less than what could be expected for an economy the size of Russia.6 The question here though is whether the FDI that comes to Russia has a significant impact on investments in fixed capital at the macro level. In addition to FDI, we can expect that changes in international oil prices will affect investment growth just as they explain overall growth of the economy. Finally, institutional factors that are thought to affect the investment climate could impact investment growth. Table 2 shows the result from running linear regressions on changes in investments on changes in oil prices, changes in foreign direct investments and changes in institutional factors as measured by the EBRD’s transition index and a composite index based on the World Governance indicators on rule of law, control of corruption and regulatory quality.
The main result from this is that foreign direct investments do lead to higher investments as do increases in oil prices. The coefficient on FDI is larger than 1, which suggests that there are positive spillovers from FDI to other domestic investments (or crowding in rather than crowding out of domestically financed investments) similar to the finding in Mileva (2008).
At the same time, the amount of FDI is relatively small compared to overall investment and the share has fallen dramatically since the global financial crisis, from a peak of over 20% in 2007 to around 5% in 2018. FDI can also play an important role in modernising and diversifying the economy since foreign investments can be associated with important knowledge transfers in terms of both technology and management practices that can facilitate a structural change of the economy. Therefore, attracting FDI should be high on the list of any policymaker that is serious about generating growth and diversifying the economy. However, the institutional factors fail to generate any significant impact on investments, which is counter to regular arguments on the importance of institutions (see, e.g., Roland, 2000 and Gorodnichenko and Roland, 2016). This can be a result of insufficient variation in the institutional variables over this time period or that the simple analysis here does not account for more complicated causal stories. This may lead to problems with endogeneity with the institutional factors, and this part of the analysis should not be taken too literally for this reason. However, there is clearly an empirical regularity between inflows of foreign direct investments and investments in fixed capital at the macro level that warrants a closer look at capital flows.
Table 2:Correlates of investments.
Note: All variables are changes in the respective variable.
Source: Author’s estimates based on data from Central Bank of Russia, EBRD, World Governance Indicators and US Energy Information Administration.
Capital Flows
Capital flows are an important link between the domestic economy and global markets in any country. The role of capital flows is not only to finance investments, transfer knowledge and generate growth at home, which is the main focus here, but also to facilitate consumption smoothing and risk management. The latter reasons for international capital flows are likely to have been highly important to understand capital flows between Russia and the rest of the world. The composition and magnitude of flows can provide important signals on how both residents and foreign entities view the growth prospects of a country as well as the functioning of financial markets and the institutions that protect property rights.7 In emerging markets, sudden reversals of capital flows (sudden stops) have been shown to be the costliest shock that these countries face in terms of loss of income at the macro level (Becker and Mauro, 2006).8 This suggests that avoiding sudden stops is a key factor for long-term growth and macroeconomic stability.
Figure 5:Private sector capital flows.
Source: Central Bank of Russia.
Figure 5 shows private capital flows in the form of foreign direct investments (FDIs) and portfolio, loans and other flows (PLO).9 Inflows and outflows are shown separately for each category, and note that for the PLO flows, both inflows and outflows can (and do) take on negative values. A number of observations are worth mentioning here. First of all, the PLO flows are both greater in absolute terms and much more volatile than FDI flows. This is very much in line with the discussion about “hot money” flows to emerging markets that say that FDI flows (“good cholesterol”) are more stable and beneficial for growth, while portfolio flows and loans (“bad cholesterol”) are volatile and associated with the problems of sudden stops discussed earlier (see Fernandez-Arias and Hausmann, 2000). The Russian story seems to be in line with this reasoning, given that large portfolio and loan inflows are in many periods followed by equally large outflows. FDI flows follow a different pattern where inflows and outflows are moving up and down at the same time. This indicates that there are common factors driving both FDI inflows and outflows but no sign that FDI inflows lead to outflows shortly after.
Figure 5 does not provide a very clear picture of how net capital flows have developed over time and what cumulative implications are at the macro level. Figure 6 therefore shows the cumulative net capital flows for FDI, portfolio and loans, and errors and omissions as well as the grand total of private sector capital flows.
Between 1995 and the first quarter of 2018, 700 billion dollars left Russia. This is twice as much as all of the fixed capital investments in 2017 and could obviously have boosted growth significantly if it had been invested in Russia instead. That does not mean that zero flows would have been optimal for the investors making these decisions, but it shows clearly that these flows are extremely important for the macroeconomic development of Russia. Most of the capital left in the form of portfolio flows and loans, but at the end of the sample, all three categories contribute to the outflows. FDI was for a long time the only component that recorded a cumulative net inflow over the period, but after the global financial crisis, there has been a steady outflow in this category as well and these outflows accelerated in 2014. More generally, the global financial crisis represents a very clear shift in capital flows, and outflows then accelerated when sanctions were introduced in 2014 before there was some levelling off in 2018.
Figure 6:Capital outflows from private sector.
Source: Central Bank of Russia and author’s calculations.
The question is then what factors may be behind these capital flows. In principle, we should expect flows to be correlated with the returns and risk on investment in Russia versus the rest of the world. There are different ways of trying to gauge expected returns and risk, but some relatively straightforward measures can be derived from the stock markets in Russia and abroad. Here, we use daily data on the Russian dollar index RTS and the S&P500 index from the US stock market. We also add daily data on oil prices since this is an important determinant of growth in Russia and also a source of foreign capital that can either be invested at home or abroad. From these data, we compute the daily returns and rolling 20- and 60-days standard deviations of our series and take quarterly averages of these measures to generate series with the same frequency that we have for capital flows. This then allows us to run a regression with net capital outflows being explained by the returns and volatility of the Russian and US financial investments as well as oil that are shown in Table 3.
Table
