SUBJECT: INTERNATIONAL BUSINESS CASE Five years after the launch of economic ref
ID: 367603 • Letter: S
Question
SUBJECT: INTERNATIONAL BUSINESS
CASE
Five years after the launch of economic reform designed to transform Russia lumbering state directed economy into a modern market system, Russia was experiencing unprecedented capital flight. In 1996 some &22.3 billion left the country, most of it illegally. In contrast a mere $2.2 billion in foreign investment flowed into the country. According to data from the European Bank of Reconstruction and Development, between 1989 and 1996 foreigner invested just $5. 3 billion in Russia compared to foreign investment of about $11.5 billion in much smaller former communist state, Hungary.
One reason for this is that Russia consistently tops the charts as the riskiest investment destination tracked by the Economist Intelligence unit. The risk includes a complex tax code that is always changing and randomly enforced, often at the expense of foreign companies. Weak and untested property and contract safeguards, endless regulations often enforced any bureaucrats and a play in field made uneven by trading and tax favor granted by the Russian government to Russian companies are also frequently cited contributing to the high risk associated with investment in Russia.
Russia is privatization laws have also tended to discriminate against foreign investors most privatization schemes in Russia favor incumbent management and or local companies. For an example, a “Shares for loans schemes in 1995 saw a dozen large companies sold for a fraction of their market value to several large Moscow banks. Foreign investors were not given an opportunity to bid on these assets. Similarly, the privatization of several large scale companies has seen the majority of stock sold to incumbent managers and employees for a fraction of the price the stock could fetch on the open market.
The failure of the Russian government to capitalize on the sale of state owned asset is self-deferring given that the country is a desperate need of capital resource to upgrade its crumbling infrastructure , which is suffering from years of neglect and mismanagement under communism. The Russian oil and gas industry is an example. Russia has the largest oil and gas reserves in the world, but it is finding it difficult to get these reserves out of the ground and to the international market. Russian oil output plummeted after the collapse of the Soviet Union, form 569 million tons in 1988 to 305 million tons in 1996. The problems include leaking pipelines, aging oil wells, a lack of new drilling and conflict between the various states of the former Soviet Union as to who actually owns mush of the oil and gas infrastructure. According to estimates by the World Bank Russia needs to spend between $ 40 billion and $50 billion per year just to maintain oil and gas production at current levels,. Boosting production back to the level achieved in the 1980 could require investment of $ 80 billion to $100 billion per year money that Russia does not have.
In an attempted to reverse this slide, in November, 1997 the government of Boris Yesltsin announced that Russia oil and gas industries would be open to foreign investment. The decree signed by Yeltsin allowed forcing investors to buy 100 percent of Russian oil companies. Within days Royal Dutch Shall had teamed up with Gazprom. Russia giant gas monopoly to bid for Rosnelt, the last big state owned oil group to be privatized. This was quick flowed by a deal under which British Petroleum announced that it could purchase 10 percent of another Russian company, Sianco, giving it a state in a huge oil field near the Chinese border. The benefits that flow to Russia from such investment could be substantial. In a report prepared for the Russian parliament, Weston oil companies said foreign development of just six identified oil and gas fields, cold create more than 550,000 jobs and earn about $450 billion over their operating lives.
However, before they are prepared to make further large-scale investment, many Western companies say they need stronger legal and tax guarantees. Their preferred method of operation would be to sign internationally recognizable production sharing agreements, which leave the ownership of natural resources with the state, but allow foreign developers a defined share of future revenues. Al through the Russian government has tried to enact such legislation; the communist dominated parliament has resisted any attempt to pass such laws.
CASE DISCUSSION AND QUESTIONS.
QUESTION 01: What are the benefits to the Russian government from foreign direct investment in general and in the oil industry in particular? (10 Marks)
QUESTION 02: What are the risks that foreign companies must bear when making investment in Russia? What are the sources of this risk? How substantial are they? (5 Marks)
QUESTION 03: Is there any way foreign companies can reduce these risks (5 Marks)
SUBJECT: INTERNATIONAL BUSINESS
CASE
Five years after the launch of economic reform designed to transform Russia lumbering state directed economy into a modern market system, Russia was experiencing unprecedented capital flight. In 1996 some &22.3 billion left the country, most of it illegally. In contrast a mere $2.2 billion in foreign investment flowed into the country. According to data from the European Bank of Reconstruction and Development, between 1989 and 1996 foreigner invested just $5. 3 billion in Russia compared to foreign investment of about $11.5 billion in much smaller former communist state, Hungary.
One reason for this is that Russia consistently tops the charts as the riskiest investment destination tracked by the Economist Intelligence unit. The risk includes a complex tax code that is always changing and randomly enforced, often at the expense of foreign companies. Weak and untested property and contract safeguards, endless regulations often enforced any bureaucrats and a play in field made uneven by trading and tax favor granted by the Russian government to Russian companies are also frequently cited contributing to the high risk associated with investment in Russia.
Russia is privatization laws have also tended to discriminate against foreign investors most privatization schemes in Russia favor incumbent management and or local companies. For an example, a “Shares for loans schemes in 1995 saw a dozen large companies sold for a fraction of their market value to several large Moscow banks. Foreign investors were not given an opportunity to bid on these assets. Similarly, the privatization of several large scale companies has seen the majority of stock sold to incumbent managers and employees for a fraction of the price the stock could fetch on the open market.
The failure of the Russian government to capitalize on the sale of state owned asset is self-deferring given that the country is a desperate need of capital resource to upgrade its crumbling infrastructure , which is suffering from years of neglect and mismanagement under communism. The Russian oil and gas industry is an example. Russia has the largest oil and gas reserves in the world, but it is finding it difficult to get these reserves out of the ground and to the international market. Russian oil output plummeted after the collapse of the Soviet Union, form 569 million tons in 1988 to 305 million tons in 1996. The problems include leaking pipelines, aging oil wells, a lack of new drilling and conflict between the various states of the former Soviet Union as to who actually owns mush of the oil and gas infrastructure. According to estimates by the World Bank Russia needs to spend between $ 40 billion and $50 billion per year just to maintain oil and gas production at current levels,. Boosting production back to the level achieved in the 1980 could require investment of $ 80 billion to $100 billion per year money that Russia does not have.
In an attempted to reverse this slide, in November, 1997 the government of Boris Yesltsin announced that Russia oil and gas industries would be open to foreign investment. The decree signed by Yeltsin allowed forcing investors to buy 100 percent of Russian oil companies. Within days Royal Dutch Shall had teamed up with Gazprom. Russia giant gas monopoly to bid for Rosnelt, the last big state owned oil group to be privatized. This was quick flowed by a deal under which British Petroleum announced that it could purchase 10 percent of another Russian company, Sianco, giving it a state in a huge oil field near the Chinese border. The benefits that flow to Russia from such investment could be substantial. In a report prepared for the Russian parliament, Weston oil companies said foreign development of just six identified oil and gas fields, cold create more than 550,000 jobs and earn about $450 billion over their operating lives.
However, before they are prepared to make further large-scale investment, many Western companies say they need stronger legal and tax guarantees. Their preferred method of operation would be to sign internationally recognizable production sharing agreements, which leave the ownership of natural resources with the state, but allow foreign developers a defined share of future revenues. Al through the Russian government has tried to enact such legislation; the communist dominated parliament has resisted any attempt to pass such laws.
CASE DISCUSSION AND QUESTIONS.
QUESTION 01: What are the benefits to the Russian government from foreign direct investment in general and in the oil industry in particular? (10 Marks)
QUESTION 02: What are the risks that foreign companies must bear when making investment in Russia? What are the sources of this risk? How substantial are they? (5 Marks)
QUESTION 03: Is there any way foreign companies can reduce these risks (5 Marks)
Explanation / Answer
QUESTION 01: What are the benefits to the Russian government from foreign direct investment in general and in the oil industry in particular?
As stated in the article, the Russia ia in desperate need in the capital resources in the country to develop and update the infrastructure of the country,
Before taking about the Russia needs of foreign investments, let’s put some light on the what is foreign investment and how it is beneficial.
In today’s co-operative world, every country wants to explore different markets in other countries. Foreign investment is the capital inflow from one country to another in which the company from where capital is invested takes an ownership stakes in the country where the capital is invested, which is termed as domestic country and in exchange domestic country uses the capital for the developmental purposes of the country.
In our case Russia where the capital is invested is in need of the capital to develop its infrastructure to give its state a better system. The capital inflow will also gives Russian economy to develop as the investment can stimulate the country’s economic development and will also benefits the local industries.
Specifically, foreign investment will develop the Russia oil and gas industry. Russia despite being the world’s largest oil and gas reserve is unable to get these reserves out from the ground and sell them in the international market. Foreign investment will helps Russia in such crises, with the infusion of the new capital, Russia can develop the industry and can resource the money in the development of the pipelines, new machinery to get oil from the ground and can maintain oil and gas production at current levels.
QUESTION 02: What are the risks that foreign companies must bear when making investment in Russia? What are the sources of this risk? How substantial are they?
The risks that the foreign companies bear are as follow:
1. Complex tax law; the complex tax code in Russia is one of the major concerns for the investors. The code is no in favor of the investors and is always changing and enforces the on foreign expenses of the investors.
2. Contacts safeguard; In Russia, the investors always have problems with the untested property and safeguards. The Russian government granted uneven laws and favor the trade code to the local companies.
3. There is a discrimination among the private and the local companies and among the foreign investors which is supported by the Russian government.
The source of the risk is itself the government. The government banks and the private industrialist is benefited and enjoys the privileged when it come to the selling and bidding of the valuable asset. The foreign investors were not given a chance to participate in the bidding of the assets. Similarly, the privatization of several large scale companies has seen the majority of stock sold to incumbent managers and employees for a fraction of the price the stock could fetch on the open market
QUESTION 03: Is there any way foreign companies can reduce these risks
The foreign investors can reduce the risk in the Russian market with the strong legal and tax laws/ code implemented for the investment.
The western countries while investing in Russia can have a legal agreement with the signed hard copy as a proof of the legal agreement which can be treated as the internationally recognizable production sharing agreement.
This will give a clear idea of the ownership of the assets, this will also represent ownership of the future development and revenue in the country for the investors.
With the clear norms, the foreign investment will have a trust in the government of Russia and will increase the capital in the domestic country.
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