Putin pushes for a long lasting legacy

  • 21 Oct 2005
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The progress that Russia has made since its socio-economic implosion in 1998 has been nothing short of spectacular. A stable political regime and a soaring oil price have meant that Russian people are better off and corporate earnings are at record highs. Restaurants, cinemas and casinos are full and foreign direct investment is pouring in. But what happens when Putin steps down and the oil price begins to fall? Can Russia maintain its new found way of life? Julian Evans reports.

Vladimir Putin has still got two more years of power ahead of him, but bankers and investors are already looking back at the Putin era with something approaching nostalgia. Take Bob Foresman, head of Dresdner Kleinwort Wasserstein's Moscow office: "Rewind back to 1999, when Putin came to power. It was the depth of the financial crisis. Look at the living standards and sense of national pride now. It's incomparable."

Historians may well look back on the age of Putin as a Russian golden age. Charles Ryan, CEO of Moscow brokerage UFG, says: "Compare him to the people who came before him — Yeltsin, Andropov, Brezhnev, Khruschev, Stalin, Lenin... we're way above the average here!"

His main achievement is the recovery of the country from the basket case it was in 1998. The government has become an investment grade-rated net creditor, and finance minister Alexei Kudrin has stored away almost $20bn of petrodollars in a stabilisation fund, the total of which is forecast to rise to $40bn by 2007.

Corporate earnings are at record highs, which has helped the Russian stock market to climb 40% since May. Russian companies are increasingly competing on the global market — Lukoil's expansion into the US gasoline market over the last two years is one example.

Ordinary Russians are getting richer. Salaries have risen by an average of 12% over the last five years, and rose 22% last year. The consumer sector has performed phenomenally, with retail stores like Pyaterochka growing annual sales at rates of over 100%.

Lennart Dahlgren, general director of home furniture company Ikea, says: "Russian families are getting more and more money, and they don't like to save, they like to spend." Ikea has already invested $1bn in Russia since it launched in 2000, which is more than it has invested in any other country. Dahlgren says the firm plans to invest another $1bn in the next two years, as it sets up shopping malls in regional cities such as Kazan and Nizhny Novgorod.

The bulging wallets of the Putin years are all too apparent in the streets of Moscow. Last year, 1,000 new restaurants opened in the city. It now has more casinos than Las Vegas. Cinemas are filled with movie-goers, and they going to see blockbusters made at home, not abroad. Every six months, the record for the highest grossing Russian film ever gets broken. In October, it was broken by Company 9, a new blockbuster about the Afghan War, which made its $10m budget back in a week. 

Those at the bottom of society are doing better too. A new report by the World Bank says that in 2002, 21% of the country lived in abject poverty. That figure had fallen to 9% by this year. The report noted that high unemployment was a serious concern in new EU countries such as Poland — but not in Russia.

On the international stage, Russia is no longer the joke it was in the 1990s. Yes, there have been slip-ups — Russia's stand-off with the West over Ukraine was avoidable and damaging.

But in general, Russia's relations with both West and East are strong. Russia is moving — though slowly — to join the World Trade Organisation, has signed up to the Kyoto treaty, and next year will host the G8 summit. It is of growing importance to the West and to China as a supplier of oil and gas.

But what will remain?

While the feel-good factor is very obvious in many parts of Russia, what will remain of it when oil prices go down? As Toby Gati, senior international adviser at US law firm Akin, Gump, says: "It is easy to be a success when oil prices are at record highs."

The economy remains resources-dependent, with 42% of GDP coming from the natural resources sector. It also still has a weak financial sector, so a sudden drop in liquidity coming from a fall in petrodollars would probably force some smaller banks into bankruptcy.

While government external debt would likely be well protected thanks to the state's large foreign reserves, the domestic economy would be hit. Several of the non-resources sectors which are doing well — construction, consumer goods and mobile phones, for example — still directly depend on the oil market.

Even a more moderate fall in oil prices, to $40 a barrel for example, would cause GDP growth to fall from last year's 7% to below 6% for the next three years, according to the research department of Bank UralSib.

The economy is diversifying from the oil and gas sector, but very slowly. The government announced a big push to encourage investment in information technology, via special IT investment parks and subsidies for foreign investment. But IT development so far has disappointed.

Elena Ivashentseva, partner at Baring Vostok private equity fund, says: "A few years ago, everyone expected IT outsourcing to take off in Russia to the same extent it did in India. But the results were much less than expected. The ministry of IT, telecoms and communications has been trying to encourage the growth of the sector, but without much success."

However, bankers and private equity fund managers say interesting new companies are being set up outside the resources sector. Ivashentseva says: "There are a number of serial entrepreneurs now starting their second or third ventures, having already sold their previous companies." She points to the success of Arkady Volozh, CEO of the internet search engine Yandex, in which Baring Vostok is an investor. "He's already started four different IT-related businesses in the last 15 years," she says.

However, Ivanshentseva sounds a note of caution: "There is still a shortage of entrepreneurially-minded people and professional managers." Even at modern, Western-minded new businesses, the service is still frequently abysmal.

The eternal bureaucrat

And new businesses, both Russian and foreign, face great challenges. Ivashensteva says: "Administrative reform has not been successful." President Putin has been struggling for some years to cut back the bureaucracy in Russia, but to enact his measures, he has to rely on the very bureaucracy he wants to cut back.

Estimates vary as to the seriousness of corruption in Russia. The Indem Foundation, a Moscow-based non-governmental organisation that encourages the development of civil society, estimated Russian companies spent $316bn on bribes in 2004 — far more than they did in 2000. But another report, by the World Bank, suggested corruption was actually less serious in Russia than it was in China or Brazil.

Sharon Tennison is president of Center for Citizen Initiatives, a lobby group which helps entrepreneurs from the former Soviet Union learn how to grow their businesses and deal with administrative barriers. She says the level of corruption in Russia is not going down, though businessmen are getting less tolerant of it, and more prepared to speak up about it.

She recently visited Russia to work directly with some small businesses, and ironically ended up getting arrested by the Federal Security Service and held in jail for several hours.

Foreign investors face at least as many administrative obstacles as Russian businessmen. But Ikea's Lennart Dahlgren says it is worth it, despite the hassles: "Only come to Russia if you believe in Russia's future, as I do, because you will face a hell of a lot of problems — effort, money, sleepless nights. If you believe in Russia, you will survive."

System failure

While Putin has helped Russia as a whole get up off its knees, many parts of Russia beyond the biggest cities are still close to collapse.

Dmitry Kozak, Putin's special envoy to the Caucasus, warned in a leaked report in July that the North Caucasus faced disintegration unless local clans appointed to power by Putin were able to attract more public loyalty.

Much housing in Russia, particularly in smaller regional cities, is getting so old it is becoming dangerous, but new homes are being built far more slowly than old buildings are falling apart.

The country's electricity infrastructure is also increasingly worn out. Deloitte & Touche estimates that $200bn of investment is needed in the power sector over the next 20 years, which is why the government is trying to privatise Unified Energy Systems (UES), the state electricity monopoly, to attract private capital. It was worn-out equipment which led to a blackout in Moscow in May, when 20,000 people were stuck in the Metro, and 1,500 in lifts, for several hours.

And the health of many Russians is decaying too. Male life expectancy is just 58, because of high levels of stress, alcoholism and infectious diseases such as tuberculosis and Aids. Russia's 143m population is falling by around 800,000 a year.

So while Putin has done a lot, much remains to be done. The president announced in September that social policies would take priority in his last two years. He is injecting $4bn into state sector salaries and earmarking more money for large infrastructure projects. But as Troika Dialog's chief economist, Evgeny Gavrilenkov, points out, social spending is not actually rising as a percentage of GDP.

Share the wealth

The government is likely to come under increasing pressure to spend its petrodollars on social and infrastructure spending in the run-up to the 2008 election. Some economists, like Gavrilenkov, recently wrote a letter to prime minister Mikhail Fradkov, pleading with him to maintain fiscal prudence. Reportedly, they were asked to do so by finance minister Alexei Kudrin, who is concerned about the effect of further increases in spending on inflation, which is around the 10% level.

But other economists think the government should share the wealth. Professor Marshall Goldman of Harvard University says: "I think the government liberals have got it wrong. To hold back the building of essential infrastructure because of worries about 10% inflation seems to me incorrect."

Above all the smaller debates, however, lies the big question — who will succeed Putin in 2008, and what kind of political system will Russia emerge into? Michael McFaul, senior associate of the Carnegie Center in Washington, says: "My advice to investors is, until 2008 — party. After 2008 — worry." Roland Nash, chief strategist at Renaissance Capital, agrees that the "massive shift in power" which the 2008 election will bring "will go a long way towards undermining today's positive sentiments".

Some investors have gone as far as to plead with the president — as Sovlink analyst Eric Kraus did — "Please Vladimir, don't go!" Unfortunately for many investors, Putin has said many times that he will indeed step down.

While Putin's legacy is certainly higher living standards and more stability, a lot of the system he has built relies on the enlightenment of the figure at the top of the hierarchy. In his bid to strengthen the 'power vertical', Putin has weakened the Duma, which scrutinises legislation far less than it did. He has failed to reform the judiciary, so as to make it more independent. The FSB (Federal Security Service) and general prosecutor's office operate with, if anything, more impunity than they did when Putin came to power. The media is more and more muzzled. And civil society has come under government suspicion and attack.

So unfortunately for all of us, Putin has concentrated so much power in the hands of the presidency, and removed so many checks and balances, that whoever succeeds him can either do a lot of good, as arguably he has done, or cause a lot of harm. 

Who will succeed Putin?

No one knows, but here are six of the favourites

Dmitry Kozak
Presidential envoy to the Caucasus

Kozak is many liberals' choice for the top spot. A photogenic lawyer from St Petersburg, he has been trusted by Putin with some of the hardest policies in the last five years, such as judicial reform and governing the Caucasus.
Unfortunately, he hasn't had much success in either area — his attempt at judicial reform was stymied by the general prosecutor's office; while the Caucasus under his beat, through no real fault of his own, has continued its degeneration, culminating in terrorists' day-time invasion of the town of Nalchik in the region of Kabardino-Balkaria in October.

Sergei Ivanov
Defence minister

Ivanov is in some ways the most obvious candidate to succeed Putin. The two worked together at the KGB in Leningrad for several years, where Ivanov was Putin's senior. 
The man is known for being tough. At a military exercise in India in October, a mortar misfired and landed metres from Ivanov. While soldiers and journalists ran for cover, Ivanov sat unmoved, and later laughed off the incident.
Foreign politicians say he is one of the more impressive members of Putin's cabinet, which is otherwise dominated by yes-men. However, some experts say he is too defensive. Fiona Hill, senior associate at the Brookings Institution, says: "When we met him, he interpreted our every question as an accusation, and always seemed to be arguing against some hidden enemy." He is also mainly focused on foreign policy.

Dmitri Medvedev
Chief of staff of the
presidential executive office

Medvedev did a PhD in law at Leningrad State University, while working as a consultant for Putin in the St Petersburg mayor's office. When Putin's fortunes rose, his did too. He became deputy head of the presidential administration, and then chief of staff in 2003 when the previous incumbent, Alexander Voloshin, resigned in protest against the Yukos saga. He was also appointed to the important position of chairman of the board of Gazprom, which some people think Putin might take over when he leaves the presidency. So could he and Medvedev swap jobs?
Medvedev would be a popular choice with liberals and businessmen. He is considered the leader of the St Petersburg liberals faction, as opposed to the St Petersburg spy faction, which is headed by Igor Sechin, deputy head of the presidential administration. However, some people question how well Medvedev has done as chief of staff. The government has failed to pass many real policies under his chairmanship, compared to when it was under the more experienced hand of Voloshin.

Alexander Tkachev
Governor of Krasnodar region

Putin seems to have a fondness for the southern region of Krasnodar — he goes skiing in Sochi every year, and frequently makes official trips to the region's warm climes. He is supposed to be close, too, to its governor, Alexander Tkachev.
Under his governorship, Krasnodar has done better than many regions at attracting investment, and it is often given as an example of economic growth beyond Moscow and St Petersburg. Tkachev is also thought to have the backing of the metals oligarch Oleg Deripaska, who is himself from Krasnodar. Tkachev is photogenic, and his hardline policy on immigrants could be popular in the increasingly nationalist environment of Russian politics. But those very policies, such as his habit of using Cossack militia to crack down on immigrants, make him distasteful to many liberals.

Alexander Khloponin
Governor of Krasnoyarsk region

Khloponin is a favourite candidate of many foreign businessmen and investors. As a young banker, he worked for oligarch Vladimir Potanin in the 1990s, then became a senior manager at Norilsk Nickel, helping to turn the company's fortunes round and raise its share price. He then became governor of the Taimyr region, and in 2002 governor of the important Siberian industrial region of Krasnoyarsk. His success at managing these companies and regions and helping them out of industrial decline has impressed many, as has his confidence and ability to deal with the media. However, his connection to the privatisation of Norilsk Nickel in the 1990s will inevitably count against him in the present anti-oligarch political environment.

Vladimir Kolesnikov
Deputy general prosecutor

The general prosecutor's office has grown in influence in the last few years, as it has been used as an instrument for the state to bring oligarchs to heel. The head of the office, Vladimir Ustinov, is close to the clan centred on Igor Sechin, the ex-KGB deputy head of the presidential administration, who is also chairman of Rosneft. 
That clan will be keen to make sure its economic and political gains are not lost under the new president. Sechin himself won't run — he shuns publicity. Ustinov may be too old. His younger deputy, however, is a possible candidate. The team would have large financial resources at their disposal, but more importantly, they would be in a great position to attack the reputations of any rivals. 

  • 21 Oct 2005

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