On Capitol Hill last week, senators debated the merits of lifting Cold War-era trade sanctions against Mother Russia. Plenty of U.S. companies are eager to see this happen.
The trade barriers are widely expected to fall this year, and when they do it will be a net positive for U.S. trade. Russia’s creaky and inefficient economy — from its sad agriculture collectives to its rusty automotive industry — won’t likely be able to compete against the larger and more efficient U.S. industrial and retail firms. Meanwhile, Wall Street could benefit from coaxing U.S. investors to take a second look at Russia, while at the same time convincing Russian firms to consider New York as the place to raise capital or go public.
Before any of this can happen, however, the two countries will have to work through the numerous barriers and prejudices that have existed between them for nearly a century.
Russia’s ascension into the World Trade Organization took 18 years. It first applied in 1993 after the nation shrugged off its communist past and moved to capitalism and it was invited to join the WTO late last year. The transition from a centrally-planned economy to the free market has not been easy. Corruption and backroom dealings have become the norm as the nation’s billionaire oligarchs violently protect their turf by any means necessary. From a debt default in 1998 to the invasion of Georgia in 2008, there was always a solid reason for U.S. investors to hold back from the Russian market.
The losers in all of this mess have been the Russian people. Russia’s economy has not progressed or modernized as it should have and is still highly dependent on energy and mineral exports to keep the nation afloat (Russia is the world’s largest oil exporter). High tariffs are imposed to protect certain large and inefficient industries, especially the automotive industry. Doing business in Russia is also difficult given the nation’s notoriously corrupt political and judicial structure. Things got so bad that in the last few years, Russia’s foreign direct investment was actually negative – unheard of for an emerging market economy.
While Russia was accepted into the club in December, the United States still has in place Cold War-era trade sanctions against Russia. The U.S. Senate met last Thursday to discuss dropping these laws so that they could normalize trade relations before Russia formally joins the WTO this summer. The main argument against lifting the so-called Jackson-Vanik amendment derives from Russia’s abominable human rights record and its questionable commitment to democracy. Republicans tried to voice their concerns but it was the Democrats that shut them down. President Obama has made the lifting of the amendment a key pillar of his trade policy. So while the Republicans are raising some noise in the Senate, the amendment will almost surely be lifted on Russia, leading to a normalization of trade relations between the two countries.
U.S. and European companies will likely benefit the most from an open Russia. The reduction in tariffs on certain goods, especially in the service industry, is expected to benefit U.S. companies hoping to tap the burgeoning Russian middle class. Major interest groups, like the U.S. Chamber of Commerce, along with 173 US companies, have sent letters to Congress demanding the normalization of trade with Russia.
Some of the big companies behind the push include General Electric (GE), Deere (DE) and Boeing (BA). GE has been especially vocal, saying that tariffs on its jet engines would fall from 20% to 5% if trade was normalized between the two nations. That would deliver a sizable boost to its profit margin and increase the availability of top-notch products to the Russian market.
Companies in the agricultural space and the automotive space will also benefit as Russia will no longer be able to bar the importation of certain food stuffs and automobiles. This could be a great boost for major US factory farm companies like ConAgra (CAG) and ADM (ADM) as well as car manufacturers like Ford (F), GM (GM) and Chrysler.
Wall Street stands to benefit from all this new investment in Russia too. If Russia is seen as a solid place to invest capital, institutional investors will demand greater access to it. This could lead to a large influx of equity and debt capital into Russia’s domestic market, all of which would yield juicy fees for Wall Street bankers.
On the flip side, the large Russian companies that currently see London as a base of operation could be lured into moving some of their operations to New York. Currently, most large Russian companies, even the quasi-state owned ones, choose to list their stock in London and even Hong Kong over Moscow given their investor bases. As more of their investor base moves to the western hemisphere it will make more sense to list in the liquid New York markets. The NYSE has been courting Russian companies — full trade normalization will most likely accelerate this nascent process.
And while some Russian companies might move operations to Wall Street, U.S. banks may see new opportunities in Moscow. The WTO rules allow for 100% foreign-owned banks to open in Russia for the first time. The only limit is that 50% of the entire banking sector must remain in Russian hands.
But while the benefits of full trade normalization are real, it will be many years before all the changes are implemented. Fearing a shock to some of its industries, Russia will be decreasing its tariffs over a 7-year period and will not be phasing them out. On average, Russian tariffs on imported goods are expected to decrease from 10% to 7.8% when all is said and done. Russia agreed to lower 33% of its tariffs from the date at which they enter the WTO. It will drop them another 25% after three years.
Some industries will have much longer lead times than others. Tariffs in the automotive and airline industries will drop in seven years, with the tariff on autos going from 9.5% to 7.3%. Meanwhile some agricultural products have an eight year time lag, with the average agricultural tariff falling from 13.2% to 10.8%. And while the new agreement will allow foreign investment in Russia’s insurance industry for the first time ever, it will be nine years before that market is open to investors.
The Senate is expected to continue debating Russian trade for a few more weeks, with passage expected in the next few months, according to Senate Democrats. Both U.S. and Russian politicians are cautiously optimistic about this new level of openness and what it might produce. But the net benefits for both countries seem to be solid. The only wild card is whether or not Russia will truly play by the WTO rules. Only time will tell.