During his state visit to Russia in June 2019, Chinese leader Xi Jinping together with president Vladimir Putin oversaw several signings of investment cooperation agreements between Chinese and Russian companies^[1]. These documents promised over a billion dollars worth of Chinese foreign direct investments (FDI) in Russia in the years to come.

In April 2019, two months before Xi’s visit to Russia, I found myself on a fieldwork project in Vladivostok, less than 200 km away from the Russia-China border, listening to local stakeholders complaining about the obstacles of  attracting Chinese capital to the Russia’s far Eastern market. When it comes to the Russian far East, the ongoing Sino-Russian geopolitical rapprochement and a few landmark investment projects have only limited influence on the interest of Chinese investors in the market just across the border. Out of $140bn of Chinese FDI in Russia in 2017, only 2% were invested in this region, despite Moscow’s efforts to establish various special economic zones (SEZs) here in order to attract FDI through reduced taxes and simplified bureaucratic procedures^[2].

Overall, there are 20 SEZs in the Russian far East: numerous Advanced Special Economic Zones (ASEZs) and the Free Port of Vladivostok (FPV). Most of them were created in 2014-2015 – when the first rounds of Western sanctions hit Russia after the Ukrainian crisis. While the FPV residents can engage in almost any kind of business, the ASEZs tend to have industrial specialization. For example, ASEZ “Khabarovsk” concentrates on logistics and manufacturing and ASEZ “Nadezhdinskoe” specializes in the forestry industry. While ASEZs provide their residents with basic infrastructure, the FPV residents enjoy the right to acquire land lots without bidding. Also, the far Eastern SEZs guarantee lowered taxes, shortened control checks, and assistance in investment protection in court to their residents^[3]. They can also enjoy customs privileges if they create a “free customs zone”: this kind of zone requires special facilities and video surveillance on the business site. 

Despite the variety of SEZs in the Russian far East and the privileges they provide, only six of them managed to attract Chinese FDI. The FPV has 34 Chinese-led projects, which pledged to invest $510mn within the next three-five years. Five other ASEZs together managed to attract 11 Chinese-led projects, which promised to bring $35bn of FDI to Russia^[4].

However, these investments are not actual, but “contracted”: in 2015-2018, the total amount of real Chinese investments in the Russian far East only reached $38mn^[5]. So far, out of 45 projects in the six SEZs that attracted Chinese investments, only five have started operating. The majority of them have been at preparatory stages for years due to local red tape and lack of infrastructure.

While Moscow’s political will worked well in establishing the far Eastern SEZs, it failed to develop a decent strategy for them. This influences the governance of the SEZs.  The Far Eastern Development Corporation (FEDC), the managing company of the SEZs, is formally responsible for dealing with the problems of the residents but does not have enough legislative and administrative power to fulfil this responsibility. The officials from the FEDC emphasize the intersecting functions of different governmental institutions involved in the development of the Far Eastern SEZs, which confuses foreign investors.

In the absence of strategic goals, the inertia of local administrations influences the effectiveness of the far Eastern SEZs^[6]. The local governments and businesspeople in the regionoften tend to see Chinese companies not as partners but as competitors – for business opportunities and resources. They fail to create informal support for Chinese investors, which is often the decisive factor for them when deciding to invest in other countries with a weak rule of law^[7].

The conflict of interest between Moscow and the localities when it comes to attracting investments to the Russian far East leads to issues with the operations within the SEZs. The residents are discontented about the constantly changing legislation related to the zone that is retroactively applied to them. The legislative changes are often associated with the concerns of the local officials that the SEZs could become “too preferential” and erode the local tax base. For example, in 2017, the officials in Primorskiy Krai decided to deprive the FPV residents of tax privileges if they bought equipment that was previously used by non-FPV residents to make sure that companies do not acquire FPV residency status to evade taxes.

Some privileges of the SEZs are not functioning fully. For example, the free customs zone that the SEZs residents are eligible for requires specific customs infrastructure construction which is too costly for the majority of SEZs residents^[8]. Some FPV projects wait for a land lot approval for several months due to bureaucratic issues with the local authorities while certain ASEZ residents complain about the poor quality of basic infrastructure.

Finally, the existence of the SEZs does not solve the bigger socio-economic issues of the far Eastern market: even though it covers 40.6% or Russia’s territory, its share in the country’s GDP is only four percent^[9]. The small size of the market and the lack of transport infrastructure in the Russian far East repel Chinese investors. More in general, the volatility of the Russian currency, lack of skilled labour in the Russian far East, and complicated Russian legislation drives the Chinese away from Russia to other investment destinations.

When Moscow created SEZs in its far East, it ended up creating the most favourable investment zones in Russia. However, the Russian authorities clearly underestimated the competition from neighbouring China and South Korea, the leading Asian economies, which are closer to the Russian far East than Moscow. The far Eastern SEZs became the last resort for domestic Russian business, but are still unable to compete in FDI attraction with major Asian markets, which have more transparent investment attraction policies, stable legislation and clear rules of the game for investors.

 

 

Notes

[1] Prezident Rossii. (2019) Rossiisko-kitayskie documenty, podpisannye v khode gosudarstvennogo visita Predsedatela KNR Xi Jinpina v Rossiiskuyu Federatsiyu. Prezident Rossii.

[2] Central Bank of the Russian Federation. (2018). Pryamie Investitsii v Rossiiskuyu Federatsiyu. Operatsii po Instrumentam I Stranam Partneram.

[3] Far East Development Corporation. (2019).  Far East Development Corporation.

[4] Ibid.

[5] Central Bank of the Russian Federation. (2018). Pryamie Investitsii v Rossiiskuyu Federatsiyu. Operatsii po Instrumentam I Stranam Partneram.

[6] Ivanov, S., Savchenko, A., Zuenko, I., and Kozlov, L. (2016). Kitaiskii Kapital na Yuge Dalnego Vostoka Rossii: Ozhidaniya Gosudarstva i Realii Vzaimodeistviya. Vladivostok: Institut istorii, archeologii i etnographii harodov Dalnego Vostoka Dalnevostochnogo Otdeleniya Rossiiskoi Akademii Nauk. pp. 5-29.

[7] Gabuev, A. (2019). Nevprovorot na Vostok. Carnegie Moscow Center.

[8] Spivak, V. and Foy, H. (2019). Russia struggles to attract Chinese capital to its Far East. Financial Times, [online]. Available at: https://www.ft.com/content/d4cf3486-681b-11e9-a79d-04f350474d62 [Accessed 11 Aug. 2019].

[9] Federalnaya sluzhba gosudarstvennoi statistiki. (2019). Socialno-ekonomicheskoe polozhenie federalnykh okrugov – 2019 g.  Federalnaya sluzhba gosudarstvennoi statistiki.