July 1st, 2010

Opinion: Khodorkovsky trial highlights reform progress

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

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