“The unique form of capitalism that developed following the Yukos affair seems likely to survive the current economic upheaval.”

No Obituaries Yet for Capitalism in Russia SAMUEL CHARAP

he global economic crisis devastated Rus- Yukos—including the arrest, trial, and conviction sia’s economy. With the exception of its of the top shareholders of Yukos’s parent company, Tneighbor Ukraine, Russia suffered perhaps Platon Lebedev and Mikhail Khodorkovsky, on more than any other emerging market. In addi- fraud and tax evasion charges, and the eventual tion to the credit crunch and capital flight that oc- dismantlement of the company’s assets and their curred in practically all these sale to state-controlled firms. The affair continues Governments markets, Russia was also hit through the present day, as the imprisoned Leb- & Markets by a collapse in demand for edev and Khodorkovsky stand trial a second time, Second in a series its main export commodi- this time on embezzlement charges.) Many sug- ties, in particular hydrocar- gested the trend toward state control would now bons. When world oil prices dropped by more become even more severe. than half in the past year, Russia found itself in They predicted that entire sectors would be deep trouble. gobbled up by corrupt officials seeking to extract The statistics are grim. Gross domestic prod- rents. The heads of state-owned or state-controlled uct (GDP) could drop by as much as 10 percent corporations, or tycoons with close connections to this year, after a decade in which growth averaged leadership, would receive direct government sup- nearly 7 percent annually. Industrial production has port and would be empowered to take over other collapsed at an even steeper rate than it did during enterprises—this would represent a “soft” nation- Russia’s 1998 economic meltdown. Unemployment alization of sorts. Many feared a reversal of the has reached double digits, decimating the country’s privatizations that had occurred in the 1990s, and nascent middle class. By the end of this year, over a wholesale redistribution of assets from the pri- 17 percent of the population, or 24.6 million people, vate sector to the state or its agents. Some observ- will be living below subsistence level. In the first six ers even claimed that Russia was embarking on a months of 2009, foreign direct investment into Rus- path toward a new economic system, one com- sia plummeted 45 percent year-on-year, the steep- pletely dominated by the state. est drop on record. The stock market has tanked. These predictions have proved unfounded—at The number of Russian billionaires has fallen to 32, least thus far. Indeed, the government’s program of from 110 just last year. And for the first time in 10 anti-crisis policies has been relatively successful, es- years, the government this year will run a budget pecially in the financial sector. Few nationalizations deficit—a whopping 7.5 percent of GDP. have occurred, and those that have taken place were As the crisis gathered steam in the fall of 2008, essentially forced upon the state. To be sure, the observers predicted an incompetent government government’s response has been far from ideal: Pol- response and a new wave of property redistribu- icy implementation in many cases has been terrible, tion in favor of the state. A trend toward greater and selective bailouts seem to have been driven by state control over the economy had already be- favoritism. But the Kremlin has not fundamentally gun with the so-called “Yukos affair.” (The term altered the country’s economic structure. The crisis refers to the government’s assault on the oil giant has not put an end to Russia’s market economy.

THE INTERVENTION TREND SAMUEL CHARAP is associate director for Russia and Eurasia in the national security and international policy program at While fears of radical state enlargement have the Center for American Progress. not been realized since the crisis hit, the preceding

333 334 UÊ 1,, /Ê-/",9Ê UÊ "V̜LiÀÊÓää™

five years did in fact witness a shift toward sig- now seven, are technically state-owned and receive nificantly greater government intervention. The funds through the budget, but the government ex- backdrop to this period of statist policy was the ercises little oversight over their activities. One retrenchment of the government that occurred in such corporation, Russian Technologies, which is the 1990s. In those years, Russian policy makers chaired by a former KGB colleague of Putin’s, has had sought to reduce the state’s role to a minimum vastly expanded its purview beyond its original by liberalizing trade, limiting intervention in mar- military-industrial portfolio and has entered sec- kets, and embarking on what would become the tors such as automobiles and metals, consolidat- largest privatization effort in world history. ing hundreds of enterprises under its umbrella. The results were far from perfect, as demon- strated most vividly by the so-called loans-for- GETTING IN LINE shares privatization, in which the state essentially Overall, during the period following the Yukos sold off its most valuable enterprises for a song. affair, the public sector’s share in Russia’s mar- But the reforms did definitively prevent a return to ket capitalization grew from approximately 20 the Soviet-era command economic model. A free percent to more than 35 percent. Of the voting market was created, flawed as it might have been. shares in Russia’s 20 largest enterprises, the state Then-President Vladimir Putin for the most part came to hold over 40 percent—compared with continued the liberalization trend in his first years 11 percent when Khodorkovsky and Lebedev in office—with the prominent exception of his were arrested in 2003. handling of the military-industrial complex. When On the political level, the Yukos affair marked energy prices skyrocketed and budgetary receipts a transition from one model of state-business re- grew accordingly, the government stowed away lations to another. Some have termed this new the new money in a stabilization fund instead of relationship “state corporatist,” with the govern- using it on popular spend- ment largely dictating the ing projects that would have rules of the game to busi- increased the state’s role. The economic conditions that once ness. Russia’s oligarchs lost The Yukos affair put an allowed the Russian government their direct influence on end to this trend. Indeed, it policy making and were of- was a watershed: After the to interfere in the market with ten forced to conduct their dismantling of Yukos the impunity are a thing of the past. commercial activities in ac- government became a cen- cordance with government tral actor in Russia’s eco- mandates. In 2006 then– nomic life. The state asserted itself across wide Prime Minister Mikhail Fradkov summed up the areas of the marketplace, particularly in strategic government’s new attitude in a question addressed sectors such as energy, aviation, shipbuilding, to big business: “Are you ready to get in line?” and banking. In the energy sector—in addition to Yet, despite this expansion of the state’s role, the nationalization of Yukos and the acquisition Russia remained a market economy—however of another oil major, Sibneft, by Gazprom—the flawed. Outside of strategic sectors, private enter- state coerced international oil majors into selling prises thrived. Even within strategic sectors, the to Gazprom their majority stakes in two large gas government did not assert absolute control. The fields, Sakhalin and Kovytka. (By the time the eco- privately owned Lukoil remains the second largest nomic crisis hit, the state controlled over 80 per- oil producer, and TNK-BP, a joint venture between cent of gas production and over 40 percent of oil a Russian firm and BP, still operates. Yukos’s de- production.) The government consolidated major mise did not lead to the downfall of all the Russian industries, including aviation and shipbuilding, oligarchs, who largely maintained their positions into state-owned holding companies. In aviation, as major actors in the private economy. For them, for example, the United Aircraft Corporation was the major cost of the Yukos affair was that they created, bringing together the majority of Russian were forced to pay their taxes in full and to under- firms in the industry. A deputy prime minister write the informal expenditures expected of them chaired the new company’s board. by the government under the banner of “corporate In this period a new form of enterprise, the state social responsibility.” corporation, took on a major role in the Russian In certain cases, the government even took economy. These corporations, of which there are steps toward liberalization. In December 2005 No Obituaries Yet for Capitalism in Russia U 335

Gazprom lifted the so-called “ring fence” that had In other words, the crisis would catalyze even prevented foreign investors from buying shares in greater state control over the economy. The eco- the firm directly on the Russian market. Now 49.9 nomic downturn would both provide opportuni- percent of Gazprom is publicly traded, with a large ties for factions in the government to extract great- proportion owned by nonresidents. Other state- er rents and spur social pressures that essentially controlled firms, such as Rosneft and the banking would compel the state to push toward near-total giant VTB, conducted initial public offerings on control. Many other Russia watchers shared simi- Western exchanges, and there are plans for partial lar opinions. Some warned of a “Yukos redux”— privatization of some of the new state-controlled wherein the authorities would use the crisis as an holdings, such as United Aircraft. Western com- excuse to move beyond control of the economy’s panies and foreign multinationals still operate in strategic sectors and establish a stranglehold on Russia, despite major problems with corruption other areas. To date, however, that has not hap- and inadequate rule of law. pened. And Russia’s crisis policies have proved a moderate success. TIME TO WORRY In the tumultuous fall of 2008, the government’s When the economic crisis hit, a collective Cas- first task was to stabilize the banking and financial sandra emerged in the Western commentariat warn- systems, which were near the point of implosion. ing that the Kremlin would use the crisis as a pretext Some regions experienced runs on banks, and a to alter the economy fundamentally. In a widely dis- number of institutions stopped allowing withdraw- cussed article that appeared in Foreign Affairs this als. The chairman of Russia’s central bank said that spring, the political scientist Ian Bremmer advanced he expected between 50 and 70 banks to fail. At a thesis about the impact of the economic crisis on one point, the stock market was down 75 percent. the relationship between markets and states across Policy makers responded rapidly and on a mas- the world, including in Russia. He asserted that the sive scale. Measures taken included: using the economic crisis would precipitate a new wave of state-owned bank Vneshekonombank (VEB) to pur- state capitalism—a term he used to describe Rus- chase shares in order to support the stock market; sia’s economic system in the post-Yukos era. providing banks with subordinated loans to match

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336 UÊ 1,, /Ê-/",9Ê UÊ "V̜LiÀÊÓää™ capital raised by shareholders; switching deposits in the energy sector. It directly supported enter- from the central bank to commercial banks; inject- prises deemed strategic, critical to the function- ing capital into the four major state-controlled or ing of a particular sector, or those located in one- state-owned banks; offering private banks a wide company towns. This support has mostly come array of liquidity facilities; and increasing deposit in the form of state guarantees for loans, credits insurance. The state was also forced to bail out from state banks, and government procurement more than a dozen banks, but it nationalized only programs. five—and these were on the verge of total collapse. In April 2009, the government passed a revised Their failure could have caused a domino effect budget with stimulative measures such as more in the financial sector. To date, these measures aid for strategic sectors and major spending in- have succeeded: No major institution has failed, creases for defense, health care, and pensions. The and the localized runs on banks stopped soon af- government also provided incentives to banks to ter they started. The barter and nonpayments that extend credit, and implemented measures to sup- were prevalent during the 1990s did not return. port small and medium-size enterprises. Russia’s Once the banking and financial systems were planned fiscal stimulus for 2009–10 (excluding stabilized, the government’s next task was to pre- support to the financial sector) is, as a percentage vent Russia’s big businesses from collapsing under of GDP relative to a 2007 baseline, the third largest the weight of their massive debts. Russian firms to have been introduced in any Group of 20 coun- had obtained an astonishing $500 billion in credit try, behind only Saudi Arabia and China’s. from international lenders in the years of plenty The central bank has also played a major role leading up to the crisis. When the crisis erupted, in the anti-crisis effort. When oil prices dropped a $50 billion fund was established by the state- precipitously in the fall of 2008 and internation- owned VEB (the board of al investors pulled out of which is chaired by Prime emerging markets, the ru- Minister Putin) to allow en- The government, in its response to ble—which had strength- terprises to refinance their ened significantly during the economic crisis, decided against debt to foreign creditors. the pre-crisis period—came The bank put stringent taking the nationalization path. under new downward pres- conditions on the loans: It sure. This forced the cen- has the right to demand any tral bank to devote massive collateral it sees fit; borrowers need permission to amounts of its currency reserves to keeping the take out additional loans, launch new share issu- ruble within its specified exchange rate “corri- ances, or sell assets; and the bank can install its dor.” Beginning in November, the bank launched representatives on the boards of companies that a gradual devaluation, allowing the ruble to de- receive loans. preciate by more than 50 percent against the dol- Because the borrowers were forced to offer large lar compared to the July 2008 exchange rate. In stakes in their firms as collateral, the VEB refinanc- so doing the bank spent tens of billions of dollars’ ing program stoked fears of a nationalization cam- worth of foreign currency reserves. paign. For example, the metals companies Rusal The central bank has come under criticism for and Evraz—both controlled by the oligarch Oleg not allowing a sharp, one-off devaluation, and for Deripaska—took advantage of the VEB assistance. sticking to its policy of maintaining a range of ac- If Deripaska fails to repay his debts and VEB does ceptable exchange rates instead of letting the ruble not prolong or restructure the loans, the state float freely. Such policies would have avoided uti- could end up with a major stake in the metals sec- lizing the reserves to the same extent. But from a tor. Indeed, there has been discussion of consoli- social and political point of view, the gradual de- dating various metals companies in order to form valuation was a success. It prevented a destabiliza- a national champion. tion of Russia’s social order in a time of economic upheaval, and the populace’s confidence in the GETTING REAL government remained high. As the crisis spread from the financial sector In an unprecedented step for the Russian bu- to the real economy, the Russian government reaucracy, where traditions of secrecy dating from took further steps. It cut the corporate tax rate the Soviet era remain strong, the Kremlin in March and introduced measures to stimulate production 2009 released the details of its anti-crisis program No Obituaries Yet for Capitalism in Russia U 337 on the government’s website and in the official tions; and business representatives attend meet- state newspaper. The program as published out- ings of the government’s anti-crisis commission. lined seven government priorities during the cri- In short, there has been no repeat of the campaign sis: fulfilling the state’s social obligations; main- of government intervention that began with the taining the country’s technological and industrial Yukos affair. potential; stimulating domestic demand; fostering The government, in its response to the economic innovation and structural reform; improving the crisis, decided against taking the nationalization investment climate through institutional reform path for several reasons. First, policy makers have and deregulation; modernizing the financial and little desire to take on the debts and liabilities of banking systems; and maintaining macroeconom- troubled firms. Second, policy makers worry that ic stability. The most recent revision, in June, also bankruptcies at major enterprises, and resulting included a list of 123 measures to be taken before changes in ownership and management, could pre- the end of this year. cipitate social unrest. They are especially wary of such problems in one-company towns, but more A STEP FORWARD generally they recognize that state ownership is not Although it remains to be seen how much of the always the solution to management problems. plan will be implemented—and how many short- Third, the leadership appears to realize that it term moves associated with the plan will corre- needs to change its approach to economic policy spond to its long-term goals—such a program, in if future crises are to prove less severe than the the Russian context, represents a step forward in current one. The economic conditions that once terms of both its public nature and its strategic allowed the Russian government to interfere in the outlook. market with impunity are a thing of the past. Fol- The anti-crisis plan explicitly rejects an expan- lowing the Yukos affair, sky-high commodity pric- sion of the state’s role in the economy—and thus es ensured investor interest in Russia despite the far the government has stuck to this principle. VEB state’s intervention campaign. Now Russia must cut off its lending facility after distributing only improve the investment climate to get funds flow- one-fifth of the $50 billion in the fund it had estab- ing again. Indeed, without a boost in investment, lished. Other state lending mechanisms have been the Russian economy is unlikely to recover in the restricted as well. And the government urged state medium term and has little chance at diversifica- banks to roll over loans to domestic enterprises so tion. Although oil prices have risen recently, inves- they could avoid bankruptcy. VEB quickly followed tors today have little money to spend, and a new suit, prolonging its loans to Rusal and Evraz for one nationalization campaign would make them loath year. Foreign banks have essentially done the same, to spend it in Russia. issuing waivers to avoid defaults, since they cannot afford more writedowns on their balance sheets. CONFLICTING PRESSURES True, the state (most often through a state- The fact that Russia has not launched a new owned or state-controlled bank) has nationalized nationalization campaign does not mean the state about 20 large enterprises. But unlike previous has taken a hands-off approach to the behavior of examples of nationalization, which often saw the the country’s major enterprises. Sometimes the government take over profitable firms at the com- state has done just the opposite, most infamously manding heights of the economy, the companies in the town of Pikalevo, which depends heavily acquired in this instance are likely to be more of a for its livelihood on a cement factory. When the burden than a boon to their new owner. The na- company ceased production during the height of tionalizations, outside of the banking sector, have the economic crisis, residents took to the streets, included incomplete residential construction proj- blocking a major highway and demanding that Pu- ects, unexplored oil fields, and stakes in real estate tin personally intervene. development firms. And eventually he did. In a meeting that was Private businesses remain junior partners in the broadcast on the evening news, Putin lashed out policy making process, but they do play a consul- at local officials, federal ministers, and Deripaska tative role at a political level. Meetings between (who owns the plant) for letting the situation get business associations and government leaders out of control. At one point Putin summoned Deri- occur on a more or less regular basis; individual paska to his seat, threw down a pen, and demand- oligarchs are brought in for one-on-one consulta- ed he sign a contract to get the plant operating 338 UÊ 1,, /Ê-/",9Ê UÊ "V̜LiÀÊÓää™ again. (Putin has also insisted that executives at DIVERSIFICATION DEFERRED state-owned banks forgo their summer vacations, And while the government has not used the cri- while President Dmitri Medvedev has decried the sis to put an end to the free market, neither has “corporate egoism” of private banks, evident in it taken advantage of the crisis to modernize and their failure to give out loans.) diversify the country’s economy. Medvedev and Some forces in the political elite are pushing Putin pay constant lip service to the notion that for greater government control of the economy. moving away from an economic model based sole- Following the Pikalevo incident, the Duma in- ly on commodity exports is the only way to ensure troduced a bill that would have nationalized the Russia’s long-term economic security, but few if enterprises in that town. Russia’s umbrella trade any steps have been taken to translate these words union has called for stepped-up intervention and into concrete policies. The structural reform agen- state takeovers. Further, the government’s relative- da has largely been stalled since 2003. The leader- ly hands-off approach enjoys little support among ship even appears to be wavering in its desire for the populace—over 80 percent of Russians are in Russia to become a member of the World Trade favor of nationalizing major enterprises. Organization—a step that would significantly im- For now, however, the government has not suc- prove the environment for investors both foreign cumbed to these forces. Given Russia’s highly cen- and domestic. tralized political system, outside pressures on the Indeed, the climate for investment remains poor executive branch have far less impact than they do today, and the rule of law continues to be notable in other countries. Of course, if the crisis contin- for its absence. Systemic corruption stifles eco- ues to cause social displacement, the state might nomic growth and foreign investment, as vividly have no choice but to take a more activist role. demonstrated by IKEA’s recent decision to discon- With the economy likely to recover slowly after tinue its expansion in the Russian regions due to this year’s potential double-digit contraction, and local officials’ demands for kickbacks and bribes. with inflation still over 10 percent, such a scenario (IKEA eventually reversed its decision after Mos- is not far-fetched. cow, apparently shamed into action by extensive Furthermore, the government’s anti-crisis poli- press coverage of the announcement, intervened.) cies have not been flawless. Selective bailouts sug- Infrastructure bottlenecks, another impediment gest government favoritism verging on outright to growth, are not being addressed—funding for corruption. Implementation of some policies has infrastructure, already low, has been cut in next been a catastrophe: The decision making process year’s budget. essentially buckled under the weight of the huge But even though economic modernization re- number of initiatives called for by the government mains a pipe dream, Russia has not abandoned the program. In the absence of strongly institutional- free market. The crisis created both opportunities ized interagency processes, rent-seeking and graft and pressures to embark on a new nationalization have been rife. The legislation and government campaign, yet the government so far has resisted edicts meant to implement anti-crisis measures that urge and appears determined to continue re- were badly written. Policies have often reflected sisting it. The unique form of capitalism that de- the government’s poor understanding of condi- veloped following the Yukos affair seems likely to tions in the economy. survive the current economic upheaval. N