Investment under Stormy Skies: The Case of Russian Firms during 2004-2016

This study investigates the impact of sanctions on investment behavior in Russia during the period 2004-2016, using a comprehensive panel of non-financial Russian companies, including both large firms and SMEs. We employ a reduced-form investment equation that incorporates the effects of sanctions while controlling for the concurrent effects of ruble devaluation and the decline in oil prices, which coincided with the sanctions regime. Using firm- and sector-level variation, we find that sanctions negatively impact the investment rate for firms directly targeted and those indirectly affected, including those affected through sanctioned trade links. To validate our identification strategy, we conduct two placebo experiments: (1) examining the investment response of Russian non-financial firms during the 2008 invasion of Georgia, and (2) analyzing the investment behavior of Kazakh firms in response to the geopolitical uncertainty generated by the 2014 sanctions on Russia. In addition, we develop a structural model of a firm operating in both foreign and domestic markets, incorporating regime shifts in a setting with partially irreversible investment decisions. This model captures the decline in the investment-to-capital stock ratio during the sanctions regime, as observed in our firm-level sample from the Orbis data. The transition dynamics of the model provides insights into the investment behavior in different phases of the Russian economy, shaped by sanctions, oil price fluctuations, and exchange rate changes.