Risky Business in Russia

When BMW was looking for a place to roll out its new top-of-the-range 7 Series model, one country immediately came to mind: Russia. Demand for luxury autos has been soaring there — BMW's Russian sales have quadrupled in the past five years and were up 54% last year alone. So the German automaker threw a splashy party in Moscow on July 8, unveiling its revamped model inside a 40-ft.-high (12 m) acrylic-and-steel hourglass that it erected on Red Square itself. The show "reflects the confidence that the BMW Group has in this country's potential," gushed Christian Kremer, the company's managing director for Russia, noting that sales were up again by a third in the first six months of this year.

BMW is far from alone in viewing Russia as an El Dorado. From luxury brands to supermarket chains to machinery companies, a growing number of Western firms has discovered that this country of 141 million can be highly lucrative for those positioned to capitalize on a consumption boom fueled by massive oil and gas exports. The result has been a huge surge in foreign direct investment: last year Russia attracted $52.5 billion — four times the $12.9 billion it pulled in as recently as 2005. That puts it ahead of two of the three other BRIC countries, India and Brazil. And while it still lags behind China in absolute terms, Russia is at the head of the pack when FDI is measured on a per-capita basis.

The big question now is whether this international love affair with Russia as a place to do business can continue. The shooting war in Georgia this month sent investors in Russian stocks rushing for the exit: the RTS stock index has sunk to its lowest level since November 2006 and is down 32% in the last three months. The fighting was the most deadly sign that Russia is not a predictable or stable investment environment, but it was by no means the only one. Along with the new geopolitical uncertainties, foreign businesses and investors are also grappling with signs of economic vulnerability such as rising inflation and slowing oil production, as well as heavy-handed corporate meddling by the government — not least in a high-profile joint venture involving British oil giant BP.

So far, no Western companies are talking publicly about revising their Russian investment strategies in the wake of the war with Georgia, and Russia watchers are sharply divided over whether there will be a medium- or long-term impact on economic ties with the West. BMW, for one, is proceeding apace with building its sales network there: by the end of this year, it aims to have a dealership in 47 Russian cities with populations of more than 300,000. One of the biggest corporate-investment programs, by Italy's Enel — which has spent about $6 billion on an effort to become a player in Russia's electricity-generation industry — also remains on track, according to company officials. They say the firm will invest a further $3 billion on revamping and building new power plants in Russia.

But heightened political tensions between Russia and the West are sure to prompt potential investors to take an even longer, closer look before plunging into the Russian market. There has been talk in Washington and elsewhere of kicking Russia out of the G-8 group of nations, and some analysts believe the Kremlin's actions will ultimately prove counterproductive for the economy. In a note to clients, Commerzbank analyst Michael Ganske wrote: "The strong macroeconomic story of the country is increasingly obscured by homemade negative headlines and developments that clearly worsen the economic outlook for Russia." Ganske went so far as to call the Georgia war "a bloody next act in a screenplay that could be named 'how to destroy the investment story of one of the strongest credits in the emerging-markets universe.' "

The conflict with Georgia is undeniably "having an impact," agrees Robert Amsterdam, a lawyer who represents Russia's most famous economic victim: Mikhail Khodorkovsky, who once headed the Yukos oil company. In 2003, Khodorkovsky was hounded out of business and he now languishes in a Siberian jail. "People who were among the most bullish on Russia are now ready to be the most aggressive in demonizing it," says Amsterdam.

Yet for every disillusioned or disheartened Russia booster considering withdrawal, there's someone else who is eager to pile back in. On Aug. 11, Credit Suisse issued a research note arguing that this is a great time to buy Russian stocks. The market "has been punished excessively over the last couple of weeks," wrote analyst Vladimir Savov. "While warfare is never a good thing, fundamentally Russia's economy and infrastructure are not affected ... The likelihood of military involvement of other superpowers is below average. The situation may end soon, to be replaced by diplomatic negotiations." And even as bullets flew in Georgia, U.S. electronics retailer Best Buy took the first step toward expanding in Russia by registering its Future Shop trademark there.