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Analysis & Opinion
13.11.10 A Spooky Economy
By Tai Adelaja

According to the Bloomberg Global Poll published on Friday, only ten percent of foreign investors are ready to put their money into the Russian economy. The report, which surveyed 1,030 investors, analysts and traders, found that foreign investors are looking more to emerging markets such as China, Brazil and India than to developed countries for investment opportunities. China was chosen by 33 percent of respondents as offering the best opportunities for investors over the next year, with Brazil second at 31 percent and India third with 29 percent. Russia garnered only ten percent. What is it about the Russian economy that scares off investors?

A similar negative picture emerged from the World Bank’s “Doing Business 2011” report, published last week. The report, which rated countries according to regulations affecting nine areas in the life cycle of a business, puts Russia in 123rd place, down from 116th in 2009 out of 183 countries. The key indicators examined include rules for starting a business, dealing with construction permits, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a business. Russia ranked as one of the most difficult places for businesses when it comes to dealing with construction permits, finishing 182nd out of 183.

Err on the Side of Caution

According to the report, a small to medium-size business operating in Moscow goes through 53 procedures over the course of 540 days at the cost of 4,141 average incomes to obtain all the necessary approvals to build a simple commercial warehouse and connect it to basic utility services. "If you go by the rules, a developer needs a year and a half on average just to get approval to build a small object," said Vyacheslav Kholopov, the director of the industrial, warehouse and land department at Knight Frank. "For small firms, the process is particularly long and costly." Kholopov said that only by fighting corruption in the system, as well as giving equal opportunities to developers, can Russia hope to reach international standards in the construction industry.

Getting connected to electricity from the local distribution utility requires nine procedures, which include undergoing multiple inspections by the utility and other agencies, as well as getting a permit from the Transportation Ministry. The cumbersome process consumes on average 302 days and costs 4,671.7 percent of income per capita, the report said. This puts Russia in the unenviable top-ten of countries with the most procedures out of the 176 economies surveyed. Last year, the World Bank, comparing the ease of doing business across ten cities in Russia, showed that dealing with construction permits is more complex in Moscow than in other cities, in part because of differences in the number of procedures required to obtain an electricity hookup.

Russia puts off investors, experts say, not because it is doing too little to improve its investment climate, but because it is doing too little too slowly. Back in 2002 Russia integrated several registers under one function, freeing entrepreneurs from having to visit separate agencies involved in business. Over the past seven years, Russia has eased conditions for business startups by creating one-stop shops to process documents, according to the authors of the World Bank report. Russia has also eased the process of obtaining construction permits by implementing a single window for all procedures related to land use. Last year, Russia introduced a series of legislative measures aimed at improving creditor rights and the insolvency system. Such changes, the report said, have helped reduce the regional average number of procedures by four, the time – by 21 days and the cost – by 8.8 percent of income per capita since 2005. Russia has made improvements in a range of other areas, from the regulation of insolvency administrators to the prevention of fraud and abuse in insolvency proceedings, the report said.

Russia has also struggled to reduce political interference in business through privatization and adoption of business-friendly regulations, which were dictated by the need to diversify the country’s mono-cultural economy, analysts say. Since Russian President Dmitry Medvedev assumed office in May 2008, he has made the country's modernization the cornerstone of his presidency. He has spearheaded efforts to re-write business regulations and taken measures to boost investor appeal. However, most of his reforms have been slow to take hold, while others have been stifled by the nation’s infamous bureaucracy, experts say. Along with Russia’s half-hearted embrace of economic reforms, many experts point to the usual villain – the country’s notoriously slow and convoluted bureaucracy – as the key factors dragging down the country’s rating as a good place to do business.

“Almost everything in Russia must be done formally and on paper,” said Anton Kalanov, head of the IFRS Department at the audit and consultancy firm Interexpertiza LLC. “There are 2.5 million in-house accountants in Russia alone, far more than what you’d expect to see in international financial centers like the United Kingdom or even Cyprus. And the only justification for keeping this army of accountants is that there is lots and lots of paperwork to do.” Kalanov, who participated in this year’s World Bank report, said Russia, unlike Georgia or the Baltic States, is having a hard time shaking off its Soviet past, he said. "Despite attempts by president Medvedev to reform the system, the country is so mired in Soviet practices that operators at different levels of government fail to see that their actions create significant hurdles for doing business in the country," Kalanov said.

Russia’s outdated customs regulations and procedures are another reason why investors continue to see Russia as a difficult place to do business. The country ranked 162 in trading across borders, according to the World Bank report. Cross-border trade with Russia can be a nightmare, according to various experts. Russian businessmen must process eight documents over 36 days and spend $1,850 on average to export goods across the borders, the report said. Foreign businessmen sending goods to Russia are required to process 13 documents over 36 days and pay $1850 on average to do so. Only two other countries – Azerbaijan and the Central African Republic – require more paperwork.

"There is a real lack of understanding about business needs, and a reluctance to meet major foreign investors halfway when it comes to import rules and regulations," Peter Davies, DHL’s director for Central and Eastern Europe and the CIS, wrote recently in Beyond Transition, a newsletter about reforming economies. "When we asked major multinationals which countries in Central and Eastern Europe and the CIS had the most straightforward customs procedures, Russia didn’t even register.” A recent report by the Economist Intelligence Unit also gave Russian import procedures bottom marks when it came to the volume of paperwork needed, the speed of processing, and the prevalence of corruption.

Socialized capitalism

The post-Soviet Russian labor code, which borrowed heavily from the Soviet socialist economy, remains a big obstacle for both investors and small-size businesses in Russia, experts say. “Russia's labor code is extremely employee-friendly,” said Valery Fedoreev, a senior partner at Baker & McKenzie law firm who participated in this year’s World Bank’s report. “Investors come to this country believing that they can hire or fire at will, as long as international labor laws are respected. What they see, however, is that in most cases an employer – local or foreign – cannot fire a bad employee unless the worker has systematically or consistently violated labor rules.” In recent years, Russia’s horse and buggy labor code has created an avalanche of litigation by workers wanting to be reinstated purportedly for being fired unfairly, Fedoreev said. Russians are also fond of suing to overturn disciplinary action meted out by employers, which they believe to be unjustified.

Fedoreev said Russian politicians have traditionally sided with workers in open labor disputes in order to boost popularity and avert social unrest. Both during and after the financial crisis, which saw many workers lose their jobs, President Dmitry Medvedev called on judges to look carefully into every case of sacking by employers. “The judges mostly interpreted Medvedev’s appeal for caution as government backing for all workers,” Fedoreev said. “The result is that Russian judges, too, are employee-friendly, the result being that many employers are having a hard time proving dismissal cases before the judges.”

Russian billionaire Mikhail Prokhorov, who is the chairman of the Committee on the Reform of the Labor Market at the Russian Union of Industrialists and Entrepreneurs (RSPP), an industrial lobby-group, sparked controversy last week for suggesting among other things that unlimited-tenure employment contracts should be substituted with fixed terms, and that the government should introduce commercial and profitability reasons for employee sackings. While some of Prokhorov’s proposals – such as the introduction of a 60-hour workweek and the authorization for employers to modify labor contracts unilaterally – have been widely criticized as “severe and over-the-top” by labor leaders, many labor lawyers do believe that Russia's labor code needs urgent revision.

“In Russia, only CEOs can get fired without unpleasant consequences,” Fedoreev said. “Western managers and investors are finding it difficult to introduce efficient staff control and management because they cannot fire bad or unproductive employees. On the other hand, the labor code allows a Russian employee to freely leave the company after just two weeks’ notice and gives him the right to work for a competitor immediately. This is asking too much from a potential investor.”
The source
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