Belarus stock exchange is finally in the starting blocks

Graham Stack for business new europe (www.businessneweurope.eu)

Belarus is staying true to its tradition of bucking trends. In the 1990s, Belarus stuck to state ownership and dirigism, while its neighbours embraced privatization and the free market. And in 2008, with the world’s stock markets in freefall, Belarus is about to finally launch its stock market, and expects share prices to soar when trading takes off.

“Stock market participants here are like sprinters waiting on their starting blocks,” says Valery Kalazhenko, deputy head of the Belarus Ministry of Finance’s Securities Department, responsible for regulating the stock market. “Everything is ready and in place, all they are waiting for is the starting gun.”

An equity market has been a long time in coming in Belarus. The Belarus Currency and Securities Exchange (BSCE) is 16 years old, but in 2007 share trading comprised a miniscule 0.7% of trading volume, with the lion’s share trading in state securities. And yet, says Kalazhenko, there are formally over 3,000 public companies in Belarus as a result of the mass privatisation launched in 1992.

But that privatization effort was mothballed just as it began to roll. The state imposed a moratorium on the selling of shares obtained by the public for their privatization cheques. And following a backlash against market reforms symbolised by Alexander Lukashenko’s rise to power in 1994, the state introduced a “golden share” rule for privatized companies, giving it the right to intervene in company management in a wide range of scenarios. As a result of these two measures, says Kalazhenko, “although all the necessary infrastructure for the stock market has been created, there has until now been nothing to trade.”

This all changed in 2008. On January 23, the government passed a programme on “Development of the Equity Market 2008-2011,” envisaging the emergence of a fully-fledged stock exchange. Implementation of the programme started almost immediately, says Kalazhenko, with a presidential decree in February abolishing the state’s golden shares, which he calls “a revolutionary step.”

The government followed up by slashing capital gains tax from a prohibitive 42% to a profit tax level of 24%, and then with the abolition of the moratorium on alienation of shares held by the population as of June 1. “These measures will ensure development of a Belarusian stock market,” claims Sergei Tinnikov, deputy head of the BCSE. “All that is required is for them to be fully implemented.”

False start

Instead of a big bang, however, the June date proved to be a false start. Similar to the hesitant steps it is making toward some democratization, the Lukashenko administration, while liberalizing the economy, is also intending to keep control of its “commanding heights.” As a result, a list is still being drawn up of around 150 strategic companies that will be excluded from exchange trading, at least in the initial phases. And until the list appears, the moratorium remains in effect. “We’re all waiting for this list to appear,” says Tinnikov. “Only when it does, will the market will take off.”

However, even when the list does appear, it will only mark the start of phasing out the moratorium over three stages. Firstly, this year the moratorium will only be lifted on companies where there is either no state stake, or the state owns over 75%. Then in 2009, shares will be admitted to trading for companies where the state owns over 50%. Only in 2011 will the shares of companies where the state is only a minority shareholder start to trade. “This is to allow our colleagues in the State Property Fund time to optimize the state holdings,” explains Kalazhenko, indicating the state is likely to increase its stake to a majority one in companies it wishes to retain control over.

Added to this is the fact that key Belarusian companies such as petrochemical giant Belneftekhim and potash giant Belaruskali, accounting together for around 40% of budget revenues, are state unitary companies yet to be corporatised. “But there remain a huge number of companies where the state is already a majority shareholder,” says Tinnikov, “and these will be free for trading very shortly.”

In fact, according to Tinnikov, while potential blue chips remain in state hands, too many run-of-the-mill companies will list on the exchange, many of them of little interest to investors. This is partly a legacy of the mass privatization in the 1990s. It is also due to the government’s decision in the interest of transparency to close the over-the-counter (OTC) market. As of June, all share trading must take place via the exchange. “We don’t need 1000 companies, we only need 100 good companies that are interesting for investors,” Tinnikov says. “We are not very happy about the decision to end OTC trading, since it means we will have far too many companies on the exchange.”

Not only will there be a huge number of companies, but also a huge number of shareholders. According to Kalazhenko, a legacy of the 1990s mass privatization is that there are around 1.5m shareholders in Belarus, out of a population of just 10m. “Our stockbrokers are currently occupied fulltime with entering shareholder data into their systems,” says Tinnikov.

The government is thus not only concerned with retaining control over strategic companies, but is also intent on avoiding a rerun of the chaotic Russian mass privatization of the 1990s that saw companies bought for pennies. Banning OTC trading is intended to stop the workers selling company shares too cheaply, especially to company management, says Kalazhenko.

Another problem is that over the last decade and a half, many shareholders have forgotten they have shares deposited at the central depository. Former workers may have died without their heirs knowing about their shares, and many Belarusians have emigrated. “Companies may find it difficult to get a quorum for their shareholders’ meetings,” says Kalazhenko.

In addition, with such an overhang of shares, Kalazhenko and Tinnikov are concerned lest punters divest their shares too quickly and too cheaply in the initial phase, before the market has formed realistic prices. “We say – wait, don’t be in any rush to sell. Prices will rise,” says Tinnikov. “But many people will think ‘a bird in the hand is worth two in the bush,’ and sell their shares straight off for easy money. In general, people here have no experience with the share market, and do not regard shares as a form of investment that will grow in value over the long term.”

Bluish chips

Most analysts say that share prices will be way undervalued at the start and are set to soar initially. With the Belarusian economy powering ahead at 8-10% growth per year, and seemingly immune to the global financial crisis so far, most companies are profitable.

However, with around 1.5m small shareholders looking to sell, it is still not very clear who is going to be buying. “We have very few structures that are potential investors,” admits Tinnikov. “Banks and insurance companies are not allowed to work on the stock market because of the risks, and the population is used to keeping money in the banks. And, most significantly, in Belarus there is still simply no such thing as a collective investor, although legislation is being considered.”

Tinnikov also expects Belarusian private capital to buy heavily into public companies. “Belarusian oligarchs will emerge – this is simply how business develops, capital concentrates. Up to now, the state has held this development back, but, as we say in Russian, ‘money goes to where money is’.”

Management ownership is also a possibility – but, as Kalazhenko emphasizes, management can buy shares in “their” companies only via the exchange and after six months notice to ensure transparency. Far from welcoming the development, Tinnikov says Belarusian factory directors are often disconcerted by the process. “Factory directors have little experience in dealing with minorities, and they are worried about what will happen with such a wide dispersion of shareholders. If large groups compete for control of the company, will they change management?”

Moreover, state companies still get cheap credits from state banks, meaning the stock market does not figure in their plans for raising finance. “But,” says Tinnikov, “the state will stop or restrict cheap credits, and then the only option is to IPO, change communication with shareholders, do everything that is completely natural in the West, and even in Russia.”

Tinnikov is expecting foreign investors to arrive. “Russians, Ukrainians, our neighbours, will buy stakes in companies they know because they work with them.” Kalazhenko emphasizes that foreign investors are also perfectly free to trade on the exchange. “The system is totally open for non-residents. You just need to open an account in the depository, and buy shares and bonds. There’s no need for approval, except when buying banks. There are only questions of tax and currency to handle, and there is very good earning potential.”

Neither Tinnikov nor Kalazhenko believe that the Belarus stock market is going to be a major regional player in the near future. But they believe it will be interesting for foreign investors as a safe haven as Russia and Ukraine nosedive. “In five years time, it won’t not a large market here, even compared to Ukraine, but there we should reach $2bn-3bn annual turnover.” says Tinnikov. “There will be 20-30 companies with good trading volume. Not fully blue chips, but certainly somewhat blueish.”

Eurasian frontier markets are top reformers in World Bank ranking

Graham Stack for business new europe

Azerbaijan is today celebrating its meteoric rise in the World Bank’s authoritative annual “Ease of Doing Business” ranking, released September 11. The Caucasian oil oasis shot up from last year’s place 97 to this year place 33, just one below Israel, making it the world’s top reformer. And it is not alone at the top: placed two, three and four among the world’s swiftest regulatory streamliners were fellow Eurasian frontier markets Albania, Kyrgyzstan and Belarus respectively.

The World Bank ranking, that surveys legislation and regulation and includes feedback from companies on registration and tax matters, is the recognized global benchmark for business environment and market entry conditions, in particular for small and midsize business.

And, according to the results of the new survey, Eurasian countries are proving to be the World Bank’s most diligent students: 34% of all reforms improving the business environment across the world 2007-2008 were enacted in Eastern Europe and Central Asia.

The surprise is, however, which countries within this regions were responsible for the lion’s share of reforms. Not the heartland of Poland, Russia and Ukraine, but a splurge of frontier markets, led by Azerbaijan.

Azerbaijan notched up improvements on seven out of 10 indicators of regulatory reform, according to the World Bank. Azerbaijan started operating a one-stop shop in January 2008 that halved the time, cost, and number of procedures to start a business. Business registrations increased by 40% in the first 6 months. Azerbaijan also eliminated the minimum loan cutoff of $1,100, more than doubling the number of borrowers covered at the credit registry, and set up an e-government system allowing taxpayers to file and pay taxes online.

Belarus, aka ‘Europe’s last dictatorship’ and where the state still owns most industry, this year shot up to place 85 from a lowly 110 in 2008.

This was the result of a year’s concerted reforms that won it the number 4th top reformer spot in the ranking. Starting a business became a whole lot easier thanks to a unified registry database, a time limit for registration, and halving of the minimum capital requirement. In addition, a one-stop shop for property registration caused time required to register property to fall from 231 days to 21.

As mountainous as Belarus is flat, and as politically turbulent as Belarus is authoritarian, Kyrgyzstan came in one place below Belarus in the overall ranking, but third place globally as reformer, with one-stop shops for registration and streamlining of construction permission.

Follow my leader

The trailblazer among Eurasian countries, however, remains Georgia. Previous years’ star reformer is this year’s star performer. Georgia takes place 15 in the world for ease of doing business, making it number 1 among the post-Soviet states, far ahead even of the Baltic states, and only one place behind business paradise Finland.

This has made it an example to follow in countries across the region. For as the World Bank’s Doing Business team explains, “if there is any advantage to starting late in anything, it’s that you can learn from others.”

This copycat effect could lead to further sudden leaps towards liberalization in states that seem to be suffocating in red tape. Belarus reformers for one often refer to the Georgian example when arguing that their goal to reach the ranking’s top 25 is feasible.

One example no one is following is Russia’s. Russia languishes at place 120, a drop of eight places over last year. The World Bank comment on Russia is brief and sad: “In the Russian Federation no major reforms were recorded.”

The only silver lining for Russia might be that newly-elected President Dmitry Medvedev has named improving the regulatory environment for small business and tackling corruption priorities for his presidency.

But even that may not help much: Ukraine for all its four years of Orange liberal rhetoric, fares even worse than Russia in the ranking. It came in at place 145, between Surinam and Madagascar.

Cosmetic surgery

However, there are question marks about the report’s findings.

One problem is that the ranking could become a victim of its own success. Governments actively boost their Doing Business ranking by initiating reforms on paper that lack follow-through in enforcement – and thus remain largely cosmetic.

World Bank representative in Belarus Martin Raiser sounded a cautionary note in comments made to bne in July.

“The Belarus authorities have set themselves ambitious goals to improve their rankings in international rankings on the costs of doing business,” Raiser said. “While we welcome the ambition to tackle these challenges broadly, we recognize that the authorities are aiming at efficiency improvements rather than wholehearted institutional change.”

Indeed, the Belarus government’s commitment to moving up the ranking in did not stop hundreds of individual entrepreneurs taking to the streets to demonstrate against the government in early 2008, a bold undertaking in Aleksandr Lukashenko’s Belarus. They were protesting against new government regulations forbidding individual entrepreneurs to hire additional workers, demanding they re-register as firms. The new regulations forced many individual entrepreneurs to quit their business.

“There were demonstrations on the part of individual entrepreneurs in the centre of Minsk, but nothing appeared about them on TV, it was all hushed up and then they were dispersed by force,” a former stall owner forced to turn taxi driver told bne in Minsk in June.

So, before rushing off to set up a bar in Azerbaijan – placed higher than Israel in the Word Bank ranking – listen to what people on the ground are saying as well.

A high-placed foreign advisor in Azerbaidzhan recently made the following comments to the bne blog:

“Petty corruption has indeed been reduced here – you don’t really see policemen hassling people for bribes anymore. But this is not the kind of corruption that anyone is worried about. We’re talking about massive corruption on a scale that is unimaginable by Western standards.”

“Take for example a well-known international oil and gas company which has been working in Azerbaijan for many years. When they have to import a small, specialized part such as a pump, say, that is only worth some $500, they end up paying around $10,000 to get it across the border,” claims the source.

“In the West, when people consider Azerbaijan, they expect corruption but they have no idea about the level it has reached. If someone were to say: ‘give me 100% of the value of the goods’, people would be like ‘are you crazy?’ But here 100% is nothing – 500%, 600% or 700% is completely normal. It’s ridiculous, but that’s the reality.”

“It’s human habit, you push things as far as they’ll go. No one has done anything to stamp out corruption, so it’s gone completely out of control and is killing the country.”

Belarus coming in from the cold?

Graham Stack for Russia Profile

In a deep-reaching move, but still little noticed in the West, Belarus, aka ‘Europe’s last dictatorship’, has shifted the tenets of its economic strategy and is actively looking to attract foreign investment – and targeting the West.

Many analysts in Minsk see the energy dispute with Moscow at the start of 2007 over subsidized gas prices and customs-free oil exports as marking a caesura in Belarus economic strategy. In 2007, Russia put Belarus on a one way track to paying European prices for its gas by 2011, and also ended duty-free oil exports that allowed its small neighbour to earn millions by refining and exporting oil to Europe.

The booming Belarus economy, running at full capacity, with 8% annual GDP growth par for the course, was urgently demanding capital investment to stop bursting at the seams. The price rises punctured the idea the state could do it all itself.

Moreover, the Kremlin actively backed liberalization in Belarus – in the hope that Russian capital would move in powerfully.

Having learnt bitterly from the Ukrainian experience under Kutchma, where Russia subsidized Ukraine with cheap gas, but Russian companies were cut out of the privatization process, Russia has step-by-step shifted to a ‘non-ideological’ approach to dealing with its neighbours.

New president Dmitry Medvedev confirmed this shift July 15th in his first major speech on foreign policy principles:

“We are fed up with ideological investments. As you know, they were made in the previous period, and it is absolutely clear how they were paid back. And there should be no clawing at our money, which was inefficiently spent to support corrupted regimes, in the future,” Medvedev told the Russian diplomatic corps, as quoted by Interfax.

So if bumping up energy prices forced Belarus to open its economy to investors, it was a win-win game for Russia.

In fact, new head of the World Bank mission to Belarus as of July 2008, Martin Raiser, dates the Russia-prompted shift in Belarus policy even further back than January 2007.

“Key aspects of economic policy changed already a few years back. In particular, the unification of the exchange rate and the customs union with Russia meant that key market signals have already been in operation for some time,” says Raiser in emailed comments.

“With the rise in energy import prices from Russia, there has been an additional push for greater efficiency and competitiveness,” according to Raiser, “and this has led to a renewed emphasis on private investment and initiative in Belarus. This is new and it is welcome.”

Reform moves

It was in 2007 that the Belarus administration startled analysts by announcing and launching implementation of a raft of reforms aimed at improving the investment climate.

There was and is a lot to improve. Pro-private sector measures introduced in 2007 saw Belarus leap up thirteen places on the World Bank’s ‘Ease of doing business index’ – from 123rd place to an only slightly less embarrassing 110th place in the world.

But this is only the start, say analysts. According to the World Bank’s Doing Business blog, “in February 2008 the Doing Business team met with 45 government officials from 17 different agencies of the Republic of Belarus. Every single one of these representatives expressed their absolute commitment to ease business regulation in the country. Their aim is to be among the top 25 countries in the ease of doing business and top 10 reformers in the World Bank’s Doing Business 2009 report.”

In 2007, Belarus also took crucial steps such as acquiring a credit rating, and launching large-scale privatization – with the sale of second largest mobile operator, Velcom, to Telecom Austria, for over 500m euros.

An indication of the dominant state role in the Belarus economy until 2007 was that all three mobile phone operators were joint ventures with the state. But in 2008 the state is looking to sell its remaining stakes in operators MTS and BeST. Bank privatization is also in the cards, with Germany’s Commerzbank looking set to acquire fifth-largest Belinvestbank. Austria’s Raiffeisen International already owns the country’s third largest bank, Prior Bank.

This burst of reform activity in 2008 has caught many observers by surprise.
Many expected the reform drive to slow, as energy prices in 2008 have shifted back in Belarus’ favour: the country looks likely to run in a record trade surplus instead of the feared deficit this year. But, according to Dmitry Kruk of Minsk’s Institute of Privatisation and Management, the government has redoubled its liberalization efforts this year, indicating that ‘a strategic decision’ has been taken by the president.

Key challenges

World Bank’s Martin Raiser sees three key challenges facing the government:

“Belarus in some sense benefits from the fact that several of its key industrial assets are relatively new (built in the late 1980s) and that government-led efforts have achieved some success in modernizing the flagship companies.”

“But a lot of inefficient often state-owned enterprises still exist in smaller towns which will need to attract private strategic investment if they are to survive.”

“Secondly, Belarus needs to make better use of its key assets – an educated labor force and strategic location as a bridge between Russia and western Europe. For this, it needs to encourage innovation and entrepreneurship to complement the high human capital and it needs to reorient trade and transport links towards Europe and make it easier and cheaper to transit across its territory.”

“Thirdly, Belarus will need to cope with a deteriorating demographic outlook and the implications this has for the social inclusiveness of future economic growth. As the labor force declines due to aging and migration, the financing of generous social transfers through high levels of payroll taxes will come under pressure and the need to improve targeting of social assistance to the truly vulnerable and to encourage greater labor force participation will become ever more pressing.”

The question facing Belarus is whether the top-down approach pursued by the government is sufficient to master these challenges. World Bank’s Raiser notes that, while the government has “the ambition to tackle these challenges broadly”, the authorities “are aiming at efficiency improvements rather than wholehearted institutional change.”

Between Europe and a hard place

Nevertheless, the logic of reform in Belarus might yet kick-start some political liberalization, to make the country more acceptable in the West.

If economic reform in Belarus was initially prompted by relations with Russia shifting to market principles, then reforms now seem to target West European investors, according to Viktar Strachuk of Deloitte, precisely to avoid Russian capital predominating in the country.

So the government wants Western investors to counterbalance Russian influence. But Western investors are still wary of Belarus, because of the stigma attached to ‘Europe’s last dictatorship.’ So ultimately, economic reform will require some degree of political liberalization at least as window-dressing. Lukashenko seems to have recognized himself that image is important: in early 2008 he hired famous British spin doctor Lord Tim Bell, who has worked for General Pinochet, Boris Berezovsky and the British Conservative Party.

Lukashenko has even promised that the upcoming parliamentary elections in September 2008 will be a ‘model of democracy.’ The claim has met with understandable skepticism from opponents. However, there is considerable room for Lukashenko to liberalise and allow opposition, without losing his iron grip on power, since he enjoys Putinesque levels of popularity, as the economy surges ahead.

On the other hand, such a move would require Belarus’ ‘Batka’ to at least allow public questioning of his infallibility – and there has been little sign that he is psychologically ready for this.

Russia’s private pension funds still in their infancy

Graham Stack for Russia Profile

Russia’s private pension funds have got off to a quick start after the pension reform conceived in 2002 first created accumulative pension savings accounts parallel to pay-as-you-earn.

From 2005 to 2007, the amount of accumulated pension savings – grew from 183,9 trillion rubles to 401.8 trillion. Of this, the share held by non-state private pension funds increased from 1.1% in 2005 to 10.6% in by the first quarter of 2008, according to Expert RA.

But, analysts point out, this impressive growth from nil was mostly due to pensions funds’ corporate links giving them captive customers. Now they must make the difficult switch to retail to tap the broader market. A new government measure is intended to help, but might instead hinder.

According to Irina Rudykh of rating agency Expert RA, who held a round table on private pension funds July 15th that gathered decision makers from government and private sector, “private pension funds’ main resource to date has been their corporative backing.” All of the top 6 PPFs according to pension reserves are linked to industrial holdings.

“The dynamic growth of pension reserves held by private pension funds – by 63% in 2005 and 46% in 2006 – was based on the activities of corporate funds,” says Rudykh. “Most large Russian holdings quickly created ‘pocket’ pension funds which grew quickly, because they had ‘captive’ clients – company workforces – and grew from nothing. So the first stage of growth was easy. There were hardly any infrastructural costs or marketing costs.”

Corporate funds can count on stable and guaranteed demand from workforce numbering hundreds of thousands in the case of natural monopolies.

But this demand is restricted exactly to these hundreds of thousands, and as the captive market is now largely captured, this growth model has reached its limits.

As a result, according to Alfa Bank analyst Olga Naydenova, 2007 saw a slow down in the development of Russian PPFs, with pension reserves held by PPFs growing by only 16.7%, the lowest growth rate since the reform was launched. The majority of analysts ascribe this slowdown to the limits of the corporate PPF model.

Getting blood out of a stone

According to Rudykh, for these funds to keep growing, they must switch to retail on the open market.

However, as easy as the initial phase was thanks to corporate captive markets, as difficult the switch to retail is likely to be.

“This is a huge market, a whole order larger than the corporate market,” says Rudyk. “But there exists here a striking paradox that must be overcome: despite the extremely low level of pension security, there is still practically no demand at all in Russia for the services of PPFs on the part of private individuals.”

For a whole host of reasons, Russians are extremely passive in respect to pensions saving.

According to Oksana Sinyavskaya of Russia’s leading Centre of Social Policy think-tank, there are a number of deep-rooted issues that make tapping the non-corporate retail market like getting blood out of a stone.

“I think that the main problem is in the lack of knowledge and lack of trust. Russian people do not know much about the pension reform, and there were no information campaigns about it, as there were for instance in Poland or Sweden). Most Russians do not know about private pension funds, and how to choose a private pension fund or a private managing company. And they do not trust either the state or private firms. However they trust private pension funds even less than the public pension fund.”

Secondly, according to Sinyavskaya, is the problem of low income: “Although incomes of Russian population are growing they are distributed unevenly, and they were too low over a long period of time. So, now people prefer to consume than to save. And most of them do not have enough money to save. And when they have it, they prefer to invest in more liquid instruments with guaranteed interest, like deposits, or buy housing.”

A further brake is is that the actual amounts accumulating are still small. “This is still virtual money that people do not feel, do not consider real,” says Rudykh.

Under the terms of the Russian pension reform, where contribution payers fail to specify a private pension fund or asset management company, the money is assigned by default to VneshEconomBank (VEB), a state-owned development bank.

Currently, according to Renaissance Capital analyst Katya Malofeeva, 95% of Russians are failing to specify a private pension fund – so their pensions land with VEB.

The irony, however, in 2007, according to Malofeeva, was that VEB actually achieved a higher return on its assets than the private pension fund average. So pension funds are not doing well enough for the average Russian to care whether the money stays with the state or not.

“Private pension funds do not demonstrate high yields and are themselves not too active in promoting their services,” says Sinyavskaya.

“There are three reasons for this. The first is strict regulation of instruments available for pension investments. The second is a high volatility of Russian financial markets, caused by its mostly speculative character. And the third is, to my view, inadequate qualification of managers in managing companies. But this we cannot prove.”

Reforming the reform?

As rapid as the growth of private pension funds has been, starting from nil, they are still only a drop in the ocean in terms of what is needed to shore up Russia’s shaky pension system.

Some analysts call Putin’s pension reform a failure, and demand a fresh start.

Others say that, while the coming pension crisis has not been banished, the time lapsed for judging the success of private pension funds is too small, especially given the novelty of many of the concepts for Russians used to a cradle-to-grave welfare state. According to Rudykh, “what is needed now is not a new reform, since the original reform was only decided on after a real struggle, but a reform of the reform.”

In autumn 2007, the issue of how to improve on the pension reform was addressed by a new minister of social development, Tatyana Golikova, who replaced the unpopular Mikhail Zubarov. Successive presidents and prime ministers, most of them called Vladimir Putin, called for new measures to strengthen PPFs.

As a result, one of Putin’s last measures as president was to sign into law the ‘Co-financing Act,’ popularly referred to as the ‘thousand for thousand’ programme. The act provides incentives for individuals to pay into pension savings accounts, committing the state to add a thousand rubles for every thousand rubles of voluntary contributions, up to a total of 12,000 rubles per year.

“This will make a difference in stimulating interest in voluntary pensions savings in PPFs,” says Expert’s Rudykh. “While Russians don’t like to save, they are attracted by the idea of getting something for free.”
Alfa Bank’s Naydennova, however, criticises the government for failing to launch a large advertising campaign to acquaint Russians with details of the new initiative, which will become effective in October 2008.
A more fundamental objection to the new law comes from those PPFs which have no corporate ties and thus are already working actively in retail.
According to Renaissance Capital’s Malofeeva, the law “On Cofinancing” was passed after three months of lobbying from big business resulted in a supplementary provision: allowing employers to add another 1000 rubles to the original 1000 rubles of voluntary savings. These 1000 rubles ‘donated’ by the employer are then tax exempt.
Malofeeva argues that this means that the law will directly benefit the ‘pocket’ pension funds of large corporations and disadvantage retail-oriented PPFs.

Critics allege that a corporation with a ‘pocket’ pension fund, for the price of 1000 tax-exempt rubles, will see 3000 rubles returned to its pension fund, to be managed by its own assets management company.
Malofeev says that this clause, in combination with the existing backbone of ‘pocket’ pension funds, could badly distort the new law. Instead of stimulating the development of PPFs, by privileging captive corporate pension funds with no presence in retail, it could instead damage the development of PPFs.
The new law, according to its critics, will create a doubly privileged group of pensioners: employees of large, often state-owned corporations such as Gazprom: being both better paid, they are more likely to afford the voluntary contribution and thus qualify for parity state co-financing, while their employees will add a further 1000 tax-free rubles for tax minimization, and see major assets flow into the company pension fund.
There are however also voices supporting precisely this corporation-based development, arguing that corporate pension funds such as Lukoil Garant, Norilsk Nickel’s fund, and Basel’s Sotsium, with household-name industrial concerns behind them that will presumably be around in fifty years time, are more suited to win the trust of the population. They also point to formerly “pocket” banks such as Gazprom Bank that have mutated into national players on the banking market in their own right.
So it seems creating a save-as-you-earn pension system has now been declared another field of mutually-rewarding partnership between the government and Russian big business.

Chubais has left the building

Graham Stack for business new europe

On July 1, Russia’s electricity sectoral holding RAO UES will cease to exist, replaced by a host of privatised power generation companies and state-owned grid operators – thanks to the efforts of ‘the great privatisator’ CEO Anatoly Chubais. Although the unbundling and privatization of RAO UES has been hailed as a huge success, concerns remain – not least because Chubais will no longer be there to look after his baby.

In the RAO UES offices, the last post was sounded for the former blue chip company, and CEO Anatoly Chubais lowered the company flag. In its place, a battery of new flags was hoisted: those of the 24 successor companies: 6 wholesale generation companies, 14 territorial generation companies, the hydroelectric giant RusHydro, and assorted grid and distribution operators.

This was the culmination of a turbulent 10 years work for Anatoly Chubais. When Chubais moved from the government to UES in January 1998, his legion of enemies predicted it would be the death of the company. Ten years later, he has proved them right.

In 1998, RAO UES was in dire straits, caught at the centre of the Kafkaesque nightmare of arrears and barter payments that passed for an economy at the time. Chubais’ reputation had taken a battering due to the scandals associated with privatisation, and suffered what seemed a terminal blow during the financial meltdown of August 1998. The ensuing economic rebound and the Putin presidency gave him a new lease of life as reformer – but made him no less controversial a public figure.

Flak from all sides

Chubais’ reform proposals for the electricity sector attracted flak from all sides: from the Communists as a matter of principle, but also from Western analysts and investors who feared a repeat of the sweetheart privatization deals, and by fundamentalist liberals. His most committed opponents didn’t stop at verbal attacks – Chubais was the target of an all-out mortar and machine-gun assassination attempt in 2005.

The protracted saga of RAO UES reform repeatedly seemed bogged down in parliamentary hearings and cabinet meetings – and yet it moved. Chubais has attributed this to direct support from President Vladimir Putin, “without whom none of this would have been possible.”

The story then exploded in 2007, as the first wave of privatizations to strategic investors took place – for unexpectedly large sums and attracting major European energy concerns.

“The result of ten years of reform is a new structure based on private property and market principles,” Chubais wrote in business daily Vedomosti, June 30th. “In the place of the RAO UES holding, new dynamically developing companies gave emerged – in generation and distribution, sales and service. A competitive market in electric power has been created in the country, and many billions of dollars in investment attracted giving a powerful boost to our country’s economy.”

“In the course of one and a half years,” Chubais continued, “Russian and foreign private investors have invested almost RUB1 trillion in our power generation companies… The detailed investment plan 2008-2012 envisages RUB4.3 trillion to be invested, with 43,000MW of new capacity alone costing RUB1,798 trillion.”

But, far from being dizzy with success, Chubais is aware of the considerable risks still facing the implementation of the reform.

Until only recently, one of the most serious threats to the reform came from Gazprom buying massively into power generation capacity, and looking set to dominate the market. Especially worrying were plans for Gazprom’s power generation assets to merge with coal concern SUEK’s, giving the joint venture a 15% share of total power generation, around 40% of fossil-fuel power generation, and almost a monopoly on supplies of gas and coal. Chubais himself referred to such plans as “the rebirth of state capitalism.” Most analysts agreed with him, but viewed the development as inevitable: what Gazprom wants it gets.

Sensational

It was thus a sensation when on June 10th Gazprom recalled the deal from consideration by the Federal Anti-Monopoly Service (FAS) with woolly justification. Abstaining from the SUEK merger plan seems to show that new President Dmitry Medvedev is on the side of the liberals, and reinforces Chubais’ reputation for beating apparently impossible odds – a reputation earned masterminding Yeltsin’s reelection in 1996.

The most serious remaining risk, in Chubais’ view, is solving the problem of cross-subsidisation of household tariffs by industrial customers, which he says totals RUB120bn per year. “Not one government resolution directed at ending this practice has been implemented over the last ten years,” he complains in his article. “As a result, the structure of the retail market is inadequate. Because of artificially low rates for households, and inflated rates for industry, we had to create the institution of guaranteed supplier, which then restricts free competition… [and thus] lead to structural conflicts between distribution companies and sales companies.”

The second serious risk, according to Chubais, is that of capex inflation pushing up prices. The huge capex programme in Russian power generation, has coincided with a doubling of costs for generation capacity on the global market over the last three years, and also with the current credit crisis increasing financing costs.

“All this will lead to a significant increase in the cost of investment programs, and… in the end prices charged to consumers,” warns Chubais, who calls on the government to rely on the market and competition to keep prices as low as possible.

Both these factors highlighted by Chubais could lead to a sharp increase in prices for electricity at a time when inflation is already surging. Moreover, today’s prime minister is a holy cow rather than a potential scapegoat, meaning that there will be political pressure to delay unpopular decisions.

Chubais nonetheless argues that price liberalisation is unlikely to be postponed. Standard and Poor’s electricity analysts are less optimistic about this. “Reforms have been beset with delays and revisions that erode the nature of the ultimate plan’s clarity,” Elena Dubovitsjaya and Ekaterina Marushkevich warn in a report. “Tariff regulation, particularly in heat generation, remains opaque and politicised despite legal changes that were designed to create a more transparent regulatory framework. In this environment we consider power generation companies to be highly exposed to the risk of political interference, including implicit price controls.”

The Standard and Poor’s team, who focus on corporate governance risks, points to politically motivated decisions, inefficient government regulation and control, limited control of new owners over strategy and investment programs, and new state monopolisation in the form of Gazprom, as risks facing the new owners.

The recent departure of top management from generation companies due to generous golden parachutes has also raised questions about future managerial capacities.

Paradoxically, according to Standard and Poor’s, one of the main threats to the reform results from another departure: “the liquidation of the fundamental ideologist behind the reform – RAO UES.”

But RAO UES head Chubais feels his work has now been done – and says his future plans involve only “to sleep for six months.”

Before going home for some well-earned kip, he left a farewell note on the RAO UES website:

“Thanks to all of you who accompanied us along the way – whatever side of the barricade you were on. We are leaving now. But the lights will stay on – because the building called the Russian power sector now has new owners.”

Rags-to-riches surprise for Russia’s power engineering industry

Graham Stack for Russia Profile

The flood of investment in expanding Russia’s power generation capacity has taken most people by surprise – not least the power engineering companies who will build it.

Russia’s huge and unanticipated success in raising 150$bn investment to expand its power generation capacity has taken power equipment producers largely by surprise, causing bottlenecks in production, soaring prices for equipment, and oligarch acquisition of engineering plants.

“No one anticipated the success of the UES spin offs in raising investment funds,” says Alfa’s Alexander Kornilov, “and so the power generation machinery sector was caught unprepared for the huge surge in demand.”

Caught unprepared

St. Petersburg based Power Machines, a conglomerate of several large power engineering plants which took shape in 2004, has 60% of the Russian market, so is taking a lion’s share of the capex. But according to Kornilov, Power Machines is facing a “severe shortage of qualified personnel and manpower.”

It was only in 2007, as the sell-off of the state’s stakes in power generation companies started, that the scale of the coming investment boom became clear. Power Machines announced February 2007 that its sales revenue could jump to $1.5bn in 2010 from $680m in 2006, as the result of $1bn in investment through 2010.

This abrupt change in fortune turned loss-making Power Machines into a hot property – with strategic importance.

Both electricity utility UES (25%) and financial-industrial group Interros (30%) announced they would sell their stakes to a strategic investor, promptly unleashing a bidding war between metal oligarchs Oleg Deripaska and Alexei Mordashov that resulted in the latter consolidating a 55% stake in the company for close to $1bn.

With a strategic investor in the driving seat, new management, and an additional share issue having raised $275m, Power Machines’ plans to more than double generation capacity of machinery produced from 8-17 GW annually looked more realistic.

But it was still running to catch up, with new demand exceeding current output fivefold. Moreover, construction of new generation capacity is on an extremely tight schedule: mandatory investment programmes stipulate 280 turbines to be built by 2011.

This bottleneck it does not just relate to turbine producers. A whole range of further industries engineering services, construction materials and construction work are coming up short.

It is not only lack of capacity. Russian produced-technology still lags far behind western counterparts.

Luckily for Power Machines, but unluckily for Russia’s electricity generators, foreign giants such as Siemens and Alstom are also running at full capacity.

“The world’s largest producers of generating equipment, such as General Electric, Alstom, Siemens and Mitsubishi, are just as overloaded as Russian Power Machines, leaving no room for an increase in their production,” says Alfa’s Kornilov.

Freedonia market report puts global electric transmission and distribution equipment demand to rise 4.4% annually through 2011, and International Energy Agency forecasts at least around €140 billion per year to be invested in power generation until 2030

As a result Russian power generators have to queue to place orders. Mosenergo reportedly paid a $54m booking fee for a $500m equipment order from a foreign producer, according to Russian Today.

The surprise guest at the feast has thus been no-name Chinese producers. OGK-2 invited Harbin Power Equipment was chosen as equipment supplier for the Troitsk HPP and at the end of April announced it was inviting a project developer from China to take part in the construction of new generating units at the plant.

These steps awakened alarmist fears of flood of cheap Chinese power station components and companies flooding the market. However, according to Alfa’s Kornilov, Chinese manufacturers still lack the quality to make real inroads.

Chubais vs. Chemezov: How to kick-start engineering

The upshot is that Anatoly Chubais – the godfather of 90’s economic reform, scourge of industrialists and idol of free-marketeers – has succeeded magnificently where the government’s interventionist silovik faction has little to show: By kickstarting a revival of the ailing machine-building sector.

For much of Kremlin economic policy in Putin’s second term was focused on reorganising the machine-building sector – including ‘deprivatisation’ where necessary.

The culmination of this policy was the establishment December 2007 of the Russian Technologies state corporation, dedicated to supporting and developing machine-building, and excercising direct control over upwards of 300 companies, and headed by Putin’s old friend Sergei Chemezov.

Chemezov argues – with some justification – that turning the sprawling machine-building sector around is the key to achieving economic diversification.

“In any country, and especially in ours, machine-building is the key sector of industry,” Chemezov told Nezavisimaya Gazeta in an interview May 28th.

And this is what Chubais has achieved with the rags-to-riches tale of power equipment producers – without a ruble of state support, and without infringing on property rights or creating opaque structures as the siloviki are wont to do.

On the same day, 21st May, that headlines were full of the maiden flight of Russia’s new regional jet, the Sukhoi Superjet 110, a product of state-owned holding United Aircraft-building Corporation, Chubais opened the first Russian-produced, combined-cycle power unit in Komsomolsk, the work of private companies and private investment, saying “a breakthrough for the country’s heavy-machinery sector.”

One company had double cause to celebrate: Yaroslav-based turbine producers NPO Saturn built the engines for the Superjet, and also the turbines for Konsomolsk power plant.

The case of NPO Saturn also perfectly illustrates the very different approaches between the ‘industrialists’ Chubais and Chemezov.

Chubais, in his speech opening the power plant, congratulated Russia’s power engineering managers, but warned them they had to stay internationally competitive to keep winning tenders:

“I’m for Siemens as well, and I’m for General Electric. If you fail to produce the 10 new units, I’ll strangle you with my own hands,” he warned them playfully, as quoted by Interfax.

Chemezov’s threats towards NPO Saturn, on the other hand, are far less playful: Russian Technologies holds a 37% stake in the company and is pushing for the company to be merged into a state-controlled conglomerate, effectively renationalizing it. Company director, Yury Lastochkin, who controls 57%, is bitterly resisting this.

Deputy Industry Minister Denis Manturov, a Chemezov ally, has publicly called Lastochkin’s position ‘destructive’, adding in a Kommersant interview, ‘I advise Mr Lastochkin to read what is set down black on white in the presidential decree about who is to do what and when,” and stating Russian Technologies would ultimately require 100% control over Saturn.

Lastochkin responded in Vedomosti that “to hand over assets we have been developing and structuring for over 10 years to complete nobodies would be beyond a laughing matter.” Asked if he feared pressure from law-enforcement agencies forcing a management sell-out, he said he hoped the state was clever enough to realize that any such ‘games and experiments’ would have a disastrous effect on such a finely-tuned technological enterprise.

Which of these two battling paradigms – Chubais vs. Chemezov, unbundling of UES vs. snowballing of Russian Technologies, competition and private investment vs. state control – wins out, is one of the first things that new president Dmitry Medvedev will have to decide.

SMEs top Russia agenda, but will Medvedev succeed where Putin failed?

Graham Stack for business new europe

Putin was a small man with big ideas, but Russian President Dmitry Medvedev is a small man who is turning to the small details. He launched his first term as president by inviting 5,000 small- and medium-sized enterprise (SME) bosses to the Kremlin to listen to their gripes.

This is new for Russia. Over the last 15 years, the Kremlin has always been first and foremost concerned with big issues, big companies and has made some big mistakes. The little people in the street have largely been ignored and bore the brunt of the suffering. However, if Medvedev is successful in cutting the red tape that entangles small businessmen, as he is promising, it would have a big effect on the Russian economy.

Medvedev has so far been hitting all the right notes when it comes to making life easier for the beleaguered SMEs. Barely a week into his new job, Medvedev called a meeting with SME representatives and prepared decrees slashing permit and licensing requirements. “You know what I am talking about,” he said at the meeting May 14 with the assembled small business bosses. “Firstly, I mean reducing the number of inspections to one every three years, with extra inspections requiring special permission from the procurator’s office… I mean a transition to predominantly notification procedure for registering small businesses, and wide-ranging introduction of compulsory insurance for small business instead of bureaucratic licensing… I remind you that our goal is that by 2020, 60-70% of the workforce should be involved in entrepreneurial activities.”

Is this a break with gigantism of the Putin area, and its focus on oligarchs, state monopolies and massive pipeline and infrastructural projects?

Heard it before

“Dear colleagues,” began the president. “We often say that it is very important for starting businesses to ‘find their feet’… Business in general – and small business in particular – has an enormous amount of complaints about unjustified administrative pressure. And this primarily comes from supervisory bodies and inspections. Hundreds of thousands of people oversee this order. Thousands of commercial organizations are accredited at these bodies to’ feed’ off inspections. Their dictates and fines, just like extortion and bribes, are an excessive burden and oppress enterprise… The government should ensure that these inspections are reduced to a minimum.”

Impressive? But this was not President Medvedev, but President Vladimir Putin in his presidential address to parliament in 2002, detailing a plan drawn up and subsequently implemented by German Gref’s reformist Ministry of Trade and Economic Development. So, six years later, why are we back to square one?

Currently, SMEs in Russia employ 24% of the workforce and contribute 22% of the GDP, compared with 78% of the workforce and 55% of the GDP in Japan, and on average approx 50% of workforce in developed countries. A study published December 2007 by the Centre for Economic and Financial Research (CEFIR) at Moscow’s New Economic School about the effects of the Gref de-bureaucratisation programme found there had been an overall average effect on SME development, but subject to massive regional differences. Federal measures only worked effectively where local government got behind them, and this only occurred in regions with, according to the survey, relatively high standards of transparency and information. In other regions, local authorities simply continued inspections as previously, ignoring the new regulations.

Another survey released in April, conducted by Trust Bank and Romir Monitoring, established that SMEs had never had it so good in terms of current business in 2007: 66% of SMEs said their market grew in 2007, compared with 51% in 2006 and 54% said business was better. But, paradoxically, despite feeling good, the same businesses say they lack confidence in their future. In comments on the survey, Trust’s managing director for development of SMEs, Nadia Cherkasova said: “for both small and midsized companies, the index of expectations was significantly lower than the index of current business. This indicated that entrepreneurs are in a permanent state of anxiety regarding the future.” Trust makes no secret of the reason for this: “administrative and criminal pressure.”

This indicates that, with small business revenues growing, the temptation for law enforcement and inspection agencies to line their pockets also grows. Entrepreneurs suspect that whatever legislative changes are introduced, local state organs will find new ways of extracting rents. SME confidence in the future falls as their business grows. In turn, lack of confidence in the future deters companies from accessing credit, and thus limits business expansion.

Big business looks out for small

The solution to all this is to replace the whole system of government licensing and inspections in favour of compulsory insurance, which was what Putin was calling for way back in 2002, in vain as it turned out. It failed to materialize then, as there was no insurance sector worthy of the name. Even compulsory third-party motor insurance was only introduced in 2003, and encountered significant initial difficulties.

But in 2008, the insurance sector has transformed beyond recognition, after five boom years, with almost all major European insurance companies now present in Russia, and professional standards soaring. This makes transition to an insurance system now feasible. Moreover, it means that there is a power lobby in favour of implementation and enforcing such a system: precisely the federal-level insurance companies. For the first time, big business is looking out for small.

In banking, as well, huge changes have taken place. And after the retail banking boom, banks are starting to look to the SME sector as a new source of business. According to Trust Bank, 2007 was the first year where the growth rate of loans to SMEs was higher than the growth rate of corporate and retail loans, according to Nadia Cherkasova. VTB has announced plans to increase SME financing by 80%. And Russia’s largest bank, Sberbank, has a special interest in small business: its new CEO, German Gref, was as economy minister the author of the 2002 deregulation initiative.

Large banks looking to do business with small companies constitute another lobby with an interest in protecting SMEs against local inspections. And not only in terms of legislation, but also in terms of enforcement. Local officials are less likely to harass entrepreneurs where this involves entangling with the corporate security services of federal–level insurers or banks.

New government legislation could work this time round if it’s backed by such powerful federal players, with money at stake where clients come under administrative pressure.

It is no coincidence that a leading lender to small business such as Trust Bank, with one of Russia’s largest branch networks, sponsors of the Romir Monitoring Small Business Index, lobbies both for extensive deregulation for small business, but also for criminal liability for creditors who fail to return loans.