German companies are increasingly investing in Russia

The way in which the Germans circumvent the economic sanctions introduced by the EU after the annexation of Crimea and the Russian embargo on food from Europe, are FDIs in Russia.

They are encouraged to do so by the Russian authorities, which offer special privileges for new investors. “Russia is a strategically important growth market for Mercedes-Benz, which is already exhibiting very high turnover. That is why we are expanding our global network with production facilities in Yesipovo near Moscow,” announced one of the heads of the Mercedes-Benz Cars Markus Schäfer in February. This statement was made on the occasion of the signing of a special investment contract with the Russian Ministry of Industry and Trade. The German corporation announced that it would invest more than EUR250m in the new factory and create a thousand new jobs. The first Mercedes SUV and E-class vehicles are supposed to leave the production plant outside Moscow in 2019, and the production is ultimately planned at 20 thousand cars per year.

“This investment demonstrates confidence in the Russian market, regardless of the current market environment. It also shows how attractive the Russian automotive industry is to foreign investors,” said Alexander Morozov, Deputy Minister of Industry and Trade of the Russian Federation.

The factory in Yesipovo is yet another major investment of Mercedes-Benz in Russia. Last year the group opened a large service center in the same region. While new car sales in Russia fell by about 10 per cent in 2016, the industry expects that they will soon grow again. There are many indications that other German companies will also increase their involvement in the Russian market.

Economic cooperation between Germany and Russia has decreased significantly in recent years. In 2016 German exports to Russia only amounted to EUR21.5bn, while back in 2012 their value was almost twice as high (more than EUR38bn). Russia is ranked only 16th among the largest foreign markets for German exports in the statistics of the German Federal Statistical Office. Even Hungary, Sweden and the Czech Republic are ranked higher. In terms of turnover volume, Russia is ranked 13th among the trade partners of the Federal Republic of Germany, mainly due to its exports of energy raw materials. The volume of trade is currently also much lower than in 2012 (EUR48bn compared to EUR80bn) and more than half the value of Polish-German trade (EUR101bn in 2016).

This situation was caused by the occupation of Crimea by Russia in 2014 and the war in the Donbass region. These developments led to economic sanctions from the European Union, to which Russia responded with the introduction of an embargo on European food.

At the end of February the German-Russian Chamber of Commerce (AHK) and the German Committee on Eastern European Economic Relations (Ost-Ausschuss der Deutschen Wirtschaft) published a survey conducted among German companies operating in Russia. It included 190 enterprises, whose total turnover in Russia amounts to EUR29bn and which employ more than 120 thousand people in that country. These were primarily companies from the machinery, consulting, food and trade industries. Half of the surveyed companies called for the immediate lifting of the sanctions against Russia, and 42 per cent wanted their gradual reduction.

“We wish Russia would strengthen its efforts to fulfil the Minsk agreements, which would put an end to the hostilities. The progress in the peace process should then be rewarded through the gradual lifting of the sanctions,” said the deputy chairman of the Committee for Eastern European Economic Relations, Klaus Schäfer, during the presentation of the report in Berlin.

According to forecasts of German experts, this year the Russian economy should grow by 1.5 to 2 per cent, and the entrepreneurs from Germany want to participate in the fruits of this economic upturn. At the same time, however, they are aware that their pressure on the politicians may not be enough to quickly restore normal business relations with Russia. Only 29 per cent of the companies surveyed by AHK and the Committee for Eastern European Economic Relations expect that sanctions against Russia could be lifted this year. Others are more skeptical and predict that this will happen in 2018 (51 per cent of the survey respondents) or even later (20 per cent). For some companies from Germany, the way to overcome the sanctions and embargoes are FDIs in Russia.

In 2016 German companies invested EUR1.95bn in Russia, which is about EUR170m more than in 2015. This means an end of the investment collapse, which took place in 2014, when the German entrepreneurs began implementing only 11 new projects in Russia worth about EUR400m. According to experts from the AHK, the upward trends will also continue this year.

Germany is among the most active investors in Russia. According to the E&Y report presented during last year’s investment forum in Moscow, there were 106 projects carried out in Russia by investors from Western Europe in 2015, the highest in a decade. German companies were involved in 36 projects (mostly in industrial production), which gave them the leading position among all foreign investors in this respect.

According to German companies present on the Russian market, agriculture and food industry are the most attractive sectors for investors in Russia. They were indicated by as many as two-thirds of those surveyed by the AHK Chamber and the German Committee on Eastern European Economic Relations. The manufacture of machinery and equipment and the energy and chemical sectors received half as many indications. It’s no surprise then, that the agricultural machinery manufacturer Claas decided to invest in Russia. The company allocated EUR120m for the construction of a new plant in Krasnodar.

In the food industry, particularly large deficits are seen in the market of dairy products, where Russian producers are only able to meet less than 80 per cent of domestic demand. The largest dairy company in Germany DMK GROUP wants to profit from this. Last year it acquired a majority stake in a Russian cheese producer located outside Voronezh and announced that production would be doubled. The new facility will not be limited to the production of the previously available cheap types of cheese, in which palm oil is used due to the deficit of milk in Russia. DMK announced that it will also produce “European” cheese types such as Mozzarella, Maasdam, Mascarpone and blue cheese in the Russian plant. Today, they are not in Russian stores due to the embargo on European food introduced by the Kremlin. In general, experts are optimistic about the DMK GROUP leadership’s decision to expand operations in Russia. But there are also sceptics, who claim that the Russians would be willing to pay higher prices for cheeses “Made in Germany”, but they won’t necessarily be willing to do that for products “Made in Russia”. In recent times, the image of Russian food producers has been greatly damaged by serious scandals. Therefore DMK GROUP will have to convince Russian consumers that its products manufactured in Russia are of “German”, that is, superior quality.

The list of German investors in Russia is much longer and also includes Henkel, which opened a washing powder and cleaning products production plant in Perm in 2016, and the pharmaceutical company Bionorica, which is beginning the construction of a manufacturing plant in Voronezh this year.

The biggest incentives for entrepreneurs from Germany are the prospects of rapid growth and the sheer size of the market. It turns out, however, that they are not as strong as they seem. German investors are complaining about the conditions of running business activity in Russia. Inflation reaching several percent annually, volatile ruble exchange rates, bureaucracy and corruption are the key factors that undermine Russia’s investment attractiveness. In the World Bank’s Doing Business report for 2017, Russia was ranked 40th out of 190 countries. This is certainly better than at the beginning of this decade, when its position hovered around the 120th spot, but still worse than in 2016, when it was ranked four places higher than now. It is currently doubtful whether Russia will be able to enter the top twenty of the Doing Business ranking, which according to president Vladimir Putin’s statements should happen by 2018.

Transparency International has an even worse assessment of Russia. In the latest Corruption Perceptions report Russia was ranked 136th out of 176 countries, together with Ukraine (Poland was ranked 29th). This means a noticeable fall compared to the summary prepared for 2015 (when Russia was ranked 119th out of 168 countries).

It seems that the Russian authorities are currently eager to attract new investors. Any company that invests EUR10m in production that has not previously existed in Russia, and undertakes to run business activity for ten years, receives a special investment contract. It allows it to participate in public tenders and gives the opportunity to benefit from tax facilitation used by local companies. Mercedes-Benz obtained such a contract by investing in the factory near Moscow.

“We will support this project in every way. It will also encourage more foreign companies to invest in the region,” said Аndrey Vorobyov, the governor of Moscow Oblast. This sounds a lot like “kind regards from Moscow”.

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