A Market of Extremes
Having faced a massive decline in Western investments, Russia is trying to discover a financial goldmine in the East. However, Russia’s Direct Investments Fund remains the only significant channel for attracting Arab investments into the country. This is clearly not enough to successfully compete for the gigantic investment resources in the hands of the Gulf monarchies.
After the introduction of Western economic sanctions, the flow of direct foreign investments to Russia has been on a path of steady decline. In 2015, they did not even break the $10 billion threshold, which is 5.5 times lower than in 2013. Preliminary estimates suggest that this indicator has reached as low as $7 billion to $8 billion in 2016.
However, this drop in DFIs applies predominantly to European and American companies and financial institutions. Investors from Arab countries, on the other hand, have been steadily increasing their presence in the Russian economy, having invested a record $15 billion over the last two years.
In the past Persian Gulf, monarchies were also known to display interest in Russian assets; however, they restricted their investment to several sectors only, such as real estate, extractive and oilfield services companies, as well as minority stakes in state-owned banks. The Arab money began to find its way to Russia in a systemic fashion only after a sovereign investment fund – the Russian Direct Investment Fund (RDIF) – was set up offering a mechanism for co-financing investment projects. In this arrangement, the Russian side not just shares the investment risks but also acts as an underwriter of sorts, guaranteeing the safety of investments and minimum returns for Arab investors. The latter have so far been represented predominantly by sovereign funds from the Persian Gulf countries.
For instance, in 2014, the Qatar Investment Authority, a sovereign fund from Qatar, announced that $2 billion would be earmarked for a direct investments fund set up jointly with RDIF. Since then, there has been no mention of any specific investment projects run by the Russian-Qatari fund. However, over the same period, the Qataris have invested around $1 billion in various projects in Russia on their own, including an investment totalling $400 million made two years ago to acquire an elite townhouse estate called Pokrovskiye Hills outside of Moscow, while in September 2016, news came of QIA’s acquisition of a 24.99% stake in the Pulkovo airport in St. Petersburg for €239 million.
In late 2015, a sovereign fund from Kuwait – the Kuwait Investment Authority – announced that they would double their investments into the joint fund created earlier, together with the RDIF, up to $1 billion. Again, there was no mention of any specific projects that had been financed by them.
In 2015, after dodging Russia for years, Saudi Arabia also invested a record $10 billion through the Public Investment Fund, a sovereign fund of its own. It was envisaged that the money from this fund would be invested over the next four to five years in Russian projects valued at $1 billion each. Infrastructure, agriculture, health care, logistics, retail, and real estate have been identified as priority targets. Nevertheless, to this day, none of these projects have been implemented. As late as mid-2016, it transpired that the Saudis provided just over $50 million to build a petrochemical combine in Tobolsk, in the Tyumen oblast.
UAE’s sovereign fund Mubadala has been much more proactive on the Russian market – it funnelled $1 billion into an investment fund created jointly with RDIF in 2013. UAE’s interest has been piqued specifically by such sectors as logistics (the fund purchased warehouses outside of Moscow from the PNK Group for $100 million), port infrastructure, agriculture, oil production, and telecommunications. In addition, Mubada took part in various transactions to privatize the stakes in Alrosy and Russian Helicopters owned by the state.
In 2016, RDIF created a $2 billion joint fund with yet another investor from the UAE – DP World – DP World Russia, a leading global port operator, where the Arab and Russian partners hold 80% and 20%, respectively. The money is slated for investments into Russian ports and logistical infrastructure enterprises. However, as of today, this portfolio is known to include only one potential investment of this sort – the probable acquisition of a 49% stake in NUTEP container terminal in Novorossiysk.
A business built on trust
While Arab capital has been increasingly gaining traction in various transactions over recent years in Russia against the backdrop of economic sanctions, it appears that it has yet to translate into a qualitative increase in investments into tangible projects. Joint funds have been slow to allocate money for real projects, which can mostly be explained by ‘execution errors’: Either the RDIF pursues multi-billion dollar projects that prove too large and it may take years to structure such deals, or being a state-owned institution, the fund offers to the Arabs projects that are not sufficiently attractive from a financial standpoint while the quality of corporate governance is also low.
In addition to these ‘technical’ aspects, Russian-Arab investment cooperation is also impeded by a number of other key factors, the first and most obvious of them being the fact that the RDIF is actually the only channel that could be used to attract Arab capital to Russia, while an efficient market presupposes the involvement of a greater number of players. This would give rise to healthy competition and make the system less vulnerable. Russian investment companies can set up more joint funds – even if they command smaller fortunes, they can have a clear-cut narrow specialization and target the development of small and medium-size businesses instead of pursuing mega projects.
Secondly, Russian partners virtually ignore private capital in the Arab countries, even though it exceeds a half of the aggregate wealth of the Persian Gulf countries. According to Credit Suisse, 59,000 millionaires live in the UAE alone, and by 2020, their number is projected to reach 96,000. In addition to sizeable financial resources (according to McKinsey, private capital in the Arab countries total more than $3 trillion), businessmen from the Gulf countries command advanced expertise in such areas as tourism, trade, construction and real estate management, logistics, transport infrastructure, and financial services.
Thirdly, the Russian counterparts tend to ignore the very existence of Islamic financing, which is a part of a huge investment potential in the Arab world. Deals in this domain are few and far between. For instance, in late 2014, Ak Bars, a bank from Tatarstan, raised $100 million from a consortium of Islamic investors. However, over the last two years, not a single new transaction involving Islamic financing has registered on the radar.
Fourthly, even though regions in Russia are in desperate need of direct foreign investments local authorities still do not spend enough energy on attracting the Arab money. This applies even to those regions that have been historically dominated by Islam. Tatarstan, for instance, still cannot claim any large investment projects that would be financed by Muslim countries.
In the meantime, what is at stake is a huge amount of money. The cumulative investments, that the monarchies of the Arabian Peninsula have at their fingertips exceed $10 trillion, and this money is predominantly invested in the developed markets, such as the United States and Western Europe, as well as leading developing countries of Asia, primarily India and China. So far, Russia has received but a minute portion of this money.
Faced with stiff competition for Arab capital, the efforts of a single institution such as the RDIF have clearly fallen short. A regular initiative is required from the community of private entrepreneurs as well as precision-guided systemic work with each investor to create not just an enabling environment but unprecedented conditions for the Arab partners both at the federal and the regional level. What is also required are new financial instruments that meet the Islamic norms as well as qualified financiers whose training or recruitment abroad for work in Russia should become a priority.Apart from working with large financial institutions at the state level, interaction with private investors is equally needed along with business climate improvements. Most importantly, it requires ongoing and targeted work, which will ultimately bring about a sustainable atmosphere of trust – a cine qua non in working with any foreign capital.