Unlike in 2000, when investments in Russian industries exceeded those in other sectors of economy, the year 2001 saw a trend reversal: The proportion of investments made in industry declined compared to that of investments in the service sector. Without waiting for centralized investments from the government, some of the country’s major metal producers, including Severstal, Magnitogorsk Steel Works and Novolipetsk Steel Works, have developed their own investment programs, which will be financed from the enterprise’s owned funds, mainly from profits.

General situation assessment

Last year saw the world economy enter a period of lengthy recession manifesting itself in the reduction of economic-growth rates, affecting more and more countries and causing decline in the consumption and demand for major goods. Metal markets are not immune to the process and the prices of semi-finished and finished ferrous-metals articles have fallen to levels unseen in the last five years, accompanying a steady decline in their consumption.

Toward the end of last year, in an effort to stabilize the situation, metal-producing countries made a decision to reduce steel production by approximately 10 percent. At the same time, according to the International Institute of Steel and Iron, world steel output has undergone only a minor reduction – approximately 0.1 percent from the year 2000’s level. The overall figure resulted from very different "contributions." Thus, the countries of North America and the EU have reduced their steel output by 12 percent and 2 percent, respectively (8 percent in Great Britain; 5 percent in France; 5 percent in Belgium), while Asian countries (China, South Korea, Taiwan and Japan) have increased their steel production by 5 percent. Steel output in the C.I.S. has also increased, mostly thanks to Ukraine, where steel production grew by nearly 9 percent. As regards Russia, its major producers – Severstal, Novolipetsk Steel Works, Kuznetsk Steel Works and NOSTA – reported cutbacks in a number of steel articles and a considerable reduction of exports.

The main problem plaguing the industry is the poor state of its production facilities and equipment; the rate of their deterioration is approximately 67 percent (for the industry as a whole) and the current workload stays at 66 percent of rated capacity. During the last several years, the rate of investment in Russia’s ferrous metals industry has been around $7-$10 per ton of steel produced. For comparison, in EU countries, where the situation with facilities and equipment is far better, the corresponding figure is $25-$27 per ton.

The rate of equipment replacement in Russia’s steel industry currently remains at 0.8-1.0 percent, i.e., far below the recommended figure of 3-4 percent. For comparison, in industrially developed countries the corresponding figure is 6-7 percent.

Investments in Russia’s steel industry and their main sources

As before, most of the investments that come into Russia’s industries are spent on maintaining existing facilities and equipment and only a minor proportion goes to financing modernization projects. A shortage of production capacity has occurred in a number of sectors, including the chemicals industry, ferrous and nonferrous metallurgy and several branches of engineering and light industry. The bulk of investment flows precisely into the better-off sectors of the economy, namely the fuel and energy sector, which indicates a lack of symmetry between the need for investments and their availability.

As regards investment sources, the last several years have seen a trend toward reduction in the proportion of owned funds and an increase in that of borrowed money. The reason is that enterprises are getting increasingly short of working capital due to reduced exports, weakened world prices and the gap between domestic and world prices.

Owned funds

Throughout 2001 the amount of owned funds invested in production development steadily declined. An analysis of export figures (precisely exports represent the main source of investment resources for most enterprises) shows that export volumes (in dollar terms) fell 12 percent-15 percent in 2001 compared to 2000.

Simultaneously, domestic consumption of ferrous metals had increased, and, though it did not bring much profit to the industry, it served to narrow the gap between export and domestic prices. If the trend continues, Russian metal producers will soon be able to compensate for the losses caused by withdrawal from foreign markets by increasing domestic sales.

The proportion of owned funds in capital investments in ferrous metallurgy fell from 57 percent in the first quarter of 2001 to 53.5 percent in the year’s third quarter, while the proportion of borrowed funds increased from 43 percent to 46.5 percent.

Borrowed funds

The total volume of borrowed funds invested in the sector increased 8 percent during January-September 2001. At the same time, the volume of direct investment fell 7.4 percent from the previous year and the proportion of direct investment in the total declined to 30 percent from 40 percent in 2000. A considerable part of direct investment came in the form of credits from foreign shareholders.

Capital flight, which is currently (according to different estimates) $30 billion per year, represents a source of investments in Russian industries because part of the "fugitive" capital is re-invested from offshore zones. This is indirectly confirmed by the geography of investment sources. Thus, 11.4 percent of all investment in Russian industries arrived from Cyprus and 48.6 percent of investment in ferrous metallurgy came from the Antilles, Gibraltar and Switzerland, and the proportion of investments coming from offshore zones is tending to increase.

The proportion of industries in the total volume of foreign investments in the non-financial sectors of the Russian economy fell from 42.1 percent in January-September 2000 to 38.6 percent in the corresponding period of 2001. Foreign investment in Russia’s industries totaled $3.755 billion in January-September 2001, most of which arrived in the form of various credits and only 31.8 percent as direct investment. The following sectors were the main recipients of foreign investments in the first nine months of 2001: The food industry (27.6 percent of the total of foreign investments in Russia’s industries), ferrous metallurgy (22 percent), oil production (14.3 percent) and metal processing and engineering (10.8 percent).

The proportion of bank loans in the total of investments in equipment replacement showed a steady decline. Despite the increase of financial resources accumulated in Russia’s banking system, the share of bank loans in the country’s gross domestic product declined and equaled 22 percent in the first half of 2001. Banks refrain from risks and are reluctant to invest in projects with long payback periods.

( The author is an analyst from the MetalTorg.ru project.)