China-Russian Economic Relations and Investment Opportunities

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China overtook Germany to become Russia’s largest trading partner in 2010. Here we take a look at the Sino-Russian economic relationship and opportunities for investors looking to enter the market.

By Teja Yenamandra

Mar. 10 – While four countries, Brazil, Russia, India, and China, form the acronym BRIC, the first two are often overlooked in favor of the latter. While Brazil too deserves its moment in the sun, this piece will focus on Russia, its growing relationship with China, and its ever-increasing attractiveness as a destination for foreign investment.

At first glance, Russia may seem like a den of iniquity. Corruption abounds, laws are squishy, and state enterprises prowl the business landscape with unfettered access to capital and resources. Thankfully, however, this gloomy picture is a little distorted.

A snapshot of Sino-Russian trade
For Russia and China, this year marks the 10th anniversary of their signing the China-Russia treaty on good neighborliness, friendship and cooperation, as well as the 15th year anniversary of the establishment of mutual partnership.

Over the past five years, Sino-Russia trade has nearly tripled in value. Trade has been mainly composed of natural resources: in 2010, crude oil and natural resources made up 48.5 percent of overall bilateral trade (something which will likely remain consistent as China continues demand energy inputs to fuel its rapid growth). China has then used those inputs, and then sent low to medium-value equipment back to Russia. Machinery and electronic products accounted for 68 percent China’s exports to Russia in 2010.

In November, both nations pledged to drop the dollar when trading bilaterally, opting instead to use local currencies. That same month, a 866 kilometer-long railway opened, connecting Russia’s largest port city on the Pacific Ocean, Vladivostok, with Northeast China.

In January, an oil pipeline linking Daqing in China’s Heilongjiang Province and Skovorodino, a Russian city, officially began production, and is expected to transport 15 million tons of crude oil per year, with a 30 million ton per year benchmark set for the immediate future.

In February, EuroSibEnergo PLC (Russia’s largest independent power company) and China Yangtze International (China’s largest listed hydropower producer) announced an official JV—YES Energo Ltd—to develop hydro and thermal power projects in Russian Siberia.

Bilateral ties have been strong for quite a while, and will likely only get stronger.

A glimpse into Russia’s economy
By nominal value, Russia’s economy is the 10th largest in the world. By geography, Russia is the world’s largest country. According to UNESCO, it also has the world’s largest supply of energy and mineral resources (e.g., natural gas, oil, coal, precious metals, arable land).

Growth rates have been fairly impressive since the Soviet Union’s collapse in 1991. Under Putin, Russia’s GDP doubled, and rose from being the 22nd largest economy in the world to the 11th.  The size of Russia’s middle class has grown from 8 million to 55 million people during those same years. However, Russia’s massive geography, untapped natural resources, and relatively low position on the global value chain indicates a huge potential for growth that is still yet to come.

During Russia’s transition from a command economy to a market-based one, many industries were privatized. Nevertheless, privatization schemes often fell short as previously state-owned enterprises were simply transformed into politically-connected behemoths. Today, most sectors in Russia are vertically integrated, and heavily concentrated in the hands of a few powerful firms.

While such a picture may seem daunting, it’s precisely how China’s economic landscape looked not too long ago.

Setting up in Russia
For the eager investor, we’ve included a brief table of the length of time it takes to set up in Russia.

Source: World Bank

Thanks to a growing domestic market, inexpensive human capital, natural resources and political continuity, Russia is increasingly being considered a country with a stable investment climate.

Although restrictions on foreign investment have been lifted, a few sectors still remain closed to foreign involvement. Regulations restrict full access to the banking sector, nuclear energy, military technology, and the space industry.

And yet, Russia is tied with China to be the BRIC country with the lowest tax rate. According to the World Bank’s Doing Business Index,  it also has the lowest effective tax rate of all other BRIC nations.

Russian policies that seek to encourage investment may be encountered in the form of tax reliefs and holidays, reduced administrative barriers, and the development of private-public partnerships. In the near future, like its BRIC counterparts, Russia’s government is planning on investing heavily in infrastructure development to promote investment and allay logistical fears.

Unfortunately, the January 2004 introduction of a single-window registration procedure has not streamlined the business registration process. In Moscow, the ease of doing business worsened with a new requirement stating that only the CEO or director of a company may file a state registration application and retrieve in person the registration certificates—no representation by proxy is allowed.

If the CEO or director cannot come to Russia to file the application in person, it should be sent by registered mail (not by courier) to the Russian registration authorities, who process the application and return it to the address of the entity being incorporated.

The registration process may take several weeks, or even months, to complete.

Foreign investors can choose from a number of different forms of business structures in Russia, from Russian legal entities to representative offices to branches of foreign legal entities.

As in China, representative offices of foreign entities are limited to conducting liaison and support functions, but branch offices are free to perform all of the foreign entity’s operations.

Many investors therefore opt for branch offices at the initial stages because these entities are allowed to engage in any kind of commercial activity, have similar procedural requirements, and are subject to less cumbersome reporting requirements than Russian legal entities.

At the same time, for many investments, including joint ventures and production plants, issues connected with licensing, customs and privatization of state property, a Russian legal entity may be better suited to an investor’s needs.

Currently, the following forms of commercial legal entities (for-profit) may be incorporated in Russia:

  • Full partnerships
  • Limited partnerships
  • Limited liability companies
  • Additional liability companies
  • Production cooperatives
  • Joint-stock companies (open and closed)
  • Unitary enterprises (state-owned legal entities not open to foreigners)

We also wrote about these mechanisms in a recent complimentary issue of Russia Briefing Magazine, titled “Establishing Business in Russia.

Joint-stock companies
In accordance with the Civil Code, a joint-stock company’s capital is divided into a definite number of shares. The participants of a joint-stock company (the shareholders) are not liable for the company’s obligations and accept the risks of losses in connection with its activity within the limit of their respective stakes. Shareholders may conclude a shareholder’s agreement regulating the exercise of their rights.

Russian law provides that only joint-stock companies may issue stock, which is deemed as securities and is subject to registration. Russian legislation describes “open” and “closed” joint-stock companies, which are broadly equivalent to public and private companies. Open joint-stock companies must disclose certain financial and other information annually.

The share capital of a joint-stock company is composed of the nominal amount of shares acquired by the shareholders. The minimum “charter” (share) capital for open and closed joint-stock companies is 1,000 and 100 times the minimum monthly wage, respectively.

A joint-stock company may be liquidated voluntarily or by court order in the procedure or on the grounds established by the Civil Code. The liquidation of a company results in its termination, with no transfer of rights and obligations by succession to other persons.

Limited liability companies
A limited liability company is established by one or several persons whose charter capital is divided into shares according to the formation documents. In this type of company, the liability of each participant is limited to the value of its contribution. The participants may conclude a participant’s agreement regulating their rights.

The charter capital of the limited liability company determines the minimum size of the company’s property guaranteeing the interests of its creditors. The minimum charter capital of a limited liability company should not be less than RUB10,000.

Full and limited partnerships
In a full partnership, partners bear (full) joint and several liabilities for the partnership’s obligations.

A limited partnership has both full partners and partners whose liability is limited to their contributions. A full partner in a limited partnership may not be a full partner in another partnership, and its liability is the same as for full partners described above.

Partnerships under Russian law are generally regarded as legal entities and are taxed accordingly.

Branches
A branch or representative office of a foreign legal entity needs to register with the authorities. To register, branches and representative offices should complete:

  • Accreditation with federal bodies
  • Tax registration
  • Registration with authorities that handle statistics
  • Registration with social funds, as mandatory contributions are required
  • Handling its bank accounts

Representative offices
An accredited representative office is not a Russian legal entity, but an officially recognized extension of a foreign legal entity. Russian law restricts the scope of a representative office’s activities to non-commercial activities.  An RO’s legal status differs substantially from that of a branch office. For example, a branch of a foreign legal entity is treated as “an enterprise with foreign investment.”

As was announced at China’s National People’s Congress, China seeks to diversify its trade partners away from the previous reliance on consumers from the United States and Europe. A more global sales and partnership strategy is being sought, and Russia, so close and very much a neighbor, is part of this unilateral development strategy. The two countries have already agreed to settle bilateral trade between them in RMB and Rubles, and important listings of Russian commodities and mining businesses are already taking place in Hong Kong to give Russia more visible access to the Chinese markets and the latent Chinese consumer base. China–Russia trade and opportunities have tended to be undervalued in recent years, however these two giants of the world economy are beginning to flex their collaborative trade muscles once again. China investors may start to find opportunities in Russia that may not have seemed so obvious before as these two great nations seek better partnerships and mutual development and progress.

Russian President Dmitri Medvedev and Chinese President Hu Jintao have been quietly building up bilateral trade. Opportunities exist for those willing to position themselves in between.

Dezan Shira & Associates’ partner practice in Russia, the Moscow-based consulting firm Russia Consulting, can offer advice over matters of Russian foreign direct investment law, establishment, taxes and accounting issues. For further information please email russia@dezshira.com.

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Russia Briefing
Offering regular news relating to the Russian economy, the market in Russia, foreign direct investment and Russian law and tax.

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1 thought on “China-Russian Economic Relations and Investment Opportunities

    Chris Devonshire-Ellis says:

    Teja : “At first glance, Russia may seem like a den of iniquity. Corruption abounds, laws are squishy, and state enterprises prowl the business landscape with unfettered access to capital and resources. Thankfully, however, this gloomy picture is a little distorted”.

    I believe so. There’s a certain large member state of the EU that has massive corruption, a suppressed media, a judiciary whose power is being politically eroded away and that has an equally autocratic dictator subverting the state for his own ends. What’s being going on in Italy the past few years is far worse than the Russian situation. Thanks – Chris

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