Committee for Russian Economic Freedom

It’s been a month since President Medvedev’s visit to Silicon Valley and burger lunch with President Obama. And almost a year since Medvedev’s “Forward Russia!” speech introducing his modernization efforts at diversifying the economy and promoting home grown technology.

Despite Medvedev’s words and perhaps good intentions, his plans to reduce the police force have stalled and his executive order ending pre-trial detention for economic charges ignored by the courts. All of this points to his “non-leadership” as Pavel Baev points out in the Eurasia Daily Monitor.

There is a strong demand for “for-of-the-same” in the welfare-oriented society and in the predatory bureaucracy, so Putin’s message is conveyed easily–and his authority unshakeable. Medvedev’s discourse of “modernization” remains foreign, and his attempts to encourage innovations are treated with the same ironic indifference as Nikita Khrushchev’s orders to introduce corn after his “historic” visit to the US in 1959. Medvedev is often reduced to complaining about the sabotage of his orders, which only signals to bureaucrats opposed to modernization that real executive power remains out of his grasp.

Civil liberties of different kinds depend on each other and Medvedev’s initiatives have had little effect on shifting Russian into a more open society.

The Russian Interior Ministry today reported that bribes have doubled since last year to $1,320 per occurence on average. And overall, the Russian economy leaks $300 billion as the result of bribes. With only 10%  going to rank-and-file policemen, that leaves a large chunk of change for provincial and Kremlin authorities.

And what could Russia do with an extra $300 billion in its coffers? Repair infrastructure, for sure, invest in alternative fuels or new techonologies, reducing its dependence on foreign investment to diversify the economy or perhaps postpone the largest state asset sale since the early 1990s.

Corruption remains pervasive and the current power structure is unwilling to kill the golden goose. Sergey Magnitsky died in pre-trial detention for refusing to renounce corruption activities of senior Kremlin officials. With much fanfare, Medvedev launched an investigation into his untimely death, but the investigation has stalled. According to Valery Borshchev, head of the government oversight panel responsible for the investigation into Mr. Magnitsky’s death,

They’re dragging their feet because some very important figures are implicated

Aleksei Dymovsky, the YouTube policeman, whose video galvanized a country inured to corruption spoke about his new quest to raise a grassroots campaign against corruption. He knows it won’t be easy as someone who participated in the pyramid corruption scheme that required police officers to hand off that day’s bribes to a “cashier,” a senior member of the police force. Those who didn’t comply were reprimanded.

The dubious charges against Russia’s mobile phone king, Yevgeny Chichvarkin show how hard it is for companies to do business in Russia, even domestic ones. The problems started for Chichvarkin in 2006 when he refused to pay bribes in order to prepare his accounting books for an initial public offering in London. His refusal resulted in the confiscation of $20 million of Motorola phones and the current charges against him. Motorola was his largest corporate partner and suffered huge losses when Department K, the interior ministry’s economic crimes division, released false warnings about the safety of their mobile phones. Motorola’s market share has dropped from 20% in 2006 to less than 1% where it is today.

Cisco has pledged a $1 billion investment in Skolkovo but John Chambers should have scratched Russia’s surface a little deeper.

Oleg Kozlovsky issued an open letter to Finnish President Halonen and Russian President Dmitry Medvedev today on behalf of the participants of the Russia-Finnish Civic Forum in Helesinki. The full text of their letter is below and the link to Oleg’s website here.

Dear President Halonen,
Dear President Medvedev,

While you are meeting today in Finland, we, representatives of Russian and Finnish civil societies, are also gathering here to discuss how non-governmental actors can contribute to cooperation between our two nations and to building a common European space based on the principles of democracy, rule of law and human rights. We would like to draw your attention to the following concerns, which are in the center of our discussions today.

Like you, dear Presidents, we also want to see Russia a modern and prosperous country. However, we believe that without ensuring fundamental freedoms, building strong democratic institutions and an independent judiciary any technological modernization efforts will fail. It goes without saying that free and fair elections and independence of the media are essential to this process.

We want to share with you some of our immediate concerns, which require resolute actions that go beyond declarations.

In particular, we are convinced that the draft law granting new powers to the FSB contradicts not only the Russian Constitution but also recognized international norms. Therefore, it should not be signed by the President of the Russian Federation.

We are extremely concerned about continued persecution of human rights defenders, political activists, trade unionists and journalists in Russia. Instead of fighting terrorism and organized crime, thousands of law enforcement officials harass civic and political activists, often under the pretext of fighting extremism. This practice must be stopped. Murders of human rights defenders, journalists and lawyers must be effectively investigated, and perpetrators brought to justice. Impunity simply must come to an end.

Lack of fair trial and due process fundamentally undermine access to justice in Russia. This includes torture in pretrial detention centers, politically motivated trials in cases of Mikhail Khodorkovsky, Platon Lebedev and others; persecution of Alexey Sokolov and Oleg Orlov for their human rights work and Valentin Urusov for his trade union activism, as well as the lack of effective investigation of murders of Anna Politkovskaya, Natalia Estemirova and Sergey Magnitsky. In the case of Magnitsky it is even more blatant because the names of those responsible for his death are well known. This list is by far not exhaustive.

Freedom of assembly continues to be denied to the Russian public. Across Europe we are united in support of Russian activists who convene peaceful gatherings in the framework of ”Strategy 31.” In a week from now, we will again express our solidarity with Russian people in Helsinki, Prague, Brussels, Berlin and other cities across the continent. We call on you, President Medvedev, to guarantee the freedom of assembly on 31 July and in the future.

We hope, President Halonen and President Medvedev, that these concerns close to our hearts will form an important part of your dialogue and that future Russian-Finnish modernization cooperation will include concrete projects in such areas as building independent judiciary, strengthening the rule of law and developing robust democratic institutions.

Reporter Natalia Gevorkyan writes in Gazeta about the lack of restraints in Russian culture that would otherwise confront and eliminate corruption from the political process.

Gazeta.ru, A Twisted Reality

Jamison Firestone describes the highlife and crimes of Russian official Pavel Karpov and Sergey Magnitsky lies in prison.

“The Kremlin says Russia is a country of great opportunity. But my trial demonstrates that it is also a country of great risks.” – Mikhail Khodorkovsky

Cloudy Precipice / Tom Burgher Gallery

Despite the recent spate of international news over the past week, from the hamburger summit in DC to the G20 in Toronto to Russian spies in Suburbia USA, underlying global economics has not changed and talk of a double-dip recession has revived. Even the dreaded “d” word was uttered by NYTimes’s Paul Krugman in his assessment of the US economy. Signs of a global weakening is evidenced by the fall in world equity indices, weak US home sales and China’s manufacturing growth is weakening as its government reduces stimulus. Debate rages on the effects of deficits on the economy. While the two sides debate the merits of deficit reduction over stimulus spending, the world economy feels like it is again at a precipice.

In the most recent Reuters’ Russian analysis, three factors remain unchanges from their last report in April: oil prices, political risk and insurgency. For the 2010 budget the Kremlin used a $75 barrel estimate, but with crude oil prices falling under $73 a barrel, the Kremlin may have to return to the capital markets trough and isuue more debt to cover budget deficits.

Medvedev understands the need for Russia to diversify its economy and made a major international push last week with his visit to Silicon Valley. However, it still remains to be seen how the power struggle is resolved. The 2012 presidential election presents political risks for investors and many anaylsts predict that:

Russia is unlikely to lure the level of investment or international support it deserves as long as Putin and his ensemble remain publicly engaged.

With the tandem leadership jostling for advantage, it remains to be seen if Medvedev’s push for modernization can resist the pull of Putin. In addition to a change of guard in the Kremlin, Reuters cites the release or acquittal of Mikhail Khodorkovsky as a sign of liberalization and a “bellwether” of Russian policy.

However, current signs point to the status quo as the authorities refuse to investigate into the suspect death of Hermitage Capital’s Sergey Magnitsky in pre-trial detention.

James Beadle

Source: PRIME-TASS
Contributed by James Beadle, a private investment consultant

MOSCOW, Jun 23 (PRIME-TASS) — Since 2003 former Yukos executives Mikhail Khodorkovsky and Platon Lebedev have been incarcerated in Russia on charges of tax evasion. At present, as their eight year stint enters its final stages, the two are on trial once more, charged with stealing millions of tonnes of oil (reputedly the same oil that they didn’t pay taxes on).

The Yukos case has always been of fundamental significance to Russia investors. The original arrests marked the end of what might be called the “liberal progressive” period of Vladimir Putin’s presidency. As Yukos was transferred to the state through a series of corrupted political interventions, so Putin’s policies became increasingly harsh.

His efforts to placate investors by offering up Gazprom delivered huge profits to a minority, but had little structural impact. And although the Russian market soared from 2004-2008, the costs and implications of the Yukos case also lingered and stacked up. Russia became increasingly corrupted as the judiciary ceased any pretence of impartiality and the bureaucracy found its powers rejuvenated. The one-party system rebounded from 15 years in the wilderness.

Today, Russia faces a new set of challenges. Although it has not acknowledged the costs of nationalist policies and political risk, unleashed by the prosecution of the nation’s former richest man, it publicly recognises that dependence on oil and gas revenues is a limited and dangerous strategy.

As Khodorkovsky and Lebedev labour their way through their second show-trial, Russia’s new president is seeking to demonstrate that the nation is changing, that business risks are on the decline and that foreign investors are welcome, wanted even.

If the facts of the Yukos case were clean cut, or even uncertain, then the trial would be of limited importance; but the scale of the farce taking place in the Moscow courtroom is rapidly becoming a political embarrassment. Few Russia specialists, this one included, expect a fair hearing, or an honest outcome. But, as the evidence stacks up against the prosecution, so the case gains importance as a litmus test of how much has changed since Medvedev came to power on a promise to end corruption and clean up the judiciary.

In recent court sessions, Khodorkovsky has cross examined a series of high profile politicians from the Putin era: former central banker Viktor Gerashenko, former Prime Minster Mikhail Kasyanov (now an embattled opposition leader), former Economics Minster German Gref (now head of Sberbank) and incumbent Industry and Trade Minister Viktor Khristenko.

All have, to a greater or lesser extent, come out against the prosecution, stating variously that no oil was stolen, that transfer pricing was legal and normal practise or that they were not aware of any theft.

The cynical argument would be to say that this new freedom of speech – which would have been inconceivable just a few years ago – is an effort to make the trial look fair before putting the pair away again. The reality is that something has shifted in Russia.

Not to say that we should expect an honest or open result. Yukos investors are currently prosecuting the government for $100 bln in the European Court of Human Rights. (Note that there was no sign of contingency for this case in the pricing of Russia’s recent Eurobond.) A victory for the defendants would certainly increase the risk of Russia being put on the hook for an extremely large sum in this related case.

More important, it would also discredit the entire Putin era, undermining much of the power vertical that has been so meticulously constructed.

The sad fact is that Khodorkovsky and Lebedev are likely to be kept in jail for a long time yet. Many senior investors will talk about why this is justified. The truth is that it will continue to sustain the risk premium Russia faces as an investment destination. (The true cost of the policies that began with the prosecution of Yukos – in terms of reputation, investor risk premium and lost opportunity – are unmeasurable, but certainly higher than the $100 bln being sought by Yukos shareholders.)

Freeing Khodorkovsky and Lebedev would be a bold move implying that things are really on the mend in Russia. It would boost investor interest and bring a difficult transitional chapter to a close. Unfortunately, with so many of the victors of that chapter still in power (is it a coincidence that there is a lengthy article about Igor Sechin in the FT this week?) such an outcome is unlikely.

At last week’s St Petersburg Economic forum, President Medvedev announced the elimination of capital gains tax on long-term fixed investment projects. It is pertinent that Russia is doing what it can to sustain high returns as economic growth has slowed and risk remains high.

Witnesses at the Khodorkovsky trial have proven that things are changing in Russia. But freedom of speech is one thing, independent judiciary is quite another.

The case is likely to confirm my 2010 outlook that the changes under-way fall short of what is needed for Russia to embark on an optimal development path, but we should never forget that in Russia the unexpected is always possible.

End

Russia 2H10

Serfs

Russian natural resource minister Yuri Trutnev annoucned that TNK-BP’s licence to develop the Kovykta gas field will be handed over to the state, where Gazprom has a natural gas monopoly. Although TNK-BP was in discussions to sell Kovykta to Gazprom for $1 billion, the transaction was never comnpleted and it appears TNK-BP will walk away from Kovykta with nothing.

Details of TNK-BP’s travails are covered in a previous post, but it’s worth rementioning that in 2007 the Kremlin passed a law restricting all gas exports to public entities, yes, Gazprom. Although the recent Reuters article touches upon weakening demand for natural gas, it neglected to mention that Kovykta is located in the eastern Russia and TNK-BP was developing those fields for natural gas export to energy hungry China. According to China’s official news agency Xinhua, China’s natural gas consumption is forecasted to more than double over the next ten years.

President Medvedev’s visit to California’s Silicon Valley last week focused on Russia’s ambition to make Skolkovo into Innovation City. But as a Moscow Times op-ed mentions, the President and the government must restore trust in government procedures and laws of the land. Only through the re-establishment of trust can Russia foster the kind of environment entrepreneurs, engineers and venture capitalists need to create and execute new ideas and projects. As an indication of his commitment, Medvedev signed along with other G20 leaders their commitment to combatting corruption and protecting whistle blowers by creating a committee that will eventually draft rules for all G20 members.

While the Skolkovo project renews debate over the successful path of Russia as a state capitalist country versus democratic capitalist nations, financial commentators have renewed interest in Friedrich Hayek, Nobel Prize winning economist. Counter to John Maynard Keyes who wrote about the importance of governmental intervention, Hayek warned against government intervention as it would lead to serfdom. Having experienced serfdom for centuries prior to 1861, Russia is at a political and economic crossroad. Will Medvedev’s commitment to innovation, rule of law and transparency extend to the coming presidential election in 2012, or will a perceived tainted election redirect Russia’s political and economic path towards greater government control and, serfdom?

San Jose Mercury News
By Jamison Firestone
Special to the Mercury News
Posted: 06/23/2010 08:00:00 PM PDT

Russian President Dmitry Medvedev visited Silicon Valley this week in hopes of wooing executives to invest in Russia. But as high-tech leaders think through the pitch, they might want to consider what could happen when their Russian investments are up and running.

I am a member of the New York Bar who’s served on the board of directors of the American Chamber of Commerce in Russia for the past six years and managed a law firm in Moscow for 17 years. My firm represented the largest foreign investor in Russia, Hermitage Fund, which once had more than $4 billion invested there.

In 2007, officials from the Moscow Interior Ministry raided my offices and my client’s offices and took all of Hermitage Fund’s statutory documents and seals. Even the Russian government now concedes in Moscow court filings that those documents and seals were then used to fraudulently re-register the companies into the name of a convicted killer. A criminal group subsequently applied for a refund of the $230 million of taxes that the Hermitage Fund paid in 2006. The payment was granted in one day, no questions asked. It was the largest tax refund in the history of Russia, a country where even the smallest refunds take months, if not years.

Hermitage hired five law firms to report the thefts and recover the stolen companies. In the two years that followed, I personally witnessed Russian officials implicated in the crimes attempting to arrest every lawyer who was involved in the investigation or reporting of the thefts. In a classic case of Kafkaesque absurdity, two of Russia’s most famous and respected lawyers were criminally prosecuted for reporting the theft. They fled the country.

third respected corporate lawyer, my partner Sergei Magnitsky, refused to flee Russia because he thought the law would protect him. He testified against the corrupt officials. One month after his testimony, he was arrested by the very officials he testified against. The next day, they tried to arrest three more lawyers, all of whom fled Russia.

Magnitsky was kept in pre-trial detention for 12 months and was tortured to get him to withdraw his testimony, but he refused. On Nov. 16, 2009, Magnitsky died as a result of torture at the age of 37, leaving a wife and two young boys.

Since then, it became public that the same group of officers and criminals had been accused of similar crimes in the past. It was also discovered that immediately after the thefts were reported, the officers’ families acquired millions of dollars in assets.

Like many people, I find Medvedev confusing. He speaks about fighting corruption, building rule of law and fostering investment, but Russia’s level of corruption continues to increase. Silicon Valley may see him as the first Russian leader to surf the Web and use e-mail, but television news still is under state control, and independent journalists, human rights activists, businessmen and now their lawyers are arrested and killed with impunity.

I would like to believe that Medvedev is sincere. But he has done nothing to bring Sergei’s killers to justice, to find the stolen government money, to help my client recover its companies or to stop the attacks on lawyers.

What happened to my client can happen to anyone doing business in Russia, and no law firm in the world can defend you in a land without law. Large companies that were sure they would have government support, like Shell, BP, Carrefour, Telenor and Ikea, were left to the wolves. In each case, the Kremlin either attacked or allowed corrupt officials to attack foreign investors that bought into the same pitch you just heard.

Caveat emptor.

JAMISON FIRESTONE is managing partner of Firestone Duncan, Moscow. He wrote this article for this newspaper.

Russian President Dmitry Medvedev looks through 3D glasses at an exhibition at the economic forum in St. Petersburg, Russia, Saturday, June 19, 2010. (AP Photo/Dmitry Lovetsky)

Just a few weeks ago Putin was front and center with his visits to Istanbul and Paris, negotiating foreign policy disputes over UN sanctions against Iran. He even made comments about his tandem leadership with Medvedev that Kremlinologist have interpreted to mean that Putin as no choice but take over the reins in 2012, lest Medvedev actually execute his modernization plans by reducing 160,000 bureaucrats and nearly 300,000 policemen. Of course not all of these government employees have profited from Putin’s rein at the helm but they benefit from the existing “old” system (“budget inefficiency and a resource-based economy” as Arkady Dvorkovich, Medvedev’s top economic advisor put it.)

What a difference a few weeks make.

This week President Medvedev is visiting Silicon Valley to drum up support for a Russian Silicon Valley in Skolkovo outside Moscow. Despite a more promising outlook for Russia’s growth this year, in order for Medvedev’s modernization to be realized, laws must be enacted and enforced.

Another hinderance to Medvedev’s efforts is widespread corruption in the country, equivalent to a third of the country’s GDP annually. The death of Sergey Magnitsky while in pre-trial detention hangs like a cloud. Today, Magnitsky’s business partner Jamison Firestone released a video documenting what the government officials who are responsible for Magnitsky’s death are doing with their ill-gotten fortunes.

Beyond the Magnitsky tragedy the Khodorkovsky trial is a symbol of the lack of property rights in Russia and is costing Russian companies a risk premium as foreign investors demand greater compensation for this political risk.

Leon Aron, director of Russian studies at the American Enterprise Institute wrote in the Los Angeles Times that:

The road to a Russian Silicon Valley starts not in California, Mr. President. It begins with unlocking the door to Mikhail Khodorkovsky’s jail cell.

This is a critical time for Russia’s development as an emerging market. It remains to be seen if Medvedev’s modernization initiatives will be allowed to proceed and allow Russia to develop in an ever crowded global economic playing field or will the presidential election of 2012 reaffirm the Kremlinologists prediction that Putin will rein in liberalizing efforts and lead Russia down the path of increased centralization in government and government oversight of business and trade.