|FDI as % of Gross Capital Formation|5.5|4.1|5.0|8.7|12.4|8.4|14.2|17.1|18.1|
|---|---|---|---|---|---|---|---|---|---|

|_Sources: World Bank, World Development Indicators (2009); Central Bank of Russia_|
|---|

Nevertheless, starting from such a low base, the stock of FDI in Russia remains substantially less than in some important comparator countries. The accumulated stock of FDI as a share of GDP was 9.5% in 2006. This compares to 26% in China, 20% in Brazil and only slightly more than in India (7.5%).

The sectoral decomposition of inward FDI is dominated by mining and quarrying (49% in 2007) with manufacturing (17%) and real estate and business services (11%) following. The increase of FDI in the last decade was predominantly channeled into oil and gas extraction, which increased its dominant position in the stock of FDI. Geographically FDI flows are very concentrated: Moscow city got 38% in 2006; the Sakhalin region got 15% and the Moscow region followed with 10%.

The two major source countries for inflows of FDI are Cyprus (around 35% in 2006) and the Netherlands (about the same). The later is explained by the special position of the Netherlands in managing cross-border transactions in the fuel and gas sectors, and the former derives from investment by Russian nationals who have capital in Cyprus (see OECD, 2008, p.16). The next most important source country for FDI is Germany, which provided 4.4% of the inflow to Russia in 2006. In the first half of 2009 the inflow of FDI was cut in half compared to 2008, and the list of major FDI partners now includes China.

To some degree the significant increase in FDI inflows to Russia in the past seven years can be explained by its macroeconomic stability, sound fiscal policy, efficient external debt management and accumulation of foreign reserves. Infrastructure projects initiated by the state may have also indirectly attracted FDI flows. But the major factor behind the increase in FDI was the increase in the price of oil that made investments in the Russian oil and gas sectors more profitable.

While the large and expanding Russian domestic market can be attractive for foreign investors, there are several very clear risks associated with the Russian economy. The first one is the high share of output and exports in the energy sectors. Being so heavily dependent on a small number of commodities with volatile prices makes the whole economy relatively volatile. Investors may need to be compensated with higher returns to compensate for the volatility, which could reduce FDI inflows. To fight the potential risks of macroeconomic instability associated with volatile oil prices, the Government launched the Stabilization Fund of the Russian Federation in 2001.

On the other hand, in the past decade, increased government control over the economy and problems with the slow pace of regulatory and administrative reforms impede FDI. The increase in government control of the economy started with then President Putin’s first Administration. President Putin became progressively more open in establishing a dominant role for the Russian state in key sectors, including scrutiny of foreign investors in these sectors. The key piece of legislation on this was the law on strategic sectors, approved in May 2008. It defines the conditions under which foreign investment will operate in 42 strategic sectors, and requires prior authorization for the foreign investor to be able to control any business entity operating in these 16