In Russia, State Firms Will Stay Public for Now

10 MINS READJan 29, 2016 | 09:00 GMT
In Russia, State Firms Will Stay Public For Now
Russian President Vladimir Putin visits a Rosneft refinery in the southern Russian port of Tuapse on Oct. 11, 2013.
Forecast Highlights

  • The Russian government will again attempt to privatize state firms to plug budgetary gaps caused by the country's worsening recession.
  • But if the Russian government tries to privatize some of its largest and most strategic firms, it will have to sell at a lower profit than it has in years past, and many of the Kremlin elite will try to prevent the plan from moving forward.
  • If the government postpones the privatization plan, the Kremlin will be forced to use funds from its coveted National Reserve Fund to cover the government’s deficit, possibly draining the fund by the end of the year.

Moscow is once again taking a hard look at its finances during this period of prolonged economic woe, this time considering privatizing of some of Russia's large state-owned firms and entities. Such a plan could raise $12.5 billion, helping cover a possible shortfall of around $37.5 billion in the federal budget. Finance Minister Anton Siluanov, who has long criticized the government's control of the country's largest companies, is spearheading the proposal.

Siluanov has been blocked for years by many of the Kremlin elite who want to maintain control over their respective assets and companies. But as Russia's recession has deepened, Moscow has grown more willing to embrace some of Siluanov's economic suggestions. In recent weeks, he pushed through a mandatory 10 percent cut in the Russian budget across all sectors, excluding pensions, further tightening an already strained spending plan. The finance minister could be building support for a tougher economic program in the future, such as privatization.

In fact, a key logistical roadblock to a privatization plan may soon be removed. Russian media outlet Kommersant, citing two high-ranking government officials, reported that Federal State Property Management Agency chief Olga Dergunova might resign Feb. 1. The report claimed Dergunova had slowed down regional privatizations and stood in the way of any federal privatization plans. Thus, she was forced to resign. Already, Russia's Audit Chamber has noted several violations connected with investment programs and management of state property by the agency worth 440 billion rubles ($5.5 billion). The agency is now sidelined from any preparations for a privatization program until someone who can facilitate the task takes over.

An official proposal for privatization has yet to be published or specified by the Finance Ministry, though Siluanov has repeatedly suggested that selling a 19.7 percent share of Russian oil giant, Rosneft, is at the top of his list. Other firms suggested in the media and by various politicians are state shipping firm Sovcomflot, Russian Helicopters, Russian Railways, regional oil firm Bashneft, VTB Bank, Vnesheconombank (Russia's state bank for economic development) and Sberbank.

Previous Privatization Plans

Of course, this is not the first time the Russian government has flirted with a large privatization scheme. Typically, Moscow begins discussing privatization when it either feels confident in its control over the country or when the country is shaken by economic uncertainty. In 2007, the government considered privatization plans after years of consolidating the economy, big business, strategic assets and firms. But the government realized it needed to modernize the economy as well, so it began to formulate plans to bring in technology. The scheme never materialized, though, as the country and most of Russia's potential investors around the world fell into a deep economic recession in 2008-2009.

The recession — like today's — motivated the government to restart its privatization efforts; this time, however, the goal was not modernization but revenue generation for the ailing firms and for the government. In 2009, Moscow adopted the New Privatization Initiative, which would allow foreign entities to own stakes in a dozen potentially attractive and strategic state companies, as well as in thousands of fully privatized smaller state assets. The initiative forced the government to tweak existing laws on foreign ownership, reversing in a single stroke the country's strategy of purging foreign influence in the country.

A brainchild of then-Finance Minister Alexei Kudrin, the 2009 plan tried to accommodate Western-trained economists and Kremlin nationalists and security officials who were wary of foreign presence in the country. New laws concerning privatization of government property explicitly outlined how the Russian government would arrange the sales with foreign entities of their choosing. The firms would simply sell their stakes not to the highest bidder but to a strategic partner of the Kremlin's choosing, maintaining some national security while promoting economic liberalism.

Kudrin's ambitious plan hoped to bring in $50 billion between 2010 and 2013 and $150 billion by 2015, mostly through selling 10 to 49 percent stakes in large firms. A modernization plan also intended to upgrade, and in some cases build from scratch, several economic sectors, including military industry, information technology, telecommunications, space, energy, transportation and nanotechnology. Former President Dmitri Medvedev pursued these plans during his 2010 world tour, signing deals with firms in Germany, France, Norway, the United States and other countries. But the plan failed abysmally. Europe's financial crisis, Russia's domestic instability and the Kremlin elite's political opposition ensured its demise.

First, the modernization and privatization programs were meant to attract mostly European partners and investment. After all, 75 percent of foreign direct investment in Russia came from EU members, and the bloc accounted for nearly half of Russia’s overall trade turnover at the time. But the EU financial crisis that began in 2008 curbed most interest in Moscow's programs, and even traditional European investment in Russia fell precipitously.

Second, hundreds of thousands took to the streets against the Kremlin in 2011-2012, creating months of political instability. Though the protests did not threaten the government's survival, it was perceived as the start of the Putin administration's decline.

Finally, the Kremlin elite who oversaw many of the big firms continued to vehemently oppose the programs. Simultaneously, the power of the more liberal-minded economic elites, such as Kudrin, began to wane. Kudrin eventually left his post as finance minister in September 2011 amid disagreements with the security establishment and Medvedev over the economic and financial future of the country.

In 2012, the government once again tried to revive the privatization and modernization programs to be completed by 2017. Russia expanded its target investors to include Russian oligarchs and turned to Asian companies for potential investment. However, because of similar economic constraints, the projects never gained momentum.

Worsening Circumstances

The current motivation for returning to the privatization plan are the same as they were in 2009. The country is in a deep economic recession, this time because of low oil prices. Russia's gross domestic product shrank 3.7 percent in 2015 — its worst decline since the 2008-2009 recession. With the economy expected to slow further in 2016, the Russian government will not be able cover its own expenses, let alone assist the big state firms, many of which are struggling with large debt.

But the economic and political environment is even worse than during Russia's previous attempts to launch privatization schemes. Russia is in a bitter standoff with the West following fighting in Ukraine. Both the United States and the European Union have political, financial and economic sanctions on many Russian firms. Investor sentiment toward Russia is sour at best; many Russian firms are no longer selling at a premium on the London Stock Exchange. Moreover, many Western firms are abandoning the Russian market. British consulting firm Global Council estimates that twice as many firms left the market since the Ukraine crisis began in 2014 than during the 2008 recession. The firm also estimates 60 large Western companies have left and dozens more could leave this year.

Consequently, Russia has reached out to potential non-Western partners, mainly from the Middle East and East Asia and was able to secure $21 billion in investments in 2014-2015. However, most of this investment focuses on agriculture and will not spur the wider economy. More important, Russia's operations in Syria and severed ties with Turkey have complicated its relations throughout the Middle East. States such as the UAE, Qatar, Kuwait and Saudi Arabia are also conserving expenditures given low oil prices. Russia has hinted over the past year that it would sell a stake in Russian oil giant Rosneft to China. But even China is slowing its spending habits, and Beijing is already contracted to invest tens of billions into Russia's energy sector. In short, there is little interest in Russia's privatization scheme from either the East or West.

Foreign firms have been wary of investing in the large state entities as well because so many are saturated with government elite. During previous privatization drives, potential European and U.S. partners convinced Moscow to remove government ministers from the big state firms, hoping to minimize the Kremlin's influence and politicization of the firms. In 2011, the government ordered ministers to resign from the boards of the state firms, but it was never fulfilled.

Russia's financial crisis has only worsened over the past year. There is less cash and assets for the Kremlin elite, so many — including proponents behind the earlier purge of ministers from state boards, such as Siluanov and Deputy Prime Minister Arkady Dvorkovich — grabbed board seats in the country's largest firms in 2015. The Kremlin’s expanded presence will only continue to scare away foreign firms from investing.

One of the largest obstacles to a privatization plan moving forward is that it will not raise enough funds to satisfy many in the government — particularly those Kremlin elite overseeing the firms. The most vocal opponent to privatization has been Rosneft chief and silovik Igor Sechin. Sechin insists that shares of Rosneft should not be sold for less than its previous two share sales. In 2006, Rosneft sold 15 percent of its shares in an initial public offering at $7.55 a share, raking in $10.60 billion. In 2013, Rosneft traded 12.84 percent in shares to BP at a time when a share was worth $8.12. But recently Rosneft's shares have been trading between $3.34 and $4.60 a share, which would only fetch an approximate $6 billion — not the $12 billion to $16 billion Sechin is demanding. Current market shares in other potential privatizations, such as a 25 percent of VTB Bank and a 10.9 percent of Sberbank would only raise $5 billion and $1.2 billion respectively.  

Because of the current value of the companies, even the initial designer of the privatization plan, Kudrin, has come out against implementing it at this time. He suggested on Jan. 22 to postpone the plans for at least the next year and a half and to use the country's National Reserve Fund, which stands at $49 billion, instead. The government would then receive substantially more for the privatized shares if and when the country's circumstances improve in years to come.

But draining the reserve fund would give the country little cushion should its economic, financial or political situation worsen still. Moreover, postponing the privatization is contingent on an improvement in Russia's circumstances — its relations with foreign partners, global energy prices and the domestic economic situation. It is a sizeable gamble for a government that has been through a tumultuous two years. So Moscow will have to choose to protect its cash reserves for an even rainier day or to sacrifice shares in some of its firms at a lower cost than many Russians would like. As in previous attempts, Russia will likely wait to privatize.

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