Committee for Russian Economic Freedom

Swedish Tele2 sells its Russian arm to VTB, a state-controlled bank, for $3.55 billion while consortium of Vimpelcom and MTS, two leading mobile networks in Russia, offers up to $4.25 billion for the asset.

In a free market economy, sellers maximize price by organizing transparent auctions between potential buyers. Through the auction procedure, buyers improve their offers and a seller gets the highest possible price for his asset while shareholders control the process and push company to shop for the best proposal.

Andrei Kostin is famous on serving Kremlin's special interests

Things are different in Russia. Transparent, competitive procedures are rarely observed in the Russian market. In many cases sellers have no other choice but to sell their assets, and do it urgently. The only possible acquirer is usually known beforehand. The sum of the deal often depends on the goodwill of a buyer and “merits” of a seller. Those, who risk stepping in with a counter offer, are ignored or severely punished.

The acquisition of Tele2 Russia, the fourth largest cellular network in Russia, fits well into a pattern of a typical Russian deal. Two largest Russian telecom companies complain that they have not been allowed to participate in negotiations with Tele2. According to VTB, the parties already signed a legally binding agreement and the deal can’t be reversed. Head of VTB Andrei Kostin makes no secret of the bank’s intentions to sell Tele2 Russia in the nearest future. Most likely, the assets will be used to form a larger company with state-controlled Rostelecom or/and Megafon, the third largest mobile network provider.

Tele2 sells its Russian assets because the company’s further development has been effectively blocked by the Russian government. In the telecommunications industry regulator can easily kill a company as happened many times in the Russian wireless market. The Swedish company was allowed neither to build 4G network nor to use its 2G network for LTE.

The economic impact of the deal will be mainly negative. The effective government control over the economy will increase as well as the capital outflow from Russia. The real beneficiaries of the acquisition will be revealed pretty soon. Non-transparent, non-competitive deal procedure demonstrates Russia’s unfavorable investment climate. Investors don’t receive fair price for their assets while the growth of non-government controlled companies depends on the relationships of their owners with the Putin’s team.

FT

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.

Fox News

Mr. Brauder attracted many billion dollars on Russian stock market

On March 7 Russian police brought criminal charges against Bill Brauder, the head of Hermitage Capital, once the largest investor on the Russian stock market. The American-born investor is accused in illegal operations with Gazprom shares. Before 2004 only Russian residents were allowed to buy stock of the Russia’s natural gas giant.

The ban for non-residents on transactions with Gazprom shares created plenty of opportunities for arbitrage. Bill Brauder successfully exploited them. Back then, selling Gazprom shares to international investors generated easy money for many leading financial companies on the Russian market. The Russian government never seriously tried to stop this semi-legal trading, though schemes to outmaneuver the formal ban and operators of these schemes were well-known.

Ten years ago Mr. Brauder championed Vladimir Putin’s economic policy. Later, when Mr. Brauder switched to criticizing Gazprom for its non-transparent corporate governance, he suddenly found himself with cancelled visa in Moscow’s airport. Soon after that his shells were stolen and his lawyer, Sergei Magnitsky, died in Moscow’s police custody after he refused to cooperate with investigators. Now, as a revenge for the advancement of the Magnitsky Act in US and Europe, Russian authorities initiated investigation against Brauder himself. Even more important, major TV channels, controlled by Putin’s clan, accused the financier not only in unlawful operations with Gazprom shares, but also in tax evasion typical for all Russian companies before the YUKOS case.

The criminal prosecution of Mr. Brauder is just one more vivid example of selective and politically motivated justice that prevails in Russian courts. The timing for the investigation of the case, well-known for more than ten years, is self-explanatory. Bill Brauder, who no longer praises Mr. Putin’s wise policies, still remains his sparring partner. This time Russia’s authoritarian leader doesn’t try to lure international financial markets. Russia’s new course is self-isolation and tight control over the national elite. Mr. Brauder, an international speculator with controversial reputation, suits perfectly for anti-western propaganda. Russian authorities won’t really try to arrest him, but Russian state-controlled TV-channels will make movies about Magnitsky’s boss in order to popularize Putin’s new political and economic course. Russian businesses and citizens will bare all the costs of self-isolation. Meanwhile, international investors will find other places with risky assets to gamble on.

Associated Press

Sergei Ignatiev, the head of Russia’s Central Bank, estimates the volume of illegal capital outflow from Russia mounted to around $35bn. He believes that almost half of this sum left Russia through identical schemes organized by one interconnected group of individuals.

Sergei Ignatiev knows more than he reveals publicly

Central bank spots illegal capital outflow by financial transactions of legal entities that have no economic activity other than these transactions and don’t pay any taxes. Sergei Ignatiev explained that this illegal capital could be formed by proceedings from drug traffic and corruption.

$35bn is around 2% of Russian GDP. Most countries have a bigger share of shadow economy. More important is that almost $20bn of illegal outflows is controlled by one group of beneficiaries, and they are not shy to be visible to the Central Bank clerks. Sergei Ignatiev rarely gives any interviews and he is even more careful in his statements than his colleagues from western countries. According to Sergei Aleksashenko, a first deputy central bank governor in 90ies, Sergei Ignatiev couldn’t have made his statement without reporting his findings first to the Russia’s political leadership and legal authorities. However, no official reaction followed the interview.

According to the unnamed source of Financial Times, the financial schemes Mr. Ignatiev is talking about are identical to those discovered by Sergei Magnitsky, a lawyer who died in Moscow’s police custody after attempting to investigate the case of financial fraud. People familiar with the Russia’s autocratic regime assume that such high-scale and transparent to Central Bank capital outflow could have become possible only with the help of somebody from the Putin’s inner circle.

Sergei Ignatiev has a lot of reasons to be cautious both in his words and actions. Perhaps, the most important of them is his deputy Andrei Kozlov who was shot dead after initiating a bold crusade on money-laundering schemes in Russian banking system.

FT

“Economic freedom, private property, competition and a modern market economy, rather than state capitalism, must be the core of a new growth model”-, proclaimed Vladimir Putin in the annual Presidential Address to the Federal Assembly of the Russian Federation. However, as Mr Putin himself once mentioned, words are given to a spy to hide his real thoughts. No surprise that the most important messages of the address are hidden between the lines.

Kremlin's imperial beauty emphasizes the sacrality of the Putin's power

Despite the liberal economic rhetoric, the structure of the address reveals Putin’s paternalistic approach to solving the problems of the Russian economy. According to the President, the government should create 25 million of jobs, provide people with housing, raise salaries in healthcare and education and build infrastructure. Vladimir Putin fails to understand that it’s the private sector, not the government that hires people and builds houses. He ignores any economic policies other than direct intervention of the state.

Mr Putin defines the role of the businesses in his world: “Businesses should work to achieve their own success as well as that of the nation; and should breed talented, sensible organisers, patrons and patriots.” In fact, the President believes that business people owe a lot to the country. He downgrades entrepreneurs to “organizers”, who fulfill somebody else’s will, not generate their own initiatives. Vladimir Putin can tolerate business only when it is loyal (“patriotic”) and generous. If businessmen don’t spread their wealth around and pledge to love their motherland they can’t “gain widespread public respect”.

Whatever Vladimir Putin says, the most liberal economy he can imagine is the state capitalism. In his world, the government directs the economy, delegating to the private sector some tasks and requiring in return loyalty and generosity. Perhaps, Mr President is also willing to recommend businessmen best places to donate their money.

The Economist

Stephen Jennings is giving up control over Renaissance Capital, once a leading Russian investment bank, to Mikhail Prokhorov’s Onexim Group. In his farewell letter Jennings expressed hope that with the new ownership structure the bank he founded 17 years ago “will be much more part of the ‘system’ in Russia”. Most likely, after Jennings’ departure, Renaissance Capital will concentrate on serving the business of Onexim group.

Financial institutions are in rough waters everywhere in the world. The Russian government took advantage of the financial crisis to tighten its grip on the investment banking industry. When in 2007 state-owned VTB entered the booming investment banking industry, its aggressive recruitment practices were a first blow to the run-for-profit investment firms. Soon after that, the government unofficially instructed state controlled companies, comprising about a half of Russian economy, to hire VTB Capital as a financial adviser for important transactions. Many Russian oligarchs, often dependent from the government, also were advised to work with VTB Capital whenever possible. Besides direct backing from the government, VTB also leveraged its unrestricted access to the government funds to win business from its capital-deprived private competitors.

Jennings quits Russia after 17 years of largely successful work

Faced with decline in revenues, independent investment firms either quit the market or were acquired by state-controlled institutions. In 2011 state-controlled Sberbank acquired Troika Dialog, a leading Russian investment bank. Explaining the deal, Troika Dialog’s founder Ruben Vardanyan admitted that there was no room for non-state controlled banks in the Russian market. Last week, after several years of losses, Stephen Jennings followed the suit.

The alliance of bureaucrats, state-controlled companies and investment banks creates the machinery for structuring high-scale fraud and corruption into legal financial transactions. Now investment bankers can take any risks, knowing that the government will always back them if something goes wrong.

Besides that, monopoly in financial services could be useful in punishing bold businessmen. Recently VTB-Capital refused to underwrite bonds for National Reserve Bank just several days before the issue should have taken place. Alexander Lebedev, the politically active owner of the National Reserve Bank, had to sell his assets and cut financing of Novay Gazeta, the last but one newspaper not controlled by Kremlin.

Having access to the most intimate information about their clients, investment banks could be instrumental in tightening control both over business and corrupted officials. No surprise that nowadays all major Russian companies prefer to work through their own investment firms. Igor Sechin recently hired several prominent bankers in order to create one for his Rosneft. Likewise, Gazprombank is in charge for most of its parent company financial transactions.

Open and competitive financial markets could have foster the diversification of the oil-dependent Russian economy by enabling the flow of money from cash rich natural resource industries to new sectors of the economy. Alas, Russian investment banking is becoming both fragmented and monopolized. The quality and availability of financial services for Main Street will deteriorate, limiting the investment and economic growth.

Bloomberg

The Russian government sacrifices savings for future pensions in order to make payments to current retirees.

After the 2002 pension reform, Russia adopted a hybrid pension system. Employers’ contributions are split between individual saving accounts of employees and the State Pension Fund, which pays pensions to current retirees. However, the compulsory pension contributions are not enough to sustain two pillars of the pension system. The federal government finances the huge State Pension Fund deficit. As the share of elderly in the population increases, the need for the government support of the pension system grows. Vladimir Putin’s pre election populism increased the pension fund deficit even further.

Former finance minister Alexei Kudrin warns about the consequences of the new pension reform

To ease the burden on the federal budget, the Russian government plans to divert compulsory pension contributions from the funded pension system to the State Pension Fund. The share of the payroll tax allocated to the individual accounts will be cut from 6% to 4% of salary, while the share that goes to current retirees will be raised by 4% correspondingly. As a result, current employees won’t be able to accumulate enough savings for future pensions.

This decision provides an insight on the government’s plans. After 2020 pensions will dramatically drop comparing to the current level and the ruling party might loose support from the key electoral group – pensioners. This will happen after 2018 – the year of the last elections in which Vladimir Putin can participate. Those, who will come to power after him, will deal with the full-scale pension crisis.

Reuters

September’s research of Gaidar Institute for Economic Policy analyses the rebound of Russian economy after 2008-2009 crisis. The institute concludes that the economic growth model of 2011-2012 doesn’t work anymore and warns of the threat of a new banking crisis.

Central Bank Chairman Sergei Ignatiev needs to choose between supporting economic growth and preventing banking crisis

Consumer spending was the major contributor to the economic growth in Russia during the last two years. More than quarter of household consumption was financed by consumer credit. However, banks don’t have resources for further expansion. Their clients prefer buying dollars and transferring them abroad instead of depositing money in Russian banks. The Bank of Russia became the major provider of liquidity, but recently it tightened its monetary policy.

The inevitable contraction of consumer credit will lead to the economic slowdown. Furthermore, several indicators point to the mounting risk of a full-scale banking crisis. The share of liquid assets in total banks assets has dropped below the level of September 2008, when a previous banking crisis happened. At the same time the “credit deficit” – the difference between banks’ loans and deposits – almost equals the amount of liquid assets. In sum, Russian banking system is ill prepared for the worsening of economic conditions.

Banks will be one more time bailed out with the government’s funding and boost of liquidity from central bank. However, the loose monetary and fiscal policies won’t trigger the much-needed growth of investments, but will fuel inflation. To speed up the economic growth, the government should commit to structural and institutional reforms, restoring the private property rights and guaranteeing fair competition to all economic agents.

Gaidar Institute

Russian GDP contracted by 0.2% in July. In the opposite, inflation picked to 7% on the yearly basis, 1% above the government’s target.

According to Andrei Belousov, Minister of Economic Development, 6% of GDP growth is needed for social stability

New statistics demonstrate that even oil price of $114 per barrel can’t help Russian economy to grow. Within its current economic model, Russia needs not just high oil prices, but constantly growing oil prices. The reason for the July’s GDP fall was the stagnation of the net export and investments, but above all the slowdown of the households’ consumption.

To combat inflation, Central Bank of Russia might raise interest rates thus nocking the economy further down. In its turn, the increased government spending might bring nothing but the spike of inflation. Economy can be in stagflation for quite long before the government dares to break the vicious circle with the painful structural reforms.

However, the July spike in inflation could be caused by the coincidence of several temporary factors such as unusual drought, ruble’s devaluation and the utilities tariffs rise. But the GDP figure is much more serious. Most likely, the government will have to forget about forecasted 4% of economic growth, to say nothing about desired 5-6%, and fight for a mere 2%.

RIA Novosti

Deputy economy minister Andrei Klepach raised capital outflow estimates

Last week Ministry of Economic Development of the Russian Federation doubled its estimates for net capital outflow from Russia in 2012. The new official forecast is about $50 billion.

Huge capital outflow is not a surprise for Russian economy. The news is the officials’ tone on commenting the issue. Less than two months ago they pledged a capital inflow in the second half of 2012. Now they adopted more gloomy view on the future economic conditions. Wisely enough, the government economists don’t want to be responsible for the country’s inability to attract new investments. External conditions on the global markets and the Russia’s lack of competitiveness almost guarantee stagnation of investments in the foreseeable future.

Deputy Finance Minister Alexey Moiseev explained in his recent interview to Vedomosti, a Russian business daily, that capital outflow is a normal and even positive process. Capital outflow triggers national currency devaluation, which increases the ruble-nominated government’s incomes from export duties and improves the competitiveness of domestic business. In line with that, the Central Bank of Russia recently intervened heavily on the currency market when the ruble was gaining value, but stayed cool when the national currency was falling. In their turn, the market expectations for continuing devaluation stimulate further capital outflow.

Chicago Tribune