The Putin Guessing Game

Posted on August 23, 2011 by

It is getting to be that time of year – it has almost been exactly four years since the last time Putin, then as President, had Russia and many foreign observers on the edge of their seats waiting for any indication of what his next step was. It was this context that made the reasonable and uninteresting decision to appoint a ‘lame duck’ government headed by Viktor Zubkov such an act of comedic cruelty.  And it only intensified the speculation until Putin announced his support of Medvedev three months later in December (and it appears  that they will follow the same schedule this year).

So, it is not surprising to see analyses from Russian observers that essentially boil down to Putin being essential for the day to day functioning of the state, due to some mystical ubermensch status. Russia has a long – multi-century – history of an entrenched and enlarging bureaucracy, spread out across 11 time zones. And during the meat of Putin’s presidency, the bureaucracy’s growth rose sharply on the back of high oil prices. As for the higher-level officials that make up the siloviki, Putin let them fill the void left by exiled, jailed, and humbled 90s oligarchs through increasing state ownership in major companies and sectors.

Putin’s Leadership Style and Delayed Retirement – Not Evil, Just Lazy

In contrast to his public persona, Putin’s approach to governing is entirely premised on avoiding fights he may not win by showering people with cash – whether its siloviki, low-level chinovniki, or pensioners. Fellow Russia blog A Good Treaty captured this disconnect amongst the Putin crew earlier this year when they failed to cut the social insurance tax by as much as Medvedev had asked. They didn’t even give a reason really, variously citing it as “fiscally irresponsible” and “technologically infeasible.” Meanwhile, the tax debt burden of small and medium enterprises (SMEs) is one reason why they comprise an abnormally low proportion of employers in the country (SMEs tend to drive employment because they  benefit more from being able to hire additional employees than do large firms).

This is why I have never understood the Putin as power-hungry authoritarian interpretation – it seems more likely that he is just lazy. As for his drawn out departure, sticking around as PM is not entirely inconsistent – it has all of the perks and none of the political and constitutional responsibilities as president (see, e.g., Kursk Sinking, Beslan). Also, the recent events in Ukraine – where former PM Tymoshenko was arrested – may give pause to Putin. Indeed, credible sources have reported that Putin’s handlers have approached European lawyers about the feasibility and logistics of obtaining international legal immunity (i.e., criminal and civil). Of course, there’s no such thing as international legal immunity, but it seems plausible that Putin is expecting from Medvedev the same immunity deal he gave Yeltsin, and he was exploring even greater protections that would prevent anyone from looking at the value and source of his assets if he were targeted with a civil action.

Foreign Investors Catch On

Over the past 1-2 years, foreign investors that focus on Russia first began to realize that the prospect of a second Medvedev term was very real.  Also, even though Medvedev has presided over less economically successful times than Putin, he is considered the smarter half of the tandem when it comes to economic growth and innovation.  With Putin, investors never knew what to expect – one year he’s enacting a flat tax and modernizing the judiciary, the next he is reversing on Production Sharing Agreements and imposing requirements for government approval on investments in “strategic sectors” that are in dire need of private investment (infrastructure comes to mind).

So no doubt investors have been intrigued by the idea of Medvedev staying on, even though almost every major Western company looking to increase its investment in Russia has done so with a “Putin” strategy (e.g., fostering connections with folks like Sechin, transactional approach of up-front “this for that” before committing to new investment).  Hence the development of joint ventures between Western corporations and Russian state  corporations, as it innoculates investors from predatory bureaucrats and probably is not much worse then partnering with a Russian firm (just ask BP).

The problem is that as an economic growth strategy, this approach to investment is limited to low-hanging fruit in extractive or heavy machinery industries, and has not led to significant technology transfers or construction of innovative manufacturing facilities.  For example, Siemens sells its ultrafast Velaro bullet trains to the Russian government (via Russian Railways), but does the manufacturing itself.  Even for the less sophisticated Velaro commuter trains, Siemens chooses to complete 80 percent of the manufacturing in Germany, and then shipping to Russian for “partly localized” production in Russia.  This is what’s called a “screwdriver assembly” factory because it does not involve any manufacturing process beyond elementary assembly.

Medvedev’s Strategy – Positive Early Results, But Under Threat[?]

But then Medvedev comes along and asks investors to take a chance on Russia, and even Siemens took note.  The Russian government still has to essentially guarantee an income stream for the factory, but at least they are getting a full-service facility out of the deal.  If you want to get a sense of the positive response Medvedev’s approach is generating, just consider increasingly long list of major Western companies pledging participation in the Skolkovo innovation park, some of which were not even thinking about a “Medvedev” strategy just last year.

But as a recent Financial Times piece reported, the enthusiasm is still restrained based on the uncertainty surrounding the election.  To put it bluntly, now that they have gotten a taste of the current president’s approach and plans, foreign investors are ready to commit to Medvedev’s Russia, not Putin’s.  This notion is at odds with the commonly repeated consensus that investors do not care about the outcome of the election – they just want “stability” (oddly, the same is said of ordinary Russians). This analysis unfortunately lacks the context of the last 13-15 years.

Russia Today – High Potential, But Fragile

Russia today is a whole different reality than the eras of food shortages and currency implosions. The country is ripe for change, but not in the Arab Spring format secretly hoped for by its Western detractors. Nor can Russia hope to mimic what Deng Xiaoping did in China or Lee Hsien Loong in Singapore (favorite scenarios of siloviki).  Russians are not suffering to get a loaf of bread, but they also are not going to respond to government-led modernization drives.  Russians don’t riot – they neglect, with stagnation more common than implosion. But the cynicism and feigned apathy conceal an intelligence and  youthful ambition that haven’t had the time or environment to develop in the post-Soviet era. So while a Putin return to the presidency would not trigger the apocalypse in Russia, it arguably would signal a turning-point away from a path where Russia realizes its full potential development. Not disastrous or criminal or evil, just disappointing.

Posted in Medvedev, Putin, Putin's Plan, russia | 1 Comment

Strategic Sectors Law Update – Second Meeting of 2011

Posted on July 21, 2011 by

On July 20, 2011, the Commission on Foreign Investments met for the second time this year and reviewed 13 applications from foreign investors wishing to pursue business projects in Russia.

Deals Reviewed

Total S.A.–20.5%–>OAO “Yamal LNG”

This is part of a larger deal where Total is paying $4 bln for 12% of Novatek – Russia’s largest natural gas producer – and 20% of Yamal.  As part of the deal, Total received a seat on Novatek’s board and the option to increase it’s stake to 19.4% in three years.  In 2009, Novatek acquired a 51% stake in Yamal for $650 mln from Gunvor, the oil trading company owned by Putin-buddy Gennady Timchenko (coincidentally, Timchenko owned 18.2% of Novatek at the time).

Last year, Timchenko became Novatek’s largest shareholder after Gazprom sold 9.4% of its 19.4% stake (detailed background here).  In December 2010, Gazprom’s shares were acquired by Gazprombank for an undisclosed amount via a special purpose vehicle (SPV) named Dhignfinolhu Holding Ltd.  Gazprom’s proceeds from the sale were later revealed in January 2011: $1.96 bln, well below the $2.84 bln market value of the 9.4% stake at the time of the sale.  In April 2011, the SPV – Dhignfinolhu Holding Ltd. – “informed” Novatek that its wholly-owned subsidiary, ZGG Cayman Holdings Ltd., had  “decreased its stake in the ordinary shares of NOVATEK from 9.4031% to zero.”  At the same time, SWGI Growth Fund (Cyprus) Ltd. “informed” Novatek that it had “increased its share in NOVATEK’s equity from 11.6473% to 15.4004%.”  SWGI Growth Fund, according to SWGI’s Annual Report, is “owned by senior [Novatek] management,” including general director Leonid Mikhelson.

There were similarly suspicious activities surrounding the Yamal sales.  In 2009, Novatek purchased 51% of Yamal LNG for $650 mln from Gunvor, Timchenko’s trading company (i.e., from one of  its largest shareholders).  Novatek also obtained an option to purchase the remaining 23.9% share for $450 mln belonging to Volga Resources, another Timchenko-affiliated company.  In March 2011, Novatek acquired 25.1% of Yamal for $526 mln, bringing its total ownership from 51% to 76.1%.  The source of this 25.1% stake is a bit mysterious – at the end of Q1 2010, Cyprus-registered Siritia Ventures Ltd. owned the 25.1%.  Siritia is owned by Gazprombank.  At the end of Q2 2010, the 25.1% had shifted to Varix Enterprises Ltd., controlled by gas monopoly Gazprom, which owns 41.73% of Gazprombank.  The actual seller has thus far not been disclosed.

ZAO “Mirakl” –100%–> ZAO “SIBUR Holding”

It is not every day that 100% of Russia’s largest petrochemical company is sold to some unknown company, but the Commission approved the sale without blinking.  So who is the owner of Mirakl?  It is none other than Leonid Mikhelson, the general director and major shareholder of Novatek (yes, the same one discussed above).  And who sold Mirakl all the shares to Sibur?  Gazprombank (yes, as above).  And as you may have guessed, the price was a little strange: valuations at time of sale (excluding debt) ranged from $7.4 to $8.2 billion, while Mirakl reportedly purchased the 100% stake for a cool $5.34 bln (150 bln RUR).

Renova –73.6%–>OAO “Nizhny Novgorod International Airport”

The Commission approved the application of OAO “Koltsovo Airport” to acquire a 76.3% stake in the Nizhny Novgorod Int’l Airport.  Koltsovo Airport is majority-owned by OAO “Koltsovo-Invest”, which is controlled by Viktor Vekselberg’s Renova.  The Federal Agency for State Property (Rosimuschestvo) owns a blocking stake in Koltsovo Airport.

Passed-Over Deals

The Commission passed over the application of:

- T.S. Trans Siberia Co Limited for the acquisition of Tolmachevo Airport
- Universal Cargo Logistics Holding for the acquisition of OAO “Vaninsky Morskoy Torgoviy Port.”

Amendments Update

In a press conference about the Commission meeting, an FAS representative stated that the amendments to the Strategic Sectors Law will be passed by the Duma in September.  The amendments are currently in the middle of their second reading, and sources indicate that they have stalled over disagreements between FAS and and the Ministry of Industry and Trade (Minprom) over how to handle changes to the “group of persons” concept (see this post).

As always, here is VVP opening the meeting:

Posted in Business and Economy, economics, Foreign direct investment, foreign investment, Gazprom, Gazprombank, Law, legal update, legislation, Novatek, offshore, oligarchs, russia, Russian economy, strategic industries, Timchenko

IKEA in Russia – Light at the End of the Tunnel?

Posted on June 21, 2011 by

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).

Posted in bribery, bribes, bureaucracy, Business, compliance, corruption, Foreign direct investment, foreign investment, IKEA, Nabiullina, oecd, rule of law | 4 Comments

Is Medvedev’s War on Corruption Working? The Case of Overpriced Medical Equipment

Posted on June 13, 2011 by

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:

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 - Kommersant reported 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.      

Posted in corruption, President Medvedev, russia, war on corruption | 3 Comments

Strategic Sectors Law Amendments Submitted for 2nd Reading

Posted on June 9, 2011 by

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 Vedomosti wrote 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).

Posted in foreign investment, Medvedev, President Medvedev, russia, strategic industries

[Mock] Medvedev Campaign Ad

Posted on May 13, 2011 by

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.

Posted in russia

What Medvedev Really Said About His Post-Presidency Plans

Posted on April 26, 2011 by

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.

Below is video of Medvedev’s interview on Dozhd:

Posted in russia | Tagged , , , , ,