Arsenyi Yatsenyuk: Rebel without a Cause

Graham Stack for Russia Profile (www.russiaprofile.org)

Ukraine’s youthful Presidential Candidate Arseny Yatsenyuk is tailor-made to be a pro-Western leader, but his stagnating ratings show how weak this political constituency has become in Ukraine. Instead, all three leading contenders in the presidential election campaign that kicked off this week are making pro-Russian statements.

History repeats itself as farce, Karl Marx apparently said. The Ukrainian presidential hopeful, 35-year-old Arseny Yatsenyuk’s great historical moment may have come and gone on June 7, 2009. During a week boiling with rumors it seemed that the two largest parties in Ukraine’s unicameral parliament, the Rada, were preparing a grand coalition to achieve a constitutional majority and transform Ukraine into a parliamentary republic, abolishing direct presidential elections. The trigger: Yatsenyuk’s meteoric rise in opinion polls, from zero to over ten percent in the course of months. Extrapolating, neither leader of the two largest parliamentary parties, Prime Minister Yulia Tymoshenko of the Yulia Tymoshenko Bloc or the former Prime Minister Viktor Yanukovych of the Party of Regions, could be sure of winning the presidential elections  January 2010. So they had apparently simply decided to call off the elections altogether, and divvy up power between them.

Yatsenyuk sprang into action. Talking to this correspondent, he called on the West to beware of the imminent creation of a Russian-backed “junta.” “If the coalition’s plans go ahead, Ukraine will return to the sphere of influence of a certain big country,” he warned, “and Ukraine will turn into a banana republic.” Calling the nascent coalition’s plans “an anti-constitutional conspiracy,” he said he would lead people out on the streets to fight them. Asked if there would be a second Orange Revolution, Yatsenyuk replied “you will see it.”

By Sunday, June 7, however, it was all over. The “putsch attempt” has been debunked as just another Ukrainian political stunt. Viktor Yanukovych suddenly backed out of the negotiations, saying that he was alarmed by the anti-democratic nature of Tymoshenko’s suggestions. The episode left Yanukovych looking wily, and even a little democratic, Tymoshenko looking like she would stop at nothing to stay in power, and Yatsenyuk like a callow wannabe popular hero.

Yatsenyuk, with his perfect English, baby-face looks, superb credentials and squeaky clean image, is tailor-made to fit the role of a “pro-Western democratic candidate.” But it is a sign of the times that there is no demand for such in Ukraine today, making Yatsenyuk seem like a rebel without a cause.

From Ukraine’s Obama to Ukraine’s Medvedev

Launching his unofficial campaign in late 2008, Yatsenyuk tried to tap into the buzz surrounding the new U.S. President Barack Obama. The media picked up the “Ukraine’s Obama” jingle, and Yatsenyuk’s spinmeisters playfully disclaimed it, pointing out “significant differences:” “Obama uses a Blackberry, but Arseny prefers an iPhone.”

This strategy paid off in the first half of 2009, as Yatsenyuk’s ratings rose meteorically to around 13 percent, fractionally behind prime minister Tymoshenko. Yatsenyuk’s advance, however, was at the expense of democratic President Viktor Yushchenko, as he was winning over the latter’s residual pro-Orange constituency. As a result, Yushchenko’s own rating fell below the margin of error, with Gallup declaring him to be the most unpopular president in the history of polling. Conversely, as Yushchenko’s rating tended to zero, Yatsenyuk hit his ceiling of around 13 percent, which was still less than Tymoshenko at around 15%, and way behind Yanukovych’s mid 20s.

Realizing that the post-Orange constituency was too small to get in the second round of the elections, let alone win it, Yatsenyuk was forced to change his tune and follow in Tymoshenko’s footsteps. The latter, formerly an iconic figure of the Orange Revolution, had already jettisoned her Orange ballast in 2008. In the course of months in 2008, she spectacularly morphed from an anti-Russian, pro-NATO firebrand into a moderately pro-Russian politician. By September she was  under investigation by the Ukrainian Security Service for acting against Ukraine’s national interest for the benefit of Russia. Not least, she refused to support Georgia in the August 2008 war with Russia over South Ossetia.

To compete with Tymoshenko, Yatsenyuk then likewise discarded the “Ukraine’s Obama” mask. Instead, he donned what Andrew Wilson of the European Council of Foreign Relations called the image of “Putin-lite,” to capitalize on the Russian prime minister’s sky-high approval ratings in Ukraine. Instead of railing Orange-style against juntas and authoritarianism, Yatsenyuk switched to declaring war on corruption, using hard-man talk of filling the jails and cutting off hands. He also showed himself happy to speak Russian in public, supported the Russian stance over gas transport, and praised Putin as “having saved his country.” “Putin-lite” is also reminiscent of Dmitry Medvedev, who enjoys a high level of approval in Ukraine, has declared war on corruption, is young and has a background in law, like Yatsenyuk.

But Yatsenyuk is not the only one trying to tap into the buzz surrounding Putin and Medvedev. The polls’ frontrunner, Viktor Yanukovych, has the best pro-Russian credentials, although he is hardly a Putinesque figure. Yulia Tymoshenko can match Putin for charisma, and has been hard at it, with Putin/Medvedev-like phrases, such as “dictatorship of the law” and “legal nihilism” tripping off her tongue, along with Putin-style promises to restore Ukraine’s Soviet-era high-tech aerospace and ship-building sectors. Tymoshenko’s enthusiasm for Putin apparently even caused the latter to postpone a meeting with her in October, lest it seem he was favouring her in the elections.

This means that switching to “Ukraine’s Medvedev” has not brought Yatsenyuk the anticipated breakthrough in the polls. The latest ratings have seen him fall back to around ten percent, and his chances of getting into the second round of elections ahead of Tymoshenko are fading. Meanwhile, Yanukovych is for the first time looking likely to beat Tymoshenko in a second round run-off.

But the remarkable result of Yatsenyuk’s switch to “Putin-lite” is that the leading three candidates in Ukraine’s crucial presidential elections are now all actively campaigning on their lack of hostility toward Russia, and their current order in the ratings corresponds to the respective plausibility of this platform

Ukraine’s new foreign minister Poroshenko “will not oversee” EU free trade negotiations

Graham Stack, Berlin / Kyiv

According to Ukraine’s ambassador to Germany, Natalia Zarudna, new foreign minister Petro Poroshenko will not oversee trade negotiations with the EU, despite being tasked by President Viktor Yushchenko with achieving an associate membership agreement with the EU as soon as possible.

“Petro Poroshenko will not oversee negotiations on the free trade part of the Ukraine-EU associate membership agreement,” Zarudna told this correspondent in an interview. “This will be done separately by ministry trade experts, with Poroshenko overseeing only the political component of the agreement.”

Zarudna says this rules out any conflict of interest with Poroshenko’s business dealings: Poroshenko is not only a close associate of President Viktor Yushchenko and political high-flyer. He is also a top businessman, and his assets are held to include Ukraine’s second largest car producer Bohdan Corporation, although he does not officially acknowledge ownership of the car maker.

“Poroshenko may be a shareholder in Bohdan, but he is not involved in operational control of the company, since this would contradict Ukrainian legislation,” explains Zarudna.

The issue is pertinent, because Bohdan Corporation is one of the principle victims of Ukraine’s economic crisis, with its revenues down 87.4% in the first half of 2009, and losses totaling $27.1m.  Analysts are questioning whether the company can continue servicing its debt, after having come close to default in August.

In an interview with this correspondent earlier in the year, Bohdan Corporation CEO Oleg Svinarchuk demanded a government U-turn on trade policy, with a shift from free trade to protectionist tariffs to save Ukraine’s car industry. Svinarchuk also bitterly criticized the terms of Ukraine’s accession to the World Trade Organisation.

This indicates Poroshenko’s ties to Bohdan Corporation could clash with his duties as foreign minister – in particular concerning trade negotiations, where higher import tariffs on cars would directly benefit Bohdan Corporation.

There are already signs Poroshenko’s appointment will benefit the company. Immediately following his appointment, the government announced a raft of measures to help Poroshenko’s automotive holdings. Prime Minister Yulia Tymoshenko called Bohdan “a strategic partner in bus production,” and announced a government order for 750 school buses worth UAH 150m, and orders for Euro 2012. There is also talk of a government credit line to modernize bus production facilities, according to sources at Bohdan.

Tymoshenko’s generosity contrasts with previous animosity between herself and Poroshenko, whom she openly accused of corruption in 2005, days before Yushchenko ended her first spell as prime minister. However, considering that votes from Tymoshenko’s party Bloc Yulia Tymoshenko were crucial for Poroshenko’s confirmation by Ukraine’s parliament, the Rada, it is likely that some wider deal is in place, believes Yelena Biberman, Ukraine foreign policy expert at Brown University.

“It could involve Poroshenko buying into Tymoshenko’s more pro-Russian foreign policy line,” says Biberman. Biberman points out that among Poroshenko’s first actions as foreign minister was to reject US radars in Ukraine as part of the US anti-missile defence system. Poroshenko said such plans, aired by U.S. Deputy Defense Secretary Alexander Vershbow, would “contradict the constitution.”

According to Zarudna, however, Poroshenko’s appointment does not signify any shift in Ukraine’s foreign pro-NATO policy. “But because of the crisis, foreign policy may be temporarily more oriented to trade and aid,” she concedes.

Meanwhile, the foreign ministry itself is pinning its hopes on Poroshenko to secure more budget funds. “The foreign ministry suffered disproportionately from budget cuts in 2008, compared to ministries more loyal to the prime minister,” complains Zarudna. “We think that Poroshenko will use his ‘special diplomatic skills’ to get more funds for the ministry.”

According to Zarudna, Ukraine’s foreign representations have had funding cut to 40% of 2008, with budget funding down 20% and hryvnia devaluation doing the rest. “We are being inventive and attracting sponsors to help with our functions,” Zarudna says.

Will Putin sign up China?

Graham Stack for Russia Profile (www.russiaprofile.org)

 

Russian Prime Minister Vladimir Putin’s last visit to China, when he attended the opening of the Beijing Olympics in August of 2008, went badly wrong when Georgia opportunistically attacked South Ossetia, and the resulting war damaged relations between Russia and the West. Putin could now continue Russia’s eastward shift on his upcoming visit to China, by signing long-term gas supply agreements between Gazprom and the China National Petroleum Corporation.

Speculation is mounting that a long-term gas supply agreement might finally be signed between the Russian gas giant Gazprom and China National Petroleum Corporation (CNPC). The plan, outlined in a number of memorandums signed by the Russian and Chinese sides, but since bogged down in negotiations over price, envisages new gas pipelines from Western and Eastern Siberia to China and the development of virgin East Siberian gas fields.

As president, Putin was closely involved in the negotiation process during his previous visits to China, and may feel that it’s now time to go the final mile. The last Memorandum of Understanding on the issue was signed in 2006: it specifies a pipeline running from West Siberia with a 30 billion cubic meters capacity, and another from East Siberia with a capacity of 38 billion cubic meters, with work due to start in 2011. That date is now clearly unrealistic, but still, for most analysts, it is just a question of time.

“We have long taken for granted that Gazprom will sell significant amounts of gas to China,” said Alfa Bank energy analyst and Head of Research Ron Smith. “The resource base of East Siberia and Russia’s Far East is very large, including two untapped world-class gas fields in Chayanda and Kovykta that are very well situated for pipeline exports to China, not to mention the Sakhalin reserves that are already being tapped.” So analysts perceive Putin’s hastily arranged visit to China as indicative of the fact that a long-term deal has been finalized for signing.

Negotiations to date have been shrouded in secrecy, but the main problem holding up implementation of the project has been arguing over the price mechanism. Russia is rooting for the same price mechanism applied to Gazprom’s European Union customers. China has pushed for a discount price previously paid by former Soviet countries, such as Ukraine. “Since then, however, the discounted deal with Ukraine ended in a very high-profile manner, and Russia is also paying full price for gas purchases from Central Asia,” said Chris Weafer, an analyst at UralSib brokerage. “Hence the rationale for China’s discounted price demand is eliminated.”

But the Chinese may instead want a gas price linked to coal prices and not to oil prices, as is the case for European customers. Since there is no global market price for gas, gas prices are linked to the cost of the fuel gas substitutes for, which in Europe is crude oil and heating oil. In China, however, gas will substitute mainly coal used in power generation. “We are not sure whether the Chinese prefer a coal-linked price, as that fuel generates the bulk of the country’s power, or whether it is a matter of a simpler argument about the absolute level of prices,” said Smith.

“Linking the price of gas to the one of oil is an anachronism,” argued Mikhail Korchemkin of East European Gas Analysis. “There is an oversupply of inexpensive gas in the world, and the market prices of oil and of gas often move in opposite directions.”

Coal prices are currently very low following the economic crash, while oil prices have soared back up to 2007 levels, making it harder to reach a compromise. However, according to a source quoted by the Russian business daily RBK, in the absence of final agreement on a long-term price mechanism, Gazprom and CPNC could still provisionally agree on fixed prices for short-term delivery volumes.

But the Chinese have some trumps that could induce Gazprom to bring the prices down from the European levels. Firstly, China is flirting not only with Russia, but also with Central Asian countries. The 7,000-kilometer-long Central Asia-China pipeline is set to take Central Asian gas to China, particularly from Turkmenistan, which has contracted to supply 40 billion cubic meters of gas annually for 30 years. Korchemkin believes that Turkmenistan probably agreed to prices around 50 percent lower than Gazprom’s European price. “Moscow will be keen not to lose the opportunity to be a direct gas supplier to China, especially with a lot more uncertainty over future gas export volumes to Europe,” said Weafer.

Secondly and most importantly, with the economic crisis having raised the cost of borrowing even for Russian giants such as Gazprom, Chinese state companies can offer cheap credits unavailable elsewhere. The summer has seen a slew of Chinese credits granted to Russian companies in telecommunications, cement and energy. According to Kingsmill Bond of Troika Dialog brokerage, “China provides cheap financing and equipment for the development of Russian infrastructure. As the head of the Russian cement association poignantly said, ‘we can’t borrow from Russian banks at less than 20 percent, but from China we can borrow at under ten percent.’”

In June of 2009, China provided Turkmenistan with a $4 billion loan to develop its massive South Yolotan field. But the mother of all such deals was signed between Russia and China in February of 2009, with CNPC and the China Development Bank offering a $25 billion loan to Russian oil pipeline operator Transneft and state-owned oil company Rosneft, as part of an agreement for Russia to supply 15 million tons of oil annually for 20 years. The credit, at an unbeatable estimated interest rate of 5.7 percent, will finance oilfield development and pipeline construction from East Siberia to China.

“If that deal were to be replicated in the gas sector, we could see a timeline agreed not only for the pipelines, but also for the development of the giant Kovykta gas deposit, as that is the logical source of gas sales to China,” said Weafer.

Russia ogles Europe’s oil refineries

Graham Stack for Russia Profile (October 5)

 

It’s official Russian policy to push oil companies to acquire downstream assets outside of Russia, and with a wave of M&A set to sweep European refineries, opportunities are looming. But European governments are not enthusiastic – and neither are many Russian companies.

 

Igor Sechin, chief “silovik” in former president Vladimir Putin’s Kremlin, now deputy prime minister for the energy sector in Putin’s government, revealed his dream to the Wall Street Journal earlier this year – a rather modest plan for the man who is believed to have masterminded the dismantling of Mikhail Khodorkovsky’s Yukos. “My dream is for Russian oil to be refined in Russia or by assets controlled by Russian companies,” he confided.

 

Sechin’s plan might be close to realization, as analysts agree the European oil product market is facing a wave of M&A. According to Jürgen Doetsch, co-owner of German oil trader Erich Doetsch, “the European downstream market is facing a structural shift,” as margins shrink due to falling demand and rising oil prices. “The golden decade when refineries in Europe earned big money is ending, and refineries could return to being loss-makers as they were for 25 years before the turn of the century,” says Doetsch.

 

The shift is marked by big 6 supermajors such as British-Dutch Shell, French Total S.A and U.S. ConocoPhilips divesting or mulling divesting refineries. Shell is looking to sell one UK and two north German refineries, and ConocoPhilips uncertain about the future of its Wilmershaven refinery in Germany.

 

Total S.A CEO Christophe de Margerie specified September 22 that Russian companies could be among the buyers: “they have a market to develop in Europe and may be interested to buy when we are interested to sell,” he told  Bloomberg. His statement followed hot on the heels of Total’s sale of a 45 percent stake in its Dutch Vlissingen refinery to Russia’s Lukoil in June for $725 million.

 

The selling is not just limited to the multinationals. Polish petrochemical national champion PKN Orlen, owner of Europe’s largest chain of filling stations, is said to be looking to divest a 63% stake in strategically significant Czech Unipetrol and an 87% stake in Lithuania’s Mazeikiu Nafta, in order to pay down $3.2bn worth of debt.

 

Governments are also getting in on the act. Specifically, Belarus government is mulling privatization of its strategically significant Naftan-Polymir refinery complex, the country’s largest, supplied by the Druzhba pipeline. Belarus has been in talks with Russian majors Rosneft and Lukoil over a sale, but is dragging its heels. “If you have money and willingness, then please come. I am ready to support the programme of privatizing the Belarusian oil refining association,” Alexander Lukashenko said September 16, evaluating the total complex at nearly $3bn.

 

Another dark horse is Venezuelan president Hugo Chaves and the Venezuelan national oil company PDVSA. PDVSA owns stakes in a number of German refineries as partner in a joint venture with BP, Ruhr Oel that controls around a quarter of German refinery capacity. Ever since coming to power in 1999, Chavez has said he will divest PDVSA’s overseas assets and in 2003 PDVSA was in talks to sell to Russia’s Alfa Group, co-owner of oil company TNK-BP, but these talks came to nothing.

 

September, however, also saw the signing of an upstream tie-up between a consortium of Russian oil companies and PDVSA to prospect and extract in Venezuala’s Orinoco regions. The partnership could reasonably also entail asset swaps seeing transfer of Venezuela’s downstream stakes in Europe to Russian companies.

 

Pipeline pressure

 

Russian companies however face considerable political resistance to plans to buy into European refineries, especially of strategic significance. Analysts thus expect the ongoing M&A wave to trigger a number of political spats between Russia and individual European countries, and also bring pipeline politics to the fore.

 

Leonid Fedun, vice president of Lukoil, Russia’s second biggest oil company and most active acquirer of foreign assets, complained to the Financial Times in April 2009 that, “some countries in eastern Europe have an extreme level of political antagonism towards Russian investments.” In the same month Russia’s President Dmitry Medvedev complained of “idiotic” fears in Spain of Russian investment in the energy sector.

 

Fedun’s comments come a week after privately-owned Russian oil company Surgutneftegaz Mol in a surprise move acquire 21% in strategically important Hungarian energy group MOL. Hungarian politicians reacted with fury and responded in dramatic fashion: the Hungarian courts allowed MOL to delay registering the new shareholder until poison pills had been adopted in the company’s charter that left decision-making power with the government-backed board of directors at the expense of shareholders.

 

Poland watched the MOL episode with equal consternation. Despite owning only a 27% stake in petrochemical giant Orlen, the government forced through similar poison pill changes to Orlen’s charter in July, “removing all chances of PKN becoming a takeover target in the future,” according to Wood analysts.

 

Such tactics may however cause the Kremlin to up the ante rather than back off. Russia has gained bargaining power vis-a-vis the Central European refining sector supplied by the Druzhba pipeline, following the start of construction in August 2009 of the Baltic Transport System-2. BTS-2 will reroute Russian oil from Druzhba around Belarus to Russia’s new Baltic port of Ust-Luga in Leningrad Region, and thus increase flexibility of export routes. Refiners remember that Lithuanian refinery Mazeikiu has its oil supply shut off by Russian pipeline operator Transneft after it fell to Polish hands instead of Russian in 2007.

 

The East Central European countries for their part put their hopes on the Odesa-Brody pipeline running through Ukraine from the Black Sea, planning to extend it to the Polish refinery of Plock, Orlen’s biggest plant. The pipeline would then ship Azeri oil to Central Europe. However the feasibility of the plan is not yet established, and the pipeline is continues to be used in reverse mode to ship Russian oil to the Black Sea.

 

Reluctant imperialists

 

The weak link in the Kremlin’s strategy could be the Russian oil companies themselves. With the noticeable exception of Lukoil, they have shown little interest in expensive acquisitions in Europe’s downstream sector.

 

Lukoil is open about pursuing downstream expansion, with major acquisitions in Italy in 2008 along with the Dutch acquisition from Total this year. However, Lukoil’s ambitions predate Igor Sechin’s watch over Russia’s energy sector. In fact the fully private company, in which US major ConocoPhilips holds a 20% stake, counts as one of the most free from Kremlin influence. And the company’s strategy of overseas downstream expansion was evident as early as the 1990s, when it purchased a chain of filling stations in the USA.

 

On the other hand, state-owned Rosneft, Russia’s largest oil company, has still to make a large foreign acquisition, and is focused on capital-intensive upstream expansion in the Arctic and Pacific shelf, with little resources left for acquisition abroad. At the most Rosneft might acquire the Belarus refineries. Gazpromneft, the oil division of state-controlled gas giant Gazprom “doesn’t really have the scale for European acquisitions to make much sense,” according to Ron Smith, head of research at Alfa Capital.

 

Surgutnefegaz, the transparency-challenged private oil company named by Igor Sechin “Russia’s best privately-run oil company” would seem the most likely acquirer of European assets. The company is believed to be sitting on a cash pile and potential war chest of $20bn, and in April this year bought 21% of Hungary’s energy company MOL for $1.4bn from Austria’s OMV, causing outrage in Hungary.

 

At the time, however, many commentators believed the move was requested by the Kremlin for political reasons, namely to stymie the Nabucco gas pipeline project in which MOL is a participant, rather than being part of Surgutneftegaz strategy. “They are very tight and unambitious with their massive pile of money, the MOL thing notwithstanding. It would be completely out of character,” according to Smith. In addition, Surgutneftegaz are more focused on downstream investment in Russia, with large investments in the Kirishi refinery in Leningrad Oblast

 

Finally, TNK-BP held talks with PDSVA on acquiring the Venezuelan companies refinery stakes in 2003, but the talks ended without any results. Analysts say TNK-BP is very focused on adding value, and the returns on European refining are not sufficiently compelling. TNK-BP is more focused on Russian downstream, having just overhauled its Ryazan refinery, one of the largest in Russia.

 

This means leaves Lukoil with a clear field in making acquisitions downstream in Europe, as far as governments allow, and, in conjunction with the ConocoPhilips 20% stake, well on its way to becoming a true oil multinational.

Georgia vs. South Ossetia: The Prequel

The South Ossetian conflict flaring up in late 1989 started the break up of Georgia. The conflict of 2008 might well have sealed it.

Four months after Slobodan Milosevic’s speech on the Kosovo Field June 1989 symbolised the start of the Yugloslavia conflict, Georgia’s nationalist leader Zviad Gamsakhurdia, backed by over 20,000 supporters including paramilitaries, rolled towards the South Ossetian capital Tskhinvali, to assert ethnic Georgian rule over the entire territory of the republic. Ossetian groups duly blocked Gamsakhurdia’s entry to the town, and violence broke out. Andrei Sakharov, not long before his death, commented gloomily on the creation of “minor empires” in the former Soviet republics.

The standoff escalated through 1990. In April 1990, the Supreme Soviet in Moscow ruled that the ethnic autonomous territories of any republic seceding from the Soviet Union retained the right to remain in the Soviet Union. Then it was Tbilisi’s turn to pour fuel on the fire. In August 1990, the Georgian Soviet adopted a law prohibiting regional parties from participating in Georgian elections. Excluded from the political process in Georgia, South Ossetia boycotted parliamentary elections in October 1990, instead holding elections to their parliament in December 1990.

In response to the South Ossetian elections, the newly-elected Georgian parliament abolished the autonomy status of South Ossetia, declared a state of emergency in the region and in late December, imposed an economic blockade on the region that was to last to July 1992.

The conflict finally escalated into war the following month. In the first days of 1991, the Supreme Council of Georgia passed a law on the formation of the National Guard of Georgia. Then on January 5th, at the time of the Orthodox Christmas festivities, several thousand Georgian troops, police and paramilitaries entered Tskhinvali and carried out violent reprisals and atrocities against the population, ostensibly in search of arms.

The weekend war

The initial fighting took place mainly in and around Tskhinvali, around the Georgian villages, and north along the road to North Ossetia, the lifeline of the South Ossetians in the face of the Georgian blockade.

According to Nikola Cvetkovski of Caucasus Links, who has written a history of the South Ossetia conflict, the fighting in Tskhinvali initially divided the town into an Ossetian-controlled western sections and a Georgian-controlled east. But fierce resistance from Ossetian irregulars meant that already by the end of January, 1990, Georgian forces withdrew to take up positions on the heights around the city. From there they enforced a blockade that lasted almost one and a half years, and aimed at cutting the town off from heat, electricity, water and food.

Actual fighting was low intensity, deploying mostly light arms. Fighting however peaked regularly at weekends, as the so-called ‘weekend warriors’ of paramilitary formations arrived from Georgia proper. The ‘weekend warriors’ were themselves more interested in looting than fighting. As a result, military fatalities stayed low, but of the roughly 1000 Ossetians killed in the conflict, only around 100 are regarded to have been militia members: the remaining 900 were civilians. In addition, according to Alexei Zverev, ethnic conflict expert at Vrije University of Brussels, 93 villages (mostly Ossetian) were completely burned down.

Even the newly-formed Georgian national guard, intended to become the core of a new Georgian army, was recruited and financed “almost exclusively by private individuals, especially successful black-market entrepreneurs,” according to Swiss security expert Christoph Zuercher, who has written the classic account of the Georgian crisis in “The Post-Soviet Wars”.

Georgia’s second main (para)military formation prosecuting the war, the Mkhedrioni (Georgian for medieval knights), was, according to Zuercher, “created in 1989 by Jaba Ioseliani, a former patron of the Soviet underworld, and funded its activities from criminal dealings, including extortion and racketeering,” and constituted “a private army at the service of the state when it was waging war against secessionist minorities.”

“The Georgian militias—the Mkhedrioni and the National Guard—were to a very significant extent driven by the presence of private entrepreneurs of violence, undisciplined weekend warriors, who conducted frequent attacks on the civilian population and took hostages,” Zuercher continues. “But in the case of the Ossetian and Abkhazian fighters, the use of military force was not mainly motivated by private profit, but by the perceived threat to the status quo posed by an independent and nationalistic Georgia. (…). Once the Georgian militias entered their territories, Ossetians and Abkhazians saw their fears confirmed, and organized violence ceased to be an option and became a necessity,” adds Zuercher in his seminal study.

Russia appears on the scene

Until then, the Soviet Centre, in its death throes, had remained largely on the sidelines in the conflict. The Soviet leadership had apparently latterly struck a deal with Tbilisi, allowing Gamsakhurdia a free hand in South Ossetia in return for accepting Soviet supremacy. This deal was shown up during the Moscow Putsch in August 1991, when supposedly nationalist Gamsakhurdia – in sharp contrast to events in Moscow and Leningrad – meekly accepted the authority of the Provisional Committee established by the putsch, and subordinated his armed units to the Soviet Interior Ministry.

The failure of the putsch, however, destroyed Gamsakhurdia’s authority: On December 22, 1991, in the last days of the Soviet Union, approximately 500 National Guard soldiers entered Tbilisi and drove Gamsakhurdia out, marking the start of the Georgian civil war. The new interim authorities—Ioseliani (leader of the Mkhedrioni) and Kitovani (head of the National Guard), then called Eduard Shevardnadze, former Soviet foreign minister, back from Moscow to head Georgia.

The struggle for power in Tiblisi now hugely exacerbated the ongoing ethnic conflicts, as the deposed president mounted military resistance from his home region in western Georgia against the new authorities in Tbilisi – and thus triggered the Abkhasian conflict, flaring up in spring 1992 and turning to war by the summer.

The conflict constellation now also changed due to the appearance of an entirely new actor: Boris Yeltsin’s Russia. Yeltsin’s new Russia, born of the idealism of the Perestroika liberal movement, and riding high on the wave of enthusiasm following the defeat of the Putsch, was more concerned about the rights of minorities in neighbouring states than the Soviet leadership had been. Russia was also sensitive to the concerns of the North Ossetian leadership, who were inundated with refugees from the South Ossetian conflict and feared further destabilisation.

According to Alexei Zverev, this new conflict constellation made Russian intervention on the side of the South Ossetians look increasingly probable. In mid-April 1992, Georgian artillery resumed daily missile attacks on the residential quarters of Tskhinvali. Then, in 20 May 1992, unidentified gunmen, whom the Ossetians claimed were Georgians, massacred a busload of Ossetian refugees fleeing Tskhinvali.

The massacre prompted North Ossetia to cut the gas pipeline to Georgia, and elicited furious statements from Russian politicians, including chief reformer Yegor Gaidar. By June 1992, Boris Yeltsin’s administration seemed to be on the brink of intervening to protect South Ossetia.

The situation was ironically saved only by a further escalation of Georgia’s own civil war between Shevardnadze and Gamsakhurdia in Western Georgia, which was simultaneously making conflict between Tbilisi and separatist Abkhazia look imminent. In the face of this extraordinarily dangerous situation, Shevardnadze could not possibly afford to fall out with the Russians.

On 22 June 1992, Yeltsin and Shevardnadze duly met with North and South Ossetian representatives in Sochi and signed a ceasefire agreement. The agreement envisaged the deployment of joint Russian, Georgian and Ossetian peacekeeping forces. The peacekeepers moved into the region on 14 July, 1992.

In view of the civil war raging at the time in Georgia and the start of the Abkhazian conflict, no one initially gave the South Ossetian ceasefire much chance. But it held 16 years… until August 7 2008.

Germany’s elections and Russia’s gas

Graham Stack for Russia Profile (www.russiaprofile.org)

 

Despite the rhetoric, Germany’s likely new coalition may slowdown nuclear power phase-out, but will not cut back on Russian gas.

 

If, as is likely, Germany’s September 27 national elections result in a new governing coalition between incumbent chancellor Angela Merkel’s Christian Democratic Union (CDU) and the small liberal Free Democratic Party (FDP), the planned phase-out of nuclear power in Germany will be slowed indefinitely, ostensibly to reduce dependency on Russian gas. However, analysts say the shift will make no significant longterm impact on German demand for Russian gas. Moreover, FDP head Guido Westerwelle as probable foreign minister is likely to be as Russia-friendly as his social democrat predecessor Frank-Walter Steinmeier, the loser of the election.

 

The man almost certain to be Germany’s new foreign minister did not mince his words when drawing conclusions from the Russian-Ukrainian ‘gas war’ January 2009, which saw supplies to Europe halted for a number of days.  “We Europeans have to do everything to free ourselves from dependency on a single supplier of energy,” Guido Westerwelle told Poland’s Gazeta Wyborcza in March, referring to Russia. “In Germany the government has made the mistake of phasing out nuclear power for ideological reasons. That makes us vulnerable to foreign energy suppliers. Germany should do what most of our European neighbors are already doing: achieve a reasonable energy mix, with renewable energy such as solar and wind power, fossil fuels such as oil, coal and gas, but also nuclear power.”

 

Westerwelle’s call to postpone nuclear power phase-out to reduce dependency on Russian gas found an echo in one of the minor scandals that livened up an otherwise lethargic election campaign in September: a detailed election-campaign PR strategy apparently commissioned by Germany’s large energy concern E.ON, subsequently leaked to the press, advised lobbyists to actively harp on the population’s “historically rooted fears of Russia.” “E.ON can draw on these fears for its own benefit,” read the leaked PR plan.

 

With Chancellor Angela Merkel’s CDU also in favour of slowing nuclear power phase-out, this coming shift in German energy policy might seem to be one of the immediate implications for Russia to come out of yesterday’s elections.

 

Russia currently supplies 37% of German gas imports. Germany relies on gas for 12% of electricity production and around 25% of total energy needs. Nuclear power, originally to be phased out by 2022 and replaced by renewable sources, counts for around 25% of power generation and 12% of total energy requirements. These figures give rise to fears that renewables will not be able to fill the space left by decommissioned nuclear plants, leading to even greater reliance on Russian gas.

 

However, analysts claim that much of the anti-Russian rhetoric is merely a political strategy to make slowing the phase-out more acceptable to voters, while it will in fact hardly impact on projected Russian gas deliveries to Germany.

 

“I do not think that a possible postponement of the envisaged nuclear phase-out is related to fears of increasing dependency on Russian gas,” argues Marcel Viëtor, Head of Foreign Energy Policy Program at the German Council on Foreign Relations. “Rather this fear is being developed by the atomic lobby to argue for the postponement. Fear of dependency on Russian gas imports is rhetoric but not factual since the Russian companies are mutually dependent on European gas markets,” says Viëtor.

 

Pierre Noel of the European Council on Foreign Relations also argues that the real reasons behind the coming policy shift is lobbying from German energy companies, who earn good money with nuclear power, together with growing electricity demand in Germany and carbon emissions reduction goals.

 

Furthermore, Russian analysts doubt that the move will even impact significantly on the projected volume of gas supplied to Germany from Russia.

 

According to VTB Capital’s gas analyst Lev Snykov, “such a move would not impact my long-term forecasts for Gazprom’s exports to Germany. Long-term Russian gas exports to Germany will grow at a low single-digit rate, although the market share may deteriorate due to a strong push towards LNG.” Similarly, energy analyst at Renaissance Capital, Alexander Burgansky, believes that, “German demand for gas may not now grow as fast as some people had expected, but Gazprom’s supplies are anyway protected by the minimum off-take commitments under the long-term contracts.”

 

Analysts also point out that Germany’s largest energy companies such as E.ON, although lobbying domestically for a suspension of nuclear power phase-out, are also heavily involved in Russia’s gas sector. EON’s CEO Wulf Bernotat is in fact a member of the Gazprom’s Board of Directors, as the company holds a 6.5% in the gas giant. E.ON and German chemicals giant BASF are also taking stakes in the major Siberian Yuzhnoe-Russkoe gas field.

 

Thus it was logical that Thursday September 24 EON was among a group of the world’s largest energy companies addressed by Russia’s ex-president, now prime minister, Vladimir Putin, in the town of Salekhard on Russia’s Yamal peninsula. Putin called on the international companies to invest in gas production in the region, destined to become Russia’s main production region in the long term, as older fields decline. Gazprom estimates total investment needed at $100bn.

 

Germany has particular interest in the massive Yamal development, according to UralSib energy analyst Viktor Mishnyakov. “Yamal is of strategic importance for the Russian government and for Gazprom as this gas will be the source for the Nord Stream pipeline project.”

Nordstream pipeline is a controversial Gazprom-led project to bring Russian gas directly to Germany via the Baltic Sea bypassing transit countries such as the Baltic countries and Poland.

 

There has been vociferous opposition from Poland and Baltic states to the pipeline. But, according to Marcel Viëtor, this is one energy policy that definitely won’t be changed under a CDU-FDP coalition.

 

“The CDU has shown different, more critical rhetoric on Russian domestic
issues than SPD did – but it has supported NordStream and German companies
cooperating with Russian companies, investing in Russia, just like SPD did,” says Viëtor. ”In a CDU-FDP-coalition this attitude is most likely to be continued.”

 

Russia – “Europe’s natural partner”

 

Apart from adjusting energy policy, the new German government’s Russia policy is likely to remain pragmatic and constructive, including disavowing Ukraine and Georgia’s bid to join NATO. With Westerwelle almost certain to become new foreign minister, the influence of SPD elder statesman Gerhard Schroeder in shaping Germany’s Russia policy will cede to the influence of FDP elder statesman Hans-Dieter Genscher, the Federal Republic of Germany’s legendary foreign minister from 1974 to 1992.

 

With 20 years marked since the fall of the Berlin Wall this autumn, events in which Genscher played a crucial role, an FDP-led foreign ministry will be especially minded to take a pragmatic and measured policy towards Russia, considering Moscow’s support for German reunification 1989-1990. Awareness of the Kremlin’s constructive role towards unification twenty years ago has even been heightened in recent weeks by archival revelations of how bitterly European leaders such as then British Prime Minister Margaret Thatcher and French President Francois Mitterand were initially opposed to the idea.

 

Outside of energy policy, the FDP regards Russia, in Genscher’s words, as “Europe’s natural ally, not natural enemy.” Added to this is the generational factor: 47-year old Westerwelle sees himself as one of a new generation of politicians that includes US president Barack Obama and Russian president Dmitry Medvedev. Westerwelle is thus an enthusiastic supporter of Obama’s “reset” policy of improving relations and cooperation with Russia. “If President Medvedev emphasizes he is a moderate politician and wants to reform his country and pursue disarmament, we should take him at his word,” he told Gazeta Wyborcza. “He is a young politician, and together with the US president, who is also young, he will have the chance to go down in history in a positive fashion.”

Taking stock of Russian growth prospects

Graham Stack for Russia Profile (www.russiaprofile.org)

Rumours of imminent growth may be exaggerated by sketchy inventory statistics. A chorus of analysts are attributing Russia’s 10% GDP contraction this year to companies selling down inventories rather than producing, and are gung ho about growth restarting as soon as inventories empty. But others are warn against drawing strong conclusions from Russia’s sketchy national statistics on inventory levels.

 

Alexei Moiseev, macroeconomic analyst at Renaissance Capital, speaks for a number of analysts arguing that Russia’s astonishing GDP collapse of 10.2% – in the first half of 2009 was the result of huge selling down of inventories by industrial enterprises rather than demand collapse.

 

“Very expensive money resulted in massive de-stocking in fourth quarter 2008,” he argues. “The trend intensified in the first quarter of 2009, with the negative contribution to GDP in this quarter exceeding 7 percentage points of a total decline of 9.8%.” 

 

Similarly, Anton Nikitin of UralSib argues, “the fall of GDP and slowdown in industrial production was mostly driven by the huge disposal of inventories” which started late 2008 and continued into early 2009. Citibank’s Elina Ryvbakova also estimates that at least one third of the collapse in production in the first half of this year resulted from destocking.

 

Since GDP is a pure production statistic, it plummets when enterprises en masse stall production lines to sell down inventory, even if turnover stays steady. And the harder they come, the harder they fall: overheated growth in 2008 brought about unprecedented stockpiling due to anticipated future demand. “Spiraling costs of raw materials 2007-2008 also caused companies to massively build up their inventories,” says Rybakova. Moisseev speaks of “a crisis of overproduction” starting in the first quarter of 2008, with inventories at 150% of their 2007 value.

 

If destocking rather than demand collapse was so much to blame for the economic disaster this year, then logically when inventories are empty stalled production will start up again. According to Moisseev, “some of the damage done to the economy has resulted from overheating in 1H08, and some of the damage will be easy to recover. Unfortunately, inventory statistics come with a significant delay, so we have no way of knowing what has been happening since, but historical experience suggests de-stocking cannot last for longer than two-to-three quarters”

 

Shadowy statistics

 

As Moiseev admits, the catch with betting on emptying inventories to kickstart growth is that no one knows very much about them. The problem is that Russian Federal State Statistics (Rosstat) reports inventory statistics only sketchily, on a quarterly basis and aggregated across the economy. The next figures won’t appear until October, meaning that forecasting growth on their basis is very speculative.

 

“The question of inventories has advanced to be the one of the key questions, especially because the economy ministry has focused on it,” explains Vladimir Sal’nikov of the Centre of Macroeconomic Analysis. “But the problem is that inventories are not counted directly and there is a high level of statistical error involved. It is very difficult to separate the real inventory level from the margin of error.”

 

According to VTB Capital analyst Aleksandra Evtifyeva, “Rosstat only provides quarterly aggregate inventory figures that don’t allow close analysis. The Economy Ministry has a wider base of statistics available and said in August that inventories were drying up. However we don’t know for instance if oil companies are included in their statistics or not.”

 

Business daily Kommersant has reported that Bank of Moscow analysts report that inventories have remained stable over the last three quarters, and that as a proportion of turnover inventory has grown by a third compared to 2006-2008. If true, this would point to demand collapse that Sal’nikov also feels has been underestimated. “It seems to us to be the case that markets have contracted more strongly than is reflected in statistics,” he says.

 

Citi’s Rybakova admits that the quality of inventory statistics provided by Rosstat is very poor. However, she says  “the magnitude of the production collapse in the first quartern 2009 is hard to explain by any other factor. It was more severe than in 1998.”

 

“Restocking however won’t be a panacea to cure the economy,” she adds. “Instead, we are seeing an adjustment down to a new production level, meaning inventory will never return to pre-crisis levels.” Rybakova believes restocking could add 1-3% to annual GDP growth, but not before 2010. Instead, she believes that consumer demand will pull Russia back up, if it strengthens. Sal’nikov also prefers demand as a growth factor – but tips deferred demand for investment goods instead of consumers.

 

With the government still holding out for growth driven by an end to destocking, skeptical voices are growing stronger. The Finance Ministry forecast for August was for 1.5% growth, but the result disappointed at 0%. Electricity consumption statistics, a proxy for industry, show demand still contracting.

 

Timothy Ash of Royal Bank of Scotland is consequently dismissive about the talk of growth. “Brokers seems to be jumping over themselves at the moment to talk up the Russia story, that recovery has begun, and that Russia will bounce back quickly. While favourable base period effects should come into play in the final few months of the year, the data flow is far from convincing,” he says.

Ships, chips and automobiles: “Reset” German-style begins

Graham Stack for Russia Profile (www.russiaprofile.org)

 

Germany is opening its doors to Kremlin –linked companies looking for technologies in automotive manufacture, ship-building and microchip production. While the current German election campaign means any investors promising to save jobs are welcomed, the new openness could also point to an economic, European dimension to “reset”.

 

When US President Barack Obama came to power ten months ago and promised a “reset” to relations between the West and Russia, the talk was of missile shields, NATO expansion, Iran and Afghanistan. No one thought that reset could ripple out to include the ownership of embattled German car plant Opel. But precisely this seems to be the case, according to Arkady Dvorkovich, econmomic adviser to Prime Minister Vladimir Putin.

 

“It is a very good political signal,” Dvorkovich said on Tuesday, September 16, referring to the deal that will see Russia’s state-owned Sberbank and Canadian car components producer Magna take a majority stake in Opel, European subsidiary of bankrupt US car giant General Motors. “It means the U.S. administration is ready for maximum economic cooperation with us,” Dvorkovich said at the Reuters Russia Investment Summit. Following bankruptcy, GM is owned by the US Treasury.

 

According to Dvorkovich, powerful anti-Russia interest groups were out to scupper the deal, accounting for General Motors’ down-to-the-wire hesitancy over the deal. But President Barack Obama’s support for the Russian bid tipped the scales, according to Dvorkovich.

 

As a result, Sberbank, Russia’s largest bank, and Magna, the world’s largest car components producers, will each receive 27.5% of the car maker. Sberbank will inject $0.5m and the German government $1.7m. Magna will oversee the restructuring of the company, with an eye to the Russia market.

 

Coming in the same week that Obama implemented a key reset policy by tearing up plans for an anti-missile shield stationed in Poland and Czech republic that Russia opposed, the presidential nod for Russia’s Opel bid raises the question whether there is an economic – and European – dimension to reset.

 

Certainly the German government under Chancellor Angela Merkel has been warming to Russia ever since Obama came to power in January 2009. Merkel had previously positioned herself as a skeptic on Russia, compared to her predecessor in office Gerhard Schroeder, and sought closer ties with the US. But Germany now seems to be moving in the wake of Obama’s reset to reembrace Russia.

 

In 2007, a wave of acquisitions by Russian oligarchs in sectors ranging from airlines to tourism caused jitters in German.  But last week, visiting the prestigious International Automotive Fair in Frankfurt last week, Merkel talked down the risks associated with Russian investors. calling Russia a “market of the future, not something to be kept at arm’s length.”

 

Merkel backed the Sberbank-Magna-Opel deal strongly and publicly all the way, despite criticism from her own economy minister and officials involved in administrating the crippled car maker.

 

This also despite the fact that the real strategic investor in the Opel case, as well as in similar deals in the pipeline for Germany’s Infineon chipmaker and Wadan shipyards, is evidently the Kremlin, through proxies such as state-owned Sberbank or other state-linked companies. This both politicizes the deals and makes them quite opaque, since it is unclear what economic entity will end up with the stake. “Our medium-term view is that Sberbank may well be a conduit for the transaction and a more logical Russian state or industrial entity will eventually be passed the stake,” says banking analyst David Nangle from Renaissance Capital, referring to the Opel case.

 

On the other hand, it is very clear what the Kremlin wants from the deals: “If the import of technologies does not take place, it will mean that (the deal) was just a waste of time,” Sberbank CEO German Gref was quoted saying to journalists on Friday.

 

The German government’s willingness to support such deals – with the nod from Obama – may point to a European dimension to reset, looking to integrate Russia economically despite the risks, rather than keep it at arm’s length.

 

Ships and chips

 

Two other deals similar to the Opel rescued have been broached by the Russians during the summer. Both involve opaque, Kremlin-linked structures bailing out struggling German companies that despite their losses have technologies the Russians want.

 

On Friday, September 18, media reported that Russia’s largest telecommunications holding AFK Sistema is negotiating to purchase a share in Infineon, the largest German microchip producer. According to Kommersant business daily, the deal currently under discussion is for Sistema to acquire 15-20% of the company for EUR 1bn, with the purchase funded by Russian state corporation Bank for Development (VEB). Sistema is a private company (although historically linked to Moscow city government).  However, following a succession of deals where the Kremlin has helped Sistema, “this [deal] could be an anticipated reciprocal ‘favour’”, says telecoms analyst Ivan Kim of investment bank UralSib. Sistema owns Russia’s largest chip producer, Sinterra.

 

And in a smaller, but similar deal, former Russian energy minister, Igor Yussufov, current member of the Gazprom board of governors, is set to acquire Germany’s bankrupt Wadan shipyards, based in Wismar and Rostock.

 

It is widely believed Yussufov is acting on behalf of Russian state-linked strategic investors, including state-owned gas giant Gazprom, and the state-owned United Ship-building Corporation. The financially stricken Wadan shipyards possess unique ice-breaking technologies that Russia needs to retool its naval shipyards to build transport vessels for energy projects in the Arctic. Again this deal has been welcomed by Merkel and the German government, despite the opaqueness about who is actually buying these asets.

 

Thus the German government seems to look positively on the Kremlin’s shopping around for technologies to modernize the Russian economy. For Vladimir Putin, and his colleague as head of state engineering and defence corporation Russian Technologies Sergei Chemezov, who according to Putin biographer Alexander Rahr were both involved in industrial espionage on Germany during Soviet times, Russian access to German technologies is a dream come true.

 

Do these deals mark an economic, European dimension to reset? On Friday, September 18, Putin called on Obama to follow up on cancellation of missile shield plans by supporting Russia’s bid to join the WTO – the longest bid in the history of the organization, with Russia the largest economy to remain outside the WTO. Former German chancellor Gerhard Schroeder has stated openly that the US has been blocking Russia’s WTO accession for political reasons. Obama’s position on Russia’s WTO bid might show whether reset can develop an economic dimension. US reset on Russia’s WTO bid will also have knock-on effects for Russian-Europe ties, since the signing of a new Russian-EU partnership agreement is largely dependent on Russia’s achieving WTO membership.

Russia: Saved by the oil, Medvedev asks what next?

Graham Stack for Russia Profile (www.russiaprofile.org)

As the ongoing crisis descended on Russia in the last quarter of 2008, its most blatant manifestation, twinned with the stock market collapse, was the plummeting oil price, falling from a record-breaking $145 to a low point of $35 a barrel. Back then it seemed that collapsing oil prices would trip Russia up as catastrophically as they did in 1998. But they soon recovered, leaving Russia ever more dependent on the black gold, and causing the country’s president to appeal to the public for help in kicking the addiction. But is Russian society able and willing to respond to his pleas for modernization?

One year on since the collapse of the Lehman Brothers ushered in the crisis, the oil price has more than doubled from that low point, to reach $72 per barrel last Thursday, with the stock market following eagerly in its footsteps. Each day, economists are proclaiming the sighting of more green shoots in the economy, and it now seems that the price of oil will be the factor that lifts Russia out of collapse, rather than ditching it.

The oil price hike looks set to continue in the short term. Last week, the International Energy Authority (IEA) raised demand forecasts for this year and next by 500,000 barrels. OPEC, also meeting last week, retained its current quotas to support the price. As a result, Goldman Sachs, Wall Street’s biggest commodities dealer, declared that oil prices could hit $85 a barrel by the end of 2009. Gazprom’s boss Alexei Miller predicted that oil could even break the $100 per barrel mark.

So despite the global crisis, oil prices have fallen only to their 2007 level – a level that at the time was hailed as unprecedentedly high. Compare this to 1998, when in the wake of a regional (Asian) economic crisis, oil prices collapsed as far down as $8 a barrel.

And there was more oil-related “good news” for Russia last week. Russia’s crude output in August hit an 18-year high. State-owned Rosneft notched a 5.5 percent year-on-year increase thanks to launching its Vankor field, and the sector as a whole is slated for a 0.3 percent increase on the year instead of the originally estimated 1.1 percent drop. Consequently, the Russian Trading System (RTS) index is likely to reach a new high for 2009 this week. Analysts and economists forecast the resumption of growth this quarter.

No credit revival

But coming out of the immediate crisis, the Kremlin is confronting the fact that Russia is now more dependent than ever on the price of oil – the very dependency that Kremlin policies over the last eight years have been trying to reduce. This is not just because the stabilization fund, intended to act as an air bag in the case of a commodity price crash, will have been used up by 2010 on funding a massive budget deficit. And not just because the current oil price still seems detached from the fundamentals and another sharp drop could still be around the corner next year.

The problem is that the flow of cheap financing from global markets to Russia that drove a lot of economic growth during Vladimir Putin’s presidency has now dried up for good. It was the dramatic expansion of credit during Putin’s second term that created the first signs of diversification – through consumer demand and the funding of new industrial projects.

The continued availability of such funds was crucial to the “Putin plan” of diversifying the economy. According to Chris Weafer of UralSib, “the evidence is that, even from the early days of Vladimir Putin’s presidency, there existed at least a broad outline of a long-term development plan to transform the economy from its dependency on natural resources to one with a better range of drivers, where the risk of the sort of boom-to-bust cycle experienced recently is substantially reduced.” The mechanism for achieving this was the classic plan to “move up the value-added chain.” Weafer claims that “the main message of last week is ‘don’t worry so much about the oil price.’ By far the bigger problem is the near-absence of credit and lending in the economy.”

Cheap credit and open Kremlin encouragement for Russian companies to borrow abroad caused an influx of international funding into the Russian private sector that now has left the county’s companies with nearly $500 billion in foreign debt to pay back. And no new credit is on the horizon. This means that growth, when it resumes, will be one-legged, based on and limited to commodity sector revenues, bereft of the prospect of industrial diversification as envisaged by Putin – and all the more vulnerable to another downturn in commodity prices.

Medvedev turns from economy to society for modernisation

With the credit-starved economy unable to deliver the modernization the Kremlin wants, there is no alternative now but to turn to society and campaign against the litany of social ills that throttle Russia’s prospects just as much as the drying up of credit markets has. This is the significance of Dmitry Medvedev’s cri de coeur article “Forward Russia!” published Thursday, September 10, almost exactly one year since the start of the crisis.

“First, let’s answer a simple but very serious question,” begins Medvedev. “Should a primitive economy based on raw materials and endemic corruption accompany us into the future? And should the inveterate habit of relying on the government, foreign countries, on some kind of comprehensive doctrine, on anything or anyone – as long as it’s not ourselves – to solve our problems do so as well? And if Russia cannot relieve itself from these burdens, can it really find its own path for the future?”

“Twenty years of tumultuous change has not spared our country from its humiliating dependence on raw materials,” he continued. “With a few exceptions, domestic business does not invent nor create the necessary things and technology that people need. We sell things that we have not produced, raw materials or imported goods.”

Alongside calling for heightened rule of law, Medvedev has recently called attention to crucial social problems: road deaths that have robbed Russia of an incredible 300,000 citizens over the last ten years, and alcoholism and smoking accounting for many times that number. Economists put the cumulative effect of these evils at two to three percent of GDP per year.

Thus, with Putin’s plan to tap industry for a modernization drive left on the rocks by the outgoing credit tide, Medvedev’s plan is to tap society’s modernization potential. The day following the publication of the article, a raft of proposals to regulate the alcohol market was published.

There should be some easy gains here, analysts say. It surely can’t be that hard to persuade Russians to wear a seatbelt or to drink and smoke less, especially given the extent of media control. All Western governments have wrestled with these same problems over the last 30 to 40 years with considerable success.

But huge hazards await anyone trying to change Russian society from the top, as Mikhail Gorbachev found out to his cost during his Perestroika-era anti-alcohol campaign – a campaign that positively impacted life expectancy, but reflected negatively on Gorbachev’s popularity. Basically, Russians do not like being preached to by their leaders.

This is the risk Medvedev will run if he tries to mobilize a distrustful society for modernization. It is a dilemma that a colleague of Medvedev’s, the Governor of the Kirov region Nikita Belykh, documented very accurately on the exact same day when Medvedev’s article was published.

Thirty-five year old Belykh, the former head of opposition liberal party the Union of Right Forces (SPS) and a sharp critic of Vladimir Putin’s policies, was appointed to head the Kirov region by Medvedev in December of 2008. “When I was in opposition,” Belykh said at a roundtable discussion on “Society and Reforms,” “I despised the authorities. Now that I am in office myself, I still don’t like them, perhaps even less so, but to be honest, I am starting to dislike society as well. A more destructive, obdurate, inadequate and stupid institution than society does not exist. We sit down together at one table, talk, discuss problems, reach an agreement and sign, and the next day they are out demonstrating against you under your window.”

“People refuse to recognize that the authorities can achieve anything,” Belykh was quoted by polit.ru as saying. “There’s an assumption of guilt. Any actions are regarded either as a provocation, or simply go unnoticed. It’s difficult not to act as a dictator, to break with the liberal idea.”

Medvedev calls for democracy po-russki

“Russian democracy will not merely copy foreign models. Civil society cannot be bought with foreign grants,” Russian President Dmitry Medvedev has said in an article published today September 10 by Internet newssite Gazeta.ru, expressing a conservative evolutionary vision of democraticisation.

Crucially, however, Medvedev said that parties would play a central role in Russian democracy, competing for power at all levels, and even nominating candidates for the post of president.

“As in most democratic states, parliamentary parties will be leaders in the political struggle, regularly replacing each other in power. Parties and their coalitions will form federal and regional governments, not vice versa, and nominate candidacies for president, and regional and local government leaders,” Medvedev said, according to Interfax.

But this won’t happen overnight. Medvedev said genuine democracy has to develop through experience and practice, and cannot simply be imported. “Only our own experience of democratic development will give us the right to say that we are free, we are responsible, we are successful,” Medvedev wrote. “Political culture cannot be changed merely by imitating political events of progressive societies, (…) freedom cannot be copied from a book, even if it is a very good book. (…) But no one will live our life for us. No one will become free, successful, and responsible for us,” Medvedev said.

Medvedev argued in favour of gradualism rather than the attempts at radical democraticisation Russia saw in the 1990s.

“We have no right to put social stability at risk and threaten life even for the sake of the loftiest of the goals. (…) Reforms are intended for people, not people for reforms. (…) Change will come. Yes, it will be gradual and well thought out, and go step-by-step. But it will be steady and consistent,” Medvedev said, according to Interfax.

Medvedev significantly failed to mention the role of the mass media and freedom of the press in his article. Instead, he highlighted an effective judiciary as the missing link in Russia’s attempts at democraticisation to date.

“Democracy is in need of protection as much as the fundamental rights and liberties of our citizens are. First of all, protection from corruption, which breeds lawlessness, lack of freedom and injustice. We are just beginning to build such a protection mechanism. The judiciary must be its nucleus,” he wrote.

Although insisting Russia had to take its fate in its own hands, Medvedev also said Russia needed more international integration to be successful. “Our internal financial and technological capabilities are insufficient today to give a real boost to the quality of life. We need money and technologies from countries of Europe, America and Asia,” he wrote, according to Interfax.

Medvedev also highlighted the roots of the demographic crisis. “The population is shrinking with every passing year. Alcoholism, smoking, traffic accidents, poor access to many of the modern medical technologies and environmental problems cut the life span of many people. An increase in birthrate that has made itself felt, does not compensate for the number of deaths,” he said.

Medvedev has made a series of strong statements about the impact of alcoholism on Russia’s development, and spoken positively about Mikhail Gorbachev’s ill-fated anti-alcohol campaign. However, specific measures have yet to be formulated.