RUSSIA: NEVER AS GOOD AS ONE HOPES, NEVER AS BAD AS ONE FEARS

By Elena Chinyaeva

It looks as if the period of “wild capitalism” in Russia, with its redistribution of property through controversial privatization deals, has ended. The country has entered a stage in which respecting minor shareholders rights, introducing transparency standards and generally doing business “properly” provide a major competitive advantage. President Vladimir Putin’s first official visit to the United States showed that the West is ready to welcome Russia among the developed nations. However, artificially speeding up the process of Russia’s incorporation into the global economy, as if it has already become a developed market, might be dangerously premature.

LEARNING TO BE RESPECTABLE

Opening the World Economic Forum (WEF) in Moscow on October 30, Andrei Illarionov, the president’s special adviser on economics, said that the good news from Russia is not just continuing economic growth amid the world recession, but qualitative changes in Russian business as well. Even the Western press, ever critical of Russian capitalism, has started to recognize the changes. On August 20, Energy Day noted that Lukoil, Russia’s No. 1 oil company, had announced the largest profit ever declared publicly by a Russian company–US$3.31 billion for 2000. The event was all the more remarkable, Energy Day added, given that Lukoil had done its financial report according to GAAP (Generally Accepted Accounting Principles) standards–a fact that in and of itself drove the oil company’s shares 2.8 percent higher. On September 20, Petroleum Economist reported the success story of another oil major, Rosneft, which declared a $1 billion profit for the year 2000. On October 1, Forbes magazine praised the Yukos oil company for successfully transforming its scandalous image to an almost exemplary one by becoming minority shareholders–friendly and transparent–a tendency that Forbes said was starting to prevail among Russian companies.

One notable sign of the qualitative changes in Russia’s economy is the growing number of consulting services. While in the past business “problems” were solved, for the most part, by bribes or guns, companies now turn to professionals for advice on what their structure should be or how to best motivate their personnel. While the industrial sector makes up about 33.5 percent of Russia’s GDP, over 60 percent of consultancies’ income in Russia comes from that sector, with 26 percent of it from the oil and gas industries. By way of comparison, in other countries the raw materials sector accounts for less than 5 percent of consultancies’ business, according to the European Federation of Consulting Associations (FEACO).

It is no surprise, then, that a year-long course of seminars on management in marketing, finance and personnel launched in September in Moscow by the Russian media holding Kommersant, the Harvard Business School, and the Moscow Higher Economic School has proven hugely popular, especially with provincial companies. Doing things “properly” is becoming fashionable in the Russian business community and opportunities to learn are appreciated. Various sectors, from banking to beer brewing, have been represented at the seminars. Large and small companies alike have attended, though medium-sized producers have been the most widely represented.

The participants in the seminars–top managers and owners–are no novices to the subject of business administration: Having read the available classics, they want the latest information and the newest methodology and do not easily buy into everything said at the lectures. They have also demonstrated a sophisticated approach to the process of solving business problems. If in the not-so-distant past, a consultant was expected simply to “make it look beautiful,” there is now an understanding that the solution to any concrete problem starts with the company’s comprehension of its prospects, strategy and place in the market.

TRYING TO LOOK GOOD

The qualitative changes in Russian business are based on macroeconomic stabilization, and the country’s leadership is showing the results of its efforts to attract investors and promote Russia’s position in the world community. If holding the WEF in Moscow was aimed at making Russia look good and reliable, it succeeded. Andrei Illarionov, who is not known for euphoric analysis, proclaimed that Russia is set to enter a new phase of transition–from a developing to a developed market economy. Last year, the economy grew an impressive 8 percent and this year, despite the deepening recession in the developed countries, growth is expected to come in at over 5.5 percent. Consumption has reached the pre-economic reform level of 1990. Yet while the state redistributed 72 percent of GDP in 1991, today it redistributes only 33 percent. Illarionov even suggested that Russian economy depends much less on world oil prices than is generally believed and that their fall would not affect its growth.

Jean Lemierre, president of the European Bank for Reconstruction and Development, praised the Russian government for successful reforms. Deputy Finance Minister Sergei Shatalov responded by announcing that the government is considering lowering the VAT further, from 20 percent to 16-17 percent (though this would require the rescinding the specially reduced VAT-10 percent–on socially important products like bread and milk), and creating free economic zones, each occupying no more than 10 square kilometers, for hi-tech industries.

Just a few days before the WEF convened, Aleksei Kudrin, Russia’s finance minister, met in Moscow with representatives of the French government. During that meeting, Kudrin told Jean-Pierre Jouyet, chairman of the Paris Club of sovereign creditors, that Russia might repay its Soviet-era debt to the Paris Club of sovereign creditors ahead of schedule. The following day, the Financial Times said that this would send a positive message to private investors. Meanwhile, three international rating agencies have raised Russia’s ratings over the past month, and its international bonds have outperformed those of most other emerging markets over the past year.

With macroeconomics in order, reforms underway and domestic businesses ready to behave, everything looks ready for the arrival of foreign investors. The U.S oil company Exxon Mobil announced during the WEF that it would start a Sakhalin-1 project, investing an initial US$12 billion to explore oil fields in the Russia’s Far East. The German trading giant Metro opened its first two centers in Moscow on November 1, with plans over the next year plans to increase the number to six, with a planned total turnover of US$480 million. Over a year ago, the Swedish furniture retailer Ikea opened its first store in Moscow. Its goal was 1 million customers and already reportedly has around about 3 million. Ikea plans to open four more stores in Moscow and St Petersburg.

Clearly, investors are getting interested. Indeed, in stark contrast to the mood just a few years ago, when world business leaders at World Economic Forum in Davos laughed at the question “Who is Mister Putin?”, many foreign analysts now believe President Putin is just the right man, keen to encourage investment and determined to drive needed legislation through the parliament–including, some expect, tax incentives for foreign direct investment. Speaking at the WEF in Moscow, Putin once again reminded the audience that Russia’s 13-percent flat income tax is the lowest in Europe, while the corporate tax was lowered from 35 percent to 24 percent. A corporate codex to make Russian companies transparent is being discussed. Putin’s wry humor was on display when he promised to make Russians happy by 2010, but said that for the time being he was announcing the creation of the anti-moneylaundering Committee for Financial Monitoring, a step expected by the West as one of the preconditions for Russia’s entry into the World Trade Organization.

This process was further reinstated during Putin’s official visit to the United States in early November. Although the main issue of the summit–Russia’s acquiescence to changes in the 1972 Anti-Ballistic Missile Treaty that would allow the United States to continue with its national missile defense project–remained unresolved, it looks certain that the notorious Jackson-Vanik amendment, which has blocked Russia from receiving Most Favored Nation trading status, would finally be dropped. In anticipation of that move, Russian stocks rose significantly as foreign investors rushed into what has again become a promising market. With Russia having becoming a close ally of the U.S. in its antiterrorist war, the West is clearly falling in love with Mr. Putin. It could prove to be a stormy love affair.

ONE STEP TOO SOON

Its economic progress notwithstanding, the economic reality of Russia remains a complex picture. It is still dominated largely by companies exporting raw materials, mainly oil, gas and metals, which are both pulling the economy ahead and in the forefront of qualitative changes in business. Since the economic collapse of the early 1990s, the extracting industries replaced the military-industrial complex as the core of the Russian economy. They have greatly benefited from the 1998 devaluation of ruble, which they use to pay their costs, while the rise in world oil prices added to their dollar profits. The extracting industries, which account for about 20 percent of Russia’s GDP, pull together other sectors, from geological exploration to machine production, and are a major political factor in Russia’s foreign policy. By dominating the European gas market and playing a significant role in the world oil and metals markets, Russia is positioning itself as an important and reliable supplier of energy resources at the time when, due to the war on terrorism, traditional Western sources might come under threat.

The extracting industries also hope to benefit from Russia’s incorporation into the WTO with the termination of the antidumping measures that are often taken against them in the Western markets. However Russia’s membership in the WTO would also mean opening up its domestic markets to foreign competition at the time when most of its domestic industries are not ready for it. True, pampering some of them–the notorious Lada car producer comes immediately to mind–would hardly solve their problems. Yet other promising sectors, such as aviation and food production, which need a bit more time to stand firmly on their feet, would suffer from premature exposure.

The tempo of the Russian economy’s growth might currently be high, but it is starting from a very low level. While generating huge cash profits, leading Russian companies are still undervalued in the stock market. According to the Financial Times, even the highest rated Russian companies, which have the biggest net profit margins in the world, are still only trading with a price/earnings ratios of about 3, while the P/E ratio of stock in Brazil’s state oil giant Petrobras is 9 and many Asian oil companies are trading on p/e ratios of 14. Russian mobile phone companies, currently the most promising investments, have P/E ratios of about 15, which is high by Russian standards but still low compared to the West.

Russia’s economy is dependent on world oil prices. The 2002 budget is calculated on the basis of oil at US$18 a barrel, and at US$12 a barrel–a possibility due to the current international crisis–many oil companies would be unable to cover even their costs. The OPEC cartel has already started pressuring Russia to cut on its oil production to maintain oil prices, threatening otherwise to let them drop oil prices to the level at which Russian production becomes unprofitable.

The Russian banking system also presents a problem because it remains unreformed and risks disappearing altogether if internal markets were indeed opened up to foreign banks.

However, as Hans Horn, the head of Arthur Andersen in Russia, once said, things in Russia never get as good as you hope for, but are never as bad as you fear. The most important goal right now for Russia is not to lose momentum by trading real economic prospects for illusory political gains. The WTO might be a prestigious international club to join, but entering it should first of all facilitate national economic development. Gaining the status of a U.S. strategic partner might tickle the ego of Russian politicians, but national interests have to come first. Russian businesses might continue to lobby the government to prevent foreign competition or give up and sell out to foreigners, but they better use the remaining time to improve by cutting costs and becoming more effective and consumer-friendly. Only then will the publication of the Russian companies’ financial reports according to the GAAP standards stop being an “event” in itself, and doing business properly become the norm.

Elena Chinyaeva, who holds a doctorate in modern history from Oxford University, is a writer with the leading Russian political weekly Kommersant-Vlast.