Committee for Russian Economic Freedom

The Siberian oil fields already passed their production peak

According to Rosstat, the governmental statics agency, industrial output in January shrank by 0.8% year over year. Adjusted for seasonality and calendar effects, the output fell by 1.5% comparing with December.

Rosstat reported negative figures for industrial production for the first time since November 2009. Though many analysts explain the figure by combination of several one-time events, the slump in year over year growth rate continues the trend of 2012. Over the past year the pace of industrial expansion slowed down each month. The oil output, crucial for the stability of the Federal budget, dipped in January by 1.7%.

The Russia’s GDP most likely will continue to grow thanks to the expansion of the public sector and growth in the service sector. However, the country’s oil industry won’t be able to contribute to the economic growth anymore, dragging down the economy in the midterm. Hence the entrepreneurial activity is suppressed by the state, there is little room for any new business development in Russia. Any economic growth in such circumstances will be weak and fragile. Alas, Medvedev’s government has no power, no public support to improve the country’s poor investment climate.

Bloomberg

“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

After almost 10 years of negotiations with Turkey and Southern European countries Russia finally outmaneuvered EU. Last week Vladimir Putin gave a start to the construction of South Stream pipeline, which will deliver Siberian gas directly to the Southern Europe bypassing Ukraine. Nabucco, a EU pet-project, is now officially dead as well as hopes of Central Asian countries to export their natural gas to Europe.

The total cost of South Stream is estimated to be around 26 billion dollars. This number can only grow as it happened with other Gazprom’s elephant projects. The company won’t see any additional income from this investment, since Gazprom will just redistribute natural gas from the Ukrainian pipelines to South Stream. Nevertheless, the giant will save up to 2 billion dollars a year, a transit fee that Gazprom currently pays Ukraine. These mediocre savings obviously don’t justify huge and risky investments.

South Stream will destroy the value of Ukrainian pipeline system and Azerbaijan natural gaz reserves

In the absence of any substantial financial benefits, Gazprom can long for broader strategic advantages as a result of South Stream.

First, South Stream will help Gazprom to corner the European market by blocking the export of Central Asian gas to Europe. Though five years ago this was a rational strategy for the Russian energy giant, now it doesn’t make a lot of sense. Liquid natural gas combined with shale gas technologies will make European market more competitive anyway.

Second, South Stream will help to reduce the bargaining power of Ukraine, the largest Gazprom’s customer. After North and South Stream will reach their project capacity, Gazprom will be able to shut down natural gas transit through Ukraine. The situation of 2005-2009 when gas supply to Southern Europe was interrupted because of the Russian-Ukrainian conflict over the transit fees and gas price won’t be possible anymore. Again, this achievement doesn’t look as significant as it did five years ago. Ukraine already pays the highest price for Russian natural gas and rapidly cuts its consumption.

In sum, the project, which looked essential for Gazprom five years ago, now doesn’t bring neither financial nor strategic benefits for the company. However, Gazprom and the Russian government fail to recognize changes on the world energy market and still fight with the ghosts of the past. Influential Gazprom’s contractors won’t allow stopping the construction as well. The drop in natural gas prices combined with hopeless investment projects might destroy the monopoly sooner than EU finishes its antitrust probe against the company.

FT

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

According to the analysis of Higher School of Economics (HSE), the Economy Ministry of Russia (EMR) is overoptimistic in its projections of inflation and the economic growth.

Even the pessimistic EMR forecast results in 3.7% GDP growth in 2013, contrasting with 2.6% of HSE forecast. EMR scenario is also quite inconsistent. The government believes that Russia will continue to grow despite the slowdown in EU – the major consumer of Russia’s oil and gas.

Deputy economy minister Andrei Klepach was a specialist in forecasting before becoming a bureaucrat

The stability of the Putin’s regime rests on the prudent macroeconomic policy during the last 15 years. Alas, now the political imperatives intervene into the government’s economic analysis. In Russia, the government’s economic calculations must demonstrate the feasibility of goals declared by politicians. The gap between the economic reality and a picture made up for Mr Putin is dangerously widening. For instance, MED is planning 7.2% of investment growth next year despite the record capital outflow from the country.

Misleadingly optimistic forecasts cause inefficient economic policies. The government substitutes institutional reforms by direct financing of pet projects. The federal budget is balanced when GDP grows by 4%, but if the real economic growth is just 2% the deficit will skyrocket. Business can’t rely on the government’s economic forecasts anymore and is loosing trust in the quality of macroeconomic policy. In the face of increased uncertainty, business curbs its investment activity. As a result even 2% of economic growth will be difficult to achieve if energy prices fall.

NASDAQ

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 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

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

State controlled Rosneft acquires TNK-BP, a joint venture between a group of Russian oligarchs and BP. The newly formed company will become the largest publicly traded oil producer, controlling up to 50% of the Russian crude oil output.

The major cause of the Soviet Union collapse was the central planning system’s failure to meet even the basics needs of the country’s population. In contrast, the Putin extraordinary popularity rests on the rapid economic growth of 1999-2007, resulted from the market reforms and privatization of 90s.

BP's CEO Bob Dudley finally exits Russia with money

Now the Putin team destroys the foundations of his regime. The de-facto nationalization and monopolization of the energy sector has already cost a lot to the Russian economy. The country’s oil industry rapid rise stumbled after the de-facto nationalization of YUKOS, once Russia’s biggest and most efficient oil company. During the last ten years state-controlled Gazprom, which has an exclusive access to the world-largest natural gas reserves, has failed to develop any new large natural gas field and faced a decrease in production.

Even if they act in the best public interest, government officials have neither instruments nor proper motivation for supervising the sophisticated corporate structures. As a result, the huge cash flows of state-controlled companies become an easy prey for managers and insiders. They make fortunes on generous contracts and illogical M&A activities of such companies as Russian Railways, Transneft, VTB, Gazprom, Rosneft and many others.

When there is little room for further oil price increases, the production growth is an obvious way to sustain the country’s economic development. The energy sector opening to the international majors and private initiative would have brought new tax revenues and prolonged the Putin team dominant position in the Russian economy and politics. However, it looks like the opportunity to get access to the TNK-BP’s multi-billion cash flows outweighs all rational arguments for a new policy in the energy sector.

FT