Committee for Russian Economic Freedom

Russian Productivity Lags as Alcohol Consumption Soars

Russian President Dmitry Medvedev, PHOTO: AFP

Along with the corruption and red tape, Western corporations mulling risk premiums on investments in Russia have long discounted the impact excessive alcohol consumption has had on plummeting worker productivity. But despite decades of sobriety campaigns, the Kremlin now estimates that Russians consume 32 pints of pure alcohol per capita per year, more than double the World Health Organization’s recommended maximum. Andrew Osborn of the Telegraph reports that an estimated 500,000 people die for alcohol-related reasons in Russia every year, something President Dmitry Medvedev has dubbed “a national disaster.”

So along with battling bribery, modernizing operations, simplifying regulations and creating reliable infrastructure, add reducing the number of alcohol-related “sick days” to President Medvedev’s daunting to-do list as he fights to lure crucial outside investment.

Russia Profile reported on Medvedev’s speech at Davos to convince world and business leaders that Russia is ready to do business again. However, Tai Adelaja notes that

Despite the horrendous terrorist attacks, experts say the only bug in the president’s ointment is the case of Mikhail Khodorkovsky, the jailed former billionaire head of Yukos Oil, which continues to cast a shadow on the rule of law and leave a negative impact on Russia’s reputation abroad.

Adelaja describes Medvedev’s top ten reasons to invest in Russia. Here are some reasons to disagree.

Number one: Russia has slashed the number of its strategic companies fivefold. It is no secret that Russia experienced record capital outflows in 2010 and despite rising oil prices faces huge budget gaps. The Kremlin as its self interest in mind when it sheds strategic assets. Putin’s government has a history of opening up businesses to investments to allow others to turnaround the company only to come in at the end to take the company away through trumped up taxes and other phantom violations.

Number two: Russia is set to embark on a large-scale sell-off of state assets in efforts to modernize its country. The Russian government is expected to sell $32 billion in assets by 2013. Foreign investors should remember that some of those state assets were acquired by the state through expropriation. Rosneft’s major assets came after the dismantling of Yukos; now Russian officials are asking investors to risk their capital in Russia again.

Number three: President Medvedev said is poised to create a “special sovereign fund” to attract foreign capital. This was written about in an earlier post. With corruption at all levels in Russia continuing to climb, it was a contributor to the attack at the Domodedovo airport on January 24, Russia is now the lowest ranked developing country in Transparency International’s Corruption Perception Index. Out of 178 countries, Russia is ranked 154th. With capital leakage out of the Russian economy at all levels, it is clear that the special sovereign fund will be a tool for foreign investors to give money to Russian officials. Prime Minister Putin, the leader of the power tandem, has built himself a $1 billion palace with money milked from the power vertical he created. Below are some pictures, provided by RuLeaks, Russia’s version of WikiLeaks.

For more pictures click on photo.

Reason four: Medvedev reiterated that Russia will refrain from imposing a special tax on banks and the financial sector in an effort to attract addtional capital into the country. Russia needs to do all it can to attract foreign investment. In 2010, $38 billion in capital flight was from not only foreign investors but Russian ones as well seeking higher returns for their investment. The Russian stock market, despite being in the so-called BRIC powerhouse and overweighted in emerging markets indices, has lagged the other countries in performance and carries a 30% discount in valuations from other emerging economies.

Reason five: the Kremlin is pressing ahead with efforts to transform Moscow into one of the top-ten global financial centers as part of a drive to diversify the economy away from energy exports. President Medvedev announed in May 2010 that Alexander Voloshin, chairman of Russia’s metals giant Norilsk Nickel, will be the newest member of a presidential council on financial reform and lead the conversion of Moscow into a global financial powerhouse. As we mentioned in an earlier post, Russia is not yet a member of  International Organization of Securities Commissions (IOSCO), which is a minimum requirement for international financial centers. Of greater concern is why financial centers appear and grow, to efficiently allocate capital. But with even Russian investors shunning their exchange for London, New York or Hong Kong and capital outflows reaching record numbers, it is difficult to see how Moscow can differentiate itself and maintain international market standards.

Reason six: Medvedev reaffirmed Russia’s ambition to join the World Trade Organization (WTO) and the Organization for Economic Cooperation and Development (OECD). President Medevedev has proven himself to be ambitious in words but lacking in execution. From his anti-corruption commission to fighting the terrorists who attacked the Moscow airport, Medvedev is the more articulate of the leadership tandem, but he is not the one who holds the power. Medevedev recently admitted that there has been no progress in the country’s anti-corruption progress.

Reason seven: Medvedev vowed to continue the implementation of energy efficiency programs, stressing that the state would also enourage more partnerships in the energy sector. Rosneft, the 75% state owned oil producer recently announced partnerships with BP and Exxon Mobil. BP seemed to have learned from their previous scuffles with Russian authorities that political power trumps business ones. So it has decided to leave its long-time Russia partner TNK and $990 million in dividends to join forces with Putin and Igor Sechin at Rosneft.

Reason eight: Russia is presently developing a mechanism that would help it share technology – especially military technology – with other nations.  This seems to be another tactic for selling state assets as the Kremlin tries to find additional sources of capital, even as the price of oil moves past $90 a barrel.

Reason nine: Russia continues to invest heavily in its human resources, including trying to educate future businessmen and officials abroad.  President Medvedev said at Davos, “Our task is to make Russia more attractive to foreign experts to work in.” Expat workers need to remember Yukos and its audit firm, PWC. During the politically motivated second trial of Mikhail Khodorkovsky, PWC officials were pressured by Kremlin officials to rescind their audit certification of oil giant Yukos to prove the prosecutor’s case. 

Reason ten: Russia is also pushing to interest investors in projects related to the development of sports and large athletic events in preparation for the Olympic Games. Russia is hosting the 2014 Winter Games and corruption is roaring its head as the Sochi Winter Games in 2014 is already the most expensive by far. Just today, the constructiion chief for the Sochi Olympics, Taimuraz Bolloyev stepped down as President Medvedev announced fraud investigations.

Russia started 2011 in the shadow of the Khodorkovsky trial. Judge Danilkin delivered a guilty verdict and the maximum sentence requested by the prosecutors, signalling to investors that Prime Minister Putin’s power vertical remained as strong as ever. Despite recovering from the lows of 2009, First Deputy Chairman of the Central Bank of Russia Alexei Ulyukayev recently told the press that total capital outflors will be in the $25-30 billion range. Russian investors took Putin’s retention of power seriously and looked for safer places to invest.

According to Russia analyst James Beadle:

[Russia's] economic development is the innocent victim in this domestic power play. Russia’s business leaders may understand this message but international investors don’t. They observe a distrubing dichotomy between words and actions. Putin has demonstrated that his arbitrary word is the law and that Russia’s legal system remains feudal…Russia’s popularity as a target for investment of all forms will be hindered by insecure political structures. Foreign direct investment will be the biggest victim.

Russia also faces pressure to reduce corrpution and President Medvedev has put that at the top of his agenda. Despite Medvedev’s efforts at combating corruption, Russia continues to fail to comply with the Council of Europe’s Group of Statees Against Corruption (GRECO). Out of 26 recommendations made, Russia completed only a third. Accoring to Alexei Volkov, head of the State Duma’s commission on anti-corruption legislation, change in the area of corruption requires “deep” analysis to see if “they will work in Russia taking into account our culture and tradions.” Would that be the culture of corruption Mikhail Khodorkovsky mentioned in 2010?

Alrosa, world’s second largest diamond producer, is considering a stock market flotation in 2012. Currently majority-owned by the Russian government, Alrosa is closed to outside equity investors. Despite some optimism that greater foreign investment would translate to better corporate governance, Alrosa is preparing for their float by restricting the ownership structure. This is standard operating procedure at Kremlin Inc. As we have noted before, the Russian government keeps tabs on its investments even as it looks for fresh sources of capital outside its border by restricting percentage of shares a Russian company can list abroad.

With state capitalism firmly entrenched in Russia, Alrosa maintained its production volume even as other diamond producers have scaled back. Alrosa sells its excess diamonds to the Russian government, which owns a $1 billion diamond stockpile. This indicates that Kremlin officials might have other uses for Alrosa besides the float on a foreign exchange, as another channel for top-level corruption.

The verdict for the Khodorkovsky trial has been postponed until next Monday, December 27th and it looks like the market has already priced in his continued conviction. Russian stocks remain at a 30% discount to other emerging market stocks based on forward price/earnings multiples. That the government or oligarchs own 44% of Russian equities may indicate a not just a strong government influence in business but also a lack of enthusiasm among foreign investors for Russian companies. And since 2005 the 24 stock offerings of Russian companies have returned 13%, but remove gas producer Novatek and the return falls to less than 1%. No wonder investors are in no hurry to allocate capital to Russia.

A spate of recent articles have noted a 45% drop in foreign direct investment in Russia for the first six months of this year. Although the global economy has been challenging for all economies, China’s own FDI fell 35.7% through July of this year.

Cyprus leads with investment in Russia, but it is a well-known tax-advantaged locale for Russian businessmen. The other leading countries are Netherlands, Luxembourg and Germany.

Chris Weafer, a frequent Russian economics commentator and chief strategist at Uralsib, discounted a large portion of the cited FDI figure by saying “actual non-Russian sourced FDI is currently negligible.”

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.

Moscow Times reports today that even though Russia is one of the top five places for foreign direct investment (FDI) it is not expected to return to pre-crisis levels until 2013. Russia’s economy shrink by 7.9 percent in 2009 and is expected to grow to 3.1 percent in 2010, according to analysts reports.

According to Capital Economics analysts:

[Russia] may not return to its pre-crisis levels until 2012. By contrast, the Chinese and Indian economies are expected to grow by more than 25 percent over the same period. So for now at least, Russia seems destined to remain the fourth BRIC.