From the conflict in Ukraine, to Russian meddling in U.S. and European elections, to management of the Syrian War, it’s clear that relations between the West and Russia have become increasingly hostile. Yet Russia remains an important part of most Western multinationals’ emerging markets portfolios. These companies are not immune from geopolitical tensions, which can impact their businesses in both direct and indirect ways.
While relatively rare, there have been a few cases of the Russian government directly interfering in Western businesses’ affairs. For example, in 2014, at the onset of the sharp deterioration in U.S.-Russian relations over the conflict in Ukraine, the Kremlin sued McDonald’s for allegedly violating the government’s safety codes, and even temporarily closed four stores over alleged “health violations.” Similarly, hours after the U.S. and EU increased sanctions on Russia that same year, Russian authorities raided the Russian headquarters of Ikea, which has long struggled with interference from the Russian government.
Some of my company’s clients (executives at large American and European multinationals) operating in Russia have also noticed increasing regulations over the past few years: they have experienced more unplanned inspections of facilities, abruptly altered labelling requirements, threats of regulatory changes from the regional and federal government, and heightened pressure to hire and manufacture locally. They have also reported receiving threats of fines and increased delays and payments while in customs at the Russian border. Interestingly, all these intrusions into business operations typically do not come from the Kremlin but from local officials who seem eager to gain the Kremlin’s favor amid instances of elevated international tensions.
Russia’s recent economic downturn, precipitated by the collapse in energy prices, has also contributed to more conservative state policies at the expense of economic reforms – which undermines the business climate and long-term growth prospects. Government revenues and private sector opportunities have deteriorated over the past few years and will be slow to recover.
This environment is altering how multinational firms operate in the country and market their products. Our clients in the area have already noticed several changes that make it harder and costlier to do business there.
Induced by rising economic pressures – and reflective of trends in other emerging markets – the Russian government has been pressured to support local businesses, often to the detriment of foreign investors. For instance, a 2014 law mandates that the government must show preference for local manufacturers over foreign firms when granting public tenders, without regard to differences in quality. In response to the West’s decision to implement sanctions on Russia, the government decided to impose tit-for-tat sanctions on various Western agricultural imports and has adopted a policy of import substitution, which means that it imports fewer food and dairy products, while subsidizing more domestically produced ones. This has been beneficial for some Russian industries but has reduced market access for foreign firms.
At the same time, multinationals are feeling pressured by the state to demonstrate their commitment to the market by further localizing their supply chain, labor, brand, and production. This poses challenges when there are no (or no high quality) local suppliers, which is often the case in certain sectors, such as healthcare.
Meanwhile, the government’s fiscal policies are reducing domestic demand. For instance, the country’s excessive reliance on commodity exports, combined with a lack of growth-supporting policies (e.g. a fiscal stimulus, support for non-commodity sectors, improved rule of law), have created problems for raising sufficient government revenues. As a result, Moscow has introduced various excise taxes and is contemplating a hike in the VAT rate (from 18% to as much as 24%) and higher income taxes (to either raise the flat rate from 13% to up to 20%, or to create progressive scale) that will hurt the spending power of consumers.
In recent years, the government has also been making funding cuts on healthcare, education, state industries, and pensions. In many cases, people have to bear more costs directly – for example to pay for more of their own healthcare – which also limits their spending power.
We also hear from clients that more government projects are being eliminated, reducing opportunities for companies hoping to sell to the government. Additionally, because Russian agencies are facing reduced federal funding, they are becoming incentivized to enact regulations or ad hoc policies to gain more revenue from foreign firms, either extracting payment at customs or imposing fines and taxes on their local operations.
Furthermore, economic decision-making has become increasingly politicized as the government has prioritized political goals (i.e. the re-election of Putin in 2018) and foreign policy over domestic reforms, such as fighting corruption, that could lead to an improved business environment. This will likely continue to make business planning even more difficult.
So, what can businesses do?
Most firms we work with feel a sense of powerlessness to handle the changing conditions in Russia. But based on the experience and strategies of our clients, there are ways that they can manage the uncertainty. Despite the tumultuous the political and economic climate, Russia still remains very attractive compared to other emerging markets, like Brazil or Nigeria, over the long term, because of its large population, public and private spending capacity, and strong resource base.
First, companies should pinpoint exactly what elements of their operations are most vulnerable to abrupt changes in foreign policy relations. Then, firms need to think through the types of political and macroeconomic events (e.g. further sanctions, oil price drop, protests, etc.) that could influence the economy (e.g. ruble volatility) and policy (e.g. import bans), and also affect their operations, local partners, and customers. These can be laid out in scenario plans with specific mitigation actions assigned to help businesses react quickly if necessary.
Since 2014, we have guided numerous consumer goods firms through this process to mitigate the effects of the extreme depreciation of the ruble on their businesses. The weak ruble has driven up inflation notably, which in turn has forced the central bank to raise interest rates, driving up the cost of credit. As a result, our clients’ distributors have had difficulty in obtaining loans and therefore have had less financial capacity to buy products from our clients to distribute to stores around the country. To preempt any operational disruptions, some clients have chosen to provide the financing to distributors themselves, so they are still able to purchase and then sell products from our clients. For many firms, this has had a significant positive impact on their ability to retain market share and brand awareness while maintaining profitability.
Second, firms should strengthen their government affairs teams to stay ahead of any regulatory changes. Multinationals can even team up with competitors (both foreign and domestic) and industry associations to lobby the government on policy decisions affecting their sector and customers.
Third, companies should consider localizing more of their operations. The more local you are, the better your chances at obtaining government tenders and the more leverage you have to push back against potentially harmful government regulation. With greater tax contributions, local labor, and sourcing from local suppliers, firms can more easily show how government interference negatively affects Russian businesses and workers.
Despite the turmoil in Russian-Western relations, having a plan to respond quickly can help multinationals weather, manage, or even capitalize on political developments.
