Russian Defense Business Directory


CHAPTER 2 - INVESTING IN RUSSIAN DEFENSE CONVERSION:

OBSTACLES AND OPPORTUNITIES

I. INTRODUCTION

In June 1992, the United States and the Russian Federation declared their intention to make cooperation in advancing defense conversion a high priority. Both countries recognized that Russian defense conversion was key to building a more economically prosperous world and assuring world peace, and that foreign investment would be important in the conversion process. The Russian Defense Business Directory was designed to facilitate the exchange of information on converting enterprises and to disseminate that information to potential business partners.

A. DEFENSE CONVERSION BACKGROUND

1. Definition

"Defense conversion," for the purposes of this Directory, is the transfer of defense production capabilities to non-defense production, either non-defense industrial products (e.g. pumps and valves) or consumer goods. However, the Law on Defense Conversion of the Russian Federation, encompasses a broader definition, which includes the possibility of a plant maintaining its defense production while expanding its non-defense production for other purposes, including the generation of hard currency exports. (See section C.1.a. for a discussion of this issue.)

2. Overview of Defense Industry

The former Soviet Union developed an immense defense industrial base with enterprises scattered throughout the various republics. About 70 percent are located in the Russian Federation. Russia contains more than 100 major defense plants; thousands of subsystem, component, and materials producers; and more than 1,000 military research, development, and test facilities. At its peak in the late 1980s, Russian defense industry employed some five to seven million workers, out of a total industrial labor force of 25 million. In addition to producing weapons, the defense industry has long been a large producer of civilian goods, producing all of the former Soviet Union's radios, televisions, VCRs, most of the refrigerators and washing machines, as well as a large share of the country's production equipment.

Defense enterprises in the former Soviet Union differ from their Western counterparts in several ways. They tend to be larger than plants in the West which produce similar items. The plants typically include on-site facilities for much of the component fabrication, which in the West would be subcontracted to other companies. Former Soviet defense enterprises also have traditionally had infrastructure responsibilities not found in the West, including schools, housing, and other social and cultural services. In addition, because central government organizations historically assured that defense enterprises received priority access to available supplies, investment, engineers and distribution of production, enterprise managers never learned to fend for themselves.

3. Current Situation in Defense Industry

Thus far, progress in defense industry conversion has been slow. Many defense enterprises are barely surviving due to cuts in weapons orders and insufficient funding to shift to civil production. Defense enterprises continue to be stymied, as they have been for the past several years, by a vast range of problems with respect to conversion. Most plant managers are faced with implementing massive structural changes in the management and operation of their plants and relationships with suppliers. The majority are having limited success, given their lack of expertise with the new products, the chaos in the economy, their lack of skill in dealing with a quasi-market environment, the difficulty of establishing new supply chains, and the lack of Western investment or domestic financial support for costly re-tooling. Meanwhile, defense plants have built up huge bank debts, as well as debts to other enterprises, while attempting to meet their payrolls and continue operations.

Russian leaders have recognized the high cost of conversion, and in 1995 earmarked some 2.3 trillion rubles in credits for defense industry--including 1.4 trillion for 1994--intended to help enterprises retool. Nevertheless, they are unable to provide the magnitude of investment resources necessary to assist defense enterprises undergoing conversion. Although their expectations have dropped considerably, Russian leaders continue to count on Western investment and foreign assistance to increase civilian production in defense enterprises. In the meantime, however, the Russian Federation is actively pursuing arms sales as a means to earn hard currency--partially to finance defense conversion.

Many Russian defense enterprises now are in the process of some form of privatization. The Russian Federation will retain possession of those weapons production facilities it deems critical to future weapons production, but the government has adopted a decree permitting 80 percent of all defense enterprises to privatize. The government retains the right to retain ownership of a significant portion of the shares in privatized defense enterprises. A number of large defense enterprises have begun the privatization process. An important side-effect of the privatization process in the defense sector has been the creation of numerous small and medium-size private companies from the bodies of large defense enterprises. (See Chapter 6 for a summary of the privatization program.)

B. GENERAL OBSTACLES

There are numerous studies and case histories available for the U.S. businessperson considering investment in Russia. Therefore, the following discussion only highlights some of the more significant generic barriers to doing business in Russia. The discussion is designed to alert the individual to some of the factors that he or she should address when developing a proposal. Good business practices require careful evaluation of all the elements; detailed knowledge of whom one is doing business with, and a clear understanding of the risks. This is especially true in the constantly evolving Russian commercial environment. The U.S. - Russian Bilateral Investment Treaty (BIT), ratified by the U.S. Senate on August 11, 1992 but still awaiting ratification by the Russian parliament, is intended to alleviate many of these generic obstacles. (See Chapter 4 for details on the BIT.)

In 1992, the Commerce Department established a business information service "BISNIS" to assist U.S. investors (phone: (202)482-4655; fax: (202)482-2293; E-Mail: [email protected]). The Department strongly encourages interested parties to contact this office as a first step, and to see Chapter 5 for other possible sources of assistance.

In addition, the U.S.-Russia Business Development Committee includes five functional and 10 sectoral working groups and subcommittees to foster increased commercial cooperation between U.S. and Russian firms. A complete listing of all these organizations and points of contact are also contained in Chapter 5.

1. Infrastructure

Authorities commonly cite infrastructure problems in the areas of telecommunications and transportation as major obstacles to doing business in Russia. Although Western firms are assisting in the development of a modern telecommunications system in Russia and the other Newly Independent States (NIS), communications limitations will continue to hamper business activity for some time. Transportation systems in Russia are inadequate, both for the distribution of goods and services, as well as the movement of people.

2. Laws and Regulations

Among the most serious obstacles inhibiting Western investment is the fluid situation in government regulations affecting business. Although the Russian legal system has abandoned many of the rules and procedures of the Soviet system, it continues to develop the laws and institutions necessary for a market economy to function, such as guarantees and definitions of property rights. Today, there are bodies of conflicting, overlapping, and rapidly changing laws, decrees, and regulations affecting both domestic and international commerce. As a result, these laws are inadequately communicated, understood, and enforced. Therefore, U.S. business persons are advised to obtain legal counsel that is familiar with the dynamics of Russian legislation. The Department of Commerce has a legal text service available through the National Technical Information Service (see Chapter 6). One of the most pressing concerns for Western investors is property ownership. Existing Russian laws on ownership regarding ownership by Western investors of land or buildings are unclear. Without definitive ownership rights, some Western firms have declined or even refused to do business. Regional governments sometimes complicate business operations by imposing laws and regulations that contradict federal ones. Moreover, local legal and regulatory regimes vary widely regarding foreign trade and investment ties, although more and more are striving to improve their regions' business climate.

Russian import taxes also may impede Western exports. On July 1, 1994, Moscow raised import tariffs to average rates of 13-15 percent, with sharply higher rates on many consumer and manufactured goods. In addition, many luxury goods are subject to an excise tax that in some cases is set at over 100 percent. In addition, most Russian imports are liable to the 20 percent VAT and a 3 percent special tax, which is levied on the value of the product plus any import tariff and excise tax. Russia, however, provides a number of exemptions to import taxes. For example, imports of food and other necessities are not subject to the VAT. The Russian Government also recently extended its 38 percent excess wages tax, although it has met with strong objections from many foreign governments.

3. Financial Considerations

Russia's nascent banking and financial infrastructure. and high inflation often create difficulties for some businesses operation in Russia. The situation is improving steadily, however, and few firms are unable to find ways around these difficulties--although at times it requires a great deal of persistence and creativity. These issues have also complicated the ability of Western firms to repatriate profits. It is advisable to determine payment options and profit repatriation strategies prior to investment. The Finance and Countertrade Division in the U.S. Department of Commerce (Room H-1104, (202) 482-4434) offers advice on methods and techniques that can be used, given that Russian enterprises frequently lack hard currency.

4. Materials and Supplies

Maintaining adequate sources of materials and supplies will be difficult in light of Russia's current political and economic climate, particularly in view of the breakdown of the distribution system throughout Russia and the NIS. Although supply problems did exist under the command system, defense facilities could seek help from their ministries and other bureaucratic oversight organizations when problems arose. Now that the command system has been dismantled, supply disruptions have increased and managers are generally on their own to devise solutions.

5. Office Facilities and Visa Problems

U.S. firms attempting to do business in Russia commonly complain about the difficulties in obtaining visas and adequate office space. The bureaucracy and delay involved in obtaining visas are a particular concern for smaller firms which cannot afford the high cost of establishing a resident office. For those firms with enough resources, office space often is not readily available. The leadership of both countries recognizes these problems and are working to resolve them. The Department of Commerce has also established American Business Centers (ABCs) in several cities of the NIS. The ABCs offer a variety of services to visiting business persons for a small fee.

6. Culture

Other obstacles faced by many Western companies engaging in trade and investment in Russia include the lack of a business culture and misunderstandings on the part of Russians regarding Western companies. Many Russians still lack even a basic knowledge of how markets operate, from the role of profits to proper business ethics. Russians often view Western firms as having very deep pockets. As a result, U.S. companies may find themselves significantly overcharged for services. In addition, this kind of business environment engenders illegal activity of every sort, including fraud. U.S. companies must exercise extreme caution in all their business ventures in Russia, taking care to investigate the legitimacy of partners and, in the absence of legal protections, which are taken for granted in the West, to obtain guidance or representation in the drafting of contracts.

7. United States Antidumping Laws

While more aptly characterized as a benchmark for, than as an "obstacle" to, increased trade, U.S. and Russian businesses must understand and comply with various U.S. laws when structuring business deals. For example, U.S. law provides for the protection of American manufacturers from unfair foreign trade practices. Manufacturers who believe that foreign competitors are "dumping" merchandise in the United States or are being subsidized by foreign governments may file for relief with the U.S. Department of Commerce's International Trade Administration (ITA) and the U.S. International Trade Commission (ITC).

"Dumping" generally refers to the selling of goods in the U.S. market at prices lower than the prices at which comparable goods are sold in the domestic market of an exporter. These sales must cause or threaten material injury to a competing U.S. industry. "Subsidies" are direct and indirect grants on the production or export of goods. They may occur in many forms, including direct cash benefits, credits against taxes, and loans with artificially low interest rates.

The U.S. antidumping legislation provides for duties to be levied on goods "dumped" on the U.S. market in order to discourage the sale of merchandise in the United States at "less than fair value" where such sales cause or threaten "material injury" to a U.S. industry. For more information, contact ITA's Office of Investigations (202) 482-5403.

C. BARRIERS UNIQUE TO DEFENSE CONVERSION

Although the Russian Federation relies heavily on Western investment to help fund the defense conversion program, serious problems hinder the efforts of Western investors who want to work with defense enterprises. Some of the problems are caused by confusion concerning who is authorized to make decisions over enterprises and sometimes lack of interest on the part of some local enterprise managers. Misunderstandings between Western firms and Russian enterprise directors have fueled the spread of rumors and convoluted excuses to explain apparent failure. The problems discussed below are representative of those affecting all potential Western investors in Russian defense enterprises.

1. Authority

The ultimate authority to approve or disapprove a deal with a Russian defense enterprise depends on the situation of a given enterprise. The central government previously had responsibility for all such actions because, through the former Russian Ministry of Industry, it owned nearly every defense enterprise in Russia. Today, however, the lines of ownership are not so clear. Privatized enterprises have the right to make their own decisions. The successor to the Ministry of Industry, the State Committee for the Defense Sectors of Industry, also continues to have influence over some plants through its ownership of shares in enterprises which have not fully completed the privatization process. The State Privatization Committee also plays a role.

People experienced in doing business in Russia have frequently suggested that the lines of authority with any potential partner be thoroughly investigated and that the Russian partner in a business transaction be responsible for obtaining the necessary Russian government approvals.

Lacking guidance from the central government, defense industrialists as well as local and regional officials are increasingly asserting their own autonomy and independently seeking foreign aid and investment. Regional and city governments and defense industrial managers and apparatchiks have created defense conversion support groups and have increased their role as players in the conversion process. Clearly, U.S. industry needs to be extremely cautious in negotiating business arrangements, ensuring that they have consulted with all the applicable and ultimate authorities.

These layers of authority have presented formidable obstacles. In addition to the State Committee on the Defense Sectors of Industry, other central government authorities involved in conversion policy include: the Ministry of Economics, Ministry of Defense, Ministry of Foreign Affairs, Ministry of Foreign Economic Relations, and Ministry of Higher Education and Science. (See Chapter 7--Russian Government Authorities Involved in Defense Conversion.)

2. Management Practices

Successful commercial development and conversion will ultimately depend on the ability of enterprise managers to break with past practices. Defense enterprise managers will find that most of the management practices developed under the planned economy of the former Soviet Union will be of little use in a market economy. Under the Soviet system,

- Managers were primarily concerned with meeting a production target assigned by central planning authorities who judged performance by indicators such as percentage of plan fulfilled or actual output level. Such criteria caused distortions and inefficiencies as managers sought to maintain output at the expense of quality, investment in new technology, and labor efficiency.

- Enterprise managers had little knowledge of or concern for the actual costs of making their products. The state routinely confiscated profits above state-set levels while making up shortfalls in profits leading the enterprise manager to virtually disregard the costs of production.

- Because of the high priority given to national defense, defense industries received the highest quality raw materials and had preferential access to the transportation and distribution networks for delivering materials. At the same time, defense enterprise managers were lauded by the central authorities for their management abilities, a factor that makes these managers less willing to change their practices to meet market economy needs.

- The central authorities told enterprises who would provide their supplies and to whom they were to deliver their product.

- Central authorities rather than market forces determined the prices for products delivered from the plant. Consequently, managers had little knowledge or concern on how to price their products.

- Managers treated labor as an inexhaustible commodity, and there were no incentives to develop an efficient work force or to economize on labor. Thus, managers tolerated indifferent labor discipline, poor attendance, high rates of alcoholism, and theft from the shop floor.

- Soviet managers typically did not replace equipment until it became obsolete, and on occasion, they sequestered and stockpiled replacement equipment without putting it into use. They resisted installing new equipment because of the resulting downtime, and central planners frequently discouraged such modernization by failing to lower the plant's production target for the period involved.

3. Inter-enterprise Debt and Bankrupty

Many defense plants have remained afloat by relying on Central Bank credits and by running up debts with other enterprises. According to Russian statistics, the Central Bank provided loans to the economy of some 12 trillion rubles in 1994--about 2 percent of GDP--and the defense sector was a major recipient. This year such loans were less generous due to the Russian Government's attempt to rein in such expenditures per its understanding with the International Monetary Fund. Inter-enterprise debts, virtually eliminated in the fall of 1992, resurfaced as a serious problem in the second half of 1993 as government efforts to reduce inflation led to relatively tight financial policies, including payment delays for many of its military purchases. Financially strapped enterprises could not pay their suppliers which created a chain reaction of unpaid debts that reverberated throughout the entire industrial sector. Industries' overdue debt to suppliers reportedly exceeded 40 trillion rubles by the end of February 1995.

By early 1994, many state-owned enterprises claimed to be deeply in debt and demanded government support to prevent mass layoffs of workers subsisting on partial wages and reduced social services. In response, a series of presidential decrees--replacing earlier, unimplemented bankruptcy laws--were issued to force the state sector to voluntarily privatize or restructure to resolve financial difficulties or face forceable restructuring or sale. The number of state-owned enterprises--primarily in the defense sector--will be reduced and run by state-contracted directors held accountable for enterprise performance. Subsequent government decrees have provided the criteria for determining insolvency, developed government options for dealing with insolvent state enterprises, specified procedures for preserving social services, and set conditions for prospective buyers of insolvent enterprises, although many of these decrees have not been fully implemented. Fear that appearance on the government's insolvency list--with over 250 entries and growing--will lead to their loss of control has motivated many state enterprise managers to find the money to settle old debts. By mid-March some 1600 state enterprises--including roughly 180 defense firms--had been identified to demonstrate the bankruptcy process.

4. Resistance to Change

Some defense industry managers and workers are still resistant to the idea of conversion. The Russian Federation is determined to continue some military production, albeit at a greatly reduced level, and some enterprise managers hope to gain those contracts and continue to produce military hardware, thus avoiding conversion. Others are not convinced that conversion is necessary, believing that Russia eventually will abandon defense conversion and economic reform and that they again will be required to produce weapons.

In addition, some defense industry employees oppose conversion because defense production was traditionally viewed as the more prestigious sector of the economy. Nevertheless, their resistance has weakened over the past few years as the special privileges associated with defense work--higher wages, special bonuses, and awards--have disappeared. Recently, in fact, wages at defense plants have become lower than those at other industrial enterprises.

Another aspect that could cause problems in the conversion process is the possibility of unemployment and displacement of persons caused by the downsizing of defense industry. Since the Russian Federation previously adhered to a policy of near full employment, it has little experience with the demands associated with the large scale retraining and job placement of defense industry employees.

5. Infrastructure/Social Support

Three major infrastructure issues serve as barriers to defense conversion: 1) social services associated with employment; 2) difficulty in industrial conversion; and 3) environmental and occupational safety hazards. Besides providing employment, defense facilities also have been responsible for supplying numerous other social infrastructure benefits including: housing, schools, day care, medical, and other community support functions. Many enterprises have been kept in operation through subsidies because of the social necessity of these services. Currently, some regions are in the process of transferring responsibility for such services to the local government, although plant managers often feel responsible for their workers and have been reluctant to give up responsibility for these services--particularly since local authorities are struggling to find a way to finance them. The Privatization decree instructs Russian enterprises not to include social and cultural infrastructure items when placing a value on the enterprise's assets.

Conversion projects may continue to provide employment for a number of these people; however, many are at risk of losing not only their jobs, but also their basic needs (i.e., shelter). Due to the housing shortage, as well as the lack of a private housing market, many Russians have no means of finding alternative housing. Again, defense facilities will be particularly hard hit because of the number of employees that they currently sustain. Thus, U.S. businesses need to be aware of and learn about these potentially overriding considerations in developing conversion proposals, and to include perhaps provisions for temporarily sustaining certain aspects of the social support system.

A second physical infrastructure barrier to defense conversion is the conversion process in and of itself. The experience of defense industry enterprises around the world indicates that attempts to re-tool military production lines to produce civilian goods are frequently unsuccessful. In the United States when defense orders fall, defense firms usually become smaller, sell out to or merge with another firm, or go out of business. Commercial markets are significantly different from the defense customers that managers have learned how to satisfy in such areas as cost and quality requirements, maintenance and service, marketing and supplier networks, the length of production runs, and the demands for technology. People, physical equipment, buildings, and land are flexible and adaptable; institutions, management, and organizations are rigid.

The general assessment of several experts on Russian defense conversion is that it will be difficult to convert an entire existing facility to civilian production at one time. Potential joint venture partners and other investors may be more successful in targeting a specific portion of the production line or "corner" of the plant for a project. Some have even suggested that successful conversion could involve establishing a new organization or building a new facility near the existing one and staffing it selectively from the existing enterprise. Decisions on how to structure a specific transaction, how to finance it (e.g., pursue a joint venture, acquire an equity interest in the enterprise, lease the facility), and where to market (e.g., for the Russian industrial and consumer market, for export to foreign markets) are best left to the parties to the transaction and what the Russian Federation will allow in the case of heretofore state-owned enterprises.

A third infrastructure factor would be the current and looming environmental and occupational safety hazards associated with many defense facilities. Defense plants have a disproportionate share of heavy industrial waste problems, and many sites are already severely contaminated. Western firms may not want to become responsible for the extremely high cost of cleaning up these sites. In addition, they may not want to expose their workers to the potentially harmful side effects of these polluted environments.

6. Divergent Expectations

In recent years, a host of Western business representatives have come to Russia to explore possibilities for investment or cooperation with local defense enterprises. However, relatively few deals have actually been concluded. Problems between Western investors and Russian defense enterprise directors stem from a number of factors, some related to the expectations of Western investors and others related to the expectations--or lack thereof--of Russian managers. Sharply conflicting expectations surface when Western investors run across enterprise directors who have no interest in conversion projects or foreign cooperation in general. According to articles in the Russian press, some enterprise directors are not interested in conversion projects at all because they expect a return to the "old days" and want to be prepared again to produce arms. Western firms interested in these facilities will have to wait for new management.

Russian officials, both from the government and from defense industry, take great pride in the capability and advanced technology of Soviet-designed weapons. Russians typically regard their defense industry as the most technologically advanced sector of the economy and as capable of matching or exceeding the West. As a result, Russian defense industry managers generally seek Western investment to help them produce a high-tech product--most likely closely related to their previous military production--for export. Western business persons, on the other hand, are frequently interested in a project to produce civilian goods for the sizeable Russian market and frequently regard Russian technology as considerably out-of-date.

Another source of conflicting expectations surfaces when Western firms appear, in Russian eyes, to be going after the "crown jewels" of a particular enterprise. Several Russian enterprise directors and academics believe that Western business persons are interested only in stealing their advanced technology and state secrets rather than engaging in real cooperation. Thus, U.S. companies will find that some potential partners harbor a great deal of suspicion regarding American motives. In a typical scenario, a Western firm will propose a joint venture with a profitable division of an otherwise-unprofitable enterprise. Some enterprise directors balk at this approach because it would mean sharing managerial control of this division with the new joint venture. According to a representative of the State Committee of the Defense Sectors of Industry, some managers are refusing to relinquish control over their best divisions because they would be left managing a struggling complex of little real value. The enterprise director prefers to talk about deals with his less-attractive divisions in hopes of boosting their value. The Western investors, not surprisingly, are less interested in such proposals.

Despite these obstacles, deals can and are being made, but successful negotiations require imagination, persistence, and demonstrations of confidence and genuine interest in mutual benefits. U.S. and Russian business persons need to understand, yet quickly get beyond, certain stereotypical criticisms: Russian enterprise managers frequently complain that American business persons are interested only in "kicking the tires" rather than discussing business deals seriously. On the other hand, Western business persons complain that the Russian "projects" they are asked to invest in are merely thoughts or concepts at best.

This Directory can help U.S. businesses learn about Russian enterprises and identify those of interest. Before traveling to Russia, however, the U.S. companies might well want to communicate their interest and ask whether the enterprise has prepared a business plan providing the detailed information typically required before businesses and financial institutions in the West engage in serious negotiations. If the enterprise has not yet prepared such a plan, there are several organizations in Russia that can assist the enterprise, including the DOD-funded International Executive Service Corps (IESC). IESC Defense Conversion teams are located in Nizhniy Novgorod and Yekaterinburg. See Chapter 5, pages 1-2 and 23-24 for points of contact, etc. Once business plans have been prepared, Russian enterprises can more reasonably anticipate serious business discussions, particularly with the Western firms that will have previously noted their interest.

D. OPPORTUNITIES

1. Quantitative and Qualitative Factors

Several positive factors regarding the Russian economy enhance the potential benefits from investments in Russia. First, the sheer size and scope of the Russian market provides opportunities for a wide variety of products. The total Russian population is approximately 150 million. It is well known that Russian consumers were deprived of many basic consumer goods and are now eager to acquire Western products. Although defense conversion may not provide immediate availability for some of these products, the channeling of industrial productivity to non-defense related items will provide a myriad of opportunities for a variety of U.S. businesses.

Second, by Western standards, the Russian labor force is generally considered to be well-educated and the defense industries have extremely well qualified, technical personnel. In addition, labor costs are relatively inexpensive for the level of education associated with work performed in high-tech defense sectors.

Third, Russian defense enterprises have an overabundance of plant capacity. Excess plant capacity resulting from severe cutbacks in defense orders has left many plants underutilized, providing a commercially attractive aspect to an otherwise negative infrastructure outlook. Defense plants also tend to have some of the most sophisticated manufacturing equipment available in Russia.

2. Areas of Qualitative Russian Advantage(1)

In 1990, the Department of Defense and the Department of Commerce co-chaired an Interagency Technology Assessment Group (ITAG) to develop a list of technologies where it was then estimated that the former Soviet Union led Western accomplishments. The technologies were measured in scientific (mathematical or physical) terms, or in business terms (cheaper to manufacture, less labor-intensive, etc.), or both.

To emphasize that there are wide-ranging opportunities for those who persist in working through the obstacles discussed above, listed below are the technologies identified in the ITAG report, Soviet Commercial Technologies.

Chemical/Allied Products (SIC 28)

o Aluminum Oxide Production Processes

o Lasant Materials (Lasers)

o Polyurethane Compounds

o Self-Propagating High-Temperature Synthesis

o Synthetic Rubber Production Processes

o Turbulent Reactor

Rubber and Miscellaneous Plastics Products (SIC 30)

o Carbon Adhesives

o Carbon-Carbon Products

o Componers

o Rolivsans Thermosetting Cast Resins

Primary Metals Industries (SIC 33)

o Dynamic Compaction Synthesis

o Elastomeric Roll Forming of Sheet Metal

o Filament Winding of Thick Section Composites Fabrication Processes

o Impulse Processing Method

o Plasma-Mechanical Metal Processing

o Vacuum Processing of Steel with Synthetic Slag and Inert Gases

o Weldable Aluminum-Lithium Alloys

Fabricated Metal Products (SIC 34)

o Rotary-Planetary Mill Machining

o Small Nuclear Power Reactors

Industrial/Commercial Machinery and Computer Equipment (SIC 35)

o Diesel Engines

o Fiber Optics Module for Automatic Control Systems

o Multiple-Reflection Optical Systems

o Waveguide Holograms

Electronic and Other Electrical Equipment/Components (SIC 36)

o Disk Explosive Magnetic Generators

o Explosive Magnetohydrodynamic Generators

o High Brightness Negative Ion Source

o High Power Gas Lasers

o High Power RF Heaters for Ionospheric Modification

o High Power RF tubes

o Laser Instrumentation

o Magnetic Flux Compression Generators

o Microgravity-Processed Ultra-Pure Semiconductor Single Crystals

o Pulsed Power

o Pulsed Wave De-Icing/Anti-Icing Equipment

o Spatial Light Modulators

o Tacitrons

o Vacuum Microelectronics

Transportation Equipment (SIC 37)

o Cryogenic Fuel Aircraft Engines

o Fan-Prop Aircraft Engines

o Gas Turbine Helicopter Engines

o Wing with Internal Framework (Lattice Control Surface or Grid Fin)

Measuring, Analyzing, and Controlling Instruments: Photographic, Medical, Optical (SIC 38)

o Biochrome Films

o Diamond-Coated Surgical Instruments

o Homosorption Filter Technology

o Jet Injection Equipment for Immunizations

o Lidar Remote Sensing

o Microstructure Laser Devices

o Performance Enhancement Electrical Devices

o Physiological Measurement Devices

o Pseudorandom Noise-Coded Waveform Processing

o Residual Stress Engineering Measurement Devices

o Vaccine Inhalator Devices

Transportation Services (SIC 47)

o Space Launch Services

o Commercial Experimental Payload Services

Engineering, Accounting, Research, Management and Related Services (SIC 87)

o Magnetohydrodynamic-Accelerated Simulation

3. Encouraging Perspectives

Eugene K. Lawson, President, U.S.-Russia Business Council, and former Vice Chairman, Eximbank, offered the following perspective as encouragement to U.S. firms to get involved in business in Russia while participating in OPIC's March 1993 Conference on Investment Opportunities in Russia:

a. Largest untapped market in world resources - Russia represents the world's largest untapped market for natural resources (e.g., timber, minerals and energy), production resources, (e.g., transportation), investment opportunities, and a highly educated, talented work force.

b. Natural trading partners - Russia and the U.S., effectively bordering on two oceans, have resources and industrial capacity the other can use, and enterprising people who can make this happen.

c. We like each other - There is a mutual and enduring respect and admiration between the people of both countries.

d. Cold, not hot, war - Remember, our two countries have never fought against each other; it was a cold, not hot, war they engaged in for much of the previous 45 years.

e. Pent-up consumer demand - The needs and preferences of individuals and families in Russia have only recently begun to acquire greater emphasis and priority. This is similar to, but far greater in scope than, the consumer-driven actions and priorities in the U.S. in the late 1940s.

f. Room for growth in international trade - The number of joint ventures between U.S. and Russian entities increased from about 40 in 1989 to approximately 400 by 1993, and there is room for much more growth.

g. U.S. is #1 investor in the new Russia - The U.S. is the number one investor in the new Russia, measured in numbers of joint ventures and actual monetary units. (See charts on following pages.)

h. No reason why U.S. cannot emerge as Russia's largest trading partner - The foregoing suggests that there is no reason why the U.S. cannot eventually become Russia's largest trading partner.

i. Get outside of Moscow - Look at the spontaneous growth of capitalism and privatization at the regional and local level throughout Russia.

j. U.S. financial institutions have room for growth of credit in Russia - European financial institutions have already extended their available credit, but U.S. financial institutions continue to have credit available for business in Russia.

4. Direct Investment Activity in Russia

INVESTMENT IN RUSSIA: 1990 - 1993

Acq. = Acquisition; JV = Joint Venture; Green = Green field investment

Number Value in Dollars

Acq. JV Green Total Acq. JV Green Total

Argentina 0

Australia 4 1 5 0

Austria 1 21 6 28 30.3 385.2 415.5

Bahamas 0 0

Bahrain 0 0

Belgium 4 1 5 11 11

Bermuda 0 0

Brazil 1 2 3 20 20

Bulgaria 1 1 0

Canada 15 1 16 52.9 52.9

Chile 1 1 0

China 1 1 2 0

Croatia 1 1 0

Cuba 0 0

Cyprus 1 1 1,300 1,300

Denmark 5 2 7 22.9 2.2 25.1

Europe (misc.) 2 2 0

Finland 3 22 4 29 26 5.6 31.6

France 2 18 12 32 1475 32.6 1507.6

Germany 5 56 36 97 27.2 1466.1 65.6 1558.9

Greece 1 2 3 5.4 5.4

Hong Kong 3 3 0

Hungary 6 1 7 4.1 4.1

Iceland 0 0

India 1 1 2 0

International (misc.) 6 3 9 9 9

Iran 0 0

Ireland 3 3 0

Israel 1 1 0

Italy 2 31 7 40 12.8 50.6 452.4 515.8

Japan 27 15 42 886.6 886.6

Kuwait 0 0

Latvia 1 1 0

Libya 0 0

Liechtenstein 1 1 0

Lithuania 1 1 0

Luxembourg 0 0

Malaysia 0 0

Monaco 0 0

Netherlands 8 5 13 20 20

Norway 2 3 5 4.3 4.3

Oman 1 1 0

Pakistan 0 0

Philippines 1 1 0

Poland 0 0

Romania 0 0

Russia 0 0

Saudi Arabia 1 1 23 23

Singapore 3 3 0

Slovakia 2 2 0

Slovenia 1 1 0

South Africa 1 1 0

South Korea 21 4 25 712.6 712.6

Spain 1 1 2 11.8 11.8

Sweden 2 15 9 2623.6 65 88.6

Switzerland 22 7 29 615.8 615.8

Taiwan 1 1 8 8

Thailand 1 1 0

Turkey 5 1 6 4.5 4.5

UK 1 37 12 50 5.5 480.6 487.1

Ukraine 1 1 0

United Arab Emirates 0 0

US 7 177 60 244 125 4379.6 66 4570.6

Total 26 531 199 756 250.4 11110.9 226 11587.3

Number of Deals Value of Deals

1990 57 14 71 299.6 299.6

1991 114 28 142 966.3 2 968.3

1992 8 215 91 314 12.8 7590.2 66.6 7669.6

1993 18 145 66 229 237.6 2254.8 157.4 2649.8

Source: East European Investment Magazine (EEIM) Database, Dixon & Company.

COMPARATIVE FOREIGN DIRECT INVESTMENT IN RUSSIA

(millions of $$)

1990 1991 1992 1993 1994

Cumulative Foreign Direct Investment 1003 1503 2957 5057 8957

- Changes in Direct Foreign Investment 360 500 1454 2100 3900

Source: Planecon, Inc.

COUNTRY DATA

1. Profile

Population: 148,365,800 people (January 1994)

(Source: Russian State Committee on Statistics)

Population Growth Rate: 0 percent

(Source: U.S. Embassy Estimate)

Religions: Russian Orthodox, Islamic, Jewish, Catholic, Protestant, Buddhist, other.

Government System: Federal with 88 republics, provinces, and regions with varying degrees of autonomy.

Languages: Russian (official), over 140 other languages and dialects.

Work Week: 40 hours per week.

2. Domestic Economy (Figures in U.S. Millions $ unless noted)

1993 1994 19951

GDP ($ Millions) 174,000 249,000

GDP (Trill.s nominal rubles) 163 740

GDP Growth Rate2 -12% -10%

GDP Per Capital $1,175 $1,682

Government Spending as Percent

of GDP 35% 38%

Inflation 900% 400%

Unemployment 5 12

Foreign Exchange Reserves 5,000 6,000

Average Exchange Rate 932 3,000

Foreign Debt 80,000 85,000

Debt Service Ratio 44 52

U.S. Economic/Military Assistance 1,400 1,600

3. Trade

Total Country Exports 44,297 46,000

Total Country Imports 26,807 24,000

U.S. Exports to Russia 2,304 2,400

U.S. Imports from Russia 1,997 2,100

U.S. Share of Host Country 8.6% 10.0%

Imports of Manufactured Goods:

Total 16,514 17,000

From the U.S. 666 900

U.S. Share of Imports 4.0% 4.7%

Manufactured Goods Trade Balance neg. neg.

Projected Average Annual Growth

Rate from World -23.5% 2.9%

Projected Average Annual Growth

Rate from U.S. -26.5% 20.1%

Imports of Agricultural Goods:

Total 5,574 5,000

From the U.S. 987 1,000

U.S. Share of Agricultural Imports 17.7% 20.0%

Agricultural Goods Trade Balance neg. neg.

Trade Balance with Three Leading

Partners:

Germany -67 -100

China +733 +500

U.S.A. -307 -200

Principal U.S. Exports: Corn (7600); Crude Oil (2709); Platinum (7110); Oil Products (2710); Iron and Steel (7200)

1The U.S. Embassy does not believe 1995 figures can be projected with reliability.

2Real rubles year/year

4. Foreign Direct Investment Statistics

According to Russian government sources, in early 1994, a total of 11,705 enterprises, including 3,011 foreign-owned firms had been registered with the state register of enterprises with foreign capital. The aggregate share capital of those enterprises amounted to USD 2.5 to 3 billion. Russians contributed 40-45 percent, while foreigners contributed 55-60 percent of the share capital. Forty-five percent of enterprises with foreign capital are engaged in the fuel and energy sector, 20 percent in processing industries, 10 percent in services and 10 percent in construction. These enterprises exported USD 2.8 to 3 billion of products (5-7 percent of Russia's exports) and imported USD 1.7 billion worth of products (5-7 percent of the country's imports).

Russian government figures for cumulative total foreign direct investment from 1990-93 (in millions USD) are as follows:

United States 4,121

France 1,536

Germany 1,482

South Korea 539

Italy 474

Austria 385

United Kingdom 205

Sweden 80

Finland 41

Japan 15

Sources: All 1994 figures are U.S. Embassy estimates, as shown in Russia Country Commercial Guide FY '95. Most 1993 figures are official Russian statistics prepared by the Russian State Committee on Statistics (GOSKOMSTAT) or the Russian Ministry of Foreign Economic Relations in May-June 1994. The Embassy used Russian government statistics to calculate GDP, GDP per capita, and debt service ratio. The Embassy estimated foreign exchange reserves, government spending as a percent of GDP.

1. 1 Derived from Soviet Commercial Technologies, Interagency Technology Assessment Group, U.S. Department of Commerce, Office of Foreign Availability, September 1990. This document is available through the National Technical Information Service, (703) 487-4650. Ask for Document Number PB-ADA-227672.