**COUNTRY COMMERCIAL GUIDE--RUSSIANFEDERATION**

**FISCAL YEAR  2000**

 

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**TRADE REGULATIONS AND INVESTMENTCLIMATE**

 

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**VI.  TRADE REGULATIONS AND STANDARDS**

** **

**Trade Barriers**

 

Since 1996,Russia’s import duties (on a trade-weighted basis) have averaged around 14percent.  A three-percentage pointtariff surcharge on all imports dating from July 1998 was revoked effectiveMarch 1, 1999.  Products for whichRussian import duties are particular obstacles include automobiles (wherecalculation based on engine displacement disadvantages many larger U.S.vehicles) and aircraft. 

 

Besidestariffs, there are two other types of charges applied to imports:  excise tax and value-added-tax(VAT).  Excise tax applies to anumber of luxury goods, alcohol, cigarettes and autos, and varies from 20percent to 570 percent on a price- exclusive basis.  The VAT rate is now 20 percent, with the exception offoodstuffs (for which VAT is 10 percent), and is applied to the import priceplus tariff plus excise tax.

 

**Customs Valuation**

 

Customs dutiesare payable on the customs value of goods in hard currency or rubles at thecurrent exchange rate.  The customsvalue is generally considered to be the CIF price of the goods imported.  A customs processing fee of 0.15percent of the goods’ actual cost is also levied.  According to customs regulations, customs processing shouldtake no longer than one month.  Ifgoods are refused by Russian Customs, regulations call for their return to thecountry of origin.

 

**Import Licenses**

 

Importlicenses are required for importation of various goods, including ethyl alcoholand vodka, 14-, 21- and 25-inch color TVs, combat and sporting weapons, self-defensearticles, explosives, military and ciphering equipment, radioactive materialsand waste including uranium, strong poisons and narcotics, and precious metals,alloys and stones.  Import licensesare issued by the Russian Ministry of Trade or its regional branches, andcontrolled by the State Customs Committee.  Licenses for sporting weapons and self-defense articles areissued by the Interior Ministry. 

 

**Russian Export Controls**

 

Weapons,military equipment and dual-use materials and technology continue to requireRussian export licenses if sold from Russia.  Oil exports are controlled through the Ministry of Fuels andEnergy's granting of access to export pipelines.  

 

**United States Export Controls**

 

Certainhigh-technology or dual-use (civilian and military) products, such as weapons,high-speed computers and other goods, are subject to United States Governmentexport restrictions, possibly including requirements for pre-license checksand/or post-shipment verifications. In the United States has banned U.S. exports to ten Russian enterprisessuspected of collaboration with Iran in development of ballistic missile and/ornuclear weapons capabilities. Exporters with questions are advised to contact the Export CounsellingDivision of the U.S. Department of Commerce’s Bureau of Export Administration(see Chapter XI for contact information) for guidance. 

 

**Import/Export Documentation**

 

Importers arerequired to complete a Russian customs freight declaration for every itemimported.  Certificates of originand conformity (see "Product Standards" below) should also bepresented at customs.  Exportersare required to complete an export declaration and, if necessary, present theappropriate export license at customs. In addition, currency control authorities require issuance of a"passport" for both exports and imports to ensure that hard currencyearnings are remitted to Russia and transfers of hard currency payments forimports are for goods actually received and properly valued.

 

**Temporary Entry**

 

Temporaryimports by foreign companies which are accredited with Russian governmentauthorities are exempt from customs duties.  This applies to goods imported only for company use and forone year only.  Companies notaccredited with Russian government authorities are charged 3 percent of thetotal cost of the product on a monthly basis.  In this case, total cost equals original product price plusall import taxes.

 

**Product Standards**

 

Many productsimported for sale into the Russian Federation are required to have acertificate of conformity issued by the Russian State Standards Committee(Gosstandart).  GOSSTANDART testsand certifies products according to Russian Government standards, rather thanother widely-accepted international standards (e.g., the ISO-9000 system).  GOSSTANDART and its authorized agentsare the chief sources for certification in Russia.  However, other agencies are involved in certification ofcertain products, including the Ministry of Agriculture (food products), theMinistry of Health (medical devices and pharmaceuticals), the StateCommunications Committee (telecommunications equipment and services), the StateMining and Industrial Inspectorate GOSGORTECHNADZOR (equipment for the mining,oil and gas industries) and others.

 

Testingprotocols from the IECEE (electrical equipment) and the IECQ (electricalcomponents), both of which fall under the International ElectrotechnicalCommission, from Underwriters Laboratories, and from other bodies are acceptedby GOSSTANDART and help to expedite certification by the Russian agency.  The certificate of conformity is validfor 3 years and must accompany every shipment.  Copies of the certificate are acceptable if original sealsof the U.S. company holding the original certificate accompany the copy.  Russian retailers are obliged to haveon hand certificates for all imported products sold in their stores; violationof this requirement can bring penalties of up to the equivalent of $10,000.

** **

## Product Labeling

 

Newregulations on labeling for non-food products came into force on July 1, 1998,augmenting food labelling requirements which took effect previously.  Companies are advised to check theircompliance with these requirements before shipping products.  Regulations can be obtained fromGosstandart (see contact information in Chapter XI).

*** ***

**Free Trade Zones/Warehouses**

 

There are noactual free trade zones in Russia. There are some free economic zones designed to encourage investments inspecific areas, as well as free customs zones and free warehouses.  Federal legislation on the developmentof free economic zones (FEZs) is no longer a Russian priority, despite theperiodic resurfacing of draft bills. In 1997, a bill  attemptingto unify tax holidays and other concessions for FEZs across Russia passedparliament only to be vetoed by the president.  Previously-established FEZs, including the high profileKaliningrad FEZ, have generated little new investment.  

 

Morerecently, with the onset of the financial crisis and the government's emphasison improving revenue collection, the concept of FEZs has been criticized as athreat to federal budget revenues. The government has turned to the model of smaller-scale, morecontrolled, "free customs warehouses" as a possible alternative, asin the case of the 1998 Automobile Industry Decree (#135).  Customs duties do not apply in freecustoms zones and free warehouses. Some production and wholesale transactions can take place within thesezones, but not retail sales.  Thestorage period is not limited. Free customs zones and free warehouses are located in customs areas(airports, seaports, railway and truck terminals) and, according to Decree 135,selected automobile factories.

 

**Membership in Free Trade Arrangements**

 

Russiacurrently participates in a free trade arrangement with the CIS.  Russia has an association agreementwith the European Union (effective December 1997), proposes to join the WorldTrade Organization, and currently receives MFN treatment and GSP status fromthe United States.  A customs unionwith Belarus, Kazakhstan, Kyrgyzstan and Tajikistan has been formed on paper,but is not currently operational. 

 

** **

**VII. INVESTMENT CLIMATE**

 

While therehas been a gradual revival in economic activity since 1998, and some newforeign investment initiatives in key industrial sectors, most foreign directinvestors are concentrating on consolidating their positions to limit theirlosses in the near term.  In thisenvironment, the Russian government faces great challenges in fashioning itsinvestment policy.  Nevertheless,the government continues to work toward creation of a more favorable investmentclimate.

 

# Openness to Foreign Investment

 

Throughoutthe 1990s, the Russian Government has placed high priority on the attraction offoreign direct investment, and 45 regions have also developed laws and programsto attract it.  To date, theseefforts have focused on tax incentives for large investment projects, a newRussian development bank, and guarantees for new investments, all of which arehamstrung by lack of funds. Investment promotion is hampered most by several factors affecting thecommercial climate.  First, manylegal underpinnings of a modern market economy remain to be firmlyestablished.  New laws andrevisions of existing laws that affect costs and conditions continue to beintroduced frequently.  Second,relatively high incidences of unfair or non-transparent business and tax practicesdissuade investors.  Third, it isulikely that most investments will show strong profits in the short term, giventhe current weakness of Russia’s economy. Finally, financing remains scarce.     

 

The 1991investment code guarantees foreign investors rights equal to those enjoyed byRussian investors.  This law wasamended by new legislation effective July 9, 1999, and includes a grandfatherclause protecting certain investments from unfavorable changes in tax and otherlaws for up to seven years. However, it also widens somewhat the legal criteria for restrictingforeign investment in some sectors. 

 

There havebeen relatively few explicit restrictions on foreign direct investment inRussia, but domestic pressures for restrictions in specific sectors aregrowing.  A 1998 law on theaerospace industry limits foreign ownership to 25 percent of anenterprise.  Foreign ownership inthe natural gas monopoly Gazprom is technically limited to twenty percent,although use of joint ventures to purchase additional shares has allowedGazprom to pursue its strategic partnership with the German company Ruhrgaswithout legal problem.  Foreigninvestors are limited to a 49 percent share in insurance companies, and a proposedlaw would limit overall foreign capital in the insurance industry to 15percent.  A 1998 law limits foreigninvestment in the electric power giant Unified Energy Systems to 25 percent orless; however, it has not been enforced to date, and foreign holdings in UESare believed to exceed 28 percent. The Russian parliament has also been discussing a law which wouldexplicitly restrict or prohibit investment in a number of sectors (it wouldfollow passage of the revisions to the foreign investment law).  

 

Current lawlimits foreign bank capital to 12 percent of total banking capital.  Last year's financial crisis devastatedRussian banking capital and, as a consequence, foreign capital approached the12 percent ceiling in mid-1999.  Inresponse, Central Bank Chairman Viktor Gershchenko has indicated that thegovernment is exploring the introduction of legislation that would raise theceiling or otherwise facilitate additional foreign capital inflow into Russianbanks.

 

Priorapproval is required for investment in new enterprises using assets of existingRussian enterprises, foreign investment in defense industries (which may beprohibited in some cases), investment in the exploitation of natural resources,all investments over 50 million rubles (currently about $2 million), investmentventures in which the foreign share exceeds 50 percent, or investment to takeover incomplete housing and construction projects.  Additional registration requirements exist for investmentsexceeding 100 million rubles. Projects involving large scale construction or modernization may also besubject to expert examination for environmental considerations.  In sectors which require licensing(e.g., banking, mining and telecommunications), procedures often can be lengthyand non-transparent.  Although thesituation has improved over the past few years, foreigners encountersignificant restrictions on ownership of real estate in some cities and regionsin Russia.  

 

Duringlarge-scale and case-by-case privatization from 1994-1997, foreign investmentwas a contentious issue.  TheRussian government failed to establish clear and consistent laws in thisregard.  The high profileloans-for-shares privatization program of 1995-1996 banned foreign investorsfrom auctions in the oil, gas and precious metals sectors.  Although foreign investors haveparticipated in Russian privatization sales, stakes are limited and problemsoften arise with respect to minority shareholder rights and corporategovernance.  In 1998, privatizationslowed significantly, first due to the government's decision to take a gradualapproach, then as both foreign and domestic investors lost interest inunrestructured enterprises that appeared unprofitable.  Since foreigners are virtually the solesource of capital in Russia's current privatization climate, there have beenseveral announcements that future sales will be open to foreign investors.  One recent sale of government shares inGazprom went to a foreign investor which already held shares in the company.  

 

The questionof foreign investment via future privatizations is not clear, and for the shortterm, controlling stakes in large state firms of potential interest generallyare not up for sale.  Nonetheless,small-scale privatization continues at local, regional and federal levels andmay present some good buys for some investors (for example, the Russiangovernment periodically sells off incrementally some of the shares it owns inlarge enterpises).  Potentialforeign investors are advised to work directly and closely with local, regionaland federal officials that exercise ownership and other authority overcompanies whose shares they may want to acquire.

 

Foreigninvestment has been hindered by the impact of the financial crisis which beganin August 1998.  A majority offirms suffered from inaccessible funds in banks, breakdowns in distribution,significant decline in demand for goods and products and nonpayment ofreceivables.  Of these problems,reduced demand appears to be the most lasting effect, with many companiesreporting revenues down by 20-50 percent even a year later.  This economic context has made it moredifficult for investment projects to secure financing, as private Western bankshave all but ceased accepting Russian risk.

 

Rule of lawand respect for property rights, though improving, remain key concerns forforeign investors.  Many large U.S.firms are reluctant to pursue a strategy of growth through acquisition inRussia due to potential liabilities associated with existing facilities (e.g., taxdebts and environmental cleanup liabilities), political pressures which wouldhinder economic restructuring, hidden financial liabilities and weak protectionof minority shareholder rights.

 

**The Energy Industry**

 

Accountingfor half of Russia’s export revenues and comprising a major share of the world’sundeveloped energy resources, Russia’s oil and gas sector holds tremendouspotential for foreign as well as domestic investment.  After a long delay, new production sharing agreement (PSA)legislation was adopted at the beginning of 1999.  The Russian government is now drafting normative acts whichwill facilitate investment in the energy sector through PSAs.  Disagreement between the licensingagency, the Ministry of Natural Resources, and the technical agency, theMinistry of Fuels and Energy, has delayed progress in the past.  Passage of PSA legislation was animportant step toward a transparent, stable investment regime, and though notadequate in itself, is a precondition for major Western energy investment here.

 

The Russiangovernment has been unable to deliver on promises of a stable environment foroilproducing joint ventures, which have operated outside the PSA context.  One U.S. joint venture partner withdrewfrom Russia in May 1998, citing the adverse effect of the imposition of morethan 40 new taxes by the Russian government since 1991.  Ruble devaluation following the August1998 crash has given joint ventures some breathing space, as has the recentrebound in world oil prices. Access to export pipelines remains problematic for these ventures.

 

Changes inthe ownership structure of the Russian oil industry have resulted in moremarket-oriented potential partners for U.S. firms.  However, the sector remains characterized by a lack oftransparency and extensive influence by Russian oil and gas firms over thegovernment and other economic actors. 

 

# Agriculture

 

Russianagriculture is grossly undercapitalized, and foreign investors remain reluctantto invest in Russian farming for several reasons.  Most Russian farm operators seek only minority partners, andfew operations are available to be wholly-owned by foreigners because ofRussian fears over possible loss of control of domestic production.  Some regional governments have addeduncertainty by imposing embargoes on movement of agricultural products out ofthe region after harvests, in order to ensure repayment of debts or localsupply.  Collective farms haveundergone largely cosmetic reform -- many are now referred to as joint stockcompanies, but still operate much as in Soviet times, carrying social welfareresponsibilities such as providing schools, healthcare and employment to localvillages.  Phase-out of subsidieshas left many agricultural enterprises underfunded, and production is often afraction of previous capacity.  Inthe absence of land reform, it is difficult to obtain clear title to land andillegal to use land as collateral for loans. 

 

Experiencehas shown that one of the most important factors determining success or failureof a foreign investment project in agriculture is the degree to which the localadministration supports the project, is willing to clear obstacles whennecessary and otherwise not interfere. Most administrations officially invite investment into their regions,but fewer are prepared to allow business to operate in a relatively open marketwithout state interference with respect to issues such as pricing inputs andoutput, and with whom businesses may contract for services.  Many local administrations still viewforeign investors as sources of cash for the support of local government andfavored businesses.

 

# Regional Investment Initiative

 

The RegionalInvestment Initiative, announced in 1997, is a collaborative effort between theU.S. and Russian governments and regional authorities.  In each of three selected regions, U.S.Government agencies work with Russian regional and federal officials to setpriorities for attracting investment. These priorities then serve as the framework for a package of technicalcooperation, financing, and partnership activities, aimed at boosting prospectsfor investment and economic growth in the given region.  This initiative is currently beingimplemented in Novgorod, the Russian Far East (with a focus on Khabarovsk andSakhalin), and Samara.****

** **

**Conversion and Transfer Policies**

 

The CentralBank of Russia (CBR) has substantially altered its exchange rate policy andtightened its currency controls since the August 1998 financial crisis.  Tighter controls have helped reducecapital outflows, thereby supporting the ruble. These include the obligatorysale of 75 percent of foreign currency export earnings (up from the previousrequirement of 50 percent) for rubles on authorized currency exchanges, a 100percent prior deposit requirement for the advanced purchase of imports, and limitationson the purchase of foreign exchange using ruble in correspondent accounts; andincreased bank reporting requirements. 

 

The ruble isthe only legal tender in Russia. There are two types of foreign currency operations under Russianlaw:  (1) current operations (e.g.,import/export contracts and loans not exceeding 180 days); and (2) capitaloperations (investments, financial loans exceeding 180 days, and deferredimport/export payments of over 90 days).  Current operations have no limitations while capital operationsgenerally require prior approval of the CBR.  The CBR has sought to streamline the approval process fordirect investment inflows.

 

Non-residentscan open ruble accounts at authorized resident banks.  "T-accounts" are for servicing import and exportoperations, "I-accounts" are used for investment activities (e.g.,paid-in capital, profit repatriation), and "S-accounts" forinvestments in government T-bills. "S-account" holders of rescheduled T-bills are not permittedto repatriate their proceeds into foreign currency other than through speciallimited auctions conducted by the CBR. Non-residents may open correspondent ruble accounts to service tradeoperations, as well as ordinary ruble accounts.  Residents may open foreign exchange accounts.****

** **

**Expropriation and Compensation**

** **

The 1991investment code prohibits the nationalization of foreign investments exceptfollowing legislative action and where deemed to be in the nationalinterest.  By law, suchnationalizations may be appealed to the courts of the Russian Federation, andare to be paid with prompt, adequate and effective compensation. 

 

Russia’scurrent leadership is unlikely to nationalize or expropriate foreignholdings.  However, localgovernment interference, or lack of enforcement of court rulings protectinginvestors, in several cases has been a problem.  The United States Embassy is tracking a small number ofcases in which foreign companies are seeking compensation for the loss of theirinvestment or property due to regional government action or inaction.  Arbitration or legal proceedings arepending in some of these cases.  Todate, no award payments have been made in these cases.** **

** **

**Dispute settlement**

 

Russia has abody of conflicting, overlapping and rapidly changing laws, decrees andregulations which has resulted in an ad hoc and unpredictable approach to doingbusiness.  Independent disputeresolution in Russia can be difficult to obtain; the judicial system is stilldeveloping.  Regional and localcourts are often subject to political pressure.

 

Many Westernattorneys refer their Western clients who have investment or trade disputes inRussia to international arbitration (e.g., in Stockholm) or to courtsabroad.  A 1997 law now allowsforeign arbitration awards to be enforced in Russia, even if there is noreciprocal treaty between Russia and the country where the order was made.  Russia is a member of the InternationalCenter for Settlement of Investment Disputes and accepts binding internationalarbitration. However, the enforcement of international arbitral awards stillultimately requires action from Russian courts and follow-up by court officersthrough a nascent marshal system that has not yet proved itself.  

 

As for legalavenues available in Russia through Russian arbitration, one is the ArbitrationCourt of the Russian Federation, which is part of the court system.  It has special procedures for seizureof property before trial, so property cannot be disposed of before the courthas heard the claim, as well as for the enforcement of financial awards throughthe banks.  Additionally, theInternational Commercial Arbitration Court at the Russian Chamber of Commerceand Industry will hear claims if both parties agree to refer disputesthere.  Applications can be made byparties to foreign trade agreements and by companies with foreigninvestments.  A similar arbitralcourt has been established in St. Petersburg.

 

As withinternational arbitral procedures, the weakness in the system is in Russianenforcement of decisions.  In onecase, for example, after three years of successful Russian litigation withrepeated favorable decisions and court orders for financial restitution, aforeign investor continues to await compensation from its former joint venturepartner.  The best strategy,therefore, is to make a conscious effort from the outset of a businessrelationship to avoid court disputes, and to ensure that contracts includelegal (under Russian law) mechanisms for resolving them to mutual satisfaction.

** **

**Performance Requirements and Incentives**

 

The provisionof investment incentives has been problematic in Russia, as the Russiangovernment’s interest in attracting investment has been tempered by itsprecarious financial situation, concern over privileges given to foreigninvestors, and interest in complying with rules of the WTO and otherinternational economic institutions which generally frown on suchincentives.  Many investmentincentives set out in the 1991 investment law, including certain tax benefits,have never been implemented, or have been largely eliminated or superseded bysubsequent laws and decrees.  

 

The currentproduction sharing agreement legislation, as amended in late 1998, requires 70percent local content.  The RussianAutomobile Decree, signed in early 1998, allows tariff breaks for largeinvestments in the auto industry (where investment projects attain 50 percentdomestic content levels within five years).  There are also proposals (including in the Duma’s draftforeign investment law amendments) to grant exemptions from customs duties forcertain foreign investments exceeding $100 million.  However, in the face of severe fiscal shortfalls, Russia’sgovernment is under strong pressure to curtail existing incentives and to avoidoffering new ones.

 

Performancerequirements are not generally imposed by Russian law, and are not widelyincluded as part of private contracts. They have appeared in the agreements of large multinational companiesinvesting in natural resources development.  A government resolution adopted in July 1998 requiresRussian airlines to purchase domestically produced aircraft in order to receivewaivers of customs duties for certain imported aircraft, potentially impactingthe export of American aircraft to the Russian market.

** **

**Right to Private Ownership andEstablishment**

** **

Both foreignand domestic legal entities may establish, purchase and dispose of businessesin Russia.  Investment in thosesectors affecting national security (insurance, banking, natural resources,communication, transportation, and defense related industries) may be limited.

** **

**Protection of Property Rights**

** **

Theconstitution and a presidential decree issued in 1993 give Russian citizensgeneral rights to own, inherit, lease, mortgage, and sell real property (usuallynot including the land on which it stands).  However, legislative gaps and ambiguities impede theexercise of these rights.  Russiadoes not yet have a land code to regulate land use and ownership.   The 1993 presidential decree gavejoint ventures with foreign participants the right to own real property, and aprivatization decree issued in the summer of 1994 permitted foreign owners ofprivatized companies to receive title to enterprise land;  however, such rights have not beencodified.  The right of Russiancitizens to own and sell residential, recreational and garden plots is clearlyestablished, with over 40 million such properties under private ownership. 

 

Although aspring 1996 presidential decree permits ownership and sale of land, includingagricultural land, the Duma maintains that the decree is notconstitutional.  Uncertainty aboutmore general rights to land title and mineral rights will persist until theDuma and president agree upon clear and comprehensive legislation to regulateland use and ownership.  Meanwhile,some regional legislatures have tried to fill in the gap.  In 1997 and 1998, Saratov and Samaraoblasts approved laws allowing free trade of land in their regions.  In mid-1999, proposals were floated toban sale of land to foreigners (citing concerns over potential Chineseinvestors’ assumption of control over border lands in Russia’s Far East). Whilethe Stepashin government has publicly distanced itself from such proposals,their active discussion contributes to lack of certainty over future Russianland ownership policy.  

 

**Intellectual Property**

 

Since 1992,Russia has enacted laws strengthening protection of patents, trademarks andappellations of origin, and copyright of semiconductors, computer programs,literary, artistic and scientific works, and audio/visual recordings.

 

The patentlaw, which accords with norms of the World Intellectual Property Organization,includes a grace period, procedures for deferred examination, protection forchemical and pharmaceutical products, and national treatment for foreign patentholders.  Inventions are protectedfor 20 years, industrial designs for 10 years, and utility models for fiveyears.  The law on trademarks andappellations of origin introduces for the first time in Russia protection ofappellations of origin and provides for automatic recognition of Soviettrademarks upon presentation of the Soviet certificate of registration. 

 

The law oncopyright and neighboring rights, enacted in August 1993, protects all forms ofartistic creation, including audio/visual recordings and computer programs asliterary works for the lifetime of the author plus 50 years, and is compatiblewith the Bern Convention.  TheSeptember 1992 law on Topography of Integrated Microcircuits, which alsoprotects computer programs, protects semiconductor topographies for 10 yearsfrom the date of registration.

 

Russia hasacceded to the Universal Copyright Convention, the Paris Convention, the BernConvention, the Patent Cooperation Treaty, the Geneva Phonogram Convention, andthe Madrid Agreement.  Under theU.S.-Russian Bilateral Investment Treaty, Russia has undertaken to protectinvestors' intellectual property rights, although prospects for ratification ofthe Treaty in the foreseeable future are slim.  The U.S.-Russia Bilateral Trade Agreement mandatesprotection of the normal range of literary, scientific and artistic worksthrough legislation and enforcement.

  

While theRussian government has successfully passed good laws on protection ofintellectual property, enforcement of those laws has been a low priority.  A new criminal code went into effect onJanuary 1, 1997, which for the first time applied criminal penalties tointellectual property violations. However, there are shortcomings in this law that need to beaddressed.  In 1997, Russia waselevated to the “Priority Watch List” category under “Special 301” provisionsof the U.S. Trade Act, primarily for failing to provide protection forpre-existing U.S. copyrighted works and sound recordings still under protectionin the United States; and Russia has retained this designation in subsequentyears.

 

Untillegislative and judicial measures are taken to provide for effectiveintellectual property enforcement, there will continue to be widespreadmarketing of pirated foreign video-cassettes, recordings, books, computersoftware, clothes and toys.  Annuallosses to manufacturers, authors and others are estimated to be in the hundredsof millions of dollars.

** **

**Transparency of the Regulatory System**

 

The legal systemin Russia is still in a state of flux, with various parts of governmentstruggling to create new laws on a broad array of topics.  In this environment, negotiations andcontracts for commercial transactions are complex and protracted.  Russia has implemented only part of itsnew commercial code (contained within the civil code) and investors mustcarefully research all aspects of Russian law to ensure that each contractconforms with Russian law and embodies the basic provisions of the new, andwhere still valid, old codes. Contracts must seek to protect the foreign partner against contingenciesthat often arise.  Keeping up withlegislative changes, presidential decrees and government resolutions is achallenging task.  Unevenimplementation of laws creates further complications; various officials,branches of government and jurisdictions interpret and apply regulations withlittle consistency and the decisions of one may be overruled or contested byanother.  In addition, while aforeign investor may win a favorable decision from a Russian court, enforcementof judgments is problematic.

 

Legalrequirements may be less burdensome than reaching final agreement with localpolitical and economic authorities; registration can be a lengthy, bureaucraticprocess, particularly where natural resources or defense production areinvolved.  Corruption is widespreadand the fears of some Russian officials that foreigners will purchase Russianassets at below-market rates can impede bureaucratic approval. Environmentalconcerns are being raised more frequently now by Russian officials at federaland local levels as considerations in the approval process for investments.

** **

**Efficient Capital Markets and PortfolioInvestment**

 

Russiaquickly established basic financial and capital markets, but both came undersevere pressure in the wake of the 1998 financial crisis.  According to the CBR, 22 percent ofRussia’s 1,407 credit organizations (down from 2,500 in 1995) are insolvent,and at least another 35 percent are in trouble.  Since August 1998, Russian banks' capital has shrunk by 60percent and the share of bad loans jumped from 10 to 43 percent.  A newly created Agency for RestructuringCredit Organizations (ARCO) is tasked with restructuring banks.  Although ARCO has begun to operate, itslegal status is not finally fixed in law, and it is undercapitalized.  International financial institutionsare expected to provide assistance to help with bank restructuring.

 

Russia'sequity markets began a slow recovery after being in the doldrums during 1998and the first quarter of 1999.  ByJune 1999, market capitalization had increased to around $20 billion, up fromSeptember 1998's low of $8 billion but still a fraction of January 1998's highof $72 billion.  By May 1999, dailyvolumes were picking up, propelling the Russian Trading System (RTS) index toits post-devaluation high of 147 in early July 1999, its highest level sinceAugust 4, 1998.

 

Regulatorymeasures have been introduced during the year designed to improve the integrityof securities markets and address problems of corporate governance.  The Federal Commission on SecuritiesMarkets (FCSM) has intensified its review of the financial condition ofprofessional market participants, limited the use of futures contracts, andinitiated investigations on possible abuses of shareholders' rights usingpowers it received under a recently enacted law.  A self-regulatory organization, the National Association ofMarket Participants (NAUFOR) has established a coordination center to gatherinformation and provide a forum to protect investors' rights.  In may, the OECD and World Bankannounced the creation of a roundtable on corporate governance in Russia toidentify priorities for policy attention.

 

A corporatebond market is in the early stages of development.  In May 1999, the FCSM registered the prospectus of a bondissue for Russian major oil company Lukoil.  Other blue chip energy producers also have announced theirintention to issue such bonds.  Acorporate bond market has become attractive in the absence of a governmentT-bill market and commercial bank lending.  It is also of interest to investors seeking outlets forrescheduled T-bills that cannot be repatriated.  Certain tax issues will need to be addressed to make thismarket attractive for short-term instruments and investors.

** **

**Crime and Corruption**

 

Crime hasbecome one of the most oft-cited concerns of foreign (and Russian)businesses.  Those involved withlarge flows of cash and goods should take precautionary measures.  While organized crime is not new toRussia, recent years have seen an increase in the range and frequency ofcriminal activity.  Unfortunately,law enforcement has been hard-pressed to keep pace with criminal advances.  U.S. firms have identified demands forgrease money as a pervasive problem. Prime Minister Stepashin and his predecessor, Yevgeny Primakov, namedthe fight against corruption as a priority of their governments due to itseconomic costs (particularly in deterring foreign and domestic investment andencouragement of capital flight). Russia has laws and regulations against bribery and other forms ofcorruption, but penalties are often insufficient to act as a deterrent.  Latest available crime statistics (for1997) show a slight increase in reported crimes.  The personal crime situation in Russia is discussed brieflyin Chapter IX of this report.

 

New-to-marketU.S. companies will do well do bear in mind that the provisions of the U.S.Foreign Corrupt Practices Act are extraterritorial and require adherence inoverseas markets including Russia. The number of U.S. firms doing profitablse busines in Russia withoutever becoming victims of crime and corruption is well into the hundreds.

** **

**Bilateral Investment Agreements**

 

Russiainherited from the USSR 14 bilateral investment treaties (BITs), with Austria,Belgium and Luxembourg, Great Britain, Germany, Italy, Spain, Canada, thePeople's Republic of China, Korea, the Netherlands, Finland, France, andSwitzerland.  These were ratifiedin 1989-90 and came into force in 1991. Russia has since negotiated another 34 accords, of which 16 have beenratified - with Greece, Cuba, Romania, Denmark, Slovakia, the Czech Republic,Vietnam, Kuwait, India, Hungary, Albania, Norway, Yugoslavia, Italy, Lebanon,Macedonia and the Philippines.  TheU.S.-Russia Bilateral Investment Treaty, signed and ratified by the U.S. Senatein 1992, has since remained unratified by the Duma.

 

**Labor**

 

Russia’slabor market is fragmented, characterized by limited labor mobility acrossregions and consequent wage and employment differentials.  In Moscow, unemployment is low, andmonthly incomes are three times higher than the national average.  Unemployment, as measured byInternational Labor Organization (ILO) standards, was 10.4 million in May 1999for Russia as a whole, or 14.2 percent of the workforce.  However, the figure reaches 40 percentin some depressed regions.     

 

Labormobility continues to be restricted by an under-developed housing and mortgagemarket, housing shortages in many cities (with the exception of Moscow), anddifficulties in obtaining government-mandated residency permits orregistrations.  Costs for existinghousing and utilities are disproportionately low relative to incomes, alsomaking workers loathe to move.  Thelack of labor mobility across regions significantly impacts wages andemployment.  Labor mobility acrossprofessions within regions is more common as workers attempt to adapt to theneeds of a market economy.  Workersin Russia are generally skilled and well-educated.

 

Wage arrearsreached around $10 billion in mid-1998 and represent the primary irritant inlabor-management relations.  TheRussian government managed to reduce this figure to $2.9 billion by March 1,1999, with help of the devaluation of the ruble.  Even during periods of high wage debts, sometimes exceedingsix months’ pay, strikes have become less frequent than in the mid-1990s.  Workers have increasingly used methodsother than strikes to call attention to their plight.  Enterprises that pay wages in full and on time generallyhave smooth labor-management relations. 

 

Russia’sunion movement is dominated by the Federation of Independent Trade Unions ofRussia, which inherited the property of its Soviet predecessors.  Trade unions outside this confederationhave found it harder to operate, as wage arrears constrain would-be membersfrom paying union dues.   

 

The Russiangovernment generally adheres to ILO conventions protecting worker rights,though enforcement remains an issue. In addition to wage arrears, worker safety is a major concern, asenterprises are often unable or unwilling to invest in safer equipment or toenforce safety procedures.