ON JULY 2, Platon Lebedev, chairman of Yukos’s parent company and Russia’s thirteenth-richest man admitted himself to hospital complaining of chest pains. The same day, he was arrested and secured in Lefortovo prison, a former KGB lock-up usually reserved for spies and traitors. He was charged with defrauding the state of more than $280 million in the privatization of a fertilizer company in 1994.
In the ensuing days, the offices of Yukos were searched by armed guards and investigations were opened into charges of tax evasion and murder by the oil company’s senior management.
Mikhail Khordorkovsky, the well-connected chief shareholder in Yukos and Russia’s richest man, was called in for two hours of questioning at the prosecutor-general’s office.
The Russian equity market reeled. Until then it had been enjoying its best six months since the 1998 crisis. UK oil major BP had shown great faith in its stability by investing around $6 billion in a joint venture with oil company TNK. That mega-deal was soon followed by the merger of domestic oil companies Yukos and Sibneft, to create one of the world’s biggest oil companies. Meanwhile, from Stillwater Mining in the US to Chelsea football club in London, Russian oligarchs were buying assets abroad, and improving their legitimacy in the eyes of foreign investors. Buoyed up by what was seen as the improving corporate governance environment – an improvement that had been led by Yukos – the stock market climbed to its highest level ever at the end of June, breaking the 500 mark for the first time, having grown almost 100% in 18 months.
Wild East echoes By July 18, two weeks after Lebedev’s arrest, the stock market had fallen to 437.2. The general sentiment was summed up by one equities investor: “If the Kremlin can do this to Khordorkovsky, it can do it to anyone. If I were BP, I’d be worried.”
Arkady Volski, president of the Russian Union of Industrialists & Entrpreneurs, said on television that the British ambassador has even floated the notion that BP should pull out of its Russian venture. BP says it will not reverse the deal.
The arrest had such a devastating effect on the stock market because it struck at the foundation of the Russian economic boom – the belief that the country was leaving behind its Wild East days and becoming a normal place to do business. President Vladimir Putin was creating a stable and predictable legal environment for business, through such initiatives as his corporate governance code.
Russian businessmen were learning the value of playing by western accounting rules, in order to attract foreign investment. No company followed this tactic more successfully than Yukos, which embraced western standards of transparency and accounting. Indeed, the normalization of Russian business was often referred to as Yukosization.
Paul Collison, oil and gas analyst at Brunswick UBS, says: “The market had moved from seeing Yukos as a company steeped in Russian politics to seeing it as a producer of a commodity that happened to be located in Russia.” Yukos, in other words, was becoming a normal, conventional multinational, like BP or GlaxoSmithKline.
And then, suddenly, those Wild East days had returned, and Yukos was embroiled in a political fight that was anything but predictable. Far from the reliable legal framework that business had enjoyed, the attack seemed to show that the Kremlin could intervene in the market and infringe on property rights as and when it wanted.
Lulia Shevtsova, senior associate at the Carnegie Endowment for International Peace and author of Putin’s Russia, says: “The business community is very concerned about what they perceive to be arbitrary justice and a weak rule of law.”
More worryingly, the attack on Yukos signalled to some market observers that the alliance Putin had forged between the state and the business community was about to fracture. Government officials said other privatizations could be re-examined.
That implied that half the business operations in Russia could be subject to sudden and arbitrary assaults by the Kremlin security services. Leading political analyst Gleb Pavlosvky said in a Russian newspaper: “There is no private property in Russia – this is the conclusive result of an analysis of this situation.” Even presidential economic adviser Andrei Illarionov warned of the threat of civil war if the state and business could not rapidly resolve the dispute. The normalization of Russian business seemed to have gone off the rails.
So why had president Putin apparently abandoned his carefully cultivated image as a free-market reformer to revert to such strong-arm tactics?
The received wisdom among many Russian bankers was that Yukos was being punished by the Kremlin for having financed two centre-left political parties, Yabloko and the Union of Right Forces, in the run-up to the 2004 elections. This, the bankers suggest, was seen by the Kremlin as an infringement of the informal contract that Putin had made with the oligarchs in 2000, that he’d leave them alone if they stayed out of politics.
Khordorkovsky broke this agreement, so Putin gave the order to reprimand him. However, according to this interpretation, his security staff went beyond the call of duty in dealing with Yukos. Roland Nash, head of research at Renaissance Capital, says: “The whole thing smacks of people getting way over-excited about their jobs.”
More important than party politics This theory has it that all that needs to happen is for Putin to call off his dogs, and for Yukos to stop meddling in politics. Then business will continue as normal. It might even be improved. Matthias Westman, chief investment officer of Prosperity Asset Management, says: “When the dust settles, this will actually prove to be beneficial. We will be one step closer to separating business from politics.”
But another theory suggests that what happened was something more fundamental than a slap on the wrists for Yukos. Harvey Balzer, an expert in Russian politics at Georgetown University, Washington DC, says: “You have the short-term political reasons – the funding of Yabloko and Union of Right Forces. But they’ll get 10% of the seats maximum. You’d have to be really stupid to do this much damage to the economy over a dozen seats in the Duma.”
Besides, oligarchs before Khordorkovsky have financed political parties. Balzer says: “My sense is that this is a much more long-term and serious issue.”
In Balzer’s view, the Yukos dispute is a flashpoint in a battle between two diametrically opposed clans within and outside the Kremlin – on the one hand, those in favour of Russia integrating into the global economic system and reducing the size of its state; on the other, those who are against such integration, and sceptical about the free-market democratic model in general.
The Kremlin faction that is against any further integration has been called the Siloviki, or “power people”, because it centres on figures in the security and intelligence services, particularly the FSB, the post-communist version of the KGB. Those in favour of increased integration include liberal-market reformers in the Kremlin such as prime minister Mikhail Kasyanov, as well as oligarch figures such as Khordorkovsky or Anatoly Chubais, the former deputy prime minister, now CEO of United Energy Systems.
The dispute between these two clans, says Jonathan Schiffer, Russian sovereign analyst at Moody’s, “will affect several issues right across the board”. Another analyst adds: “It’s serious, because everything is still up for debate.”
The Carnegie Endowment’s Shevtsova says: “The first thing to realize is this is not the first time these two groups have fought. The first was in 1996.”
In 1996, in the run-up to another election, ailing president Boris Yeltsin had an approval rating of only 3%. The communist candidate, Gennady Zyuganov, was way ahead in the polls and it appeared probable that the communists would regain power, and possibly renationalize industries.
Yeltsin at that time was primarily advised by the head of his personal security service, an ex-KGB bodyguard called Alexander Korzakhov, and other Siloviki officials from the presidential administration and the FSB. These officials were ambivalent towards democracy and hostile to the oligarchs, who threatened their own influence over the president. Under the influence of the Siloviki, Yeltsin came close to dissolving the Duma via a fake terrorist threat, cancelling the election, and extending his term in office indefinitely.
Yeltsin banks on the oligarchs Only Chubais, the architect of the privatizations that enriched the oligarchs, managed to dissuade Yeltsin from this path. At the last moment, the coup was cancelled, and the oligarchs took over Yeltsin’s presidential campaign. Korzakhov, who saw himself as a champion of “Russia and the state”, was furious at losing influence with Yeltsin to people he thought “wanted to sell and rob this Russia”. One evening, his staff arrested a Chubais official coming out of the campaign headquarters with a box full of money.
Yeltsin subsequently sacked Korzakhov and his Siloviki allies, and threw in his lot with the oligarchs. The oligarchs then had unprecedented political power for the next two years, until the 1998 market crash.
Carnegie’s Shevtsova says: “The oligarchs won that war. The next war is unfolding, and the oligarchs are losing.”
Putin, who came from the FSB/KGB himself, has always had a coterie of Siloviki advisers around him. These include former KGB officials Viktor Ivanov and Igor Sechin, who are now deputy heads of the presidential administration and are considered the leaders of the Siloviki clan; Nikolai Patrushev, head of the FSB; and Yury Zaostrovtsev, deputy head of the FSB in charge of “economic safety”, who is considered the economic strategist of the group.
These figures have their own links to business interests. They are connected to the CEO of state oil company Rosneft and to Sergey Pugachev, former CEO of Mezhprombank. They are also on good terms with Alexei Miller, CEO of Gazprom, and other Gazprom senior bureaucrats.
The other clan, the oligarchs and liberal market reformers, includes several figures within the Kremlin – among them prime minister Kasyanov, presidential economic adviser Andrei Illarionov, minister of trade and economic development German Gref, and finance minister Alexei Kudrin. Beyond them are various powerful quasi-political business interests, such as Chubais, head of Unified Energy Systems, and Khordorkovsky.
The liberal clan believes the neo-liberal model of society is the future for Russia.
It supports increased liberalization of the economy, restructuring of the electricity and gas markets and privatization of energy utilities UES and Gazprom, and the gradual slimming down of the state bureaucracy in favour of open and transparent markets. It also favours an increasing integration of Russian companies with foreign investors and companies, through bond and equity issues and strategic sales such as TNK’s merger with BP.
The more enlightened members of this community, including Khordorkovsky, are also increasingly recognizing that their cause involves trying to support the growth of civil society and protecting free speech and human rights against the power of the state.
As the Carnegie Endowment’s Shevtsova says: “Khordorkovsky is the first Russian oligarch to develop ties with civil society, to support independent media, and to give assistance to human rights activists. For example, in April he gave $100 million to the Russian State Humanitarian University. He’s tying himself to liberal democratic values.”
Khordorkovsky is far from a liberal democrat by conviction. Indeed, if anything, he is a social Darwinist, believing the world is divided between the strong, who produce, and the weak, who live off the strong.
But he has become a liberal democrat by necessity, because he increasingly believes the real danger to his business interests is the overly centralized and authoritarian Russian government. As he put it in a TV interview on July 20: “Today we must definitely decide if our country’s future will be totalitarian.”
That is an important shift. Many Russian businessmen and bankers still believe that a strong authoritarian state is a necessary protection for business in Russia. A head of international banking at a Russian bank, for example, his tongue loosened by a few drinks, told Euromoney that Putin should change the constitution and stay in power indefinitely. “All that human rights stuff is bullshit,” he said. “It works in America and Britain but it is not for Russia. Russians are Asians who look like Europeans. We need strong government.” But what Russia’s business community has learnt, rather dramatically, in the past few weeks is that strong authoritarian government can infringe on the property rights of businessmen just as easily as, say, the human rights of civil rights activists.
| Khordorkovsky: questioned about alleged corruption at Yukos |
A fair-weather free marketeer The liberal/oligarch contingent is generally believed to have had the upper hand over the Siloviki clan for the first two years of Putin’s administration. This has led to the perception among many westerners that Putin is a free-market reformer. But one analyst says: “I don’t think he is correctly characterized as a free-market reformer. The reform team is very thin. We’re only talking about two dozen people, and he only listens to them because so far they have delivered the goods.”
The Siloviki contingent, throughout the Putin administration, has also been fighting to assert its own influence and force Russia in the direction it wants. As one analyst says: “Putin has some very dangerous people around him, from the point of view of western financial services.”
Jonathan Schiffer of Moody’s agrees: “The Siloviki aren’t at all market-oriented. They want much more of a state-led programme.” These people are against opening up Russia to international markets, because they think that would make it vulnerable to a takeover by western financial interests.
To those who hold this view, such figures as Chubais or Khordorkovsky are threats to national security, because they are in favour of international integration and a smaller state. Just as Chubais was frequently accused of being a CIA agent, so the Siloviki are deeply suspicious of Khordorkovsky, as someone with connections to US politicians and foreign businessmen such as Lord Rothschild. That was why Platon Lebedev was put into a KGB prison for traitors and spies.
Khordorkovsky has developed international contacts such as Rothschild or Henry Kissinger in the belief that this would provide a protection against the state. Rothschild publicly supports Khordorkovsky, who is a business partner of his. He tells Euromoney: “I hope the present troubles will soon be resolved and that the progress of Yukos under its outstanding leadership will therefore be maintained.
But these contacts are unable to protect him from the FSB faction. Indeed, they merely confirm the FSB’s suspicion that he is part of a CIA/IMF/Jewish financial conspiracy to rob Russia. Georgetown University’s Balzer says: “The first call Khordorkovsky made was to the US ambassador. He made the same mistake that [exiled oligarch] Vladimir Gusinsky made, which was to believe your friends in Washington and Wall Street can help you against the Kremlin.”
The Siloviki, by contrast, want to build a strong Russia through a centrally controlled economy and an authoritarian government. As Balzer says: “They don’t like globalization because they can’t control it. In globalization, no-one is in control. One of the people I used to work with in the late Soviet period summed the attitude up very well: ‘you have to either manage something or destroy it.'” They want a centrally controlled economy because they can control it against foreign and internal enemies. As Pravda, the state news agency, put it: “[The Siloviki] are obvious patriots, they will not listen spellbound to Washington and Brussels”.
Beyond ideology, the Siloviki, like the oligarchs, have their own personal financial motives. Evgeny Gavrilenkov, chief economist of Troika Dialog, says: “They have power but no assets, and they want a piece of the pie.” Their quest for more personal assets is one of the reasons the Siloviki are against greater transparency – the original oligarchs have already taken their assets, and now want their market capitalization to increase, while the Siloviki are still taking them. Balzer says: “Gazprom has $1 billion construction costs. It’s totally untransparent. That’s an awful lot of people making an awful lot of money, and they don’t want that to change.”
Like any bureaucracy, they want to protect their power. Moody’s Schiffer says: “These people are dead against the oligarchs because the oligarchs want a much smaller state. The Siloviki know that if the oligarchs keep getting power for the purpose of reducing state power, the Siloviki will die the death of a thousand cuts.”
Despite western beliefs that Putin was a liberal-market reformer, the Siloviki faction has always exerted real influence over him. One Russian political source says: “These are the people he really knows and trusts.” That means there is a genuine danger they will steer Putin away from further liberal reforms in his second term, and towards further authoritarianism.
The degree of their influence over Putin can be seen from his attitude to the media. First, oligarch Boris Berezovsky was exiled and his TV assets seized in 2000, partly because of a documentary he financed that claimed the FSB/Siloviki had planned a supposedly terrorist bombing in Moscow that killed 300 people. He remains in exile in London.
Then, in 2001, TV oligarch Vladimir Gusinsky was exiled, and his TV station, NTV, was taken over by Gazprom. More and more independent media have been shut or seized by the government until finally TVS, Russia’s last independent TV station, was closed down on June 21 this year. Putin himself retains a Soviet, closed attitude to TV appearances – all the questions at his press conferences are either screened or planted.
But the Siloviki have been less successful at getting hold of assets. In 2002, they attempted to redistribute property from the oligarchs to themselves through various bills in the Duma. All these attempts failed, thanks to the oligarchs’ support there. As Troika Dialog’s Gavrilenkov says: “The Siloviki are realizing that the new parliament may well be more diversified.”
Fighting over energy
The Siloviki have also been trying to accrue new oil assets through Rosneft. But Yukos’s merger with Sibneft has created a Russian oil company that will be hard to compete with for new oil reserves.
Yukos is also building a private pipeline to Murmansk together with LUKoil, Sibneft and TNK. Transneft, the state pipeline monopoly, which is also connected to the Siloviki, sees this as an attack on its monopoly and on the Siloviki’s asset base.
The UES restructuring is also pressing on, which will reduce the size and power of the state. Rumours also persist of a plan to restructure Gazprom, which has provided an important source of political and financial power for the Siloviki. To top it all off, president Putin has said he will not run for power in 2008. As Gavrilenkov says: “They have very limited time. This is their last chance to reallocate property.”
So will this attempt succeed? Probably not. The Siloviki may succeed in winning a few battles, over pipelines or oil reserves. They may succeed in garnering short-term political support – indeed, 70% of respondents to a radio poll said they supported renationalizations.
But the war over which direction Russia is heading is all but won. Khordorkovsky told the New York Times recently: “What we are seeing is the most repressive and aggressive part of the bureaucracy in its dying throes.”
The war is moving in favour of the liberals for two reasons. First, thanks to the man who defended the oligarchs from the FSB the first time they clashed – Chubais. In his new role as CEO of UES, he may be criticized by minority shareholders for the cavalier fashion in which he has tried to sell off UES assets.
What’s more, in the words of one Russian journalist, he may be “the most unpopular man in Russia” because of his 1990s privatization drive. He has, however, at least managed to oversee the liberalization of electricity utility UES. That is now irreversible.
The liberalization of UES, in turn, is likely to lead to the liberalization of Gazprom. Troika’s Gavrilenkov says: “We are moving towards an electricity market. The smaller electricity companies will need a gas market to buy gas according to demand, so it makes sense to have a deregulated gas market.” Although Gazprom’s CEO is unlikely to help the oil oligarchs in any sell-off of Gazprom, the sell-off will decentralize power away from the state. Russia’s accession to the World Trade Organization, whenever it happens, will also open the gas market to foreign competitors, which will also weaken the state’s control and financial support.
Secondly, the free-market model will win in Russia not because of big business or Khordorkovsky’s international contacts, but because of little business. It will win because of the growth of new companies, particularly in the consumer sector, such as juice manufacturer Wimm-Bill-Dann ; or Ramenka and Perekroistok, two fast-growing supermarket chains.
These smaller companies, more focused on the domestic consumer market, are forging an entrepreneur culture, and following normal business practices, with foreign management advice, and without any history of asset thefts.
Shopping fever And together with this growing entrepreneur class is a growing middle class, with growing disposable income, that is rapidly discovering the joys of shopping. Mobile phone penetration, for example, which is often a good indicator of disposable income, has reached 50% in Moscow.
Anton Khmelnitsky, head of equities at Brunswick Asset Management, says: “The shopping fever is mad. When I was last in Moscow, I was struck by the sheer range of choice in supermarkets. Russians haven’t settled on favourite brands yet, so it’s all up for grabs.”
A growing number of Russians, therefore, have a stake in capitalism. The pension reform introduced this year by prime minister Kasyanov will slowly increase this stakeholder culture. And a growing percentage of GDP comes from services, the sector that is the least controlled by the state. Khmelnitsky says: “These bottom-up changes are what are ultimately driving the direction Russia takes.”
Nonetheless, Russia’s continued progress towards the liberal free-market model is unlikely to be straighforward. “Russian politics”, says Renaissance Capital’s Nash, “will continue to be clumsy, and will continue to generate headlines that look like everything is heading for disaster.” From the point of view of investors, stock market prices are likely to continue slightly lower, as people remember that Russia still has political risk.
Khmelnitsky says: “People have been over-complacent about political stability in the last two years. It is still a fragile democracy.” One rating analyst says of the presidential constitution in Russia: “This is a structure that lends itself to arbitrariness, regardless of who is at the top, so current events shouldn’t be unexpected. It’s a structural problem.”
The fight between the Siloviki and the liberals will continue for the next four years. Most expect Putin eventually to separate the clans and release Lebedev from prison, though a closed court trial of the billionaire had denied him bail at the time of writing.
But further flashpoints between the two lie ahead: over the reform of Gazprom, new oil reserve sales, the liberalization of Sberbank, WTO accession and, above all, the fight to succeed Putin in 2008. The position of liberals within Putin’s government, such as Kasyanov and Gref, will be a good indicator of which clan has the upper hand.
In the medium term, some of the solutions to crises like these could well be political. Troika’s Gavrilenkov thinks the problem is that there is no right-wing party in Russia, to represent big business. Perhaps Khordorkovsky will establish one. Khordorkovsky himself has reportedly been talking in private conversation about reforming Russia into a parliamentary democracy, to spread power away from the centre. At some point, Russia needs to consider the issue of campaign finance reform for its Duma.
These issues will all have to be addressed at some point. For the time being, in our rush to defend Yukos and free-market democracy from the FSB, we should not forget that the FSB have a point. After it lost the first war against the oligarchs, the oligarchs captured Yeltsin’s government and helped cause a stock market crash in two years.
No doubt many oligarchs would still like to capture the state – indeed Khordorkovsky has courted the favour of governments worldwide. The middle path between the oligarchs and the Siloviki is what Putin needs to rediscover in his remaining four years in power.
