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Interview

with Edward S. Verona, President and CEO, U.S.-Russia Business Council (USRBC)

07.03.2013 / Energyboardroom

For four and a half years now, you have been the president and CEO of the US-Russia Business Council. What have been your main priorities in this period?

In terms of improving US-Russia trade, our key priority has been to assist –in any way we could– Russia’s accession to the World Trade Organization (WTO). When I assumed my position it was not at all clear that this journey would have a successful outcome. There were many impediments, both with regards to the accession package as well as the geopolitical situation – such as the conflict with Georgia.

The negotiations were very intense, addressing issues such as intellectual property rights, phyto-sanitary standards, non-tariff barriers, dispute resolution processes, adherence to the Information Technology Agreement, etc. These negotiations were particularly important vis-à-vis the disappointment of some of our members with China’s WTO accession. Many of them felt that China’s accession package was insufficiently robust back when it was adopted in 2003. Russia’s accession process required longer deliberation in order to ensure that it addressed all possible concerns.

Another factor that stretched the process out by another year was Russia’s decision in 2009 to suspend its WTO negotiations and conclude a customs union with Belarus and Kazakhstan. The changes this brought about had to be reflected and edited back into the WTO documents that had already been agreed upon.

Once Russia became a member of the WTO, the U.S. needed to extend permanent normal trade relations (PNTR), or most favourable nation (MFN) status, to Russia. That occurred in December 2012 and, as a result, U.S. companies now enjoy the benefits that Russia’s accession provides.

In addition, we have been keeping our members abreast of what has been happening in other areas, such as the prospects for a Bilateral Investment Treaty. Now that the WTO accession has been accomplished, there is a better chance of negotiating such a Treaty.

You mentioned the WTO accession was no certainty 4.5 years ago. Now that the WTO members –particularly countries like Georgia– have welcomed Russia by granting it accession, do you feel that there has been a global perception change towards Russia?

It is important to bear in mind that three successive U.S. administrations gave strong support to Russia’s WTO accession. The lengthiness of the negotiations was due to the general desire to have a highly detailed agreement that would avoid any ambiguities, rather than to any change in attitude towards Russia. External geopolitical factors may have had some influence on the business community, but the perception was not fundamentally affected by them. The Georgian conflict was one of those geopolitical factors, which was dealt with diplomatically. In the end, the parties involved showed flexibility and willingness to compromise.

The most important factor was Russia’s own determination to belong to the WTO and its readiness to take the necessary measures. It is always the incoming country that must make concessions and harmonize its customs codes and tariff schedules with the existing members.

You mentioned in a recent statement that “the WTO membership is not without its critics in Russia. Some industries fear the foreign competition that the opening will bring.” What counterarguments can you give them?

We should not deny companies the opportunity to compete on a level playing field. Whether people are for or against this agreement no longer matters, because the official accession has now taken place. Companies that spend their time trying to protect their business from competition fail to do the things they need to do to be competitive.

As an example, one of the best things that happened to US automobile manufacturers was competition from foreign companies – mainly Japanese. It forced them to be more competitive and turned them into stronger companies, precisely because they have developed models that are more globally competitive. Today, American automobiles are second to none and very successful in Russia.

The audience that still needs convincing –perhaps– is the broader Russian public. They must understand that Russia needs to belong to the WTO to be attractive to investors. Most multinational companies do not look at markets as individual countries, rather as regional or global markets. They scale plants to serve more than just local markets. Consequently, if a country does not belong to the WTO it is unlikely to be considered suitable when a potential investor is seeking to build a global supply chain.

To Russian consumers, one can argue that they have been paying substantially higher prices on imported consumer goods. WTO accession is going to bring prices down over this transition period. People tend to overlook the benefit of lower prices that comes with trade liberalization, focusing instead on the handful of industries that cannot compete in a global marketplace.

A lot of international companies have localized manufacturing facilities in Russia. Do you feel this has been a necessity to succeed in this market, particularly for companies active in the power industry?

Most of the companies that built facilities in Russia probably did so because they knew Russia was in the process of applying for WTO accession. For the automobile sector, Russia had a program which established conditions under which foreign automobile manufacturers could enjoy certain reduced tariff rates on components and even complete units. To enjoy these benefits, they were required to build production capabilities to achieve a level of output of 360,000 cars per year. In addition, 60 percent local content targets will have to be achieved over a 10-year period, including transmissions and engines. This was one of the most intensively-discussed areas during the WTO negotiations, and it was agreed that these conditions can remain in effect until 2018.

Companies that are building major plants are naturally going to look for local suppliers whenever possible, due to transportation costs, local availability of spare parts, and so forth. Facility owners and operators therefore have a self-interest in having local manufacturing capabilities. Big ticket items that power plants would be looking to buy, would likely be large turbines, generators, boilers, valves, pipes, power transmission lines, and so forth. Why not locate a factory for the production of such equipment in a country that has a huge potential domestic demand?

One concern potential investors could have in Russia –based on experience in China– is onerous technology transfer requirements. If intellectual property rights are not guaranteed, then investors will be less willing to set up facilities here. China has earned a bad reputation in this matter. It is something Russia should keep in mind.

The Russian President has made it clear that the country’s economy should decrease its dependency on its the oil and gas sector. As the Russian economy diversifies, how will this impact its trade balance with the US?

Over the last ten years, Russia’s dependency on the oil and gas sector has increased; it now accounts for roughly two thirds of foreign exchange revenues, half of federal budget revenues and about a quarter of GDP. This exposes the economy to volatile commodity price cycles.

However, it does not mean that abundant natural resources have to be a “resource curse,” as some call it. There are examples of other countries that rely heavily on primary commodity exports that have prospered, such as Norway, Canada and Australia. Even Brazil –which continues to rely predominantly on primary commodity exports– has done very well at developing high value-added export industries. More importantly, the country shifted from being an importer of oil in the past to an exporter of oil today. The country has done very well at developing advanced oil production technologies –deepwater, ultra deep water, etc.

The paradox for Russia is that when oil and gas prices are on the upswing they put upward pressure on the ruble, which in turn hurts the competitiveness of manufacturers. Natural resources give Russia a competitive advantage and weight in the global economy, but at the same have made it harder to grow other industries. Policymakers need to put into place the right laws and regulations to encourage the growth of other sectors. In my view, there is still a lot of work to be done around transparency and corruption, bureaucracy, etc. More work is required on what is broadly referred to as rule of law, such as an independent judiciary, competent judges on commercial legislation, intellectual property, respecting contracts, etc.

After RAO UES, the power sector has been restructured. Has the paradigm of opportunities in the Russian power sector changed for your members in recent years?

It certainly has been important for companies manufacturing goods or providing services to the sector. There is a need to increase substantially power generation capacity in Russia, and the sector has suffered from underinvestment in recent years, which is problematic for an economy that is growing strongly in energy-intensive areas.

From my personal understanding, a few specific issues have complicated investment in the sector. One major issue is the absence of a reliable market for balancing long-term gas contracts and spot demand. Electric utilities need to be able to negotiate stable long-term sales contracts that have effective mechanisms to ensure a viable rate of return and incentives to lower the cost curve.

At the end of the day, many of these issues boil down to managing risk and achieving a reasonable rate of return on investment. There may be a role here for multilateral or bilateral investment guarantee agencies, such as OPEC, EBRD, etc. Such entities could help bridge the confidence gap by providing an additional guarantee or an equity stake to ensure that the necessary rules and regulatory framework is both fair and properly enforced.

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