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"The only business in
Russia is politics," said Russian oligarch Mikhail Khodorkovsky.
When he made this comment two years ago, it was true. But the
devaluation of the rouble on August 17 1998 destroyed the so-called
Russian oligarchs and broke their hold on power. Average incomes
have tumbled, life expectancy has begun to fall again and hundreds
of small and medium enterprises have been killed off.
With a depressed economy, those in power scrambled to grab
what little money was available. Russia is now the riskiest country
in the world for investors and ranks among one of the most corrupt.
The government has become more intrusive, returning to the
principles of central planning in some sectors. Shareholder and
investment rights abuses are now more blatant as businesspeople,
facing an unpredictable future, have sought to consolidate their
control over the best companies and businesses while they can.
The picture is bleak, but not hopeless. Devaluation has also
forced a much-needed restructuring on Russia. With a cheaper rouble
and an absence of imports, the balance of payments has improved and
Russian industry, smothered for nearly a decade by an overpriced
rouble, has been booming.
Many of the banks and firms have collapsed, but those that
remain are leaner and more commercial as competition increases.
While politics is still profitable, many companies have seen that
money can be made from business alone.
The rise in international commodity prices, especially oil,
has put Russia on a solid financial footing. As long as oil prices
do not fall again, Russia will no longer need to depend on IMF and
World Bank handouts.
For the first time since 1991 the economy is growing, albeit
from a low base, and despite, rather than because of, government
policy.
With historic parliamentary and presidential elections over
the next six months, politicians are distracted by electioneering
and the war in Chechnya, and have left the economy on autopilot.
All attempts at reform have stopped. Whether they will be started
again, and what shape they will take, depends on which leader the
people elect.
Banks
Russia's financial sector was the most sophisticated part of
the economy and the worst hit by devaluation. The dominant banks at
the centre of Russia's financial industrial groups (figs) belonging
to the seven so-called oligarchs, were mostly destroyed. The
financial crisis also tore through the smaller independent banks.
From a peak of 2,500 banks in Russia, an estimated 1,500 are still
functioning, and analysts think that no more than 200 or 300 of
these are liquid.
The government's greatest failure was not reforming the
banking sector. The Central Bank of Russia (CBR) has shown itself
incapable of forcing restructuring and seems to pander more to
powerful businesspeople rather than worry about health of the
banks. Although the CBR withdrew a few licences the moves were too
few, and too late.
"I am surprised that CBR didn't install temporary
administration in any of the banks [following devaluation]," says
Sergei Ivanov, a bank analyst with Troika Dialogue, Russia's
largest brokerage. "Nor have they said anything about these banks'
ability to repay their debts."
Household names such as SBS Agro had their licences removed
18 months after they were first crippled and have moved everything
of value into parallel banks or off-shore, leaving behind
debt-ridden hulks.
"There has been a transfer of SBS Agro assets. You only need
to go to an SBS Agro branch, and there you will see a sign in black
and white saying 1st OVK [mutual credit society]," says Richard
Hainsworth, the Moscow representative of Thomson Bank Watch. He was
referring to the new parallel bank that has taken over all SBS
Agro's branches.
In the midst of the financial crisis a raft of new banks
sprang up. Rosbank has taken over Uneximbank's credit card business
and custody service. St Petersburg Menatep now owns all 46 of
Menatep's Moscow branches and its balance sheet ballooned
eight-fold since devaluation. And Inkombank has collapsed, owing
its 234,000 depositors about Rb5.74 billion ($250.76 million) that
they are unlikely to ever see.
The only winners from devaluation are the two smallest
oligarch banks, Most Bank, controlled by would-be Russian Rupert
Murdoch, Vladimir Gusinski, and Alfa Bank, owned by Mikhail
Friedman.
While most of the others were little more than treasuries for
their industrial holdings, these two received few of the industrial
gems handed out during the notorious 1995 loans-for-shares deal and
concentrated more on banking services.
Most Bank had help from its old friend and mayor of Moscow
Yuri Luzhkov, who placed some of the city budget funds through the
bank to maintain its cashflows. That allowed Most Bank to offer
depositors the encouragingly named "you-can't-lose" restructuring
scheme and the "mutually-beneficial" scheme. Nevertheless, the bank
is still struggling.
"It is still not clear if it is going to make it," says
Margot Jacobs, a banking analyst with Moscow brokerage United
Financial Group/Paribas. "If I were a depositor, I would not put my
money in Most Bank, neither would I if I were a corporation that
isn't connected to Gusinsky or Luzhkov."
Of all the figs, Alfa has come off best from devaluation.
Analysts believe it had only a small exposure to state treasury
bills (GKOs) and forward currency contracts that caused so much
damage after devaluation.
Over the last nine months it has been working hard to fill
the gap left by the collapse of its bigger rivals.
"We are at the start of the recovery process," says Maxim
Shashenkov, the head of Alfa's sales department. "Alfa is well
capitalized and in a good position to rebound. Our highest priority
is to open as many retail branches as we can afford."
Rankings in the rest of the banking sector look different.
Pre-crisis niche players such as Sobinbank have leapt into the top
five. Previously a little known bank,
Euromoneynamed it one of the most profitable banks in the
world in 1998. Other medium sized banks have been advertising
heavily for new business and growing relatively quickly.
The only effort the state has made to reform the sector has
been to set up ARCO (Agency for Restructuring Credit
Organisations). The idea was first floated after devaluation, but
it took another nine months before the body was formed. And it
wasn't until the end of this summer that ARCO began to tackle some
of the most difficult cases, such as Rossiyskiy Kredit,
Promstroibank and SBS Agro.
Its position was improved in November with another Rb1
billion in cash ($38.3 million) to add to its Rb10 billion charter
capital for deadwood banks. But the CBR estimates that more than
Rb100 billion is needed to restructure the sector.
"Creditors are agreeing to whatever terms the fig banks [in
default] want to offer because they have nothing else to lose,"
says Kim Iskyan, a bank analyst with Renaissance Capital, a Russian
investment banker. "ARCO is just another piece in the Russian bank
restructuring lie."
Not only have the names changed, but the role of banking has
changed. Both companies and the state have taken more direct
control over cashflows.
Gazprom, for example, removed all its money from accounts in
the National Reserve Bank, Imperial Bank and others to its own
Gazprombank. The change killed off Imperial, and nearly killed NRB,
while making Gazprombank one of the biggest in the country.
Likewise Eurofinance has jumped into the list of top 10
banks. Previously little more than a money chute for the CBR to
send cash abroad, it has recently increased its charter capital by
Rb200 million in the summer to Rb1.4 billion and is now seen as one
of Russia's most reliable banks.
As part of the retreat to central planning practices, the
state, previously happy to make use of commercial banks, has been
putting the accounts of its most profitable businesses into banks
it has more direct control over. Eurofinance now handles the
accounts of state arms exporter Rosvooruzheniye and military plane
producer MAPO, among others, which accounted for an estimated $2
billion in arms exports last year.
While the state is taking more financial control of industry,
industry is turning to the state for protection. The Titanic of
Russian banking, the "unsinkable" Sberbank, has had a fillip as
companies make more use of the only bank in Russia guaranteed not
to collapse.
It has regained its control over the retail banking business,
holding 85% of all private deposits. For the first six months of
1999 Sberbank's loan portfolio grew by 90% - accounting for 35% of
the bank's assets - against 25% at the end of 1998.
Only a mini-boom
If banking suffered the worst from devaluation, industry
benefited the most and has been enjoying a mini-boom over most of
this year.
The picture looks bleak from the outside, but for many
Russian producers 1999 will be their best year on record. As the
population changes to domestically produced products, wage arrears
tumble and barter is no longer the only way to get paid, Russian
producers are working at full steam to meet demand.
Industrial production fell rapidly following the crisis, but
by September 1998 it had bottomed out as Russian producers raced to
fill the gap. By May the cash from these sales began to percolate
into the system, bringing with it a sense of improvement. And by
the end of 1999 the government began to boast about a "Russian
recovery".
In September Goskomstat (the state committee on statistics)
reported that industrial production was up 20% on the previous
year. Although this comparison is from a low base, analysts predict
Russia's industrial production will end this year up about 7% and
show the first GDP growth since 1991 of around 2%. By October
imports had fallen by up to 45% on the previous year. In many
sectors, industrial production is not only back to pre-crisis
levels, but has risen to levels not seen since the fall of the
Soviet Union.
Energy
All the raw materials producers have benefited from
devaluation. The energy sector, earning dollars and paying costs in
roubles, has not been the fastest growing, but it is the one
driving the economy.
Russia's low inflation - estimated to end the year at between
35% and 45%, rather than the 100% to 200% predicted early in 1999 -
means that profits have rocketed.
One of the fastest growing sectors is oil production, driven
by the nine-year highs in international oil prices.
The oil sector was partly responsible for the 1998 crisis, as
oil production makes up to a quarter of all Russia's exports. When
the price of oil fell to lows of $9 a barrel the loss in oil-tax
revenue for the state unnerved investors in Russia's $20 billion
worth of GKOs. The subsequent exodus sank the rouble.
Many of those investors may be gone, but with a barrel of oil
going for upwards of $25, profits are back. The leading companies
in the sector are making at least $14 off each barrel exported and
many are reporting estimated year-end earnings of more than $1
billion. Production is rising almost across the board.
For example, Surgutneftgas, one of Russia's strongest oil
companies, reported stronger than expected operating profits for
the first nine months of 1999. Its operating margin was up to 49.8%
with a net profit of $837 million, of which $414 million was earned
in the third quarter alone. Tatneft did equally well, generating a
margin of nearly 44%.
Similarly, LUKoil, another Russian oil major, reported a 328%
increase in production and earned a net nine-month income of $656
million. LUKoil is illustrative as, like all the Russian oil
companies, (except Surgut) it owes a lot of money to foreign
creditors. So while its profitability increased, margins rose less
than they could have. LUKoil's net operating profit was up only
19%.
Increasing cashflows and lower dollar costs have allowed
Russian oil companies to invest more than expected in their
production facilities and, as a result, overall crude oil output
has been rising. In November the increase in output accelerated, up
1.5%, putting Russia on target for a total output for the year of
303 million tonnes, which bodes well for continued growth during
2000.
These are good results for the oil companies, but the
increased cash in their pockets reduces the pressure to tackle
restructuring and investment. For heavily indebted companies such
as Tatneft, which owes more than $650 million of short-term debt to
foreign creditors, the boost from high oil prices has done little
more than stave off disaster.
Utilities
The oil companies remain under the heel of their masters, but
in the utilities there has been progress towards rationalizing the
sector.
With rising domestic oil prices the national power grid
operator United Energy Systems has been trying to root out
corruption and impose some fiscal order under its "young reformer"
boss and leader of Russian privatization Anatoly Chubais. Unlike
the oil sector, state-owned UES has a controlling stake in all but
four of Russia's power generators and also controls the
transmission system.
Tackling a notoriously bad record of cash collection from the
wayward regional power producers, or energos, Chubais has managed
to raise cash collection from 15% a few years ago to more than 40%
by the end of the second quarter. This is a huge increase
considering that most of heavy industry was doing 90% of its
business in barter until the crisis.
At the same time power consumption - often taken as a proxy
for industrial activity - has started to grow again for the first
time since 1991. Electricity demand is estimated to have grown by
2.7% for 1999 and will reach 832 TWh by year end; the highest level
since 1995.
Chubais has been fighting to introduce a real wholesale
market for power and has also managed to sack some of the
worst-offending directors of regional energos who were creaming off
payments for themselves. Cash collection in some of these
facilities jumped from a paltry 9% to more than 20% though Chubais
is being fought every step of the way.
Caius-Roa Rapanu, a utilities analyst with Moscow-based
investment bank Renaissance Capital says: "It is a slow and
difficult process, but by the end of next year the utilities sector
should look completely different from that of today."
Light industry
Most of Russia's raw materials producers have received a
boost from the double bonus of rising international commodity
prices and the cheap rouble. But progress in Russia's light
industry, especially the food processing industry, gives the most
cause for hope.
Import substitution has played a role as the imported food
products have been priced out of the market and cleared from the
shelves. But imports never accounted for a significant part of the
market.
Imported food as a percentage of total imports fell from 17%
in the second quarter of 1998 (just before the crash) to less than
10% in the fourth quarter of 1998. Over the first nine months of
last year imports of food products began to recover, but the make
up of imports has changed considerably. They are now largely coming
from CIS (Commonwealth of Independent States) countries, and
finished goods have been replaced by raw materials to support
domestic production.
For example, pre-crisis Italian pasta products have been
almost entirely replaced by the hard grain needed to make it
locally. Likewise imported brands of beers' share of the market has
fallen from 10% to less than one per cent over the last 12 months,
but domestic production is up 33% in November year-on-year.
Russian consumers have changed to domestically produced
goods. Cheaper prices are important, but market research companies
believe the deciding factor is that Russian goods are now seen as
better quality than international brands produced locally.
While consumer spending has fallen across the board, it has
fallen fastest in the international brands. Consumer spending was
down about 15% year on year in November, while sales of
international brands fell by an average of 50%, according to German
research company GfK. The domestic producers are taking up the
slack.
Across the board international brands that previously led the
market are being replaced by Russian brands - some of which are
more expensive than their better-known rivals. Russian producers
are doing little or no advertising (with a few exceptions like
Russian producer Wimm Bill Dann's promotion of the J-7 juices) yet
their sales are rocketing.
Some domestic producers report that sales were already back
to pre-crisis levels by January of last year and have been growing
strongly ever since, although they appeared to be slowing again in
the last months of 1999.
In beer production, the strongest of the food products,
devaluation has only slowed growth. Consumption has been rising
steadily from a low of 15.3 litres per capita in 1996 to about 23.3
in 1998. Despite the increase in production already recorded over
the first nine months of 1999, there is still plenty of room for
the market to grow.
Producers such as foreign-managed Sun Interbrew are running
at full capacity and are on a buying spree of privatized Russian
brewers to increase production capacity. At the same time many
international companies have arrived in the last six months to set
up shop.
South African Breweries has started producing its Golden
Barrel brand and Turkish brewer Efes has opened lines of Old Miller
and Efes Pilsner. The foreign-managed Bravo group has kicked off
production of Bochkaryov, Lowenbrau and Yunkerskoye.
"It is like a sailboat race," says Mitch Krasny, vice
president of finance for Sun Interbrew, which sold a 34% stake to
Belgium giant Interbrew earlier this year. "Everyone is milling
about before the start jockeying for position. The race in Russia
is about to begin."
Investment climate
As sales grow, food processing is now taking most of the
foreign direct investment (FDI). In 1995 food processing accounted
for 25% of all investment into industry, which has leapt to 60% by
third quarter of 1999.
However, food production is only a relatively small part of
the economy, accounting for just over 5% of GDP over the first nine
months of 1999, and is certainly not big enough to drive the
economy.
Russia is earning most of its money from raw materials
exports and here the investment climate is bad and getting worse.
Investors have little confidence in Russia, reflected in pitiful
levels of FDI. Over the first three quarters of 1999 FDI fell
another third on the previous year to a total of $6.47 billion,
according to Goskomstat. Russia is at the bottom of the pile,
however you look at it.
Hungary leads the former Warsaw Pact countries in terms of
per capita FDI between 1989-98 with $1,667 per person, whereas
Russia has attracted only $63 per capita. Only four of the 25
former Soviet-bloc countries have done worse.
The picture is equally bleak as a proportion of GDP. FDI in
Russia accounts for less than 1% of GDP, whereas most central
European countries receive between 4% and 6%. Only the Slovak
Republic gets less than Russia in terms of GDP.
Investors have been ripped off too many times and in the last
few months of last year there has been a string of fresh abuses
that has brought Russia some of its worst press.
In November, a St Petersburg arbitration court ordered a US
government-backed investment fund to return its majority holding of
54% in the Lomonosov Porcelain factory to the state.
Setting a precedent, the court said that the privatization of
the factory in the early 1990s was illegal and - in a move that
must be particularly galling to the investors - turned the assets
over to the management which organized the privatization. Unless
they can overturn the ruling investors from the US Russia
Investment Fund (TUSRIF), with its partner KKR, stand to lose $4.25
million.
"We have been disenfranchised," says Alistair Stobie,
vice-president of Delta Capital Management, which manages TUSRIF's
investments. "The whole story makes a mockery of legal process. It
shows that political pressure can override the government's own
legal process."
Dmitri Vasiliev, head of the Federal Securities Commission
(FSC) that oversees share registration, was so disgusted with the
decision that he quit his job. Vasiliev has been the champion of
minority investors shareholders rights and his departure has been
another big blow to confidence.
In a letter to the State Property Ministry that began the
proceedings against the Lomonosov factory, he wrote that the
decision, "creates an extremely dangerous precedent and will be a
real shock to investors, including foreign investors, and can
provoke their mass exodus from Russia".
The day after Vasiliev's departure from the FSC another
foreign investor, American container-king Kenneth Dart, lost his
stake in several oil production facilities, ending a five-year
battle.
Dart had been fighting with oil major Yukos, controlled by
oligarch Mikail Khodorkovsky, who has been trying to wrestle these
producers away from the minority investors. On October 15, the FSC
registered shares that would dilute Dart's stake in Yukos'
subsidiaries Tomskneft, Samaraneftegaz and Yuganskneftegaz to
virtually nothing, despite an injunction from one of the regional
arbitration courts.
Sharon Cornwell, president of Dart's advisory company
Wellesley Advisers, says: "Now we have a government agency that is
ignoring the law. [Our suit] is a test. Can due process force a
government agency to follow the rules? Maybe not, but it is such a
fundamental issue in investment - the protection of property
rights."
The coup de grace came only a few weeks later when BP Amoco
lost control over the Chernogorneft production facility that is
nominally owned by Sidanko. BP acquired 10% of the oil major,
controlled by oligarch Vladimir Potanin, in 1997, paying $571
million. The Chernogorneft facility is one of the most profitable
subsidiaries in the Sidanko group, but was wrestled away by Tyumen
Oil Company (TNK) at a "bankruptcy" auction in November. TNK paid a
mere $178 million for the company, despite the fact that it sold
more than $1 billion worth of oil in 1998.
The Sputnik Fund, a Sidanko ally and one of the potential
bidders at the disastrous auction, is now suing TNK in Russia and
New York but is unlikely to get Chernogorneft back.
Russia has become one of the most dangerous places to invest
in the world. The assassinations of the early 90s have largely
stopped, but Russia tops both the list of most risky countries in
the world in a recent
Economistsurvey, and lists of the most corrupt countries in
the world. Legislation exists but is rarely enforced.
"[Chairman of TNK Simon] Kukes and the others understand
there is a need for foreign investors and that they have a role to
play in the Russian economy," says an oil analyst. "But they don't
seem to care about their reputation at all. All they are thinking
about is putting money in the bank now."
Short termism and the elections
Russian big business leaders are thinking only of the short
term for the time being. With no clear leadership they have been
left to their own devices and are grabbing everything they can.
With presidential elections in June, the future is so
uncertain that there is little point in planning beyond next
summer.
To solve its worst problems Russia needs a strong leader,
determined to impose change on the economy and uphold the rule of
law. There is little chance of a return to central planning, but
the pace of reform, which will no doubt continue to be slow,
depends entirely on who wins the next elections.
Four blocs are vying for top position: the Fatherland/All
Russia coalition (FAR) headed by Moscow mayor Yuri Luzhkov and
ex-prime minister Yevgeny Primakov; the Communists led by Gennady
Zyuganov; the Kremlin-sponsored Unity party led by emergencies
minister Sergei Shoigu; and liberal-reformers Yabloko led by
Grigory Yavlinsky.
At the start of the election season, FAR was the front-runner
with well-respected Primakov the favourite to replace Yeltsin on
the presidential throne. However, the Kremlin has played the game
skillfully.
Riding on the overwhelming popular support for the war in
Chechnya, prime minister Vladimir Putin's popularity has soared
from nothing to 45% in a matter of three months. He is now Russia's
most popular prime minister ever.
Treading cautiously, Kremlin-loyalist Putin came out in open
support for Unity at the beginning of December. Unity is little
more than a Kremlin vehicle designed to eat away at FAR's voters -
and the party's popularity jumped 6% ahead of FAR's almost
overnight.
Although at the time of writing the exact composition of the
new Duma was yet to be determined, it will be significantly
different from that of the last four years.
The last elections in 1995 offered Russians a simple choice
between going forward (Yeltsin) or back to the old system
(Communists). The communists won just less than half the vote and
were by far the strongest power in the Duma, slowing efforts to
push through reforms.
In these elections the communists will lose a lot of their
power, but perhaps more importantly the protest vote that went to
radicals like ultra-nationalist Vladimir Zhirinovsky will be taken
by a new middle ground. There will also be an increased number of
independent unaligned deputies, bringing with them more power for
the regions but without obvious affiliation to any of the national
parties.
While few of the parties - bar Yabloko and the communists -
have any ideology to speak of, politics has taken a step towards
the centre. With the communist grip over the Duma broken and the
radical extremist failing to clear the 5% hurdle, debates will be
less polarized, leaving more room for consensus and deals in the
new Duma. Depending on who wins the presidential election, this is
probably a good thing.
Little noted, the fact that Russia is having elections at all
- fought on hoardings and TV rather than on the streets or with
guns - is a significant step in the reform direction and probably
Yeltsin's biggest contribution to Russia's transition. While the
OSCE and others will no doubt find plenty to complain about during
the voting, Russia is now a democratic country, albeit a rough and
ready one.
The exact composition of the Duma is important for the
presidential elections. Both Unity and FAR are convenient alliances
between powerful regional governors and others and could easily
fall apart after the Duma vote. Members of these two parties could
realign to support one or other presidential candidate, depending
on the division of power in the Duma.
The increased number of independent deputies could be
decisive in the run-up to presidential elections as many can
deliver whole regions to their chosen candidate. The makeup of the
new Duma will be crucial in their decision of who to back.
Presidential elections are scheduled for June 4 2000, but
were they held tomorrow, Putin would beat Zyuganov for the job
hands down. Primakov is the only other candidate with a realistic
chance of winning at the moment.
What would Russia be like under these three men?
Putin
Putin has become popular because of the war in the south, but
he has deliberately said little about his economic policy. His
advantages are that he is young and healthy, but his meteoric rise
has meant his political powerbase remains weak, leaving him
vulnerable.
"There are two scenarios for Putin," says Roland Nash, head
of research at Renaissance Capital. "There is a danger that he will
be hijacked by the group of oligarchs that stand behind Yeltsin, or
that he will try to get things done in the same way as he got the
war in Chechnya done."
On the few occasions Putin has talked about economics he has
said the right things. He admits that his command of economics is
weak and is likely to hand over the running of policy to a group of
technocrats, such as Mikhail Zadornov and Vladimir Ryzhkov.
Primakov
As prime minister for eight months, Primakov is better known.
A canny political player, Primakov is also weak on economics. With
him would probably come the same group of technocrats to make
economic policy.
On the positive side Primakov's open attack on oligarch Boris
Berezovsky, while he was prime minister at the beginning of this
year, suggests that he would be independent and maybe even
anti-corruption. He has also shown himself able to balance the
interests of the power fractions of the Duma and bring them
together in consensus.
On the downside Primakov is already 70 years old and has had
back surgery recently. His health could fail in the next four
years, leaving Russia with yet another infirm president.
"The key question is how much support both Primakov and Putin
would give to the technocrats who are running economic policy - how
strongly they would enforce the rules and provide them with
necessary authority," says Nash. "It is naïve to think either man
would run a radical reform programme, but they should allow the
important secondary goals - like reforming the tax code - to be
reached."
There is little to choose between the two men. Putin is the
more risky bet but offers the possibility of faster reform. Under
Primakov progress would be slow, but most Russians would welcome
the stability he offers. And for businesses working in Russia over
the last eight years, stability, rather than economic reform, is
what they crave the most.
Zyuganov
Zyuganov will almost certainly be the man to beat in the
presidential elections. But it is also almost certain that he will
be beaten. The communists have a hard-core of some 30 million
voters that always vote communist, but the party - despite
increasing its focus and improving its understanding of Russia's
economic needs - has failed to appeal to a wider audience.
The Communists have abandoned the traditional stance of
central planning and are selling themselves as a "socialist party,"
in the style of Britain's New Labour.
They espouse policies that accept private land ownership and
free enterprise, but would increase state control of key sectors.
There is merit in their arguments that reform would have been less
painful if it had been done more slowly, but a top-heavy intrusive
administration would mean very slow progress. Despite some
short-term benefits for the poor and old, mixing free markets and
central planning only results in inefficiencies, leaving Russia
wallowing in misery.
Mystery Man
Analysts agree that the possibility of an unknown Kremlin
candidate could appear over the next six months. Since March 23
1998 Yeltsin has sacked four prime ministers and remains
unpredictable. Putin could disappear as fast as he arrived.
"A rational man would resign today and let Putin step into
his shoes while his popularity is high," says Nash. "But Yeltsin is
not a rational man."
Russia will continue to drift for the next six months.
Neither the new Duma, nor the government will have much to say on
policy and, assuming that Putin remains as prime minister, the
government will be preoccupied with getting their man into office.
Putin himself is clearly concentrating on first winning the
war and then being elected president. These concerns over-ride less
pressing matters such as negotiating with the IMF over the release
- now on hold - of the next tranche of its standby credit facility.
That is the best-case outcome. The worst thing would be if
when the Duma reconvenes the day after Orthodox Christmas on
January 18, that it carries a vote of no confidence in the
government.
Under the Russian constitution, if the Duma votes no
confidence three times Yeltsin has the right to dissolve the Duma.
But the constitution also says that the Duma may not be dissolved
during the first 12 months after it is elected, creating the
possibility of a constitutional crisis.
With so many unknowns Russian businessmen and industrialist
see no reason to think long term. The best hope the country has is
to get through a winter that will see power shortages, finish a war
that could isolate the country from the international community and
hope that oil prices don't fall until the end of next year.
The Russian people are stoical and have a great capacity to
endure suffering, making civil unrest unlikely. With an
inexhaustible faith in the greatness of their country the poet
Fyodorov Tyutchev summed up the Russian mentality with the words
that are as true today as they were in 1866.
"Through reason Russia can't be known,
No common yardstick can avail you:
She has a nature all her own -
have faith in her, all else will fail you."
Rouble/dollar exchange rate versus international reserves
Source: CBR, Moscow Times
Trade balances
Industrial production
Source: Russia Economic Trends
It's back to cash
"Devaluation has given Russian industry a breathing space,"
says Roland Nash, head of research at Renaissance Capital. "But
there is little evidence that it is being followed by investment,
which will carry through the restructuring of the economy."
Investment is down, but some economists say that is not
important for the time being. A recent report by Moscow brokerage
Troika Dialog points out that as Russian factories are only using
about half of their available capacity, they have plenty of room to
increase production without the need to invest in new lines.
"Look at Poland," says Al Breach, an economist with Goldman
Sachs in Moscow. "It grew strongly for two years from 1992 while
investment inflows actually fell. Investment only took off in 1994
after the companies were already profitable. The same thing could
happen here." Production is growing because one of Russia's worst
problems has been solved. The reduction in rouble-denominated costs
and the consumers' preference for domestically produced goods have
been important factors in kick-starting the economy. But it is the
death of the so-called "virtual economy" that has had the greatest
effect.
Non-payment of bills has been rife in Russia for eight years.
In heavy industry up to 90% of business was done in barter, or
unsecured and unregulated promissory notes, known as "veksels" were
used in place of money. Barter has been popular because, under
Russian tax law, wages must be paid before taxes. By doing all
their business in barter, and keeping only enough money in the bank
to pay wages, Russian firms effectively dodged taxes. While costs
increased with the rising rouble, companies found that, instead of
booking a real loss, they could inflate barter prices and book a
"virtual profit" instead. For managers of these firms, inflated
barter prices provided an opportunity to cream off fat margins for
themselves.
With devaluation the situation has changed. As costs have
fallen Russian companies find themselves in the position where they
can book real profits: as a result the amount of cash in the system
has increased. For years Russia's companies have had a bad tax
payment record, but federal tax collection rose a provisional 115%
year-on-year in the second quarter of 1999 and tax receipts have
outstripped the 1999 budget estimates since July. Unusually,
Russia's biggest taxpayers º mainly oil, gas and electricity
companies º paid their Rb2 billion for October in full, according
to the tax minister Alexander Pochinok.
This all points to a massive reduction in barter. Wages in
the pocket of the worker and profits in the accounts of companies
may be worth less, but at least they are being paid in cash rather
than macaroni, sex aids and raw materials, as was standard practice
until last summer.
As a result government finances are looking healthy for the
first time in years. The rise in tax receipts has broken the
government's dependence on handouts from the international
financial organizations. While oil prices remain high, Russia
should be able to service its debt payments without going to the
IMF.
The IMF has been holding back on the next $640 million
tranche of its $4.5 billion stand-by credit because of Russia's
failure to meet specified targets. Given that Russia has always
failed to meet these targets and has always been paid in the past,
and is now meeting more IMF targets, the decision is clearly
political. The international community wants Russia to stop the war
in Chechnya and has hung the loan until Russia buckles under, which
it is unlikely to do until the war is won or next summer's
presidential elections are past. However, with high debt servicing
obligations over the end of the year, and again next summer, the
Central Bank of Russia (CBR) will have a struggle to find cash to
meet its obligations. Recent press reports have claimed that the
CBR has been borrowing from the state-run Sberbank in a series of
covert bond sales worth $670 million in order to raise money.
"These credits are essentially an extremely non-transparent way of
printing money," said Peter Westin, an economist at the Russian
European Center for Economic Policy.
The government has also issued new OFZ and GKO bonds and sold
them to the CBR to meet foreign obligations. In a move that
analysts are calling "little more than an accounting trick" and
which calls the CBR's independence into question, the CBR issued
loans of $6.7 billion to the government in November to help it
service its foreign debts, and government securities worth Rb229.5
billion. Even with the present trade surplus of $2.5 billion a
month it will be difficult to balance the books, and the rouble is
weakening as a result. Analysts predict it will fall to about
Rb35/$ by the end of next year from the current Rb26/$. The next
budget assumes that the country will secure several billion dollars
in external financing, which Russia is less likely to get since the
Chechen campaign started, but it also assumes oil prices of $18 per
barrel. If prices were to fall from $25 per barrel to $17 per
barrel, export receipts would decrease by up to $10 billion,
leaving the monthly trade surplus at somewhere between $1.0
billion. And that might very soon begin to threaten Russia's debt
servicing abilities and the value of the rouble. "If oil prices
stays high it will be good for Russia," says Tom Adshead, senior
political analyst at brokerage Troika Dialog. "But it if it falls
below $16 they will be in trouble."
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