No Fear Of The Bear? Bilateral Economic Relations Between Germany And Russia

Germany-Russia tiesGermany-Russia ties

Jens Bastian via Macropolis | As various countries in the European Union prepare for watershed elections in the course of 2017, analysts at will be discussing the implications of these elections and the issues most likely to impact the electoral agendas. We start off with a look at Germany and its strong bilateral (economic) ties with Russia.

Germany’s economic interests in Russia are significant before and despite the sanctions regime which is in place since Spring 2014. Investments in and German exports to Russia have largely withstood the tense political climate between Berlin and Moscow after the illegal annexation of Crimea and Russia’s military involvement in eastern Ukraine. Recent cyberattacks by Russia against German institutions have raised concerns about intervention in political affairs during the electoral campaign in Germany ahead of federal elections in Autumn 2017.

While conditions for doing business in Russia are improving for many blue-chip German companies as well as niche players, providing access to financing for their counter parties remains a challenge. The existing sanctions regime places restrictions on many Russian lenders from doing business – apart from retail banking – with their European peers.

The rising investment interest also has a political impact. Russian authorities and businesses hope that expanding investment and trade volumes will put additional pressure on Berlin to start relaxing or even terminating the current sanctions regime against Russia. Thus, the ripple effects on the substance of the foreign policy dialog vis-à-vis Russia must be borne in mind because of increased investment activity by German companies.

The challenge thus includes the consideration to what degree rising German investment interest in Russia can play a role in de-escalating political tensions between Moscow and Berlin. It remains a strategic priority for Russia’s foreign policy to have the existing sanctions regime lifted. German companies lobbying for a review of the sanctions policy – e.g. via the Russian-German Chamber of Commerce in Moscow (IHK) – have become ever more vocal during 2016 the more they are expanding investment in Russia.

The export and investment performance of German companies to Russia displays a contrast in volume and dynamics. In 2015 German exports to Russia declined by 26 percent compared with the previous year. The decline to 21.8 billion euros reinforced an export trend of German companies to Russia, which had also gone south by 18 per cent for the whole of 2014, and by 5 percent in 2013.

This downward path was supplemented by Russian exports to Germany which declined by 22 percent in 2015, reaching a total volume of 29.9 billion euros. It is noteworthy that the trade balance with Russia is negative for Germany, one of the few countries with which this is the case for the so-called Exportweltmeister (exports world champion).

More specifically, bilateral trade has fallen from 80 billion euros to 52 billion since 2012. Russia’s principal exports to Germany are raw materials, in particular oil products and natural as well as liquefied gas. Metal goods and petrochemical products are equally at the vanguard. Germany’s main exports to Russia are mechanical engineering products, motor vehicles (e.g. Mercedes, VW and BMW) and vehicle replacement parts, chemical and electrical products (e.g. Siemens AG, Henkel AG), food and agricultural produce.

By contrast, the bilateral foreign direct investment landscape shows no signs of decline. Per the Russian Direct Investment Fund, a sovereign-wealth fund set up to assist financing international investment in Russia, Germany was the second-biggest investor in Russia in 2016, behind China. Russia’s First Deputy Economic Development Minister Alexey Likhachev is confident that German investments in the Russian economy reached up to 3 billion euros ($3.3 billion) by the end of 2016. German firms invested nearly 1 billion euros into the Russian economy in the first half of the year. Direct investment rose to 2.05 billion euros in the first nine months of 2016. That volume surpasses the amount for all of 2015 and contrasts with a net outflow in 2014.

German companies have done business in Russia since the czarist era. German investment in and exports to Russia have a long tradition and form part of established bilateral economic diplomacy. As regards geographical concentration, most German investment is located in western Russia, primarily in and around the urban centers of Moscow and St Petersburg. German companies’ economic ties with the Far East of Russia are less pronounced as these regions have closer cooperation with China and South Korea.

In this context, it should not be forgotten that there still is a significant German minority living and working in Russia. Per the foreign office in Berlin they number approximately 400.000 citizens. German companies are involved in numerous language and education as well as social, community-support and other cultural projects in Russia as part of their corporate governance responsibilities.

Financial controversy

A major point of controversy in bilateral economic relations concerns the financial sector. More specifically, this to an ongoing investigation into allegations that Deutsche Bank helped its clients in Russia disguise suspicious trades. In 2015 the US Department of Justice, New York’s Department of Financial Services and the UK’s Financial Conduct Authority each launched separate investigations into the so-called Russian “mirror trades”.

The allegations involve clients using the Deutsche Bank subsidiary in Moscow to buy securities in roubles and to subsequently sell them shortly thereafter in a foreign currency. The total volume of the transactions under review is significant. Deutsche Bank is said to have found a total of $10 billion of suspicious trades in Russia, including $6 billion in mirror trades. The trades in question may have allowed Russian customers to illegally move money from one country to another, in violation of money laundering controls and in breach of Western sanctions against Russia over the Ukraine conflict which went into effect in Spring 2014.

In September 2015, Deutsche Bank decided to close most of its Russian operations, focusing only on transaction banking services. The move made Russia the first casualty of the bank’s sweeping plan to shrink the group’s global footprint to a regional one. Investment banking turnover had fallen steeply in Russia since 2014 following the imposition of sanctions over the Ukraine conflict and the accelerated economic downturn in Russia.

The investment surge expressed by German and other international companies is also the result of domestic incentives crafted by Moscow to entice Western businesses. A Russian government decree from early 2016 offers foreign firms “Special Investment Contracts”. These must include a multi-year commitment to invest at least 750 million roubles ($11.8 million) in Russia. The contract subsequently awards companies the same status as domestic producers and traders, thereby making them eligible to apply for Russia state contracts and special tax benefits.

Frosty politics

The frosty political relationship between German Chancellor Angela Merkel and Russian President Vladimir Putin has hardly impacted on bilateral economic ties. Despite the economic crisis in Russia and the existing sanctions regime, more than 5,500 German companies are currently active in Russia. Overall, doing business in Russia has been profitable for them, even if it requires careful consulting because the country’s many regulatory idiosyncrasies such as customs clearance, licensing certification and administrative procedures despite Russia’s accession to the World Trade Organisation (WTO) in August 2012.

The bilateral political relationship with Russia continues to be strained as the economic sanctions remain in place and Chancellor Merkel is regarded as their lead advocate in Europe. Moreover, the two targeted cyberattacks which Germany’s intelligence agency BND (Bundesnachrichtendienst) has attributed to Russia – the hacking of the Bundestag’s computer network in 2015 and impairing internet as well as telephone services in November 2016 – will resonate in the kind of dialog that Berlin and Moscow seek to establish ahead of the federal elections in autumn 2017.

President Obama’s executive order from December 30, 2016 against Russia sought to retaliate against efforts to influence elections in the United States and those of “allies and partners”. This justification was interpreted in Berlin as a clear reference to concerns that Russia’s next targets may be Germany and France. Already there are reports of Russian influence operations in both countries concerning cyberattacks and old-style information warfare.

Over the course of the Ukrainian sanctions regime against Russia German companies have continued to increase their investments in the country. While Moscow has been threatened by Western leaders about possible new sanctions for its actions in Syria, such warnings have not served as a deterrent for Germany corporates. Instead of lingering concerns about Russia’s support for the Syrian government, they are speculating on an economic recovery in Russia on the back of higher oil price revenue and a weak domestic rumble currency.

The coalition government of chancellor Merkel continues to support the sanctions regime against Russia. But there are differences of emphasis as concerns a post-sanctions policy environment. The conservative CDU party insists that Russia must withdraw from Crimea as it is an illegal annexation in March 2015. Representatives of the junior coalition party, the social democrats (SPD) argue that while the annexation was illegal, the future status of the peninsula must be renegotiated after the termination of existing sanctions.

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The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.