Western investors are passing Russia by and heading toward emerging markets further east, deterred by political instability, an arcane legal system and punitive taxation, a recent report shows.


The report, "Multinational Investments in Emerging Markets," produced by the consulting company Ernst & Young, shows Russia and the former Soviet Union lagging far behind countries like China, India, Indonesia and Mexico in attracting foreign capital.


The survey charts the investment intentions of 230 of the world's top 1,000 multinationals in the United States, Europe and Japan, and flies in the face of upbeat Russian government predictions earlier this year that it was set to attract large sums of foreign capital.


"There's a lot of tax problems and political problems here," said George Reese, managing partner of Ernst & Young in Moscow. "Investors are cautious about stepping into the middle of that."


"There just hasn't been a lot of investment here to date," he said.


That would appear to conflict with what CS First Boston estimates at a $2 billion inflow of foreign investment in Russia's nascent securities market this year.


In August, Anatoly Chubais, then the head of privatization, said foreigners were investing $500 million a month in Russian securities and predicted that total capital injections from abroad would total $10 billion by the end of 1994.


This would compare well with previous years. In the six years up to and including 1993 foreign investment in Russia amounted to a mere $2.7 billion, with just $700 million invested last year, according to the Economics Ministry.


But the purchase of Russian securities is not considered direct capital investment, and that amounted to just $278 million in the first six months of this year, according to the Economist Intelligence Unit.


The survey shows that, while there are small pockets of significant investment most notably in the energy sector, only 6 percent of the multinational companies surveyed saw the former Soviet Union as an investment priority.


This compares with some 57 percent who targeted China -- Moscow's old rival for hegemony in the communist world -- as the most attractive emerging market in which to sink their cash.


The report named political instability as the most significant factor deterring foreign investment. Problems relating to legal infrastructure, currency exchange controls and taxation also featured prominently.


Political instability was cited as a deterring factor by 49 percent of companies in relation to the former Soviet Union. In contrast, only 26 percent saw this as a barrier to investment in China.


"Clearly providing political stability must be the main priority for countries seeking to attract investment from multinational corporations," the report commented.


Alexander Romanov, a consultant on foreign investment with Ernst & Young in Moscow, however, said that for large investors in the energy sector, political instability was not a major concern since their position was protected by Russia's need to earn foreign exchange.


"For big investors in oil and gas, the political situation is irrelevant because its a major source of hard currency for Russia," he said.Romanov added that the lack of a clear legal and tax framework combined with the absence of favorable legislation that would attract capital from abroad were much bigger obstacles.


"There's big uncertainty over legislation applicable to investment," he said. "There are practically no regulations for attracting foreign investors."


The creation by Prime Minister Viktor Chernomyrdin this summer of a foreign investment council, which includes foreign business executives, was a hopeful sign, Romanov said.


Chernomyrdin also announced plans in July for a five-year tax holiday for foreign companies, plus a three-year exemption from detrimental changes in the law, but these measures have still not been implemented.


Other changes in the pipeline, however, could have more effect.


Parliament is due to discuss a major reform of the tax system in its current session that would shift the fiscal burden away from business toward individuals. The introduction of a new Civil Code in January should also provide Russia with a clearer basic commercial law.