To Russia, With Love

Today we’re happy to bring you another interview, this time with Russian-based Igor Yegorov. Igor will give us an insider’s view about government corruption, investment opportunities and life in Russia.

International Man: Igor, you hear positive things about Russia. Like the fact that there is a fair amount of money in the country and that there are supposedly some good investment opportunities. At the same, you hear about corruption issues, and of course, there is the shadow of Putin in many aspects of the political establishment. So it’s good to be able to talk with somebody who’s on the inside who can help us get a clearer picture of the realities of the country, rather than the media’s spin on it…

Igor Yegorov: Yes, the media often uses very generic terms. That’s the way they have to do it. But Russia, like America and Canada, is a big country. So it’s very hard to speak in generic terms.

I will confine myself only to the European part of the country, which I know best. Even that is a huge place… For example, North-West of Russia, which is part of European Russia, stretches itself 1,500 km from north to south and almost the same distance — even more so — from east to west. So it’s a huge territory with maybe about 12 million people here. I live in St. Petersburg and that is considered the capital of northwestern Russia.

Moscow, meanwhile, is 800km Southeast. And it’s a huge city. About 10 or 11 million people.

I’m not often in the southern part of Russia, Siberia, or other places. So in those parts I can only speculate. But there is a big difference in Russia between the big cities – which would be considered to be cities with more than a million people – and between the smaller cities or the rural areas which are much poorer and less developed.

So when we speak about Russian investment opportunities, or about money in consumer markets, we are speaking only about the larger cities. That’s where the economy is most active.

IM: OK, great. Why don’t you start by telling our readers a little bit more about yourself.

IY: Well, I was born (and still live) in St. Petersburg.

I have spent about 16 to 17 years of my life working for different organizations. I worked in a commercial bank from 1994 to 2000. At the time, commercial banking was only starting. In fact, the bank where I worked had banking license number 3. So It was really one of the first commercial banks to open in Russia after the Soviet era.

Then I worked about 4 years in the US Department of Commerce in St. Petersburg. And after that, I moved to the US Russia Center for Entrepreneurship, which was a very good move because entrepreneurship is a very interesting place to be. I met a lot of great people and I really started thinking much more broadly. I also had a much bigger sense of freedom, which is also great.

So that’s basically my professional background.

I also completed a PhD at the University in St. Petersburg, which was an interesting exercise. But I don’t have a scientific career.

As for international experiences, I have not worked outside of Russia, but I lived outside for a year when I studied in Sweden. Of course I’ve spent a lot of time abroad, have visited a lot of countries in Europe and I’ve also been in the States and Canada many times. So I kind of have a good grasp of life in Western Europe and America.

IM: Can you tell us a little bit about the current organization you manage The US Russian Center for Entrepreneurship?

IY: Well actually I don’t manage the whole organization. I manage the St. Petersburg office. There are two other offices, and the main one is in Moscow.

Basically, the organization was established and financed by the US Russia Investment Fund, which in turn was set up by the US Congress under the Freedom Support Act Legislation, around 1995.

The US Russia Center for Entrepreneurship supports entrepreneurs by creating training and networking opportunities for them here in Russia.

Because Russia was viewed as a country with a “transitional” economy after the Soviet collapse, it was deemed important to support democratic institutions and the new market economy back then. The management culture was also lacking back then too…

So we’re basically a non-profit organization that provides learning and networking opportunities for entrepreneurs.

There is a requirement in many countries to have disclaimers, so I probably also have to say that views expressed here are just my own, not anyone else’s...

IM: Igor, what attributes must a Western investor/entrepreneur have to survive, and even thrive, in Russia’s business climate?

IY: Well, you have to understand that when we talk about Russia, we are talking about a post-Soviet country. So you have to keep in mind the attributes of the people who were brought up in the Soviet Union.

And unfortunately, the life we had in Soviet times didn’t foster the good traits you would expect in businessmen. For instance, it’s not widely known here that business should begin with ethical values in mind, that you have to be honest in your dealings, etc. When people let you down, they’d often say: “this is business, nothing personal.” So it’s quite difficult for people who expect honest behavior to be the rule to do business with partners in Russia.

From experience, I know that a lot of Western entrepreneurs who have not had any experience of doing business with countries like Russia have difficulties.

So, to be successful in Russia, I would say the first thing you really need to have is experience in dealing in complex environments.

You see, you have to remember that people here don’t always say what they mean. And they don’t always act as they promise.

And often it’s also another issue of understanding each other. English is not a language that is well spoken here. So you have the issues of translation. You have issues of understanding your partner.

I think that it would be very difficult to do business on the ground here without speaking Russian. In fact, all the foreign entrepreneurs I know in St. Petersburg and Moscow speak pretty good Russian.

And you probably need to know the country’s recent history and culture quite well too.

Here’s another important thing. You need to be able to distinguish between your partners… and their motives… very well. Like I said, people are often dishonest with you. They’re not straightforward so you need to guess… or know… what they are striving for, instead of just taking what they say at face value.

IM: So to summarize, you’re saying that to do business successfully in Russia, unless you know the language, it’s probably better if you have a local partner — someone you can work with who understands the language. And you also need to understand your partner’s motives, because what they specifically say may not always be truthful, honest or forthright.

IY: Yes, unfortunately that’s true. I see this everyday.

IM: Just as an aside, is there a standardized version of Russian… or is it like German, where you can drive 200km and it’s a completely different dialect?

IY: Russian is the same everywhere, whether you go to Vladivostok (which is near China and Japan) or St. Petersburg. You may have some small details in pronunciation, but basically it is the same language.

IM: Igor, what are some of the biggest advantages right now of doing business in Russia?

IY: I think there are a lot of opportunities right now in Russia.

I mean, the fact that not a lot of people actually come here to do business is probably the biggest advantage of all. I can think of only a few instances where people would say there is a lot of competition in their field. The majority of people will say there is little or even almost no competition in the markets they work in.

So I would say that the main advantage of doing business in Russia is that, albeit some markets are very competitive, there are many in which you are probably not going to have a lot of competition, or you would be able to find your niche.

Also, since Russia is a resources-rich country, you can probably find what you need here in terms of resources locally. But if you need equipment and technology, you most will likely need to import that. This is a disadvantage, of course. Russia is an expensive country so your cost structure will probably be higher than in Canada or in the States, which may surprise you. But that is how it is.

IM: Is there anything specific that’s more expensive, like imports for example. Or is the whole economy in general more inefficient, and therefore more expensive?

IY: Well, I’m not sure about Canadian prices, but I know for instance that fuel and gas prices in America are cheaper. Office space is generally cheaper in America. I would think also in Canada. And real estate is cheaper over there in America and Canada than over here.

Of course I don’t know what a good apartment in a downtown Canadian city would go for. But I can tell you that a small one-bedroom apartment (about 80 square meters, which is roughly 800 square feet) in the center of Moscow would go for about US $500,000. In St. Petersburg, around $300,000.

So housing is expensive.

Now in terms of salaries, what you will pay for a qualified employee will probably be on par with what you would expect to pay elsewhere.

For taxes and accounting services, I can give you an example… I recently talked to a manager of one of the big four accounting firms in St. Petersburg. They have an office here of about 200 people.  Whereas in other countries you’d have 2 accountants per 100 people, in Russia you probably have 4 or 5. So the amount of reporting you need to do for a business is very significant.

All this paperwork for the government.

I think in general, office costs here are very high and since Mr. Putin’s government tends to regulate most of the economy, it limits competition. So efficiency is also lower than it is internationally.

So to answer your question, I think the general inefficiency of the Russian economy keeps prices high.

IM: What are some of the other potential pitfalls western investors or entrepreneurs should look out for?

IY: To tell you the truth, most of the Russian entrepreneurs with international experience or foreign businessmen with experience in Russia I have spoken with would say that Russia is not so different from other countries in the world. Of course it has its difficulties. But it also has its advantages. I personally think China and some other countries would be a lot more difficult to do business in.

Russia is part of the western civilization. We have similar values.

What I would say about potential pitfalls is this: do your homework. You need to understand the country, the people.

And of course you need to study the laws and regulations that would apply to you in your specific area of business. Because of the potential penalties, if you do something wrong your business could suffer significantly (and you too personally.) Russian regulators are too often around not to regulate you, but to prosecute you for mistakes, real or not. There will be no mercy. So you have to be sure you know what the regulations in your case are and what the punishment for breaking them might be. But other than that, I don’t think anything else is really that different.

IM: Which specific industries do you see as the biggest opportunities for a well-skilled entrepreneur and investor coming in from overseas?

IY: Let me briefly mention some of the sectors that were in a bubble mode over the past 10-15 years… and then it would be easier to try to make a forecast based on that.

After Russia transitioned to the market economy, the consumer products and services sector went up tremendously. This happened because there was a huge deficit in many things people wanted. So food processing, packaging, clothing, etc. all went up. People got returns only available to venture capitalists in the west…sometimes dozens of percent annually.

And then of course there was the huge bubble in 1996, 1997 in the government bond market. And then the collapse in 1998. People who bought cheap government bonds (very cheap after simultaneous default and devaluation) in 1999 and 2000 made a fortune because they went up several times in the following years.

In the last ten years there has been a huge real estate bubble. When you compare real estate prices in 2000-2001 to 2011, prices have increased about tenfold. So that was very profitable. And not just housing, but all types of commercial space —office buildings, hotels, you name it.

And retail trade was also huge over the past ten years. Dozens of retail chain store outlets developed from scratch in all possible sectors – food retail, cosmetics, clothing, catering, everything. So that was profitable too.

But in the meantime there was a lack of investments in basic industries like utilities. So now we have a problem with rising electricity costs, water supply and so on.

If the Russian government is able to create conditions which will allow companies and investors to invest in basic infrastructure, then I would guess this will be a really big opportunity. Because Russia is not that technologically advanced. Russia has raw materials, but there is a lot of new technology in the world in all sectors relating to green energy, energy efficiency and the like. And this is what we do not have here…

So whereas the energy prices are as high here as anywhere else, the degree of penetration of advanced energy saving technology, for instance, is very low. Any type of technology that is being applied elsewhere can be successfully applied here.

Also, remember that Russia is a very cold country. Here I think we have 227 days of official heating season during the year, so we spend a lot on energy. And so I think that industries that are related to utilities, utility management and building management - I think they can be in big demand.

I believe agriculture is very important. Russia was previously one of the largest suppliers of food products in the world. Now we have huge areas of great land just lying idle. Right now, for instance, some of the best soil in the world (south of Moscow) is cheaper 80 to 100 times than not so good soil of say Great Britain.

I know, for example, successful foreign businesses that buy land and equipment to cultivate the land. They then bring in people from Sweden or elsewhere to run and service the equipment and they are very successful.

IM: You mentioned that real estate prices in larger cities increased tenfold over the last ten years. Why, then, wouldn’t contractors and developers build more to increase supply?

IY: They can’t. Because in order to build, they need the local government to build roads and provide basic infrastructure like sewage, water supplies and electricity. And the regional governments don’t take care of that.

You basically can only build on plots that already have infrastructure. And you don’t have too many of those around. So I think that is one factor.

Another factor is that money supply is much easier to increase than supply of real goods. And since 1997 money supply growth on average (as expressed by M2) was between 25 and 50% every year.

A lot of people, specifically in Moscow, started out by buying one apartment in 2001. Then, as prices skyrocketed two- and threefold, many of them bought additional apartments.  So now you have people in Moscow and St Petersburg who have 2 or 3 or 10, or sometimes 15 apartments that they rent out.

You can rent an apartment in Moscow and get an income of $1,000-$2,000 a month. So many people either rent out their apartments and live somewhere else … or they just sell and buy somewhere cheaper like Berlin or Paris.

So this is an indication to me that real estate is very over-priced. And people who know that can take advantage of that and get a good return.

IM: Igor, are there any political or economic trends that might be of some concerns to western investors or entrepreneurs?

IY: Well, one concern has been in place for the past ten years, maybe a bit less.

It is this: unfortunately, the type of freedom we enjoyed ten years ago has been gradually suppressed, to the point that it now feels less free to be a businessman in Russia. You really feel like the law does not protect you, or that it is designed to limit your ability to act freely So I’m hoping this trend will be reversed. Without freedom and, more specifically, economic freedom, no country can prosper.

IM: When you say you don’t feel as protected by the law, can you give us a specific example? Does it have to do with contract law between parties… or is it the government itself dictating how things should go… or is it an increase in bureaucracy?

IY:  Of course increases in bureaucracy are ugly — you have to struggle with all these additional costs. But there is also contract law.

If you have a contractual obligation with some party and you happen to find yourself in an arbitrage court, the court will probably resolve your disputes based on law. So the problem is not so much between parties and regulation.

The issue is rather with business people at all levels who are very well connected with the law enforcement agencies. Because in these agencies there are many corrupt people who will break the law.

So if you are a successful businessman, and somebody finds your business attractive… well, they may raid your business with the help of these corrupt agency workers. It can happen and if it does, your business will probably be taken away from you. Unfortunately I have to say this has happened to many people.

This is really a big risk. This is what is holding back a lot of investments. It is also why many entrepreneurs in Russia don’t like to have tangible assets. Because if you have tangible assets — like houses, plants, equipment — you’re much more at risk. Intangible assets are much more difficult to seize.

IM: I’ve read that many people who want to do business in Russia base their company in Serbia instead, because Serbia and Russia have a free trade agreement, and apparently they have a better respect for rule of law there than in Russia.

IY: Yes. Almost all of the largest Russian companies — the so-called oligarchs, the big companies —are based in some offshore jurisdiction. In fact, more than 50% of Russian money finds its way back into Russia through offshore jurisdictions. But Serbia is not that popular - Cyprus is a much bigger place for that.

It’s really the legacy of the Soviet Union that law enforcement agencies were established as they are… above the law. They were used by the communist party to suppress protests and restrict freedom. Well, under Putin’s law, these agencies have resumed a similar role. It’s unfortunate because in my view, it is really preventing Russia from becoming a much more prosperous country.

I would look for that trend to reverse.

Will it reverse? I hope so. I’m sure there are a lot of people who will want to do business in Russia again. But of course, when that happens it will probably be a little bit late to try to establish yourself. As always, it’s the contrarian people who get better returns than others.

IM: Have you made any observations that give hope to the idea that the trend could reverse… or does it just look like you have to buckle down, wait it out and see what happens?

IY: When I talk to people here in Russia, most people don’t believe it will reverse. Which tells me that the reverse is probably quite near! Because when nobody believes, it’s a good indication…

I recently talked with a Canadian in Istanbul. He said that protests started in Tunisia after a small merchant whose business was taken away tried to kill himself in the streets. This prompted the protest and people are now demanding a freer society.

My sense is that the Russian so called elite are scared to death by the chain-reaction around the Mediterranean Sea. I think people are requesting change.

I’m not, however, a political commentator in any way. I don’t know what will happen… or when. But I do think there is a generational shift. The people who support Putin need to start thinking about the fact that he won’t be able to rule forever. The younger generation will not be loyal to their predecessors. So it’s a big political risk here and I’m not really sure what might happen.

IM: What do you say to those who say that Russia is a dictatorship controlled by Vladimir Putin, that it’s a place where freedom is restricted and where political contacts hold the power, not contracts or rule of law?

IY: I would say that if you live in a country where your freedom is less restricted than in Russia, all the better. But you need to understand that this freedom is not a given, it is rather something people have fought for in previous generations.

People in Russia are also fighting for their freedom. But it’s very difficult.

Now… is Russia a dictatorship? No, I don’t think so. It lacks a lot of the traits real dictatorship have — like the spirit, the power, the legitimacy, the military backing. I would rather suggest terms like “plutocracy” or “oligarchy”. But not a dictatorship. And certainly not controlled by a single individual, it would be a mistake to say that; the current system is supported by powerful groups and also by entrenched socialistic (that is, paternalistic) psychology of people, and any leader would have to cater to this reality or face a real political struggle.

As for the rule of law, I would say that a social consensus is developing that a rule of law is really important. The people have discovered this by their own experience, by their own suffering. In fact, many Russians try to adhere to rules when conducting business with locals or foreigners

As for the political contacts, again, maybe it’s important for big companies or an oligarch in the oil industry, for example. But for us here on the ground, it doesn’t really matter. These contacts don’t matter for us. But I would agree that freedom is restricted.

IM: OK, so If you were in my shoes… as a western investor or entrepreneur looking for opportunities… what would be the first few steps to getting started in the country?

IY: I think I would look up information on the Internet about your market. You’ll probably not find much.

I would also recommend you come to Russia, maybe on a tourist visa. You know, I find it interesting that a lot of people who have been to dozens of countries have never been to Russia.

Come to Russia and see it with your own eyes. Visit Moscow, St. Petersburg and maybe a few other cities. Talk to people. Go visit some companies. Attend social events. That way you get your own personal experience and you will be able to make your own personal judgments. I think this is a step to take. You know, see it with your own two eyes.

I know a woman who lived in Moscow who worked for a very large American investment house. She told me she often asked foreign businessmen why they invested in Russia. Almost everybody said the same thing: they came to Russia because they liked the culture. The literature and the culture.

So I think it is important that you like the country and the people. Because living and doing business in Russia is very difficult. But then again, it can also be very interesting. Very dynamic.

Here is the thing: finding and speculating on opportunities in Russia is very difficult. I mean, the stock market is extremely shallow — it’s driven by bank stocks. The contract law is very difficult, as we discussed. So you probably need to be an investor living inside the country. It’s very difficult to be speculating here. You have to be here for the long term and that requires commitment, a lot of time and energy.

So I really don’t think it’s for everyone.

Also, the living conditions here are tough. I mean, it’s not Mexico. It’s not a warm place. It’s not a nice place to lay on the beach. Having said all that, I think it can be an experience for everyone to come and see, to try and figure out for yourself if there are any good opportunities here for you.

IM: Do you have anything else to add before we close off the interview?

IY: Yes. I just wanted to say that in my travels, I had many prejudices about countries I never visited before. But once I visited those countries, what I saw “on the ground” was almost always totally different from what I expected. This has happened many times to me. So now I probably would not say anything about a country before I actually went there myself!

IM: Great advice. Thank you Igor for the comprehensive interview.

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