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

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

Show your passport or pay a fee

Vladimir Putin proposed a set of amendments to Russian migration laws. According to the new regulation, Russian citizens will have to inform the government about the place of their residence as well as about all inhabitants living in their real estate. Otherwise homeowners will face charges of up to $230 for individuals and up to $26,500 for legal entities. Even more, in some cases property owners could be imprisoned for three years for violation of registration laws.

In the Soviet Union tough migration regulations (“propiska”) restricted people’s mobility. After the collapse of communism, the rapid development of large cities was one of the important forces beyond the economic growth. Moscow still needs more people: the unemployment rate is 0.5% while average salary in the capital is two times higher than it is in Russia. Soviet propiska prevented the formation of any agglomerations competitive with Moscow.

New rules will tie the citizens of small depressive cities to their flats. The new law is a clear signal to all Russians: the government doesn’t welcome any mobility.

The real impact of the law is remained to be seen. Russian state doesn’t have a totalitarian machine of Soviet Union and is not able to impose complete control on the country’s citizens. Most likely, the strict law will be enforced only on some special occasions. The police and migration authorities are likely to boost their cash flows from corruption. Muscovites, protesting against Putin’s third tenure, will be divided into two castes: those, who have all legal rights to live in Moscow and those who could be stopped by every policemen.

Russia Beyond The Headlines

State conglomerate Russian Technologies is selling control stake in the world-largest titanium producer through a management buyout. The deal that totals almost one billion dollars was priced at a 16% premium to VSMPO-Avisma’s average share price over the last three months. Russian Technologies will still hold 25% of the company, retaining a certain control over the company’s strategy.

What looks like an example of a successful privatization case might well be a large-scale fraud.

Sergei Chemezov is selling VSMPO-Avismo to his friends after orchestrating a fall of Anatoly Serdukov in a corruption scandal

First, in 2006 private owners sold their shares to Russian Technologies with 30-50% discount to the market price. The deal took place soon after the YUKOS case triggered a nationalization campaign in Russia. Most likely, VSMPO’s owners were forced to sell their shares to Russian Technologies, headed by Sergei Chemezov, one of the most influential figures in the Putin’s team.

Second, the current management buys the controlling stake without any competition from outsiders within a non-transparent procedure. Russian Technologies didn’t bother to organize a competitive auction in order to maximize the selling price. The status of a state corporation grants the conglomerate a right to avoid any privatization procedures prescribed by the Russian laws. Were they invited, Russian and international majors would have been definitely keen to bid for a company controlling 30% of the world titanium market. Within an auction, the premium for control typically mounts to 70-80% over the market price. In the VSMPO’s case the premium to the market price could have been even higher because the company’s current market price reflects the low liquidity of its shares and non-transparent corporate governance procedures.

Third, the management obtains control over the company with the help of the government-controlled Sberbank and Gazprombank, which provide funds for the management buyout.

To put it simple, officials first forced one group of private owners to sell VSMPO for half of its market price and then sold the company to new owners with a great discount to a fair value. Insiders’ benefits from managing and acquiring the company probably count in billion dollars. In the context of this deal the recent corruption scandal in the Ministry of Defense looks just like a media campaign to distract public attention from a real large-scale corruption.

Reuters

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

Several anticorruption probes became public in Russia last week. First, the defense minister was ousted and some of his close associates were arrested. Second, a former deputy head of the Ministry of Regional Development was arrested. Third, several high-ranked officials were dismissed in the course of investigation in the Federal Space Agency. In all these cases high-ranked officials are suspected in embezzlement of state funds.

Anatoly Serdyukov was a defense minister in 2007-2012 and served as the head of The Federal Taxation Services before that. He spearheaded the tax prosecution of YUKOS during his time in the tax office. His high-ranked associates were in the center of the tax fraud schemes, discovered by Sergei Magnitsky. According to the investigation of Novaya Gazeta, an independent newspaper, the federal budget lost around one billion dollars in such schemes. For now the investigators’ claims against Mr Serdyukov’s employees (but not himself) total three billion rubles (less than 100 million dollars). Roman Panov from the Ministry of Regional Development is suspected in defrauding the federal budget of 90 million rubles (less than three million dollars) out of many billion dollars wasted in the highly inefficient construction projects dedicated to the APEC summit.

KGB veteran Sergei Ivanov is in the center of the anticorruption campaign

The loud anticorruption campaigns don’t help to curb the corruption burden on the Russian economy. Plenty of famous cases, investigated by anticorruption activist and publicized in the media, are left without any attention from the officials. Anticorruption campaigns usually reflect the internal Kremlin fights. The real reason for Mr Serdyukov’s fall was either that he was not able to maximize cash flows from corruption or was not willing to share the wealth with his influential colleagues from the Mr Putin’s team. Charges against his associates most likely were triggered by his decline to buy the obsolete but overpriced production of the domestic defense industry.

More competitive political system is much needed to cure corruption in Russia. Free media, independent law enforcement authorities and court system are efficient instruments for combating corruption. An alternative is a dictatorship headed by a cruel but incorruptible leader – a model of governance that Russia experienced in Stalin’s years. The Putin’s Russia is equally far from the both poles of low corruption. As a result, corruption is flourishing as well as loud anticorruption campaigns.

CBS News

The Russian State Duma has approved the country’s draft federal budget for the next three years at first reading.

Defense Minister Anatoly Serdyukov won one more battle for public money

Overall, the federal budget demonstrates the government’s commitment to the responsible macroeconomic policy. The Russian government is prepared to deal with the probable drop in oil revenues, that constitute almost half of the federal government income. Russia’s huge national reserves as well as flexible currency exchange rate allow dealing with an economic crisis of any scale.

The budget breakdown provides insight on the priorities of the Putin’s team. One third of the federal government spending is assigned to defense, security and police. According to the analysis of Gaidar Institute, a leading Russian think tank, the military spending is the only part of the budget growing in real terms in 2013-2015 with the total three-year increase of 37%. In contrast, the healthcare spending will be cut by 50% from the current mediocre level.

The details on the defense budget are not disclosed: 50% of spending is secret. Assumingly, most of the money will be spent on the rearmament of the Russian military force. These huge, largely nontransparent cash flows have already provoked new clashes between Kremlin clans. Investigators from the Chief Military Investigative Directorate of the Investigative Committee (IC CMID) raided on the offices and luxurious apartments of the high-ranked defense ministry employees soon after the Defense Minister presented the military budget to the parliament.

The federal budget also demonstrates the real balance of power in Russia. The functioning of the newly elected President and his administration, a superficial body without any status in the Russian constitution, will cost in 2013 50% more than in 2012. The Medvedev’s cabinet is almost four times cheaper.

The federal budget reveals that “siloviki” and their leader Vladimir Putin will do whatever it takes in order to stay in power and enjoy the public money bonanza as long as possible.

RIANovosti

Novatek's key shareholder Gennady Timchenko knows how to explain the advantages of competition

During the VTB Capital investment forum “Russia Calling!” Vladimir Putin not only criticized Gazprom for corruption, but also stated: “We should change the economy of the company and provide access to transport systems, first of all to gas pipes”.

Russia’s president withdrew his unconditional support of Gazprom at the difficult time for the company. The European Commission attacks the monopoly within an antitrust probe. Igor Artemyev, the long-standing head of Russia’s competition regulator, criticized Gazprom as “an ineffective company” and offered his help to the European authorities. New energy Minister Alexander Novak promised to allow western majors owning oil and natural gas licenses in Russia’s Arctic waters. Meanwhile, Novatek, the second largest natural gas producer in Russia, found a way to export its natural gas, undermining Gazprom’s monopoly on the European market. Gazprom’s margins were simultaneously hit by multi-billion discounts the company had to offer to its largest European clients and almost twofold increase in the mineral extraction tax. The monopoly declares that it will abandon the development of new natural gas fields because of the tax increase, making the government responsible for the projects that Gazprom wasn’t able to develop for many years.

The new tone of the President and bold statements of his ministers might demonstrate the shift in the Kremlin’s energy policy. Though the concept of “energy superpower” maximized Gazprom’s profits in the recent years, it undermined Russia’s energy industry long-term competitiveness at the time of rapid changes in the world’s energy market.

New pragmatic policy has its influential beneficiaries. Among them is Novatek, a raising natural gas producer, where Putin’s old friend Gennady Timchenko owns 25% stake. Natural gas ambitions are also declared by Igor Sechin, another Putin’s old friend and Rosneft’s CEO. In sum, new energy policy will create opportunities for the president’s friends, boost government’s income and, perhaps, improve relationships with the European partners. It remains to be seen whether competition among Putin’s friends is enough to foster economic growth in Russia.

Gazeta.ru

In 90-ies Putin was responsible for the international economic ties of Sankt-Petersburg

Vladimir Putin signed a decree about “Measures to protect interests of Russian Federation in the international trade of Russian companies”. According to this order, Russian “strategic” companies, including Gazprom, Rosneft, Aeroflot and many others, will need to get government’s approval on their pricing policy abroad, any M&A activity and particularly on releasing any data about their business to the foreign regulators.

The largest Russian companies won’t be able to operate efficiently on the global markets under this order. They will need to discuss their every move abroad with the bureaucrats in Moscow. In fact, top managers of the “strategic” companies will turn into assistants of the government’s officials, who, in their turn, can’t do anything without an approval from the President’s administration, a de-facto parallel government. This highly centralized decision making system will be even less efficient than Soviet style planning because there is no plan in place, no vision of the future.

Putin is willing to stay in power at any costs and he is not sensitive to the tremendous economic damage the new regulation will bring to the leading Russian companies. His recent initiatives distinctly demonstrate that he is keen to unbundle the economic interests of the ruling class from the West in order to secure more freedom for harsh measures inside the country.

First of all, the new regulation is designed to protect some shadow activities of the Russian state-owned corporations. For instance, Gazprom is known for using nontransparent schemes in its European trade. Within one of the most famous schemes the monopolist was selling natural gas to Ukraine not directly, but through the firms of Dmitry Firtash, a person with a controversial reputation. The documents, disclosing the details of such schemes and their real beneficiaries, could fall into hands of European regulators during their numerous raids on the European offices of Gazprom.

Second, Putin hopes to tight control on the ruling class through restraining its international business. Based on his own experience as a head of the Sankt-Petersburg’s economic cooperation committee in 90-ies, he might believe that one can trust nobody working in this sphere. He probably wouldn’t trust even himself.

Reuters

During APEC summit in Vladivostok, Vladimir Putin actively promoted railways as a convenient route for the Asian goods to the European markets: “Baikal-Amur Mainline and Trans-Siberian line allow to halve both cost and time of transportation”.

Old friends always have something to talk about

Meanwhile, the average speed of moving goods by Russian Railways decreased by 10% in 2011 and the monopoly faced numerous charges from its underserved clients. In 2012 it failed to transport flawlessly oil, the major Russian good. In 2003-2012 the total length of the main lines in Russia contracted; no new lines were constructed in 2011. At the same time, the average cost of moving of one tone of goods for one kilometer by railways in Russia is approximately two times higher than the cost of moving goods by railways in US.

However, the company is in good hands. Vladimir Putin’s old friend has been managing the monopoly since 2003 first as a senior vice president and since 2005 as a president. After more than ten years of reforms, the company still doesn’t control its costs, can’t attract private capital and depends on the government subsidies. Nevertheless, the board compensation grew by astonishing 37% in 2011.

The major achievements of the monopoly’s president Vladimir Yakunin are not in the company itself, but nearby. The business of Russian Railways privileged partners is thriving. According to the Reuters Special Report, Andrey Yakunin, the son of Russian Railways president, is one of such success stories. While Vladimir Putin keeps public attention on building new routes from Asia to Europe, his friends are safe to make their business.

US News