IT WAS ALL going so well. Russia's economic development and trade ministry had upgraded the end-of-year GDP growth forecast twice to 5.7% and economists were even more ebullient. The stock market was flying, having reached analysts' end-of-year forecast by June. And Russia had seen the first really big foreign investments since reforms started in 1991.
Then, on July 2, Russian police arrested Platon Lebedev, the man credited with rescuing Russia's biggest oil company, Yukos, from bankruptcy in the wake of the 1998 crisis, and a nasty power struggle broke out between the liberal-market-oriented Kremlin factions and the unreformed old guard. The stock market immediately fell heavily, capital flight shot up again and the threat of renationalization appeared to hang over all of Russia's leading companies.
Russia has put in a sparkling economic performance over the past two years, but the war between the two opposing factions for the long-term control of Russia's development has been an unwelcome reminder that politically nothing much has changed. And while president Vladimir Putin can take the credit for the strong
economic results, the blame for the political imbroglio also rests with him.
What had started as a routine dig at Yukos CEO Mikhail Khodorkovsky, Russia's richest man, from his enemies in the Kremlin quickly spun out of control. Instead of prostrating himself, Khodorkovsky mustered his allies in the international business community and Washington to lobby on his behalf - a move that inflamed the situation further.
As the scandal widened it has become more complicated as everyone with an axe to grind has bundled in. But the most popular theory is that the two major Kremlin factions have gone to war in a battle for control over Russia's development after the next presidential elections slated for March 2004 (see Euromoney cover story August 2003).
"It has become a fight to influence Putin's second term in office," says Sergei Markov, director of the Institute of Political Studies. "It is clear that he will win the elections, but what his policies will be and who will make up the team that will set them is still not clear."
In one camp is big business and the oligarchs; in the other the unreformed KGB colonels, interior ministry officials and the security services - collectively known as the Siloviki, or "power people", a political force left over from the communist era.
The Siloviki have been losing power steadily since Putin came to power and the terms of the debate have narrowed since Boris Yeltsin stepped down in 1999 - the start of Russia's sustained economic recovery.
No quarrel over need for economic reform
United Energy System's CEO Anatoly Chubais pointed out earlier this year that no-one was arguing over the need to reform the economy. Four years of strong economic growth have convinced everyone of the need for change and the benefits of free-market capitalism. But there is still no agreement on precisely what this means in practical terms.
"The perception of a battle between pro-market and anti-market forces is incorrect. Both wings of the 'party of power' are using different methods to gain advantage over the other in order to establish a central role in the 2004-08 presidential administration," says Chris Weafer, head of research at Alfa Bank. "But whatever its composition, that administration will follow an economic and reform agenda broadly similar to the one seen over the past three-and-a-half years, because that is what the situation clearly demands."
What is most worrying about this fight is that Putin seems to have gone back on a historical promise that underpins the oligarchs' confidence in Russia's growth. Within two months of taking power, Putin called all Russia's leading businessmen into the Kremlin in July 2000 for what has come to be called the "oligarch meeting" and struck a bargain: no nationalizations of their companies if the stealing stopped.
For most of the 1990s the oligarchs had sent cash abroad because of the threat of renationalization should the communists return to power. However, the oligarch meeting made explicit the promise of stability that was implied by Putin's victory. Both sides in the current row understand that trying to undo this deal would lead to chaos.
"Most people in the Kremlin are against revisiting the privatization of 1995 as they realize that it is a Pandora's box. To renationalize these companies would start such a huge fight for control that it would undo Putin's main achievement - political and economic stability," says Markov. "They also realize that although some KGB colonel might be more honest than the oligarchs, no-one believes he will be a better businessman."
Several political heavyweights, such as prime minister Mikhail Kasyanov and economic development and trade minister German Gref, were quick to weigh into the fight on the side of the oligarchs, saying that there would be no renationalizations.
"There have been no changes in either the government's or the president's position on the issue and there is not going to be any revision," Gref said within a few days of Lebedev's arrest.
After the initial jitters the stock market stabilized, having dropped from a high of about 520 to 450, as it became clear that the attack was Yukos-specific and that the loans-for-shares privatizations of 1995-96 that created most of Russia's blue-chip companies would not be revisited. However, the row rumbled on as Putin, the only one with the power to separate the battling factions, made only a few ambiguous statements.
What triggered off this row in the first place? The consensus is that Khodorkovsky's biggest sin was to back the main Duma opposition parties with funding in the run-up to the December parliamentary elections.
Other oligarchs, such as Interros boss Vladimir Potanin, have made a big show of supporting the Unity/Fatherland-All Russia alliance, the Kremlin's party of power, and publicly aligned themselves with the powers that be. By backing the opposition, Khodorkovsky stuck his political neck out. The other two oligarchs who have attempted this - Boris Berezovsky and Vladimir Gusinsky - are now living in self-imposed political exile abroad for their sins.