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February 28, 2008

Russia: Political System Could Drag Economy Down

by Robert Coalson

Can presumed President-in-waiting Dmitry Medvedev escape the shadow of Gazprom and other megacorporations? (AFP)

President Vladimir Putin's two terms produced consistent, impressive economic growth. Putin leaves the presidency with the country's coffers filled, its debts paid down, and investment rising.
However, some economists are warning that the foundation of Russia's prosperity is shaky and that the government is in a poor position to cope with the changing circumstances brought on by a global downturn.

"We are absolutely unprepared for complications in the financial-economic environment," Unified Energy Systems head Anatoly Chubais, a Yeltsin-era first deputy prime minister overseeing the economy and privatization, said earlier this month.

Former presidential economic adviser Andrei Illarionov and economist Mikhail Delyagin are among those who have warned that Russia's economic growth -- driven exclusively by high global energy prices -- has not produced improvements in the country's infrastructure or even the seeds of economic diversification.

"In terms of GDP, we have passed France and Italy," Delyagin told the BBC recently. "But the size of our GDP is not determined by our development. It is determined by the global price of oil, first of all, and the price of our metals exports, secondly. This isn't our doing."

He added that the volume of goods transported by rail declined in 2007, which he attributed to the "degradation" of the infrastructure. He said the extent of Russia's paved-road system has fallen steadily over the last three years.

Prices, And Panic, Rising

Recent spikes in inflation have also caused considerable alarm and have spurred the government into action. A 2.3 percent rise in January was driven mostly by rises in the prices of basic foodstuffs, increases that directly and inordinately affect the poorest segments of Russian society. According to Rosstat, the cost of the government's standard basket of basic staples rose by 22.3 percent in 2007 on average, with even higher increases seen across the Far East.

The recent price increases have exposed a vulnerability that stems from Russia's dependence on imported foodstuffs and medicines. The government's response so far has been to compel wholesalers to freeze prices, although most experts see this as a stopgap solution designed to get the country peacefully through the political transition from Putin to his chosen successor, First Deputy Prime Minister Dmitry Medvedev.

Economists are all but unanimous in the opinion that the government's 2008 inflation target of 8.5 percent is unrealistic. Officials such as Central Bank First Deputy Chairman Aleksei Ulyukayev and Economic Development and Trade Minister Elvira Nabiullina have been deployed in recent days to assure the public, to quote Nabiullina, that "there is no need to carry out reforms with painful social consequences."

Although the Russian public is generally complacent, when the government reformed social benefits to the needy in 2005, thousands of pensioners and others poured into the streets around the country and called for Putin's resignation.

The government was deeply shaken by these rolling protests and has since been proactive in preventing similar situations from erupting -- mostly by co-opting or sidelining the leaders of the demonstrations. The Kremlin understands how thin a veneer of legitimacy is bestowed by the country's cynically managed election system.

"Our long-term goals must be understood by everyone, supported by all the citizens of the country," Putin said in a major policy speech on February 8. Political analyst Dmitry Oreshkin wrote this month that a "national" dialogue on the future of the country is essential. But given the regime's obsessive compulsion for control over the information space and its successful marginalization of independent thought in all areas, the conditions for such a dialogue are simply nonexistent in Russia today.

Too Powerful?

While the new government's economic choices will be penned in on one side by its need to begin closing the country's appalling gap between rich and poor and to help the vast masses living in poverty, it will also be limited on the other hand by the new giants of the economy, the state-controlled megacorporations that have been formed aggressively over the last few years.

Even as the impoverished have been systematically deprived of their levers of influence on the government, these corporations have concentrated economic and political might to an extent that threatens to make rational economic planning impossible.

True, both Putin and Medvedev have spoken about the need to reduce the role of these companies. Medvedev told a business gathering in Krasnoyarsk this month that "the quality of the companies in which the state participates must be raised and bureaucrats must be removed from management organs."

But undoing these behemoths, which are headed by the most influential figures of Putin's inner circle -- including deputy presidential-administration head Igor Sechin, Russian Railways head Vladimir Yakunin, First Deputy Prime Minister Sergei Ivanov, Rostekhnologii head Sergei Chemezov, and others -- would seem a politically unlikely task. Even if all these people are dismissed from their government posts, their lobbying might within a cabinet headed by Putin will be formidable.

Rises in food prices have caused concern (ITAR-TASS)

However, there is plenty of reason to doubt the sincerity of Medvedev's criticism of the state corporations. Medvedev himself, after all, is the head of Gazprom's board of directors and has apparently had no problem with his dual role or that company's "quality." Moreover, he has overseen that company's aggressive expansion both domestically and abroad. This week he inked a deal with the Siberian Coal-Energy Company that would create a $20 billion joint venture that would control more than 50 percent of the country's electrical power plants and their supplies of coal and natural gas.

Revealingly, this joint venture would seem to fly in the face of the government's stated goal of privatizing the electricity-generating system and has been opposed by Unified Energy Systems head Chubais, former Economic Development and Trade Minister German Gref, and Energy and Industry Minister Viktor Khristenko. Analysts, not surprisingly, do not expect the government's Antimonopoly Service to block the controversial deal.

Running Up A Tab

In April 2007, presidential economic adviser Arkady Dvorkovich broke ranks and publicly condemned the trend toward more megacorporation. He argued that they have so much political clout that even the Audit Chamber cannot monitor them and that their charters are constructed in ways that put them outside antimonopoly and other legislation. He said the firms have already been lobbying for tax concessions and said they are quick to use their political advantages to make up for their market shortcomings.

The power of these companies -- and the power of the government to resist them -- may be tested over the issue of corporate debt. Although Russia has dramatically paid down its state debt in recent years, it has accumulated a staggering corporate debt, estimated by the newsweekly "Itogi" at $423 billion. The lion's share of that debt is owed by state-controlled banks and state companies like Gazprom and Rosneft. Many of these companies have used their clout to have themselves placed on the government's list of "strategically vital" enterprises, meaning that the state guarantees their debts.

Such a guarantee makes it easier for these companies to attract credit in the West. Take the case of Rosneft. During the politically motivated takeover of the private Yukos, Rosneft -- whose chairman is Putin insider Sechin -- took loans of $22 billion to purchase Yukos's production assets. In all, the company's debt now stands at $27 billion, with payments of $5 billion due in mid-March. In January, Sechin lobbied the government to pay the debts, but was turned away.

On February 22, however, a consortium of leading Western financial institutions agreed to a $3 billion credit -- no doubt swayed, at least in part, by the company's standing with the government. Just as Western loans helped Gazprom take over the independent NTV in 2000-01, now they have helped in the dismemberment of Yukos. At the same time, Yukos's victimized Western shareholders seem unlikely to get any compensation for their losses. In December 2007, a U.S. court ruled that Russia has "sovereign immunity and therefore could not be tried in an American court."

Even the docile Federation Council has weighed in against the state corporations. The upper chamber issued a report on the legal framework of Russia this month that described the creation of such companies as "the trademark of Russian economic policy."

According to the report, the unregulated companies create "ideal conditions" for the transfer of state property to the private sector with "minimal financial gain" for the state. The report says that the charters of these companies mean that the common legal environment is being replaced by fragmented, exceptional frameworks. Speaking to gazeta.ru, INDEM foundation head Georgy Satarov said, "nothing more favorable to an explosion of corruption than the creation of state corporations has yet been conceived."

As Russia's post-Putin political transition unfolded through the Duma elections in December 2007 to the presidential election on March 2, market analysts were confident of one thing. For the foreseeable future, the safest investment bet in Russia is companies close to the government. But for the long term, all bets are off.
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