An analysis of the effectiveness of investment in housing in Russia

(for St. Petersburg and North-Western Region of Russia)

Terminology

1. Provided construction market analyst and investment concerns exclusively the market of North- West region of Russia, if not specifically stated otherwise.
2. The presented analysis relates exclusively to the construction market, which includes residential housing market as well as some construction and operation of commercial real estate such as office space and storage facilities, etc.
3. All figures relating to land and volumes are in metric system.
4. All financial indicators are presented in Russian rubles, unless otherwise indicated.
5. The course USD to RUR at the time of writing the report was 23.4573 rubles / USD.

Overview

Construction industry in Russia in recent decades has undergone significant changes of stagnation and decline in 90 years of the twentieth century to the development and substantial growth in the first years of twenty first century.
Changes touched not only the volume and pace of construction, but also the structure of the industry, joining Russia in the construction market of new technologies, materials, sources, routes and patterns of investment and financing.
Political and macro-economic life of the country, starting in 2000 has also undergone
significant changes, formed and voiced by President V. Putin in perspective, adopted and continues gradual development of the President D. Medvedev.

Residential construction today is very much favored and from 2004 is presented, budgeted and maintained the Russian Federation’s national project called "Affordable and Comfortable Housing to the Citizens of Russia ".

The dynamics of price growth in the secondary housing market since January 1998 is 2992.82%, and the market of newly built housing is 2539.93% and continues to grow.

Indicators of growth in price of 1 square meter of housing from 01.01.1998 to 06.27.2008 (10 years), ruble/m2

The increase in prices since early 2008 for the month of June had already amounted to 25%.
Growth in land prices, as well as commercial real estate has a similar trend, according to
some even exceeding the above positions.
The volume of new housing in 2007 exceeded annual record of the volume of construction of Soviet times and continue to grow.
Volumes commissioning of commercial real estate - office centers, trade and
warehouses, hotels, as well as large logistics complexes grow 2 times greater than the pace of residential housing construction, and the deficit in the market of commercial construction is not declining, and continues to grow.

Particular attention should be paid to the consideration of land use.
Russia adopted a system of land zoning, which represented major factors relating to housing:

1. Earth settlements
2. Earth Farming
3. Earth's industrial enterprises
which translated from one category to another, usually in the category of "Earth settlements"
indeed represents a fairly complicated, and cost-consuming procedure, but contains a good business potential. Special statistics in this regard are not there, everything depends solely on the location of their land and demand.
For a more detailed review the current state of real estate market - land, housing, commercial real estate acquisition or perhaps an order of case studies presented at the site of the Group of Companies RosBusinessConsulting (http://www.rbc.ru/company.shtml) http://marketing.rbc.ru/industry/1203813.shtml

Investment climate of St. Petersburg

Rating of investment attractiveness

In September 2003 Russia entered the top ten most attractive for foreign investment countries. Russia has committed the most remarkable breakthrough: in 2002 it jumped from number 32 to 17, as in 2003 to number 8, and 6^th place in 2005.
In October 2003, international rating agency Moody's raised the ceiling in sovereign rating for Russia to investment grade Baa3. Earlier, Russia has been speculative rating Ba2. As a result, Russia for the first time in its history won investment grade credit rating (Vaa3). Simultaneously to the same level -- Va1 - were raised ratings of ruble bonds and bank deposits in the ratings
foreign currency. Forecast of all ratings - stable.
In October 2005, Moody's upgraded rating on Russia and liabilities in foreign national currency at one stage - to "Baa2" from "Baa3". Outlook on the rating remains stable.
Existing ratings are the highest investment attractiveness levels of ratings ever assigned to Russia. The level of these ratings reflects relatively high the country's ability to promptly and fully implement their bonds, shows the creditworthiness of Russia.
On May 22, 2007 the international rating agency Fitch Ratings upgraded Long-term ratings of St. Petersburg to foreign and local currencies from Level BBB- to BBB. Outlook on ratings - "stable".
On February 2, 2004 rating agency Standard & Poor's revised forecast changes in the rating of St. Petersburg from "stable" to "positive" in connection with the continued growth in the city’s economy and improve the structure of debt that will positive impact on the creditworthiness of St. Petersburg if the new administration will demonstrate the continuity of financial and socio -
economic policies. At the same time, Standard & Poor's confirmed the long-term credit rating of "BB”. Later, in November 2005, the rating agency Standard & Poor's rating upgraded to the level of BB + (positive).
On April 21, 2006 agency Standard & Poor's upgraded the long-term credit rating of St. Petersburg to "BBB-". The forecast changed rating - "stable".
On March 7, 2007 agency Standard & Poor's confirmed the long-term credit of Saint Petersburg to "BBB-". The forecast change rating was upgraded from "stable" to "positive".

Support for investors; the protection of their rights

Government supports investors exercised at the state legislative federal and regional levels, ensuring the protection of private and foreign investments.

Support for investors at the federal level

Foreign investors can take place in the Russian Federation different ways.
The simplest way of doing business in Russia is to establish a branch of foreign organizations.
Another way of doing business in Russia is being directly involved in commercial organization. As noted above, if a foreign entity becomes the owner of more than 10 percent of shares in the authorized capital of household society, it already has direct investment in accordance with the Federal Law "On Foreign Investment in the Russian Federation." The opportunity to participate in commercial organization can be either in the process of establishing a new entity, or through the acquisition of shares and (or) the assets of an existing customer.

Customs nature of the investment incentives

According to the customs and tax laws, incentives to pay customs are payments provided in accordance with the Law of the Russian Federation "On Customs Tariff" as of 21^st of May,
1993, � 5003_1 and the second part of the Tax Code.
Exemption from value added tax on goods imported on the customs territory of the Russian Federation, applied in accordance with the provisions of Article 150 of the Tax Code.

Tariff concessions

According to Article 35 of the Russian Federation Law on Customs Tariff (Revised
on December 24, 2002) as of 21^st of May, 1993 � 5003-1, the following are exempt from customs
duties:
-- Equipment, including cars, machinery, as well as materials comprising the kit of the supply of related equipment and components imported to customs territory of the Russian Federation in loans granted to foreign nations and international financial organizations according to international treaties of the Russian Federation (Article 35, paragraph "N." Act);
-- Goods imported into the customs territory of the Russian Federation, including
imported for leasing, to carry out the works on production sharing agreements in accordance with the program of such works and investment with an estimate of costs, approved in said agreement stipulated order, or exported from the territory in under the terms of the agreement. In such a case, levying import and export customs duties replaced section products in accordance with the terms
of the production sharing agreement concluded in accordance with federal law on production sharing agreements "(Article 35, paragraph "O", Act).

Tax credits

In accordance with Article 150 of the Tax Code, importation into the customs territory of Russian Federation, technology equipment, components and spare parts to it, imported as a contribution to statutory capital organizations are not subject to taxation. .
In Russia investment laws are not detached from reality, and apply to very active foreign investors, who, along with Russian parties protect their investment activities violated rights under the judicial system.

Support for investors at the regional level
Government guarantees of St. Petersburg

Providing government guarantees of St. Petersburg is in accordance with the law of St. Petersburg from 07.30.1998. The law is on government supporting investment activities in the territory of St. Petersburg and the Regulations on the selection of investment projects implemented with the involvement of collateral (safeguards) Administration of St. Petersburg, approved by chairman and KEPP Finance Committee chairman 4.11.1997 d.

Regional tax breaks

Article 11_2 Law "On tax benefits" provided a legal provision which created the participation of St. Petersburg and foreign investors on the basis of international agreements of Saint Petersburg with governments of foreign countries, following tax benefits:
The release of seven years or a deadline set by international agreement, but no more than seven years, following the payment of taxes and payments:
-- Property tax on businesses in parts of the amounts credited to the budget of St.
Petersburg;
-- Land tax in the amounts credited to the budget of St. Petersburg.
Special condition for receiving benefits are actually contributing to foreign investors in the charter capital created entity, which is the equivalent of at least $1 million U.S. dollars, and direct capital investment in the sector of material production of St. Petersburg, produced by foreign party entity, is the amount the equivalent of at least $10 million.
-- Providing investment tax credit (the tax deferral of payment)

City of St. Petersburg on July 12, 2002 adopted a law on investment tax credits "� 316-28, as well as developed and approved by the Committee of Finance Administration of St. Petersburg on August 6, 2002 � 56_ p "Regulations on investment tax credit."
-- Providing incentives to investors when renting real estate of St. Petersburg.

-- Providing benefits of rent for the land and facilities of non-residential zoning.

-- Providing extensions and postponements of payments for the provision of facilities of real estate.

In accordance with the Law of St. Petersburg on investment in real estate of St. Petersburg from July 30, 1998: federation, foreign citizens, as well as Russian and foreign legal entities can serve as the investors and can participate to bid for rights to provide them with real estate located in the city of St. Petersburg, on investment conditions.
News of 24.04.2008 reported:
Source: http://realty.rbc.ru/regions/article.shtml?url=2008/04/24/12952239&region=spb

One of the biggest German companies Hochtief AG displays the Russian market as its developing unit. As it became known in the RBC Daily, St. Petersburg already registered subsidiary of Hochtief Development Russland, which will lead office and will pursue investments throughout Russia. While the company does not name its potential projects, already knows that it will invest in the sector of Northern commercial real estate capital St. Petersburg and Moscow.
German holding company Hochtief AG unit includes Hochtief Airport, Hochtief Development,
Hochtief Americas, Hochtief Asia Pacific and Hochtief Europe. The turnover of companies in 2006 amounted 15.5 billion euros. At the end of 2006 portfolio company reached 25.1 billion euros.
St. Petersburg already registered subsidiary of German group Hochtief Ltd.
Development Russland. While German group would focus their attention only on the market of St.
Petersburg, press secretary Hochtief AG Christian Gerhardus told RBC Daily: "Here we are studying several proposals for buying land for future projects. First of all we are interested in higher office building segment, as well as hotels and storage facilities. The volume of investments and future projects projected high and difficult to know at this point." He noted that the company will look for promising projects in other regions, particularly in Moscow. Hochtief Development Russland will work as a classical developer, buying spots and attracting funding. Construction will be done by local subcontractors, and at the final stage projects will be sold, the source explained,
close to the company.
Market of St. Petersburg attracted German holding company so to get land in this prime location of Russia if Moscow is no longer possible, believes the director of consulting Alexei Chizhov. Profitability of commercial real estate sector of St. Petersburg concedes Moscow 2-3%, but it is easier to enter because of their civilization and it is closer to the West, agrees Director of Development group of companies TSDS Vyacheslav Lazarev. According to analysts of the company Astera, the average yield of commercial real estate projects in Russia today is 12% to 4-6% in
Western Europe and 5-7% in Eastern Europe. According to a senior investment analyst, Vladimir Sergunina, the main challenges that face the new investors will be linked to the harmonization of projects and obtaining the necessary facilities for their implementation.

Market housing investment climate and the St. Petersburg region does not concede similar indicators of St. Petersburg, and for some items (land, industry and production of construction materials), even exceeding them.
More information on the market of construction industry and investment climate of St. Petersburg
area can be found on the site of St. Petersburg region: http://www.lenobl.ru

An active and dynamic development of road network around St. Petersburg (ring-road construction - Ring Automobile Road), ZSD (Western High-Speed Diameter), design and construction of the third transport ring, passing exclusively on the territory of the Leningrad region, the construction of toll roads St. Petersburg-Moscow, the construction of Seaport in Ust-Luga, Leningrad area to fully assume the processing of marine cargo, carried out today in the ports of Finland, Germany and gives Pribaliyskih States a significant incentive to attract people of Russian Federation and adjacent
states as a workforce of engineering and management personnel and, accordingly, to ensure their quality, affordable and comfortable housing in St. Petersburg region.

Housing finance
Common financing options

The most common options in housing finance are:
1. Government participation (through the allocation of land, organization and construction of communications, roads, etc.) at a level not exceeding 25%.
2. Investment funds from private investors.
a. Investment funds from pension and mutual funds
b. Funds of construction companies (spec homes)
c. Funds of future homeowners, such as equity in construction.
The funds that come from future homeowners are usually available as savings, formed from the sale of existing home, public subsidies and mortgage loans granted by banks on overall market grounds.
Mortgage lending in the last 3 years has been very dynamic and widely spread. Credit terms are as close as can to the U.S. mortgage lending terms, but annual interest rates for credit start from 9%.
All the investment options equity participation are already sufficiently regulated, settled as the
federal law and continue to develop.

The acquisition of property in land

The acquisition of property in land is governed by the Land Code of the Russian Federation and
regional legislation and submitted transparent procedures Auction bidding in cases where land is purchased from the government.
Upon acquisition of land of secondary market, including land zoning such as farming is carried out in accordance with standard procedures for the sale of real estate.
All transactions with real estate and the transition of ownership of real estate property is registered in the state registration http://www.gbr.ru

Lending by banks in construction

One of the weaknesses and undeveloped housing credits is the fact that it was impossible to ensure procedures and regulations of banks to organizations, carrying out construction. The reason is the lack of long history of production, lack of basic facilities and, respectively, credit history enterprises. Typically, here today, under construction of multi-residential complexes or a cottage villages, new enterprises, which lead from the start of construction and subsequently implement
operation and management of these residential complexes.

In the process they build working under the brands of well-known construction companies, and after remain small Management Company, manage the operation of these complexes.

Private investment in residential (low stories) housing construction

The active development of residential low stories housing market and rapid return on your investment parish funds that led the market, even non-profit organizations that invest in development projects that provides significant benefits in any of the phases of their implementation.
There is a company that buys in the secondary market that has already designed in a property
land in order to resell them over a short period of time - six months to a year -- in this case the benefit of the investment is 25% to 100% and substantially exceeds the deposit proposals of banks. There are companies who acquire such plots, minimally investing in preparations for the massive housing construction -- the laying of roads, connection to communications - electricity and gas that gives a supplement to the original value of more than 2 or even 3 times more than initial investment.
The coming into the market for developers, whose business consists exclusively in the preparation of land to massive low-story building, thereby gives investors good investment benefits with minimal investments.
But parish to market of low-story construction, investors "full cycle", implementing the construction of households "turnkey", from the acquisition and preparation of land use its own production of construction materials or designs, implementation and operation management functions built in
towns in the years ahead will give investors the biggest such investment gains.

Review of housing market in the Leningrad Region

In the first quarter of 2008, analysts have observed a sharp increase in the suburban real estate market. According to the "St. Petersburg Real Estate" (http://www.spbrealty.ru/)
Today 96 townships are open for sale for cottages and there are 88 more at the design stage.
It should be noted that the construction of residential households in Leningrad is merged into cottage villages. The number of households ranges from 5-15 in elite class, and 200-300 in economy class.
Classification of cottage villages conditionally divided into:
1. Average
2. Business
3. Premium
4. Elite
and the price differs from the 2000 USD per square meter to 6000 USD per square meter; excluding the price in class ELITE.
Consequently, the cost of one cottage, the average total living area of 150 m2 (1615 sq.ft) ranges from 300 000 USD to 900 000 USD. The cost of 1 square meter of real estate Class ELITE starts from 10 000 USD per square meter and in exceptional cases reaches 25 000 USD per square meter.

Lots are classified as already mentioned, depending on category of land, their degree of preparation and connection to the necessary communication and location, which often plays a decisive role in pricing.
For example the most expensive areas are estimated along the shoreline of Neva, as well as other rivers and lakes. The existence of water surface gives to 2-3 fold increase in price plot, the value of which may exceed the value of the homes on it.
On the number and prices of some of the proposals in the townships of cottage you can view the
presentation from the site "All the towns of St.-Petersburg and Leningrad region" http://poselkispb.ru/ , where the proposal and proposed to consider investment proposals for settlement ERMAK Community St. Petersburg (http://ermak-communitu.spb.ru)

In the market of commercial real estate - office, commercial and entertainment centers, hotels, etc., main factor is the pricing location facility investment, with demand being as high quality performance, finishing and filling facility investments necessary communications, its layout and even species characteristics.

Plans and projects of households

Long history and visual example of St. Petersburg as the architectural world, raises concepts and intentions of future homeowners’ level given their citizenship standards. Hence there is increased interest in projects with stone, solid and cultured. A significant proportion in the structure of the proposed project represents a log house, where the leaders are certainly the Finnish with their projects and their plans for construction.
Slight but steadily rising interest due to affordability formed to quick-frame prefabricated buildings of light, but strong materials that have passed the test of time in Scandinavia, Canada and northern
Europe. Restrictions on the market are technology and materials used in the U.S. market.

Building materials and construction

Traditionally, the construction industry in North-West Russia used cement - concrete materials, processed round and sawn wood, glue, beams, bricks, structural blocks and monolith, keramzitobeton and penopolistirolbeton in blocks.

In the outdoor decoration typical use is natural stone, artificial stone, plastic siding, prefabricated metal, and ceramic tiles. The material for the roof recently became metal, asphalt cover; often continue to use and less expensive slate of ceramic coating tiles and copper. In roof structures dominated by lumber, although limited, imported from Finland are starting to use prefabricated metal of company called Makron Rossette.

Equipment life

In the design and construction of residential low story households use the most common brands of equipment for the fence, feed and water filtration, combined heating systems using gas, oil and
electricity, integrated system of waste disposal and treatment of life and also in security, protection of intellectual and filling homes.

Landscape beautification

In the landscape improvement used natural and artificial materials, open landscape is plotted with special mixtures of grasses, arranged open and closed swimming pools and natural bodies of water are used for bushes and high plantings of trees. Typically, new owners of real estate property surround their new household with fences relevant to desires of homeowners or dictated by the status and level of security of the neighborhoods.

Opportunities for investors

We're working on preparation for the implementation of investment projects at various levels of investment of 50 million USD and above, which consists in identifying, finding business models and implementing such projects in the Leningrad Region.

One of the projects for possible implementation is before us as a draft of ERMAK Community St. Petersburg (http://ermak-community.spb.ru), involving the resettlement through dilapidated housing in the immediate vicinity of St. Petersburg to create two residential plots Class "Business" and "Elite".

As mentioned above, the dominant role played in pricing are:

1. Location
2. Types
3. The quality of execution
4. The availability of communications
  
The draft pricing of the above factors are connected together, which gives confidence that despite the labor resettlement of dilapidated housing, future prices of real estate will more than cover the costs incurred.

The main parameters of the project

Town Im.Sverdlova is located on the right bank of the Neva in Vsevolozhsk district of Leningrad region.

The distance of the village from St. Petersburg is 20 km, distance from Automobile Ring Road, giving the shortest access to all areas of St. Petersburg and departure in the suburbs is 7 km, and to Vsevolozhska city, district centre distance is 20 km.

Town sparsely populated, partly built multi-houses, partly by low buildings with a perspective to development through the renovation and development of new land within the settlements.

PLOTS FOR TERRITORY - RENOVATION

One of the most difficult problems associated with land settlement is the renovation of dilapidated housing resettlement, but a reasonable integrated approach provides an opportunity to carry out the release of land settlements from dilapidated housing with a maximum social effect. One of the priorities of dilapidated housing resettlement is submitted, including the corridor-type houses, which is the only shelter for large quantities, usually disadvantaged families who do not have in the short term self opportunities to improve their housing situation.

Our task, as proposed by the Administration "Sverdlovskoe urban settlements" is to find solutions for the resettlement of dilapidated housing and the development of settlements in the territories stations:

1. UL.ERMAKOVSKAYA, HOMES FROM 1 TO 8 (called ERMAK)

2. 1-Y MIKRORAYON, HOUSES WITH 19 TO 23 (called CENTER)

Old housing at the sites represented 2 - x storied buildings built in the 30ies, already for lesser quality homes, of which 2 corridor-type homes, and the remaining majority represented populated houses such quality.

Area 1 site is occupied by dilapidated housing, is about 5 hectares, the area of second site is approximately 0.5 hectares.

The first station is located in the western side of the village, 2 - and in the central part of the settlement, both located in the first section of the line of the Neva, are the lands of settlements, the distance between them on the shoreline about 3 to 4 kilometes.

CONCEPT OF DECISION

The conceptual solution for the resettlement of dilapidated housing and development in areas liberated territories "ERMAK" and "Center" is phased relocation of residents in dilapidated housing or other exempt municipal housing as well as in the newly built as part of an integrated investment project a new 5 - storey house on plot "Center" at the same time and phased construction of a new, low, modular housing and individual houses and cottages, grouped in separate residential complexes at the site "ERMAK".

HIGHLIGHTS PARAMETRY INVESTMENT PLAN

With the phased construction of 3 - 5 x section - and storey building at the "Center" to be attended by the Administration "Sverdlovskoe urban village" in the form of temporary shelter from municipal housing are exempt credit shelter in the newly constructed house.

DIMENSIONS 3 - 5 H SEKTSIONNOGO - ETAZHNOGO ZHILOGO HOMES
AT UCHASTKE "Center"

The total area of the building is estimated at 12 750 M2, including, of which 10 300 M2 - the total area of apartments and 2 450 M2 - a combined area of public service:

1. At 18 apartments on 50 m2 on each floor,
TOTAL 90 apartments with total area of 4 500 m2

2. At 6 apartments on 100 m2 on each floor,
TOTAL 30 apartments with total area of 3 000 m2

3. By 4 to 140 m2 apartment on each floor,
TOTAL 20 apartments with total area of 2 800 m2

The area of the courtyard and adjacent territories is 2 200 m2

TOTAL 140 and, if necessary, dividing large apartments into smaller and all 160 apartments in the new house will ensure all tenants living today in dilapidated housing to individual housing in accordance with the rules set forth the current legislation.

The first floors of the external perimeter sections provided premises for commercial use - shops, beauty salons, cafes, etc., which will provide the newly formed TSZH necessary means for improvement and maintenance of the home, front and back yards and adjacent to the house territories.

More than half of all apartments are premium - whose windows overlook the Neva, which is a significant advantage.

Ability to maximize the use of government subsidies and credits to settle the waiting and mortgage lending for able-bodied tenants relocated from exempt municipal housing, and with sales of apartments in the new house will allow third parties to make debtors and the resettlement of poor families in dilapidated housing are exempt municipal or newly purchased specifically for their shelter. In any case, each of the resettled from dilapidated housing suggests priority and equal conditions for resettlement in new housing.

PARAMETERS OF HOUSING COMPLEX ON THE PLOT OF "ERMAK"

At the total land area "ERMAK" in 5 hectares to be built around 50 block homes type "town house" area from 120 to 450 m2 in land area hundredth part 2, and 16 individual houses, isolated at the sites of 12 to 18 kitchen. Storey houses from 2 to 4.

Optional proposed basement and operated by a gable roof, inspection hatches and summer or winter space on the roof, heated or "cold" garages, interior fittings built furniture and household appliances.
All houses are "species" - targeted species on the Neva River.

The inner courtyard is equipped with common tennis courts, children's sports grounds and places of recreation, including equipment on the quay length of the coastline for leisure complex tenants.

Part 1 - x floors outside the perimeter of the complex available for commercial use - shops, beauty salons, kindergartens, studios, cafes, etc. That will allow for the newly formed TSZH receive stable income to pay for content inside the territory of common use and protection of the complex.

MILESTONES AND DATES ON INVESTMENT PLAN

Contents Stage Indicative deadline implementation

The volume of investments and investment profits

Estimated investment in the implementation of the project is estimated at $48-50 million USD.

Investment gains from the project investor full cycle, which is investments ranging from dilapidated housing to resettlement of construction using their own production facilities for producing memory, window and door structures, systems and coatings of rafter roofs range from 50 to 100%.

As property investor benefits remain active in the production units and remember in the monolith, assembly line to produce door and window units and the production line to produce Rafter systems and structures for technology Rosette (http://www.fin-lmk.ru/rosette.html) and profiles to cover roofs.

Other projects

In addition to higher debated draft, in the field of our attention there are a number of other investment projects involving the construction of cottage villages with the use of agricultural land.

The World’s Best-Kept Secret

Deniel Torniley (Senior Vice President, The Economist Group)

When doing business in Russia, you may lose all your money. Your Russian business partner will steal it because he or she is a swindler. Besides, the Russian mafia will get you right in your hotel room during one of your visits either to Moscow or St. Petersburg

This is the standard approach to business in Russia and it has almost nothing to do with reality. Successful business in Russia is one of the best guarded secrets in the world. The achievements and experience of Western companies demonstrate that it is possible to operate successfully on the Russian market.

A Boom in All Sectors

Today, businesses in developed Western economies are almost incapable of securing incomes whose growth approaches at least ten percent; more and more often, they turn their eyes towards the so-called BRIC markets (Brasil, Russia, India, and China), China and India coming first in the list. Nevertheless, sales growth rates in Russia are among the world’s highest (the volume of Procter & Gamble’s sales in Russia reach 65% of their sales in China, and Russia comes seventh according to sales volume in the structure of the company’s operations).

It is not only a boom in the consumer sector. The sales of Western IT companies such as IBM, Oracle, and Microsoft have been expanding by over 50%, and sometimes even by 100%, annually over the past several years.

Russian heavyweight players strive to enter international stock markets and increase their transparency and the quality of corporative management, which in its turn facilitates their sales. The annual surplus of sales in Russia is 30% and above for such companies as Dow Chemicals and DuPont. The companies consider that their business in Russia is developing perhaps even more successfully than on other national markets. The two companies intend to arrange their own production in Russia. According to their estimates, they have a one- to two-year head start before Russian competition strengthens.

Pharmaceutics and medical companies are boosting their sales by 25-35% a year. Most of them have registered their Russian affiliates to enter the ruble market and diversify their distribution.

Service companies are also developing their business successfully in Russia. One of the “Big Four” auditor companies is expanding its operations in Russia much faster than in any other country in the world. Western banks managed to organize a series of medium-scale acquisitions last year. Retail is seen as the most promising sector in Russia’s banking business.

Competition Strengthens

Most Western companies in Russia report strong profits with their strong sales, which is a rarity globally. The FIAC survey indicated that 55% of companies are seeing profit increases of more than 20% per annum. An EIU survey of 280 companies ranks Russia in the top spot among other markets.

The market is so profitable because competition is relatively low. Another reason for the high profits is that when Russians have disposable income, they will spend it on quality products, even if they are consumers with modest incomes. Russia is probably the best premium-price market in the world today. Almost all regions in Russia are available for further business development. The average Western company does business in ten to thirteen regions and wants to expand as Moscow tightens up. On a scale of sales, if the average company sells a hundred items in Moscow, it will do 25-30 in St Petersburg and five to fifteen in other regions.

Sales will remain good, but profits may go down from unsustainably high levels as salaries for Russian staff start to rise, office rental costs boom, and advertising costs pick up. Profit levels are now under more pressure, but despite that, the Russian market is still very attractive.

Growth to Continue

The ruble is now one of the strongest currencies in the world. Full ruble convertibility, introduced last July, means higher domestic investment, more financing opportunities for Western investors, a rising stock market, and an even stronger ruble. Russia’s entry into the WTO, set for 2009, will enhance business opportunities for Westerners but will not help Russian companies very much, which is why they have been resisting it.

The country’s economy keeps developing, and it looks like the trend will last for at least another five years. The GDP will grow over 6% for the next three years. The retail sector is growing at 30% per annum, with food sales rising 45%. %. Annual disposable income will increase by 13% per annum until 2011 – one of the fastest levels globally. Real wages (after inflation) rose 14% in 2006 – perhaps the fastest real wage growth in the world. Domestic credit leapt 110% in 2005 to $50 billion, but credit emission will still be growing 30% annually. In industry, fixed investments will grow at 10% each year until 2012.

Not So Bad

Perhaps the firmest and most inaccurate prejudices concern the legal system. Nearly all Western law firms and the Big Four accountants argue that Russia has a functioning tax and legal system that works fine for their Western clients. Commercial cases take four to ten months to resolve on average, quicker than Central European jurisdictions and the US and UK. Legal costs are therefore much lower: 10-15% of those in the US and 30% of those in Europe. The arbitration process in Moscow is so good that most Western companies choose Moscow ahead of Geneva or Stockholm on their lawyers’ advice. Admittedly, attaching assets is tough. Some judges in the regions are corruptible but as appeals get closer to Moscow, the chances of success rise.

Why do Russian courts have such a bad image in the West? The Western media often distorts things. They report the initial sensational aspects of any case involving Western business but then fail to follow the story through.

Trustworthy

Most Russian business partners are trustworthy, and most Western executives actually enjoy working with Russians. Developing personal relationships brings good commercial rewards. During the 1998 ruble crash, many Russian distributors went out of their way to repay credits to their Western partners when they could have claimed bankruptcy and skipped off with the money instead. As one UK pharmaceutical company said, “In Russian business, one’s word actually counts for something and contracts work. This is not so in Ukraine.”

There are swindlers in Russia too, but companies report some of their lowest bad debt levels in the world in Russia at 0.2-0.5% of sales. No wonder Western companies often operate on standard credit terms with their distributors of 90-180-360 days. Corruption is overblown and depends on where you judge it – from the West or from within Russia. It exists but is no worse than in other big emerging markets. Several EIU benchmark reports support this: China, India, and Russia are all in the same ballpark. Surveys by the EIU Vienna office of country and regional managers who know the market intimately indicate that more than 95% think corruption is nothing unusual, that it is not getting worse, and that it is manageable. Western pharmaceutical companies report more problems with re-exports from Greece to Scandinavia than from Russia to Europe.

Problems: Imaginary and Real

There are three main risks for businesses in Russia. First, if oil prices collapse, this will damage Russia, but the oil price outlook is steady and Russia is building up massive reserves in its Stabilization Fund. Second, the political succession to Putin as President could unravel. However, it looks unlikely, as Putin is trying to put all the pieces in place to ensure his legacy and stability. He obtains popularity ratings in objective opinion polls of over 65%, because for most Russians, the last five years have been the best for combining economic success with political stability since 1914.

 Third, the ruble looks very strong and continues to appreciate. If the oil price fell to $45 per barrel and a spate of Russophobia cropped up, the markets might make a bet against the ruble. Nevertheless, currency reserves look strong enough to combat this, and a ruble drop of 20-30% would not faze the government and would please Russian exporters.

Western companies in Russia will face much more commonplace commercial challenges in the next five years. Sales growth will stabilize, while costs will rise. Executives will have to manage expectations downwards as the market matures. Companies will have to manage more regions. Retaining the best staff will require excellent HR skills. Distribution will remain murky but more companies will undertake their own.

Companies will invest more in factories and look to factory floor efficiency to raise productivity. In corporate structures, executives will ponder where to stick Russia; increasingly, as the market grows, it will become a stand-alone market, detached from CEE structures, and reporting to global headquarters. Perhaps the Russian government should give itself a present: employ a Manhattan PR agency to improve its business image. Those companies that operate in Russia are aware of its advantages, but others are not.

Analytical material prepared by

General Manager Manasseh Makolskiy of

OOO Agency of Mortgage Services

St. Petersburg, Russia

And Joseph Max Ivannik

Senior Production Manager of America’s Home Place

Chattanooga, TN United States of America