Business Watch: October 29, 2002

Second-ranking oil company Yukos's second-quarter results, announced in a 24 October press release, showed an improvement over the first quarter but a decrease in comparison with last year. The balance sheet, drawn up in accordance with U.S. GAAP (Generally Accepted Accounting Principles) standards, showed revenues of $2.56 billion, a 27.5 percent increase over first-quarter results. Net profit was $758 million, 64.1 percent more than in the first quarter but a 14.3 percent decline against 2001 second-quarter revenues. Oil production for the period was 16.8 million tons, an average of 1.349 million barrels per day (bpd), and a 17.6 percent increase over last year's results. The company reduced second-quarter expenditures to $1.87 per barrel, a 17.6 percent reduction from last year's figures. Yukos Chairman Mikhail Khodorkovskii lauded the results, ascribing them in the press release to "the Company's unprecedented successes in reducing production costs and increasing output." "Vedomosti" commented on 25 October that while the report showed declining profits over the past year, Yukos still managed to post the best results in the industry. Overall, analysts found little cause for surprise in the figures. "Vedomosti" noted, however, that Yukos's acquisition of Lithuanian Makeikiu Nafta could have a negative effect on third-quarter profits. DK

The conflict over the Moscow Oil Refinery (MNPZ) led to a three-day hiatus in supply shipments from 22-25 October, "The Moscow Times" reported on 26 October. The refinery is the focal point of a tangled struggle for control that pits the Moscow city government and Moscow Oil Company (MNK) against Tatneft and influential oilman and politician Roman Abramovich's Sibneft. The dispute has produced two rival boards of directors and management structures, as well as myriad contradictory court decisions. The Moscow government retains physical control of the facility through MNK head Shalva Chigirinskii. Both Sibneft and MNK supply the refinery with oil. Supplies dried up when a court decision prohibited MNK from further deliveries; Sibneft has already pumped its October quota. Though supplies resumed on 26 October, "Vedomosti" reported on 28 October that the source of the current supplies "is still unclear." With the conflict likely to continue, speculation has focused on the effect of future supply stoppages on the capital's gasoline market. "Finansovye Izvestiya" reported on 23 October that MNPZ controls 55 percent of the Moscow gasoline market. If it stops production, other refineries will not be able to step up production fast enough to fill the gap and "a shortage will have an immediate effect on prices." Moscow Fuel Union board member Yevgenii Arkusha downplayed the potential danger of a price hike in comments to "Vedomosti" on 23 October, saying MNPZ supplies only 10 percent of the city's gas pumps, with supplies for other filling-station networks coming from other refineries. DK

Japanese Nippon Oil will receive two shipments of Russian Urals brand crude oil totaling 2 million barrels in December, "Nefte Compass" reported on 23 October. The two 135,000-ton cargoes, to be loaded by TotalFinaElf in Novorossiisk on 26-29 October, originate with state-owned Russian oil company Rosneft and State Oil Company of Azerbaijan (Socar). Though the freight costs of such long-distance shipments tend to raise eyebrows in the industry, "both buyer and seller claim that the deal was profitable," "Nefte Compass" reported. Japan, which imports 80 percent of its oil from the Middle East, is looking for alternate suppliers. At the same time, Russian oil companies are seeking new buyers. Yukos and Tyumen Oil Company (TNK) recently made test shipments of crude to the United States. DK

Russian mobile-phone retailer Evroset plans to outsource the production of its own line of mobile telephones, "Vedomosti" reported on 24 October. Evroset has the largest mobile-phone retail network in Russia, controlling 15 percent of the Moscow market. Evroset head Yevgenii Chichvarkin told "Vedomosti" that talks are under way with a large Taiwanese firm to produce a line of Evroset mobile phones that will feature a unique design. According to Chichvarkin, Evroset's phones will be priced at about $200. The company hopes to sell 2,000-3,000 units in January 2003. DK

Russia's two largest mobile-phone operators have announced that their clients will be able to manage their bank accounts by phone, gazeta.ru reported on 21 October. Subscribers to VimpelCom's Bee Line GSM network who have Sberbank debit cards will be able to use SMS messaging to check their account balances and recent transactions. VimpelCom rival Mobile TeleSystems (MTS) unveiled a nearly identical service at virtually the same time, also in cooperation with Sberbank. Both services are called "Mobile bank." Future plans call for giving clients the ability to initiate transactions at the touch of a button. Gazeta.ru called the service more of an attempt to spruce up Sberbank's "moss-grown" image than a genuine advance in customer service. "Vedomosti" noted on 22 October that Deltabank, Masterbank, and Guta-bank already use SMS messaging to inform some of their account-holders of completed transactions. DK

The federally funded Electronic Russia program, which was allotted 600 million rubles ($20.5 million) this year, will see its total funding up through the year 2010 slashed to less than one-sixth of the current 76.16 billion rubles, "Kommersant" reported on 25 October. Lawmakers cited poor coordination and insufficient regional participation in the ambitious program, which aims to use the Internet to bring government closer to the people, improve the nation's school system, and even simplify the payment of taxes. DK

A study by IT research firm IDC depicts an increasing number of Russian Internet users against a backdrop of falling rates for access, "The Moscow Times" reported on 24 October. Most users will continue to rely on dial-up connections, with broadband access remaining limited to the corporate market, according to IDC analyst Simon Baker. The IDC report estimated the market for Internet-access services in 2002 at $600 million. First Deputy Communications Minister Boris Antonyuk stated on 24 October that while the number of Internet users in the world will double over the next three years, the number of users in Russia will increase eightfold, "Vedomosti" reported on 25 October. "Vedomosti" cited a September study by the Public Opinion Foundation that estimates the number of Russian Internet users at 9 million, or seventh place in Europe. DK

Norilsk Nickel became Russia's largest gold producer with its acquisition of gold producer Polyus, "The Moscow Times" reported on 25 October. Polyus accounts for approximately 15 percent of Russian gold production and posted earnings of $135 million and a net profit of $54 million in 2001. Norilsk Nickel picked up a 100 percent stake in Polyus for an undisclosed sum. The acquisition by Norilsk Nickel, the world's leading producer of nickel and palladium, underscores the company's diversification into precious metals. "We want gold to become our company's third area of activity after nickel and palladium production," Norilsk Nickel Deputy Chairman Maksim Finskii told "Vedomosti" over the summer, the newspaper reported on 25 October. Price cycles for gold differ from those for nickel and palladium, and the addition of Polyus will allow Norilsk Nickel to even out its revenue flow over the year. DK

Billionaire Oleg Deripaska and his company, Basic Element (BasEl), spent the week pursuing expansion plans. Deripaska, who made his fortune in the aluminum business, now seems intent on broadening his empire to include the aviation, insurance, and pulp-and-paper industries. Last week, Deripaska's BasEl and the Irkutsk Aviation Industrial Association (IAPO) made an offer to acquire bankrupt German-U.S. jet builder Fairchild Dornier, AP reported on 22 October. Fairchild Dornier filed for bankruptcy in April after running up $670 million in debts, "Vedomosti" reported on 23 October. The acquisition would position Deripaska to take part in a tender to produce a next-generation Russian regional airliner. The state will pay 15 percent of development costs to the winner of the Rosaviakosmos regional-airliner tender. The money could come in handy, as experts estimate that Fairchild Dornier's 728JET project could require $1 billion in investment to reach markets. Fairchild Dornier's creditors will vote on the offer at a meeting on 5 November. On the pulp-and-paper front, Deripaska's BasEl, acting in conjunction with Petersburg banker Vladimir Kogan, continues to make moves in a complex legal game of cat-and-mouse to gain control of pulp-and-paper mills in Kotlas and Arkhangelsk. Deripaska and Kogan announced plans in late June to create an $800 million timber-holding company, "Vedomosti" reminded readers on 25 October. On the insurance front, Deripaska recently announced that he owns a 17.8 percent stake in insurance company Ingosstrakh, "Vedomosti" reported on 23 October. Open admissions of ownership, taboo in the secretive world of Yeltsin-era oligarchs, are the latest fad among Putin-era tycoons. Oil magnate and Yukos head Khodorkovskii led the way, owning up to controlling 61 percent of the nearly $8 billion oil giant. DK

The Institute of Corporate Law and Governance (IKPU) released its second-quarter 2002 rankings of 25 Russian corporations, "Vedomosti" reported on 23 October. Taken together, the corporations represent 95 percent of the total capitalization of Russian stock issuers. The top five corporations were: VimpelCom, Lenenergo, Unified Energy Systems (EES), Norilsk Nickel, and Yukos. "The Moscow Times" termed EES's third-place rating "eye-catching," noting on 23 October charges that "CEO [Anatolii] Chubais is orchestrating under-the-table asset giveaways." Former IKPU Director Dmitrii Vasilev became the first deputy CEO of MosEnergo, an EES subsidiary, in September. The quality of corporate governance in the Russian business world remains a contentious issue, with a lack of financial transparency and the status of minority shareholder rights frequently drawing criticism. DK

Financial markets witnessed a flurry of regulatory activity with brokers advancing new proposals for regulations even as the president continued a trend of rejecting recently developed amendments to existing legislation. Vladimir Putin "tore to shreds" proposed amendments to the law "On The Securities Market," "Kommersant" reported on 22 October. The amendments, which have already been passed by parliament and the Federation Council, concerned derivatives, pre-issue disclosures, financial consultants, and price manipulation. The president sent the law back to parliament with the remark that it "requires significant additional work." The rejection seems to indicate that the president has sided with the Antimonopoly Ministry over the Federal Securities Commission (FKTsB), "Kommersant" noted. The FKTsB was largely responsible for the proposed amendments, which would have extended its regulatory powers. A draft bill on guaranteeing bank deposits met a similar fate when the presidential administration indefinitely postponed a discussion scheduled for 24 October, "Vedomosti" reported on 21 October. The Main State Legal Administration (GGPU) objected that deposit guarantees should be replaced with a system of deposit insurance. The law is now unlikely to be submitted for parliamentary consideration before next year. For his part, Igor Kostikov, the chairman of the FKTsB, announced on 21 October that legislation is being developed to introduce Russian Depositary Receipts (RDR), "Kommersant" reported on 22 October. RDRs would allow Russian investors to purchase shares in foreign companies. The FKTsB is also preparing amendments to change existing rules that tie the amount of corporate bond issues to the size of companies' charter capital, "Vedomosti" reported on 22 October. Meanwhile, brokers asked the president to consider changing the "Law On Joint-Stock Companies" to stipulate dividend calculations on the basis of net profit, "Kommersant" reported the same day. The absence of clear standards for calculation has allowed some Russian companies to manipulate dividend payments to the detriment of minority shareholders. DK

The Ministry of Economic Development estimated that Russia's gross domestic product (GDP) grew by 4 percent in the first nine months of 2002, Interfax reported on 24 October. The ministry forecast that GDP will rise by a total of 3.9 percent in 2002. DK

Dutch financial company ING Groep N.V. announced on 24 October that it will be the first foreign company to launch a non-state pension (NSP) fund in Russia, according to a press release on the company's website (http://www.inggroup.com). ING, which provides pension services in 30 countries, will work with corporate clients in Russia. Jan Nijssen, member of the Executive Committee ING Europe and chairman of the Central Europe region, said in the press release that he sees a demand for "novel products" in Russia and that "[p]ension funds will provide structural support to the Russian economy." The NSP will start out with a modest 1.5 million rubles ($47,304), the minimum sum required by Russian law, but could grow quickly. ING is currently holding talks with a number of large Russian companies. Vasilii Chukulaev, ING's marketing and sales director in Russia, confidently claims, "Our products are of Western quality." This may not be enough to guarantee success, however. "Our enterprises aren't used to giving money to foreign structures," the director of one NSP told "Kommersant" on 25 October. Or, as Yevgenii Yakushev, deputy director of the ElectroEnergy NSP, put it, "Figuratively speaking, we don't eat dogs, even if they're a delicacy in Korea." DK

Moscow Deputy Mayor Vladimir Lesin and South Korean Ambassador Chung Tae-ik attended groundbreaking ceremonies on 24 October for the Lotte Group's construction of a $400 million business complex in Moscow, "The Moscow Times" reported on 25 October. The Lotte Group, a South Korean and Japanese holding that brings together 60 companies, posted a $15 billion turnover in 2001. The New Center complex, which will include a supermarket and a hotel, is the largest South Korean investment to date in Russia. "The Moscow Times" cited "sources close to the project" as estimating construction costs at $100 million. The five-star hotel is slated for completion in late 2006. DK

The board of directors of Vestel Elektronik Sanayi Ve Ticaret, a leading Turkish producer of home electronics, decided on 22 October to enter into a joint venture with Russian television manufacturer Rekord, the Regulatory News Service of the London Stock Exchange reported on 23 October. Vestel's stake in the joint venture will comprise 74 percent; the new firm's start-up capital will be $1 million. Interfax reported on 24 October that Vestel intends to invest up to $20 million in the production facility, which is intended to firm up Vestel's position on the Russian market. The factory will be located 100 kilometers to the north of Moscow and is slated to begin producing 2 million television sets annually in 2004. DK

The Yelabuga Automobile Factory (EAZ) held a ceremony on 22 October to open an assembly line for the production of Belarus-1221 tractors in the republic of Tatarstan, "Rossiiskaya gazeta" reported on 24 October. Under an agreement between the Minsk Tractor Factory and EAZ, parts from Minsk will be assembled for the Russian market in Yelabuga. Russia desperately needs new tractors to replace an aging fleet of 780,000 units, all but 50,000 of which are ready for the scrap heap; but Russian consumers have limited buying power to purchase new equipment. The EAZ will assemble 300 units by the end of 2002, with plans to increase production to 5,000 units annually by 2004-05. DK

A draft bill under consideration by the Georgian parliament aims to stimulate economic growth by creating Chinese-style free-trade zones (FTZ), "Vremya MN" reported on 23 October. An adviser to the government of Guangdong Province who took part in drafting the bill is quoted as saying he feels the port city of Batumi is a strong candidate for a free-trade zone. Georgia's need for economic revitalization was underscored by a recent request from the Georgian Finance Ministry that the Paris Club write off the country's $1.8 billion foreign debt. DK

The road to every Russian hell has been paved with eloquent, unheeded explanations of the missteps that led to the current impasse and the even greater dangers that lie ahead. On 22 October, Yevgenii Yasin made his bid to join the pantheon of prescient voices crying out in the wilderness, presenting a report on the Russian economy entitled "The Burden Of The State."

Yasin and his report mark a certain departure from the classic tradition of lonely intellectuals penning jeremiads for posterity. Minister of economics from 1994-97, Yasin now heads the Moscow-based Expert Institute, a pro-Western think tank that has received financial support from the Ford Foundation and Eurasian Foundation. "The Burden Of The State" was collectively authored by a group of liberal Russian economists (where "liberal" is to be understood in its post-Soviet incarnation as a bedrock belief in the efficacy of free-market mechanisms and support for reducing the state's role in the economy).

The report's greatest merit is the clear snapshot it provides of the Russian economy after more than a decade of free-market reforms. According to the report, the most striking feature of this economy is its "large and inefficient state sector, as well as the significant extent of informal state influence on business." Russia's greatest woe is that "the state's share of the economy comprises some 60-65 percent" of GDP, a far greater percentage than in Western European countries. The report's conclusion is simple and categorical: "The burden of the state must be reduced."

The report is unstinting in its diagnosis of systemic flaws. The 2002 budget equals 41 percent of GDP, while 29-30 percent is an "optimal level" for Russia. Moreover, the budget is excessively centralized, with the central government usurping educational, health-care, and pension functions and funds that are best delegated to regional authorities. The high rate of the unified social tax -- 35.7 percent -- ensures the continued existence of a vast shadow economy. Russia has a significantly higher ratio of pensioners-to-taxpayers (69.2 percent) than, for example, Germany (55.3 percent) or England (40.6 percent). In the absence of competitive bidding, state procurements are a morass of corruption and kickbacks. The state continues to own too many enterprises and institutions, and manages them on an uncompetitive basis. Military reform is stalled. Underpaid officials with excessive powers are a magnet for bribes. Corruption drains business of $33 billion annually.

The report's recommendations are as direct as its criticisms. Lower budgetary expenditures to 27-29 percent of GDP by 2006-07. Cut the state's share in assets and GDP production from 45-50 percent to 20 percent by liquidating state unitary enterprises and transforming budget-supported institutions into non-commercial public organizations. Trim the armed forces and slash military expenditures by 15-20 percent. Reduce the number of bureaucrats by one-half and raise the salaries of remaining functionaries fourfold to reduce opportunities for corruption.

The report concludes, "The majority of the measures proposed here are not new." The problem is that they have not been implemented. While the report concedes that "bureaucratic resistance and populist forces" may consign its recommendations to the dustbin of paths not taken, it warns, "It must be clear that this will come at the cost of Russia's future prosperity."

Reactions consisted largely of a sympathetic shrug of the shoulders. "Russian liberals have used new facts and figures to prove old ideas," wrote Konstantin Frumkin in "Nezavisimaya gazeta" on 23 October. Frumkin noted that, "according to Yasin himself, the report brings together recommendations that were developed by the cabinet but are currently delayed or deferred." Irina Granik, writing in "Kommersant" the same day, lauded the report for honestly depicting the "colossal" extent of corruption -- 12-13 percent of GDP -- and defining "how and where the state hinders economic growth." In an editorial on 23 October, "Vedomosti" sighed, "Everyone has known for a long time what needs to be done." No one does anything because reforms strike at the interests of the very officials who are charged with carrying them out. The editorial trails off with the modest hope that perhaps the president will look to the report for a reminder of what should be done once elections are behind him and he "finally has a chance to get his way."

If the report's strength is its unflinching focus on the negative ripple effect of the bloated state, its weakness is a lack of attention to why so little has been done and how more could be accomplished. Readers left cold by the disavowal that "in many cases the authors intentionally left aside social and political conditions" are to be forgiven for seeking wisdom elsewhere.

Why should we care about a grim, academic report full of weighty proposals unlikely to be implemented? After all, the current state of affairs presents numerous signs of improvement against a generally stable backdrop. Some make even bolder claims. A September article in "Business Week" described Russia as "the multinationals' new darling." A report in "Investment Advisor" on 21 October lambasted the laggard U.S. economy and touted investment opportunities in Russia, breathlessly concluding, "It is difficult to decide what is more remarkable: that the U.S. seems to have self-destructed so spectacularly, or that Russia is now so successful."

We should care about the Yasin report because its judicious diagnoses are the necessary antidote to the seductive hyperbole of "rah-rah" journalism. Great investment opportunities undoubtedly abound in Russia. Those concerned with the long-term perspective for the entire country, however, must fix their gaze on the structural underpinnings that were the undoing of the Russian economy when it faced its last great test in 1998. For while the precise time and nature of future hardships defy accurate prediction, the likelihood of their eventual occurrence does not. DK