Committee for Russian Economic Freedom

Time magazine’s Simon Shuster today posted an article about young Russian entrepreneurs fleeing the country. The piece features a 22-year-old tech guru named Alexei Terentev, whose web hosting company, NKVD.pro, is now valued in the millions of dollars. But thanks to a business climate marked by fraud and fear, the economic activity Terentev’s company is to produce will not be benefitting his homeland: Alexei left Moscow for the Czech Republic to develop his business and hasn’t looked back:

The reasons for his move, as well as his haste, are the typical worries of the young entrepreneurs […]: corruption and bureaucracy, the forces that are driving the biggest exodus since the fall of the Soviet Union. […] Now the country is stable and the cities are thriving. But small-business owners seem to feel less safe than ever.

Shuster cites data that shows Russians paid nearly $600 million in bribes to authorities for “security provisions,” in 2010 – 13 times more than in 2005 – and then describes the calamity that befalls business owners if bribes aren’t paid: visits from inspectors, auditors or the police until the company is overwhelmed. If that doesn’t work, expect a corporate or government raid to follow, as was the case in 2000 for NTV television or in 2003 for Yukos Oil.

Earlier this year, Agava, one of Russia’s leading web hosting companies was raided by police, its server farm raided just weeks later. And this is happening , Shuster writes, while the Russian government is trying to enlist businesses to move to Skolkovo, Russia’s notional version of Silicon Valley. But the businesses that have signed on for Skolkovo are, not surprisingly, having trouble recruiting talent.

To drive the point home, Shuster quotes a California venture capitalist, Alexandra Johnson, who advises Russian businesses. “You need an entire ecosystem to support innovation,” she says. “You need incubators, entrepreneurship, managers to run the businesses. You need the rule of law. Many elements of this ecosystem are still missing in Russia.”

Read Shuster’s full article here.

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.

Alexey Navalny, Los Angeles Times

Alexey Navalny speaks with Sergei L. Loiko of the Los Angeles Times about his efforts to uncover corruption in Russia. His profile has recently been elevated as Russian authorities take note of his efforts by opening a criminal fraud case against Navalny.

What’s your advice for those thinking about investing in Russia?

On the whole, investments in Russia may be profitable, and I am in no case warning against investing in Russia. But the gains for investors could be significantly higher if Russian companies were at least abiding by the basic rules of corporate management employed in the West. Investing in Gazprom [the state natural gas monopoly] could yield profits too. But if we made some basic steps aimed at curbing corruption within Gazprom, the company’s worth would rise by about 30%.

In practice, investors have no possibility to influence major Russian companies’ performance and receive information about it. My associates and I have spent three hard years constantly trying to get the basic documents about the performance of big companies such as [oil firms] Rosneft and Transneft. Finally we got a court order that the most basic documents be opened to us. But as a rule, the information about the work of such companies still remains a closely guarded secret.

When did you start to work to expose corruption?

It all started about five years ago as I realized that I needed to do something to safeguard my personal investments. The most interesting investment venues in Russia are oil- and gas-sector companies. These are a bunch of so-called major companies in Russia. Some of them are formally private, but they are all under state control. When I started to invest in those companies, I quickly saw that the dividends were very small while their management were leading luxury lives in their lavish villas in France, Spain and so on.

How seriously has corruption infiltrated the power hierarchy of Russia?

Russian power structures are corrupt inside out. People who don’t become part of corrupt schemes cannot efficiently work within the Russian government.

What are your thoughts on a fraud case opened against you by the Russian Investigation Committee?

It is a purely political and completely falsified case initiated at the very top. None of the cases I initiated have ever reached that level of attention. The Kremlin [leaders are] very irritated by the fact that they cannot control my blog in any way, [so they are responding,] be it scare tactics, a system of licensing or blunt money. I know they can do anything to me if they want.

It is the risk that comes with my job. But I am ready to take that risk. We have already received anonymous telephone calls with threats unless we drop our investigations. They have been digging dirt on me all this time and have come up with such a flimsy case in which they are not even accusing me of embezzling the money but just fraudulently causing some damage to an obscure provincial company. They want to scare me. For them the best outcome would be if I emigrate. But I will not give them that pleasure. I choose to stay and face the risks.

People who fight corruption in Russia take great risks. I am prepared to take these risks to make life in our country better. I will continue to do my work against all odds.

Deputy Prime Minister Igor Sechin, Russia’s top energy official and one of Prime Minister Vladimir Putin’s closest political allies, offered valuable insight into the nation’s investment climate during a rare interview with the Wall Street Journal. Sechin portrayed the risks that fueled an estimated 25 percent decline in direct foreign investment last year as strengths. Remarkably, Sechin asserted that the controversies involving Yukos, Hermitage Capital Management and the troubled BP/OAO Rosneft deal prove Russia is a safe bet for investors. Hermitage CEO William Browder responded that Sechin’s assessment will further erode investor confidence.

The risk of losing one’s business in Russia today is real. But it is not the greatest risk investors face. Investors in Russia risk losing their lives.

Reason One: Chances are you and your clients will lose money.

Russia is “one of the world’s riskiest locations for business to invest in,” according to a survey of 196 nations by U.K risk-assessment company Maplecroft. Russia is the 10th-riskiest country for investors, sliding from 15th last year to place between Pakistan and the Central African Republic, concluded Maplecroft’s annual Political Risk Atlas released in December 2010.  Brazil, India and China, which along with Russia make up the so-called BRIC group of leading emerging-market economies, are ranked 94th, 26th and 62nd, respectively. Russia’s “poor performance is compounded by its ‘extreme risk’ ratings for its business environment, corporate governance and the endemic nature of corruption, which is prevalent throughout all tiers of government,” Maplecroft said.

Reason Two: Russia is the world’s most corrupt major economy.

Little surprise that Russia is also the world’s most corrupt major economy, according to Transparency International’s 2010 Corruption Perceptions Index issued in October, sliding to the 154th spot of 178 countries and placing it alongside Tajikistan and Kenya.

Reason Three: Even President Medvedev says conditions are “very bad.”

Following the conviction of former Yukos CEO Mikhail Khodorkovsky on a second round of trumped up charges in December 2010, President Dmitry Medvedev noted that only 14 companies went public on his country’s market in 2010. “This is nothing to be proud of,” Medvedev told business leaders. “Part of the problem is, of course, is our investment climate, which is bad. Very bad.”

Reason Four: It’s not worth the hassle and you could wind up in jail or worse

The conviction of former Yukos Chairman Mikhail Khodorkovsky’s on a second round of trumped up charges in December 2010 may have “unintended repercussions” for business in Russia, state-controlled VTB Capital said Dec. 31.The “most disturbing detail” was the court’s rationale for the verdict, VTB said. Charges based on Yukos’s use of internal transfer pricing, which redistributes cash flows among units of a holding company, creates a precedent that leaves other businesses open “to attack.” Meanwhile, lawyers in the U.S. are racking up massive billable hours representing corporation and their board members fearing prosecution under tougher Foreign Corrupt Practice Act enforcement. Moreover, CEOs are feeling pressure from board members and shareholder groups to avoid the financial and legal nightmare associated with getting entangled in corruption scandals in Russia and elsewhere. And anyone thinking about investing in Russia ought to remember what happened to corporate counsel Sergey Magnitsky when he tried to defend investor rights in Russia – he died under brutal conditions in a Moscow jail.

Reason Five: Small investors lose, too

Only the the bravest, or most foolhardy, of small investors would consider wading into the Russian swamp, Brian Milner wrote in the Globe and Mail, citing Peter Zeihan of Stratfor, a global intelligence firm based in Austin, Tex. “Russian law, when it comes to portfolio investments, is at best inconsistent,” Zeihan said. “I don’t think we’re ever going to see a rebound of activity to the levels we saw in 2006-07. Too many people have been burned.” Russia, Zeihan said, “is not a global player economically in any way, with the exception of energy sales to Europe. That’s all they’ve got. I don’t mean to say it’s small, but it’s certainly narrow. And the Europeans, to be perfectly blunt, are pretty sick of the Russians. So any time there’s a decrease in demand in Europe, the first importer that gets cut is Russia.” The country, he says, is “in a long, slow twilight. They’re going to have a couple of great years while the Europeans are in a mess. And they have relative strength because the Americans are distracted in the Middle East. But they realize that they’re on borrowed time.”

Reason Six: The Russian equity market’s bad reputation is priced in

There is little doubt that Russia has a poor image and this is probably why its stock market is one of the most lowly-rated of the emerging economies, with an average price-to-earnings ratio of about seven or eight times, the Moscow Times reported.

Reason Seven: Putin’s vendettas hurt the economy and scare away investors

Arkady Dvorkovich, the Duke University-educated aid to Medvedev, said that “a significant part of the international community will have serious questions” about the Khodorkovsky case and that “the assessment of the risks of working in Russia will increase.” Moreover, Roland Nash, co-founder of Verno Capital and a 16-year veteran of doing business in Moscow, told journalist Chrystia Freeland that the Khodorkovsky case had exacted a real, quantifiable economic cost. “The Russian equity market would be worth several hundred billion dollars more if it weren’t for the critical Western perception of Russia, and the Khodorkovsky case is the principal example of that perception,” Nash said. “Within Russia, everyone who matters understands exactly what the Kremlin is trying to say: that there is no one above the rule of the Kremlin.”

Reason Eight: The smart money is going out, the dumb money is going in.

The unreasonably harsh punishment of unbreakable Khodorkovsky and Lebedev shows that this system has grown so thoroughly corrupt that by trying to prove its power it actually destroys its credibility

analyst Pavel K. Baev argues. This disappointment translates into re-evaluation of business and investment prospects in the country of self-serving bureaucracy – and into capital flight that increased sharply in the last months of 2010. In 2010, total captial outflows from Russia amounted to $38 billion. President Medvedev quite possibly doesn’t understand that the Khodorkovsky case is not a minor setback for the markets, as it was five years ago, but the irrefutable verdict for his ‘modernization’ agenda.

Reason Nine: Russia is a sucker’s bet

According to Peter Cohan, president of Peter S. Cohan & Associates, a management consulting and venture capital firm:

Russia is under the illusion that it can use PR spin to dissipate investors’ concerns about its past abuses of capital providers and convince new suckers to invest there. The fate of Khodorkovsky is one particularly unpleasant example. Three cases of Russia’s hostility to outside investors:

• How Russia used its legal system to kick out BP executives, including Bob Dudley (now BP CEO), from an energy joint venture
• How Russia offered the founder of Hermitage Capital, an investment firm that had placed capital in Russia, the option of his life or his money
• How Sawyer Research, a small Cleveland, Ohio, company, lost its $8 million investment in a Russian quartz plant to “creeping expropriation”

The simple reality is that investors may get seduced into a country by high growth rates, but if that growth should slow, the country’s bones will poke through.

Reason 10: Russia will remain backward as long as Putin thwarts modernization

Putin has used the second Khodorkovsky show trial to make clear that he is unwilling to ease his informal authoritarian style, even as Russia seeks a path toward modernization, according to James Beadle, an independent investment consultant and a founding partner of the financial blog Market Melange wrote in an op-ed:

Economic development is the innocent victim in this domestic power play. Russia’s business leaders may understand the message, but international investors don’t. They observe a disturbing dichotomy between words and actions. Putin has demonstrated that his arbitrary word is the law and that Russia’s legal system remains feudal. But once again, 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. Learning from Yukos, as well as Shell, BP and many others, companies will be hesitant to invest in long-term fixed assets as long as the government’s word is the only guarantee that their rights and property will be respected.

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.

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.

President Dmitri A. Medvedev, in a Soviet-built luxury car, with Gov. Arnold Schwarzenegger.

As a counterpoint to President Dmitry Medvedev’s visit to Silicon Valley back in June, California Governor Arnold Schwartzenegger was invited to visit the Skolkovo, the new business school started by Medvedev to encourage high tech innovation with ambitious Silicon Valley aspirations. Despite intense support by the Russian political and business elite, incubating entrepreneurs in Russia face bureaucratic hurdles to success.

As part of Medvedev’s push to diversify the economy, he has launched an anti-corruption campaign but the results have demonstrated the systemic nature of corruption in Russian society. Recently, Yury Chaika the Prosecutor General has announced that the average bribe increased 30% from last year from 30,500 rubles ($1,015) to 23,100 rubles. At a meeting of the heads of the law enforcement agencies, Chaika exhorted his colleagues, “In 2008 and 2009, we saw a significant revival of work in this area, but the results of the activities of law enforcement agencies in the first half of this year confirm complacency and a decrease of effectiveness and quality of work.”

At the capital markets level, a disappointing IPO market this year reflects the lack of progress in strengthening the rule of law, scaling back government intervention in business and allowing greater political expression. So far, the Russian IPO market has totaled only $3 billion this year, of which $2.2 billion is made up of the Rusal IPO on the Hong Kong Stock Exchange in March. This is only a tenth of the $20 billion IPO market predicted earlier this year by sell-side analysts.

Although markets have been volatile, the Russian stock market has posted a 5% gain this month along with gains by other emerging markets powerhouses China and India. However valuations on the RTS Index are trading at an average multiple of 7 times 2010 earnings where other emerging markets are seeing an average of 13 times earnings. This is the inherent risk premium for businesses doing business in Russia as investors seek safer harbors for their assets.

Transparency International’s 2011 Corruption Perception Index is to be released next Monday, October 25 and it will be telling whether Russia improves or inches ever closer to the likes of Sierra Leone and Zimbabwe.

Jailed Russian businessman Mikhail Khodorkovsky and Hermitage Capital’s Bill Browder know all about doing business in Russia and how successful businesses can be run aground by the capricious whims of government officials. Khodorkovsky’s second trial is approaching its end and despite the trappings of a functioning judicial system, the ultimate decision maker of his fate rests within the Kremlin.

Investors should also heed the fate of Sergey Magnitsky, Hermitage Capital’s attorney who refused to give in to corrupt tax officials only to pay with his life. Recently, both US houses of Congress introduced the “Justice for Sergei Magnitsky Act of 2010”, which is not only symbolic but hits his perpetrators in their pocketbooks. The bill prevents Russian officials implicated in Sergey’s murder from entering the United States and freezes their assets here.

When introducing the bill, US Senator Benjamin Cardin said,

“Nearly a year after Sergei’s death, the leading figures in this scheme remain in power in Russia. It has become clear that if we expect any measure of justice in this case, we must act in the United States…At the least we can and should block these corrupt individuals from traveling and investing their ill-gotten money in our country.”

Although Russia is a tempting place to invest in new business with their highly educated population and large reserves, you should take caution to the promises offered by President Medvedev. He has promised much but delivered little during his term and with the 2012 presidential elections coming up, the winds are blowing against his direction and even his meager declarations of modernization, transparency and accountability may come to an end.

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

The 2010 St. Petersburg International Economic Forum will start next week on June 17. This is a key capital markets event for investors, business people and policymakers and supported by the Russian Federation. Talk about the economy and banking is everywhere. This neatly dovetails into Russia’s own focus on economics as the main engagement point with other countries, especially those in the G20. Below is a letter from CREF’s Chairman Pavel Ivlev to forum attendees.

CREF Chairman’s Letter to St. Petersburg Economic Forum Attendees