Garry Kasparov

United Civil Front leader Garry Kasparov writes in the Wall Street Journal today that given Vladimir Putin’s repression of his own people and the way he cozies up to dictators (Chavez, Assad, Lukashenko), the U.S. should not be interested in a strategic partnership with the Kremlin.

Rather, he writes, U.S. lawmakers should do what they can to promote human rights in Russia, namely through the  passage of the Sergei Magnitsky Rule of Law Accountability Act, which would “bring visa and asset sanctions against Russian government functionaries culpable of criminal and human rights abuses.”

Read Kasparov’s entire op-ed here.

Natalia Orlova

The Moscow Times reports that market analysts in Russia are anxiously awaiting President Vladimir Putin’s picks for cabinet before prognosticating about the Russian economy.

Investors are waiting to see if Putin’s choices for top economic posts are serious about implementing the reforms necessary — stopping corruption, respecting property rights,  tamping down the bureaucracy – to instill confidence in both domestic and foreign investors.

Alfa Bank chief economist Natalia Orlova told The Moscow News’ Natasha Doff:

The litmus test will be the announcement of a new cabinet and how committed the new team will be to reform. Putin has presented his goals, but the question of who will make sure the goals are implemented depends on the composition of the cabinet.

Deutsche Bank economist Yaroslav Lissovolik added: ”A specific list of priorities that may encapsulate a short-term reform program [...] is the biggest question mark for investors and it is something that will probably ultimately decide the overall vector of the stock and financial markets this year.”

After last December’s rigged Duma elections and post-election protests, investors pulled out of the market in droves, citing political uncertainty.

Earlier, the offshore exploration partnership had announced that it would invest upward of $500 billion in developing Russia’s vast energy reserves in the Arctic and Black Sea, where hydrocarbon reserves are estimated at about 85 billion barrels in oil-equivalent terms.

“Today really is a historic day,” said Rex Tillerson, CEO of Exxon Mobil, at the signing ceremony. “It marks the beginning of a new and broader relationship between our companies.” Igor Sechin, former Rosneft chairman and the architect of the deal, pointed out that the enormous potential for the U.S.-Russia cooperation could help the countries “overcome [their] over-politicized relationship.”

While the oil majors celebrated these achievements, some analysts pointed out that the deal represents Rosneft’s official legitimization of the assets stolen from Yukos and its shareholders, including hundreds of American investors.

Founder of the Committee for Russian Economic Freedom Pavel Ivlev has criticized Exxon’s decision to work with Rosneft. In his statement, quoted by the Financial Times, he said: “As it becomes a key partner to a Kremlin-run concern, Exxon can either play a formative role in pushing for much-needed rule of law protections in Russia or it will bear responsibility for abetting the Putin regime as it launders its ill-gotten gains and seeks to expand its personal wealth at the expense of the Russian people.”

Former Yukos CFO and CREF’s expert Bruce Misamore responded to the news with an op-ed in the Moscow Times. “Exxon is investing with a company whose largest assets were stolen from Yukos shareholders by the Russian government. What is ‘legitimate’ about theft? […] There is no doubt that [former Yukos] shareholders would not agree with the Kremlin’s toadies that any form of ‘legitimization’ whatsoever has occurred,” he wrote.

In a letter to the editor of the Washington Times, Misamore also noted that in September 2011, the European Court of Human Rights ruled that the tax and legal actions that led to Yukos’ forced bankruptcy were illegal. Today, former Yukos assets comprise up to three-quarters of Rosneft’s value.

According to Misamore, “The court has asked both sides to begin “just satisfaction” negotiations, which, in effect, means a price tag will be placed on Russia’s penalty. Yukos will soon submit its significant request for reparations, and the ball will then be firmly in Russia’s court.”

In other words, Exxon and other foreign investors must be very brave to be doing business with the Kremlin. They seem well aware of the risks. They should keep in mind that if justice is restored and the stolen assets are ever returned to Yukos, the reparations for its shareholders could be collected from Rosneft’s partners.

Some 81 percent of the respondents to a national poll conducted mid-March said the level of corruption in the country is “high,” up from 75 percent in 2010. Forty-three percent believe corruption cannot be eradicated, as opposed to 39 percent who said it can be eliminated one day.

Meanwhile more than a third (35 percent) of the Russian electorate said they could not judge the work of President Dmitry Medvedev after nearly four years. (Imagine a third of the U.S. population not being able to judge a president’s job after even four months.)

Even more telling, 72 percent of the respondents said they saw no difference between the policies of Medvedev and his presidential predecessor / successor, Vladimir Putin.

Read more about the polls here.

Mikhail Khodorkovsky

Deutsche Bank’s head of research and strategy for Russia Yaroslav Lissovolik wrote in a note that the odds of Khodorkovsky being granted parole are “significantly higher than any time in the past,” according to Bloomberg News.

“Releasing Khodorkovsky would boost Russian stocks five percent to 10 percent,” he added. The chief strategist at Troika Dialog also said he puts the odds of an early release for Khodorkovsky at 50-50.

Earlier this month Russia’s Presidential Council on Human Rights urged President Dmitry Medvedev to pardon Khodorkovsky ahead of Prime Minister Vladimir Putin’s inauguration, scheduled for May 7.

Medvedev did order Prosecutor General Yuri Chaika to review the guilty verdicts against Khodorkovsky. Chaika has until April 1 to present his findings.

Although shares began the week with a slight rise, the violent arrests of hundreds of protesters caused the RTS Index to sag by 4.4%, while U.S.-traded shares slid the most in three months.  Bond market yields on Russia’s 2020 dollar bonds fell to their lowest since they were issued in April 2010, while the ratings agency Fitch announced that it would re-evaluate its outlook for the country.

These developments are in many ways counterintuitive.  Money doesn’t care about democracy, human rights, or freedom of expression; it is instead attracted to stability, predictability, and opportunities for growth.  On the surface, having 16 continuous years of the same leader in Russia would seem like the definition of stability, but upon closer examination, there is actually very little continuity of the 2000-2007 boom that brought Russia into the ranks of the BRIC economies.

First, there have been key changes in the administration’s staff, with the notable departure of Finance Minister Alexei Kudrin, the individual who has been credited with building up Russia’s foreign reserves.  Mr. Kudrin was not removed from his post over performance, but instead tendered his resignation last fall because the Kremlin continually ignored his warnings that the administration was over-exposed.

Alexei Kudrin

“Over several months, despite my numerous objections, public and otherwise, decisions were taken regarding budget policy which undoubtedly increased the risks to budget execution,” Kudrin wrote in his resignation statement last September.   “These risks [would] spread inexorably to the whole national economy.”

Unfortunately, there is little indication that the Russian government has heeded Kudrin’s warnings, and have instead further over-extended fiscal commitments while remaining overwhelmingly dependent on oil prices and subject to future price swings.

Because of the deepening unpopularity of Vladimir Putin prompted by the protest movement, he was compelled to extend extravagant populist spending promises in order to shore up support for the election, including pay raises for all public sector workers.

Although in a recent speech, Putin said that his new spending promises would not exceed 1.5% of annual GDP, independent sources say otherwise.  An independent assessment by Capital Economics calculates the total bill for election-related promises will be even higher, reaching 4.8 trillion roubles ($165 billion) per annum, or 4-5% of GDP.  Meanwhile, Fitch Ratings points out that the new defense, healthcare, public wages spending are unsustainable:  “If delivered, these increases could cost $160 billion, or 8% of projected gross domestic product (GDP), over his six-year term (…) pushing up the fiscal breakeven oil price to around $117 per barrel for 2012.”  These unfunded fiscal commitments will soon put significant pressure on the stabilization fund, which will quickly gnaw away at investor confidence.

If foreign investors believe that another go-around with Vladimir Putin means a reduction in political risk, they should run the numbers.  In January and February of this year, spending rose by 37% compared to a year earlier. That’s more than twice the 14% increase previously budgeted for 2012 – itself more than double expected inflation of 6%, while the implied expectation that oil stay well above $117 a barrel represents a seriously risky bet.

During the presidency of Dmitry Medvedev, who, despite being constrained by the looming veto of the prime minister, there was an emphasis placed on economic modernization, as the government pursued policies to build innovation capacity, higher education, technical training, and special tax incentives to attract research and development investments.  Under Putin, we can expect such efforts to diversify the economy to be halted and reversed, while dependency on oil exports deepens even further.

Justin Burke of EurasiaNet has argued that Putin has had very little success in moving Russia away from oil.  During his tenure, “The performance of knowledge-based economic sectors have experienced declines,” he writes.  “The share of equipment and machinery, for example, fell from 10.9 percent of all exports in 1999 to 4.5 percent in 2011. Meanwhile, exports of chemical products declined from 8.5 percent of overall exports in 1999 to 6 percent in 2011.”

Adding to these basic structural challenges, most analysts believe that Putin’s strident anti-American and anti-Western outlook will contribute to a deterioration of diplomatic relations among trade partners, further reducing its opportunities to reach new markets through its new status as a World Trade Organization member.

Many bankers maintain a rosy outlook on Putin’s ability to competently manage the economy, however, these same analysts concede a direct tie between their confidence in the Russian economy and the strength of the protest movement, which alone should be cause for concern.

In an environment of growing opposition, unpunished corruption, and unsustainable fiscal exposure, the investment community would be wise to revisit the “stability narrative” and realize that today’s Russia is a different world from the last Putin administration.

James Kimer is president of K Social Media Solutions.

Nouriel Roubini

NYU economics professor Nouriel Roubini is predicting that Russia faces a “lost decade” economically when Prime Minister Vladimir Putin returns to the presidency this spring.

Tai Adelaja reports in the Moscow News that Roubini, who met with Putin earlier this month, is highly concerned with the Russian economy’s continued reliance on commodities like oil and natural gas and with its leaders’ inability to do more than pay lip service to much needed institutional reforms.

London-based Capital Economics notes that even if Putin were to follow through with his campaign pledges, it would cost the Russian government more than $160 billion by the end of his next president term. That would raise the oil price that Russia needs to balance its federal budget from about $117 per barrel at present to $130 per barrel.

All this means that Russia is likely to fall behind its BRICS counterparts in development with Putin leading the nation, as he won’t be able to “shake the Russian economy out of its doldrums,” Roubini said.

Adelaja concludes:

Roubini believes that Putin’s ambitious plan to accelerate growth by 6 percent or 7 percent over the next 10 years is unrealistic. While efforts to intensify reforms could bring some economic effects, they are bound to stumble on problems like aging infrastructure and poor investment climate, he said.

Alexei Kudrin

Former Finance Minister Alexei Kudrin and other prominent economists are rejecting calls from Prime Minister Vladimir Putin to levy a one-time tax on Russian business leaders who participated in the privatization deals in the 1990s.

Should the government implement this tax, Kudrin writes, “The legal and economic environment would deteriorate. If the privatization deals struck 17 years ago are encumbered, this would undermine new privatization and ownership rights as a whole.”

University of Houston business professor Craig Pirrong says there’s no reason to believe that extracting fines from those who profited during the rush to privatization would be a one-time thing. As Pirrong writes on Seeking Alpha, “As any victim of blackmail or a protection racket knows, the demands for payment never stop.”

He continues:

There is no dispute that there was a massive transfer of wealth from the public domain into private hands in the 1990s. […] But sunk costs are sunk. […] What Putin should be concerned about is the future, and this proposal […] will damage Russia’s future prospects. For it emphasizes the principle […] that property is held at the sufferance of the state, and is subject to the whim and caprice of the strongman.

Craig Pirrong

Economists say the privatization tax may suppress investment and encourage further capital flight.

And given how the rush to privatization has allegedly enriched Putin and his inner circle (more than almost anyone else), it’s not as if he and his cronies would to pay a fine themselves.

Instead, Pirrong concludes, Russia needs “more institutions, a real rule of law [that] constrains government fiat, and less unconstrained discretion in the hands of Putin and his ilk.”

Sergei Magnitsky

Courtney Weaver of the Financial Times reports that, in a development that defies words, Russian investigators are planning to posthumously prosecute Sergei Magnitsky, the Hermitage Capital lawyer and whistleblower who uncovered a $230 million fraud, only to be locked up in Russian prison, where he died after being beaten and undernourished.

Some Kremlin observers believe, and Interior Minister officials have acknowledged, that this prosecution is a way for Moscow to counter the various legal actions being brought by Magnitsky’s family and Hermitage Capital against those responsible for his death. But Hermitage chief Bill Browder believes a formal case against Magnitsky would have the opposite effect:

The lack of concern about how this appears abroad is astounding. This will only harden the position of foreign governments and parliaments who we have approached to impose sanctions across the world.

The implications extend to the investment community, which remains concerned that baseless actions like these demonstrate “the gap between Putin’s [pro-reform] rhetoric and reality,” said Tom Mundy of Otkritie Capital in Moscow.

Putin has been working overtime to attract foreign investment but has yet to see the fruits of his labor: the Russian equity market, Weaver writes, “still trades at a price-to-earnings ratio of 5.4, a 47 percent discount to the MSCI emerging market index.”

Click here for the New York Times article on the potential Magnitsky trial.

(Ratings are calculated by subtracting the percentage of pessimists from the number of optimists. Negative numbers indicate more pessimists than optimists).

What is causing this lack of confidence on the economic front?

“The sharp drop in economic optimism in the fourth quarter after Vladimir Putin’s decision to reclaim the presidency next year is positive proof that the political situation plays a role,” said Elsa Bikchurina, a senior analyst at the Solid Investments financial company.

“Right now, small and medium-sized businesses are extremely cautious and unwilling to take chances” since they have “no clarity as to what the future holds,” added Dmitry Orlov, the core shareholder and CEO of a mid-sized bank Vozrozhdeniye.

For IBR’s survey owners and directors of 100 small and medium-sized Russian businesses interviewed.