Tuesday, 22 April 2008

Medvedev to maintain Putin’s grip

Wall Street Journal - Financial News

Jason Corcoran in Moscow

21 April 2008

Despite a new President, the Kremlin is likely to increase state control of certain sectors

Medvedev has promised to adopt many of Putin’s (pictured) policies

Russia has a new leader, but the indications are that the country’s business community will have to wait for a new political era. President-elect Dmitry Medvedev may be the first Russian leader to have worked in the private sector, but he owes his victory in the March 2 presidential election to the endorsement of his predecessor, Vladimir Putin, and has promised to adopt his mentor’s policy of tightening control of the country’s companies.

Under Putin, the Russian state has consolidated control over large sectors of the economy and several business leaders have been jailed or have fled the country. Record oil prices first brought creeping nationalisation of energy resources but state intervention is spreading to other sectors and the Kremlin is dictating the rules for foreign investors.

A strategic industries bill, which was approved by the Russian Parliament in early April, will extend state control beyond the commodities sectors. Recent raids by security services on the offices of the Russian-British joint venture TNK-BP and attempts by a federal property agency to seize control of Moscow’s privately owned Domodevo airport suggest the goal posts for investors are moving.

Arnab Das, global head of emerging markets strategy at Dresdner Kleinwort, said: “Russia is reasserting itself as a counterweight to the US and economics is a tool in its armoury. Medvedev and Putin will continue to try to balance geopolitical goals with the need to have free and fair markets.

“The statists, rather than the free-marketeers, may seem to have the upper hand now but the integration of Russia into global financial and trading systems is helping the reform agenda despite the backsliding we have seen with the introduction of price controls.”

The strategic industries law, which was passed in the Duma at the beginning of this month, lists 42 sectors that will be categorised as strategic and in which foreign investments will be either prohibited or limited. The law will require non-state foreign investors to receive permission from the Russian authorities to acquire 50% or more of a company. In the oil and gas sectors, limitations are substantially stricter with the limits of participation set at 10% for foreign companies and 5% for sovereign wealth funds. Foreign investors that already own more than 5% of a strategic company will be required to declare their holdings to the Russian Government.

Igor Lebedinets, analyst at Russian bank Renaissance Capital, said: “We believe the adoption of this bill is mainly aimed at increasing the Government’s influence in major sectors of the economy, including mass-media although the internet sector is excluded from the list. We have a negative view of the bill because we think it might create additional bureaucracy barriers for foreign investment deals and may slow growth in these industries.”

The list has expanded since 2005, when Putin first ordered the legislative changes. In addition to defence, energy, aircraft and aerospace industries, and critical infrastructure – all of which have long been deemed strategic – the legislation accounts for nanotechnology, fisheries and the late inclusion of mobile telecommunication.

The Government says it needs to resuscitate strategic sectors that have suffered from a lack of investment since the collapse of the Soviet Union, but critics argue the policy is anti-competitive and will dissuade foreign direct investment.

Bankers say investors are aware of the state’s increasing role in designated strategic sectors and that the potential benefits of gaining exposure to a country enjoying a prolonged economic boom – where annual gross domestic product is forecast at 7% in 2008 – outweighed the political risks.

Ivailo Vesselinov, senior economist at Dresdner Kleinwort, said: “Foreign companies involved in oil and gas are well aware of the risk factors involved and of the existence of an environmental regulator who monitors the industry, but on a risk-adjusted basis they realise there is nonetheless a lot of profit to be made on the ground.”

Steven Hellman, head of client coverage in Russia for Credit Suisse, said national sponsorship of select industries, or even re-nationalisation, can be positive in the short term if it encourages investment in underdeveloped sectors of the economy. He said: “The technology and automotive industries would be examples. Of course, this must be done in a manner that is fair to all shareholders and there comes a point when market forces should be allowed to take over to ensure efficient development for the future.”

The apparent renationalisation of Russia’s resource sector was a recurring theme during the Putin presidency.

State-controlled gas company Gazprom flexed its muscles last year by taking control of Sakhalin-2, Russia’s largest combined oil and natural gas development, after a campaign against foreign operator Royal Dutch Shell over alleged environmental violations. The Russian-British joint venture TNK-BP is this month likely to finalise the sale of its stake in the Kovykta gas field to Gazprom. TNK-BP, co-owned by BP and a group of Russian billionaires, has been subject to speculation that the Kremlin wants the Russian owners to sell their stakes to a state organisation to let the Kremlin tighten its grip on the energy sector.

Analysts interpreted a recent search of TNK-BP’s offices by the Federal Security Service and the arrest of an employee on suspicion of industrial espionage as signs the Government is increasing pressure on the owners to sell. Russia’s Federal Migration Service said it was not conducting a concerted effort against UK energy group BP, which recalled its 148 foreign employees because of “a lack of clarity over their current visa status”.

Home-grown energy companies and their oligarch owners have also come under the spotlight of resource nationalism.

The Kremlin is seeking the extradition from the UK of Mikhail Gutseriyev, the owner of the oil company RussNeft, who fled Russia last year after accusing the state of forcing him to sell his company through the levying of politicised tax charges.

The RussNeft case echoes that of the oil group Yukos, which ceased to exist from last November following the carve-up of its assets during the summer and the continued incarceration in Siberia of its former owner Mikhail Khodorkovsky on tax evasion charges.

Nick Jordan, head of Lehman Brothers’ Russian operation, said that the apparent renationalisations have involved acquisitions of assets at fair market value. As head of investment banking at Deutsche Bank, Jordan was involved in advising Gazprom on its bid to acquire the Yukos production asset Yuganskneftegas. An auction was later held and Yuganskneftegas was sold for $9bn (€5.7bn) to Rosneft, a rival energy company.

In an interview with Financial News, Jordan said: “The transition from communism to what we have at present has not been perfect but there has been an overly strict focus on this Russian transition. I would say it is fairer to compare the natural resources sector with its emerging market peer group. Look at the Middle East and Latin America and how many of those companies have been sold to foreigners or are public.”

Jordan, who also advised Gazprom-Media on its successful campaign to seize control of independent television station NTV, believes the term renationalisation has been used loosely in Russia.

He said: “It is a term that has been used rather generally here for a number of years. In almost all cases where a company has been brought back under Government control, it has continued to reissue shares to the public or has retained its public share ownership, which means it is not nationalised in technical terms. In each case there has either been an acquisition at fair market value or there has been a local legal process”

In the latest tug-of-war over private assets, East Line, the owner of Moscow’s Domodevo airport, is fighting an attempt by the Federal Agency for Federal Property Management to nationalise some of its assets. The agency claims the terminal was illegally privatised a decade ago. Das said foreign investors and politicians are right to adopt divergent views of such attempts by the state to reclaim prized assets. He said: “Whether renationalisation is creeping or galloping in Russia, it is bad news for what the country wants to achieve economically. The International Monetary Fund, the World Bank and the US Treasury are right to view what is happening in prescriptive ideological terms.

“That is what they are there for, just as bankers and businessmen are right to reconcile what is happening as a function of the state and part of the economic cycle, and should be expected to position themselves to do business in that context.”

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