Since we are about half through the Fifa World Football Championship, we offer you today a full economic and political picture of the host country Russia, based upon the Market Profile by the Hong Kong Trade Development Council Research Arm

Overview

Amid recovered oil prices, macro stabilisation, and improved business and consumer confidence, Russia’s economy is expected to keep growing at a tepid pace. However, a return to solid growth will need private investment and a lift in consumer sentiment. Structural reforms designed to bolster investor confidence could greatly enhance long-term growth prospects. These reforms will need to address key constraints to productivity growth, such as the remaining weaknesses in the investment climate, the lack of sufficient competition, the physical and nonphysical barriers to infrastructure connectivity, the relatively low innovation capacity of firms, and the mismatch between available skills and those demanded by the labour market.

Source: World Bank

Major Economic/Political Events and Upcoming Elections

September 2015

Russia carries out first air strikes in Syria, saying it targets the Islamic State group. But West and Syrian opposition say it overwhelmingly targets anti-Assad rebels instead.

November 2015

Turkey shoots down Russian warplane on Syria bombing mission. Russia, Turkey’s second-largest trading partner, imposes economic sanctions.

September 2016

Parliamentary elections: The ruling United Russia party increases its majority, with The remaining seats won by other pro-Putin parties. Key opposition figures such as Alezei Navalny barred from standing.

June 2017

EU extends sanctions against Russia for another six months over the conflict in eastern Ukraine

July-September 2017

The US and Russia engage in a back and forth diplomatic row involving hundreds of diplomatic staff after the US Congress approved new sanctions for Russia’s alleged meddling in the 2016 presidential election.

February 2018

Vladimir Putin inaugurated for fourth term as president after beating minor candidates in the March election.

March 2018

The US deepened sanctions on Russian individuals and entities for their alleged association with US election meddling and a wave of purportedly Russian-borne cyberattacks on energy infrastructure in the US. There is pressure on the US and its allies to ramp up sanctions. The new sanctions include Russian intelligence services, the Federal Security Service (FSB) and Main Intelligence Directorate (GRU), and six individuals working on behalf of the GRU. This round of sanctions blocks all property of those targeted that is subject to US jurisdiction and prohibits US citizens and legal entities from engaging in transactions with them.

Source: BBC country profile

Major Economic Indicators

Note: (e) estimate, (f) forecast

Source: IMF, World Bank

External Trade

4.1 Merchandise Trade

Source: WTO, World Bank WITS database

4.2 Trade in Services

Trade Policies

Russia and Ukraine signed a programme of economic cooperation in 2011, before the Maidan revolution. The document was planned for implementation by 2020 and provides for enlarging free trade and mutual protection of investments, creating a system of payment and settlement operations, and ensuring free movement of citizens. However, in Q118, Kiev announced the cancellation of its economic cooperation agreement with Moscow, marking a further decline in interstate relations.
In March 2018, officials from Iran, Kazakhstan and Russia reached an agreement on a trilateral memorandum of understanding that sets the stage for broader wheat trading. Iranian private millers are not allowed to use domestic wheat for flour exports at present, so the proposed deal includes the import of 100,000 tonnes of Russian wheat every month for private millers in Iran. In February, Tehran was in discussions with Russia on finalising the wheat import deal that would allow it to increase flour exports to Baghdad and other new regional export markets. Negotiations on the trilateral trade agreement were led by the Eurasian Economic Commission and this will help to increase and diversify Russia’s export base.
In Q118, negotiations on the creation of a free-trade zone between the Russia-led Eurasian Economic Union (EEU) and Iran were ironed out, according to statements made by a Russian government official. Russian Presidential Aide Yuri Ushakov announced on April 2, 2018 that negotiations for a free trade zone agreement between the EEU and Iran had been settled and the deal could likely be signed by the end of May 2018. EEU countries, including Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia, have been working toward a free trade area with Iran since 2015.
The broader concern within Russia’s trade profile is the limited diversification away from high reliance on primary sector output. Investors will be dissuaded by the lingering obstacles to trade that stem from the country’s stalled transition from a centrally-planned to a free-market economy. Although Russia became a member of the WTO in 2012, it continues to implement policies and duties which restrict trade freedom and add to the difficulties faced by exporters and importers. While the Russian government at all levels offers moderately transparent policies, actual implementation can be inconsistent. Moreover, Russia’s import substitution programme often leads to burdensome regulations that can give domestic producers a financial advantage over foreign competitors.
Russia’s trade openness remains encumbered by tight protectionist measures. The average tariff rate remains the second-highest regionally, at 6.3%, driven by the levying of considerable duties on imports of animal products (which average 23.1%), beverages and tobacco (22.1%), clothing (11.7%), transport equipment (8.9%) and manufactures (8.4%). The lowest tariffs are applied to cotton (0.0%) and petroleum (5.0%). Russia’s failure to fully commit to WTO guidelines is a feature of its unpredictable trade policies.
Any import or export transaction equal to or over the value of USD50,000 requires a ‘deal passport’ authorised by a Russian bank, through which the payment will be processed. Although there are generally no problems with obtaining deal passports, this adds to the bureaucratic obstacles faced by businesses engaged in international trade.
Import VAT is payable to customs upon importation of goods. The tax base for import VAT is generally the customs value of the imported goods, including excise duties. Either the 18% or 10% VAT rate may apply upon the import of goods to Russia, depending on the specifics of the goods. Import VAT may generally be claimed for recovery by the importer, provided that the established requirements for such recovery are met.
The government’s import substitution policies, such as the Food Security Doctrine, cause significant uncertainty for businesses and may result in quotas or increased duties on imports.
There are various items that fall under the import substitution regime, with certain items of machinery being restricted for import into Russia – such as coal mining machinery – where a special duty rate applies.
In July 2014, sanctions were enacted in a coordinated manner by the EU, the US, Canada, and other allies and partners. These sanctions were further strengthened in 2018. These sanctions restrict access to Western financial markets and services for designated Russian state-owned enterprises in the banking, energy and defence sectors. They also place an embargo on exports to Russia of designated high-technology oil exploration and production equipment as well as designated military and dual-use goods. Externally imposed restrictions on imports of Western-borne capital goods have delayed exploration projects in the mining sector especially.
The Russian government holds significant stockpiles of metal ores and precious metals such as palladium, and restricts the amount of metal that can be exported each year. We believe that high entry barriers and substantial regulation will obstruct new, especially non-Russian companies, from entering the mining industry, which will continue to hinder growth in the sector.
There are also various export duties and bans imposed on various items, ranging from agricultural products to minerals deemed vital to the domestic economy. Arbitrary tariffs on exports have also been implemented on primary sector commodities in order to regulate prices on the domestic market. For example, in December 2014, a new levy on grain exports was announced, the third such time that exports of grains have been restricted since 2007. This remains in place as of March 2016, having been adjusted several times, although it has been largely ineffective in increasing the availability of wheat to the domestic market and pushing down prices.
Following the signing of a package of agreements in November 2009 to establish a Customs Union (CU), Russia, Belarus and Kazakhstan began using common external tariffs (CET) in early July 2010 and launched the common economic space on January 1, 2012, enabling free movement of goods, services, capital and workforce between the three member states. A treaty aiming for the establishment of the Eurasian Economic Union (EAEU) was later signed on May 29, 2014 by the leaders of Belarus, Kazakhstan and Russia, and came into force on January 1, 2015. Following the signing of respective treaties aiming for Armenia’s and Kyrgyzstan’s accession to the EAEU on October 9, 2014 and December 23, 2014, Armenia entered the EAEU on January 2, 2015 and Kyrgyzstan acceded on August 12, 2015.
In August 2016, the Russian government added unwrought lead to the list of goods deemed essential to the internal market. Goods stated on that list may become subject to an export ban to ease internal market conditions. The Russian government has also established a permanent fixed rate of export duties on other ores, such as tungsten ores and concentrates, at 10% of their customs value.
There are also various export duties on ethane, butane and isobutene and restrictions on trade in strategic minerals such as platinum and palladium. Despite rising palladium prices, the Russian government will continue to exert tight control over the amount of palladium supply exiting the country, thus restricting the sector’s growth prospects.
Even within the Eurasian Economic Union (EAEU), there are export licensing requirements on unprocessed precious metals, commodities, waste, scrap, ores and concentrates of precious metals, as well as on untreated mineral stones.
Import and export duties are calculated as a percentage of the customs value of the goods (ad valorem) or in euros per unit of measurement of the goods, and/or as a combination of these two rates. In most cases, however, ad valorem customs duties are levied as a percentage of the customs value of the goods. For most Hong Kong-type consumer products like garments, household hardware, consumer electronics, timepieces and jewellery, current tariff rates stand at 5%-20%. On the other hand, export duties are set for a few commodities like oil products, copper, nickel and goods made of these materials. Meanwhile, anti-dumping proceedings against Hong Kong have been scarce. As at end-September 2017, Russia did not apply any AD measures on imports originated from Hong Kong.
The Russian customs tariff classification is based on the Harmonised Commodity Description and Coding System (HS). All goods carried across the country’s customs border have to be declared to customs authorities of the Russia Federation. A customs declaration should be submitted within 15 days after the goods are presented to customs authorities. Customs duties, if any, should be paid to the authorities when the goods cross the Russia border.

Trade Agreement

6.1 Trade Updates

Moscow has negotiated some FTAs and trade pacts, notably with other Commonwealth of Independent States (CIS) states, Serbia and, most recently, Egypt, which lower barriers to trade with these countries. Russia is also a member of the newly formed Eurasian Economic Union (EEU), which was launched in 2015, and also comprises Kazakhstan, Belarus, Armenia and Kyrgyzstan. This customs union is intended to abolish tariff and non-tariff barriers to trade between members and align customs duties for trade outside the bloc.

6.2 Multinational Trade Agreements

Active

Eurasian Economic Union (EEU), comprising Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia – The EEU, which is based on the Customs Union of Russia, Kazakhstan, and Belarus, was established in 2015. It was later joined by Armenia and Kyrgyzstan. In 2016, Vietnam officially became the first non-regional country to join the bloc. The union is designed to ensure the free movement of goods, services, capital and workers between member countries.
Egypt – Egypt is a minor trade partner to Russian exporters at present, though growing gas and high wheat demand in Egypt may provide an opportunity to boost trade flows.

Partially Active

Commonwealth of Independent States FTA (CISFTA), comprising Kyrgyzstan, Russia, Ukraine, Belarus, Uzbekistan, Moldova, Armenia and Kazakhstan – CIS states remain key trade partners, but Russia has suspended the application of the FTA for bilateral trade with Ukraine, meaning that barriers have been raised with Russia’s largest trade partner within the group.

Source: WTO Regional Trade Agreements database

Investment Policy

7.1 Foreign Direct Investment

Foreign Direct Investment Policy

To stimulate investment with an aim to diversify its economy, the Russian government is providing a wide array of incentives for investors developing new products, technology in the energy efficiency, nuclear engineering, space technology, medicine and IT industries. Major incentives include profits tax/property/VAT tax exemption, reduced social contribution rates, special customs regime and a 150% deduction of qualifying costs for companies conducting eligible R&D activities to reduce profits tax/increase deferred tax assets.

Other key sectors for development and investment include pharmaceutical and medical, real estate, innovations and technology, infrastructure, aluminium, iron and steel, lead, platinum-group metals, precious metals, nickel, copper, zinc, coal, telecommunications, transportation, agriculture and food and gas.

However in practice, the Russian government continues to impose some restrictions on trade flows and limits on foreign direct investment in certain sectors, while state-owned institutions are prevalent in all areas of the economy.

FDI is prohibited in some strategic sectors, as detailed in the 2008 Strategic Investment Law, which include exploitation of natural resources, defence, media and industries, in which SOEs have a monopolistic advantage. Any investor seeking to increase shareholdings or gain a controlling stake in any company deemed to be in a strategic sector will require prior government approval, which is not always guaranteed and frequently comes with certain conditions imposed. This prevents large-scale foreign investment in many potentially lucrative sectors, with the law also being arbitrarily applied to some activities that do not initially appear to fall under the description of a strategic sector. This was illustrated in 2012, when internet company Yandex was deemed a strategic asset, limiting foreign ownership in the company. In the extractive industries, government approval is required for foreign ownership above 25%. If a transaction occurs in contravention of the Strategic Investment Law, the companies involved may be subject to harsh penalties, including the complete voiding of the deal.

Another major barrier faced by foreign investors in Russia is the large-scale government presence in the economy through complete or partial ownership of companies in a wide range of sectors. SOEs dominate the market in some industries, notably hydrocarbons (through Gazprom and Rosneft), banking (Sberbank and VTB), and telecommunications (Rostelecom). Following the collapse of the Soviet Union, the country began a long and arduous privatisation process which is still ongoing, but the government has maintained an interest in many companies, whether as a minority shareholder or the owner of a ‘golden share’ (50.1%). Thus, in several instances in which foreign investors have become involved with SOEs, they remain limited to minority shareholding positions. This often leaves them unable to influence company policy and subject to undue control by the board of directors. Competition between private entities and SOEs is also limited in certain sectors where the playing field is tilted in favour of government enterprises.

Russia’s Strategic Sectors Law (SSL) establishes a list of 45 ‘strategic’ sectors or activities in which purchases of controlling interests by foreign investors must be pre-approved by Russia’s Commission on Control of Foreign Investment. In 2014, the Russian government expanded the list to include companies, investments and transactions. Regulations require Russian government approval for foreign firms to invest in strategic sectors and, in some cases, ban majority foreign ownership. Most government initiatives in 2015 point to a stronger government influence in SOE activities, including placing senior government officials on major SOE boards, dictating the percentage of SOE purchasing that must come from small and medium enterprises, and requiring Russian-made equipment purchases for government-funded projects.
In addition to a raft of pro-business reforms introduced by Putin since 2012, which have improved the operating environment, there are a number of incentives offered to encourage FDI. These will vary according to the location of the investment, the amount of capital provided and the type of economic activity. Foreign investors are exempted from the effects of unfavourable changes to legislation (for example, tax hikes or new caps on foreign ownership) for a period of seven years, if they hold more than 25% of capital in a company. A major new incentive introduced in 2014 is an income tax break for companies locating in 13 Far Eastern and Siberian regions, which effectively reduces the profit tax rate from the usual 20% levy to 0% for the first five years after initial sales income is received, and to 10% for the following five years. Some regional authorities offer a reduced corporate income tax rate of 15.5%, available for both foreign and national investors.
The most significant incentives and benefits, however, are offered through the numerous special economic zones (SEZs) that are available throughout the country to investors, divided into four broad categories. These SEZ categories are Industrial, Technology Implementation, Port, and Tourist and Recreation SEZs. These SEZs are all intended to target specific industries, for example shipping and freight transport, hotels and tourist activities, automotive and mechanical engineering, or software and pharmaceuticals. Businesses located in these zones benefit from more efficient bureaucratic procedures, freedom from customs duties, state investment in transport networks, and subsidised expenditure on infrastructure. The government also hopes that SEZs will foster the development of sophisticated industrial clusters, which enhance technological advances and boost economic growth in particular regions.
Foreign ownership is permitted, with the exception of some sectors designated as strategic. Russia’s regulatory environment will continue to restrict foreign investment from entering the country’s mining sector. Defence, oil and gas, power, mining, media, transport, and agriculture are key sectors affected. Foreign ownership in air transportation, financial services, insurance, media and agricultural land is also restricted to a maximum of 49% ownership. There are significant barriers to entry facing foreign insurance firms looking to tap into the enormous long-term growth potential of the Russian insurance market. Foreign entities considering entry to or expansion in the Russia financial sector will also need to be mindful of economic sanctions imposed by the US and EU, which potentially restrict operations over the short-to-medium term.

Sources: WTO – Trade Policy Review,The International Trade Administration (ITA), U.S. Department of Commerce

Free Trade Zones and Investment Incentives

Taxation – 2017

Value added tax: 18%

Corporate income tax: 20%

8.1 Important Updates to Taxation Information

The list of VAT-exempt goods and services includes basic banking and insurance services, services provided by financial companies (depositaries, brokers, and some others), educational services provided by certified establishments, sales of certain essential medical equipment, passenger transportation, and certain other socially important services. Effective as of January 1, 2017, a list of services rendered through the internet or other similar electronic networks by foreign suppliers to Russian individuals are subject to Russian VAT.
On January 1, 2019, new changes will be introduced, which will require foreign entities to register for VAT purposes and pay taxes if they provide electronic services to legal entities and individual entrepreneurs. Depending on the particular type of service, either the 18% VAT rate or a VAT exemption may apply. If a foreign supplier is directly involved in settlements for electronic services provided, it would be required to register for tax purposes in Russia and fulfil its Russian VAT obligations (including payment of Russian VAT and filing VAT returns with the tax authorities).

8.2 Business Taxes

Foreign Worker Requirements

9.1 Localisation Requirements

Performance requirements, such as job creation or investment minimums, can be imposed as a condition for establishing, maintaining, or expanding an investment. Securing a work permit in Russia is the employer’s responsibility and the deadline for the foreign labour requirement falls on May 1 annually.

Companies are informed of how many and which of their applications have been accepted in the following months and not all applications are successful. In 2013, the foreign labour quota for the entire country was 410,126. Some notable changes in Russian immigration policies and practices for 2015 and early 2016 include the decline in the number of HQS work permits being issued and a rise in the number of foreign nationals prohibited from entering Russia.

Presidential Order No. 583 of 28 November 2015 introduced restrictions on employers hiring/employing Turkish nationals.

The prohibition does not apply in the following cases: If, up to and on December 31, 2015, the Turkish nationals were employed or engaged for the provision of services in Russia and had proper work authorisation documents; or if the Turkish national’s employer is on the list of employers approved by the Russian government in the relevant Resolution. This Resolution, however, has placed a limit on the number of Turkish nationals that can be employed in Russia by a firm.

9.2 Obtaining Foreign Worker Permits for Skilled Workers

In 2006, in a bid to compensate for the country’s demographic decline, the Russian government started simplifying immigration laws and launched a state programme assisting voluntary immigration of ethnic Russians from former Soviet republics. Overall, securing a working visa in Russia is both complex and relatively expensive, presenting bureaucratic and cost burdens to investors looking to import foreign labour. Russian immigration authorities operate a visa quota system for foreign workers. Immigration authorities have recently been given powers to revoke quota allocations to employers if they are found to be in breach of Russian labour and tax laws. There are work permit exemptions for employees in a number of fields, and there is a newly introduced work visa category for highly-qualified professionals. This new category speeds things up considerably, as there are no quota restrictions for highly-qualified professionals. To qualify for this permit, foreign specialists must be compensated with no less than RUB2 million per year. The permit can be issued for up to three years.

9.3 Visa/Travel Restrictions

Visas are issued by diplomatic missions or consulates of Russia, the Ministry of Foreign Affairs or the Ministry of Internal Affairs (directly or by proxy). Visas can be single-entry, double-entry or multiple-entry.

Ordinary visas are divided into private, business, tourist, study, work, humanitarian, and entry visas for persons seeking asylum.

Foreign citizens from most Commonwealth of Independent States (CIS) countries and those who are permanent or temporary residents of the Russian Federation do not need entry visas.

In spite of a large number of foreign workers arriving in Russia, mainly from the CIS states, the system of attracting them is ineffective. The mechanism of selection of foreign workers from the CIS countries by professions and qualifications does not meet the needs of Russian employers. Most foreign workers’ labour contracts are limited to 1 year, which does not contribute to the employers’ interest to invest in professional training of migrants.

9.4 Language/Cultural Barriers

Though foreign language skills, especially in English, are becoming more widespread, Russian is widely spoken.

Knowledge of the Russian language is one of the key migrant characteristics which to a great extent determine his/her adaptation and integration into the recipient community.

9.5 Migrant Labour Regulations

There are three types of work visa in Russia: firstly, the single entry visa, which lasts for 90 days and is issued by the Russian consulate on the basis of a work visa invitation; secondly, the multiple entry visa, which is reissued on the basis of a single entry at a local branch of the Russian Federal Migration Service (FMS) and the visa for highly qualified specialists whom earn more RUB2 million per year.

The cost and duration taken to acquire a working visa in Russia varies according to the country of an individual’s origin.

If permits are required the complicated and time consuming application process raises costs for employers and there is considerable risk for the employer as the information given in the application is binding.

The application requires details of the position they intend to fill as well as the nationality of the expat. The process can take up to a year and once granted a permit is valid only for the specific job it was issued for and cannot be transferred to different companies or subsidiaries of companies in other regions in Russia.

If the work would require the employee to work in different parts of the country, the application must be completed for every region the employee will work in. In 2010, ‘Highly Qualified Specialist’ was introduced as a new term in Russian immigration legislation. An HQS is a foreign citizen earning not less than RUB2 million per annum from an employer in Russia. A simplified quota-free one-step application procedure for work permits and visas is established for HQS intending to work in Russia for Russian legal entities or branches of foreign legal entities (but not representative offices).

Such HQS may apply for work permits and work visas valid for three years with the opportunity to extend their validity for subsequent three-year periods, in comparison with one-year work permits and visas received by other foreigners.

Risks

10.1 Sovereign Credit Ratings

10.4 BMI Political and Economic Risk Indices

BMI Risk Summary – Q2 2018

Political Risk

The political status quo is likely to see only modest changes following the March 2018 presidential elections. With living standards having declined since 2014 alongside oil price declines, rouble depreciation and budget cuts, the prospect of greater social unrest is on the rise as evidenced by public protests across the country at the beginning of 2017. Following large scale protests surrounding the 2011 parliamentary election, the Kremlin has adopted a much tougher stance against domestic dissent and opposition voices. While a weak domestic economy will encourage a continuation of the government’s adversarial foreign policy stancethis will have diminishing returns in terms of its popular support. Relations with the West will remain icy due to Russia’s annexation of Crimea and intervention in Syria to prop up President Bashar al-Assad, the latter of which threatens to drag Russia into a prolonged, frozen conflict, acting as a significant drag on resources even as the domestic economy languishes.

Economic Risks

Russia’s economic risk index scores compare relatively well to emerging market peers due to low public debt ratios, high FX reserves and a current account surplus. That said, growth drivers will be elusive in the absence of much higher oil prices or a significant ramp up in structural reform momentum, neither of which looks probable in the coming years. The inflexibility of the labour force means that there will be a hit to future economic growth, as labour is not as easily channelled into sectors that need more workers in a ‘new’ Russian economy. Meanwhile, business investment has been in decline since December 2011, elevated interest rates have hurt the ability for companies to expand, and the FX depreciation has not really helped productivity or growth in non-energy sectors.

Operational Risk

Despite access to a large labour market, vast natural resources and robust financial sector, the Russian market remains hamstrung by structural challenges that highlight the slow pace of reform over the years. Businesses operating in the country face risks stemming from high state involvement in the Russian economy, pervasive corruption, an infrastructure deficit and an ageing population. Tepid economic growth and increasingly frosty relations with the West serve to further impair Russia’s attractiveness to investors and undermine its business environment. In particular, still-low global oil prices and the imposition of Western sanctions continue to hamstring trade and economic growth, while involvement in the Ukraine and Syria conflicts has heightened security risks and further dampened investor sentiment.

10.5 BMI Operational Risk Index

Hong Kong Connection

11.1 Hong Kong’s Trade with Russia

11.2 Treaties and agreements between Hong Kong and Russia

Alongside the Air Services Income Agreement effective since June 2010, Hong Kong signed a Comprehensive Double Taxation Agreement (CDTA) with Russia on January 18, 2016, which entered into force on July 29, 2016. To accommodate greater synergies, Hong Kong and Russia are also in the process of negotiating an Investment Promotion and Protection Agreement (IPPA).

Note: China (mainland) and Russia signed an Agreement for the Avoidance of Double Taxation (DTA) on 13 October 2016 and Investment Promotion and Protection Agreements which came into effect on February 12, 2000.

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