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Putin vs. the Oligarchs: How a Failure to Protect their Assets Could Cost Him his Job

With the inauguration of Vladimir Putin to the Russian presidency on 07 May 2012, Russia’s leading entrepreneurs instead of the restoration of political stability can see their investments and corporate assets exposed to growing political risks.

In the fall of 2011, the country’s middle class together with diverse opposition forces and a bohemian circle of writers, singers, and prominent journalists, challenged the corruption of the electoral process in Russia which led to the questionable victory of the pro-government United Russia Party following parliamentary elections. Most importantly, the opposition rallies in Moscow questioned Mr. Putin’s ability to deal with Russia’s archaic and non-transparent political and economic system. He responded with promises of extra public spending and genuine competitive elections while painting a gloomy picture of political chaos if he was forced out.

Ironically, Russia’s highly divided opposition movement and a nascent middle class, so vocal during the recent public demonstrations in Moscow, are not the real threat to Vladimir Putin’s rule. His two biggest challenges in the next two years will come from growing divisions within the political and business establishment as well as potential new waves of mass discontent with unpopular economic reforms in Russia’s big industrial centres. As a result, even if Putin manages to reach his short-term objective of restoring stability through political reforms and additional public spending, he may find it highly problematic to be able to retain power beyond 2014.

The planned reforms of the domestic pension, educational systems, and budgetary organizations seek to decrease government spending and facilitate greater economic stability in the country.

In reality, however, these reforms could lead to a considerably larger wave of widespread mass protests in comparison to last year’s Moscow rallies or the social upheaval of January 2005 which was caused by the monetization of social benefits reform. The combination of Russia’s WTO membership and the prospective liberalization of domestic gas prices could also have a negative impact on the big industrial centres of the country which traditionally benefited from government protectionism. Although these reforms and policies are vital for Russia, their timing and sequencing may prove politically unstable.

As a result, Putin’s position in 2013-2015 could ironically be a replay of the presidency of Boris Yeltsin during 1998-99 when key elite groups led by regional governors and oligarchs tried to influence Yeltsin’s succession. In the case of Vladimir Putin’s third presidential term, diverse interests within Russia’s business establishment are likely to play the main role in facilitating Putin’s departure and succession.

Big Business and the Growing Political Risk

The key dilemma for Russia’s billionaires is how to safeguard their assets in a politically volatile environment. Although twenty years have passed since the collapse of Soviet communism, property rights are still not protected in Russia. The country’s businesses, big and small, are still exposed to a highly corrupt legal system, arbitrary executive power, and non-transparent political structures. Moreover, Russian companies are often compelled to regularly contribute a large share of their gross profits to corrupt payments to the domestic regulatory, security and law enforcement agencies. In the 2000s, in order to ensure long-term protection of their investments by the international legal system, Russian billionaires increasingly started to rely on protection through partnerships with leading foreign investors (as was the case of the Russian-British joint venture, TNK-BP), and elaborate offshore ownership structures including Western contracts. However, following the Yukos affair, leading Russian entrepreneurs opted to limit their political risks through a good personal relationship with Vladimir Putin.

In 2000-2008 Putin’s ‘power-vertical’ of centralized decision-making and high popularity ratings made him politically invincible. At the same time, rising global oil prices gave him domestic credibility as an “effective economic manager” and boosted his confidence in international affairs. Since party politics and democratic legislative structures were of no importance, Vladimir Putin emerged as the only force in the Russian political system that could maintain its stability. Naturally, such a system lacks an institutionalized mechanism for the succession of political power, transparent interactions between economic and political players and long-term protection of property rights. As a result and ironically, the leader, who no longer enjoys high popularity ratings and could no longer rely on the highly-corrupt law enforcement apparatus to stay in power, becomes the system’s main liability in the eyes of the elites.

Putin’s Tarnished Image and the Loyalty of Elites

Putin’s primary problem has been a loss of his credibility as a leader of national unity who can effectively fight widespread corruption, modernize and diversify the economy, promote social mobility and deal with growing social inequality. Moreover, Dmitry Medvedev’s interim presidency, despite the limited impact of most of his policies, have created certain expectations of change not only within the society but also among the modernizing segments of big business. In this respect, the return of Vladimir Putin to the Russian presidency has become associated with a return to stagnation, not stability.

Although in the fall of 2011, Putin averted political confrontation by allowing mass protests to run unhindered in Moscow, his condescending comments about the opposition rallies tarnished his image as a confident political leader. Moreover, public remarks, by the head of the Russian Orthodox Church, Patriarch Kirill, urging Putin to treat the opposition with respect further undermined Putin’s position as an unchallenged ruler. In a surprising coincidence, Patriarch’s comments were immediately followed by a widespread campaign against him accusing him of living a lavish lifestyle and benefiting from government quotas for alcohol and tobacco imports and oil exports in the 1990s. The Patriarch responded with a full backing of Putin’s presidential bid while undermining speculations about Putin losing the support of powerful members of the Russian elite.

Putin also appeared to be particularly worried that Russian billionaires would start financing the opposition movement in order to protect their assets during politically unstable times. He chose a simple but seemingly effective strategy to secure the loyalty of the entrepreneurial elite. In February 2012, he suggested that Russia’s big business should expect to pay a one-off windfall tax on the assets originally obtained during the “unequal privatization” of the 1990s. At first glance, Putin’s idea appears to be aimed at fulfilling his electoral promise of providing extra public spending while calming social instability and appeasing communist and nationalist groups within the opposition movement. In reality, however, Putin merely used the windfall tax threat to ensure the loyalty of big business during the presidential electoral cycle and the growing political protest. In this context, Putin’s message to Russian billionaires was simple: “support the opposition at the peril of losing your assets.”

Further Putin’s economic populism and political rhetoric, questioning the legitimacy of Russian privatization in the 1990s, could make the earlier privatized assets even more politically toxic and expose them to further arbitrary demands. Putin’s windfall tax idea has already created rifts within the domestic corporate and political establishment and has been criticized by former minister of finance, Aleksei Kudrin, and Russian billionaires, Mikhail Prokhorov and Vladimir Potanin, as dangerous for the country’s investment climate as well as undermining the protection of property rights in Russia. Even if the Kremlin decides to abandon the tax as too divisive for the elites, it will be difficult to prevent the debate on unequal privatization of the 1990s from dominating the domestic political agenda in the future.

Putin-era Billionaires and the new Privatization Wave

The focus on the “unequal privatization” of the Boris Yeltsin era has attracted public attention to the swift rise of Putin-era billionaires and the ongoing battle within the Russian government over the second wave of privatization. Under Vladimir Putin, several of his alleged friends from St Petersburg, emerged as the primary beneficiaries of profitable state contracts, particularly in Russia’s most lucrative economic sector – the oil and gas industry. Some such as Gennady Timchenko and the Rotenberg brothers came to prominence as trading partners to Russia’s national champions, Gazprom and Rosneft. Having generated significant capital, these new players have begun to acquire corporate assets, often from state-controlled companies at a considerable discount. For example, in 2008 the Rotenberg brothers bought Gazprom’s construction assets and subsequently merged them into a private corporation, Stroygazmontazh – Russia’s major pipeline building contractor.

One of Russia’s richest men, Gennady Timchenko, as a co-owner of the commodity trader, Gunvor, which handles over 1/3 of Russian oil exports, has also been expanding his influence in the domestic oil and gas sector. Timchenko acquired over 20% in Russia’s largest independent gas producer, Novatek, as well as important stakes in foreign and domestic oil and gas service, transportation, and chemical companies. The emergence of Gennady Timchenko has been welcomed by some foreign investors who see him as playing a positive role in challenging the traditional dominance of state-controlled energy champions Gazprom and Rosneft in the Russian oil and gas sector.

Putin-era billionaires are also emerging as a decisive third force in the ongoing fierce battle between the liberal and conservative wings in the Russian government over the future privatization of state-controlled oil and gas companies, such as Rosneft, Transneft, Transnefteprodukt, and Zarubezhneft.

The liberal wing in the old Putin government, represented by Deputy Prime Minister Igor Shuvalov, the minister for economic development Elvira Nabiullina and presidential economic adviser, Arkady Dvorkovich, argued that the state-controlled companies should be completely privatized (with the government retaining a golden share). In the opinion of the liberals, this new wave of privatization will enable Russia to attract investments for industrial modernization and the promotion of greater transparency and efficiency of the state-dominated sectors of the domestic economy.

However, these liberal privatization attempts have been hindered by the conservative wing of the Russian government, represented by a group of KGB veterans, or siloviki, headed by Igor Sechin. The conservatives do not completely reject the future privatization but seek a delay until the external economic situation sufficiently improves to make the sale of state oil corporate assets more profitable for the state and the government. The siloviki also highlight Rosneft’s strategic importance for monitoring the domestic oil industry, attracting foreign investment and technology for new large-scale projects in East Siberia and the Arctic, being a key tax contributor to the Russian budget, as well as potentially becoming a global national oil company (NOC) which will promote Russian energy interests abroad.

Although the Putin-era billionaires, such as Mr. Timchenko, have traditionally enjoyed good relations with the government conservatives, they are poised to benefit from the new privatization and will therefore likely back the liberal wing. Business circles, which missed the Russian privatization gravy train of the 1990s, are well aware that the new owners of the privatized companies will play a highly prominent role in the domestic oil and gas sector. As a result, the battle for these assets could be severe and could create further rifts within the Russian government and Putin’s inner circle.

The Russian Business Dilemma

The biggest threat to Russia’s stability comes from the growing infighting within the country’s political and corporate elites which could become particularly prominent in the domestic oil and gas sector. In the context of the growing public discontent, Russian elites could seek co-optation of various factions and groups within the highly divided opposition movement in order to protect their corporate assets in the post-Putin era and potentially gain new ones. In the best case scenario, Vladimir Putin will postpone oil and gas privatization until Rosneft boosts its international presence and capitalization through its recent partnerships with international oil companies, such as ExxonMobil, ENI and Statoil.

Putin could also facilitate a pact between corporate elites and their political allies on a peaceful division of assets offered for privatization. In the worst case, privatization under conditions of growing divisions within the elite and another wave of mass protests coupled with economic instability in external markets could lead to a fast erosion of the existing political and economic system in Russia. In these circumstances, co-operation among key Russian business groups will be of paramount importance for the stable transition into the post-Putin era. However, as long as Russia does not have strong democratic institutions, such as free elections, real multiple parties, and free speech, as well as transparent and uncorrupted court and law enforcement system, private corporate assets will continue to be exposed to arbitrary demands of future Russian rulers and possible political storms.

This problem will remain until Russian elites realize that the stability of the domestic political and economic system can not be based on one man’s popularity ratings, or his effective control over the highly centralized decision-making process and the law-enforcement apparatus. Access to the international legal system, partnerships with Western companies and the use of Western contracts offer only short-term protection of property rights in Russia. Without the establishment of strong democratic political institutions, effectively channeling interests and grievances of diverse social groups, corporate assets of Russian business elites cannot be reliably secure over the long-run.

This realization may drive Russia’s big business towards lobbying Vladimir Putin for real political reforms. The question remains whether Putin will be able to meet these aspirations or will be coerced into cutting his presidential term short.