BEAR NECESSITIES. Working with Russia in times of uncertainty

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1 BEAR NECESSITIES Working with Russia in times of uncertainty MILTTON INSIGHTS I JUSSI SEPPÄLÄ

2 The interviewed influencers and experts: Aaltola, Mika Affairs, Programme Director Anttonen, Matti Ministry for Foreign Affairs, Under- Secretary of State Cawén, Klaus Kone, Director Federley, Sari Tekes, Senior Adviser Hedenborg, Tomas Fastems, Group CEO Heikkinen, Anna-Kaisa Special Adviser to the Prime Minister Herranen, Virpi Tekes, Head of Tekes Russia Heusala, Anna-Liisa Aleksanteri Institute, senior researcher Hienonen, Jukka SRV, CEO Hietanen, Kari Wärtsilä, Director Himanen, Hannu The Finnish Embassy in Moscow, Ambassador Huttunen, Tuomo Fennovoima, Stakeholder Manager Hyvärinen, Esa Fortum, Director Iho, Ville Finnair, COO Jumpponen, Jari East O ffice, Director Jämsén, Kauko St. Petersburg s Turku Centre, Director Kanerva, Ilkka OSCE, President, Member of Parliament Kangaspuro, Markku Aleksanteri Institute, Research Director Kiskola, Reijo Arla, CEO Kivinen, Markku Aleksanteri Institute, Director Korhonen, Iikka Bank of Finland, Head of BOFIT Koskelainen, Anu-Leena The Finnish Embassy in Moscow, Counsellor Koskinen, Marita Prisma Russia, COO Lamminen, Johanna Gasum, CEO Lehtinen, Kari Paroc, CEO Limnéll, Jarno Aalto University, Professor Liuhto, Kari Turku School of Economics, Professor Moshes, Arkady Affairs, Programme Director Mykkänen, Kai Confederation of Finnish Industries, Director Mäki-Leppilampi, Marjo The Finnish Embassy in Moscow, Minister Counsellor Nikkola, Petteri SEB Bank, CEO Orpo, Petteri Minister of Agriculture and Forestry Pietiläinen, Timo Finnvera, Head of Representative Office in St. Petersburg Pokela, Pekka Gaia Consulting, Business Director Poljatschenko, Kirsi-Maarit Finpro, Head of St. Petersburg Trade Center Pynnöniemi, Katri Affairs, Senior Researcher Raik, Kristi Affairs, Senior Researcher Rantala, Marcus Ministry of Defence, State Secretary Rautonen, Lenina Danske Bank Russia, Director Romakkaniemi, Juho European Commission, Head of Cabinet Saari, Sinikukka Affairs, Senior Researcher Sirén, Torsti National Defence University, Department Director Sivonen, Mireta Pohjola Bank St. Petersburg, Chief Representative Suominen, Esa Ministry of Finance, State Secretary Tiilikainen, Teija Affairs, Director Tiri, Mirja Finnish-Russian Chamber of Commerce, CEO Tulokas, Pirjo Consulate General of Finland in St Petersburg, Consul General Tynkkynen, Veli-Pekka Aleksanteri Institute, Professor Valo, Raimo East Office, CEO Vuori, Timo Finnish Chambers of Commerce, Director Väätänen, Juha Lappeenranta University of Technology, Professor 3

3 Bear necessities: working with Russia in times of uncertainty Russia holds many possibilities, but it also poses threats. In November 2014, Miltton compiled a report on the current Russian situation from the strategic viewpoints of Finnish commercial and industrial life. The report, which is based on the views of top Finnish experts, maps large-scale opportunities, taking risks and threats realistically into account. From the Finnish point of view there are a lot of opportunities, and businesses have not overlooked them. Four out of five big Finnish companies operating in Russia have increased their Russian trade and turnover this year. Some have doubled their sales. Nearly a third of Finnish businesses are planning investments. A crisis also brings possibilities: Production in Russia may be more profitable than ever and cheap commercial spaces may invite businesses to expand. Bye for now, big spender Economic sanctions and the devaluation of the ruble have had an adverse effect on the purchasing power and real income of Russian consumers. The ban on the import of food items, which is largely due to Russian countersanctions, has led to the more expensive import of goods, for instance, from South America. Russia s own agricultural production and food industry have not been able to answer the increasing demand, slimming the wallet of the average Russian. On the other hand, Russian consumers are accustomed to hard times and see supporting domestic production as patriotic. This patriotism is also reflected in the increased interest of Russian businesses to involve themselves in projects developed with foreigners. Russian tourists, important to the Finnish economy, are fewer in numbers and spending less money while visiting Finland. Travelling abroad is also restricted by EU sanctions that keep home a number of Russians who have been placed under travel bans. This is especially inconvenient for the elite, who are used to foreign travel and whose children often study abroad. Russian consumers are investing safely, for instance in real estate. Consumers are holding back on other large investments and car sales, for example, are lagging. Interests on mortgages are being kept low, which the interviewed experts see as Putin s way of preventing discontent. Residential construction and sales have continued strong, considering the overall economy, benefitting companies like Tikkurila and Finnish construction companies operating in Russia. The St. Petersburg region is the largest consumer market near Finland and will remain important for the Finnish economy in the future. The 4

4 interviewees believe there is a market for Finnish businesses in providing basic services, and that health services geared towards the Russian market should still be developed actively. Health services geared towards the Russian market should still be developed actively. There are also opportunities for Finnish businesses in the travel sector, as Russian travel agents are suffering from financial problems. Despite weakened purchasing power, the interviewees believe that catering for Russian consumers may in the long term be the most durable and safest way of trade. The quality associated with Finland s brand continues to offer high opportunities for success, especially in nearby regions. Living with uncertainty Uncertainty is, however, the common denominator in the views on Russia shared by the Finnish influencers interviewed for the report. Putting superpower mentality ahead of peaceful economic interests concerns most experts. Finland s location remains a certainty; no-one is playing down Russia s importance to Finland. Many experts feel that the Ukrainian crisis has sealed Russia in a state of continuous uncertainty. Finnish companies will have to find ways of adjusting to these circumstances. Concern over the situation in Russia is reflected in the communications of many businesses. Businesses do not want to jeopardise investments that have already been made, but planned investments are not widely publicised either. This may give the public too negative an image of economic opportunities in Russia. Businesses are awake, but they aren t shouting it from the rooftops. Potential in the industries of the future The biggest opportunities for Finnish businesses lie in the massive need for reform in Russia. The Russian energy sector is outdated in its operations and Finland s world class expertise on energy issues could improve its efficiency. With climate change, Russia is looking north. The Arctic will become increasingly important in replacing current oil and gas reserves. Finland has high-quality arctic know-how, especially in cleantech. The heating reform approved by the Russian government in October is probably the best example of large-scale opportunities for Finnish know-how. Its potential has been discussed astonishingly little in public, even though the St. Petersburg region alone would hold a billon euro market for the Finnish energy and construction industry. Although, as the case often is with Russian reform initiatives, it is not yet certain that the heating reform will go ahead. If the Russian heating market will begin to open up next year as planned, the multiplier effect will extend from consulting, the production capacity of electricity and heating, construction and insulation all the way to the missing thermostats in Russian homes. Russia has immense potential for development and savings in in energy efficiency, and Finns are well equipped 5

5 to carry out such reforms. On a strategic scale, there are opportunities in many other fields in which Finns are specialised. Arctic natural reserves and developing transportation routes make up one of these sectors. Team Arctic, a cooperation model for Finnish businesses, offers expertise from specialised ship building and shipping to oil spill prevention and from harbour logistics to the production of renewable energy and energy-efficiency. The initiative has received high-ranking attention from the Finnish State. Russia is just moving into an age of modern production industries. Finland can offer the world s best in industrial automation and modern production technology. Finnish technology for the engineering industry is in great demand in Russia, but EU sanctions make exporting goods difficult. In Russia, military and civilian industries are tied together, which makes interpreting sanctions difficult. These three sectors are strategic in scale and the role of the State is discussed in the report. The fourth, consumer sector, is discussed separately. The Russian purchasing power has weakened with the economy and the ruble, but the consumer market is still the key to success for Finnish companies. The St. Petersburg region and tourism to Finland are especially important. Going native pays off In addition to opportunities, there are uncertainties and problems. Russia has already approved and is planning more actions that direct domestic consumer demand away from imported products to Russian ones. This also Russia s way of attracting investments it cannot afford itself. A Western product becomes Russian, if it has been made in Russia. Russia is looking for investments rather than export. Investments and trade carried out in rubles are, on the other hand, the way Finnish businesses should operate in Russia, as the ruble becomes weaker. Strategically, the businesses that have localised operations in Russia, such as Tikkurila or Fazer, fare best in this situation. Direct investments in Russia and ruble-based operations benefit companies. Russia s nationalist boom makes operating in Russia more practical than exporting goods to Russia. Russians want to work with domestic partners in business-tobusiness operations, so businesses who have positioned themselves as local brands have a more stable position than export companies from the Eurozone. The Finnish meat producer Atria, for instance, has factories in Moscow and St. Petersburg and is more protected than Valio, who is suffering from the export ban on food items. Unpredictable politics, uncertain economy The devolving ruble is at the heart of nearly all of the issues. The ruble market is insignificant on a global scale, and currency reserves are becoming depleted with debt payments. Attitudes towards import are 6

6 becoming more negative with the weakening ruble. It is paradoxical that the benefits of devaluation for exporting energy are lost with the reducing oil prices and Russia s dependency on Western oil drilling technology. This high dependency will continue because at the moment, Russia has no money or apparent willingness to invest in its own drilling technology. At the moment the weakening of the Russian economy is being slowed down by income reserves from the energy sector s stronger days. Russia s dependence on income from the export of oil and gas is its weakness. The low price of oil is shrinking the State s income and there are no alternative sources. When the price of oil was high, Russia collected an easy income, but economic reforms and investments in new industries have not been successful. Oil price is predicted to stay down for a long time, which does not bode well for the Russian economy as it is. The Russian economy is suffering from its one-sidedness. Finland has been exporting refined products that require highly-skilled labour to Russia. Russia, in turn has solely exported energy and raw material to Finland. Russia is lacking modern production industries, but there is no capital for the large-scale investments required to change this. At the moment Western sanctions against Russia are making the situation even more difficult. The situation could only be improved by lifting the sanctions on Russia and reopening the flow of Western investments. There is no growth to be had in high oil prices, so structural reforms and foreign investment is needed. The interviewed experts do not see that Asia could take the Russian economy out of its gloom. They are calling for reforms and cooperation with Europe. The Russian business sector has hundreds of billions in foreign currency debt. This, paired with economic sanctions is eating away the country s own ability for investments. Because of this, investments needed for economic reforms cannot be made and Russia s biggest strategic problem is left unsolved. After Vladimir Putin s return to presidency, economic reforms have anyway been on the back burner. An important gauge for Putin s plans is whether Russia s large security reserves will be invested in reforms. So far, this has not been done. Many interpret this as Putin s way of preparing for a prolonged crisis. Combined with a hard-line nationalist rhetoric and continuing military actions, this does not bode well. Russia has been flexing its muscles both in Ukraine and in the national air spaces of its neighbours. Military juxtaposition has increased and Finland is not living in a vacuum. Russia s superpower agenda dominates its actions. Russia s dependence on energy export remains a fact, and Europe is looking for ways to cut back its dependence on the export of Russian energy. The Russian economy is taking a harder hit with the low price of oil than with economic sanctions. If the global economy does not pick up and the price of oil remains low, Russia will be in even bigger trouble. In the coming years this will lead to the shrinking of the economy and trade -- and in worst scenarios, military aggression to hold back economic discontent. Next year will be one of solutions in many ways. Will Putin lift the counter-sanctions against food items, if there is an increasing shortage? 7

7 Can the Russian business sector take care of its debts, as the economy and the income from oil are shrinking? Will Russia s relationship with the west become even more strained? What will happen with the sanctions? Will Putin s popularity stand the test? Are there new conflicts on the horizon? If the crisis becomes badly prolonged and causes the economy to collapse, Putin s popularity could be badly shaken. At the moment there is nothing so acute that it would give cause to expect changes in the Kremlin. It can be expected that Putin will hold on to his power for a long time. Most of the interviewed experts hope that the situation will be resolved with a change of policy from Putin. However, a compromise that would satisfy both the West and Russia seems unlikely. There are many uncertainties, but few clear answers. It is certain, however, that they Finns will not be fleeing from Russia in masses. The majority feels that the must hold on to their current positions and maintain relationships for better times. But despite of all difficulties, could this be the moment to invest? Answers vary. Many see that this is a time when the stakes on the Russian market could be redistributed. Others are more cautious. There are no right answers. Everyone has to find their own solutions, preferably relying on a long-term strategy. 8

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