Strategic Sectors Law Update – First Commission Meeting of 2012

Posted on June 3, 2012 by

Last month, then-PM Vladimir Putin chaired his final meeting of the Commission on Foreign Investment Oversight (at least until 2024 barring any change to the makeup of the Commission). Indeed, the Commission meeting was one of the final significant acts by PM Putin, at least judging by his public calendar. There is a certain degree of historical symmetry to timing of the meeting: then-Pres. Putin signed the Strategic Sectors Law in the last three days of his presidency in May 2008. Perhaps because this was his final meeting – or perhaps due to the lack of applications to discuss – Putin opened the meeting with some general remarks on the application of the law over the past four years:

“As a matter of fact, a new mechanism has been created and tested for attracting foreign investment and granting foreign companies access to operate in strategic sectors of the Russian economy. Since it was formed four years ago, the commission has considered more than 140 applications from foreign companies and investors. An overwhelming majority of those applications has been approved.”

In some ways, Putin’s observations are correct. The SSL did fill a legal/regulatory void that existed prior to its enactment, which meant that ‘strategic’ investments were subjected to informal negotiations and political interference (the Siemens-Power Machines case being the most famous example). On the other hand, Putin’s comments are premised on a belief that the list of strategic industries is as narrow as possible. Surely more foreign companies would invest in Russia’s media and fishing industries if they were not deemed ‘strategic’. Moreover, based on media reports of Commission meetings, we know that many – if not most – of the applications reviewed by the Commission have in fact been submitted by offshore entities controlled by Russian oligarchs (including Putin friends Timchenko et al). Thus, to say that the SSL is a mechanism for attracting foreign investment is a bit of a stretch, and Russia still has a lot of ground to cover in improving its investment climate.

Some other interesting statistics on the Commission’s work over the past four years:

  • 140 applications have been considered by the Commission
  • 132 applications received preliminary approvals, 26 included preliminary obligations
  • 8 applications were denied, and 26 applications were abandoned by the applicants
  • 38% of applications related to the extractive industries sector
  • 21% of applications related to companies with encryption licenses
  • 11% of applications related to natural monopolies
  • 10% of applications related to companies that work with infectious agents
  • 9% of applications related to media companies
  • 6% of applications related to companies active in the defense sector

Applications Reviewed at the Meeting

Below are several of the deals that have been publicly reported so far.

  • Changi Airport Group (CAG) - the Commission approved the Singaporean CAG’s acquisition of 30 percent of the shares of Sochi International Airport (Международный Аэропорт Сочи), Krasnodar International Airport (Международный Аэропорт Краснодар), and Anapa Airport (Аэропорт Анапа) from Oleg Deripaska’s holding company, Basic Element (Базовой Элемент). Interestingly, the approval was subject to several obligations on the part of CAG to maintain the secrecy of certain airport operations and to immediately comply with any orders in the event martial law is declared. Indeed, the Russian Ministry of Defense came out in opposition to CAG’s acquisition of shares in the Sochi and Anapa airports because they are used for defense purposes, in addition to civil aviation.
  • AgustaWestland - the Commission approved AgustaWestland’s (Italy) acquisition of 50 percent of the shares of Helivert (Хеливерт), a Russian helicopter company. The purpose of the deal is to form a joint venture for the production of AW139 civilian helicopters in Podmoskovye, Russia.
  • Others - the Commission also reportedly approved Norilsk Nickel’s acquisition of Taymyr Gaz (Таймыргаз) and “a number of deals by TNK-BP”, although the details of these transactions are not available.
More recently, the Russian government announced plans to include internet companies (e.g., Yandex) in the list of ‘strategic’ companies, thereby requiring government approval of acquisitions of shares in those companies by foreigners. Naturally, such a move will not be not only draw the ire of foreign investors but also raise eyebrows considering the role the internet has played in recent opposition protests (not to mention that it is coinciding with a movement among like-minded countries to ‘regulate’ the internet via a UN entity).
As always, we end the post with VVP’s opening remarks to the Commission meeting:

Update: as expected, PM Medvedev will chair the Commission going forward, according to Order No. 888-r issued today. The members of the Commission will be as follows (new members in bold):

  • PM Dmitry Medvedev (Chairman of Commission)
  • First Dep. PM Igor Shuvalov (Dep. Chairman of Commission)
  • Igor Artemyev, Head of FAS (Secretary of Commission)
  • Andrey Belousov, Minister of Economic Development
  • Alexander Bortnikov, Head of FSB
  • Arkady Dvorkovich, Dep. PM
  • Sergey Donskoy, Minister of Natural Resources
  • Sergey Kiriyenko, General Director of Rosatom
  • Alexander Konovalov, Minister of Justice
  • Denis Manturov, Minister of Industry and Trade
  • Nikolai Nikiforov, Minister of Communications
  • Alexander Novak, Minister of Energy (previously on Commission as Dep. Min. of Finance)
  • Vladimir Popovkin, Head of Roskosmos
  • Dmitry Rogozin, Dep. PM
  • Vladimir Selin, Head of Federal Service for Technical and Export Control
  • Anatoly Serdyukov, Minister of Defense
  • Anton Siluanov, Minister of Finance
  • Maxim Sokolov, Minister of Transportation
  • Vladislav Surkov, Dep. PM

I don’t recommend reading too much into this, but it’s worth pointing out that the new members of the Commission are 9 out of the 19 (i.e., not a majority). Also, there are now 19 members of the Commission, versus 18 under PM Putin. This is accounted for by the addition of Maxim Sokolov, Minister of Transportation, to the list. All things considered, the new members belong to the vaguely-defined ‘pro-investment’ crowd, notably Dvorkovich and Siluanov.

Posted in foreign investment, Medvedev, Putin, russia, strategic industries | 2 Comments

Russian Business Environment Update – Part I

Posted on April 14, 2012 by

Economic Fundamentals

Economic indicators over the past year were mixed, although a consensus view appears to be forming that they were a net negative and, notably, underscored the long-run structural deficiencies in Russia’s economic development model rather than short-term risks. The cementing of this view gained traction in January, when Fitch cut Russia’s outlook from positive to stable. In April, Fitch’s analysis was apparently vindicated by the announcement that Russia was cutting its 2012 GDP growth forecast to 3.4% (compared to 4.3% in 2011).

In March, Financial Times published an in-depth analysis of Russia’s economic situation, finding that the country will likely begin running twin deficits (i.e., budget and current account deficits) within the next few years. The prospect of becoming a twin deficit country would be particularly threatening to Russia, as such deficits are typically financed by attracting capital from abroad (something at which Russia does not excel).

Also in March, the World Bank released its Russian Economic Report, which noted that, despite recovering GDP growth to near-pre-crisis levels, most of Russia’s recent economic strength was due to the recent surge in oil prices. Moreover, Russia’s post-crisis recovery has been weak compared to other economies. The 2011 OECD Economic Survey of the Russian Federation concluded that a primary source of Russia’s weakness remains the wide gap in the business climate in Russia vs. OECD countries. And rather than facing its dependence on fossil fuels and unattractive business climate, observers argue that the Russian leadership is fixated on short-term solutions, such as retooling the tax system to target gas producers rather than oil producers.

The 2012-14 Forecast for Russia by the Bank of Finland Institute for Economies in Transition similarly anticipates weak GDP growth over the next several years (regardless of unusually high oil prices). BOFIT highlighted that, despite the oil price growth from early 2009 -11, Russia still experienced net capital outflows in 2011. In addition, fixed capital investment growth remains tepid even now that capacity utilization is back to pre-crisis levels.

Investment – Russian, Foreign, or None of the Above? 

The surge in domestic capital outflows - i.e., Russians moving money out of Russia – suggests that local investors and business owners are not up to the task of making the investments needed to modernize the Russian economy. The locals’ equivocal stance on keeping their money in-country and the “twin-deficit” specter noted above mean that Russia’s only viable modernization strategy relies heavily on “benevolent” foreign investment. Indeed, while Russian businesses are free to take all “low-hanging fruits” afforded by the Russian economy and then ship profits abroad, the Russian government wants foreign investment only if it promotes its modernization agenda (see, Skolkovo). PM Putin admitted as much the other day when discussing the development of the oil industry on the arctic shelf, saying:

We hope that major global corporations will be our partners in implementing shelf projects. I’d like to say that I have already asked government members to think of ways of making invitations to these projects more effective, and making use of the opportunities of strictly Russian companies. Of course, our domestic companies will have to work on certain terms – they will have to attract the necessary funds and technology rather than simply trading their right to take part in these projects.      

What Putin is referring to are schemes in which a Russian company wins the exploration or drilling rights to a given deposit or field during a competitive bidding process, and then turns around and sells the rights at a mark-up to a foreign company that actually intends to develop the field. It was Putin’s Strategic Sectors Law that severely limited the ability of foreign companies from participating in Russia’s extractive sectors, short of playing a minority role in a joint venture with Gazprom or Rosneft. Ironically, BP – which has the most substantial presence in Russia via its TNK-BP – was unsuccessful in forming such a venture with Rosneft precisely because of its ties to Russia (i.e., TNK owners opposed it).

It’s unclear whether Putin’s change of heart will reassure foreign investors. And unfortunately, similar “business climate” risks in other Russian sectors – which are far less profitable than oil/gas – have an even greater cautionary effect on foreign companies. Statistics on FDI seem to evidence the hesitancy of foreign investors to “commit” to Russia.  Although all forms of foreign investment inflows fell dramatically in 2008-09 due to the crisis, FDI inflows peaked in 2007 (at $27 bln), with no growth between 2007-08, and then plummeted 44% between 2008-09.

The good news is that growth of FDI inflows was positive in 2011 for the first time since 2007. The bad news is that the aggregate total is still only around 2/3 of the 2007 number, and this slow recovery in FDI stands in contrast to a rapid – almost bubble-like – increase in “other foreign investment.” To the extent the “other” category consists of genuine foreign investment (vs. repatriated capital), it is typically in the form of short-term debt issued to large enterprises with the lender poised to withdraw its money at the first sign of trouble. It was the foreign “portfolio” and “other” investors who led the charge out of Russia following the war with Georgia, culminating in panic sales after the Lehman collapse. In other words, this type of foreign investment will almost certainly not stimulate the modernization of the Russian economy, and may in fact have a net negative effect. Most important, Russia’s FDI inflows as a % of GDP are much too low to sustain the sort of extreme makeover that the Kremlin anticipates (see graph below).

Russia – the Ideal Investment Destination?

One counterintuitive yet compelling conclusion is that the problems facing Russia described above would make it the most attractive investment destination among its fellow BRICs. For example, in addition to the weakening growth in China, 2010-11 was the year that everyone figured out that (i) China doesn’t want/plan to make clothes, toys, and other low-cost consumer goods forever, and (ii) Chinese enterprises have been engaging in massive theft of their Western “partners’” trade secrets and intellectual property, with the goal of replicating entire developed industries, but without the political or social shocks that would likely accompany the organic development of such industries (see this excellent BusinessWeek feature on one companies travails). As for India, it is clear that its impressive growth is largely a function of starting from such a low base, and it’s strange to put a country with 42% poverty rate and 75% literacy in the same group as Russia, China, and Brazil.

Most important, the global anticorruption fervor shined a light on corruption in Brazil, China, and India. As people from or having lived/worked in these countries can attest, the officials have always been just as corrupt. The perceptions of what corruption is, however, have grown less tolerant and more strict as incomes have risen. In this regard, the Russian population’s inherent distrust of officials and penchant for conspiracy theories means they are uniquely attuned to any hints of corrupt behavior. As a result, indicators like Transparency International’s Corruption Perceptions Index are flawed and even misleading in cases where a lower “perception” of corruption actually suggests a greater acceptance of corruption (or at least a definition less broad than TI’s). Despite the methodological problems inherent in trying to measure a real phenomenon like corruption based on the subjective perceptions and judgments of local observers, the CPI is relied on very heavily by anticorruption practitioners and businesses when evaluating which country offers the appropriate risk-reward balance to a foreign investor.

The CPI‘s weakness as an indicator of “real existing corruption” does not mean that the corruption risk in Russia is exaggerated, only that it is not helpful as a tool for comparing corruption risks in Russia vs. the other BRICs. Thus, if Russia’s corruption and weak rule of law are roughly on par with the other BRICs, you could see how Russia would be more appealing. Specifically, Russia’s low FDI/GDP ratio and ambitious modernization plans mean that the Russian government will finally have to start following through on its promises to improve the business climate.

Part II will address the unique non-economic risks that Russia must tackle and mitigate in order to attract the domestic and foreign capital investment it needs in order to transform the economy.

Posted in corruption, foreign investment, PM Putin, russia, strategic industries

Jackson-Vanik: Exit, Stage Left

Posted on March 14, 2012 by

There is a now-infamous study on the subject of “decision fatigue,” which looked at decisions by Israeli judges to grant vs. deny parole. The researchers found a wildly skewed trend in the judge’s decisions, but not by criminal history, ethnicity, gender (even rehabilitation programs had less impact). Rather, the prisoners in front of recently-fed judges were granted parole 70 percent of the time, while those in front of hungry judges were granted parole only 10 percent of the time. Plotted on a graph, the chances of parole sink drastically as the previous meal becomes a distant memory (image taken from study):

The researchers concluded, among other things, that (i) glucose depletion in the brain increases the effort required to make complex, although binary decisions such as whether to release a criminal into the public; and (ii) as the decision-making process grows more difficult, individuals will tend to prefer the “safe” decision of not making any changes (in this case, denying parole, and keeping the prisoner incarcerated).

Decision Fatigue in U.S.-Russian Relations

Although the situation is not identical, it is possible to discern a similar type of “decision fatigue” that plagues U.S.-Russian relations (Bush ‘freedom agenda’ and Obama ‘reset’ notwithstanding). The reason is that Russia (as USSR) was the U.S.’s primary antagonist for nearly 50 years, resulting in a set of reliable behavioral interactions aimed at forestalling sudden change and uncertainty (raising risk of nuclear war). Now, Russia is not our primary antagonist, but the behaviors remain. Consequently, like the Israeli judges, U.S. and Russian policymakers more often than not opt for no change in the U.S.-Russian relationship, which is convenient because we already know what roles to play after 50 years of practice. This is particularly true with Congress, where pushing a rethink of Russia policy is a low reward / high risk gambit. Still, one would hope that Congress would at least spot the low-hanging fruit – moves that benefit the U.S., respond to Russian concerns, and eliminate Cold War legacies that no longer serve any purpose.

Repealing Jackson-Vanik – A High Reward/Low Risk Improvement

Very soon, Congress will have the opportunity to take action on an issue that, for practical purposes, was irrelevant up until now. With Russia’s accession to the WTO scheduled for August, the deadline for repealing the Jackson-Vanik Amendment is closing fast.

The Jackson-Vanik Amendment was added to the U.S. Trade Act of 1974, with an aim of pressuring the USSR on human rights issues, particularly restrictions on the emigration of Jews from the Soviet Union. The effect of Jackson-Vanik is to deny permanent normal trade relations (PNTR) status to communist countries that restrict emigration. The President, however, may waive the application of Jackson-Vanik on a yearly basis, which has been done for Russia without fail since the Soviet collapse. The WTO, however, requires all member countries extend PNTR to one another, and Congress has permanently lifted the application of Jackson-Vanik from a number of former communist states (e.g., Kyrgyzstan, Georgia, Mongolia, Ukraine, Vietnam).

So, in principle, repealing Jackson-Vanik for Russia should be nothing more than a procedural issue: it has no practical application due to the annual waiver, but now must be lifted to comply with WTO regulations. Unfortunately, the ‘decision fatigue’ over Jackson-Vanik is already showing, with some members of Congress treating Jackson-Vanik like an essential element of U.S.-Russian relations. For example, Sen. Orrin Hatch said, “The president would have Congress pass PNTR and ignore Russia’s rampant corruption, theft of U.S. intellectual property, poor human rights record and adversarial foreign policies for a market that amounts to .05 percent of U.S. exports.” Hatch is a smart guy – he knows Russia gets PNTR every year already, and thus that not repealing Jackson-Vanik will not influence Russian behavior. But the autopilot is already on, and Hatch doesn’t see that the issues he cites would be helped by repealing Jackson-Vanik.

Why Repeal Jackson-Vanik Under the Hatch Criteria:

  1. Human Rights/Democracy/Corruption – although related to human rights, Jackson-Vanik dealt with a specific issue – freedom of movement for Soviet Jewry – that died with the Soviet Union. This happened because Russia swapped its economic/political model for ours, albeit with imperfections. Further integrating Russia into the international economic system will undermine corrupt oligarchs/officials who profit from Russia being kept in the dark. Perhaps most persuasive – the leading members of the non-systemic opposition (Navalny, Milov, etc.) are all for lifting Jackson-Vanik.
  2. Foreign Policy – again, if the U.S. would like more leverage over Russian behavior, it would make sense to increase trade and investment in the country. Hatch seems to imply that if we could get U.S. exports to Russia down from .05 percent to .025 percent, Russia would join NATO all of a sudden.
  3. Intellectual Property Rights – if the U.S. does not repeal the Jackson-Vanik amendment by the time Russia accedes to the WTO, we will not be able to use WTO dispute resolution mechanisms (e.g., enforcement of TRIPS Agreement).

Most important, Congress needs to remember that if Jackson-Vanik is not lifted, the U.S. will face all of the negative consequences (WTO-related sanctions, nullification of WTO agreement with Russia, higher barriers to entering Russia), and Russia will still be better off than it was before (i.e., in the WTO). In contrast, repealing a Soviet-era relic that has not been used in decades will be no more of a ‘victory’ for Russia than for the U.S. Instead of being seduced by the old rhetoric and patterns, Congress should weigh the consequences, listen to the protest leaders in Russia, and repeal Jackson-Vanik this session.

Posted in congress, corruption, foreign investment, jackson-vanik, russia, WTO | 12 Comments

What to Make of Putin’s Anti-Offshore Crusade

Posted on January 22, 2012 by

Last month, PM Putin addressed the Government Commission on Electricity Generation. At the meeting, Putin launched into a searing critique of Russian companies using offshore “front companies.” Indeed, Putin noted, “Taking the Russian economy and its strategic sectors out of shady offshore zones is our high-priority task for the upcoming period.” Putin then went on to report on the findings of an audit conducted by the Ministry of Energy, which he ordered during a meeting with Deputy PM Igor Sechin in November. Specifically, the audit found “almost 50% [of senior officials of the power and energy sector] are affiliated with 385 commercial companies, except for those currently employing them.” Putin even named certain officials identified in the Ministry of Energy report.  Vedomosti later reported that all of the energy officials identified in the audit either resigned or were fired within one week. [Update: Vedomosti has published a useful follow-up to the report here; cross-posted here]

Putin concluded by saying, “We must be absolutely clear about the ownership structure, beneficial shareholders, and beneficiaries[of these companies]. This is a key sign of a civilized business climate and mature economy.” Putin then ordered the Ministry of Energy, Ministry of Economic Development, industrial agencies, and state corporations such as Gazprom, Transneft, Russian Railways, Sovcomflot, Vnesheconombank, VTB,  Rosatom, and Sberbank to “[take] and report on [similar] measures taken within the next two months.”

The Missing Order

On December 28, Putin issued an order (поручение) formalizing the request made during the meeting. The order – No. ВП-П13-9308 от 28 Декабря 2011 г. – is mysteriously difficult to locate online, prompting panicked, lengthy forum discussions among Russian lawyers looking for the elusive document. Fortunately, TRM was able to locate a copy, and made it publicly available here.

The order is five pages long, with three attachments, and requires certain state-owned companies to submit two types of information:

  1. Financial Info on Managers – information on the income, property, and property debts of all members of the management team and Board of Directors, in accordance with Attachment 1
  2. Info on Business Partners – all information – including identities of ultimate beneficiaries – on contracting parties (контрагенты), in accordance with Attachment 3

The order is addressed to the following companies:

  1. Rosatom
  2. INTER RAO UES
  3. RusHydro
  4. East Energy System
  5. Far East Energy Management Company
  6. System Operator UES
  7. Federal Grid Company UES
  8. MRSK Holding
  9. Gazprom
  10. Transneft
  11. Irkutskenergo
  12. Russian Railways
  13. Sovkomflot
  14. NGO Market Council
  15. Aeroflot
  16. Rostelecom
  17. Avtodor
  18. Vnesheconombank
  19. VTB (exempt from item 2)
  20. Sberbank (exempt from item 2)
  21. Rosselkhozbank (exempt from item 2)

As Vedomosti reported, Deputy PM Sechin personally prepared the list and notably excluded Rosneft, where he until recently served as Chairman of the Board. Rosneft replied to Vedomosti‘s article, saying it was untrue, and added that it is complying with the instructions in the order. Also left off were Sergey Chemezov’s Rostekhnologii and United Shipbuilding Corporation, as well as Rosnano.

State-Owned Companies – “Let’s Not and Say We Did”

The immediate response to Putin’s order by officials at the affected companies included various stages of shock, denial, and outrage. One legitimate complaint is that it is factually impossible to comply with the order, as currently formulated, because of the number of partners with whom these companies do business (even if the reportable contracts are limited to a certain $$ threshold). And if the contracting parties refuse to provide the information, the Russian companies would have to break their contracts with them. There are plenty of private American companies that would simply refuse to provide information on ultimate ownership, if only out of principle. The government gave some ground this month when it excluded clients from the reporting requirement, and limited ‘ultimate ownership’ information to business partner shareholders owning more than 5 percent of the company’s stock. President Medvedev also proposed delaying the deadlines for providing the information until after the March presidential elections.

Putin’s Born-Again Support for Corporate Governance

Putin’s new campaign against the evils of offshore entities is a bit puzzling, to say the least, because they have always been a problem in post-Soviet Russia and Putin has never expressed much concern about them. One tempting conclusion is that this is a reaction to the public outrage over corruption, but Putin’s instructions to Sechin came before the December Duma elections and subsequent protests.

Interestingly, Vedomosti reported that virtually all candidates for posts on the affected companies’ Boards of Directors will be drawn from Medvedev’s personnel reserve. Indeed, this furthers a trend over the past few years of Medvedev acolytes filling state-owned company positions. Could the new disclosure requirements be meant as a “gift” to Medvedev upstarts possibly looking to cash in on their new posts? This also seems doubtful, as Medvedev and his people have come out strongly in favor of the new rules, even suggesting that they could soon be passed into law.

The most interesting outcome will be the volume and level of detail of the material disclosed. If it is high-volume/detail, anticorruption campaigners will undoubtedly mine the disclosures for evidence of wrongdoing. The campaigners themselves have cautiously praised the new campaign, while noting that it is arising out of the current political climate and does not address Russia’s systemic corruption in a systematic way. Moreover, the disclosure requirement has all the hallmarks of a typical Russian response to complex problems – more paperwork. Note that these disclosures will shed no light on situations where business partners are pressured by officials to sign side contracts with service providers linked to said officials (e.g., as allegedly happened in the Valery Morozov case).

Finally, even if this is a good idea, why limit its application to state-owned companies, which should presumably be given more autonomy than government ministries/agencies? For example, when the Ministry of Health procures medical equipment for government hospitals, it is not required to identify and disclose the ‘ultimate beneficiaries’ of the suppliers. At least Gazprom in theory has an incentive to not overpay for goods and services because it is expected to be profitable, while government ministries can waste their entire budget without anyone noticing.

Posted in Business, Business and Economy, corruption, Dmitry Medvedev, Gazprom, goskorporatsii, legal update, offshore, PM Putin, President Medvedev, Rostekhnologii, russia, state corporations, utilities companies, Vedomosti, Vladimir Putin, war on corruption | 2 Comments

Tipping Points – Handicapping the Chances of an ‘Arab Spring’ in Russia

Posted on January 6, 2012 by

Who are the Protesters?

VTSIOM recently published a survey of the protesters, conducted at the rally at Sakharov Prospekt on Dec. 24. The survey results confirmed other reports that the protesters are mainly drawn from educated, urbanized elites, prompting the name, “revolution of the satisfied.” The survey found that the typical protest-goer is a Russian man under 45 with a high level of education, and middle class income, who heard about the protest on the internet. Interestingly, although 27 percent of those surveyed reporting voting for Yabloko, 33 percent voted for ‘systemic opposition’ parties LDPR or the Communist Party.  A strong plurality of protesters went to Sakharov Prospekt mainly because of the Duma election results. And even though being against Putin was not one of the leading reasons for people attending, the slogan “down with Putin” (долой Путина) was the second most popular, after “For free/fair elections” (За честные выборы).

Tipping Point? Even Feodor I Ruled Russia for 14 Years

As I argued in this previous post, increasing disappointment among the Russian populace is an inherent feature of the system Putin created. That said, these initial protests share more in common with the 2009-10 Iran protests than they do with the 2011 Egyptian revolution, both in terms of the makeup of the protesters and the nature of the complaints. Unlike Egypt, Russia’s protesters are not drawn from all ranks of society and all regions of the country. While intelligentsia are great for speeches and pamphlets, you need the sans-culottes to actually get the work done. Also unlike Egypt, Russia does not have a deeply-rooted opposition ready to form a cohesive party that could arguably represent a plurality of the country (see Muslim Brotherhood). Even the Iranian protesters had Mousavi as the victim of Ahmedinejad/clerical perfidy. Russians only have Just Russia, the Liberal-Democrats, and the Communists (nobody is arguing Yabloko would get into the Duma in a free election). Thus, Russian protesters are mad generally at dirty elections, but have no organizational lever for channeling that energy or claiming victimhood. For lack of a better term, Russian protesters lack agency. This is why, much to the State Department’s chagrin, we cannot expect a “Color Revolution” in Russia – seriously, who would take over? And this is before considering the fact that a slim majority of Russians do not support the protesters (although notably an emerging majority of Russians do not approve of Putin).

Most important (in my humble opinion) is that the Russian authorities are displaying the wisdom of having been in power for quite a long time, but not the arrogance of being in power for way too long. Remember that the turning point in all of the Arab Spring countries was the overreaction of the authorities against the protesters – and the utter befuddlement amongst Arab dictators that ordinary people do not like them. While Mubarak’s “tipping point” may have been unleashing goons mounted on camels into central Cairo, the Russian authorities have been noticeably restrained in their treatment of protesters since the first protest immediately after the election results were announced. Even now, most of the ‘crackdown’ forecasts are intramural affairs, with talk of a possible consolidation of core Putinists and expelling of all others. Without a violent overreaction by Russian authorities, the opposition is not provided a ‘flash in the pan’ moment that totally delegitimizes the regime’s right to continued existence, which can then be posted and shared ad infinitum on the interwebs.

“Russia is the only country where no matter what you say about it, it is probably true”

That all said, there is a sense that Russia has changed, and is changing, for good right before our very eyes. Of course, a lot of this is blown out of proportion by journalists living in the moment – Jack Reed types who can be forgiven. But there is some truth to it. Another relevant point is that the last two previous Russian upheavals – 1917 and 1989 – were largely driven by upper-class intellectuals, much like the current protests. Still, the Bolsheviks were to revolution what Henry Ford was to mass production. And Alexei Navalny seems like a highly intelligent guy, but he’s no Vladimir Lenin. That leaves 1989, which these protests are beginning to look more and more like, and will fan the flames of opposition hopes. In 1989, however, the authorities basically stood down – largely because all the constituent republics declared independence anyway. So we do not see that ‘death of an empire’ dynamic. The question then is whether Putin is the type to just step down from power when faced with nothing more than a large number of angry professionals calling him names? Something tells me he’s not the type.

That leaves one possible scenario, assuming that a bunch of accountants, engineers, and lawyers will not resort to unprovoked acts of violence: a run-off election where Putin loses. For the opposition, obviously the ideal approach would be to force the authorities to allow  their candidates to run, particularly those who missed the filing deadline (i.e., Navalny). But this does not seem likely to happen – the Russian authorities care about the law too much – and the opposition would fracture between ten candidates anyway. Therefore, it seems like the only likely run-off election will be between Putin and Zyuganov. It will be interesting to see: (i) whether Putin’s people will spin a yarn about nationalization the way Yeltsin’s people did in ’96 and (ii) whether these middle/upper class Russians could hold their nose and vote for someone so anachronistic and uncool as Zyuganov and the KPRF. I actually think they could, given how poorly they view Putin and his coterie at the moment. So will Communism come back to Russia via a democratic coalition of nostalgic pensioners and highly-educated professionals? As crazy as it sounds, it seems like a possible outcome. Stay tuned.

Posted in duma, Government of Russia, protests, russia | 2 Comments

The Ghost of Medvedev’s Presidency Lives on … in Putin

Posted on November 12, 2011 by

Yesterday, PM Putin did his annual sit-down with the Valdai discussion club. Since its inception, the Valdai meeting has come to be seen as a forum where Putin relaxes the message discipline and says what he thinks without much of a filter. Whether this is true or just another stage-managed PR gimmick, one can only guess (likely, Putin himself hardly knows anymore). In its previous sessions, Putin’s theme has been resolute – criticisms are unfounded and perhaps motivated by a desire to weaken Russia, and the Putin era has been a unequivocal success. Putin’s argument has consistently relied on two main premises: (1) that the Russian people overwhelmingly and unconditionally support Putin and the political system he created; and (2) that there was no end to economic growth in sight, with general economic well-being improving at a rapid rate. Ironically, to the extent that premise 2 has been correct, it has made the sustainability of premise 1 increasingly less viable.

Russian Magic Show

Russia’s economic “miracle” over the Putin years was largely based on the incredible contraction of GDP following the collapse of the Soviet Union and the subsequent devaluing of the ruble and deleveraging of state finances. Thus, Russia not only enjoyed a devaluation-fueled export boom, but it had existing un- or underutilized capacity available to fuel that boom. The spike in oil prices was icing on the cake, which allowed the Russian government to accumulate funds for social projects and to avert crises. Due to the low starting point and additional stimuli, the lives of ordinary Russians improved dramatically during this time period. Rather than having to encourage the growth of new industries, the Russian government could create jobs “out of thin air” with spare capacity. And instead of structuring state expenditures and obligations around tax revenues, Russia financed social stability with its oil revenues windfall. The rapid rise in disposable income jump-started the growth of the retail and real estate industries. Consequently, Russia’s economic growth from 2000-08 was concentrated in legacy industries from the Soviet Union (extractive industries, some manufacturing) and new “fluff” industries dependent on consumer spending.

Recent Economic Forecasts Look Grim

Recent economic forecasts do not bode well for the Russian economy either. For example, the Ministry of Economy’s 2010-14 forecast assumes a GDP growth rate largely driven by investment in fixed capital assets. But others have designated this “wishful thinking” because investment growth has been extremely volatile. So far investment has only grown 4.1 percent this year, and Russia will be lucky if quarter IV growth pushes the annual number to the predicted 6 percent. Moreover, MinEcon is assuming investment growth of 7.8 percent in 2012, 7.1 in 2013, and 7.2 in 2014, which all seem unlikely in light of the current dynamics. Most important, even if MinEcon’s investment growth projections are correct, these numbers will be “insufficient for large-scale modernization of the economy,” and thus the estimates are predicated on the continuing import of capital assets.

With respect to foreign investment, the picture is also bleak. Although foreign investment increased so far in 2011, the proportion of foreign direct investment (FDI) fell dramatically, by over 50 percent. The biggest growth was in “other foreign investment,” which mostly included loans and other financial credits to Russian firms, the majority of which had a term of 180 days or less. Such short-term financial credits are the type of foreign investment least likely to spur modernization. In fact, many of the financial credits are probably inter-company loans within a group of companies where cash is held offshore.

Unhappy Dialectic of Putin Power

The logic is simple: as Russians’ economic well-being rose at a rapid rate, their support of Putin and the Power Vertical softened because it was based on expectations that would be inherently unsustainable in even the healthiest, most innovative economy (i.e., unchecked, rapid economic growth over an indefinite period of 10+ years). Russians have not only grown to expect that their incomes will rise every year, they have grown accustomed to a high rate of income growth as well. So, the campaign slogan is not – “are you better off now than you were four years ago,” but rather “are you 3x better off now than you were four years ago.” This is in addition to the political science theory that a growing middle class will demand more representative forms of government, which is not clearly applicable to present day Russia.

In the case of pensioners, Putin backed down from a fight over pension reform in 2005, instead opting to retain mandatory military service for young students. This approach has set the tone for all benefits debates, again with any reduction posing a serious risk to the Power Vertical. Similarly, Putin grew the size of the bureaucracy to pursue his centralization project in the regions, which also served as a de facto jobs program. If modernization requires that the bureaucracy be slimmed down, it undermines the stability of the Power Vertical.

In sum, Putinism was so successful, that it ensured its own demise. Most countries have adopted “safety valves” for situations like this – some use elections, others purges, and still others coups. But there is a sense that this time is different, as evidenced by unrest in both developing and developed countries. And Russia is in the unenviable position of having no safety valve (in fact, several were dismantled during Putin’s post-Beslan reforms).

Putin on Ice

Putin’s comments at Valdai seem to reflect Putin’s lack of understanding of the predicament he is in, as he is poised to return to the presidency for another 12 years. Putin did the familiar victory lap about this political era, albeit with less vigor than in previous years. But he did admit that the “world is changing” and that “we are thinking about it too,” referring to Medvedev’s modernization program. According to Putin, Medvedev took the modernization issue “out of the paper and office sphere” and into the “public consciousness.” Putin also acknowledged that Russia’s political system is “not perfect” but hastened to note that he “does not know of any perfect systems.”

According to journalists at the meeting, Putin proposed introducing something called “direct democracy” to help rebuild trust and connections between the authorities and Russian populace. An unfortunate turn of phrase perhaps: “direct democracy” was the name of the political model elaborated in the late-Muammar Gaddafi’s Green Book.

Medvedev’s Modernization Ghost

In some ways, Putin’s comments on Medvedev and the public consciousness are prescient. Although Medvedev did very little of substance during his term, he did not fail to use the “bully pulpit” to harp on the ills of corruption and the need for a modernized, innovative economy. It does not take much thought to see that the targets of Medvedev’s critique are byproducts of or encouraged by the Putin political system. Thus, Medvedev legitimized attacks on the Power Vertical by adopting a chief national priority – modernization – that is inconsistent with the Putin model. By assuming the mantle of modernization at Valdai, Putin indicated that the ghost of Medvedev’s presidency will continue to haunt him.

Video of Valdai Meeting

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Strategic Sectors Law Update – Draft Amendments and Commission on Foreign Investment Meeting

Posted on November 10, 2011 by

Last week, PM Putin chaired the latest meeting of the Commission on Foreign Investment and the following day the draft amendments to the Strategic Sectors Law (SSL) entered their third reading, after languishing in 2nd reading purgatory since the summer.

Final Draft Amendments 

The second reading of the SSL amendments were finally passed by the Duma on October 19, and the third reading was adopted on October 25. The Federation Council rubber stamped the law on November 8, and the only remaining step is Pres. Medvedev’s signature. This may be the last piece of significant legislation Medvedev signs as president due to the Duma elections in December and presidential elections in March. Ironically, the original SSL legislation was the last significant law signed by then-Pres. Putin on May 5, 2008, two days before Pres. Medvedev assumed office.

Although all of the changes were within the second reading, for ease of reference, I will refer to changes between the second and third reading. I have highlighted the changes in this document, which shows deletions (strikethrough red), additions (blue), and relocations (green). A “clean” version of the third reading is here.  Aside from some stylistic/technical tinkering, the only significant changes were provisions that were added or enhanced between the second and third readings. These include:

  • Liberalized Threshold for Extractive Industries - previously, companies investing in oil, gas, or mining companies had to apply to the Commission if a transaction involved the acquisition of 10 percent or more of a Russian company’s shares. The amendments raise this requirement to 25 percent.  Note that this follows up on last months lowering of the export duty on crude oil. Viewed in conjunction, the two policy changes suggest the Russian government is concerned about the health of its oil export industry – the cash cow that has largely fueled its ‘economic miracle’ since the early 2000s. It also indicates a realization that foreign investment is essential to maintaining Russia’s place among the leading oil producers/exporters. In some cases, the 10% vs. 25% difference may be important, but I doubt it is very many. If the Russian government was really serious about encouraging foreign investment in this sector, it would have hiked the approval requirement to the same level as every other sector covered by the SSL law – i.e., a controlling stake of 50+ percent. Furthermore, it is interesting that investors have yet to hear what relationship the extractive industries have to national security, such that they require higher scrutiny than, for example, weapons manufacturers.
  • Exemptions for Radiology Activities - the amendments also exempt activities involving the use of radioactive materials from coverage by the SSL law. This is likely aimed at promoting FDI in the country’s nascent medical device industry, primarily in the area of diagnostic imaging (e.g., the radiocontrast elements used with CT scanners would qualify as ‘radioactive’ material). Russia has thus far failed to encourage FDI in anything but ‘screwdriver’ assembly facilities where all of the high-skill, high-tech manufacturing is done offshore, and the final components are assembled by semi-skilled Russian workers. Clearly, the Russian government would like to see a more substantial FDI than this.
  • Notable Non-Changes - though the more liberal extractive industry threshold and radiology exemption are tangible victories for foreign investors, the SSL law amendments lack provisions addressing many foreign investors’ most significant concerns. In particular, there was no reduction in the number (42) of so-called ‘strategic’ sectors. Yes, fisheries are still strategic. Yes, television – most of it state-owned and unprofitable – is still strategic. The latter category is particularly tragic. U.S. networks are churning out more quality television than most people have time to watch, while Russian shows remain absolutely dreadful. Another non-change worth noting is that the concept of ‘control’ was not given a more precise definition. This is significant because a transaction requires Commission approval based on certain percentage ownership thresholds, OR if the transaction would result in a foreign investor gaining control over an enterprise. Although the law provides a list of examples, it is not exclusive.
So there you have it – the first amendments to the SSL law, after 3+ years since the law’s passage, and 22 months since the amendments were announced.
Commission Meeting
On October 24, PM Putin presided over a meeting of the Commission on Foreign Investment.  In his preliminary remarks, one interesting statement Putin made related to Russia’s improvement in the World Bank’s Doing Business rankings, which were released recently. The benefit of the Doing Business rankings is that they are based on hard facts – e.g., number of procedures to register property, days to clear customs – and not ‘perceptions’ like many other metrics. So it is intriguing to know that these rankings are on the Russian government’s radar, even if they have been cited opportunistically in this particular case.
So far, the following deals addressed during the Commission meeting have been reported publicly in the Russian press:
  • Pirelli Acquisition of Kirov Tire Factory from SIBUR Group - Pirelli purchased the Kirov Tire Factory from SIBUR, based on an agreement between SIBUR, Pirelli, and Rostekhnologii. The total price paid for the tire manufacturing assets was EUR 222 mln.
  • Polyus Zoloto FTSE Listing Delayed - perhaps the most newsworthy event from the Commission meeting did not involve an approval – Mikhail Prokhorov’s mining company Polyus Zoloto had applied to list on the FTSE. The Commission delayed an official decision on this request. According to Dmitry Peskov, the decision was not politically motivated but instead the “matter required additional work because certain documents were lacking” (“недоставало нескольких документов“). Let’s be clear – in Russia, documents can always be missing – you cannot clear a shipment through customs without a stack of paper (bumagi) as thick as War and Peace. Indeed, discretion comes into play in these situations and a decision by the Prime Minister of Russia is never prevented because a few documents were missing.
  • Norilsk-Nickel? - news outlets reported that the Commission would consider Norilsk-Nickel’s stock buy-back plan, although there have not been any post-meeting reports on whether this was actually considered.
  • Électricité de France S.A - during the introduction to the Commission meeting, Putin “singled out” a “very interesting and promising project” in the energy generation sector. Specifically, he noted, Électricité de France S.A (“EDF”)”plans to establish a special company in Russia that will introduce innovation and state-of-the-art technology in management and organizing the work of power-generating facilities.” The only problem is that there is literally no information on this supposed company on the web. While EDF has been active in the Russian power generation sector in the past – e.g., in a JV with Inter RAO – there simply is no reference to this new company in EDF’s press releases or on the web generally.
Really? Is that it? This is the smallest number of approved deals – specifically, one – that has been publicly reported from the Commission meetings since the passage of the SSL law. What is the explanation? One plausible candidate is that the upcoming Duma and Presidential elections have foreign investors spooked and putting FDI in Russia on hold until the picture is more clear in early 2012. Of course, most of the foreign investors that have submitted applications to the Commission in the past are from the Eurozone, and the ongoing turmoil may be contributing to a dearth of new projects. Finally, the soon-to-be-law amendments, which will relieve Russian firms from applying for approvals even if transactions are achieved via offshore entities, may be putting many of the domestic/”foreign” transactions on hold until the amendments pass. Perhaps reflecting this lack of “action,” for the first time ever the Prime Minister’s website did not publish a video of the Commission meeting. Thus, we will have to commemorate this meeting with a picture of PM Putin’s [possibly final] Commission meeting studying documents.

Posted in Foreign direct investment, foreign investment, legal update, legislation, PM Putin, President Medvedev, prokhorov, Rostekhnologii, russia, strategic industries