table 1. Basic Parameters of Investment Development in Russia in 1999-2003.
Chart 1. Basic Parameters of Investment Development in Russia in 1999-2003.
Chart 2. Investment share in GDP of Russia
Chart 3. Social results of investment development in Russia in 1999-2003
Chart 4. Comparative investment attractiveness of Russia and the Subjects of the Federation

Manoeuvres on the legislative field
Lawmaking is the quickest and most effective way to improve investment climate in a region
Chart 5. Expert weights of potential and risk factors

Main Results of the Rating
For the first time there turned out to be no region with minimal investment risk in Russia. Nevertheless, the leading subjects of the federation do have a mechanism of low investment risks reproduction

Table 2. Rating: Russian Regions Divided by Investment Climate Rating in 2003-2004
Chart 6. Rating: Investment climate of Russian regions in 2003-04.
Chart 7. Distribution of Russian regions according to investment risk and potential
Map. Investment risk in Russian regions in 2003-2004.
Table 3. Investment Risk in Russian Regions in 2003-2004
Table 4. Regions with the least integral investment risks
Table 5. Investment potential of Russian regions in 2003-2004.
Table 6. Regions with greatest number of accidents
Table 7. Regions with the poorest population
Table 8. Regions with the most and least "investment active" authorities
Chart 8. Regions leading in total volume of investments per one official
Chart 9. Direct foreign investments attraction per one official in 1999-2003.

Candidates to appointees
The results of elections held in 2003-2004 confirmed our forecast made two years ago. Achievements in forming investment climate predetermine chances to succeed with the electorate
Table 9. Forecast of the probability of reelection and results of electing heads of executive authorities of the Subjects of the Federation in 2003-2004
Table 10. Heads of the regional executive authorities, who created most favorable investment conditions during their governing
Table 11. Heads of the regional executive authorities, who managed to achieve the best rates of investment risk reduction during their governing
Chart 10. Results of the activity and probable political prospects of the current governors od the Subjects of the Federation

Information and methods
Table 12. Regions with the best provision with cellular communication
Table 13. Regions with the best Internet penetration

Investment paradox
There has appeared a phenomenon of risk division in Russia: investment risks are being transferred from the federal level to the regional one

Since 2000 investment attractiveness of Russia has been growing, but growing also have been investment risks in most regions of the country. Cardinal risk reduction on the regional level could be expected in 2009-2010 the earliest, when the administrative reform will have been completed and the vertical of power will start working in full all the way down to the municipalities.

State image
Since 1999 ratings of the international rating agencies have been clearly showing a favorable attitude of investment community towards Russia. For instance, according to Euromoney magazine, our country has gone up in the national rating from the 133rd place in March, 2000 to  the 64th in September, 2004. Russia has surpassed Azerbaijan  and again become the fifth among the former USSR countries.
For international pundits the investment attractiveness of the country is first of all related to the state of its economy and finance. Super high oil prices and high prices for metals ensured a great inflow of money into the country and thus the possibility of early repayment of foreign debt. The Russian GDP growth in 2003 made 7,3%. This accordingly was accompanied by the growth of production of main products and services, growth of investments and especially direct foreign investments into the economy. The number of regions with reduction of industrial production has decreased twice as compared to 2002 (see table 1).
These changes led to qualitative shift in technical fitting out of the economy: for the first time in 15 years the main assets depreciation has decreased, the share of investments in GDP has made 18% as compared to 16,4% in 2002. Though we are still far from the "investment corridor", one can state, that last year in the Russian economy there appeared some signs of the investment type of development. The growth of the real income of the population is quite impressive and the rates of poverty reduction have increased.
In the sphere of state governance there was further normalizing of legislation and enforcement of vertical of power – the actions of the authorities have become more predictable on all the levels of state government and local self-government. Even the  "YUKOS case" couldn’t discredit the federal authorities in the investors’ eyes.
Finally, in political sphere the results of the State Duma elections, in the investor’s view, contribute to improving stability in the society, since they practically exclude any confrontation between legislative and executive powers in the process of laws adoption.

Risk division
Any changes, more so the reforms touching the very foundations of state structure, increase the number and effect of uncertainty factors and thus the investment risks.
And the rating results clearly prove it – average regional index of investment attractiveness grew sufficiently in 2003, but the number of regions with the reduction of integral risk index reduced by more than two times. To a great degree this was sequent to the preparatory stage of the reform: quite negative for the regions change of interbudget relations, changes in the legislation related to the administrative and social reforms, new principles of forming elective state bodies.
Since 2000 we’ve been witnessing a paradox of "risk division", when investment risks are being transferred from the federal level to the regional one. In spite of the fact that investment attractiveness of Russia in the world is growing, average regional risk indices, especially that of political and social risks, in 2003 increased. Only the average of economic risk decreased which last year depended rather on the market situation, than on the reforms impact.
The reform has effected in stabilizing the political situation on the federal level and in credibility gap for regional and municipal authorities. The unanimous voting at presidential and parliament elections, that reduced the “federal constituent” of political risk, was exceeded by the increased political tension in regions, especially in the republics of Southern Federal okrug. Regional government retirements have become more frequent and the number of inspections of regional governors has increased.
The growth of social risk was influenced by such factors as aggravation of strike movement and growth of accidents at communal grids in winter time.
The average of legislative risk of investments in regions hasn’t noticeably changed. This was achieved due to the manoeuvres of regional authorities on a fast-to-change legislative field.

Manoeuvres on the legislative field
Lawmaking is the quickest and most effective way to improve investment climate in a region

Regional authorities have to eliminate consequences of the changes in the federal laws, that are negative for the local investment climate. That’s why it is only natural that local legislative conditions have become the most important factor of investment climate changes. Regions and municipalities started to actively develop regional strategies and programs, devise new instruments and improve the ways of interaction with investors.
Investors react adequately to it. According to the poll results, they traditionally believe that the investment climate largely depends on just the legislation.

Federal innovations
Federal investment and taxation legislation have undergone great changes lately:

· There was introduced, for foreign investors in the first place, "grandpa’s reservation", that is, those changes in the Russian legislation having negative impact on the investors’ activity will not be applied to investment projects for some time;
· Providing guarantees for investment protection has been confirmed;
· Granting benefits to investors has been legalized;
· There has been introduced a possibility of getting additional benefits for the projects considered to be of top priority;
· They’ve abolished a major part of federal tax benefits, reduced the number of grounds for granting deferment and installments of tax payments and transferring the right of introducing tax benefits to regional and local level.

From the federal law “On closed municipalities” there have been withdrawn all the clauses about federal tax benefits, and it reduced investment attractiveness of the closed towns. At the same time there have been adopted the “Program of developing science towns", according to which the federal budget of 2005 is to render significant financial aid to the seven existing science towns and it improves investment attractiveness of the regions they are located in.
One of the most important peculiarities of the recently adopted federal laws regulating investment activity is a complete abolishing of social tax benefits for foreign investors but for customs benefits for equipment brought as a contribution to the authorized capital. Nevertheless, the federal investment law still has some limitations to foreign investors’ participation in privatization. Thus, the federal law does not allow to use foreign investments at the enterprises located within the boundaries of the closed municipalities. The RF government decisions limit the access of foreign investors to privatization of oil and gas companies, enterprises extracting ores of strategic materials, precious metals and gems, radioactive and rare-earth elements.

Regionals getting active
In regulating investment activity regional authorities use their own approaches, forming economic policy that takes into account their regional peculiarities.
The main among the local laws is the constantly changing Law on investment activity. Regional law-makers introduce into the latest editions of this law a number of new norms, namely on the investment projects of top priority and conditions for their realization, and on regional target.
Regional administration define different forms of state support for investors, implementing their projects on the territory of the region, according to the provisions on investment projects contest. Projects that have passed the investment contest are necessarily included into regional investment program. These provisions are quite successfully implemented in Khabarovsk and Krasnodar territories.
Of principal importance is the provision of benefits and limitations for investments envisaged in regional laws. As a rule, benefits are applied to the following taxes: regional part of profit tax, legal entities’ property tax, land and transport taxes. Indispensable condition for beneficial taxation is separate accounting of priority investment projects.
For investors it is of great importance that the region had a law on state land-survey.
In order to improve the quality and quantity registration of natural resources, to improve their multiple use, protection and reproduction it’s important to adopt a regional law on state cadastre of natural resources.
Because there was no Federal law on free economic zones, since mid nineties in some regions there have come into effect regional laws on zones of special status.  Many of these zones seized existing because the regional laws contained clauses contradicting the federal law. Nevertheless such zones have been preserved in Novgorod province, there are regional laws on territorial industrial zones in Nizhny Novgorod, Sverdlovsk provinces, Republic of Bashkortostan, Buryatiya and other subjects of the Federation. These zones are set up as an experiment to create favorable conditions for the inflow and investment of domestic and foreign capital.
One of the novelties in investment legislation are regional provisions on investments insurance. According to it investments can be, and in some cases envisaged by the Russian legislation, should be insured.
Following the Federal centre policy, some regions admit foreign investor to participate in privatizations of small industrial, construction and transport enterprises, as well as trade, public catering and consumer services companies only through permission of the local authorities or authorized organizations.
All these parameters of investment legislations were systematized to the best of our knowledge and taken into account when estimating legislative risks and preparing the rating.
Novgorod province has become the leader for the third time and for the first time Moscow has dropped out of the top ten.

Main Results of the Rating
For the first time there turned out to be no region with minimal investment risk in Russia. Nevertheless, the leading subjects of the federation do have a mechanism of low investment risks reproduction

The main peculiarity of the new rating is the absence of regions with minimal risk (categories 1A, 2A and 3A I table 2; on charts 6 and 7; on the map). Even the four survived leaders – Novgorod, Yaroslavl, Belgorod provinces and Saint Petersburg  (see table 3) – have their risk index increased and transferred to the category with moderate risk. This is the first case in nine years.
Serious changes in the political and economic and social situation in the country, that occurred last year, and appearance of new risk factors (see "Information and methods") resulted in significant changes in regions’ ranks of integral investment risk.
Group 2C - "Medium potential – grave risk" has reduced and changed the composition. Krasnoyarsk territory, Sakha (Yakut) Republic, Chelyabinsk province and Yamalo-Nentsky autonomous okrug have left it for a better category 2B, and Novosibirsk and Irkutsk provinces entered it with their increased risk index. Among the positive results one should note the spurt of Taymyr autonomous okrug from the zone of extreme risk, the transition of Amur province and Chukot autonomous okrug from the group of grave risk to that of moderate risk. Khanty-Mansyisky autonomous okrug has reduced the risk to moderate and thus "cleared out" category 1C. The three regions brining up the rear of the integral risk – Chechen, Ingush Republics and Koryaksky autonomous okrug – have left without changes.
For the first time Moscow has left top ten regions. Though economic, financial and social risks are minimal, but some circumstances such as complex legislation, worsening ecological and criminal situation in the city, didn’t allow the capital to keep its place in the group of leaders. If last year it left category A of the regions with the minimal risk and shifted from the second place to the sixth, this year it is only 15th in the rating. Though the capital is still very attractive, investing here gets more and more complicated. Nevertheless, due to its high – and constantly growing – investment potential and various possibilities, as well as closeness to federal authorities Moscow remains the most attractive place for investors.
In all the nine ratings among the top ten regions with the minimal risks there invariably were only Tatarstan and Belgorod province (see table 4).

Secrets of leaders and reasons of failures
Well-thought-out social and economic policy and effective work with investors coming to the region allowed the leaders – Novgorod, Yaroslavl, Belgorod, Orel provinces and Saint Petersburg – to create a stable favorable investment climate in their regions. The leadership of these regions wasn’t affected seriously even by such factors as changes in inter-budget relations, suspension of free economic zones, complications in inner political situation and in most cases limited investment potential. Longstanding efforts of regional authorities resulted in creation in these regions self-supporting mechanism of low investment risks reproduction.
Thus, the second (year 2003) wave of investments in Novgorod province is to a great degree the result of a long-set system of interaction of the authorities with businessmen and investors. All the draft laws concerning the business climate are being agreed upon with the business community and are not adopted without their consent.
In Yaroslavl province back in 2001 there was passed a law on stimulation of economic development, according to which there was adopted a procedure of granting subventions to provide financial assistance to investors. As a result of such stimulation of investments in 2002-2003 and first half of 2004 the tax base of three municipalities of the province grew by two thirds, and total budget income of the province grew by more than 3 billion rubles un this time.
This year the ranks of regions according to the integral investment risk have changed much more than they did last year. If in 2002 the average rate of region’s progress along the investment risk scale was 5,9 positions, in 2003 it was already 10,8 positions. For the potential scale these figures were 1,8 and 1,2 positions accordingly. The greatest progress in potential rank (see table 5) was 4 positions up - Tomsk, Sakhalin provinces and Chukot autonomous okrug, and six positions down – Bryansk province. On the integral investment risk scale Yamalo-Nenetsky autonomous okrug has gone up by 44 positions this year, and a number of provinces, on the contrary, have dropped sufficiently – Vladimir province by 43 positions, Astrakhan province by 37 positions, Ivanovo province by 33 positions. Such significant increase of the investment risk in the latter three regions is accounted for by negative changes in legislative, economic, financial and especially social risks. Thus, all the tree of them are the leaders in accidents at steam and heating grids (see table 6). In 2003 Ivanovo in province there were 60% of people with the income below living wages (see table 7), and in Vladimir province - 46%, as compared to 22,5% on the average in Russia. As a result, Ivanovo province dropped from the 3st position to 87th, Vladimir province - from 23rd to 83rd and Astrakhan province – from 42nd to 79th.

Officials, risks and investments
Favorable investment climate is not an end in itself. It should be converted in volumes of attracted investments. The achievements of regional authorities here are quite different. Most investment active and inert regions are presented in table 8.
In the last five years most of all investment per one state or municipal official naturally came in natural resources regions: Yamalo-Nenetsky, Nenetsky and Khanty-Mansiysky autonomous okrugs, Sakhalin province and Komi Republic. Besides two capitals, having significant investment temptations, the top ten includes two neighboring to capitals regions (Moscow and Leningrad provinces) and Krasnodar territory.
Only ten regions have a higher level of investments volume per one official than the Russian average. And since foreigners are not admitted to the Russian natural resources (but for Sakhalin), these top ten mostly present the regions whose government is better in cooperating with foreign investors. Besides mentioned above capital provinces and Krasnodar territory, foreigners start moving to the periphery. Foreigners-friendly Novgorod and Kaluga provinces enjoy their special attention.

Candidates to appointees
The results of elections held in 2003-2004 confirmed our forecast made two years ago. Achievements in forming investment climate predetermine chances to succeed with the electorate

The four-years discussion about the way of forming regional governments and the status of the heads of the subjects of the federation seems to be at its logical end. The President has finally decided to cut the knot of contradictions that is Russian democracy in regions and take up all the responsibility for regions development.
With the “new order” it’s logical to assume that major part of the candidate to appointees will most probably be acting heads of regional governments. Of course the final decision on choice of candidates is to be done by the President, but in any case he will have to rely on some objective criteria for their performance estimation. After checking the results of the forecasts of the regional leaders’ fate made 2 years ago, we may say that investment rating of regions can be used as one of the objective instruments for integral estimation of these leaders’ performance efficiency and probability of their further success in their position.
 

Information and methods
Starting provisions
Two characteristics are used for defining investment attractiveness: 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. 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, 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.
The results of the research are presented in tables, charts and a map, showing distribution, dynamics and grouping of regions according to investment risks and potentials and their constituents, and also explanatory text. The rating proper is the division of regions by overall potential and integral risk into 12 categories (table 2, charts 6 and 7 and the map).
More than 100 basic qualitative and quantitative characteristics have been used in the analysis of investment risk and potential constituents. The main sources of information are data of the Federal statistics committee, Ministry of finance of the RF, Ministry of economic development and trade of the RF, Central Bank of the RF, Ministry of tax and duties of the RF, Ministry of natural resources of the RF, Ministry of internal affairs of the RF, law database “Konsultant Plus-Regions” databases of "Expert RA" rating agency. Information on cellular communication and internet in the regions was provided by company iKS-Consulting. The results of the federal and regional elections were obtained at the web-site of Central Election Committee of the RF and election committees of regions. Besides, in making the rating we used information on legislation, strategies and programs of development presented on the sites of regions and also mailed by some administrations on their own initiative.
Estimation of the contribution weight of each of the integral risk or potential component was done through special interviewing of experts from Russian and foreign investment and consulting companies. This year among the experts there were a lot of heads and specialists of German companies working in Russia – members of the German Economy Delegation in Russia. We also asked for expert opinion heads of investment departments of some regions.
The results of the comparison of expert weights of different types of risk and potential are presented on chart 5. Experts still attach much importance to legislative and political risks and also to labor potential in forming favorable investment climate.

Necessary changes
A peculiar feature of the present, ninth rating is that there have been revised the system of regions` numbering in tables and charts. In all the previous ratings the numbers of regions corresponded to their numbers in the system of economic regions of the former USSR. Nowadays this system is not valid any more and has been exchanged for the numeration according to federal districts in statistics.
Last year was notable for some important events in political, economic and social life of the whole country and some of its regions, due to which the position of some regions in the investment rating changed dramatically.
In 2003-2004 the “political landscape” of Russia has changed completely: there were held Duma and presidential elections, also highest officials were elected in 30 regions. Besides, in estimating political risks we took into consideration such facts as interethnic tension in the region, law suits against governors, resignations of regional governments etc. These changes were to the best advantage of Moscow, Perm, Kemerovo and Tomsk provinces, who have gone up in the rating of political risk by more than 40 positions in a year. Altai territory, Republic of Kabardin-Balkaria and Yaroslav province lost most of all.
Stirring up of federal and regional law-making, new laws appearance led to redistribution of regions according to the level of legislative risk. Average change of this risk rank in 2004 was 20 position as compared to 2003. For instance, Khakass Republic improved its rank by 69 positions, Yamalo-Nenetsky autonomous okrug – by 59 positions, and Alaniya (North Ossetiya) Republic – by 53 positions. Vice versa, the legislative risk has increased drastically in Tatarstan, Altai and Komi Republics.
New risk factors predetermined a more thorough approach to social, criminal and ecological risks. Thus, in social risks for the first time we took in to account such a frequent happening in small regional towns as heating grids accidents and also the poverty level (see table 6 and table 7). In calculating ecological risk besides the intensity of economic activity impact on the environment we took into account comprehensive estimation of climatic conditions of human life according to O. Nazarevsky`s technique developed back in seventies.
Finally, the criminal risk was estimated with all the possible completeness including the frequency of terrorist acts.
Among the types of investment potential the procedure of estimating infrastructural potential has undergone most changes. The data provided by iKS-Consulting allowed to adequately estimate this type of potential taking into account internet and cellular communication coverage in regions (see table 12 and table 13).

See also:
Investment Rating for Russia`s Regions, 2002-2003
Russian Regions` Attractiveness to Investors Rating, 2001 - 2002
Investment Attractiveness Rating of Russian Regions 2000 – 2001