The volumes and dynamics of foreign direct investment are formed as a result of the joint action of many conditions and circumstances. This article is dedicated to examination of the impact of one of the factors determining the dynamics and geographical structure of foreign direct investment between 2014-2020, both inward and outward, which is sanctions introduced by the Western countries. Russia’s international actions, especially the invasion of Ukraine and the annexation of Crimea in 2014, brought significant changes in its international economic and political relations. In response to the Russian actions, the USA, the EU and their allies have imposed a series of sanctions. The sanctions imposed by the group of Western countries in 2014 aimed at isolating Russia in the political, financial, economic, technological, scientific, and informational space. The study shows that Russian Federation is not a priority investment destination for these countries. It was found that the changes in foreign direct investment to the sanctioned countries turned out to be less significant in most of cases.
Russia’s international and geostrategic actions, particularly the invasion of Ukraine and the annexation of Crimea in 2014, caused significant changes in its international political and economic relations. As a result, responding to the Russian invasion the United States of America, the European Union and their allies have imposed a series of sanctions. From March 3, 2014, to September 13, 2018, the USA and the EU imposed 15 economic, 12 financial and 22 corporate sanctions against Russia (Radio Free Europe, 2018). During this period, 31 personal and 5 diplomatic sanctions were imposed. Also, one sanction related to the war in Syria, two sanctions related to the presidential elections in Russia, and three sanctions related to the incident with Sergei Skripal in 2018 were applied. In response to the sanctions, Russia has banned the import of certain food items from the EU and further strengthened its long-term import substitution policy aimed at ensuring economic sovereignty and the supply of basic commodities, as emphasized since the early 2000s. The Russian government also approved “Government Program on Industries and Competitiveness” to increase domestic production in almost all sectors (Korhonen et al., 2018).
Since March 2014, the EU has gradually introduced restrictive measures against Russia. These measures were taken in response to the illegal annexation of Crimea and the deliberate destabilization of Ukraine (European Council, 2021). The US Congress imposed sanctions in support of the sovereignty, integrity, democracy and economic stability of Ukraine and condemned Russia’s unjustified military intervention in the Crimea region and its occupation, as well as any other form of political, economic or military aggression against Ukraine (United States Congress, 2014).
According to Sultonov M. (2020) Western sanctions were seen as acts of aggression against Russian interests. For example, Yevgeniy Primakov, a prominent Russian politician and diplomat, interpreted the conflicts and sanctions related to Crimea as an attempt by the United States to promote the establishment of military control over the Black Sea as part of the US policy aimed at establishing a unipolar world order and taking Russia out of world politics. A representative of the Russian scientific community, Rustem Nureev divided the reasons for the sanctions against Russia into geopolitical and economic ones. He sees attempts to weaken Russia’s position on major international issues and limit the competitiveness of Russian companies in the global market and especially in the European market (Nureev et al., 2016).
Coincidentally, in July 2014, the price of crude oil on the international energy market began to fall. The price of WTI/Brent crude oil fell from USD 106.1-110.1 on July 2014 to USD 56.9-61.7 on July 2015 and to USD 32.1-30.1 USA in January 2016. Fuel exports as a percentage of Russian merchandise exports decreased from 71.2% in 2013 to 48.2% in 2016 (The World Bank 2020a). This external shock, caused by the imposed sanctions and the low oil price, had a significant impact on the Russian economy. Accordingly, the purpose of this paper is to analyze the impact of sanctions on the Russian foreign direct investment and to review its consequences.
The restrictive economic measures of the United States, the EU and a number of other countries, which have been in effect for more than five years, became the new normal conditions for the functioning of the Russian economy. Nevertheless, the uncertainty of both the magnitude of their effects over the past period and the possible further strengthening of sanctions and their consequences remains very high (Domínguez-Jiménez et al., 2020).
As it was mentioned the first sanctions of the EU, the USA and a few others against the Russian Federation related to the situation in Crimea and Eastern Ukraine were introduced in 2014. They were directed against individuals and companies and were not significant. Even though the imposition of these sanctions was accompanied by an increase in the volatility of the Russian foreign exchange market and a decrease in gross capital inflows, already in the second quarter of 2014, these negative effects faded away according to Prilepskiy I. (2019). A much more serious blow to the Russian economy was the introduction of the sectoral sanctions by the EU and the US introduced in July 2014. They made difficult for foreign financing of state-owned banks and leading companies in the oil and gas sector; the access to advanced mining technologies was limited. Also, they reduced the possibility of importing dual-use products into the Russian Federation. Subsequently, the US sanctions were tightened by reducing the maturity of financial instruments that fell under the sanctions of companies in which US residents are allowed to invest. The EU sanctions were consistently extended.
Nelson R. (2017) concluded in her work that in 2014 and 2015, the Russian economy faced several challenges, including capital outflows, rising inflation, the depreciation of the ruble, budgetary pressures and weaker growth prospects. According to her many experts believe that the sanctions are exacerbating Russia’s economic problems. However, it is difficult to assess the impact of sanctions in isolation from other domestic and international factors, especially from low oil prices. It remains to be seen how effective the sanctions are in terms of changing the behavior of the Russian government. While the Russian government continues to face a few economic challenges, many of which are unrelated to sanctions, economic forecasts suggest that the Russian economy is stabilizing. She states that investor sentiment towards Russia may be improving.
Additionally, the researcher inferred that some US business groups expressed concerns about the economic costs of the sanctions against Russia for the USA. In the long term, the impact of sanctions may depend on several factors, such as the ability of US companies to find alternative markets, the potential spillovers from slower growth in Russia, and whether Russia takes additional responsive action against the United States.
Prilepskiy I. (2019) in his work dedicated to analysis of the impact of sanctions on the Russian economy notes that the long-term effects of sectoral sanctions may include a slowdown in productivity growth and a reduction in the potential GDP growth rate due to their negative impact on investment. The financial consequences of the sanctions, related to the opposition to capital inflows, appeared already in the short term. Thus, already in the third quarter of 2014, the capital inflow into the Russian Federation became negative.
The researcher states that the negative impact of the sanctions on capital inflows was associated both with the direct effect of sectoral sanctions, restrictions on borrowing by Russian issuers, and with an indirect one caused by the deterioration of the growth prospects of the Russian economy and uncertainty about the future actions of the Western and Russian authorities. Against the background of the difficulty in refinancing external liabilities, some companies had to sale of accumulated foreign currency assets to ensure payments on external debt. As a result, net accumulation of foreign assets in the third quarter of 2014 turned negative for the first time since 2009. According to the scholar, at the level of the economy, the sanctions contributed to the weakening of the real exchange rate of the ruble.
Nguyen T.T. et al., 2021 examined the impact of economic sanctions imposed by Western countries on the exports of the Russian Federation and the impact of the countersanctions responded by Russia on its imports. They found that economic sanctions against Russia and countersanctions from Russia led to a decrease in both the aggregate value of a country’s exports and imports. The effects of sanctions and countersanctions turned out to be heterogeneous for export and import products. The sanctions seriously affected the export of oil products from the country, reducing the value of exports by about 36.56%, while the impact of sanctions on the export of non-oil products from Russia was insignificant. At the same time, countersanctions caused a decrease of the imports of agricultural products by 54.52% and a decrease of the imports of non-agricultural products by 20.86%. The decline in exports and imports indicates that these non-tariff barriers are harmful both for the Russian Federation and for the countries imposing sanctions.
Bělín M. et al., 2021 showed in their work that Russian sanctions imposed on food imports from Europe and America led to a reduction in trade flows about 8 times more than those imposed by the EU and the US on exports of extraction equipment. These results do not appear to be related to the redirection of trade flows through countries that do not apply sanctions. Thus, the difference in the effectiveness of sanctions can be explained by the limited retroactive effect of Western sanctions, which allowed exemptions for exports under contracts concluded before 2014.
As it is well-known, Russia is one of the main suppliers of natural resources. Ratner M. et al., 2021 in their study of European energy security indicated that Russia is the most important supplier of natural gas to the EU. U.S. Administrations and Congresses have viewed Europe’s energy security as a US national interest. In late 2019, Congress passed the National Defense Act for Fiscal Year 2020, which included sanctions related to the construction of the Nord Stream 2 and Turk Stream gas pipelines. The researchers concluded that while the United States and the EU have sought to facilitate the export of pipeline natural gas from the Caspian region and liquefied natural gas from the United States, this has not been achieved in sufficient quantities to counter Russian exports. Moreover, they state that regions such as North Africa and the Eastern Mediterranean have potential as alternative suppliers, but their ability to increase exports is limited.
Kazantsev S. (2020) revealed that in the first two years of the anti-Russian sanctions, the flow of direct investment to the Russian Federation from foreign countries dropped sharply. Most of them are from the United Kingdom, Luxembourg and Cyprus, which have the characteristics of offshore and transit countries. The contribution of the main initiator of anti-Russian sanctions, the United States, to a decrease in the volume of flows of net direct investment from countries that imposed anti-Russian sanctions against Russia was insignificant. The drop in foreign direct investment from countries that introduced sanctions was short-lived. The researcher notes that already in 2016, its gradual, albeit unstable, recovery began. Additionally, he indicates that aggressive anti-Russian financial and economic policy pursued by a few countries has significantly reduced the attractiveness of foreign countries for Russian investors. In 2014–2015, outward foreign direct investment of Russian Federation in most of the sanctioned countries declined.
Liuhto K. (2015) indicates that a significant part of outward foreign direct investment of Russia falls on the operations of Russian corporations in their domestic market. The author concluded that, although the Western sanctions are directed against a relatively small number of Russian citizens and companies, they nevertheless affect some key persons in Russia, hydrocarbon producers and largest banks. Consequently, direct impact of sanctions can be significant. Also, their indirect impact should be considered, such as the depreciation of the ruble and the increase in interest rates of Russian banks, which reduces the ability of Russian companies to invest abroad.
Kuznetsov A. (2021) studied the features of the outflow of foreign direct investment from Russia in 2018 – the first half of 2020. The researcher identified three main reasons for the new stagnation of Russian foreign investment expansion: 1) the strengthening of “sanctions war” after the election of Vladimir Putin for the 4th presidential term; 2) a slowdown in global economic growth in 2018-2019 amid relatively low prices for hydrocarbons and other raw materials exported from Russia; 3) the crisis was caused by the coronavirus pandemic in 2020.
Thus, the majority of researcher agree sanctions imposed by the USA, the EU and their allies had direct impact on foreign direct investment of Russia. Consequentially it can be assumed that capital movement between Russia and those countries should reduce. This hypothesis is be considered in the study.
The source of data on foreign direct investment is the balance of payments (BOP). A country’s financial position in the world market is usually assessed by its balance of payments. This is an important indicator for predicting the degree of a country’s participation in world trade and determining its ability to pay.
The balance of payments is a table of correspondence between external income and expenses, which reflects all foreign exchange receipts received by a given country from other states, as well as all funds paid by a country to other countries during a certain period. In other words, it can be defined as a statistical summary of all transactions between residents and non-residents for a specific period, usually a year or a quarter. Its data make it possible to track the forms of attracting FDI, repayment of the country’s external debt, changes in international reserves. In Russia, the Federal State Statistics Service collects mainly basic data on the balance of payments. Then the Central Bank compiles and publishes (Frolova, 2005).
The CBR defines that foreign direct investment occurs when a foreign investor makes an investment of 10% or more of shares an organization. The threshold value of 10% of shares is generally considered necessary for the ability to influence the activities of the organization and participate in its management. The data on foreign direct investment usually provided by Central Bank of a country.
The Central Bank of Russia deliver a few statistical data. IMF’s Balance of Payments and International Investment Position Manual, 6th Edition (BPM6) provides the conceptual and methodological basis for statistics on FDI by CBR. The International Investment Position (IIP) is a statistical report that reflects at a certain point in time the composition and value of residents’ financial assets against non-residents. The IIP reflects the balances of assets and liabilities at the reporting date, as well as changes for the period that have occurred as a result of transactions, value changes (revaluation) and other changes (CBR, 2021).
The Central Bank of Russia provides statistics of FDI by country and by industry, flow and stock. For this research foreign direct investment stock and by country was collected from the CBR. The period of statistical data dated from 2014 to 2020. In order to understand the impact of sanctions on Russian FDI the paper attempts to analyze the changes of shares of countries that imposed sanctions in total FDI through years.
Absolute numbers provided by the CBR were calculated into percentages using a simple formula:
y = Xc *
Where xc – absolute volume of FDI from/to a country,
FDI – total volume of FDI of a year.
For this analysis manly countries of EU, the USA and some other countries that imposed sanctions were chosen. Some countries such as Denmark or Ireland were excluded from the analysis due to confidential data or negative amounts in statistical data of the CBR. Hypothetically the share in FDI volume of countries introduced sanctions should decline.
It is important to mention that if investments of a resident of country A come to the Russian economy from country B, then the official statistics of the Central Bank of Russia show them as coming from country B, and not A. Accounting is carried out according to the principle of the economic territory from which the investments came, and not according to the principle of the place of registration of the investor. So, if investments of US resident companies enter the Russian economy through other countries, as well as investments from funds earned on the territory of the Russian Federation, the Central Bank of the Russian Federation does not consider such investments as received from the USA. And there can be a lot of such investments. Thus, it can be considered as a limitation of the study.
Inward foreign direct investment of Russia
The impact of the 2007-2008 global financial crisis that shook the global economy had a significant impact on Russia’s international investment position. The figure 1 shows that the decline in inward foreign direct investment was overcome by 2014. However, subsequent years under pressure from the sanctions of the United States and the EU the investment opportunities of the Russian economy have deteriorated significantly. According to the Ministry of Economic Development of the Russian Federation, foreign sanctions have significantly reduced the ability to attract capital from abroad (Platonova, 2019).
It is important to mention that decline in 2014 was compounded by the almost simultaneous fall in crude oil prices. Concurrently with the imposition of sanctions, Urals oil prices fell by almost 50% between June 2014 and early 2015. Traditionally, this decline was associated with a decrease in export and tax revenues in Russia, as well as with tightening financial conditions. Thus, in 2014 and 2015, these negative consequences were exacerbated by the imposition of sanctions, as well as the possibility of imposing additional sanctions (Korhonen, 2019).
According to the statistics of the World Bank (2021b), the flow of direct investment to the Russian Federation from foreign countries decreased in 2009 after the global financial crisis that began in 2008, decreased in 2012 and fell sharply in 2014–2015 after the introduction of anti-Russian sanctions in 2014 and fell of crude oil prices (Figure 1).
The various restrictive and prohibitive measures taken by a number of states with respect to the Russian Federation affected foreign investors both in Russia and abroad. The share of inward direct investment from foreign countries that imposed sanctions to the Russian Federation in the total volume in 2014–2020 is small (Table 1). The shares of some countries might be underestimated since foreign direct investment comes to the Russian Federation both directly from the investing country and in transit through another state, as well as from offshores.
It can be seen in the table 1 that the biggest percentages of IFDI through years came from Cyprus and Netherlands which are well known as popular destinations for Russian outward FDI. Thus, these investments can be described by offshore companies and countries with preferential tax regimes. Investments of residents of Russia coming into the country from offshores are considered by the Central Bank of the Russian Federation (CBR) as foreign. Important to note that the CBR data includes investments made by investors of Russian origin, but through offshore structures. Additionally, the Central Bank’s statistics based on the balance of payments exclude investments made in Russia by subsidiaries of foreign companies, because such investments do not cross the Russian financial border.
The shares of IFDI coming from Cyprus and Netherland between 2014 and 2020 fell from 36,54 % to 32,26 % and from 14,43 % to 8,57 % respectively (Figure 2). This can be related to changes in Russian OFDI and the deoffshorization process that Russia government has been pursuing. Interestingly, there was not much of changes in investment from Germany. Moreover, percentage of direct investment from some countries such as the UK, France and Switzerland raised.
Prilepskiy (2019) notes that from 2015 to the first half of 2017, the expansion of the sanctions lists was mainly due to small (on the scale of the Russian economy) organizations, which, along with maintaining a responsible macroeconomic policy of the Russian Federation, allowed Russian and foreign economic agents to continue to adapt to sanctions. However, the discussion in the United States of Russia’s interference in the American elections in 2016 increased the uncertainty about the future development of the policy of restrictions. The Countering America’s Adversaries Through Sanctions Act (CAATSA) of August 2017 fundamentally complicated the cancellation of previously adopted sanctions, created the prospect of imposing sanctions against mining, metallurgical and railway companies and semi-state companies of the Russian Federation. Threats included imposing secondary US sanctions against non-US residents who carry out significant transactions with persons involved in the Russian sanctions lists.
The transition to a tougher sanction regime on the part of the United States was manifested in 2018 in the imposition of tough sanctions on the so-called Specially Designated Nationals and Blocked Persons List (SDN) against Russian individuals and companies, including Rusal. SDN leads to a ban on investing in debt securities of these companies with a certain maturity, and to the freezing of all assets under the jurisdiction of the United States and a ban on any transactions with them. Both US residents and non-residents are prohibited from any transactions with persons on the SDN list under the threat of secondary CAATSA sanctions. An example of secondary sanctions was the inclusion in the SDN list of the Equipment Development Department of the Chinese Army for the purchase of S-400 complexes from the Russian Federation. As a result of toughened sanctions from the USA, inflationary pressures increased and monetary policy tightened in 2018, despite otherwise favorable external conditions in that year such as rather high oil prices and global economic growth rates. It leads to further deterioration of investment climate of Russia.
Outward foreign direct investment
Outward FDI is a normal phenomenon, conditioned primarily by the desire for growth and, accordingly, the search for new market in other countries, technology, natural resources etc. The stability of legislation, the financial, economic and socio-political situation of several foreign countries, their comfortable tax legislation and a favorable business environment are also attractive for Russian investors. However, in the last decade, some of these advantages have disappeared and have been questioned.
This was facilitated by the events of March 2013, when, according to the decision of the authorities of Cyprus, 9.9% were written off at one time from deposits placed with banks of the country, the amount of which exceeded 100 thousand euros, and from deposits of a lesser value – 6, 75 %. Also freezing in banks of Wall Street, the City of London, Canada, Austria and several European countries of international reserves of Libya, Syria, blocking of accounts of individuals and legal entities, direct seizure of property facilitated to a drop of Russian OFDI (Kazantsev, 2020).
All this showed that investors can lose their funds for financial, economic and political reasons of the legislative and executive bodies of the states in whose jurisdiction their capital is placed. Growing up in 2013 the flow of outward direct investment from Russia to other countries declined sharply in 2014 and 2015. (Figure 3). It seems that anti-Russian sanctions and possibly, measures of the first stage of the capital amnesty in the Russian Federation in 2015-2016 had an effect of this decline of OFDI.
Nevertheless, it can be noted that Cyprus is the main destination for Russian OFDI (Table 2). The fact that both inward and outward FDI highly related to Cyprus and the Netherlands reveals the peculiar feature of Russian FDI, so-called “round-tripping”. According to the 4th edition of Benchmark Definition of FDI of the OECD of 2008, round-tripping is defined as the transfer of local funds from direct investors to a foreign country, followed by a return of these funds in the first economy (local economy) in the form of inward FDI (Repousis et al., (2019).
Ledyaeva S. et al. (2015) highlight significant differences between investors that are part of round-tripping and genuine foreign investors. While pseudo-investors prefer to invest in resource-rich regions as well as in regions with low governance scores and high levels of corruption, genuine foreign investors prefer regions with seaports and more skilled labor. Thus, the share of round-tripping investment in total FDI is significantly higher in corrupt regions. Real FDI in Russia comes mainly from developed countries, thus bringing modern technologies and know-how to the recipient regions. Consequently, in the long term, significant interregional differences in the level of corruption can lead to uneven technological development of Russian regions and exacerbate interregional inequality.
International political events in recent years, such as sanctions, also affect the degree of “offshorization” of Russian business. This is one of the key characteristics of outward FDI from Russia in recent decades, which explains the significant scale of outward FDI and the absence of Russian MNCs among the world leaders. According to Kuznetsov (2021) the official non-Russian status of companies registered in Cyprus and in similar jurisdictions in 2014-2016 has repeatedly helped Russian companies to avoid additional discrimination in Western countries. However, over the past two or three years, Russian private business became fearful of insuring assets against encroachments from the state and reducing taxation by re-registering in offshore zones. Registration of Russian MNCs in foreign counties ceased to protect private MNCs from new anti-Russian sanctions. Moreover, the Russian government began to revise tax agreements with offshore destinations such as Cyprus and the Netherlands. However, the volume of Russian OFDI to these countries is high (Table 2).
Interestingly, investment to Germany has not changed much (Figure 4). Moreover, the shares of the UK in total Russian OFDI increased during 2014-2020. The share of receiving Russian investment of the USA as a main country that imposed sanctions has decreased during the analyzed period but not significantly.
Thus, based on calculations and data analysis it is hard to tell that a significant deoffshorization of Russian OFDI happened. Kuznetsov (2021) notes that the national policy of deoffshorization is still contradictory, which can be partly explained by the multidirectional impact of foreign policy changes in recent years on Russian MNCs. Also, it can be concluded that despite sanctions imposed by the EU Cyprus and the Netherlands remain the main recipients of Russian capital.
After reviewing the literature on this topic, it is clear that Western sanctions have had a negative impact on the Russian economy over the past five years. At the same time, fluctuations in oil prices continue to have a greater impact on Russia’s economic performance. Thus, it might be concluded that the sanctions have the expected effect. From the point of view of countries that imposed sanctions against Russia, the taken measures represent an obvious economic price for the unwanted actions of Russia. While FDI has not been banned, it is likely to suffer too. Russian sanctions and countersanctions also entailed certain costs for Western countries. Their exports to Russia were lower than they would have been otherwise. This may be true for sectors where Russia has not introduced an import ban.
The statistics of the World Bank show both net inward and net outward FDI fell sharply in 2014. The factor of sanctions, according to many researchers estimates, plays a key role in reducing inward foreign direct investment. As for the outward FDI, this may be due to the almost simultaneous imposition of sanctions due to the strengthening of the CBR in the fight against the outflow of “gray” capital.
The analysis of CBR data revealed that despite of sanctions the direction of Russian inward and outward FDI did not change much. Moreover, it proved importance of understanding round-tripping of Russian capital. Offshorization is a widespread phenomenon for Russia. Most of Russian money flows through Cyprus and offshore centers, which account for highest percentage of Russia’s inward/ outward FDI stock. The scale of round-tripping can have very significant socio-economic implications. Thus, the better understanding of this phenomenon is needed.
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Hungarian University of Agriculture and Life Sciences (MATE), Hungary
Dr. habil. Magda Róbert
John von Neumann University, 6000 Kecskemét, Hungary
5 Vanderbijlpark Campus, North-West University, Vanderbijlpark 1900, South Africa
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