By the end of president Vladimir Putin’s second term next spring, Russia should be tasting the first fruits of a state-supported investment boom that can renew creaking infrastructure and revive manufacturing potential.
The mother of all oil price windfalls – of which Putin could only have dreamed when he took office in 2000, and which has persisted for the seven years since then – has finally, last year and this, produced a substantial growth in investment.
The extent to which these funds are channelled in the right directions depends on Russia’s bloated state bureaucracy on the one side, its banks and businessmen on the other – and on how much the Kremlin wants, and is able, to tell them what to do.
But one way or another, this great power, whose capital stock suffered catastrophic underinvestment both in the Soviet Union’s twilight years and during the 1990s slump, is finally retooling – literally and metaphorically. And that may turn out to be Putin’s most significant legacy.
When Putin leaves – as he probably will, notwithstanding the Kremlin spin doctors’ occasional tests of public opinion on a possible third term – Russia will be a far less democratic place than when he came to office.
But economically, Russia has been transformed. And the relationship between the state and private business has been turned upside down, too, by Putin’s efforts to divide and rule not only the Russian “oligarchs” who rose to prominence in the 1990s, but also the foreign oil companies, most of whom have decided to toe the Kremlin’s line.
For Russia’s population, the best-case scenario is that the investment boom will be sufficiently well directed to make some impact, long term, on the country’s demographic meltdown and still-deep social deprivation. The worst case is that state-directed capitalism fails to get to grips with these issues before oil prices settle back and the Putin boom comes to an end. That’s a problem for the 2010s.
Easy money
From whichever angle analysts look at the Russian economy, they share a common optimism about the investment boom. Roland Nash, head of research at Renaissance Capital, tells Emerging Markets that there are three drivers.
“First: Russian companies want to invest – and there is capital available to do so. The financial markets are expanding very rapidly. Small and medium enterprises still have problems accessing funds, but larger Russian corporates do not.
“Second: Russia’s infrastructure has reached the end of its lifespan. And this is critical. Foreign investors may be getting closed out of oil, but in the power sector, for example, it’s a different story. If the money doesn’t go in, the lights will go out. Simple as that. Capacity is falling by 5% a year and demand rising by 7% a year; in some parts of Russia, only one in 15 new applicants for electricity can get it.
“Third: capital globally wants to invest in risky assets. It’s looking for upside: you can see this in the IPO market, in real estate, and in the bidding for Russian oil assets.”
Fitch Ratings estimated in a recent study that domestic investment in Russia amounted to 21% in 2006, compared to an average of 26.5% for the 10 new EU member states. The good news, though, was that gross fixed investment accelerated throughout the year, growing 12% on average.
And net private-sector capital inflows surged to $41.6 billion in 2006, up from $1.1 billion in 2005 and a net outflow of $8 billion in 2004. Last year’s figure included $31 billion of foreign direct investment. Analysts at Deutsche UFG in Moscow agree. Economist Alexei Zabotkin says the “investment big push” is the new key macro theme. “The stories closely tied to the ‘new capex cycle’ paradigm are domestic energy reform and rapid financial deepening, with the latter to be supported by the still lax monetary backdrop.”
At the centre of Russia’s capital goods restocking are state-primed investment programmes. There are four principal strategies:
1. The corporate national champions, who are likely to provide the biggest element of public spending. Gazprom is on course to invest $69.7 billion in 2007-09 and become a bigger spender than Shell; the power company UES, which has now started privatizing key generators, hopes to grow investment from $7 billion in 2006 to $17-18 billion annually; and the oil pipeline monopoly Transneft plans $14 billion of capex this year, more than double last year’s.
2. Budget spending will grow, from $157 billion in 2006 to $275 billion in 2008 – in part through the “national projects” – new housing, agriculture, health and education – for which deputy prime minister Dmitry Medvedev, a possible presidential contender, is responsible.
3. Public-private partnerships, arranged via the economic development ministry – of which 10, from a tunnel under the Neva in St Petersburg to a toll road in Moscow, have so far been agreed.
4. The stabilization fund. When the fund of sterilized oil revenues reaches the equivalent of 10% of GDP (about $125 billion), it will be split in two. Anything above that level will be placed in a separate “fund for future generations” – which finance minister Aleksei Kudrin believes should be invested offshore, as the stabilization fund currently is, but most other politicians think should be used inside Russia.
With elections looming, the pressure to use the second fund for internal investment will grow. Former premier Evgeny Primakov, a champion of state-led development and social spending in his time, said recently that those who “argue against spending a single kopek of the stabilization fund at home ... even on transport infrastructure” will lose out in 2007.
Nash at Renaissance says: “Kudrin’s big idea was not to give the money to the bureaucracy, which would waste it. But now things are so bad with infrastructure that the consensus is against him. The question is – will the money be frittered away and end up seeping into the economy and fuelling inflation, or will it be directed to necessary infrastructure and boost development over the next decade?” A big question.
Obedient capitalists
Another achievement for which Putin will be remembered is his reordering of the relationship between the state and private capital. Russia’s largest corporates are getting used to being told what to do by the Kremlin, the reverse of the situation when Putin arrived.
And Putin’s rules don’t just apply to Russians. The outcome of two recent bankruptcy auctions of the assets of Yukos suggest that foreign companies have accepted the need to play the game, too. Yukos was Russia’s second largest oil company before it was smashed up by court cases and extra tax demands in 2004-05 and its main owner, Mikhail Khodorkovsky, jailed for ten years.
In the first auction, of a 9.44% stake in the state oil company Rosneft, which had belonged to Yukos, Rosneft itself was joined in the bidding by TNK-BP, of which BP owns 50%. TNK-BP pulled out after 10 minutes, with the price just $90 million above the $7.5 billion starting price, and Rosneft paid $7.9 billion for the stake.
BP said the price had simply gone up too far for it. But GML, Yukos’s main shareholder, said the auction’s outcome was predetermined, and TNK-BP’s presence had legitimized state sequestration. Analysts pointed out that the episode may help TNK-BP in its negotiations with government officials over its Kovykta gas project in eastern Siberia, in which Gazprom wants a stake.
The second auction, of a $5.3 billion package of assets including 20% of Gazpromneft and three gas producers, was won by a consortium headed by Eni of Italy. Straight after the sale, Eni announced that it would sell a 51% stake in the package to Gazprom under a call option arrangement made before the sale.
Chris Weafer, chief analyst at Alfa Bank, says that the Kremlin’s marshalling of relationships with foreign oil companies goes alongside a clear set of rules for Russia’s own oligarchs – who have contributed a significant portion of the funds that have flowed into state-controlled companies during IPOs.
Cash invested in Rosneft and Sberbank “has almost certainly come from a large group of Russian dollar billionaires and companies controlled by them”, Weafer says. “It is actually a neat mechanism for the state to use these people’s funds to further its own industrial ambitions.” Of course the investment has been profitable too, he adds.
New rules have been laid down for oligarchs, Weafer argues. As well as the commandments of 2000 – stay out of politics, pay taxes and operate within the law – they are now expected to use their wealth to support state objectives and help Russia. And those in the natural resources sector should invest in downstream processing and the value-added segments of their business.
Top down politics
The final piece of the Putin jigsaw is the so-called “managed democracy” that will be on view during the parliamentary elections in December and the presidential poll in March next year. Political parties of which the Kremlin disapproves are unlikely to play any significant part.
United Russia, the Kremlin-created “party of power”, has now been supplemented by a Kremlin-created opposition party, Just Russia, headed by federation council chairman Sergei Mironov – who recently called for the constitution to be changed so that Putin could stand for a third term. The communists are expected to lose more votes to both of these, while the right-wing liberal opposition will struggle to pass the 5% barrier to parliamentary representation.
It’s part of a general erosion of democracy. Most media is state controlled, and critical journalists keep dying strange deaths. Tolerance for non-Russian nationalities is worn away by state thuggery in Chechnya and skinhead thuggery elsewhere.
And most observers agree that whether Putin is succeeded by Dmitry Medvedev, by deputy prime minister Sergei Ivanov, or by some as-yet-unknown wunderkind to be plucked from obscurity as Putin himself was, the machinery of government will not change substantially. There may be short-term fall-out between Kremlin factions after the March election, but the unity wrought by Putin is unlikely to crack open.
Putin will be thanking his lucky stars the oil prices held up as long as they did during his first two terms. His successor will pray that they don’t fall too far, too fast.