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. Last Updated: 07/27/2016

Where Russia's Capital Is Hiding

Russia needs to "build a bridge between an inflationary past and an investment rich future," President Boris Yeltsin told a meeting of both chambers of parliament two weeks ago. All well and good, but in these parts "investment" can mean anything from subsidies from the Central Bank to fiber-optic cash injections beamed from Wall Street.

Already an expert in the first type of investment, Prime Minister Viktor Chernomyrdin has lately been learning about the second. During a whistlestop tour of London's financial district this week, away from the glare of isolationist lobbies in the Duma, he unashamedly courted private backers from the West.

"Hurry up, ladies and gentlemen, you're running late," he politely told London's financial community. "The possibilities of the Russian market are unlimited."

But everybody already knows that. home-grown and foreign investment in Russia really ought to be a big hit. Given the illogical nature of production under central planning, even minor efficiency gains add up to considerable competitive advantages for domestic investors. Russia should also be the toast of the West's "emerging market" whiz-kids, being close to Europe geographically and culturally, and boasting superb natural and human resources.

But Russia's recent investment performance is far from impressive. Domestic and foreign kapitalovlogenia -- fixed capital formation -- fell by 26 percent in real terms during 1994. Investment last year averaged only 16 percent of gross domestic produce, compared with 20 percent among the G-7 and a staggering 32 percent among the "big three" emerging markets -- China, India and Indonesia.

What's the problem with Russia and why should Chernomyrdin be worrying about it? One reason behind low domestic investment is a lack of domestic financing. Other nascent market economies display a close correlation between resident's investment and the amount they save.

Russians apparently save around 30 percent of their income -- which is quite a lot. But the problem is they save not to earn interest on their rubles -- thus providing funds for domestic investment -- but in order to hold inflation-proof dollars.

Combine low ruble savings with capital flight running at $20 to $50 billion a year, and you have low domestic investment.

Another thing that has Chernomyrdin worried is that foreign investment is falling fast. He can take consolation in the fact that this is not an exclusively Russian phenomenon. The emerging markets craze was in large part a symptom of recession from which the West itself is now emerging.

But Russia has fared worse than most: Since the summer, reported monthly foreign investment in Russian securities has fallen from around $500 million to $50 million.

Some of the fundamental obstacles to investment in Russia are common to domestic and foreign financiers. On the portfolio side -- investment on the stock market -- procedures have always been unclear and have lately become baffling. The latest dose of legislative doubt, involving Central Bank permission for hard-currency settlements, has led to near paralysis on Moscow's stock markets.

Tax liabilities are another imponderable. Often contradictory changes in tax law, emanating from half a dozen sources, can be applied "retroactively." Calculating the feasibility of investment projects almost impossible. Rumor has it that a leading reformist politician employed three economists full time for a month to work out his personal tax liability. They failed.

Foreign and domestic investors -- while itching to tap into Russia's undoubted potential -- are unlikely to pull out the stops until the government makes some serious moves to improve commercial and financial legislation.

So why is Chernomyrdin so upbeat now? And why in London? One obvious reason why a graduate cum laude of Russia's fuel and energy complex should visit a shrine of capitalism is to send signals to the IMF, putting the $6.3 billion stand-by loan crucial to Russia's budget beyond doubt.

Another reason is that the government may be trying to establish a market for Russian "Eurobonds." Foreign funds will play a crucial role in financing Russia's budget deficit this year, and are certain to again in 1996. Given recent noises from Washington, the role of IMF money in Russia and elsewhere looks set to decline. Something will have to plug the gap.

The fact that Russia may be looking to sell bonds overseas is welcome, as is any move away from Central Bank financing. However, any Eurobond market would be still-born until investment -- particularly foreign investment -- is buoyant.

Despite the current retreat from emerging markets, given its potential, Russia could achieve high domestic and foreign investment with ease if only investors could be more certain about legislative fundamentals. Eurobonds -- and other overseas borrowing -- could then play an important role in building the bridge away from high inflation.

Liam Halligan is an economist at the Moscow-based Center for Economic Performance. Geoff Winestock is on vacation.