Russia's Progress in its Privatization and Modernization Plans
17 MINS READJul 30, 2011 | 13:54 GMT
Russian President Dmitri Medvedev is expected to approve a revised list of state companies to be privatized, along with a privatization strategy, by Aug. 1. The new privatizations are part of a wider privatization and modernization campaign intended to draw in foreign expertise, technology and investment. The privatization efforts have generated so much foreign interest that the Kremlin has expanded the program. Moscow is trying to strike a balance between national security interests and a need for more modern infrastructure and investment in strategic sectors.
The Russian government will present Russian President Dmitri Medvedev a revised list of state companies to be privatized and strategy for privatization by Aug. 1. Russia launched its privatization plan and the related modernization plan at the end of 2009, but enthusiasm for the programs has been so great that Medvedev ordered their expansion. Once Medvedev approves the revised list, it will go to Russian Prime Minister Vladimir Putin for final approval and adjustments. Moscow changed its economic strategy in late 2009 after nearly a decade of economic consolidation during which the Russian government took over most strategic industries. This created state champions in every sector from energy to telecommunications. The goal was to oust foreign and anti-Kremlin influence from Russia while the country strengthened internally after a decade of chaos following the Soviet Union's collapse. The state champions ended up in the hands of a group of former KGB or current Federal Security Service elements who were more concerned about the political and security aspects of the Russian economy than its efficiency. This is not to say that such a move was unnecessary; however, it did not foster a modern or strong economy. Cracks began to show in this economic model in 2008, when Russia was deeply affected by the global financial crisis. As Russia strengthened internally and grew more confident of its influence in its periphery, the Kremlin became less concerned with non-Kremlin influences in the economy and more concerned about organizing the economy in order to plan for a strong future in Russia. This led to a far-reaching strategy to modernize and expand the state companies while attracting massive investment. The plan was twofold. First, the Kremlin launched its modernization program to update and expand its seven strategic sectors: energy, space, information technology (IT), military, telecommunications, transit and nanotechnology. Second, Russia reversed its stance on state monopolies and allowed foreign and non-Kremlin-aligned groups to invest in the firms.
Russia's modernization efforts have been under way since early 2010, when Medvedev went on a series of foreign tours to rally support and strike deals for foreign firms to begin sending billions of dollars and modern technology into Russia. It is unclear how much money the Kremlin will spend and how much it is attracting from foreign partners, but the interest from those foreign firms has been great. The interest in the sectors undergoing modernization is as follows:
Energy: Most foreign energy majors that left Russia during the economic consolidation have started negotiating their return to Russia, knowing that large energy opportunities await. The Kremlin is interested in many new projects, like the Yamal natural gas fields, liquefied natural gas (LNG) and exploration in East Siberia. Some of these projects need new technology and others need heavy investment. Companies getting involved include France's Total, U.S. firms Chevron and ExxonMobil, British firm BP and Dutch-British firm Royal Dutch/Shell. Russia is also overhauling its aged electricity sector, with German firm RWE spearheading the modernization efforts along with Russian state firm Gazprom.
Information technology: Russia's IT sector is a decade behind the West's and in dire need of technology and investment. The Kremlin also wants to create its own IT hub, modeled after — though smaller than — the United States' Silicon Valley. Medvedev's public tour of the Silicon Valley in 2010 helped garner interest from Cisco, Microsoft, Google, Facebook and Twitter for creating this Russian hub, dubbed Skolkovo. Some of the U.S. firms are already contributing billions of dollars. Other foreign firms like Finland's Nokia are also interested.
Space: Russia's modernization efforts in its space industry are different from those in the other sectors. Instead of asking foreign firms to come in, Russia is hiring a large number of space personnel being laid off in the United States. Russia is offering a slew of incentives for Americans (and Russians who left for the United States during the post-Soviet "brain drain") to move to Russia to work in its space program. Some STRATFOR sources say that Russia has also been discussing joint modern space programs with France, though details of such discussions are unknown.
Military: Russia has shifted its policies on its highly guarded military industrial sector to start accepting foreign military supplies, such as unmanned aerial vehicles from Israel and Mistral-class helicopter carriers from France. The Kremlin understands that it cannot produce every piece of military hardware needed to modernize its military to internationally competitive standards, so it is opening up to foreign partners in specific areas, though the Kremlin remains cautious about national security.
Telecommunications: Russia's telecommunications sector is also in dire need of modernization and expansion. The country's cellular and landline networks lag far behind the West's. Much of the modernization is occurring through the privatization program, in which foreign partners will take stakes in the state telecommunications champions. Firms from Norway and Finland have been the most interested in this area.
Transit: The modernization of Russia's transit sector mainly consists of installing high-speed rail to connect strategic parts of the country and other countries, and of revamping the shipping sector. Thus far, the rail connections planned are Moscow-Minsk, Moscow-Helsinki, Moscow-Riga, Moscow-Kiev, Moscow-Crimea and Moscow-Sochi. Most of the funding for these new connections is coming from German firm Siemens, which is investing billions. The exception is the Moscow-Helsinki connection, which the Finns will most likely pay for. Russia is selling pieces of its shipping firms and ports in the privatization program, though there is considerable interest from both the French and South Koreans in further modernization. The South Koreans specifically want to take their advanced technology on icebreaking ships to Russia, and many deals have already been made.
Nanotechnology: The modernization plans for nanotechnology are a little more vague than plans for the other sectors but are clearly a focus for the Kremlin, which has pledged $11 billion for this sector by 2015. Russia wants to reclaim its place in the field of modern science after years of falling behind due to losing so many technical minds to the West after the fall of the Soviet Union. Russia is partnering with groups from the United States, Germany and Finland to attract the cash and technology to help build its new nanotechnology hub, the International Innovative Nanotechnology Center, just outside Moscow.
The privatization program, set to expand in August, had three goals when it began. The first emerged from the financial crisis, during which Moscow took on thousands of failing assets and businesses. The Russian government simply could not keep these assets, as they drained the Kremlin's coffers. The privatization program is a venue for Moscow to sell off the approximately 5,000 nonstrategic assets, such as ports, industrial plants and small banks, it acquired during the crisis. The second goal is to sell non-controlling stakes in 10-12 of Russia's strategic large firms to specific Kremlin-approved partners. This has been the most publicized and controversial part of the Kremlin's current strategy, because it involves giving foreign partners access to some of Russia's most important state-owned companies, such as oil giant Rosneft, leading banks Sberbank and VTB, and even the military technology umbrella organization Russian Technologies. The decision has attracted major interest from some of the world's most powerful countries and businesses. This move is meant to bring in the technology and capital needed to expand and modernize Russia's state champions. Of course, the Kremlin is being very cautious in carrying out these privatizations — unlike the large asset sales — in order to protect Russia's national security and the Kremlin's hold over the country. The third goal of the privatizations was to raise cash that, theoretically, would be invested back into the state monopolies for expansion and modernization. However, the 2008 global financial crisis greatly affected the Russian economy. In 2010 the budget deficit rose to $101 billion. The Kremlin then decided to use funds raised by privatization to help pay down the deficit by 2014. The Kremlin estimated that stakes sold in the state assets would bring approximately $20 billion, and the stakes sold in the large strategic monopolies would raise another $29 billion. Fortunately for the Kremlin, global oil prices rose over the past year from roughly $80 to $100 per barrel, giving Russia a surplus of approximately $130 billion. Russia immediately used the cash to pay down the budget deficit, bringing it to less than 1 percent of gross domestic product. This leaves any money raised by privatization available for economic modernization and expansion. (click here to view interactive graphic) The foreign interest in Russia's privatization plan has been so great that the Kremlin decided to expand it, roughly doubling the number of strategic state monopolies to be partially privatized. The new list that will be submitted to Medvedev by Aug. 1 will include at least 15 strategic state firms. By early 2012, another six to eight firms could be added, for a total of about 22 state strategic firms being partially privatized. The Kremlin estimates that with the newly expanded list and state asset sales, the privatization program could bring in approximately $202 billion by 2016 instead of the previously estimated $49 billion by 2013.
The Shifting Russian Environment
In order to attract attention and interest in its privatization and modernization programs, Russia has been shifting the public perception of its political and economic environments. First, Russia's leaders have been working to make the country appear more democratic. In the past few months, the Kremlin has been repealing restrictions on non-Kremlin-run political parties. Naturally, behind the curtain these new political parties have strong Kremlin connections and are under Kremlin influence — but this is about perception. In March, Medvedev outlined a series of steps to improve Russia's investment climate, including a repeal of the cap on foreign investment in Russian firms, tax breaks on investment and new companies, new laws on business and investment protection, laws limiting government involvement in private business, anti-corruption measures, and improvements to infrastructure like customs, airports and business postal services. One of the more controversial steps is to remove all state ministers from their positions on the boards of the state strategic enterprises by Oct. 1. These ministers are:
Deputy Premier Igor Sechin: Rosneft, Interao and Rosneft
Finance Minister Alexei Kudrin: VTB Bank and Alrosa
Energy Minister Sergei Shmatko: Gazprom, RusHydro and Zarubezhneft
Transport Minister Igor Levitin: Aeroflot and Sheremetyevo Airport
First Deputy Prime Minister Viktor Zubkov: Russian Agricultural Bank and Rosagroleasing
Defense Minister Anatoli Serdyukov: Oboronservis
Agriculture Minister Yelena Skrynnik: United Grain Company
Communications Minister Igor Shchyogolev: Svyazinvest and Channel One Television
All the political, economic and organizational changes may look like a massive overhaul of the Russian system, but the state ministers leaving the top companies are being replaced with a different Kremlin-loyal cadre. Any anti-corruption program in Russia is not likely to change anything, as Russian culture historically fosters such practices. Furthermore, any investment protection would be more political than legal. The only real incentives are the repeal on foreign involvement in strategic Russian firms and the tax breaks. The Kremlin's goal is to make Russia look attractive to bring in the interested parties, but the Kremlin will still decide which of those parties will actually get the deals on privatization of the strategic firms or modernization investment into the big seven sectors. Despite Russia's renewed enthusiasm for foreign investment and modern technology, it is still more concerned with national security than with a thriving economy. Russia has learned from its past that if it opens itself up to too much foreign influence, the Kremlin can lose control of the whole system.
The Foreign Policy of Modernization and Privatization
Though many parties are involved in negotiations to invest or gain a stake in the privatizations, most of them are from a very short list of countries: Germany, France, the United States, Finland, China and South Korea. The Kremlin has used its privatization and modernization programs as a foreign policy tool in order to strike larger deals and strengthen relationships. In some cases, Russia has simply needed technology and has had to make political concessions to gain the technology it wants. In other cases, Russia has been after political deals and allowed a foreign partner to participate in the modernization and privatization process as a sign of good faith. The Russians are preventing some foreign countries, like Sweden and Japan, from taking part in the privatization and modernization drives because politically the countries are at odds with Moscow.
Germany is the strongest foreign presence in both programs. It is no secret that Moscow and Berlin have been growing closer. The foundation of their relationship has long been energy — Russia supplies more than 40 percent of Germany's natural gas. In the past few years, Germany and Russia started exploring ways to link their countries further via investment and joint business projects. The Germans could offer investment and technology in transportation, energy and nanotechnology. Germany's interest in Russia prompted the Kremlin to re-examine the laws capping foreign participation in strategic Russian firms and sectors and consider whether such laws would help sustain Russia's economy in the long term. Germany's participation in the programs is about the larger Russo-German relationship, as well as Germany's desire to invest strategically in foreign economies and Russia's desire for German involvement and technology.
France too has been highly interested in participating in the programs, especially in the energy, transit, space and military sectors. France has many reasons for such enthusiasm. France's Total has been striking multiple deals with Russian energy firms Gazprom and Novatek in order to gain a stake in Novatek, create joint ventures with both companies and begin its own projects, such as new natural gas fields. France is one of the leading countries helping Russia begin developing the next phase of its energy sector: the Yamal Peninsula and LNG facilities. This goes along with France's interest in Russia's transit sector, as it wants to gain influence in future energy shipments. But for Paris, this is not just about lucrative, prestigious or strategic investments; France wants to ensure that it has a strong relationship with the Kremlin in order to balance the Berlin-Moscow axis. France is looking to be Russia's main partner in space and military in order to hold Moscow's interest.
The United States
The U.S.-Russian relationship is complicated both politically and economically. Initially, the United States was not even considered as a possible participant in the modernization and privatization programs, as Moscow and Washington had been at odds for years over which would be the dominant influence in the former Soviet sphere. Russia has grown more confident in its position in most of its former Soviet territory, however, and has re-evaluated its ability to have a dual foreign policy strategy with the United States — one of cooperation and aggression. The modernization and privatization programs have been a major means of cooperation for the countries. The Kremlin knew that it would need to turn to the United States for technology in specific fields, like information technology. This led to a political deal, with Russia agreeing to increase support and aid for the United States' efforts in Afghanistan. Despite this supposed warming in relations, the fundamental disagreement over which country should dominate Eurasia has not ended, making any agreements between Washington and Moscow more out of opportunity than camaraderie.
South Korea began striking deals with the Russians very early on in the modernization and privatization programs, taking part in the modernization process before the plan had even been announced. The South Koreans have made deals to sell icebreaker ships to Russia and build the ships themselves inside Russia. Negotiations over the icebreaker ships led to South Korea's interest in helping to modernize the state champion Sovkomflot and purchase many of the privatized assets related to the shipping industry. Seoul's eyes are set on Russia's energy, especially after the expansion to the Yamal fields. When Yamal is producing, the LNG facility is built and the icebreaking ships are in place, Russia will have a wealth of energy available. France and South Korea are both betting on their investment in these Russian privatization and modernization plans to help them gain political and energy deals in the future.
Finland is newer to the Russian modernization and privatization plans, but the Kremlin has already welcomed its interest. Finland and Russia have a cooperative relationship, being neighbors and already sharing strong economic ties in sectors like timber. But Finland is looking to expand into transit, IT and telecommunications. Finland is not particularly interested in IT itself, but investment in Russia's new IT sector will give the Finns political leverage to get into other fields. As the Germans are building half a dozen new high-speed rail links in Russia and the region, Helsinki wants to ensure it gets its own connection in order to foster its relationship with Moscow and expand its critical telecommunications sector to Russia. Telecommunications giant Nokia is Finland's largest company and, before 2008, accounted for more than 4 percent of Finland's gross domestic product and a quarter of all of Finland's exports. However, it is struggling to compete against foreign firms like Apple and Samsung and now only accounts for 1.6 percent of Finland's gross domestic product. This has stunted Finland's overall economic growth. During a recent meeting between Medvedev and Finnish President Tarja Halonen, negotiations began that could allow Nokia to expand and modernize the Russian telecommunications sector, giving Nokia new life.
China's involvement in the modernization and privatization programs is also a newer development. Originally, STRATFOR sources indicated that China and its firms were on the list of groups banned from the plans. Russia has long been wary of China's ability to easily invest abroad and the sort of political weight it can carry. But Russia and China have been working on some large energy deals that involve tens (if not hundreds) of billions of dollars of new energy infrastructure connecting the two countries. As the energy discussions became serious at the start of the year, Russia began to accept China's interest in the privatization program. China Investment Corp. (CIC) has been allowed to purchase a small fraction of the initial stake of VTB Bank, though the purchase was symbolic rather than substantial. CIC is actually a part of the Chinese government, investing Beijing's hefty foreign reserves abroad to help diversify China's investments. However, it maintains a low profile in its outward activities, not getting politically involved like China's other foreign investment firms. CIC has had difficulty expanding into Western countries and has long considered investments in Russia, but the political risks were too high until now. Next, CIC is being considered to take on one of the largest and most important privatizations: Sberbank. CIC's negotiations are a way for Moscow to show good will to Beijing in order to forge the broader relationship each wants in the future. Moscow also knows Beijing has the cash necessary to take on a privatized share of a firm as important as Sberbank.