Russia’s capital outflow should worry investors

May 27, 2011

By Jason Bush
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Russia seems unable to stem ever-increasing capital outflows. Official statistics show these amounted to $43 billion during the six months to March, and a further $7.8 billion in April. Officials are puzzled. They should be worried.

In theory, the recent rise in oil prices ought to be drawing more investment into Russian assets. But according to one school of thought, higher oil prices may in fact have contributed to the capital flight: Russian oil companies park part of their profits abroad. Yet official statistics show that delayed repatriation of profits — $7 billion in the first quarter of the year — is no higher than normal, casting doubt on this theory.

Another, relatively benign, explanation is rouble liquidity. Over the past year Russian companies were able to borrow roubles at relatively cheap rates, making it advantageous to use local debt to pay off foreign debts or fund foreign acquisitions. This explanation falls a bit short: in recent weeks domestic liquidity has tightened, interest rates have risen — and the capital outflow has intensified.

Some Russian officials put forward yet another reason: political uncertainty, since no one knows whether President Dmitry Medvedev or Prime Minister Vladimir Putin will occupy the Kremlin after the 2012 presidential election. It may be that some business groups fear a change in the balance of power, or the possibility of conflict within the elite. Yet previous elections weren’t accompanied by capital outflows on such a scale, and it’s not obvious that either leader has major surprises in store.

In reality , Russia’s poor investment climate may be the best explanation, and the most disturbing. The outflows coincide with dwindling domestic investment. Capital expenditure actually fell by 1.5 percent in the first quarter, compared with a year earlier, and it remains 9 percent below its pre-crisis level.

But why would investors suddenly notice that Russia is a dicey place to put their money? It may be that their behaviour reflects anticipated returns as well as risks. Economic growth, forecast at just over 4 percent this year, has halved since before the financial crisis. Meanwhile, a recent hefty rise in payroll taxes has added to the burden on business. Further tax hikes are inevitable, with rival government factions now bickering over the details.

Some of these problems may also be linked to forthcoming elections, including parliamentary ones in December, as business must foot the bill for the inevitable vote-buying. But even after the elections, there’s no straightforward solution to sluggish economic growth, the steadily rising fiscal burden — and the old problems of corruption and bureaucracy. Until Russia manages to address these concerns, capital will have many reasons to flee.

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