Why Investing in Russia Is Risky Business

Russia is not an easy country for outsiders to understand. Winston Churchill described it as a "riddle, wrapped in a mystery, inside an enigma," and today's investors might well share his viewpoint.

It's still hard for many investors to shake memories of the era of Soviet communist rule, even decades after its spectacular collapse in 1991. The period of euphoria that followed was brief and was replaced with a regime of heavy-handed government and a culture of crony capitalism.

While everyday investors may not be able to invest directly in the Russian stock market, you may have some exposure to the country through mutual funds, exchange-traded funds (ETFs), and American depositary receipts (ADRs), which are certificates issued by U.S. banks that represent a certain number of shares in foreign companies.

Whether you choose to actively invest in Russia is completely up to you, but it isn't always easy. In this article, we explore some of the intricacies of what it means to invest in the largest country in the world.

Russia's Invasion of Ukraine

The main hurdle Russia faces is the war in Ukraine. Russia first asserted itself by annexing Crimea in 2014. These actions led to the establishment of economic sanctions from many countries and the destabilization of the region. On Feb. 23, 2022, Ukrainian officials met and approved a state of emergency, putting curfews in place and banning political rallies. They also advised Ukrainians living in Russia to leave the country in anticipation of an attack.

A day later, Russian troops officially invaded Ukraine by entering the country through Belarus and Crimea. The move came after Russia unsuccessfully called for restrictions on NATO's military activities and plans for expansion.

The Ukrainian government appealed for support from the international community. Western countries, including the United States, pledged military and financial aid to help keep Russia at bay. Because of its continued advances, which included airstrikes and a humanitarian crisis in Ukraine, many key players in the global community began shutting Russia out in an attempt to limit the country's access to global funds.

For instance:

• Russia's central bank assets were frozen by major governments like the U.S., the U.K., the European Union (EU), and Canada
• The World Bank said it suspended all of its active programs in Russia and Belarus in March 2022
• The Biden administration announced economic sanctions, barring all Americans from making new investments in Russia in April 2022
• A number of countries stopped importing goods from Russia, including diamonds

Russia responded in kind by banning exports as well, including agricultural products, timber, telecoms, and medical products among others. Almost 50 countries were affected by the move, such as the U.S. and the U.K.

Bust to Boom in Russia

In 2001, economist Jim O'Neill coined the acronym BRIC to refer to the four developing economies he predicted would dominate the global economy by the middle of the 21st century: Brazil, Russia, India, and China. In 10 of the next 11 years, Russia's GDP grew more than 4% annually.

Russia had the eighth-largest in the world in 2022, with GDP coming in at $2.24 trillion. But, the country's transition from a communist world power to an emerging economy was not easy. The ruble was devalued in 1998 following a national economic crisis—the same year that its economy began growing after several years of contraction.

Plummeting oil prices and sanctions from Russia's annexation of Crimea in 2014 set off a financial crisis that plagued the country's economy until 2016. The economy rebounded in the second half of the decade, with the MOEX Russia Index reaching all-time highs in January 2020 before the COVID-19 selloff.

Russian stocks rebounded quickly from their March 2020 lows and climbed steadily through 2021 just to be knocked back down in early 2022 when the Russian invasion of Ukraine sent stocks tumbling 44%. As a result, markets were closed for a month beginning the week of Feb. 28, 2022, and reopened in March with vast trading restrictions.

Russia's Challenges

Russia is the largest country in the world by landmass, coming in ninth on the list of the world's largest nations by population, at around 144 million. Many of them have enjoyed some income growth over the past decade and are spending an increasing amount of their income on holidays and luxury goods and services.

However, the country's reputation as a haven for oligarchs is not understated. Its per capita GDP, which is a reasonable measure of the prosperity of a nation's citizenry, was $15,345.10 in 2022, according to the World Bank. That was below the level of some former Soviet Socialist Republics (Latvia, Lithuania, and Estonia) and most former Eastern Bloc countries, including Romania, Poland, and Slovakia.

According to the World Bank, Russia's economy grew 4.3% in 2021, a strong rebound from the COVID-19 pandemic. The organization expects the recession to continue through 2023 because of the effects of the global economic sanctions.

Russia's Natural Resources

Investors are generally attracted to the Russian market for its natural resources. Oil and gas are a major part of the national economy. In fact, Russia was the world's third-largest oil producer after the U.S. and Saudi Arabia, accounting for 11% of global production. Its primary market for its oil and petroleum exports is Europe, from which it derives the majority of its oil and gas revenues.

Russia's continuing dependence on oil leaves its economy vulnerable to the volatility of global oil prices and other factors—notably economic sanctions from other countries. They were imposed on Russia by the United States and the EU in response to Russia's annexation of Crimea in 2014.

As noted above, some major countries, including the U.S., banned Russian oil imports completely and the EU began developing plans to wean itself off Russian fossil fuels.

Mineral Wealth

Aside from its oil and gas reserves, the nation also sits on billions of dollars in mineral deposits. The country's GDP from mining was $41.5 billion in July 2023. It is also believed to possess the world's largest diamond resources.

Russia also has a large amount of gold deposits and was traditionally a large exporter of gold until the global community hit it with sanctions after its invasion of Ukraine.

Energy and minerals are considered a partial blessing and a partial curse because Russia's heavy dependence on resources represents a risk. When you invest in Russia, you have to keep in mind the direction of commodity prices—just like energy.

Human Capital

Russia is rich in human resources as well. Its educational tradition is superb in mathematics and the hard sciences and excellent in languages. As such, it produces plenty of brainy workers. Russia boasts an astounding 99.7% literacy rate and boasts one of the highest rates of tertiary education attainment among OECD countries.

Corruption in Russia

Politics may represent Russia's biggest investment risk. While there are many examples, the case involving Yukos is, perhaps, one of the most notable examples in modern times.

Yukos was arguably one of Russia's biggest and most successful oil companies until 2003. The company's chief executive officer (CEO), Mikhail Khodorkovsky, ran afoul of President Vladimir Putin when he made comments in 2003 against the country's corruption and political system. Khodorkovsky was arrested that same year on fraud and tax evasion charges and was sentenced to 14 years in jail.

Yukos was forced into bankruptcy, and its pieces were sold off for fractions of its actual market value.

A Barrier to Doing Business

"Corruption significantly impedes businesses operating or planning to invest in Russia. High-level and petty corruption is common, especially in the judicial system and public procurement," notes a 2020 profile of business in Russia prepared by the Risk and Compliance Portal, a business resource maintained by GAN Integrity.

Foreign investors have often faced challenges brought on by Russian bureaucracy. The Russian government also has a record of putting pressure on foreign energy companies to consolidate control over the country's largest and most important hydrocarbon deposits.

In 2008, police raided BP's Moscow office in an attempt to persuade shareholders to sell their stakes in a joint venture between the British oil giant and Russian oil producer TNK.

Meanwhile, major multinational companies like Ikea, McDonald's, and Starbucks have declared a moratorium on Russian operations and investments due to the war in Ukraine.

Ranking Russian Corruption

Russia came in 137th out of 180 nations on the 2022 Corruption Perceptions Index from the anti-corruption organization Transparency International, a tie with Paraguay and Mali. (The U.S. came in 24th.)

Russia has a lot of obstacles to fair and efficient business practices, according to the index. It's safe to say that corporate corruption and a lack of transparency are major risks for investors in Russia.

The Bottom Line

Investors need to know the national risks that can threaten their investments as they seek investment opportunities around the world. High returns come from high-risk investments and emerging markets are among the likeliest of places to find returns that outperform those of developed nations.

While Russia offers high returns, it is dominated by energy companies, the state of regulation is still under development at best, and the political risks are greater than elsewhere, especially when you consider the impact of its invasion of Ukraine. That's a striking feature of investing in Russia. The risks and potential rewards are both high.