Banking crisis on Cyprus became the major concern for Russian leaders during last two weeks. Both Putin and Medvedev several times publicly commented the situation around the island. Kremlin-controlled TV-channels even broadcasted the emergency session of the Cyprus parliament, constructing from the island’s story an important myth and even a tragedy for all Russian TV-viewers.
According to Dmitry Medvedev, Cyprus continues to "rob the loot"
Nevertheless, Russia refused to bail out Cyprus. No surprise, since possible cumulative losses of the Russian state from 10% deposits cut would have been much less than additional 6 bln euros Cyprus needed to receive financial aid from EU.
The Cyprus crisis was exploited by Kremlin’s propaganda for several reasons. First, the story of a financial disaster in a faraway land helps to distract citizens from domestic issues. Second, the collapse of Cyprus offshore economy fits well with the Putin’s strategy of economic self-isolation.
Financial tragedy turned into a comedy after Medvedev’s serious proposal to found an offshore on the Russia’s Far East Kuril islands. Alas, the prime-minister fails to understand that low taxes were neither the only nor the most important reason for Russian business to register on Cyprus. Above all, Russian businessmen run to Cyprus and other jurisdictions in order to protect their property rights that can’t be fully guaranteed in Russian courts. Besides, Russian companies, including state-controlled monopolies, need flexible instruments in order to structure their M&A deals. Cyprus inherited its law system from Britain, and the island’s juridical system, unlike its banks, still works well. In order to see Russian companies returning home, the Russian government needs to restore the independence of courts and parliament, improve the corporate law and create friendlier business environment. Until it happens, Russian companies will depend on the news from offshore havens.
The Siberian oil fields already passed their production peak
According to Rosstat, the governmental statics agency, industrial output in January shrank by 0.8% year over year. Adjusted for seasonality and calendar effects, the output fell by 1.5% comparing with December.
Rosstat reported negative figures for industrial production for the first time since November 2009. Though many analysts explain the figure by combination of several one-time events, the slump in year over year growth rate continues the trend of 2012. Over the past year the pace of industrial expansion slowed down each month. The oil output, crucial for the stability of the Federal budget, dipped in January by 1.7%.
The Russia’s GDP most likely will continue to grow thanks to the expansion of the public sector and growth in the service sector. However, the country’s oil industry won’t be able to contribute to the economic growth anymore, dragging down the economy in the midterm. Hence the entrepreneurial activity is suppressed by the state, there is little room for any new business development in Russia. Any economic growth in such circumstances will be weak and fragile. Alas, Medvedev’s government has no power, no public support to improve the country’s poor investment climate.
The Bank of Russia raised the benchmark refinancing rate to 8.25%, while the government failed to find money for all Putin’s pre-election promisses.
Putin and Russian economic authorities are not at the same page
Considering that the industrial production shrank in August, raising interest rates is not a typical monetary policy. However, the central bank had a little room for maneuver since January-August inflation had already exceeded the bank’s target of 6%.
While Bank of Russia demonstrates its commitment to bringing inflation down, Vladimir Putin is pumping money into the economy by increasing pensions and public sector salaries.
These decisions will damage the private sector. Financial institutions are going to follow the central bank by increasing their interest rates. German Gref, the CEO of state-controlled Sberbank, which dominates the Russian financial sector, has already acknowledged that the bank was likely to increase its interest rates. As a result, the business activity and the credit-infused consumer boom will slowdown, leading to the economy stagnation.
Further expansion of the public sector could have saved the economy from contraction. However, Medvedev’s government refused to include Putin’s generous pre-election promises into the 2013 budget. Technically, they were following the newly adopted budget rule, according to which the expected government’s oil revenues are fixed at a certain level.
Budget restrictions coupled with tough monetary policy make the economic stagnation inevitable in Russia in the mid term.
Neil Buckley, the Eastern Europe editor of the Financial Times, writes on the Valdai Club website today about the IPO shortfall in Russia, summarizing the dismal first half of 2011 for Russian companies looking to go public:
Analysts originally forecast private companies could raise more than $25bn in 2011 from so-called initial public offerings of their shares, up from only $5.5bn last year. In fact, only $3.9bn was raised in the first half of the year from a mere six deals.
Seven other planned Russian IPOs were postponed in the same period, he notes, prompting:
…more soul-searching about Russia’s lack of attractiveness to international investors, even as president Dmitry Medvedev has announced measures to try to improve the investment environment. It comes as domestic investors also seem reluctant to invest in Russia ahead of parliamentary elections in December and next March’s presidential poll – leading to billions of dollars of net capital outflows in recent months.
While IPOs the world over have underperformed, Russia’s case is especially gloomy, as investors have been burned by Russian IPOs not materializing and poor performance with those that did, at least in the traditional extracting industries like metals and mining. (Search engine Yandex is the successful exception mentioned here.)
Buckley concludes by citing the political discount, often called the “Khodorkovsky discount” after the imprisoned former chief of Yukos whose case represents many of the challenges faced by Russian entrepreneurs today, that keeps Russian markets undervalued:
It is difficult to achieve top valuations for Russian IPOs when its whole market remains undervalued largely because of the political “discount” investors apply to the country [due to] perennial concerns over corruption and weak rule of law, [which] seem to reflect uncertainty over the outcome of the presidential election, and whether Russia will be able to conduct reforms needed to boost its flagging economic growth.
Half of all Russian businesspeople and students want to flee the country, according to the Levada Center, an independent, non-governmental Russian polling and research organization, and as reported in France’s daily financial newspaper, Les Echoes.
Almost a quarter of the entire Russian population would like to emigrate, according to the poll. The principal reasons: the high cost of living (67 percent); corruption (49 percent); and criminal activity (48 percent). As it is, more than 100,000 Russian are leaving the country each year, according to a number of sources.
Meanwhile, Charles Clover writes in today’s Financial Times about “ascent and dissent,” how with rising wage disparity in Russia comes rising dissatisfaction with the economic status quo, where the children of civil servants are more likely to score high paying jobs than more qualified, less well-connected individuals. That inequality only feeds on itself, as those locked out of the upper echelon have little chance of breaking in:
While income distribution in Russia creeps towards Latin American levels of inequality, having widened notably since the turn of the millennium, the state has incubated an ever more entrenched and inaccessible elite that now controls government and business, and jealously guards its privileged domain.
The effect of the burgeoning bureaucracy, which President Medvedev has promised to cut by 20 percent but thus far has failed to do so, has bred discontent in Russian business and intellectual circles. What happens on account of this malaise (Clover also quotes Mikhail Prokhorov here, who says no one in midsummer 1991 was predicting the August coup) could be more of the same — or a drastic change. Clover concludes:
[W]ithout comprehensive economic reforms, aimed at creating more skilled private sector jobs, social mobility in Russia will probably continue to decline. The consequences are anyone’s to guess – but they are unlikely to be joked about.
Washington Post reports that massive and unprecedented outflows from Russia signify deep uncertainty about Russia’s future and its ability to provide a stable platform for economic growth. Russia has well-known domestic infrastructure needs and President Dmitry Medvedev has made modernizing and diversifying the economy as a central issue in his presidency. But with $30 billion leaving the country in the first four months of 2011, the loss of confidence in the Russian government to make infrastructure changes and support the rule of law is evident in both domestic and foreign investors.
Russia’s currency reserves are buffered by the high price of oil, but that usually meant a stem in capital outflows. Not so this year. Evsey Gurvich, head of the Economic Expert Group in Moscow cites political uncertainty in the 2012 presidential elections as one of the reasons for capital flight,
In our country, personal guarantees, personal relations, are still more important for big businesses than laws and rules and formal regulation.”
Another reason he cited was the “weak business environment” in Russia due to the pervasive corruption and expropriation of private business by government officials.
That is another way of talking about corruption, bureaucratic capriciousness and courts that take their orders from on high.
The reaffirmation this week of the conviction of Mikhail B. Khodorkovsky, the onetime oil tycoon who lost his company and his freedom after he challenged Putin, probably translates into “several more billion dollars on the run from Russia,” Gontmakher said.
Domodedovo Airport, the only privately owned airport in Moscow, has come under relentless pressure publicly from the authorities, and that, [Yevgeny] Gontmakher, [deputy director of the Institute of Contemporary Development in Moscow] said, sets a very visible and “awful” example.”
“Trust, but verify” – “doveryai, no proveryai” or “Доверяй, но проверяй” – was President Ronald Reagan’s catchphrase in pressing Soviet leaders for weapons inspections. Now nearly a quarter-century later, trust between the US and Russia is in short supply as President Obama and Russian President Medvedev were unable to show progress on missile defense. Tension levels were already edging higher after the U.S. State Department raised concerns over a Moscow appeals court’s decision to uphold a guilty verdict for former Yukos CEO Mikhail Khodorkovsky on a second round of politically motivated charges, spurring capital flight from Russia amid investors fear that Prime Minister Putin will elbow Medvedev from power.
Pavel Ivlev, CREF’s chairman remarked,
The US and the Western world shall not forget what President Reagan said. “Trust, but verify” is very much applicable to Medvedev today, who is known of saying right words, but very weak on delivery.
We previously wrote about record capital flight out of Russia due to political uncertainty. Both the New York Times and the Washington Post have articles covering this topic. While Kathy Lally at the Post relies on Olga Kryshtanovskaya, a member of Putin’s United Russia party, for her main assertions that there is no competition and it is all a show, Ellen Barry at the Times reports that something more substantive is in progress. Barry refers to a Churchill Winston remark that refers to the Kremlin transfer of power as bulldogs fighting under a carpet,
An outsider only hears the growling, and when he sees the bones fly out from beneath, it is obvious who won.
Barry doesn’t try to predict the winner but Prime Minister Putin has been in the headlines by reprimanding Russian trade officials who were seeking to comply with World Trade Organization’s rule before ascension. James Bacchus, a former chief judge for the World Trade Organization wrote,
Putin’s Russia is something considerably less than an open society. There is evidence aplenty of his decided disdain for the rule of law. A commitment to uphold the rule of law is implicit in signing the WTO treaty. Although not mandated in so many words by the treaty, conscientious allegiance to the rule of law is inherent to a national commitment to comply consistently with WTO rules.
Putin has likened the prolonged WTO accession process to an “ambush” of Russian economic interests. Evidently, he wants Russia to be able to enjoy the benefits without bearing the burdens of being in the WTO. He seeks the tariff concessions and the safeguards against trade discrimination that come with WTO membership, but he does not seem to want WTO commitments to impede unduly on his continued ability to impose the whims of what often seems an arbitrary rule.
Despite Putin’s omnipresence in Russian politics and economy, he was uncharacteristically quiet in the BP-Rosneft deal. BP trying to regain its footing after the Gulf Oil spill entered into a deal with Rosneft while ignoring their existing partners in Russia, Alfa-Access-Renova (AAR). After legal contests in London, AAR has won a major concession, Arctic exploration.
Financial Times reports of $26.3 billion in capital flight leaving Russia through April of this year. Arkady Dvorkovich, President Medvedev’s top economic advisor said,
The assessment by the president is that we did not have real progress in improving the investment climate. We need progress now in the short term. Investment is very low and capital flight is very high.
Conventional wisdom says uncertainty with the 2012 presidential election is making investors, both foreign and domestic skittish. But with little substantive difference between the tandem leadership, investors seem to reacting to Russia’s infrastructure.
Chris Barter, co-chief executive of Goldman Sachs in Russia, insists
Some kind of enduring reform of the financial and judicial system is needed because currently the rate of capital outflows is unsustainable.
Over the past week the plug seemed to be pulled on the BP-Rosneft deal, only to have the Kremlin step in and resuscitated it with a deadline extension to the middle of May. Despite government meddling in this case, there have been other signs that President Medvedev has moved further away from Putin’s managed democracy and the rule of law are taking hold.
Pavel Felgenhauer writes in the the Eurasia Daily Monitor
Russia’s tandem rulers – President Dmitry Medvedev and former president and current Prime Minister Vladimir Putin – continue to profess their friendship, but these statements are increasingly unconvincing as the presidential elections that will install a new head of state for six years come closer. In Russia elections are shamelessly rigged and results prearranged by a corrupt bureaucracy, so the nomination of an official candidate is indeed the election per se, while the casting of the popular vote is a public relations exercise, mostly intended to appease foreigners and gain international legitimacy. The present tandem arrangement with Putin as the all-powerful prime minister officially sitting in the backseat with Medvedev performing the role of a largely figurehead president cannot continue much longer, certainly not for another six years, as it is already beginning to visibly crack.
Last year, President Medvedev signed into law that those charged with economic crimes should not have to face severe pre-trial detention, however, Russia’s best known political prisoner Mikhail Khodorkovsky has been in pre-trial detention since the start of his second trial. In an appearance before Russia’s Supreme Court, Khodorkovsky won his detention appeal.
The decision was a moral victory for Khodorkovsky, who was sentenced to remain in prison until 2017 in a December ruling condemned by Western governments and rights groups, but it will not lead to his release.
Are these signs that Medvedev’s power is ascending? Ordering top government officials to step down from their directorships of large Russian owned companies has not drawn comment from Putin, who set up the system. Perhaps this is a glimpse of modernization in action, Medvedev-style.