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May 17, 2016 | 19:20 GMT

11 mins read

Reining in Putin's Cronies

Russian President Vladimir Putin and Igor Sechin (R), CEO of state-controlled Russian oil giant Rosneft, may be at odds in debates over proposals to make state firms pay more funds to the government.
(MIKHAIL KLIMENTYEV/AFP/Getty Images
Forecast Highlights

  • To cover budgetary shortfalls, the government will try to force large state-owned firms to increase their contributions.
  • Many companies will comply, although Rosneft and Gazprom will resist future directives, sparking conflict inside the Kremlin and in elite circles.
  • The patrons of state-owned firms will have to decide whether to accept a reduction in power or to confront Russian President Vladimir Putin, who fears that these elites could band together to form a stronger opposition.

Moscow is desperate for cash. In the midst of a recession caused by low oil prices, Western sanctions and anemic foreign investment, the government needs revenue to meet budget shortfalls. The Kremlin has already cut the government budget twice since the end of 2015 — 10 percent each time. It now aims to keep this year's budget deficit below 3 percent of gross domestic product, or just under $40 billion. The deficit in the first quarter has inched up, however, until it is nearly 4 percent of GDP. The government has emergency pools of cash to draw on: the $73.8 billion in the National Wealth Fund and $50.6 billion in the National Reserve Fund, totaling about 10 percent of Russia's GDP. But the Kremlin has hesitated to touch these funds for the past two years. It will first resort to a flurry of other measures: sizable energy taxes, a plan to bring companies back from offshore and the privatization of many large state-owned firms.

It has also turned to the massive state-owned corporations for help. Russian Finance Minister Anton Siluanov is drafting directives that would require these companies to pay a minimum of 50 percent of their net profits via dividends to the government. This would be a massive increase for many of them. In 2015, some large firms paid a quarter of their profits to the government: Rosneft, $1.3 billion; Gazprom, $2.6 billion; Transneft, $40 million; and RAO UES, $1.62 billion. Others are already accustomed to contributing more, such as Alrosa and Bashneft, which both handed over 46 percent of their net profits.

But state firms and their powerful backers, known as the silovarchs, are pushing back against the proposal, hoping to stall or cancel it. This has expressed itself in terms of infighting over the plan within the Kremlin. One side of this dispute wants to implement the plan in the government's revised budget due in June to plug the current budget deficit. The Finance Ministry has instead suggested implementing the plan in 2017 through the 2019 budget. Another disagreement is whether companies should pay according to Russian Accounting Standards or International Financial Reporting Standards. (The international standard tends to reflect a smaller net profit, which would result in less money allocated to the government.) Russian Prime Minister Dmitri Medvedev weighed in, saying state firms should take the highest figure by either standard to determine how much to allocate.

Russian Energy Minister Alexander Novak has been a major critic as well, saying the state's primary energy firms, Rosneft and Gazprom, should be exempt because they already contribute from their revenues before also contributing from their net profits. When oil prices were high over the past decade, the two firms automatically handed over any revenues above $93 dollars a barrel of oil on top of the revenue and net profit taxes. In 2015, Rosneft paid $33.9 billion (44 percent) of its revenues to the government budget and then also paid a quarter of its net profit dividends.

Rosneft and Gazprom have held meetings over the past week to discuss whether to accept the Ministry of Finance's proposal. Rosneft is countering the proposed 50 percent rise in dividend payouts with a 35 percent rise instead. Gazprom's board has submitted a request to the ministry for an exemption to the dividend increase — a request that the finance minister has ignored thus far. Gazprom's board is now also considering a proposal similar to that of Rosneft and will decide May 19. Less powerful firms, such as Bashneft and Transneft, have indicated they would accept the new government proposal. The Russian Ministry of Economic Development is drafting an amendment that would force some firms, such as Transneft, to pay 100 percent of their 2016 net profits to the state. Transneft's net profit was $2.1 billion in 2015, a sizable sum for the Kremlin.

Past Attempts

This is not the first time the Kremlin has tried to take a greater share of profits from these state-owned firms. Russian President Vladimir Putin introduced similar schemes in 2011 and 2013 to draw in much-needed cash. Unfortunately for the president, he received pushback from the powerful silovarchs, who operate the companies as their personal fiefdoms. At the time, the Kremlin failed to force these silovarchs or their firms to comply. The question now is whether the Kremlin will risk reining in the firms and the silovarchs who form the foundation of Putin's power in the Kremlin.

The silovarchs — a term derived from "siloviki," referring to politicians from the military or security services, and oligarch — have roots in the earlier part of the last decade, when the Kremlin was cracking down on their predecessors, the powerful oligarch class. The oligarchs rose to prominence in 1997 after President Boris Yeltsin initiated a loans-for-shares auction. Numerous businessmen lent the cash-strapped Russian government money in exchange for shares in large Russian enterprises. These entrepreneurs then stripped the country's most profitable enterprises from the state, particularly in the energy sector. Subsequently, their wealth exploded, transforming them into the well-known oligarchs.

The Kremlin lost many of its most lucrative assets and the oligarchs used their influence to force Yeltsin's government to change policies in investment, business, finance and other sectors. Many oligarchs also owned major media outlets, molding the discussions and views of the Russian public. During Yeltsin's re-election campaign in 1996, the president was forced to turn to the oligarchs to fund and publicize his run, in spite of his distaste for the entire group. When Yeltsin won, the oligarchs were rewarded with a greater share of Russia's economy through television and metals licenses. They were also able to position more of their allies inside the government.

Subduing the Oligarchs

However, one of Putin's first initiatives when he came to power was to strip most of the oligarch class of their wealth and bring the rest to heel. During his first two terms as president, the Kremlin consolidated the largest, most lucrative and strategic sectors of the Russian economy back under the Russian state. Putin then appointed key loyalists from his inner circle (mostly from the federal intelligence apparatus or from his cronies in St. Petersburg) to oversee the reclaimed firms by either chairing the company, sitting on the board or installing supporters. Some Kremlinologists estimate that 78 percent of Russian government, business and social leadership is currently linked to the Federal Security Service (FSB) or to Putin's St. Petersburg allies.

 

The new elite — tied to Putin — became the silovarchs. And like the oligarchs, the silovarchs have wealth, position and power and even hold positions in the government. The oligarch class still exists in Russia, but nearly all of them have had to compromise with the Kremlin to keep their wealth and companies. They now do the Kremlin's bidding, staying out of politics and out of the state's way. 

The silovarchs' task was clear: remain loyal to Putin and act as the foundation of the new leader's power in the Kremlin and economy. Their other duty was to use their firms to help rebuild a strong Russian state. In return, Putin has maintained a silent contract with them to allow these elites to use their positions to establish their own power in the Kremlin while lining their pockets with the spoils (after the state took its share).

It has yielded a system in which some of the Kremlin's most powerful politicians, their aides, family members and cronies sit on the various boards of all the major state firms, hold shares or have charge of those inside.

Notably, the members of the Kremlin elite all have some sort of ties into Russia's largest and most lucrative companies. However, though many of the silovarchs live in luxury, most only admit to modest incomes. For example, Liberal Russian political analyst Stanislav Belkovsky alleged in 2014 that Russia's largest silovarch is Putin himself and that the president controls 37 percent of Surgutneftegaz, 4.5 percent of Gazprom and 75 percent Swiss oil-trading firm Gunvor. If true, Putin's fortune would rival that of the world's richest. Analysts of the recently disclosed Panama Papers tried to follow the money trail connected to Putin, but could never find actual documentation of his wealth.

Similarly, Prime Minister Dmitri Medvedev formerly oversaw Russian natural gas giant Gazprom and is rumored to maintain shares in the firm. Medvedev's salary as premier is approximately $175,000 a year, but he reportedly built a $58 million second home outside of Sochi in 2010. Head of the Presidential Administration Sergei Ivanov sits on the boards of Rostelecom, Ros Hydro and insurance giant Sogaz and is rumored to maintain shares in all. Though he makes a modest $126,000 annual salary, he reportedly owns a $10 million house on the Black Sea.

The silovarchs' positions as both government employees and players in state firms give them a level of protection and privacy that the oligarchs never had. Nearly all of the silovarchs maintain positions and ties into only state firms and not firms run by the oligarchs, which are more transparent. As the silovarchs amass their secret wealth, Putin has remained secure in his position as the overseer of the entire system of loyalists and state leaders.

Shrinking Fiefs

However, the state firms have been hurting for the past two years. Many of these companies have requested government assistance to offset their declining revenues. The Kremlin has provided only small amounts to help. In 2016, the government unveiled a $30 billion anti-crisis package, but the majority of those funds are allocated for regional government budgets or to the automotive and rail industries. None of the larger silovarch-related firms, such as Rosneft, Gazprom or Rostech, have received any meaningful aid from the government. Instead the government is forcing the firms to cut their own spending and, in some cases, to possibly privatize shares.

Amid this change, the silovarch's fiefdoms are diminishing. One of the largest silovarchs, Russian Railways chief Vladimir Yakunin (who is one of Putin's supporters from St. Petersburg and former deputy transport minister) resisted the Kremlin's orders to cut spending in his firm. Yakunin also lobbied the government to provide financial support to his railway firm — one of the largest in the world. He did not fare well. In December 2014, Yakunin was fired, marking the first of the powerful silovarchs to fall. Putin sent a clear signal that reckless spending among the state firms had to come to an end.

Now the government is debating whether to demand more money from state firms for the national budget, testing whether the silovarchs will continue to fulfill the two primary duties that earned them their positions: supporting Putin and strengthening the Russian state. Some silovarchs will push back against government demands to protect the firms that provide their power and wealth. But Putin has shown that he is willing to take down some of the most powerful of his inner circle.

Specifically, Putin's move against Yakunin was rumored to be a signal to Rosneft chief Igor Sechin, whose power extends from the massive oil firm, across the electricity sector and deep into the FSB. Sechin is already defying Kremlin plans to privatize his oil firm, challenging the government's right to take more of Rosneft's cash. Other challenges could come from defense industry chief Sergei Chemezov, who only reluctantly accepted cuts in the government's defense spending.

The stage is set for a bitter struggle in the coming months between the government's need to protect its budget and the silovarchs' desire to maintain their power and influence. It has been easy for the silovarchs to remain loyal to Putin and the system he created during a decade of relatively healthy economic growth. Putin can handle single dissenters such as Yakunin, but he must be wary of those powerful elites banding together should the Kremlin continue on its confrontational path.

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