Back from the Abyss

Russia's Fragile Recovery

Shopping Mall Russia
This shopping mall at Moscow's Manezhnaya Square has been doing brisk business (Photo: AFP).

Spurred by current oil prices, the Russian economy has taken off. The stores are never empty and the oligarchs have turned over a new leaf.

This past April 25, at the crack of dawn, Mikhail Khodorkovsky left Moscow to attend a colloquium in Paris. It will be a chance for the head of Yukos, the most profitable oil company in Russia, to meet with other participants, who include Qatar’s minister of energy and the head of TotalFinaElf. He will also answer questions from journalists who will be pressing around him in far greater numbers than last year. This is because Khodorkovsky, who in a few years has become the richest man in Russia, (worth US$3.7 billion), is an enigma.

The former oligarch, once accustomed to crooked financial deals, is now being wooed by the full array of foreign investors. Not satisfied with having transformed his group into a veritable cash machine, he himself has donned the garb of “Mr. Clean.”

The great cleanup has begun, and time is pressing for the promise made by Vladimir Putin when he took power—to attain, in 15 years—the same living standard as Portugal. For the time being, he can count on an economic situation that seems very rosy indeed, but things could become gloomier if the price of a barrel of oil were to drop again.

In the Moscow suburb Teply Stan, a constant procession of cranes and trucks is completing the construction of the largest shopping mall in Eastern Europe. But, even now, free shuttles cross the city’s ring road to pick up customers from the nearest metro stops. The more well-heeled customers have parked their Ladas, Peugeots, or Fiats in the gigantic parking lot.

Since Dec. 14, 2001, when the IKEA store opened, the crowds haven’t dissipated. With its pine shelves and children’s beds, the Swedish brand has become a big hit in Moscow, so much so that it has broken records for the number of visitors.

Thanks to renewed economic growth, Russians are recovering from a serious hangover and are once again finding their appetite as consumers. In Moscow, even the luxury boutiques are coming back. On April 17, a pack of photographers elbowed its way through to catch a glimpse of the bevy of stars invited for the opening of the Bulgari store.

Less glamorous, but more revealing, are the register tills at the Seventh Continent supermarket chain, which, to the great joy of Vladimir Yaroshevsky, fill up with rubles. At the age of 34, this former Russian diplomat recently began running the premier retail distribution chain in Moscow, with 25 stores. “The purchasing power of our customer base has surpassed the level before the 1998 crisis,” he asserts. The result is that sales, which reached US$200 million, are growing at an annual rate of 50 percent! Once the reserve of Moscow’s elite, the chain offers a variety of products stamped “Made in Russia,” which are much more affordable than foreign brands, thanks to the ruble’s devaluation.

All of this is filling up the order books of local producers. Thus, Belaya Dacha (the White Dacha), a prosperous small business on the outskirts of Moscow, sees its tomatoes, lettuce, and eggplant selling like mad. “After the 1998 crisis, the company was headed straight for bankruptcy. But our customers now understand that it is a lot more advantageous to grow produce in Russia than to import fresh produce from foreign countries,” comments Vladimir Landishev, the young head of this former collective farm converted into a shareholder corporation.

In 1993, when privatization was getting under way, specialists from Belaya Dacha were sent to the Netherlands, Finland, and Israel to study cultivation methods, and all superfluous jobs were eliminated. Under Landishev’s leadership, yields have doubled: 40 kilograms of tomatoes per square meter, compared to 16 five years ago.

Belaya Dacha is not the only Russian producer to benefit from the crisis. In the food sector, the Wimm-Bill-Dann group, a completely Russian firm despite its name, has become the king of yogurt and fruit juice. So much so that it has begun to lure foreign investors: In early February, the company was listed on the New York Stock Exchange with great fanfare. Danone took advantage of this opening to acquire 4 percent of the company.

But isn’t it true that the Russian economy is too dependent on black gold? After all, oil is largely responsible for Russia’s economic resurgence. No sooner had he come to power than Putin benefited from the rising price in oil: From $10 per barrel in 1998, it has hovered about an average of $23 per barrel for the past three years.

With 1 million barrels more per day than two years ago, the country has become the number-one producer of crude oil in the world, ranking ahead of Saudi Arabia. This did not fail to have an impact on the tax revenues of the country, which have tripled since 1999. The money from petroleum has made possible the stabilization of public finances and paying down a portion of Russia’s debt.

“The manna from oil revenues has also helped to calm social tensions: The population’s income grew 6 percent last year, after increasing by 9 percent in 2000,” notes Otto Latsis, the deputy editor of the daily Novye Izvestiya. As for Putin, he has benefited from the return to a degree of political stability, managing to get some reforms passed regarding taxes, the justice system, and land privatization.

“In four years, the situation has turned around completely,” asserts William Browder, the head of Hermitage Capital Management. “At that time, the prices for raw materials were at their lowest point; the regime was threatened by political instability; Russia was cut off from foreign financing; a feeling of inertia and pessimism was pervasive. Today, not only is the economic climate more favorable, but on a scale of 1 to 10, the government deserves a grade of 11 for its reforms.”
True, the Wild West feel has not totally vanished, and the security companies still have many bright days before them. Similarly, it is still inadvisable for Russian journalists to take too great an interest in certain matters. At the end of April, the editor in chief of a newspaper in the Volga River town of Togliatti, who was looking into a corruption scandal, was found dead in his car, his body riddled with bullets.

Yet, the rule of law is finally emerging. The paradox is to see it taking hold where you least expect it: in the large companies that are in the hands of the Russian oligarchs, the very ones who divvied up among themselves the country’s riches during privatization.

Khodorkovsky is one of them. His 38-year journey, recounted in rich detail by the U.S. journalist David E. Hoffman, is a saga of the Russian oligarchs. [Hoffman’s book The Oligarchs was published this past January by PublicAffairs.—WPR] The former Komsomol (Communist youth) official first became a smuggler, then went on to become a banker, a government adviser, and finally, an industrialist.

The Russian took advantage of his influence to gain control of Yukos’ oil fields for next to nothing ($350 million) during privatization in 1995. By pressuring and threatening the min-ority shareholders and taking advantage of the shady accounting of the time, he imposed his will—sometimes brutally—pushing aside anyone who got in the way.

There was a time when the name Yukos had a sinister ring. Hoffman recounts how Khodorkovsky, after taking over, sent out a force of 300 armed men to take possession of the wells and refineries in Siberia. And how he took advantage of the 1998 crisis to get out of paying his creditors in the West, all the while carefully squirreling away the company’s money in tax havens.

Today, the company headed by Khodorkovsky is not merely extremely wealthy. It has the highest market capitalization in the country ($24.6 billion as of May 17); on revenue of $7.4 billion in 2001, it had $3.7 billion in profits. Still, it has cleaned up its image, thus becoming the country’s model corporation.

This is a revolution that is easily explained. First of all, the arrival of Putin in the Kremlin has reshuffled the cards. Mistrustful of Russian capitalists, the former KGB colonel made himself quite clear. “Shortly after his election in March 2000, he summoned some 50 business leaders to the Kremlin,” recounts Chris Weafer, chief of research at Troika Dialog, a Moscow brokerage firm. “He gave them two years to clean up their act, pay their taxes, and obey the law. In return, he promised that he would not launch any witch hunts.”

Two years later, with the exception of Boris Berezovsky and Vladimir Gusinsky, two billionaires who went into exile, the oligarchs have no regrets. True, they no longer call the shots in the Kremlin, as they did in Yeltsin’s time, but their economic power has been strengthened. “About 20 of them control 40 percent of the gross national product and 90 percent of Russia’s exports,” says Andrei Ryabov, a political researcher at the Carnegie Center in Moscow.

There remains the question of opening up Yukos to foreigners. The group’s main shareholders, Khodorkovsky in particular, have announced that they want to reduce their holdings from 63 to 51 percent. Khodorkovsky, the first to make the transition to transparency, is first in line, of course. Why so much eagerness? Quite simply, the motivations have changed. “Under Yeltsin, the oligarchs were in a race to grab up the country’s assets,” explains Jim Henderson of Renaissance Capital investment bank. “It was a matter of getting the companies to generate as much money as possible as quickly as possible, so their rivals would not end up gobbling everything up. Today, they have time on their side, and they can think about long-term strategies.”

Already, growth in recent years is showing signs of running out of steam. After reaching 8.3 percent in 2000, and 5.3 percent in 2001, it is expected to fall to 3.2 percent this year. The government’s room for maneuvering is narrowing while reform projects are only just being implemented. And there is a huge amount that remains to be done, with the Kremlin’s first target being the bureaucracy inherited from the Soviet era. While the number of public officials has decreased on the federal level, the regional ranks have swelled, slowing down every initiative and blocking the implementation of reforms.

Under such conditions, we can well understand why the level of foreign investment remains exceptionally low: less than $30 per inhabitant, in contrast to $250 per inhabitant in Poland or $460 in the Czech Republic. Aware of the difficulties, Putin has set as a priority Russia’s accession to the World Trade Organization by 2004. Is this simply a polite gesture for the White House, just a few days before President George W. Bush’s visit to the Kremlin? No, because the head of state of Russia, where 40 million inhabitants live below the poverty level, understands that if he wants to keep the promise he made in December 1999, i.e., to catch up to Portugal by 2015, he no longer has any choice.

The Troika Dialog firm has done the calculations. At present, the annual income per capita in Russia is $2,300, a fifth that of Portugal. With a 4-percent growth rate, Russia will have to wait until 2065 to surpass Portugal. If it manages to spur its growth rate to 8 percent per year, it can expect to catch up in 20 years as long as the oil continues to flow abundantly.