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UNCLAS MOSCOW 000112 
 
SENSITIVE 
 
SIPDIS 
 
DEPARTMENT FOR EUR/RUS AND EEB/IFD/OIA 
STATE PLS PASS USTR 
 
E.O. 12958: N/A 
TAGS: EINV OPIC KTDB USTR RS
SUBJECT: 2009 INVESTMENT CLIMATE STATEMENT FOR RUSSIA 
 
REF:  08 STATE 123907 
 
(Entire report SBU draft document) (No paragraph markings) Per 
reftel request, attached is post's draft 2009 Investment Climate 
Statement for Russia.  We have also e-mailed the draft as a Word 
document to EUR/RUS and EEB/IFD/OIA. 
2008 Investment Climate Statement - Russia 
Russia presents many promising investment opportunities with the 
potential for dynamic growth in sales and profits.  However, 
investors face several significant challenges, including a complex 
regulatory and legal system that requires professional help to 
navigate, widespread corruption, a lack of respect for the rule of 
law, and immature banking and financial markets.  In addition, 
state-owned entities have a major presence in many economic sectors, 
and hence may be potential competitors of new investors. 
Russia's economy is still developing, not diversified, and is 
largely focused on natural resource extraction.  GDP sharply 
contracted in the last two months of 2008.  Although it posted a 7.3 
percent growth rate for the first nine months of 2008, the final 
figure for 2008 is expected to be 6.8 to 7.0 percent, as compared to 
8.1 percent in 2007.  The numbers for 2009 are expected to be even 
lower, ranging from 0 percent growth to 2.5 percent.  Fixed capital 
investment saw an increase of 13.1 percent January-September, which 
was lower than the 21.3 percent increase during the same period in 
¶2007.  Most of the capital investment in the first nine months of 
2008 went to energy, manufacturing, real estate, and transportation. 
 
According to the Central Bank of Russia, foreign direct investment 
(FDI) inflows exceeded $50 billion in the first 9 months of 2008, as 
compared to $38 billion during the same period in 2007.  End of year 
estimates place FDI at $55 billion.  At 4% of GDP, this level of FDI 
inflow is on par with other emerging markets.  The United Kingdom 
and the Netherlands continued to be the top source countries for 
investment inflows during the year, reflecting these two countries' 
heavy investments in Russia's energy sector. 
Capital account liberalization, which took effect on July 1, 2006, 
helped increase net inflows to Russia in 2006 ($40 billion) and 2007 
($82 billion).  The general economic slowdown stemming from the 
financial crisis and shocks to investor confidence, however, have 
produced a marked shift for 2008, increasing capital outflow and 
putting additional pressure on the ruble.  As of October 1, 2008 
(latest available data at this writing), capital outflows were equal 
to capital inflows.  BNP Paribas has estimated that investors 
withdrew about $140 billion from August - October 2008.  According 
to the Central Bank of Russia, net private capital outflow reached 
$50 billion in October 2008 alone. 
A sense that the Russian investment climate had generally 
strengthened in recent years has been undermined by recent Russian 
government actions, such as the apparently politically-motivated 
investigations into businesses (e.g., the TNK-BP oil and gas joint 
venture and the Mechel coal company) and the military conflict with 
Georgia.  The global economic downturn also exposed Russia's 
weaknesses.  Many structural improvements remain necessary, such as: 
judicial reform to establish an independent and effective judicial 
system; banking reform to improve the capacity of the financial 
sector; accounting reform to promote greater transparency and 
integration with the international business community; a legal and 
regulatory framework for preventing insider trading; and 
improvements in corporate governance. 
Reducing government bureaucracy and corruption has long been high on 
the agenda of businesses large and small, Russian and foreign, 
operating in Russia.  While President Medvedev has committed his 
government to fighting corruption, his only progress to date has 
been the enactment of new anti-corruption legislation. 
Openness to Foreign Investment 
The global economic slump during the latter part of 2008 dampened 
foreign investor enthusiasm, which had been stoked by Russia's 
economic growth and rising incomes in recent years.  The Russian 
Federal State Statistics Service estimates that since 2000, the 
economy has demonstrated real growth of 72%, where real disposable 
incomes have grown 209% in the same period.  Recent real income 
growth deceleration, however, combined with citizens' fears about 
the future of the Russian economy, raise concerns about future 
growth, particularly is the retail and consumer sectors.  While many 
U.S. firms reported that their return on investments in Russia was 
among the highest in their international operations, the global 
financial crisis and recent Russian government actions may retard 
their Russian investment plans. 
The Russian government has repeatedly emphasized foreign 
investment's critical role in Russia's economic development, but has 
been reluctant to allow unfettered access in practice.  The 1991 
Investment Code guarantees foreign investors rights equal to those 
of Russian investors (although some industries have limits on 
foreign ownership - see below).  The 1999 Law on Foreign Investment 
also affirms this principle of national treatment. 
In practice, the Government of Russia (GOR) tends to favor joint 
ventures with local entities, especially state-owned entities, or 
direct cash injections, particularly in Russia's "strategic 
sectors."  This has been most obvious in the energy sector, in which 
the GOR continues to tighten its grip and typically limits foreign 
companies to minority stakes (often 20 to 25 percent) in larger 
projects.  In the area of consumer products, however, international 
companies have been able to set up and expand their operations with 
relatively few restrictions. 
At the federal level, Russia is establishing special economic zones, 
high-technology parks, and special tourist regions to encourage 
foreign investment.  At the regional level, many local governments 
have developed laws and programs to attract FDI, which include 
techno-parks near universities and export zones near ports and 
borders.  Although federal tax reform aimed to create a level 
playing field for all investors and limit the scope of incentives 
regions can offer, large foreign investors continue to receive 
incentives from local authorities in practice.  In addition, many 
local administrations view foreign investors as sources of cash for 
support of municipal services, which can range from topping up 
teachers' salaries or provision of carpentry and plumbing services 
to maintenance of a municipal park or supply of heat to a village 
from a processing plant's boiler. 
While FDI inflows had picked up substantially since 2004, the slow 
pace of structural reforms and the ever increasing role of the state 
in some sectors of the economy continue to restrain foreign 
investment.  In response to the global financial crisis, the GOR is 
preparing to support various sectors of the economy in return for 
control of assets and revenue flow, and the role of government and 
quasi-government entities could become even more opaque.  The lack 
of clarity in Russian tax law and administration, inconsistent 
government regulation and enforcement, unreliability of the legal 
system, underinvestment in infrastructure, difficulty in conducting 
due diligence, and high levels of corruption can dissuade 
investors. 
Rule of law, corporate governance, transparency, and respect for 
property rights, including intellectual property rights, although 
improved over the years, remain key concerns for foreign investors. 
As a result, while there is increased interest, many U.S. companies 
remain cautious about investing in Russia. Concerns about possible 
liabilities associated with existing operations (especially 
environmental cleanup) and inadequate bankruptcy procedures are also 
factors. 
In recognition of widespread corporate governance problems, the 
Federal Service for Financial Markets has had a corporate governance 
code in place since 2002 and has endorsed an OECD White Paper on 
ways to improve practices in Russia.  Some large Russian companies 
have developed their own policies, although implementation is not 
always robust.  International business associations such as the 
American Chamber of Commerce in Russia, the Association of European 
Businesses in Russia, and the International Business Leaders Forum, 
as well as Russian business associations such as OPORA, the Russian 
Managers Association, the National Council on Corporate Governance, 
and the Russian Directors' Institute stress corporate governance as 
an important priority for their members and for Russian businesses 
overall. 
Roughly three-quarters of the Russian economy has been privatized, 
although the GOR continues to hold significant blocks of shares in 
many privatized enterprises.  The privatization of remaining state 
holdings is scheduled to continue, but could be delayed as a result 
of the current economic slowdown.  Furthermore, the GOR may 
ultimately acquire/re-acquire additional shareholdings in Russian 
companies if GOR-financed loans, collateralized by shares, are not 
repaid. 
Often foreign investors participating in Russian privatization sales 
are confined to limited positions and face problems with minority 
shareholder rights and corporate governance.  Moreover, the 
treatment of foreign investment in new privatizations is likely to 
remain inconsistent.  Potential foreign investors are advised to 
work directly and closely with appropriate local, regional, and 
federal ministries and agencies that exercise ownership and other 
authority over companies whose shares they may want to acquire. 
The GOR approved a new "Strategic Sectors" law in May 2008.  The law 
restricts new foreign investment in 42 sectors deemed "strategic." 
Investors wishing to exceed set ownership limits must seek approval 
from a special commission, chaired by the prime minister.  There are 
concerns that the approval process may prove to be non-transparent 
and burdensome.  Concurrent amendments to legislation governing 
subsoil resources restrict foreign investment to a 10 percent 
threshold in entities controlling large oil and gas deposits, which 
are defined as "strategic."  Potential investors in such entities 
must seek the approval of the special commission. 
The government has reasserted control over the oil and gas sector in 
recent years.  Foreign investors who want to do business in the 
Russian oil and gas sector should keep in mind the key roles played 
by the state companies Rosneft (oil) and Gazprom (gas). 
Particularly in oil and gas investments, Russian officials at both 
the federal and local levels frequently raise environmental concerns 
as considerations in the approval process for investments.  In some 
instances, it is difficult to say whether such concerns are 
genuine. 
Production Sharing Agreement (PSAs), which were used to attract 
foreign investors into oil and gas production are out of favor with 
the Russian government, and are not likely to re-emerge as a tool 
for attracting investment.  Only two major PSA projects, Kharyaga 
and Sakhalin 1, with majority foreign ownership remain in Russia. 
Under pressure, one PSA, Sakhalin 2, sold its majority stake to 
Gazprom.  Sakhalin 1 has recently come under some pressure as well 
to sell its gas production to Gazprom.  In 2007-8, BP and its 
Russian partners in oil major TNK-BP were engaged in a public battle 
for management control of the company.  Following a string of 
official actions by Russian state bodies affecting TNK-BP operations 
and expatriate personnel, the two sides reached an agreement in late 
2008 that many observers saw as resulting in a dilution of BP's 
influence over its investment.  The dispute dealt a major blow to 
investor confidence in Russia, and raised questions about the GOR's 
respect for the rule of the law and the independence of state 
administrative bodies. 
In 2003, Russia enacted several amendments to the insurance law that 
effectively liberalized the market, allowing majority-owned Russian 
subsidiaries of insurers from the European Union to sell life and 
mandatory forms of insurance in Russia.  Although the law only 
permits those companies with offices in the European Union to open 
subsidiaries in Russia, the regulator has interpreted the 
legislation as allowing any foreign insurer to set up life insurance 
operations in Russia as long as the company has an office in the EU 
via which the investment is made.  As a result of bilateral WTO 
negotiations with the United States, Russia agreed to allow foreign 
insurance companies to operate through subsidiaries, including 100% 
foreign-owned non-life insurance companies, and branching after a 
transition period. 
In July 2008, RAO UES, the electricity holding company that 
controlled all of Russia's power assets with the exception of those 
connected to nuclear energy, completed its corporate reorganization 
and ceased to exist.  Although the unbundling and privatization of 
RAO UES was initially hailed as a huge success, concerns are growing 
as investors' plans to modernize and expand electricity 
infrastructure make less economic sense under current market 
conditions. 
The Russian automotive industry has been booming and has been the 
fastest growing automotive market in Europe.  Foreign brands account 
for over 75% of car sales.  In 2005-2007, Russian legislation 
offered reduced customs tariff rates on automotive parts imported by 
companies assembling vehicles in Russia.  Many foreign auto 
manufacturers took advantage of the reductions and set up assembly 
operations in Russia, including GM, Ford, Toyota, Peugeot, Isuzu, 
Kia, Nissan, Volkswagen, and Renault.  The GOR is now offering 
similar investment incentives to foreign producers of car parts and 
components who agree to set up domestic production operations in 
Russia. 
In December 2008, PM Putin signed a GOR Resolution that increased 
the duty on most imported automobiles from the current 25% to a new 
rate of 30% (and raise the minimum Euro-specific duty that is based 
on the engine volume by a corresponding amount), and imposed a 
prohibitive duty on cars older than five years (current law applies 
a prohibitive duty to cars older than seven years).  The move is 
seen as a measure to help local auto manufacturers, such as Avtovaz, 
weather the global economic crisis.  The new duties became effective 
on January 12, 2009 for a period of nine months. 
Thanks to active government intervention, the agricultural and 
agribusiness investment climate has improved in recent years. 
However, future growth is likely to be tempered by a reduction of 
financing in the agricultural sector brought on by the global 
financial crisis, lingering uncertainty regarding land tenure in 
Russia, and restrictions on foreign ownership of agricultural land. 
 
Despite supportive statements by GOR officials regarding investment 
in agricultural processing facilities located on land previously 
designated for production agriculture, some projects have been 
thwarted through exploitation of legal ambiguities about land 
purchase and control, due to entrenched interests which want to 
reduce competition.  There have also been blatant, though ultimately 
unsuccessful, attempts to raid foreign enterprises and to take over 
their processing facilities through illegal means. 
Visas for Businessmen and Investors 
The GOR requires visas and residence permits for businessmen and 
investors.  Work and residence permits must be renewed periodically 
-- a cumbersome process.  Russia's visa system for residence and 
work permits is very complicated, and potential investors would be 
well-advised to consult the State Department and U.S. Embassy 
websites for the latest information on Russian visas 
(moscow.usembassy.gov/russian-visas.html and travel.state.gov/ 
travel/cis_pa_tw/cis/cis_1006.html#entry_requ irements).  In some 
sectors, requirements that a certain percentage of staff be Russian 
citizens may have a negative impact on foreign investors. 
Conversion and Transfer Policies 
While the ruble is the only legal tender in Russia, companies and 
 
individuals generally face no significant difficulty in obtaining 
foreign exchange.  Finding a bank licensed to conduct foreign 
currency transactions is relatively easy.  While the following 
discussion represents a "snapshot" of current requirements, 
investors would be well advised to seek expert advice on the 
controls in effect at the time of an investment. 
Currency controls exist on all transactions that require customs 
clearance, which in Russia applies to both import and export 
transactions.  The procedures involved have been greatly simplified 
in recent years.  The importer or exporter presents the "deal 
passport" documents to a bank licensed to provide foreign currency 
transaction services.  The bank bears the responsibility of ensuring 
that the flow of funds related to the import or export complies with 
CBR regulations. 
A "deal passport" is a set of documents that importers and exporters 
provide to banks authorized to review whether the transaction meets 
currency control regulations.  Once an authorized bank signs the 
deal passport, it monitors the entire transaction for compliance 
with currency regulations, and the importer/exporter must use that 
bank for all parts of the transaction.  The importer/exporter then 
presents the signed passport to clear shipments through customs. 
The Federal Customs Service notifies the bank once the shipment has 
been cleared.  The authorized bank then monitors compliance with 
payment regulations. 
Only authorized banks may carry out the sale or purchase of foreign 
currency transactions.  According to currency control laws, the 
Central Bank retains the right to impose restrictions on the 
purchase of foreign currency, including the requirement that the 
transaction be completed through a special account.  The Central 
Bank has eliminated security deposit requirements on foreign 
exchange purchases. 
Expropriation and Compensation 
The 1991 Investment Code prohibits the nationalization of foreign 
investments, except following legislative action and where deemed to 
be in the national interest.  Such nationalizations may be appealed 
to the courts of the Russian Federation, and the investor must be 
adequately and promptly compensated. 
At the sub-federal level, expropriation has occasionally been a 
problem, as has local government interference and a lack of 
enforcement of court rulings protecting investors.  The embassy is 
tracking a small number of cases in which U.S. companies are seeking 
compensation for the loss of their investment or property due to 
regional government action or inaction. 
Dispute Settlement 
Russia has a body of conflicting, overlapping and rapidly changing 
laws, decrees and regulations, which has resulted in an ad hoc and 
unpredictable approach to doing business.  Independent dispute 
resolution in Russia can be difficult to obtain since the judicial 
system is still developing.  Courts are sometimes subject to 
political pressure.  According to numerous reports, corruption in 
the judicial system is widespread and takes many forms, ranging from 
bribes of judges and prosecutors to fabrication of evidence.  In 
addition, court decisions are at times not executed.  The bailiffs, 
who are charged with enforcing court judgments, report to the 
Ministry of Justice rather than the courts.  They sometimes fail to 
enforce those judgments due inter alia to legal restrictions and 
limited trained personnel. 
Many attorneys refer their Western clients who have investment or 
trade disputes in Russia to international arbitration in Stockholm 
or to courts abroad.  A 1997 Russian law allows foreign arbitration 
awards to be enforced in Russia, even if there is no reciprocal 
treaty between Russia and the country where the order was issued. 
Russia is a member of the International Center for the Settlement of 
Investment Disputes and accepts binding international arbitration. 
Russia is also a signatory to the 1958 New York Convention on the 
Recognition and Enforcement of Foreign Arbitral Awards.  However, 
enforcement of international arbitral awards still requires action 
from Russian courts and follow-up by bailiffs, which have yet to 
become consistently effective enforcers of court judgments. 
Commercial disputes between business entities are heard in the 
Arbitrazh Court system.  That court system has special procedures 
for the seizure of property before trial so that it cannot be 
disposed of before the court has heard the claim, as well as for the 
enforcement of financial awards through the banks.  Additionally, 
the International Commercial Arbitration Court at the Russian 
Chamber of Commerce and Industry will hear claims if both parties 
agree to refer disputes there.  A similar arbitration court has been 
established in St. Petersburg.  As with international arbitral 
procedures, the weakness in the Russian arbitration system lies in 
the enforcement of decisions. 
Performance Requirements and Incentives 
Performance requirements are not generally imposed by Russian law 
and are not widely included as part of private contracts in Russia. 
However, they have appeared in the agreements of large multinational 
companies investing in natural resources and in production sharing 
legislation.  There are no formal requirements for offsets in 
foreign investments.  Since approval for investments in Russia 
frequently depends on relationships with government officials and on 
a firm's demonstration of its commitment to the Russian market, this 
may result in offsets in practice. 
Right to Private Ownership and Establishment 
Both foreign and domestic legal entities may establish, purchase, 
and dispose of businesses in Russia.  As mentioned in other sections 
of this report, investment in some sectors that are regarded as 
affecting national security, such as natural resources, energy, 
power, communication, transportation, and defense-related 
industries, may be limited. 
Protection of Property Rights 
The Constitution and a 1993 presidential decree give Russian 
citizens general rights to own, inherit, lease, mortgage, and sell 
real property.  The rights of Russian citizens to own and sell 
residential, recreational, and garden plots are clearly established, 
with over 40 million properties of this type under private 
ownership.  Mortgage legislation enacted in 2004 facilitates the 
process for lenders to evict homeowners who do not stay current in 
their mortgage payments, which in theory should make mortgage 
lending (and the housing market) more attractive to lenders and 
developers.  However, foreclosures and evictions by lenders are 
rarely tested within Russia's legal system.  Complicating this 
picture further is a GOR plan, not formally codified at this 
writing, to provide relief in the form of an extended grace period 
to homeowners affected by the financial crisis.  Mortgage lending is 
in its initial stages, but its growth, up from an estimated USD 5.5 
billion of the total amount of outstanding mortgage loans in 2006 to 
USD 27 billion as of October 1, 2008, has been stymied by the 
domestic credit freeze.  Land ownership rights and limitations for 
foreign investors are discussed in other sections of this report. 
While Russia has made significant advances in improving its 
intellectual property rights (IPR) protection regime, many 
challenges remain, including the need for reform of Russia's IPR 
legal and regulatory framework, a court system with greater 
expertise in IPR cases, and greater enforcement and investigative 
efforts from law enforcement and prosecutorial agencies. 
Copyright violations (films, videos, sound recordings, and computer 
software) remain rampant. Legitimate DVD sales are on the rise, 
however, thanks in part to cheaper legitimate products, a growing 
consumer preference for high quality goods, and increased law 
enforcement action against pirates.  The local business and 
entertainment software industries have also reported declining 
levels of piracy. 
Russia's IPR regime lacks an explicit protection for pharmaceutical 
test data.  An amendment to address this concern is pending Russian 
government interagency approval. 
Russia has acceded to the Universal Copyright Convention, the Paris 
Convention, the Berne Convention, the Patent Cooperation Treaty, the 
Geneva Phonogram Convention, and the Madrid Agreement.  Russian law 
on topology of integrated microcircuits protects computer programs 
and semiconductor topologies for 10 years from the date of 
registration.  As part of its WTO accession process, the Russian 
government is working to ensure that Part IV of the Civil Code, its 
new comprehensive IPR legislation that went into effect on January 
1, 2008, is consistent with the requirements of the WTO Agreement on 
Trade-Related Aspects of Intellectual Property Rights (TRIPS).  In 
2008, Russia applied to join the World Intellectual Property Rights 
Organization (WIPO) Copyright Treaty and the Performance and 
Phonograms Treaty. 
Transparency of the Regulatory System 
The legal system in Russia remains in a state of flux, with various 
parts of the government continuing to create new laws and 
regulations on a broad array of topics.  In this environment, 
negotiations and contracts for commercial transactions, as well as 
due diligence processes, are often complex and protracted. 
Investors must do careful research to ensure that each contract 
fully conforms to Russian law and embodies the basic provisions of 
the new and, where still valid, old codes.  Contracts must likewise 
seek to protect the foreign partner against contingencies that often 
arise.  Keeping up with legislative changes, presidential decrees, 
and government resolutions is a challenging task.  Uneven 
implementation of laws creates further complications; various 
officials, branches of government, and jurisdictions interpret and 
apply regulations with little consistency and the decisions of one 
may be overruled or contested by another.  As a consequence, 
reaching final agreement with local political and economic 
authorities can be quite a long and burdensome process.  Companies 
should be prepared to spend a good bit of money on local legal 
counsel to set up their commercial operations in Russia. 
Tax Considerations 
Russia has a flat individual income tax rate of 13 percent for 
residents and 30 percent for non-residents, one of the lowest rates 
in the world.  Deductions are allowed for, inter alia, home purchase 
or construction and exclusion of earnings on the sale of real 
property held for more than five years.  The Unified Social Tax 
(UST), which is paid by employers and covers pensions, healthcare, 
and social security, is currently set at a top rate of 26 percent on 
salaries up to 280,000 rubles (about $10,000) per year.  The GOR has 
discussed introducing legislation on raising the rate to 34 percent, 
a change that could enter into force in 2010. 
Excise duties are levied only on alcoholic beverages, tobacco 
products, cars, motor fuel, and oil.  Oil production is subject to 
two main taxes -- the Mineral Extraction Tax (MET) and an export 
duty, which are tied to the level of Urals export prices. 
The approximate marginal tax rate on a barrel of exported oil is 90 
percent when the oil price is above $25/bbl.  Despite some recent 
modest improvements to the oil tax regime, the onerous tax structure 
is still considered to be a major hindrance to the major, 
multi-billion dollar investments needed to develop new production 
areas. 
The corporate profits tax is set at 24 percent.  Regions are 
allowed, at their discretion, to lower the tax rate to 20 percent. 
Prime Minister Putin has recently announced, however, that the 
profit tax rate will to drop from 24 to 20 percent.  Regional 
governments will retain the latitude to adjust rates at the local 
level, a provision that many regions have made use of in the past. 
For dividends/interest earned by non-residents, the profit tax rate 
is 15 percent. 
Since the Yukos affair, many companies have become more reluctant to 
engage in aggressive tax optimization schemes.  In addition, market 
forces are driving businesses toward more transparent accounting 
practices, prompting firms to review their accounting procedures and 
improve their tax behavior.  For example, firms with clean books 
have an easier time accessing local credit and foreign capital than 
their shadier competitors. As a result, tax compliance levels are 
gradually increasing. 
Nonetheless, problems in the tax environment remain.  Surveys have 
shown that many entrepreneurs complain about the complexity of the 
tax code and requirements of other regulatory and inspection bodies. 
 Well-intentioned SMEs often go out of their way to follow the law 
but are then penalized for making mistakes in documentation.  They 
complain that the tax police make no distinction between hard-core 
tax-evaders and inexperienced small-business people who do not fully 
understand the bookkeeping requirements.  Companies often have 
little recourse other than the courts during tax disputes.  While 
firms have successfully appealed to the courts, tax authorities are 
often slow to implement judicial decisions.  Penalties for 
non-compliance include confiscation of property and freezing a 
company's bank accounts. 
Efficient Capital Markets and Portfolio Investment 
The Russian banking system remains relatively small, with RUR 3.2 
trillion ($112 billion) in aggregate capital as of October 1, 2008. 
While the successful implementation of the Deposit Insurance System 
in 2004 has proved a critical psychological boon to the banking 
sector, evidenced by growth in overall deposits, it remains one of 
the weakest parts of the Russian reform program.  Despite measured 
progress, the Russian banking system is not yet efficiently 
performing its basic role of financial intermediary (i.e., taking 
deposits and lending to business and individuals).  Approximately 
one third of the population still prefers to keep personal savings 
"under the mattress" rather than in the banks.  In the wake of the 
financial crisis, Russia's banking sector is under stress and may 
change dramatically in the near to medium term. 
Russia's two main stock exchanges are in Moscow:  (1) the Russia 
Trading System (RTS), and (2) the equity trading floor on the Moscow 
Interbank Currency Exchange (MICEX).  The benchmark RTS index and 
the MICEX index each declined approximately 70 percent in 2008.  The 
average daily trading volume for 2008 was $52.8 million on RTS 
(compared to $76.4 million in 2007) and $1.47 billion on MICEX 
(compared to $2.35 billion in 2007). Trading volume is largely 
dominated by large oil and gas companies such as Gazprom, Rosneft, 
and Lukoil.  Trading activity at Russia's other exchanges, such as 
the Moscow Stock Exchange and several regional centers, is low. 
The Law on the Securities Market, as amended in 2003, includes 
definitions of corporate bonds, mutual funds, options, futures, and 
forwards.  Companies offering public shares are required to disclose 
specific information during the placement process, as well as 
quarterly.  In addition, the law defines the responsibilities of 
financial consultants who assist companies with stock offerings and 
holds them liable for the accuracy of the data presented to 
shareholders. 
The corporate bond market is currently the most rapidly and 
dynamically developing sector in Russia's capital markets, but 
conditions may change rapidly in light of the global financial 
crisis.  High and increasing demand from enterprises for funds in 
the absence of an effective bank lending system is the main driver 
of growth.  It is also boosted by weaknesses in other sectors of the 
capital market: the absence of more attractive ruble-denominated 
alternative asset classes, low and even negative real interest rates 
on the secondary government securities market, the absence of 
speculative opportunities on the currency market, and a significant 
volume of rubles from oil export earnings.  Subprime-related 
concerns at the beginning of the year served as a brake on 
issuances, but new issuances rose to RUR 660 billion (face value) in 
2008 compared to RUB 452 billion during 2007. 
Steady development notwithstanding, the corporate bond market 
suffers several problems.  It is still quite narrow, which makes it 
difficult to provide the necessary level of liquidity for relatively 
small issues, even if the issuer is a blue-chip company.  Another 
problem is the expense of preparation, including development of each 
issue's parameters, prospectus registration, underwriting services, 
etc.  A 0.8 percent issuance tax adds to that expense.  Another 
barrier to the growth of the market is a provision of the federal 
law "On Joint Stock Companies", which requires that the volume of a 
bond issue not exceed a company's authorized (charter) capital. 
Political Violence 
Although the use of strong-arm tactics is not unknown in Russian 
commercial disputes, post is not aware of cases where foreign 
investments have been attacked or damaged for purely political 
reasons.  Russia continues to struggle with an ongoing insurgency in 
Chechnya, and the Chechen Republic and neighboring regions in the 
northern Caucasus have a high risk of violence and kidnapping. 
Corruption 
Perception of corruption in Russia slightly worsened in the last 
year.  According to Transparency International (TI), Russia has 
scored 2.1 out of 10 this year, down from 2.3 in 2007 -- the lowest 
standing in the last eight years.  Out of the 180 countries surveyed 
in the 2008 Corruption Perception Index (CPI), Russia was in 147th 
place (deteriorating from 143rd place in 2007) and is on the same 
level as Bangladesh, Kenya, and Syria.  Denmark, New Zealand, and 
Sweden scored the highest (9.3), while Somalia came in last with a 
score of 1. 
Russia's standing was not a surprise.  The high level of corruption 
and its pervasiveness is acknowledged both by Russia's top officials 
and society at large. 
Russia's INDEM foundation estimates that millions of corruption 
offences are committed every year in Russia at a cost of 
approximately $300 billion, almost equal to Russia's federal budget. 
 There have been few prosecutions and/or dismissals of high-level 
corrupt officials that would send a clear deterrent message. 
The Government of Russia has repeatedly designated the fight against 
corruption and the enforcement of law as priorities.  Russia is a 
signatory to the UN Convention against Corruption and to the Council 
of Europe's Criminal Law Convention on Corruption.  In May 2008, in 
one of his first major steps as president, Dmitry Medvedev announced 
that he would head a newly-established Council for the Fight Against 
Corruption.  On December 25, 2008 President Medvedev signed new 
anti-corruption legislation into law.  The legislation requires 
government employees and their families to declare their income and 
assets and, absent permission from their bosses, would prevent, for 
a period of two years, government employees from working with 
businesses connected with their previous government duties.  These 
latest measures are part of a series of anti-corruption legislation 
adopted earlier in the year. 
In July 2008, the Prosecutor-General's Office created a new website 
for citizens to report corrupt practices by public officials.  The 
special anti-corruption department promises to study all complaints. 
 According to the Interior Ministry, in January - October 2008, the 
total number of corruption investigations reached 11,492 (up 7.6% 
y-o-y), out of which 8,890 cases were sent to court for further 
prosecution.  In total, 5,285 officials received criminal 
convictions for corruption offences, up 6.4% compared to the same 
period of 2007. 
Bilateral Investment Agreements 
Russia has bilateral investment treaties (BITs) with over 40 
countries, though it is in the process of re-negotiating some of the 
agreements due to concerns existing language may not be compatible 
with Russia's future WTO obligations.  The United States and Russia 
currently do not have a bilateral investment treaty, but both sides 
have expressed a desire to conclude one. 
OPIC and Other Investment Insurance Programs 
In an agreement ratified in 1992, the U.S. Overseas Private 
Investment Corporation (OPIC) was authorized to provide loans, loan 
guarantees, and investment insurance against political risks to U.S. 
companies investing in Russia.  OPIC generally insures against three 
political risks: expropriation; political violence; and currency 
inconvertibility.  In 1994, to meet the demands of larger projects 
in Russia and worldwide, OPIC doubled the amount of insurance and 
quadrupled the amount of finance support - to USD 200 million in 
each case - it can commit to an individual project (for a total of 
USD 400 million).  In the event OPIC would need to pay a currency 
inconvertibility claim, it would use the exchange rate in effect on 
the date the claim is submitted.  OPIC also makes equity capital 
available for investments in Russia by guaranteeing long-term loans 
to private equity investment funds. 
Labor 
The Russian labor market remains fragmented, characterized by 
limited labor mobility across regions and consequent wage and 
employment differentials.  The unemployment rate, using 
International Labor Organization (ILO) standards, fell slightly in 
the first half of 2008 but rose sharply in the wake of the economic 
crisis. 
Labor mobility continues to be restricted by a lack of affordable 
housing, an under-developed mortgage market, and the continued 
existence of overly-bureaucratic procedures governing residency 
permits and registration.  Most sectors of the economy had been 
suffering from a shortage of skilled labor force, but diminishing 
economic activity, caused by financial strains, is likely to balance 
the situation. 
Despite a number of labor conflicts (mostly over higher wages), the 
general situation remained calm.  From January to September 2008, 
official statistics registered only four enterprises where strikes 
took place.  Experts, however, believe that these statistics 
underestimate the level of labor conflict. 
Approximately 45% of Russia's workforce is unionized, down from 65% 
three years ago.  The GOR generally adheres to International Labor 
Organization (ILO) conventions protecting worker rights, though 
enforcement is often lacking.  The 2002 Labor Code governs labor 
standards in Russia.  When adopted, it was meant to diminish the 
role of the government in setting and enforcing labor standards, 
with trade unions and a more flexible labor market playing a role in 
representing workers' interests.  However, there are no clear 
enforcement mechanisms for an employer's failure to engage in good 
faith collective bargaining.  Revisions to the Labor Code since 2002 
have included new procedures for investigating industrial accidents 
and the requirement that businesses employing more than 50 workers 
must establish a work safety division and create a position for a 
"work safety specialist." The enforcement of worker safety rules 
continues to be a major issue, as enterprises are often unable or 
unwilling to invest in safer equipment or to enforce safety 
standards. 
National Priority Projects 
In the spring of 2005, President Putin announced plans for four 
National Priority Projects in health, education, housing, and 
agriculture.  These projects were meant to share the benefits of the 
recent energy-fueled economic boom with ordinary Russians and to 
tackle some of Russia's most pressing social and economic needs. 
While the projects have made progress in improving health and 
education, there have been few evident improvements arising from the 
housing and agriculture projects. 
The National Projects provide investment opportunities, especially 
in medical equipment manufacturing, agricultural equipment sales, 
and housing construction.  The 2008 budget for the projects was RUB 
330 billion (USD 12.5 billion), slightly more than the 2007 budget 
of USD 11.4 billion.  In September 2007, the GOR decided to 
transform the National Priority Projects in health, education, and 
housing into mid-term (2009-2012) state programs as of 2009.  The 
state programs will keep the priorities of the national projects, 
supplemented by new directions of development.  In 2008 the National 
Priority Project on Agriculture was made part of a five year 
National Program for Development of Agriculture and for Market 
Regulation for the period from 2008 to 2012. 
Foreign Trade Zones/Free Ports 
To date, six Special Economic Zones have been established pursuant 
to legislation passed in 2005: in Zelenograd and Dubna in the Moscow 
region (focused on micro-electronics and nuclear technology, 
respectively); St. Petersburg (information technology); Tomsk (new 
materials); Lipetsk (appliances and electronics); and Yelabuga (auto 
components and petrochemicals). 
The Russian Federal Special Economic Zones Management Agency and its 
regional offices, a real estate management company, and a 
supervisory board, which includes representatives of SEZ residents, 
manage the zones.  Enterprises operating in industrial-production 
zones (20 square kilometers) pay lower unified social taxes, and 
those within progressive-technical zones (2 square kilometers) are 
allowed to write-off all R&D expenses.  Both types of zones benefit 
from reduced land and property taxes and a waiver of customs duties 
on imports and finished exports. 
In 2007, seven special tourist economic zones were established in 
the Krasnodar, Stavropol, Altai, Kaliningrad, and Irkutsk regions, 
as well as in the constituent republics of Altai and Buryatia.  In 
June 2008, a tender committee approved creating three port special 
economic zones to stimulate infrastructure development.  The 
locations included the airports of Krasnoyarsk in East Siberia and 
Ulyanovsk in the Volga area, and the Sovetskaya Gavan port in the 
Khabarovsk Territory, in the Far East. 
The SEZs are developing gradually, led by the Moscow region and St. 
Petersburg, but poor infrastructure is hampering their growth. 
Transportation and logistic challenges make SEZs in more remote 
regions less attractive.  The special tourist economic zone in 
Krasnodar, site of the 2014 Sochi Winter Olympics, was expected to 
attract significant foreign investment, but that prospect has become 
more uncertain in the current financial climate.  The SEZ in 
Kaliningrad, previously established in 1996, has been able to 
attract some moderate investments, but those in the Russian Far East 
have had less success. 
Foreign Direct Investment Statistics 
(NOTE: Tables 1 through 4 providing Russian investment data have 
been deleted in order to facilitate the investment climate 
statement's transmission as a cable.  The data was provided in the 
Word document sent to EUR/RUS and EEB/IFD/OIA, and is available from 
the Embassy Moscow Economic Section by sending an e-mail to Economic 
Officer Aaron Fishman:  fishmanad@state.gov.  END NOTE.) 
Table 1 shows flows of foreign investment by country for the first 
nine months of 2008, compared to the same period in 2007. Total 
foreign investment declined by 13.8% in the first nine months of 
2008, compared to the same period in 2007.  According to Russian 
statistical practice, total foreign investment numbers include 
direct investment (FDI), portfolio investment, and "other" 
investment (largely trade credits).  Cyprus consistently figures 
high as an investor because most investment coming from Cyprus is 
actually returning Russian capital.  (Note:  The data in the Tables 
below is from the Russian State Statistical Service and may differ 
from data maintained by the Central Bank of Russia and the U.S. 
Department of Commerce.) 
The numbers in Table 2 represent an accumulated stock of total 
foreign investment, which include FDI, portfolio, and "other" 
investment. 
Table 3 shows foreign investment by region over the first nine 
months of 2008, compared to the same period in 2007.  Moscow 
continues to attract the largest volume of investments, mainly due 
to the concentration of companies' headquarters and the largest 
concentration of consumers with high purchasing power. 
Table 4 shows investment by sector over the first nine months of 
2008, compared to the same period in 2007.  Total investment in such 
sectors as trade, extraction of fuel, and transport and 
communications fell by over 50%, while other real estate, production 
and distribution of power, gas and water, finance, food, and 
construction became higher investment growth sectors in 9M08, 
compared to the same period in 2007. 
RUBIN