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. Last Updated: 07/27/2016

WTO to Rattle Service Sector

Services such as insurers and distributors will face the stark choice of finding foreign partners or seeing their investments evaporate once Russia joins the World Trade Organization, the World Bank said in its semiannual country report Monday.

Yet a hostile investment environment and a shaky legal framework could trip up investors from abroad, who have often found it difficult to enforce contracts with Russian partners, analysts said.

Russia, which is in negotiations to join the WTO as early as next year, will see annual additions of $19 billion to its gross domestic product in the one or two years following accession, the World Bank said. Over the longer term, Russians' incomes will increase by $64 billion per year, the report said, largely by lifting barriers on multinational providers of services.

Membership would also bid up wages in the competitive export sectors and attract labor away from domestically-oriented businesses such as food processing, textiles and small- and medium-sized enterprises, the report said.

"There are complementary reforms the government can take to deal with diversification and sectors which are not expanding," David Tarr, the World Bank's lead economist for international trade told reporters. "Reducing regulatory burdens on small and medium enterprises is crucial."

The losers in a number of sectors could create "significant political lobbying against measures associated with WTO accession," the report said.

Moscow, which needs the blessing of the United States and other trade partners for WTO membership, is engaged in negotiations on key points such as foreign ownership in telecoms and life insurance businesses. Washington has also pressed Russia on price subsidies, lax enforcement of intellectual property rights and poor protection of commercial secrets.

The talks are expected to last until the end of the year, and Moscow hopes to complete the talks before the WTO's summit in Hong Kong in December.

Some analysts disputed the World Bank's conclusions, arguing that the removal of caps will bring in little more capital.

Foreign companies are collectively allowed to control up to 20 percent of the total capital on the country's insurance market but in reality participate in only half as much, said Boris Khait, president of Spasskiye Vorota, the sixth-largest Russian insurer by revenue.

"Considering the specifics of the market -- that the 'insurance culture' here is relatively immature and foreign companies already come insured -- I'm not sure what a Western provider could contribute beyond what Russian companies are already doing," Khait said.

In the banking sector the ratio of capital controlled by foreign groups has also fallen, even after restrictions were removed. And in telecoms, foreign companies already face few restrictions on participation but still would find it hard to enter the market without Russian partners, said Konstantin Chernyshev, a senior analyst at UralSib.

Although foreign direct investment reached a record $11.7 billion last year, it remains among the lowest in the region when calculated on a per capita basis.

"The Czech or Hungarian model does not seem to be the model the government has in mind when it comes to foreign investment," said John Litwack, the World Bank's chief economist in Moscow.

"The vast majority of foreign inflows to Russian firms consist not of direct investment, but bank credit," the report said.

Uncertainty over property rights and ever-changing regulations appear to have spooked many potential investors.

"The protracted Yukos affair has been the center of attention in this regard, but many other companies have also apparently experienced increased harassment, often from the tax administration under the guise of exposing and collecting unpaid taxes from previous years," the report said. The taxman raked in an estimated 470 billion rubles ($17 billion) in back taxes last year, the World Bank calculated, as opposed to less than 150 billion in 2003.

Nevertheless, the report predicted that if Moscow joined the WTO, "there would be a significant increase in FDI and an increase in multinational firms operating in the business services sectors in Russia."

Those domestic businesses that fail to attract foreign partnership will lose out, the World Bank said.

"The Russian firms that become part of a joint venture with foreign investors are likely to increase the value of their investments. Russian capital owners in business services who remain wholly independent of multinational firms ... are likely to see the value of their investments decline."

The report also pointed out that Russia's growth since 2000 has been "strongly pro-poor," with the number of people living below the subsistence level decreasing from over 27 percent in 2001 to below 18 percent last year.

Yet the World Bank also warned about creeping inflation. In combination with surging capital inflows, rising costs could push inflation above 10 percent, Litwack said.