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The Kremlin Wars (Special Series), Part 3: Rise of the Civiliki

12 MINS READOct 26, 2009 | 23:45 GMT
Summary
The global economic crisis has led the Kremlin to examine its decisions about running Russia's economy, financial sectors and businesses. A group of intellectuals including Russian President Dmitri Medvedev, called the civiliki, want to use the crisis as an opportunity to reform the Russian economy. The civiliki's plan will lead to increased investment and greater efficiency in the economy, but it will also trigger a fresh round of conflict between the Kremlin's two powerful political clans. Editor's Note: This is part three in a five-part series examining the Russian political clans and the coming conflict between them.
Click here to download a PDF of this report In the aftermath of the global economic crisis, Russian Prime Minister Vladimir Putin has had to step back and examine the Kremlin's decisions on running the country's economy, financial sectors and businesses and the effects of a state-controlled system on investment, growth and the freedom of capital. In response, a group of Russian intellectuals called the civiliki, who are trained in economics, law and finance, have presented proposals on "fixing" the economy. The civiliki (a play on words, since the Federal Security Service and other members of the security class in Russia are called the siloviki) is a new group of economically liberal-minded (by Russian standards) politicians and businessmen. This group includes Russian President Dmitri Medvedev, Finance Minister Alexei Kudrin (who is also a deputy prime minister), Sberbank chief German Gref and many more. The civiliki are not ideologues like the liberal Russian reformers of the 1990s and understand that the Russian economy and institutions must maintain some sense of balance with national security and national interests. But the civiliki also see how much damage the siloviki's control of key power structures and businesses has done to the Russian economy. The civiliki's plan has one main goal in mind: to implement real structural reform in Russia's major economic sectors. This will improve competition, attract investment and purge waste and mismanagement. The plan has three parts — purge the non-business-minded siloviki from positions of economic responsibility, introduce new pro-investment laws and partially liberalize the economy. It is an incredibly ambitious plan that would reverse laws designed by the FSB and Putin over the past six years. But the reforms are being spearheaded by the one man Putin trusts on all finance and economic issues: the civiliki's Kudrin. Kudrin is an experienced official, being one of the very few to make the transition from the Yeltsin era to Putin's Russia and having held a prominent position in every one of Putin's governments. The reason for his longevity at the Kremlin is simple: Rather than playing politics (to the extent usually seen in Russia) he is a technocrat who makes decisions based largely on the economic facts. His numbers-oriented mind, apolitical nature and competency as a manager are at least as important to Russia's relative financial stability as the strong energy prices of the past decade. Because of this, Putin values Kudrin's counsel greatly. Kudrin has also been an important buffer between Deputy Chief of Staff and First Aide to Vladimir Putin Vladislav Surkov and Deputy Prime Minister Igor Sechin, the heads of the Kremlin's opposing clans — until now.

Kudrin's Plan

Part 1: Purging the Siloviki

The most controversial part of Kudrin's plan is to purge the siloviki from positions of control over businesses and economic institutions. The siloviki clan, run by Sechin, took command of most of the Russian state firms over the past six years, and has — by Kudrin's technocratic reckoning — run them poorly. The siloviki run firms including oil giant Rosneft, rail monopoly Russian Railways, Russian airline Aeroflot, nuclear energy company Rosatom and arms exporter Rosoboronexport. The issue is that the siloviki have placed former KGB agents as heads of industry and businesses though many have no expertise as businessmen. According to Kudrin, it was largely Sechin's clan that sought access to international credit before the global economic crisis hit. Some $500 billion flowed into Russia via such connections, flooding the Russian financial sector with foreign capital. Sechin's clan spent the money as if it were free, often on irrational mergers and acquisitions that increased the clan's political power but had little economic purpose. When the global recession occurred, all those funding sources dried up in a matter of weeks. And as the ruble declined, all of those loans still required repayment — in the then-appreciated U.S. dollars, euros and Swiss francs. Consequently, the Russian economy suffered a contraction worse than any other major state in the world. The Kremlin was forced to bail out many firms, particularly those linked to Sechin's clan, to prevent a broader collapse. As part of the efforts to contain the crisis, the Kremlin also spent more than $200 billion on slowing the depreciation of the ruble so that the loans taken out by corporations and banks did not appreciate so much that they would not be repayable. From Kudrin's perspective, this was a huge cost to save companies whose managers had no business being in business. Kudrin's plan is to weed out the security-minded officials now occupying leadership positions in industry and business, leaving only those who can actually run their institutions properly. But in doing this, Kudrin would strip Sechin's clan of massive economic and financial clout —something the siloviki would not stand for.

Part 2: Making Russia Investor-Friendly

Next, Kudrin's plan calls for legal changes that would make Russia more attractive to investors. One of the issues investors have with Russia is that there is very little legal protection, which leaves them highly vulnerable to hostile takeovers and becoming a target for the Kremlin or its power players. Moreover, the few legal authorities that do exist — like the Federal Tax Service or the Audit Chamber — often are tools for the Kremlin to help it pressure Russian and foreign firms that the government wants to either destroy or devour. The best-known case of this is the story of Yukos, whose owner Mikhail Khodorkovsky had evolved from businessman to ruler of Russia's vast oil sector and aspiring politician — much to the Kremlin's ire. In 2004, the government brought the full power of a reinvigorated state to bear against Khodorkovsky and sent him to a Siberian prison. Other examples are of the Kremlin targeting energy assets belonging to foreign firms like BP and Royal Dutch/Shell to give those assets and/or control over projects to state-controlled energy firms. In theory, the new investors' rights laws would protect businessmen and investors in Russia. The country has never had sound laws protecting investors' rights. However, it is most likely that any new laws will leave the state plenty of wiggle room to ensure that the Kremlin has significant control over investors' actions. The next step to creating an investor-friendly Russia, according to Kudrin's plan, is to repeal the strict energy cap laws Putin put in place in 2007. These laws affect strategic industries and clarify which assets would be off-limits to foreigners. The sector affected most by these laws was energy. The laws limit foreign firms' ability to own more than 40 percent of a project in the country and forbid foreign firms from owning any projects involving the subsoil. These laws have made Russia an unattractive environment for foreign businesses to maintain or expand investments in energy projects, even though Russia is one of the world's most energy-rich countries. But Kudrin's plan involves more than repealing the energy laws and allowing foreign firms to rush back in. There is a political side to the plan, masterminded by Surkov. The changes in Russian energy laws will allow foreign companies to own up to a 50 percent stake in projects, but if a foreign firm wants majority control then it must "trade" assets outside of Russia with one of the Russian energy behemoths. In essence, Russia will allow foreign companies to own majority stakes in large projects like the new fields on the Yamal peninsula in exchange for downstream projects in those companies' own countries. The goal is for Russian energy companies to not only move more into the downstream sector, but also have greater access to international markets — something the Kremlin can use later for political purposes. STRATFOR sources say deals like this are already being negotiated with firms like BP, France's Total and EDF Trading, and U.S.-based ExxonMobil.

Part 3: Reprivatization

The last part of Kudrin's plan is to reprivatize the vast number of companies the Kremlin has taken over in the last few years. Under Putin, the Russian state once again became the main driver of economic activity. Upon becoming leader of Russia in 1999, Putin set a goal to reverse the massive privatization that occurred during the 1990s — like the housing and voucher privatizations and loans-for-shares schemes — that, in most Russians' eyes, wrecked the country. Putin wanted to put the Kremlin back in control by consolidating its power over a slew of economic sectors, including energy, banking and defense. As of this year, the Russian state and regional authorities own approximately 50 percent of Russian businesses, according to Kudrin. In the short term, Russian state control over strategic sectors made sense. It pushed out forces that were not too friendly with the Kremlin, like the oligarchs and foreign groups. But it also allowed the state to marshal its financial resources toward certain key domestic and foreign policy goals. Russian economic consolidation under the state brought about a stability that most Russians had longed for after the 1990s. However, in the long term, the lack of non-state funding and private capital has become a problem, creating inefficiencies across the board — particularly in areas where the state does not focus a great deal of its resources. Russia is traditionally capital-poor; therefore, any major economic overhaul needs to include the creation of an investment-friendly climate. The financial crisis made this clear; when the state took on the burdens of the failing private sector, it swallowed more businesses and industries but also took on their debt and need for cash. Kudrin's plan is for the state to step back and start reprivatizing some 5,500 firms over the next three years — which would drop state ownership in Russian firms by approximately 20 percent. The goal is to abandon some of the companies currently draining the government's coffers, but this step will also generate cash through the sales needed for the government to plug 2010's estimated budget deficit. Kudrin also believes that once the government starts to reduce its stake in companies, a more competitive environment will form in the Russian economy, allowing it to become more diversified. Kudrin wants to ensure that the next reprivatization looks nothing like the feeding frenzy of the 1990s. In the minds of the civiliki, the failures of the 1990s were caused not only by investor greed but also by the state's failure to create a rational environment for privatization. The Russian state in 2009 is much stronger than it was in the 1990s, so Kudrin believes that the new round of privatization would be controllable, and the fact that the Kremlin would know who would gain control of each company would keep anyone hostile to Russian (read: Kremlin) interests out. The last thing Kudrin wants is a new generation of oligarchs. Kudrin's plan would start with selling the state's stakes in companies purchased during the financial crisis, such as telecommunications giant Rostelecom and a series of banks, including Globex, Svyaz and Sobinbank. After that, the civiliki would like to consider companies such as oil giant Rosneft, banking giant Sberbank and railway monopoly Russian Railways for privatization — a rather bold move since many of these companies are run by the siloviki. In Putin's mind, the state consolidated the economy during Russia's identity crisis in the 1990s. Certain people, groups, influences and companies needed to be purged, in his opinion. Now that this has been completed, the government can step back and, in a highly controlled manner, start to reprivatize businesses. Putin is starting to believe that this is all just a cycle.

Easier Said Than Done

Kudrin and the other civiliki's plans are a technocratic approach to a crisis that has been long in the making in Russia but was exacerbated by the global financial crisis. The civiliki's plans have very specific economic goals in mind, leaving out power politics. The plan is actually not a new one, but it is one that the siloviki have continually sidelined over the years as they placed national interests above economic reform. The civiliki have also never been powerful enough by themselves (even with one of their own as president of the country) to push through any of their reforms. What the civiliki needed was for one of the truly powerful clan leaders in Russia to stand behind their reforms. Fortunately for Kudrin and the civiliki, one such leader — Surkov, who serves as Medvedev's deputy chief of staff and first aide to Putin — has done just that. However, Surkov is not interested in Kudrin's plan in order to reform the Russian economy. He sees the plan as something that will help him eliminate his rivals and consolidate his power.

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