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Speculative Benefits: Economists Urge Caution as the Russian Economy Appears to Be Getting a Boost from Surging Capital Inflows

Russia says it has recorded an unprecedented increase in capital inflows in the first half of this year, in the latest sign that the Kremlin's efforts to stimulate economic growth and improve the country's investment climate may have started to bear fruit. Between January and June of this year, investors pumped a total of $87.7 billion into the Russian economy, according to the Federal State Statistics Service (Rosstat). Analysts say the inflows are unprecedented, even when compared with the pre-crisis year of 2007, when foreign investors literally tripped over each other to invest in Russia.

However, the figures should not lead to a conclusion "about the real investors' activity" in Russia, as half of the sum, or $44.4 billion, was invested in the financial services sector, which in turn reinvested $44.5 billion overseas, the Vedomosti business daily reported on Thursday. A similar pattern was reported in the first quarter when investors injected $24 billion into the economy through the financial services sector, and Russian companies invested just about the same amount overseas. Most of the inflows consist of short term, highly liquid investments in the range of six months, and they are neither portfolio nor direct investments, the paper said. About $42.9 billion of the funds came from Switzerland, but Russian companies invested $24.6 billion in that country over the same period, figures from Rosstat show.

Russian companies' investment overseas also hit a record $67.2 billion in the first half-year, amid efforts by the Kremlin to allow more domestic enterprises to float shares abroad. The Russian Federal Financial Markets Service (FFMS) drafted a new regulation in July to allow Russian companies to place 100 percent of their shares abroad, a move experts described as "revolutionary," as Russian companies are currently barred from placing more than 25 percent of their shares on foreign stock exchanges. The relaxed rules would, however, not apply to companies in the so-called strategically important sectors, where the 25 percent limit would be retained, while companies in the extractive industries would be subject to even more severe restrictions of five percent.

The move got a green light from President Dmitry Medvedev at the St. Petersburg International Economic Forum in June, where he directed that more indigenous companies must be encouraged to invest overseas. In the past, Russian companies have opted for stock exchanges in London, New York and Hong Kong for their share placement, so they could have more opportunity to attract a wide range of foreign investors and further boost the share price than in Moscow.

Despite a corresponding capital outflow, the inflows of overseas short-term funds to the financial services sector in the first half year have been robust by Russian standards. The sector recorded inflows of $1.3 billion between January and June, a mere four percent of the $30 billion capital inflow for the economy. Prime Minister Vladimir Putin said last month that foreign direct investment in Russia in the first half of 2011 increased by 39 percent (almost the level of the pre-crisis year 2007) and came to over $27 billion. The recovery of the Russian economy and the government's measures to improve the business climate in the country give grounds to hope that the FDI could hit $60 to $70 billion, Putin said.

Analysts on Thursday offered a mixed bag of reasons as to why Russia is experiencing a sudden surge in capital inflows. Sergei Aleksashenko, a former deputy finance minister and first deputy Central Bank chairman who is now director of macroeconomic research at the Higher School of Economics, suspects nefarious activities by market speculators. "It would seem at first like an intensive investment activity by speculators who trade in short-term financial instruments. However, speculative transaction has always been the prerogative of banks, and not big companies, as with this case," Aleksashenko said. "However, if the funds flowed in and flowed out, I would put it down to some kind of scheme."

Natalia Orlova, the chief economist at Alfa Bank in Moscow, described as "worrying" the simultaneous spike in overseas investment by Russian companies. "The sudden upsurge in short-term capital inflows reported by Rosstat can be explained as intensive activity by Russian oil and gas companies," Orlova said. "However, the figures don't look so impressive when it is remembered that Russian businesses have also been actively investing abroad despite the huge need for domestic investment."

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