January 25th, 2010

CREF Chairman’s Open Letter to World Economic Forum Attendees

Dear World Economic Forum Attendee:

As you prepare to attend the World Economic Forum, keep in mind that in a cramped court room just a few blocks from the Kremlin a drama is playing out that will have profound implications for the future of economic and political freedom in Russia. That country’s former leading business leader, YUKOS Chairman Mikhail Khodorkovsky, is undergoing a bizarre second trial on fabricated charges after he criticized Vladimir Putin for failing to abide by the rule of law. Sentenced to eight years, Khodorkovsky now faces an additional 22 years in a Siberian prison camp.

This Kafkaesque proceeding embodies everything that stands in the way of Russia achieving stability, growth, prosperity and Democracy for its people. GDP surges and plummets with oil prices, inflation and unemployment each exceed 10 percent, while the average salary is about $500 a month.  Respected companies like Ikea, the Swedish home furnishings giant, have been forced to declare a moratorium on investment in Russia, frustrated by Russian officials’ disregard for contractual obligations and fair play.

As a U.S. Senator, President Obama sponsored a bi-partisan resolution supporting Khodorkovsky after the first prosecution, stating that the case raises “troubling questions about the impartiality and integrity of the judicial system in Russia,” and that the imprisonment represents “a violation of the norms and practices of Russian law.” Other leaders from Italy, Germany, and European organizations joined in extending their support for Mr. Khodorkovsky.  Courts from Switzerland, the United Kingdom, the U.S., Netherland, Lithuania, and Cyprus, among others, have dismissed elements of the YUKOS affair.

The Russian government’s contempt for the Rule of Law and the simultaneous proliferation of corruption remains a huge impediment to direct foreign investment for this key player in the world economy. Both US and Russian officials have publicly acknowledged Russia’s weak property rights and rampant corruption as reasons to avoid doing business in Russia.

Russian First Deputy Prime Minister Igor Shuvalov said at an international conference on January 21, 2010, “Investment…is possible only with solid protection of private property rights. Therefore this problem is directly linked to the course of modernization.” On January 12, 2010 US Ambassador to Russia John Beyrle stated, “Russia is still a very tough place to do business. The combination of bureaucratic and administrative obstacles intertwined with pervasive corruption in Russia still constitutes a pretty significant risk premium for American investors and American businessmen who want to enter the Russian market or grow their businesses.”

Russian attorney Sergei Magnitsky was arrested in November 2008 after defending Hermitage Capital against expropriation by government officials. After being denied medical treatment during his year-long incarceration, Magnitsky died in Russian custody last November. If this can happen to Khodorkovsky and Magnitsky, what investor or corporation seeking to do business in Russia is safe? Why invest in Russia as long as Khodorkovsky is behind bars?

According to Russian government studies and US State Department statistics, it’s estimated that corrupt officials rob the Russia people of an estimated $300 billion annually, a sum equal to 18% of the country’s gross domestic product. The response to the newly-adopted package of anti-corruption legislation initiated and promoted by President Medvedev and passed by the Duma in December 2008, has been tepid at best. Medvedev recently admitted publicly that corruption is still endemic in Russia. The excessive role of government in the economy and business sector, which spurs the supply side of corruption, aggravates the problem.

As 2010 begins, signs of Russia’s complacency have become larger and the world stage is beginning to notice. The Khodorkovsky trial and continued politicization of the courts and trade illustrate the increasingly hostile nature of the Russian business environment.

Additional information can be found on our briefing “Russian Roulette: Current Investment Risks in Russia.”

Best regards,
Pavel Ivlev

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