Committee for Russian Economic Freedom

Davos 2011

News out of Davos that the Moscow regime has struck mega mega oil and gas deals with BP and Exxon Mobil has heightened a sense among other potential investors that Russia may not be worth the risk. In their agreement with Igor Sechin’s state-controlled Rosneft, BP even turned its back on long-time Russian partners TNK, which took action yesterday in a London court to protect its interests.

Exxon Mobil also doesn’t seem to have a problem in doing business with Sechin and others who built Rosneft by stealing the assets of Yukos and sending its chairman Mikhail Khodorkovsky to a Siberian prison.

Despite an attempt by President Medvedev at Davos to promote investing in Russia, the corruption tax on investment flows directly to the Kremlin. As these two deals demonstrate, the Kremlin orchestrates deals to enrich themselves, adding resonance to Medvedev’s own words to Russian business leaders on December 29 that the country’s investment climate is “very bad.”

As Mikhail Khodorkovsky recently said to the International Herald Tribune and others,

It is obvious that those who can truly be called “oligarchs” – those who have combined state power and big business in one individual – were created by none other than Vladimir Putin and are his comrade-in-arms. The rest of the “Forbes faces” – and indeed a significant part of small business as well – have agreed to pay tribute to the bureaucracy in one form or another…Russia is a sovereign state, but to support deception to demonstrate respect for its corrupt officials, is amoral.

At World Economic Forum this year, Russian officials headed by Finance Minister Alexei Kudrin were no where to be seen. Ian Bremmer, head of the foreign policy think tank Eurasia Group blogged that

Russia as a topic generally comes across as a negative in global circles–revisionist geopolitics, resource nationalism, and strongly authoritarian (albeit charismatic, in a fashion) domestic leadership.

Those negative sentiments were backed up by 75% of Russian businessmen attending Davos and predicting another year of stagnation or further economic decline.  This mood was backed up by dismal economic numbers in 2009. The Russian economy shrank 7.9%, the most in 15 years and analysts forecast the economy to shrink by 8.5% in 2010.

Although President Dmitry Medvedev keeps up the positive drumbeat on foreign investment in Russia, business leaders are more circumspect, expressing concerns over instiutional corruption stifling economic development and entrepreneurial spirit. German Gref, CEO of Russia’s largest bank Sberbank talked about

…the mood of fear gripping the private sector since the state take over oil major YUKOS several years ago.

Former YUKOS CEO Mikhail Khodorkovsky wrote in last week’s New York Times op-ed piece that Russia only exports gas and corruption and its refusal to see the limits of a state-controlled petro-economy is taking Russia down the path to becoming

a classic third-world style, raw materials-based economy, where corruption is the norm rather than the exception and there is no working system of democratic and social institutions.

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