Business Analysis: Forget the China story, Russia offers a greater prize for Western investors

The chief executive of BP, Lord Browne of Madingley, is in Moscow today to meet President Vladimir Putin and discuss the company's future co-operation with Russia. On his mind will be three recent developments, none of which sends particularly positive signals about the welcome that awaits investors in Russia.

The most immediate, from Lord Browne's point of view, is the £495m demand the jointly owned TNK-BP has received out of the blue from the Russian government for back taxes.

The second is the threat by the Russian government to revoke the company's licence to develop the huge Kovykta oilfield in Siberia.

The third is the fate of Mikhail Khodorkovsky, former head of the now bankrupt Yukos oil company: his long-running trial for tax evasion and fraud ended two weeks ago and the verdict is expected next week.

Lord Browne's meeting was planned well before the tax bombshell landed. That the head of a major foreign company finds it necessary - and has the opportunity - to take such matters right to the top of the Russian administration, however, adds a further negative signal. The President is seen as having the power to decide what are fundamentally business problems that would be resolved in most developed countries by resort to precedent and the law. In Russia, alas, the laws are still too inadequate and enforcement too erratic to inspire great confidence among investors.

By no means everything on the Russian business front is dark these days, however. And there are hints that the mood of investors may be starting to change, perhaps quite radically. One straw in the wind was the weekend announcement from Dixons that it was taking out an option to buy Eldorado, Russia's biggest retailer of electrical goods. Until now, British involvement in Russia has focused on natural resources: oil, gas and gold. This is a rare sortie by a British company into the Russian consumer sector. The French, Italians and Scandinavians are increasingly well-established, but British companies have generally fought shy.

In announcing the move, John Clare, the chief executive of Dixons, made a shrewd observation. There were, he said, two quite different consumer markets in Russia: an increasing number of major cities where demand was for the latest in electronic gadgetry (I-pods, digital cameras, lap-tops and the like), and small towns and rural areas where people were still considering the purchase of their first washing machine.

This is true. It is also true, as Russian officials have recently stated, that the Russian consumer market is still very far from being saturated. There are poor people in Russia, but there are also growing numbers of "ordinary" people, not the "super-rich", with money they want to spend and too little to spend it on.

Mr Putin has also indicated that he may finally have understood the harm done to investor confidence by the seemingly arbitrary treatment of Khodorkovsky and Yukos. Three weeks ago, he told Russian business leaders there would be no review of the suspect privatisations of the Nineties and aggressive prosecutions for back taxes would be restrained - and both measures would be enshrined in law. In other words, Yukos was a one-off.

These assurances remain to be tested. Suddenly, though, Russia is looking a more realistic investment opportunity just as serious questions start to be raised about the promise of another market with which Russia has often been - unfavourably - compared: the vast pool of potential consumers that is China.

While Russia had seemed almost to give up on attracting foreign investors, especially after the 1998 rouble crash, China has been awash with foreign money. Its vast population, its seemingly indefatigable growth rate - 9.5 per cent last year - the cheapness of its labour and its determined effort to court foreign investment all proved powerful incentives. Powerful enough, as some Russians would ruefully comment, for human rights considerations and the backward state of China's legal system to be ignored. The projected rewards were just too attractive.

Set aside for a moment the slowness of China to yield any profit to its multitude of investors. There need be no rush, most of them say, they are in China for the long term. The long term, however, seems to grow ever longer. China's consumer market has been much slower to develop than many envisaged. The demand for cars, in particular, has slowed, leaving Chinese producers with large stocks unsold, and not readily saleable abroad. This was apparently one consideration underlying the recent refusal of Shanghai Automotive to help bail out MG Rover. Another, of course, was common sense.

China's potential has been judged largely by its GDP growth rates. And its growth, while spectacular when compared with most developed countries, has been from a very low level.

China, unlike Russia, is a country that is still industrialising. The migration of its largely rural population to the cities is still in progress - with all the social disruption that this entails.

Protests, against local officials, corruption, poverty and discrimination, have been multiplying, and these are only the incidents reported. The recent demonstrations against Japanese interests should also ring an alarm. The Chinese authorities are clearly not averse to mobilising historical resentment for an overtly nationalist purpose. Foreign investors be warned.

Beside China, Russia is an industrialised economy. As such, its recent growth rates - at around 7 per cent - have been not at all bad, especially in view of the amount of Soviet-era manufacturing capacity that is obsolete or mothballed. Right now, the spending power of the average Russian greatly exceeds that of the average Chinese. Pensioners' protests at the start of the year over the monetisation of many social benefits hinted at the possibility of social disruption to come, but the protesters were bought off - a solution facilitated by Russia's booming oil revenues.

Which highlights a second distinction between the two economies. The Russian exchequer's dependence on oil and gas exports for balancing the books is a source of continuing criticism by outsiders, who fear what could happen if prices fall. The Russian government, however, has planned for this eventuality by treating all windfall revenue as a bonus that is kept in a special "stability fund".

It is also well aware of the risks of petro-dependency, and ministers have spoken recently of an accelerated programme to develop a home-grown high-technology and services sector.

The question has to be asked, however, whether China's position is any healthier than Russia's. It is currently the largest importer of energy after the United States. With an economy so dependent for income on exports of manufactured goods (accounting for more than one third of revenue) which go mostly to the US, it is doubly vulnerable: to high energy prices and to a fall in demand, especially from the US.

So far, both US and British investors have shown far greater readiness to treat business and political interests in separate compartments in their dealings with China than with Russia. Washington's major quarrel with Beijing about China's refusal to revalue its currency against the US dollar has largely been kept in the business department. The post-Tiananmen arms embargo, currently an issue between the EU and the US, is one of the few examples of political "linkage", the cold war concept so detested by Russians.

Until the two countries are viewed through an equivalent prism, the real opportunities in Russia will continue to be missed - along with the real risks of investing in China.