It has been six months since I last wrote on IKEA, and I thought it was time to check in on TRM’s favorite foreign investor in Russia. In December, it appeared that IKEA’s problems were only getting worse. The whole story started in Feb. 2010 when two top execs were fired over corruption allegations – that they authorized a subcontractor to pay off a city utility in St. Petersburg in order to get their Mega Mall connected to the power grid. In late 2010, IKEA named a new director to its Russia business – Per Wendschlag – and announced a halt to any new investments in Russia. The halt appeared to be tied to bureaucratic obstacles related to planned IKEA stores in Ufa and Samara, and problems with an existing store in Moscow.
What a Difference a Half-Year Makes
To TRM‘s surprise, IKEA seems to have made quite a bit of progress in Russia, and is resuming its planned investments in that country. Last week, the State Construction Inspection Agency in Samara approved IKEA’s construction plans for its future mall “Mega-Samara.” As I detailed earlier, IKEA’s administrative problems Ufa are long-standing and serious – so serious that the aforementioned fired execs felt the need to draft an “enemies list” for that province alone. So this is a major obstacle overcome indeed. And in Ufa, the two planned stores – and IKEA furniture outlet and Mega Mall – are slated to open at the end of next month. IKEA has also resumed its expansion in the Moscow region, today announcing the purchase of large land tracts in the Khimki business park. IKEA is even launching new business plans, such as its recent decision to open a bank in Russia.
High-Level Help to Turn Things Around
The turning-point for IKEA’s Russia business came in April, when the Ministry of Economic Development reached out to IKEA’s Russia leadership and convinced them to resume their business expansion in the country. Indeed, Minister Elvira Nabiullina proudly announced that the Swedish retailer had agreed to not only resume its construction of new stores, but also to invest in Russia’s manufacturing capacity through localization initiatives (IKEA’s Swedwood business has had a few manufacturing plants in Russian since 2002). Of course, this is not the first time that Russia has used its crappy investment climate to cajole strategic investors into making investments they otherwise would not make (see this post for more examples). Still, given the size and predicted growth of the Russian consumer market, it is probably worth it for IKEA to manufacture a few more tables in Russia in exchange for federal protection of its retail outlets.
Whither the Corruption Investigation?
The one open question is on the status of the corruption investigation into IKEA’s St. Petersburg store. Nabiullina made it pretty clear that there will not be an investigation or prosecution on the Russian side (no surprises there). But what about the Swedes, who had previously indicated that an investigation was ongoing? According to a Transparency International report that tracks anticorruption enforcement, IKEA is not one of the companies currently under investigation or prosecution by the Swedish authorities. Nor is there any indication that the Dutch authorities are involved (IKEA’s holding company parent is headquartered in the Netherlands). So has IKEA dodged a bullet? Not necessarily. The European law enforcement authorities are still relatively new to the anticorruption game, and are not so quick on the draw as the U.S. DOJ and SEC.
Lessons Learned?
Ironically, IKEA’s entire history in Russia – starting with the infamous Lennart Dahlgren, to the two fired expat execs, to the current leadership – represents a case study in how to succeed, then fail, then succeed in the Russian market. In Dahlgren, we find a savvy expat who actually knows and appreciates Russian culture and business climate. He used this knowledge and contacts to navigate the “wild 90s” and ensured IKEA’s place as the premiere foreign retailer in Russia. The two failed execs – based on the news reports – encountered a difficult situation but responded on the basis of a very superficial understanding of Russia (i.e., drafting enemies lists, trying to bribe judges, cutting corners with subcontractors). Finally, with Per Wendschlag we seem to be witnessing a resumption of the Dahlgren model, but with a Medvedev era twist (i.e., building relationships at the federal, rather than local level).
By now most readers are well familiar with Medvedev’s “war on corruption.” We know new laws have been passed and enforcement has reportedly increased. Still, many of the new laws are often ignored (e.g., income declaration requirements). And much of the purported increase in enforcement is actually from prosecutors counting garden-variety fraud prosecutions as “anticorruption” cases. But anecdotal evidence from Medvedev’s most targeted anticorruption campaign – in public procurement of medical equipment – suggests that his war on corruption may be working.
“Absolutely Cynical and Brazen Theft of Public Money”
The move against corruption in medical procurement got its start almost exactly one year ago, when Head of Control Department Konstantin Chuichenko reported to Medvedev on inflated prices paid for high-tech medical equipment in public purchases throughout Russia. Medvedev demanded a substantive report, which Chuichenko delivered on August 10, 2010. The report found that public purchases of CT scan machines were typically at prices 200-300% higher than manufacturer prices. Chuichenko explained that the reason for the discrepancy was the use of offshore intermediaries by Russian companies selling to the Russian government. The offshore intermediaries substantially marked up the price allegedly in order to mask the margin between the manufacturer and end-user prices (Medvedev commented that the offshore and Russian companies are likely owned by the same individuals). Chuichenko added that “corruption was evidence” in several of the tenders. Medvedev agreed, calling the scheme “an absolutely cynical and brazen theft of public funds.” Medvedev ordered Chuichenko to, among other things, implement price monitoring and to bring corrupt officials to justice.
“I demand the sum of … 1 MILLION DOLLARS.”
Following Medvedev’s order to investigate and prosecute corrupt officials, there were several low-profile criminal prosecutions against mid-level medical procurement officials throughout Russia’s regions.
But perhaps the most interesting case unfolded by accident in November 2010, when a group of individuals were arrested for their involvement in an extortion scheme, including Andrey Voronin and Vadim Mozhaev, two high-level members of the Presidential Administration. The scheme was pretty simple – Mozhaev and others would inform manufacturers of high-tech medical equipment that their company had been placed on a non-existent “black list” of companies who would not be allowed to participate in public procurement for their products. Channeling Dr. Evil, Mozhaev offered to remove the companies from the black list if they paid $1 million.
But, as the saying goes, “no plan survives contact with the enemy.” When Mozhaev et al posed their extortion demand to Toshiba (via a Russian distributor), Toshiba’s country manager (to his great credit) acted like you would in a normal country – he went to the police. And the MVD detectives (to their credit) acted like law enforcement officers in a normal country – they investigated.
Indeed, the MVD investigated rather well – their plan was to have Toshiba pretend to agree to the extortion demand and wear a hidden camera at the meeting, with a result worthy of Hollywood. The characters: Toshiba’s country manager and former Deputy Minister of Health Aleksey Vilken. The scene: Novikov restaurant “Sushi Vesla,” located right off of Lubyanka Square. The props: a hidden camera, cigarettes, and some phony SWIFT transfer confirmations, showing that the money had been wired to a designated offshore company. Here is a news report showing the meeting with Vilken:
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As a result of this investigation, Voronin, Mozhaev, and others were arrested for their extortion attempt. Voronin has already pleaded guilty and is “cooperating” with investigators.
Vilken Strikes Again
Over the past few months, there has been a focus on corruption within defense purchases. The chief military prosecutor reported that 20% of the military budget is stolen through corrupt schemes. A leaked Audit Chamber report highlighted the same problem, finding that $71 mln worth of public tenders for military procurement involved violations of the Law on Procurement. So it was not very surprising when Alexander Belevitin, the Chief of the Defense Medical Administration, was arrested earlier this month for taking a $167k kickback in relation to the purchase of medical equipment. In order to avoid detection, Belevitin and his co-conspirators had used none other than former Dep. Minister of Health Vilken as an intermediary. The bribe payer in this case was reportedly a citizen of India from the company DIN International. Unlike the Voronin case – where the participants will be charged with extortion – Belevitin and his compatriots will be charged with bribe taking under Art. 290 of the Criminal Code of RF.
Scoring Medvedev’s Anticorruption Drive
There are a few characteristics of the war on corruption in medical procurement that merit attention. First, the prosecutions have been comprehensive - they have targeted purchases throughout Russia and individuals at all levels of the procurement process. Second, this drive has ‘gone the distance’ in that people who never would have been prosecuted in the past are in fact going to jail. This is an important kind of ‘optics’ in Russia where the constant refrain from the public is ‘где посадки?’ (basically, “where are the arrests?”). Third, the drive seems to be working - Kommersantreported last month that medical equipment – particular CT scanners – were being sold at below-market prices in public tenders this year.
So, in many ways Medvedev’s campaign in this area has been highly successful. To many foreign observers, it does not meet any of the several litmus tests for the end of all corruption in Russia (e.g., release of Khodorkovsky, prosecution of Putin). And to many Russians, it may not have any readily apparent benefits. But the benefits - millions of dollars saved in medical purchases – are real and the prosecutions do serve as a warning to others in different sectors. Lastly, the fact that these successes were achieved in the course of only one year is impressive by any standard.
Today, the Strategic Sectors Law (SSL) Amendments were submitted for their second reading. The SSL Amendments will also likely undergo a third reading, and the assumption is that the changes between the second and third readings will be more substantial than between the first and second.
The SSL Amendments did not undergo many changes between the first and second readings. You can look at a track changes version here. The only “significant” change was the addition of the following language:
“This federal law does not apply to transactions … between organizations under the control of the Russian Federation or citizens of the Russian Federation, who are tax residents of the Russian Federation (except for citizens of the Russian Federation who have dual-citizenship).”
This new language – which was proposed by the Russian Government – appears to be an implementation of one of Pres. Medvedev’s “ten steps” to improve the investment climate in Russia (#8). Namely, the change would exempt from coverage any transactions involving offshore entities that are controlled by Russian companies. When Vedomostiwrote that this was the change Medvedev was proposing, I wrote that it must be some mistake. After all, the new language seems to encourage the common Russian practice of holding capital offshore. Indeed, this change does limit the application of the law, but only to the benefit of large Russian enterprises, not foreign investors.
In any case, this is by far the most significant change to the SSL proposed so far, as it would drastically reduce the number of cases within the Foreign Investment Commission’s jurisdiction, both legally and practically (most of the applications have involved Russian offshore entity transactions).
Well, the new official meme is that it is Medvedev v. Putin, if not officially then unofficially, for 2012. If Medvedev was campaigning in the United States, we would already be deep into the campaign ad season, so he has some catching up to do. That’s why I have decided to lend a hand to our electorally-challenged brethren in Russia by throwing together a Medvedev campaign ad prototype (obviously the production value is a bit low). Do I think we will see such ads in Russia soon? Nope, but it would be a lot cooler if we did.
Well if the 2012 election has unofficially kicked off in Russia, the Western media has officially started failing to cover it in a meaningful way. Last night, the Associated Press published a wire report entitled, Russia’s Medvedev Hints He May Not Run Again, Clearing Way for Putin. And of course, being an AP wire, the story has been picked up in virtually every major newspaper of the United States, sending it on a hyperdrive course into the realm of Established Truth. The only problem is, Medvedev neither hinted nor cleared ways during his interview at Dozhd (rain) television station.
You can read a Russian transcript of the interview with Medvedev here, but below is a translation of the relevant question (which were submitted by viewers, btw):
Zygar: Sooner or later of course you will no longer be president – in 2012 or 2018.
Medvedev: [that is] absolutely correct.
Zygar: Have you already thought about what you might do after? Perhaps, you will be involved in some innovative business?
Medvedev: That’s a very good question, Mikhail. Now I am always asked the same question – will you run for president or not? And if you do not run for president, then do you see yourself in government service? But nobody asked the human question – what will you do once you have finished your work [in government service]? I can say – it is not a simple issue to find another life after holding such a post.
Zygar: To imagine Bush or Obama after being in power is possible, but to imagine Medvedev or Putin after being in power is practically impossible.
Medvedev: Yes, especially because the whole experience of the preceding [Soviet] era showed that when a person leaves power, his life is for the most part over. An exception to this is Boris Nikolaevich Yeltsin. He already was, of course, quite old but nevertheless in his final years he lived an interesting life – he traveled a lot, read books, and in this way was lucky. What will I do? I honestly do not know. But I am confident that I will find interesting work. I also have a large number of hobbies that, like any person, I will pursue after my time in state service. Basically, I would like to enjoy an active life. And there are these new technologies that you have which I like very much.
Sindeeva: Teaching, perhaps?
Medvedev: Sure. Certainly at Skolkovo. If everything by that time is working well, I would like to teach there. I would also like to teach at other places, because I think any former head of state must tell about both his positive and negative experiences, both in his own country and elsewhere.
[end translation]
As you can see, Medvedev’s statement is explicitly NOT a discussion about the 2012 election, as he points out in his initial response. Furthermore, how is nobody interpreting this as a subtle hint to Putin? The message is, don’t be like guys in the Soviet era, who clung to power until they died. Enjoy yourself, like Boris Nikolaevich did! See, he read books, if by read you mean drank and by books you mean vodka. And what about the reference to teaching outside of the country? Code for “I’ll let you flee to the UK”? In any case, Medvedev’s statements are a little more gray than the AP report led its readers to believe.
[TRM's second installment on recent events in Russia]
Medvedev made quite a few headlines two weeks ago with a series of moves that signaled a renewed push to ‘improve the investment climate’ in Russia. This is, of course, not a new issue for Medvedev, and I have criticized him in the past for his administration’s highly technical, legalistic approach to bringing about change. But this time Medvedev appears to be thinking big and is aimed at practical goals. Medvedev summarized ten of these goals at the Commission on Modernization and Economic Development. And while these measures do not threaten the ‘power vertical’ structure of the Russian state, some do strike at the intertwining of state and capital also known as “Kremlin, Inc.”
The ten steps are:
Lower compulsory social insurance payments by January 1, 2012
Creation of procedure to examine complaints on state agencies’ action/inaction that include allegations of corruption
New powers to the Ministry of Economy to review regulations and provide the Ministry of Justice with a list of overly burdensome regulations for repeal
By May 2011 each federal district will receive a ‘special investment ombudsman’
Privatization of large government shareholdings and removal of government ministers responsible for regulation in particular sectors from sitting on boards of directors of companies operating in a competitive (i.e., non-monopoly) environment
Increase rights of minority shareholders of public companies to access to information
Establishment of a Russian investment fund by mid-summer with the purpose of attracting foreign direct investment (note: previously reported that it would attract portfolio investment as well)
Submit a draft law by May 15 to narrow the jurisdiction of the Commission on Foreign Investments in Strategic Sectors
Appoint Deputy Prime Ministers to ‘process’ agencies like customs, registration offices, work permit providers, etc. If the quality of an agency’s work does not improve, the head of the agency will be replaced
Establishment by beginning of May 2011 of mobile reception offices of the President of the Russian Federation in every region of Russia to receive and review complaints about the authorities
Medvedev discussing his 10 steps:
Liberal Vertical
One notable characteristic of many of the steps is that they are wholly consistent with the ‘power vertical’ structure that Putin established and then perfected during his second term in the wake of the Beslan Hostage Crisis. Then, the threat was from foreigners coming into Russia. Now, the threat is from foreigners who don’t want to come into Russia. The strategy is the same – establish more top-down control over the regional and federal structure. Granted, Medvedev is not cancelling elections of governors or anything else that infringes on ‘local sovereignty’. Rather, he is betting that a lot of investors’ problems stem from having nobody to contact when they have a problem. There is some precedent for this – the Kaluga Region is widely known as the best investment destination in Russia, with investors explaining that Gov. Artamonov gives them his personal cell number. So in short, this does not represent a serious departure from the current structure of government in Russia.
The Money – Kremlin, Inc. Under Threat?
Many observers in the Russian and international media have concluded that the privatization of government shareholdings in major companies and, most important, removing Ministers from government boards of directors constitute a direct attack on Kremlin, Inc. generally and Dep. Prime Minister Igor Sechin in particular, who sits on the boards of Rosneft, Rosneftegaz, and INTER RAO UES. Some people smarter than me have argued that weakening Sechin is actually Putin’s initiative, because has never quite been comfortable with the silovik horse to which he hitched his presidential cart (he did quit the KGB to work for Sobchak, after all).
My own view is that these actions do not, on their own, constitute an existential threat to the system of Kremlin, Inc. Indeed, the ‘privatization’ of most of these government companies is with the caveat that a ‘golden share’ will remain with the state. And when it comes to companies, control is all that matters. These aggressive moves by Medvedev do, however, seem to be a shakeup at the individual or group level of the beneficiaries of Kremlin, Inc. Indeed, a lot of Sechin’s power comes from his role in INTER RAO and Rosneft. Foreign firms wishing to do business on these companies’ ‘turf’ usually find themselves having to broker deals directly with Mr. Sechin, because his dual-role as board-member and minister make him the de factor primary stakeholder. As a mere deputy PM, Sechin will have a lot less reasons to be conducting such business meetings.
The Tandem – Putin Power Under Threat?
An additional, stranger conclusion was made out of Medvedev’s speech: that he undercut the power of PM Putin ‘without asking’. A Vedomostiarticle last week claimed that Medvedev’s proposal regarding the Strategic Sectors Law (step #8 above) had this effect. Specifically, the article states that Medvedev proposal is aimed at narrowing the law’s coverage so that it does not include deals by offshore entities that are de facto controlled by Russian citizens/companies. I have two interpretations of this issue.
First, is that Medvedev’s handlers mistakenly included a ‘reform’ that is already included in the draft amendments pending in the Duma. In particular, I am referring to the loophole in the current legislation that expands the Strategic Sectors Law’s jurisdiction to any ‘group of companies’ to which a foreign investor belongs (which I have covered here and here). The pending correction to this loophole seems to fit within Medvedev’s statement, especially because it was mentioned in the same breath as ‘deals in which international financial organizations are participating’ (another ‘reform’ in the pending amendments). So it could just be a big screw-up (kind of liking VVP getting the FDI numbers wrong over and over), and I really don’t think we can overestimate the incompetence of the people running Russia. But what if Vedomosti got it right, and Medvedev meant excluding offshore companies that are ‘de facto’ owned by Russian companies?
The second interpretation is that perhaps Putin wants to distance himself from these sorts of transactions, but doesn’t want to be the one responsible for doing so (leaving no fingerprints, so to speak). The problem is that investments via Russian oligarchs’ Cypriot, BVI, etc. offshore entities (offshorki) have become one of the most common kinds of deals occupying the Commission’s time. Aside from the embarrassing fact that such deals do not represent real FDI but rather repatriated Russian capital, Putin may have another reason to not want these deals to receive such public treatment.
For example, at the most recent meeting of the Commission, Putin approved Omirico Ltd.’s (Cyprus) purchase of Novoport Ltd. (BVI). Both of these companies are the worst kind of offshorki – so-called ‘one-day companies’ (odnodnevki) that compliance lawyers warn their Western clients about. So who’s behind Omirico? State-owned Transneft and Summa Capital. Behind Novoport? Kadina Ltd., which is owned by none other than Putin judo buddies Aleksandr Ponomarev and Arkady Rotenberg, and LDPR deputy Aleksandr Skorobogatko (which literally translated means ‘quickly rich’ – you cannot make this stuff up!). The object of the deal was the Novorossiysk Commercial Sea Port (NMTP). NMTP was owned by Novoport (50.1%), Rosimushchestvo (20%), Sberbank (18.63%), and an LSE float.
Transneft/Summa, via Omirico, wanted to purchase a controlling stake in NMTP (via Novoport). But the deal was structured somewhat strangely. First, a condition precedent of the deal was that Omirico sell the Primorsk Commercial Port (PTP) to NMTP – yes, sell an asset to the asset which it is acquiring. This was done for just over $2 billion, and Sberbank was even nice enough to finance a large portion of the purchase. Second, Omirico purchased (likely with the proceeds of the sale of PTP) Novoport for [reportedly] $2.5 bln, far above the holdings’ value of $1.38 bln. So Transneft sells PTP to NMTP for $2 bln, and then buys a controlling stake in NMTP for $2.5 bln. If you take a step back, which you can do with the handy chart I made (click image below), you can see that this is essentially the transfer of over $1 bln in Russian taxpayer funds to Putin’s judo buddies, without any business/market explanation. Obviously, these are not the kinds of deals that Putin wants to give his personal blessing to, especially with sharks like Aleksey Navalny swimming around Transneft’s financial records (kind of surprised Navalny hasn’t pursued this story). Thus, if Vedomosti interpreted Medvedev’s words correctly, the goal may be to insulate the premier from deals that hit a little too close to home.
A number of recent events in Russia show that the 2012 Russian presidential election campaign is in full swing. In keeping with true Russian style, this campaign is aimed not at a mass Russian audience, but rather the political/economic elites involved in the soap opera-like battle for Russia’s wealth and power.
The Power – Who May Enforce the Law?
Unlike Libya, Russia does not carry out missile strikes against civilians who are opposed to the regime. Instead, the Russian government elects for a ‘death by a thousand cuts’ strategy, which is planned and managed by law enforcement bodies. Most important is the ability to bring prosecutions against individuals and companies in Russian courts that are notoriously supportive of prosecutors. The stakes are even higher now that Medvedev’s team of legal nerds have added teeth to portions of the criminal code and other statutes. But who will be targeted?
For some time, Russia only had a General Prosecutor’s Office, and it alone was responsible for initiating criminal investigations and prosecutions. That was until early 2007, when then-Pres. Putin decided to create the Investigative Committee (SK or Следственный Комитет), which would take over some of this authority and whose chief would be selected by the President (currently Putin law school chum Aleksandr Bastrykin). The result has been a divided structure between the SK and Prosecutor General, with periodic hints at the creation of a single ‘super-agency’ with sole investigative/prosecutorial authority.
This week, the conflict between the two sides spilled out into the open after a series of aggressive moves, culminating in accusations from SK that Chaika’s son – Artyem Chaika – is involved in the illegal ‘underground’ casinos that have recently come under fire. Upon hearing this, Chaika reportedly went straight to Medvedev and requested a meeting. According to meedia reports, Medvedev sat the two sides down yesterday and insisted that the conflict stay out of the public eye and that the junior Chaika be left alone (all very Putinesque). Notably, the Chaika case is likely to end ‘only’ with the firing of the Moscow prosecutors who initiated the case, because “their last names came out during the scandal.”
Some analysts in Russia havesuggested that the scandal could result in the firing of both Chaika and Bastrykin. If Medvedev were to take such a step, it would be a significant demonstration of his power and raise his profile going into 2012. Medvedev is not close to either Chaika or Bastyrkin, and there isn’t really anyone on deck for Team Medvedev and could fill the role of Russia’s top prosecutor (though Chuichenko, Konovalov, and Vinnichenko come to mind). So letting each side punch each other out is also good for Medvedev.
The last time there was a similar dust-up between the siloviki factions was 2007, when it was the FSB vs. Federal Narcotics Service vs. Investigative Committee vs. Prosecutor General. Then (and now), the tensions boiled over due to the uncertainty of the post-Putin transition (this was before Putin announced his choice). In the midst of the conflict, Putin named Viktor Zubkov as Prime Minister, which turned out to be a wildly successful move – it was inconsequential enough to not affect any interests, yet strange/unexpected enough to convince the warring parties that they all had the same amount of information (zero).
So is it Medvedev’s turn to play a wild card like Zubkov? Maybe. But the current situation differs because the question is whether it will be Medvedev or Putin, and their Odd Couple routine seems to be losing its magic. So the only reasonable option is to unexpectedly introduce a third individual in a way that would keep open the question of Medvedev or Putin or the new guy. For example, Medvedev could buy time this way if he appointed Putin to an ‘inferior’ post but replaced him with someone like Igor Sechin. In any case, I continue to believe that Medvedev will probably stay on for a second term and that Putin is cooperating or even directing the ‘signalling’ to the various factions.
zed a subcontractor to pay off a city utility in St. Petersburg in order to get their Mega Mall connected to the power grid. In late 2010, IKEA named a new director to its Russia business – Per Wendschlag – and announced a halt to any new investments in Russia. The halt appeared to be tied to bureaucratic obstacles related to planned IKEA stores in Ufa and Samara, and problems with an existing store in Moscow.
