Russia has never been an easy country for outsiders to understand. Winston Churchill described it as a "riddle, wrapped in a mystery, inside an enigma," and today's investors might well share his viewpoint.

It's still hard for many investors to shake memories of the era of Soviet communist rule, even decades after its spectacular collapse in 1991. The period of euphoria that followed was brief and was replaced with a regime of heavy-handed government and a culture of crony capitalism.

  • Russia has enormous natural wealth in oil, gas, and minerals, including diamonds.
  • Corruption and a lack of transparency are significant barriers to business.
  • Its dependence on oil leaves it vulnerable to commodity price swings.

Bust to Boom in Russia

Russia's transition from communist world power to an emerging economy was not an easy process for its citizens. It wasn't until 1998, the year the Russian ruble was devalued in response to an economic crisis, that its economy began to grow.

Over time, its pace of growth put it on par with other dominant emerging markets such as Brazil, India, and China. The size of its economy is not on the same level as those nations: Russia ranks 11th in size among the world's economies in terms of gross domestic product.

The country's main stock market has shown steady growth. The MOEX Russia Index, a closely watched composite index, hit the skids at about 570 points at the beginning of 2009, along with most of the world's indexes. It has climbed steadily since, reaching just under 3,200 at the end of February 2021.

It is still possible to generate investment returns in Russia. The trick for investors is to understand Russia's challenges and opportunities.

Russia's per capita GDP, a reasonable measure of the personal wealth of ordinary citizens, is about a third that of European Union nations.

Russia's Challenges

Russia comes in 9th on the list of the world's largest nations by population, at around 146 million. Many of them have enjoyed some income growth over the past decade, and are spending an increasing amount of their income on luxury goods, services and holidays.

However, the country's reputation as a haven for oligarchs is not understated. Its per capita gross domestic product (GDP), a reasonable measure of the prosperity of a nation's citizenry, was $11,585 in 2019, according to the most recent data available from the World Bank. That was below the level of many nations formerly under Soviet rule, including Croatia, Estonia, Lithuania, Poland, Slovakia, and Slovenia. (Per capita GDP that year was $34,913 in the European Union and $63,343 in North America.)

Russia appears to have coped relatively well during the COVD-19 pandemic of 2020 and into 2021. A report from the World Bank estimated that its economy would shrink by 4% in 2020, less than projected earlier due to fiscal, monetary, and social policies that helped contain the costs of the economic disruption.

Russia's Natural Resources

Russia's biggest draw for investors is its plentiful natural resources. Oil and gas play a major part in the Russian economy in terms of production for internal purposes and for export.

As of 2017, Russia was the world's largest producer of crude oil and its second-largest producer of dry natural gas, according to the U.S. Energy Information Administration. Russia also has exposure to the energy industry through a number of key joint ventures in Africa and other energy-producing regions.

Its continuing dependence on oil leaves its economy vulnerable to the volatility of global oil prices.

Mineral Wealth

But oil and gas are not the only natural resources that are plentiful in Russia. The nation is sitting on trillions of dollars in minerals. It claims to be the source of 83% of the gold exported to Europe. It is also believed to possess the world's largest diamond resources.

That being said, energy and minerals are part blessing, part curse. Russia's heavy dependence on resources represents a risk. When you invest in Russia, you have to keep in mind the direction of commodity prices.

Human Capital

Russia is rich in human resources as well.

Its educational tradition is superb in mathematics and the hard sciences and excellent in languages. It produces plenty of brainy workers. Russia boasts an astounding 99% literacy rate and approximately half of the country's citizens have some post-secondary education.

Russian Corruption

Russian politics may represent the biggest investment risk.

Consider Yukos, arguably one of Russia's biggest and most successful oil companies. In 2003, its CEO, Mikhail Khodorkovsky, ran afoul of President Vladimir Putin. Russia's courts convicted him on trumped-up charges and slapped him with an eight-year jail sentence. Yukos was forced into bankruptcy, and its pieces were sold off to Putin allies for fractions of its actual market value. Yukos shareholders lost their shirts in that affair.

That notorious example was a while ago, but there's no evidence of substantial change since.

A Barrier to Doing Business

"Corruption significantly impedes businesses operating or planning to invest in Russia. High-level and petty corruption is common, especially in the judicial system and public procurement," notes a 2020 profile of business in Russia prepared by the Risk and Compliance Portal, a business resource maintained by GAN Integrity.

Russia has at times made it difficult for foreign investors to operate in an environment free from bureaucratic pressures. Police raided BP's Moscow office in 2008 in an attempt to persuade shareholders to sell their stakes in a joint venture between the British oil giant and Russian oil producer TNK.

Other global operators including Carrefour and DeBeers have backed out of operations in Russia. The Russian government has a record of putting pressure on foreign energy companies as part of its effort to consolidate control over the country's largest and most important hydrocarbon deposits.

Companies that pride themselves on ethical business practices, like Swedish home furnishings giant Ikea, have declared a moratorium on Russian investments due to the ongoing concerns.

Ranking Russian Corruption

Russia came in 129th out of 179 nations on the 2020 Corruption Perceptions Index from the anti-corruption organization Transparency International, a tie with Azerbaijan, Malawi, and Gabon. (The U.S. came in 25th.)

Based on the Corruption Perception Index, Russia has a lot of obstacles to fair and efficient business practices. Even Iran, Libya, and Pakistan are perceived as having less corruption.

It's safe to say that corporate corruption and a lack of transparency are major risks for investors in Russia.

The Bottom Line

As they seek investment opportunities around the world, investors need to know the national risks that can threaten their investments. High returns come from high-risk investments and emerging markets are likely places to find returns that outperform those of the developed nations.

While Russia offers high returns, it is dominated by energy companies, the state of regulation is still under development at best, and the political risks are greater than elsewhere.

That's a striking feature of investing in Russia. The risks and potential rewards are both high.