It’s official: Russia is a magnet for money. For the first time in its post-Soviet history, Russia in 2005 attracted more private capital than it exported. The capital inflow is a sign of the huge appetite for Russia among foreign investors and lenders, who are now pouring more money than ever into Russian loans, securities, acquisitions, and greenfield investments.

True, last year’s net private capital inflow was just $300 million – less than 0.1% of GDP. China, by comparison, logged inflows equal to 6% of GDP in 2004. Still, Russia’s results were much better than government forecasts, which earlier last year anticipated a net outflow of up to $10 billion.

The unprecedented surplus represents a dramatic turnaround from the days when money used to leak out of Russia like a sieve. Net private-sector outflows averaged around $20 billion a year during the late 1990s, a sign that neither local nor foreign investors could be induced to park their cash in a country infamous for its political and financial instability.

«Impressive turnaround». Even the recovery of the Russian economy after 2000 didn’t immediately stem the hemorrhage. True, by 2003, the annual net outflow had fallen to just $1.9 billion. But then came the notorious Yukos affair. Investors were horrified, and capital flight shot up again, to $8 billion in 2004.

The latest figures are a sign that foreign investors have recovered their nerve. «It’s an impressive turnaround, given fears of a worsening following Yukos. The country and business shrugged that off, and people are investing relatively happily,» says Al Breach, research director at Brunswick UBS.

A key factor driving last year’s surge was the continued strong performance of the Russian economy. GDP grew by 6.4% last year, buoyed by record high oil prices. Rising tax revenues from energy exports also mean that the government’s finances are impressively healthy. Last year the government ran a budget surplus equal to 7.5% of GDP. The improvement in Russia’s public finances prompted international credit rating agencies to upgrade the country to investment grade, which has added to Russia’s investment attractiveness.

Foreign loans. So where is all the money going? The Central Bank’s data show that loans to Russian companies accounted for the bulk of the inflows. These were worth some $39.4 billion, up from $16.2 billion in 2004. Russian banks, too, were active in borrowing abroad, raising some $18 billion, or $5.3 billion more than they invested overseas. In comparison, portfolio investment amounted to just $3.1 billion – still a big improvement from $800 million in 2004.

The growing share of loans could be grounds for caution. Although a healthy sign of bankers’ confidence in Russian borrowers, bank lending generally brings fewer benefits to a recipient country than other forms of investment, and may even be risky if debts get out of hand. What’s more, notes MDM’s economist Peter Westin, the surge in foreign borrowing partly reflects the weaknesses of Russia’s own underdeveloped banking and financial systems.

More worrying than the build up of debt is that much of the new loans are going to state companies rather than to the private sector. Last year Gazprom took out a mammoth $13.1 billion loan from a consortium of Western banks in order to finance its acquisition of Sibneft. Likewise, state oil company Rosneft borrowed $6 billion from state banks, indirectly financed from abroad, to fund its controversial purchase of Yukos’ main production unit.

Strengthening government. That’s why not all Russians are impressed by the healthy balance-of-payments data. Skeptical local newspapers argue that foreign borrowing is being used to finance creeping renationalization of the Russian economy. Russia’s finance ministry has also criticized the growing appetite of state companies for foreign loans. Last year finance minister Alexei Kudrin called for caps on the amount that state companies could borrow abroad.

A more positive indicator of foreign investor sentiment towards Russia is foreign direct investment (FDI). FDI was up by 38% to $16.7 billion. That’s a far cry from the days, prior to 2003, when Russia managed a meager FDI trickle of $4 billion each year.

With so much hard currency now flowing into Russia the government has been able to dramatically improve its financial position. Last year it repaid some $21.3 billion in foreign debt, while the Central Bank’s forex reserves jumped by $61.5 billion, or 51%. This remarkable improvement in the country’s public finances is one reason why Russia watchers see few negative clouds on the immediate horizon. Barring a spectacular upset, such as a dramatic fall in international oil prices, Russia could well prove to be an even bigger magnet for foreign investment this year.