Kaliningrad turns into an EU-flanked tax haven for Asian firms?

In 1996, a special economic zone was established in Kaliningrad to encourage investments in the region. The zone’s attraction is duty-exempt import. If a company can increase the value of an imported product by 30 per cent and change its customs heading, it is entitled to sell the product exempt of duty elsewhere in Russia as well.
The special economic zone has resulted in a steep increase in Kaliningrad’s foreign imports and sales to the mother country. The region’s share of Russian imports is ten times bigger than its share of the country’s GDP.
Despite its status as a special economic zone Kaliningrad has not managed to convince foreign investors. At the end of 2005, direct investments totalled less than 90 million US dollars, or slightly over 90 dollars per each Kaliningrad resident.
Direct foreign investments per inhabitant in Kaliningrad are only one seventh of the Russian average. In contrast, per-inhabitant investments made by foreign companies in Lithuania are nearly 20 times larger than those of Kaliningrad. This is a huge difference, taking into account that only 15 years ago both Lithuania and Kaliningrad came under the same economic system.
The Kremlin, too, has noted the disappointing progress in foreign investments. To rectify the situation, a new law for the Kaliningrad special economic zone entered into force in April 2006.

As provided in the new law, the special economic zone established in 1996 will be abolished in ten years’ time. Companies that were active in Kaliningrad before the new 2006 legislation took effect will enjoy exemption from duty and may continue duty-exempt re-exports to Russia until 2016.
In a nutshell, the new law stipulates the following: a company that invests a minimum of 150 million roubles, or some 5 million US dollars, in Kaliningrad is exempted from income and property tax for a period of six years. After this it gets a 50-per cent deduction on taxes for another six years. Tax concessions are not altogether insignificant: Russia has an income tax of 24 per cent and a property tax of 2.2 per cent.

An comparison of foreign direct investment stock in the Baltic Sea
region
FDI stock change                                         FDI stock per capita by
during 2000-2004                                         the end of 2004 (USD)
Kaliningrad   428%                                                    92 *
Russia 306%                                                             689
Denmark 133%                                                         18013
Estonia 360%                                                            7198
Finland 230%                                                            10695
Germany 128%                                                         4222
Latvia 216%                                                              1975
Lithuania 274%                                                         1782
Poland 179%                                                             1594
Sweden 173%                                                           18074
* Kaliningrad FDI stock per capita at the end of 2005.
Sources: UNCTAD 2005, Kaliningrad statistics 2006, author’s calculation

In terms of new investments, however, tax concessions carry less importance than does the predictability of Russia’s investment climate. The main feature of the new legislation is that it will remain in force until the end of March 2031.
The new special economic zone will improve Kaliningrad’s competitiveness in relation to its neighbours on the Baltic Sea. Some of the companies in Kaliningrad have already improved competitiveness at quite a startling pace. Rapid development may soon result in ‘Made in Russia’ being found on an increasing number of products on sale in the EU. Any assessments of the future competitiveness of Russian products should take into account, for example, that Kaliningrad-based Telebalt already engages in licence manufacture with South Korean Samsung.
In addition to Koreans, the Chinese have also noted the dormant potential in Kaliningrad. China’s eighth biggest automobile manufacturer, Chery, has set up a plant in Kaliningrad, the goal being to manufacture 10,000 vehicles a year. Is Kaliningrad turning into an EU-flanked tax haven for Asian companies?
To date, Asian businesses operating in Russia have focused on the Russian market, but this may yet change. Companies and policy makers in the EU would hardly welcome the idea of an Asian tax haven in their own region.
Apart from the new special economic zone, Kaliningrad also offers splendid beaches, visited by more than 250,000 Russian tourists in 2005. The region is still waiting for a breakthrough among foreign travellers, though, with only 75,000 visitors from other countries entering the region last year. Why has Kaliningrad not managed to attract more foreign tourists?
Some of the reasons retarding the development of tourism in Kaliningrad include poor traffic and transport connections, slow border formalities, undeveloped conditions of airports, hotels and travel services, as well as the visa obligation. Granting EU citizens visa-free travel for short visits might give tourism a much-needed boost in Kaliningrad. This could apply, for example, to visits lasting a maximum of 14 days.
A decision on visa-free travel for fixed periods would carry more significance than the new law on special economic zone. If, for example, Kaliningrad were to be visited by half a million foreign tourists, each leaving 200 US dollars in the area, the foreign capital collected in one year would exceed the total amount of direct investments seen in the past 20 years.
Reciprocal visa waiver agreements between the EU and Kaliningrad should be made a long-term objective. In terms of visa-free travel, Kaliningrad could pave the road for closer cooperation between the EU and Russia.

 

Kari Liuhto
Professor at the Turku School of Economics and Director
of the Pan-European Institute
Liuhto has worked as expert in several EU-funded projects
in Kaliningrad.