Afghan heroin could kill US-Russian reset

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

In context of the “reset” in U.S.-Russian relations, the two countries’ cooperation over Afghanistan has been hailed as a model for working together in other areas, ranging from Europe to Iran and North Korea. But with the reset hardly underway, opinion differences are already emerging between Moscow and Washington over anti-narcotics policy in Afghanistan.

Russia’s security policy hawks tend to react negatively to the United States acting unilaterally, deploying interventionist military power and tweaking UN mandates to expand missions. But when in 2008 U.S. hardliners pushed for the American military and allies to widen the fight against the Afghan Taliban to include military engagement of the country’s billion-dollar narco-industry, including a shoot-to-kill policy against heroin producers and a blanket aerial crop-eradication campaign, Russia’s siloviki stood up and applauded.

U.S. hardliners regarded Afghanistan’s opium production as a crucial source of financing for the strengthening Taliban insurgency, and drew inspiration from the America’s experience of having fought and largely won a war with drug producers in Columbia. In 2007, the U.S. ambassador to Columbia William Wood, an ardent supporter of aerial crop eradication, was reassigned to Afghanistan to step up the war on drugs. “If there is no poppy, there is nothing to traffic,” Wood told reporters on arrival. In 2007, military operations supporting manual eradication got underway, and in January 2009, a leaked letter by NATO’s Supreme Commander General John Craddock to European counterparts declared an effective shoot-to-kill policy for the drug war, saying it was “no longer necessary to produce intelligence or other evidence that each particular drug trafficker or narcotics facility in Afghanistan meets the criteria of being a military objective.”

Iraq, Iran and North Korea are all examples where Russia has vehemently opposed the use of American military force against weapons of mass destruction. But without any sense of irony, Viktor Ivanov, the head of Russia’s Federal Anti-Narcotics Service (FSKN) speaking in February called Afghanistan’s heroin “a weapon of mass destruction of a special kind,” and expressly demanded that the United States and its allies in Afghanistan engage and destroy it.

Ivanov’s reasoning is clear: Russia is the country worst affected by Afghanistan’s heroin exports. According to FSKN statistics, Russia has up to 2.5 million drug addicts, mostly in the critical reproductive age group of 18 to 39, with the number surging by 80,000 a year. Ninety percent of drug addicts in the country use Afghan heroin. These alarming figures do not take into account the enormous number of HIV infections transmitted via dirty needle sharing. “Today it is self-evident for everyone that the state should take decisive emergency measures to prevent an approaching national catastrophe,” Reuters reported Ivanov as saying in May, adding that “it is time the world community got serious about the Afghan drug problem.”

Although Ivanov has no official foreign policy remit, he is not simply a law-enforcement officer lobbying for a larger budget. A former KGB officer, he is a longstanding associate of the current Prime Minister Vladimir Putin, and a key member of the influential “silovik” network of former KGB officers from St. Petersburg responsible for Russian security policy. He was a top Kremlin aide throughout Putin’s presidency before moving to the FSNK in 2008. And there is also a special personal background to Ivanov’s interest in Afghanistan: he served there with the Soviet forces in the 1980s during the Soviet Union’s disastrous occupation. His move to the FSNK duly shifted the organization’s attention from the domestic to the international dimension of Russia’s heroin problem.

It is testimony to Ivanov’s influence that the joint declaration given by U.S. President Barack Obama and Russian President Dmitry Medvedev at June’s Moscow summit listed combating illegal drug trafficking alongside the fight against terrorism and armed extremism as shared goals in Afghanistan, with Obama acknowledging that “Russia has deep concerns about the [Afghan] drug trade and its infiltration into Russia.”

New man on the job

The Obama-Medvedev summit was the birth of the U.S.-Russian “reset,” and the new spirit of cooperation was marked by Russia’s agreement to allow the transit of U.S. weapon cargo to Afghanistan. But ironically, as part of Obama’s global adjustment of foreign policy, the U.S. policy in Afghanistan is also being reset – and the results are not looking like anything Russia would want them to be.

Obama’s shift away from George Bush’s hardline policies has seen both general Craddock and ambassador Wood lose their posts this year. Instead, a veteran Democrat diplomat Richard Holbrooke has taken over the U.S. policy in the area as the American special envoy to Afghanistan and Pakistan. Holbrooke is a longstanding opponent of any form of crop eradication, whether on ground or by air, and indeed largely denies that Afghanistan’s opium trade is the main source of funding for the Taliban insurgency.

“If the drugs ended tomorrow, it would not have a major effect on the Taliban source of funding,” Holbrooke declared in June at a ceremony to mark General Stanley McChrystal’s assumption of command of American and NATO forces in Afghanistan.

Holbrooke pointed out that the ground-based crop eradication program has been costly in terms of money and lives, and has failed to make any impact. These are points the Russians agree with – but instead of ending crop eradication, Ivanov is demanding a step-up to aerial eradication, and lamented general Craddock’s departure in an interview he gave to the Kommersant daily in June.

In response to Holbrooke, Ivanov claims it would be possible to end the Afghan opium production swiftly, and adduces two examples: firstly, he says, following the UN’s condemnation of Afghanistan’s heroin exports in 1999, in 2000 and 2001 the Taliban reduced the opium harvest practically to zero. Secondly, the U.S. crop eradication campaign in Columbia has been largely successful. According to Ivanov, 74 percent of the coca crop was destroyed in 2008, with no increase in armed resistance.

Ivanov says the UN should force the United States and its allies to take decisive action against opium production in Afghanistan, firstly by declaring Afghan’s narcotics trade an international threat, as it has done with terrorism and piracy. Following this, Russia should make the next annual renewal of the UN mandate for international troops in Afghanistan conditional on action against heroin production and trafficking. “The further presence of coalition forces in Afghanistan should be made conditional on an undertaking to destroy drug fields,” Ivanov told a conference in April. Russia’s UN Security Council veto means that theoretically, Russia has the leverage to do this.

Ivanov has gone as far as to propose tying U.S. transit of weaponry to Afghanistan via Russia to a more active pursuit of crop eradication on behalf of the Americans. “The granting of transport corridors to NATO forces in Afghanistan should be conditioned on a commitment to destroy sown areas, laboratories, stocks and other infrastructure of the Afghan drug business,” he told Russia’s Duma in late June.

With Russian demands for crop eradication becoming more strident while U.S. strategy moves decisively away from the approach, the signs do not bode well for U.S.-Russian cooperation in the one policy area where it has been strongest to date.

At the same time, however, U.S. strategy is shifting away from unconditional support for the Afghan President Hamid Karzai, an opponent of crop eradication who has been frequently accused of protecting major figures involved in opium and heroin production. Indeed, on August 28 reports appeared in the media that Holbrooke had had a major row with Karzai over allegations of ballot-stuffing in the August 20 presidential elections.

A more distanced approach toward the Karzai administration could make Holbrooke’s plan to go after the big fish of heroin production and trafficking, instead of the small fry opium farmers, seem more plausible to the Russians. This is something that Ivanov, who has called for a UN blacklist of Afghan drug barons to be compiled, could go along with. On the other hand, Russia’s drugs tsar is skeptical that the big fish can be found in Afghanistan. “All these people live a long way from Afghanistan, for instance in United Arab Emirates and Saudi Arabia,” he told Kommersant in June

Medvedev moves against state corporations

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

Medvedev Asks State Prosecutor General to Inquire into the Activity of Seven Major State Corporations

The much-anticipated shift toward more liberalism in Russia marked by Dmitry Medvedev’s election as president in March of 2008 but delayed by last year’s war with Georgia and this year’s economic crisis looks to be slowly getting started. Under the Kremlin’s patronage, an alliance appears to be forming against the state corporation juggernaut.

In December of 2007, a key Medvedev friend and confidante, university friend and law faculty colleague Anton Ivanov, now chairman of the Supreme Arbitrage Court and as such the chief of Russia’s system of commercial courts, said that “relations between state and business are like a seesaw – they tip to one side and then to another. There was a time when the state had lost influence over business to the extent that it practically handed out indulgences for the non-payment of taxes. Now we are in tougher times. Perhaps the seesaw has even tipped too far in the other direction, and it is time to re-determine the correct balance between business interests and state authority.”

Anton Ivanov plays a similar role for Dmitry Medvedev to the one that Sergei Ivanov played for former-President and now Prime Minister Vladimir Putin – a trusted friend and a top official. And whereas Sergei Ivanov counted as a key member of Putin’s hawkish network of former St. Petersburg KGB agents known as the “siloviki,” Anton Ivanov is a key figure in Medvedev’s liberal network of the St. Petersburg civil law scholars, nicknamed the “civiliki.”

However, the shift from statism back toward liberalism has been slow in coming. Cynics argue that Medvedev is merely a placeman until Putin resumes the presidency in 2012. Optimists say a planned policy shift has been derailed by the Georgian war in 2008 and the economic collapse in 2009.

Until now the cynics seemed to have the better arguments. However, in what is seen as Medvedev’s first real independent initiative, on August 10 he requested the State Prosecutor General Yuri Chaika to audit the activity of the seven state corporations set up in 2007 to manage various fields of the economy, from the defense sector production and export to the construction of facilities for the 2014 Sochi winter Olympics.

With their wide-ranging powers and little room for oversight and accountability, the state corporations seem to adhere to a state-dominated model of bureaucratic capitalism that could crowd out private enterprise and increase corruption. Moreover, over the previous eight years their anomalous legal form – neither truly state-owned nor private, neither truly non-commercial nor solely profit-oriented – has outright contradicted much of the progress in creating a unified legal space in Russia.

In speeches and interviews in the run-up to his election as president, Medvedev frequently repudiated “state capitalism,” calling it a dead end and declaring that he is on the side of private enterprise and innovation. His failure to back words with deeds until now only reinforced the impression that he was a puppet of his Prime Minister Vladimir Putin.

Collective discontent

Medvedev’s move comes just after a number of different bodies raised a chorus of criticism of state corporations in June and July. This points to a carefully orchestrated campaign to discredit state corporations and to the fact that the president has enough political backing across state bureaucracies to get his way.

The first blow was dealt by the “civilik” Anton Ivanov. In early June, in an interview to the Vedomosti business daily, Ivanov publicly reprimanded state corporations, calling for a moratorium on their creation and for the enforcement of “generally-binding norms for all legal entities.” “It is not for nothing that legal scholars criticize state corporations,” he said. “Because their assets are private, but you can’t call them private in essence. And if the decision was to be taken to liquidate a state corporation, who would get the stakes in the companies owned by them? We need to stop calling old structures by new names, when they in fact remain the same in essence.”

In June, the Presidential Council on Legal Codification went even further, calling for the elimination of state corporations as a legal form altogether, since they have no place in Russia’s civil code.

Then in July and August, the powerful Audit Chamber and the Anti-Monopoly Service joined in the chorus. Both are headed by former members of the liberal Yabloko party, Sergei Stepashin and Igor Artemev, respectively. Perhaps more importantly, they both have little jurisdiction over state corporations and would like to change this.

Thus, a report prepared by the Federal Anti-Monopoly Service (FAS) and leaked to the Kommersant daily named state corporations as one of the main threats to competition in the Russian economy. Writing in Vedomosti about the correct way to go about modernizing the Russian economy, the Head of the Audit Chamber Sergei Stepashin argued that this had to be done by changing legal norms to support and reward innovations, not by Soviet-style “sectoral” corporations, which he said “had failed to justify themselves.”

Finally, Valentin Zavadnikov, the chairman of the Federation Council’s industry committee, put up bitter resistance to a draft bill setting up a state corporation to run Russia’s roads. Back in February of 2008, Zavadnikov authored a damning Federation Council report on state corporations, calling them “the perfect chance to transfer state property to the non-state sector with no financial benefit for the state and at the risk of uncontrolled use and alienation of assets.”

Civiliki vs. siloviki

The Kremlin’s move against state corporations has two targets: the “civiliki’s” concern about the disastrous implications for Russia’s developing civil code of the state corporation anomaly and the desire to eradicate it by converting state corporations into other legal forms provided for in the civil code – such as joint stock companies or government agencies.

Ironically, this might be the easier part. A number of state corporations themselves are headed by liberals who are likely to tow the Kremlin’s new line. Liberal Anatoly Chubais, the head of Rosnanotech, the state corporation for developing nanotechnologies, declared in August that changing the legal form would make no real difference in Rosnanotech’s activities. Sergei Kirienko, a former liberal party colleague of Chubais and now the head of atomic power state corporation Rosatom, is also unlikely to object to a change in form. Nor is Dmitry Kozak, the head of the Olimpstroi State Corporation for constructing the facilities for the Sochi 2014 Olympics and a liberal colleague of Medvedev’s at the St. Petersburg law faculty, likely to kick up a fuss. In fact, Vedomosti recently reported that Olimpstroi is likely to be transformed from a state corporation into a federal target program.

As a sign of the tide turning against state corporations, one planned state corporation to own and run Russia’s roads was scaled down to a state company in July, thanks to the efforts of the above-mentioned Valentin Zavadnikov in the Federation Council. Likewise, there apparently will be no state corporations in the space and rocket industry, Deputy Prime Minister Sergei Ivanov told journalists yesterday. Instead, the country will resort to forming vertically integrated public joint-stock companies.

And in August, Russia’s Finance Ministry abandoned the project of a state corporation for managing Russia’s financial assets. Deputy Prime Minister and Finance Minister Alexei Kudrin, who in 2007 criticized state corporations for de facto privatizing state assets free of charge, said that the state corporation form “was no longer deemed suitable” and another legal form would be found instead to do the same job.

But the big stumbling block will be what to do with the mother of all state corporations – Russian Technologies (RT) – the very first state corporation established in December of 2007. RT was originally based on defense sector exporters and their suppliers, but rapidly snowballed to include companies ranging from metallurgy to carmakers. The corporation is headed by the influential friend of Putin’s Sergei Chemezov. He is the man who single-handedly tailored the state corporation legislation to suit his personal goals, and is not likely to surrender his huge privileges without a major struggle.

Suspicion of Russian Technologies’ activity runs even deeper than suspicion of the legal form of state corporations. Chemezov’s activity as head of RT seems not just to threaten the integrity of the civil code, but the overall primacy of private property in the Russian economy. In contrast to the other state corporations that operate in specific fields of activity, Russian Technologies has acted as a cross-sectoral “Ministry of Deprivatization,” acquiring privately-owned companies and often prompting accusations of behaving semi-legally as a “corporate raider.” RT’s latest major hostile acquisition was the fairly successful engine and turbine producer Saturn, which, as a private company owned by CEO Yuri Lastochkin, developed engines for the Superjet aircraft and a new generation of turbines for gas-fuelled power stations.

According to Kirill Rogov of the Institute of Economy in Transition, “Medvedev’s target is not only state corporations in general, but also one certain corporation in particular: Russian Technologies. Whereas for other state corporations the consequences will be limited to adjusting their status to conform with the Constitution and Russia’s laws, for Russian Technologies this is the beginning of the end of the project itself.”

Halting the Russian Technologies juggernaut would thus finally mark a modest beginning to the project announced by Anton Ivanov in December of 2007 of re-tipping the scales away from the state, and back toward private enterprise.

Legal eagles Obama and Medvedev swap notes

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

The Connection Between the Lawyer Presidents is More Curious than Medvedev Seems to Have Realized

When they first met, Russian President Dmitry Medvedev played up the common legal background he shares with U.S. President Barack Obama. And despite question marks over the veracity of Medvedev’s claim to have studied a “legal reference work” authored by Obama, the influence of the Russian president’s legal schooling is palpable, in his public statements, policies, and above all his appointments. But is his habit of hiring like-minded colleagues really a bid to consolidate the rule of law, or just good old-fashioned nepotism?

Relations between U.S. and Russian presidents are full of paradoxes. Since the collapse of the Soviet Union, each new Russian president has been paired with a new U.S. president – Bill Clinton and Boris Yeltsin, George W. Bush and Vladimir Putin, and now Barack Obama and Dmitry Medvedev. The previous two presidential pairs featured an unlikely personal bond, which nevertheless failed to prevent tensions escalating between the countries.

Obama, after his first meetings with Medvedev, seemed to deliberately avoid any sentimentality, emphasizing that he wants a relationship based on shared national interests, not personalities. In fact, Medvedev’s response to Obama was more personal than vice versa, inspired by his and Obama’s common background as legal scholars.

Following the two presidents’ first meeting at the G20 summit in London in March, Medvedev commented that “we have read the same books.” Following a bilateral meeting at the G8 summit in L’Aquila on July 10, the footnote swapping seemed to have gone one step further: Medvedev said he had previously studied a “legal reference work” co-authored by Obama. “This is curious to say the least,” Medvedev remarked.

The issue is actually even more curious than Medvedev seems to have realized: Obama, as a legal scholar, published nothing, except one research note to the Harvard Law Review as a graduate. Medvedev’s own publication record is far more impressive than Obama’s – having co-authored a standard work on Russia’s civil code in the 1990s.

What publication was Medvedev referring to, then? It could be that he meant the Harvard Law Review. Obama famously edited the prestigious periodical between 1980 and 1990 as its first black editor. These were also the years when Medvedev was completing his doctorate in St. Petersburg.

However, according to a number of sources, it is extremely unlikely that the journal was available at St. Petersburg State University until the late 1990s. Also it is unclear why Harvard Law Review could have been interesting for a Russian legal scholar at that time.

More likely is that Medvedev confused Obama’s editorial position at Harvard Law Review with his later teaching post at University of Chicago. University of Chicago law school publishes the famous journal “Law and Economics.” “Law and Economics” is the flagship journal of the neo-institutional economic school that analyses an economy according to its legal institutional framework, and as such is a key journal in Medvedev’s field of commercial law. Obama’s faculty friend and now top economic advisor, Austan Goolsbee, was lead editor of the journal in the 1990s.

Neo-institutional economics became mainstream in Russia in the second half of the 1990s, as it became clear that macroeconomic stabilization and privatization did not work if an economy lacked efficient laws and institutions. As a result, government economic reforms started to focus on the legal sphere. This shift was embodied by the appointment of legal scholar German Gref as a long-serving economy minister between 2000 and 2007. Gref studied and taught alongside Medvedev in the St. Petersburg law faculty in the early 1990s.

Medvedev must have studied this school of thought – and may (wrongly) think Obama edited its foremost journal when he taught at the University of Chicago. In fact Obama taught constitutional law, and was concerned with issues of race and citizens’ rights quite distant from Medvedev’s scholarly interests.

Civiliki: Network or norms?

Whatever the truth, Medvedev’s response to Obama demonstrates how strong his identity as a civil law scholar remains, despite years of working in the Kremlin and government. This is an identity he shares with other top officials and friends, nicknamed the civiliki, to distinguish them from Vladimir Putin’s ex-KGB network of siloviki.

This identity was underscored last week by a visit to his alma mater, St. Petersburg University’s law faculty, posted on his video blog on the Kremlin website, where Medvedev reminisces about his years studying and teaching there. Ilya Nikiforov, an associate lecturer at the civil law department, pointed out that “Medvedev even contributed a chapter for a civil law textbook, co-authored by members of St. Petersburg Law School, after having become president last year.”

Medvedev’s background in law does not just serve him intellectually, but as a source of personnel appointments. Besides Gref, who now heads Russia’s largest bank, the state-owned Sberbank, the new Minister of Justice Alexander Konovalov also studied and taught alongside Medvedev in Petersburg in the 1990s, where he lectured on Roman and civil law.

From among Medvedev’s undergraduate classmates (class of 87), Konstantin Chuichenko heads the Central Control Directorate in the presidential administration, Nikolai Vinnichenko is presidential envoy to the Urals Federal District, Artur Parfenchikov heads the State Bailiffs Service, Nikolai Gutsan is deputy prosecutor general, and Valeriya Adamova chairs the Moscow Arbitration Court. About a dozen other colleagues and classmates are scattered through the top echelons of the state as well as Gazprom.

Most civil among the civiliki, and the closest to Medvedev, is his longtime friend, former classmate, faculty colleague and textbook co-author, Anton Ivanov. Ivanov was catapulted to head Russia’s Supreme Arbitration Court, the country’s court of final instance in commercial disputes, also with prerogatives in norm setting, in 2005.

Like Medvedev, Ivanov has retained close ties to academia, as scientific director of the law faculty of Moscow’s prestigious Higher School of Economics. According to deputy dean of the faculty, Natalia Rostovtseva, Ivanov’s position is not a formality. “He plays an active role in the life of the faculty,” said Rostovtseva. “He teaches the second year course on the civil code, and examines. Moreover, he insists that students get practical experience by attending sessions of the Supreme Arbitration Court and completing internships there.” Ivanov himself complains that he now only has time for three or four publications per year.

Ivanov is notable for having taken a principled position against siloviki policy in the state sector of the economy. In June he called for a moratorium on the creation of state corporations such as giant defense sector and engineering holding Russian Technologies, headed by leading silovik Sergei Chemezov, a personal friend of Vladimir Putin’s. Ivanov argued that Russia’s civil code does not envisage any such hybrid form of private and state property, and demanded “common norms for all legal entities.”

Likewise, Medvedev’s rhetoric against “legal nihilism” and his calls to strengthen the rule of law obviously draw on his roots in jurisprudence.

On the other hand, the civiliki network might turn into a “jobs for the boys” club, ensuring the loyalty to Medvedev of what are meant to be independent institutions. On July 7, for instance, a former St. Petersburg law faculty member, Sergei Mavrin, was proposed by Medvedev as deputy chairman of the constitutional court. Prior to this, new legal amendments empowered the president to propose candidates, whereas previously judges had voted on new members. Mavrin is now widely tipped to head the constitutional court when current head Valery Zorkin steps down in 2012.

So the crucial test for Medvedev’s presidency could be whether his declared interest in strengthening legal norms is actually implemented, or whether his academic background will simply serve him as a source of cadres, equivalent to Vladimir Putin’s siloviki network.

Similarly in U.S.-Russian relations, a reset will only work if Obama’s and Medvedev’s shared legal background helps them move ahead with strengthening the rule of law in the international sphere. If their legal interest is simply used as a basis to build a personal relationship, the history of the previous two presidential pairs, where personal friendship failed to prevent escalation of Russian-U.S. tension, may be doomed to repeat itself.

A Renault u-turn urgently needed as Russia outgrows Avtovaz

Graham Stack for business new europe

Four months after the sensational announcement that turnaround experts Renault would become strategic investors in Russia’s Soviet-era car giant Avtovaz, analysts are hoping the company will now unlock a new class of low-income car owner.

It had been a long time since the producer of Lada cars, traditionally associated with gangland slayings and financial manipulation, made positive headlines, but December’s news that Carlos Ghosn’s Renault would take a 25% stake in Avtovaz caused a stir. The match between Russia’s ailing un-restructured car giant and Renault’s legendary turnaround star Ghosn, the man who single-handedly rescued Japan’s Nissan from the verge of bankruptcy, seemed perfect. Could he do the same this time, or had he bitten off more than he could chew?

“I was absolutely astonished. I refused to believe the reports, thinking the story was just groundless rumours, until it was confirmed officially,” is how Trust investment bank’s automotive analyst Aleksandr Yakubov recalls his surprise.

The surprise was all the greater because Avtovaz had been effectively renationalized in 2005, in a quite bizarre form: Russia’s state-owned arms exporting monopoly Rosoboronexport (ROE) had taken control, dislodging the previous management who controlled the company through an opaque system of cross-ownership by subsidiaries, and sending in whole battalions of riot police to expel criminal gangs from the premises.

Since ROE favours a policy of consolidating companies in sectoral holdings under state ownership, there were suspicions that moves were afoot to set up some national automotive corporation together with truck producer Kamaz and other Russian producers – and call on state funding to re-launch the Russian car industry. So it was a welcome surprise when ROE saw the light and called in Renault – banking $1bn for a 25% stake that had cost them a fraction of that.

While the ROE decision was surprisingly enlightened, analysts wondered about whether the same was true of Renault’s involvement in the troubled car giant. With only a 25% stake, how could they hope to turn the company around? Renault simply referred to the fact that they had bought into the biggest brand on what will very soon be Europe’s biggest market. And that it was very much the “people’s car” brand they were interested in.

Europe’s largest car market

With the value of Russia’s car market growing 57% in 2007 to $53.5bn, making it set to overtake Germany to become Europe’s largest in 2008, Avtovaz, Russia’s dominant car producer with 24% of the market, should be looking up.

Purely in volume terms, the market increased 36% on year to 2.75m cars, according to European Intelligence Unit. And growth is set to continue, driven by surging disposable incomes, which have increased twofold since 2000, and are currently growing at 10% on year. And a new wave is already breaking, with a surge in auto loans facilitating car purchases. Over 2002-2006, the proportion of new cars purchased on credit exploded from 7% to 42%. According to Autostat estimates, in 2007 new car credit grew 89% on year to $17bn. “Already in the near future,” says Renaissance Capital’s transport analyst Eduard Faritov, “this proportion could reach the European level of 60-80%.”

But this will still be just the tip of the iceberg: car penetration in Russia, despite a two-fold increase since 1993, is still astonishingly low. Even after a decade of strong growth, there are only about 185 cars per thousand people in Russia, compared with 205 per thousand in Central Europe, and dwarfed by the 450-600 per thousand level common in Western countries. And, according to Faritov, half of that car fleet is older than 10 years and in urgent needing of replacement.

All this of course looks like great news for Avtovaz – only it isn’t. While Avtovaz initially capitalized on Russia’s rebound after 1998, boosting production substantially through 2001, subsequently its sales stagnated. Why?

The Russian market is simply outgrowing Avtovaz, say analysts. “The market structure has changed dramatically, and is continuing to change dramatically,” says Faritov. “The structure of demand has shifted away from cheap cars. The average car price is now $20,000 – twice that of 2002. Lada cannot capture this demand.”

Yakubov agrees. “Avtovaz is looking very vulnerable. Higher incomes in Russia combined with retail credit and car loans are paradoxically translating into lower sales for Russian-made passenger cars – and Avtovaz, in contrast to the other Russian automotive producers, is completely exposed to the passenger car market.”

According to Renaissance Capital, the largest price segment in value terms is now the premium car segment (over $40,000), amounting to $10.9bn, or 20%, of the total passenger car market. The value of the $20,000-plus market is now larger than that of the sub-$20,000 segment. The shift in market structure is exemplified by the shift from used-car imports to new imports as the main alternative to Russian production. The new imports segment has grown at almost 70% per year over the past five years, increasing to more than 61% of the total market in 2007, from 17% in 2001. In 2002, used-car imports formed the largest segment in value terms ($4.8bn), followed by Russian cars ($3.6bn) and new imports ($2.3bn). By 2007, the situation had reversed: new imports segment ($32.8bn) had become the leader, followed by Russian-made foreign brands ($7.62) and used imports ($4.9bn).

If this was not alarming enough for Avtovaz, a government programme to boost foreign-branded car production took off in 2002, causing foreign-branded production in Russia to rocket 24 times. By the end of 2007, there were nine plants either running or planned in Russia, with total investment at more than $3.7bn. Total foreign-brand production is slated to reach about 1.46m units per year by 2010.

In response to this flood, Avtovaz has taken its finger out – but only to stick it in the dyke: previous Soviet-era management under Vladimir Kadannikov mostly limited itself to upgrading existing models, laying a Western veneer over the Soviet soul. “Avtovaz basically has not produced a new model since the 1970s,” says CentreInvest’s Natalia Sorokina. “And if things go on like this, it’s future might well be just assembling components.”

Renault’s revolutionary sLogan: “cheap but not crap”

In the face of these changes that threaten to shunt Avtovaz’s “cheap and crap” cars to the scrapheap, what does Renault think it can change?

True, managerial guru Carlos Ghosn turned Nissan around spectacularly, but as he himself admits, Nissan was the complete opposite case to Avtovaz, being a company with solid engineering traditions whose costs had spiralled out of control during a domestic recession. The key to understanding Renault’s interest in Avtovaz is not Nissan, but Romania’s Dacia plant that Renault acquired in 1999 – and the Logan model launched there in 2004, of which 600,000 have already been sold. The new business model behind the Logan could be the lifeline Renault throws to Avtovaz.

The Boston Consulting Group highlighted the Logan in a report named, “Tapping into Central and Eastern Europe’s 200m Neglected Consumers.” Boston calculates that 200m of the region’s 350m people live on incomes above the poverty line and below median household income. Together they account for half the region’s disposable income, and conscientiously by multinationals – until Renault’s Logan came along.

Promoted as the €5,000 car, the Logan made car buyers of income groups that producers had not previously considered potential customers. In a region characterized by low levels of car penetration, the Logan significantly dropped the market entry level, creating a new class of low-earning car owners.

The secret of the Logan’s success is that, in contrast to Lada cars, it’s cheap, but not crap. The design has economized on electronics and soundproofing, making the ride and driving experience less comfortable, but not compromising reliability. Cutting out much of the electronics even boosts reliability and ease of servicing. The Logan is also better adapted to Eastern European roads, thanks to a high chassis, and its engine is adapted for poor quality fuel. Basically, the Logan cuts costs by cutting elements that are anyway dubious in the Eastern European context.

Costs are also kept down by low-tech assembly lines that demand little initial investment. The Romanian Dacia plant hardly uses robots, as the cars are pieced together largely by hand. Wages are low, but the workers of the former obsolete state-owned giant are happy that their jobs have been saved. This strategy is tailor-made for such obsolete socialist giants: because the margin on such a cheap model is so small, and investment to be kept minimal, the strategy demands pre-existing large production capacities, a pre-existing dense dealership network, and a pre-existing established “people’s car” brand. Dacia had all three of these – and Avtovaz all the more, boasting production capacity of 1m vehicles per year, a dealership chain stretching from Lvov to Vladivostok, and a brand that is folklore in Russia.

So what Renault offered Avtovaz was the managerial knowledge of how to create a Russian Logan at Avtovaz – and with it a whole new class of low-income car owners.
And in March 2008, the two sides agreed the appointment of four influential Renault top managers to Avtovaz: Yann Vincent, as managing director; Kristian Muller, as senior vice president and procurement manager; Hugh Demarchez, as vice president; and an unnamed financial control manager.

However, Renault will not just be providing philosophy lessons, but also supplying technology for implementation. As CEO Ghosn said in an interview with business daily Vedomosti in March: “Costs are not the main problem. Avtovaz’s main problem today is the medium-term and long-term attractiveness of its production line. The plant needs a new platform, engine and transmission. This is where we are ready to help. Our main task is to support the Lada brand and help it retain its leading role in Russia.”

The big secret is what Lada’s new budget car, planned to replace its Classic model in 2009 and the lynchpin of the strategy, is going to look like. Avtovaz CEO Boris Alyoshin let slip that it will have a Lada platform, but the power-train will probably be supplied by Renault. As such, the car will be distinguished from the Logan, of which a Moscow-based joint venture produces 70,000 a year, but have enough of Renault’s engineering to constitute a new word in quality for a Lada car. Alyoshin has said the details of Avtovaz’s new Renault-supported strategy will be finalized and made public in May or June. Only then will it become clear just how much influence Renault is going to exercise.

Analysts were mystified as to why Renault was ready to get involved when only a blocking stake was on offer. “I just don’t know why Renault bought a blocking stake that gives them so little influence,” says Faritov.

“Control was never an issue,” explains Sorokina. “It was always clear that Avtovaz would retain control; the issue was which European partner would be chosen.”

The answer may be that ROE’s crisis management at Avtovaz, which had taken the first long overdue steps towards controlling costs and initiated reshaping the ownership structure, was able to assure Renault of its commitment to reform. Immediately prior to the deal’s announcement in December, the ROE management’s political weight was upped a notch, with CEO Vladimir Artyakov being appointed governor of Samara region, and government heavyweight Boris Alyoshin, formerly head of the Federal Industry Agency, taking over himself as the new CEO at Avtovaz. This means that Avtovaz management has the authority to implement whatever strategy is decided upon – and if they buy into Renault’s strategy wholeheartedly, the chances of its successful implementation are good, even if Renault only has a minority stake.

However, one measure that Renault used to good effect at Dacia is unlikely to be replicated at Avtovaz – job shedding. “Avtovaz has a workforce of 104,000,” says Faritov, “and produces only twice the number of cars as Toyota does with a tenth of that number.” However, analysts are certain that no sweeping job cuts are on the cards. “Avtovaz basically employs all of Toliatti,” says Trusts’ Yakubov, “and now as a state-run company, the political costs of laying off large numbers of workers would be enormous.”

But there is a workaround solution that seems to be on Renault’s mind, and would leave everyone happy. “Sooner or later,” Ghosn told Vedomosti, “we will start using some of Avtovaz capacities for our own production.”

Russian shipping and shipbuilding: The league of national champions

Graham Stack, for Radio Free Europe / Radio Liberty

In the 1990s, as the Soviet economy collapsed, the shipping sector was one of the few to bob to the surface, buoyed by international demand for its tonnage. It migrated to offshore tax havens and operated under flags of convenience.

As a consequence, less than 10% of Russian fleets’ business was done in Russia, and a decade of surviving in international waters forced Russian shipping companies to become lean and mean.

Now the ‘Kremlin-garchs’ want to change things: they want Russian shipping home again – to increase added value in the energy sector by serving national oil and gas giants. And with the prospect of demand for ships mushrooming due to giant offshore energy projects and Arctic shipping lanes opening, they also want Russian shipping companies to buy Russian-built ships.

Actors in the Sovcomflot-Novoship merger

The vehicle for state policy in maritime shipping a new ‘national champion’, created by merging the state’s 50.3% share in Novorossisk-based Novoship, the world’s twentieth largest carrier, into 100% state-owned Sovcomflot, the world’s sixteenth largest. The result is the world’s fifth largest shipping company.

The driving force behind this policy, of which implementation started in 2007, is the former Minister of Transport Sergei Frank, himself originally from the shipping industry in Vladivistok, moving to the Ministry of Transport in 1995, and becoming minister in 2000. Frank had advocated such a merger while in office. In 2004 he left the ministry to become CEO of Sovcomflot, evidently tasked with implementing the merger and effectively renationalizing Novoship.

2004 can be considered the birthyear of the new era of industrial restructuring of state-owned assets and related private assets in Russia, including renationalisation of the latter through ‘market methods’ – a term that however in Russia traditionally has a very broad meaning, including use of legal and extralegal coercion. In the first Putin term, further privatization of state assets was formally on the agenda, but a lack of political will meant that state-owned assets remained in limbo.

In 2004, as a result of Putin’s administrative reshaping of government, a powerful Federal Agency for Industry under Boris Aleshin, an industrialist, emerged with a remit to restructure state assets to create large merged companies or sectoral holdings that could compete internationally. Instead of being privatized, these were to remain under state control, but take on (foreign) strategic investors or conduct IPOs and enter international alliances to attract funds and technology.

Moreover, the Yukos case and the post-Beslan transition to appointed governors in 2004-5 strengthened the Kremlin against big business and regional lobbies.

Alongside the appointment of Aleshin and Frank, 2004 also saw Sergei Chemezov, often regarded as the mastermind behind this plan, and an old friend of Vladimir Putin, take over as head of state arms intermediary Rosoboronexport, and launch a programme of restructuring the defence sector through renationalizing privatised companies. The reshaping of government 2004 also led to the corporatisation and connected restructuring of industrial giants Ministry of Railways and Ministry of Atomic Power, pushing industrial policy firmly to the fore, for the first time since the collapse of the Soviet Union.

Despite this ‘sea change’ in 2004, the Sovcomflot-Novoship merger has been a work of compromise, in particular regarding the regional component: Sovcomflot is registered in St. Petersburg, of which the governor Valentina Matvienko has influence in the Kremlin. Novoship, in its turn, is the largest tax payer in the southern region of Krasnodar territory, the governor of which, Alexander Tkachev, is an influential pro-Putin nationalist whom pundits occasionally tipped as a Putin successor. In addition, Sochi, successful Winter Olympic candidate, is located in Krasnodar. Tkachev was particularly active in lobbying against any reregistration of Novoship away from Krasnodar as a result of a merger, and partly as a result, Novoship will remain an independent affiliate of Sovcomflot registered in Novorossisk.

Frank himself is not overtly aligned with any Kremlin groups. As CEO of Sovcomflot he replaced Dmitry Scarga, appointed to Sovcomflot in 2000 at the age of 30. Scarga was linked to the Petersburg group around the Baltic Pipeline System that includes Alexei Miller, who in the same year became head of Gazprom. In 2005, Sovcomflot filed a lawsuit in Britain against Scarga, by then a ‘senator’in the Federation Council, due to financial manipulations uncovered at Sovcomflot’s British subsidiary causing damages of $200m. Scarga moved to London ostensibly to defend himself. Criminal charges in Russia were subsequently opened against him, and an extradition request filed in early 2008. Scarga is now claiming political asylum in Britain – alongside former Novoship CEO Tagir Izmailov (see below). Both these cases indicate at the very least that Frank can count on support from law enforcement and justice organs.

During Putin’s first term, the supervisory board of Sovcomflot was chaired by Dmitry Kozak, a close Putin aide and reformist liberal with a law background. After the Beslan hostage-taking, Kozak moved to become presidential representative to the Southern Federal District, and was replaced by Igor Shuvalov, also a Putin aide on economic matters and a liberal. Neither of them, nor Frank, are closely associated with the silovik faction of former and current KGB / FSB members – showing that the ‘national champion’ industrial policy launched 2004 currently enjoys consensus support among government groups, and can rely on the backing of law-enforcement agencies irrespective of whether siloviki are directly involved in running the business or not.

Implementing the merger

Such backing from law enforcement and legal organs soon proved necessary, since Novoship management resisted the merger from the start. Despite the state’s 50.3% stake retained, Novoship management exercised de facto control over the company through cross-ownership with subsidiaries and influence over financial flows. The company was growing strongly and expanding its fleet rapidly. But state officials and Sergei Frank argued it was doing nothing to reduce exposure to the volatile spot market, and was suspected of shifting assets offshore.

As in many other cases, the complex financial structures set up by insider management in order to control their companies ultimately proved to be their Achilles’ heel: When company president Tagir Izmailov openly expressed opposition to the proposed merger in 2005, he found himself charged with abuse of position and money laundering, and fled to London. In December 2006, ex-chairman of subsidiary Novoship-Invest, holder of 6.5% of Novoship, shot himself after being summoned for questioning. Days before the merger was finalised, management tried to offload a 14.41% stake held by Novoship’s Liberian-registered subsidiary to Gazprombank – to retain some independence from the new bosses – but Moscow blocked this at the last minute.

Kremlin mistrust of management or ‘insider’ ownership for important companies – such as titanium producer Avisma, car giant Avtovaz, plane manufacturer Irkut or Novoship – appears to be one of the driving forces behind current restructuring. Kremlin officials suspect management ownership – often through cross-ownership of companies by their subsidiaries – of restricting companies’ growth prospects, because insider owners risk losing control of the company, and thus their position, if they take on badly-needed strategic investors. The state then proves its point about vulnerability by coercing management into selling up.

Nevertheless, for all the charges brought against former Novoship management, analysts regarded Novoship as – at least formally – more transparent than Sovcomflot. Novoship disclosed its results on a quarterly basis. Sovcomflot disclosed very little and there is an ongoing criminal case against former manager Dmitry Scarga and other management members, who are accused of defrauding the company.

The league of national champions

What does the Kremlin want of its new national champion? Now that state companies Gazprom and Rosneft have secured control of development of offshore gas and oil reserves (specifically the massive Shtokman and Sakhalin projects), the idea is to create linkage to other domestic sectors to increase added value generated in Russia. Shipping services are the obvious next step. Next in line are the shipyards. Ideally tripartite alliances of Russian oil and gas giants, Russian shipping companies, and Russian shipyards should emerge. Sovcomflot management talk of the merged company acting as a catalyst for the development of maritime clusters similar to the role played by Maersk in Denmark, NYK in Japan, Stena Bulk in Sweden or COSCO in China.

Sovcomflot is moving rapidly in this direction, specializing in energy and ice-class shipping, placing orders home and abroad, and rapidly expanding its fleet of LNG carriers, with large orders placed at Korean and Japanese yards – no Russian shipyard currently produces LNG ships, although Baltic shipyards plans to start in 2011.

Supporting offshore projects is however seen to be only the first step. With the Arctic ice melting due to climate change, the Arctic is opening up both for more energy exploration – the US Geological Survey estimates that 25% of the world’s undiscovered oil and gas reserves are located in the Arctic – and also for shipping route: the North-East passage, if sailed from Hamburg to Yokohoma – is almost 40% shorter than passing through the Suez canal.

The offshore developments are expected to put in place a lot of the shipping infrastructure needed for the Arctic to become a main shipping lane, if present climate change trends continue. Sovcomflot estimates that over the next ten years, Arctic shipping will quadruple in connection with Shtokman alone. Currently there is almost no shipping in this area at the moment, and so there is little current competition.

Sovcomflot is not the only Russian shipping company to be thinking along these lines. The smaller, private Vladivostok-based Primor’e Shipping Company (PRISCO) is also an oil carrier currently increasing deadweight at 18% pa and looking to expand into the LNG market. Prisco is well placed for Sakhalin oil shipping and the company has won contracts to ship oil even against bigger players such as Sovcomflot, with a $150mn contract to ship oil for Exxon in Sakhalin. As the relationship with Sakhalin develops, Prisco expects half of its business to be domestic.

The question for PRISCO is whether Sovcomflot’s status as national champion will not jeapardise its ability to win contracts for Sakhalin, after national champions Gazprom and Rosneft having taken leading roles in these projects. Furthermore, if shipping sector consolidation were to continue, PRISCO, or other private shipping companies, might find itself under pressure to sell out to the state-owned shipping giant.

Meanwhile, having merged into a national champion, rich pickings also loom for Novoship in connection with the planned Burgas-Alexandropolis oil pipeline, in which the Kremlin is involved. According to Renaissance Capital, the company is set to become a preferred partner for shipping Russian oil to Burgas.

In early 2008, the advantages of the merger for Novoship became more evident.
Sovcomflot management outlined significant synergies in both revenue generation and on the cost side, including attracting new clients with, for instance, right of first refusal contracts, and savings potential through joint purchasing, cheaper debt financing and the reduction of administrative expenses.
Despite the fierce resistance from Novoship management, minorities and investment banks were mildly positive about the merger – pointing to the chances to increase liquidity and create economies of scale. The merger should produce both synergies and diversification: Novoship is a classic tank oil carrier working the Black Sea routes, while Sovcomflot concentrates on the ice-bound Arctic and hi-tech transport of liquid natural gas.

Analysts argue that size does matter when it comes to international competitiveness, and that the new company will enjoy considerably more pricing power. One of the tenets of the state shipping doctrine has been to move away from the spot market and time charters – where everything is short term and subject to oil price fluctuations – towards establishing long term contracts with direct customers.

Most importantly, in January 2008, Sovcomflot signed a cooperation agreement with state-owned oil pipeline monopolist Transneft for oil shipping to the Burgas-Alexandrupolis pipeline. The January 2008 agreement envisages Novoship becoming the seaborne carrier linking the Transneft pipeline ending in Novorossiysk with the new Burgas-Alexandrupolis pipeline in Bulgaria and Greece that bypasses the Turkey-controlled Bosphorus.

The agreement is very positive for Novoship, since it will support the targeted shift from the volatile spot market towards more sustainable pipeline-like utilisation. However, this deal also showed that the Sovcomflot merger was by no means purely a case of industrial restructuring. It was also a key component in the Kremlin’s pipeline policy looking to expand and diversify its oil and gas pipelines to Europe, while crowding out other competitor pipelines bypassing Russia. This means that the company is of strategic interest to the Kremlin, which could in the future run counter to commercial considerations.

The merged company is correspondingly emitting contradictory signals in terms of its interest in boosting shareholder value and internationalisation.

The new Novoship board appointed in January 2008 is positive sign in this regard, including three independent directors, a rarity in Russia, with two of them non-Russian: Marlen Manasov, managing director of UBS Securities and Robert Sasson, an investment banker, former Head of EBRD Mission in St. Petersburg. Analysts agreed this indicated Sovcomflot was intent on boosting Novoship capitalisation in preparation for an IPO of the entire group.

However, in February 2008, this policy experienced a significant set back, as state interests prevailed over commercial. Inside sources reported that Sergei Frank had been lobbying for independent directors to join the Sovcomflotboard, specifically Morgan Stanley’s Elena Titova and Deutsche Bank’s Charles Ryan. But instead, state officials supported Andrei Kostin, CEO of state bank VTB – and most significantly the new CEO of Transneft, Nikolai Tokarev, a probable former KGB man. Tokarev’s inclusion instead of an independent director indicated that strategic state interests would prevail over commercial considerations in running the company as a member of the league of ‘national champions’.

Uniting Russia’s struggling shipbuilders

The Novoship merger was the prelude to a sweeping overhaul of the shipbuilding sector, the cornerstone of which was the presidential decree of March 9th, 2007, “On the Establishment of the United Shipbuilding Corporation” (USC). This decree provided for consolidating all state-owned assets in the shipbuilding branch, totalling around 40 companies, into a holding with 100% state ownership.

The Sovcomflot-Novoship merger was child’s play in comparison to setting up the USC. The template for the USC was the United Aircraft-builders Corporation (UAC) established in 2006. However, here there are also substantial differences: the aircraft industry consolidation came initially ‘from below’, with considerable consolidation between Irkut, Sukhoi and MiG already underway. Moreover, the Russian aerospace industry includes some very internationally competitive production, such as the MiG and Sukhoi fighter jets, around which a successful company might be built.

Government officials seem, in contrast, to have made decisions about the USC at speed and without consultations. The USC bundles all existing state shareholdings in maritime shipbuilders. There was a strong political flavour to its launch, with much telegenic championing of ‘national shipbuilding’ by at that time potential presidential sucessor Sergei Ivanov. At the same time, relatively efficient fully privatised outfits, such as Petersburg’s Baltiskie Zavody and Northern shipyards, both owned by oligarch Sergei Pugachev’s United Industrial Corporation group, were not invited to join.

The formation of the new holding is not to be completed until 2009, and is already well behind schedule. In its final form, the USC will unite 40 odd companies from Kaliningrad to Konsomolsk-on-Amur, ranging from federal state unitary enterprises (FGUPs) to joint stock companies where the state is only a minority shareholder. Alone the process of inventorying FGUP’s assets and converting them into joint stock companies is, Sergei Ivanov has himself admitted, extraordinarily laborious. The need to facilitate integration influenced the decision to structure the company along regional lines, instead of functional roles; there are to be regional centres in Petersburg, Severodinsk and Vladivostock.

In fact the operation has already run into considerable difficulties, reflected in personnel turnover in top positions. There was initial confusion over who would head the supervisory board. Originally it was expected that Sergei Ivanov would do so, then defence minister Valery Serdyukov was tipped, and finally deputy prime minister Sergei Naryshkin got the job in July 2007.

The difficulties in putting together the corporation were even more apparent regarding the crucial position of CEO. Alexander Burutin, first head of the USC and charged with swift implementation of the presidential decree, resigned in September 2007 after three months of fruitless negotiations with shipyard managements about the terms of their integration. It took over a month to find a replacement for Burutin, with the first choice candidate for the job, Andrei Dutov moving instead to head the State Industry Agency. The next best candidate, retirement age Yury Yarov, a former cabinet minister, in the 1980s boss of current prime minister Viktor Zubkov, was finally appointed October 23, with six months having lapsed since the presidential decree.

What does the Kremlin expect from USC?

The declared goal of the USC is to strengthen commercial, not military, shipbuilding in Russia. To cite Vladimir Putin’s annual address to parliament 2007, the modest goal of USC is ‘for Russian shipbuilding to occupy a decent niche on the world market’.

Currently, Russia basically has zero market share in the global commercial shipbuilding industry. Whereas Japan and South Korea each produce 70m tonnes deadweight per year, Russia turns out only 1m, lagging behind Vietnam, Iran and Turkey. But Russian companies place orders worth $1bn for ships each year, 80% of which go abroad. In fact, 80% of Russian ship-building output is for naval procurement. The imbalance is a legacy of the Soviet era, where naval shipyards were concentrated on Russian territory, with merchant fleet ships being built in Poland, Finland and East Germany, and Ukraine.

As a result, even now that state defence procurement is soaring, Russian yards are on average only working to one third of their capacity. This makes the idea of Russian commercial shipping companies placing a higher proportion of orders with Russian shipyards so alluring.

However, Russian shipyards largely fail to compete even on the domestic market. They suffer from productivity levels far lower than South-east Asian countries. They are also unable to achieve turnaround times anything like the Asian countries, on average half as fast, which is critical, or reliable. Furthermore, Russian shipyards lack the capacity to build the ships with over 80,000 tonnes deadweight that enjoy wide global demand. One major problem here is the location of major shipyards, such as the Admiralty and Baltic shipyards in the historical heart of Petersburg, where there is simply no room to expand

The call of the Arctic

Despite this seemingly hopeless position, Russian planners have identified a market niche they believe Russian shipyards could fill. The grand plan for the ship-building sector is to build vessels to service the Shtokmann gas field and the Pacific shelf projects, as well as for the Arctic shipping routes expected to increase fourfold over the next 10 years.

Government estimates put the number of platforms needed for offshore oil and gas production by 2030 at 40, the number of 85 specialized ships at 80 with more than 140 support ships needed. Demand is set to boom for atomic icebreakers, hydrographic craft for exploration, ice-class oil tankers and LNG carriers, as well as platforms for oil and gas drilling, and pipeline-laying and transport ships

The policy is realistic in looking for Russian shipping to occupy a specialist niche – ships specially suited for Arctic operations. Thus the USC does have a vision going beyond the next elections: an alluring vision of Russia’s twin evils – dependency on budget money and dependency on the resource sector – cancelling each other out – with military shipbuilding diversifying into commercial, and the economy as a whole beginning to put added-value on its resource base.

However international competition still has a head start in tackling these new challenges. Japanese and Korean yards dominate global production of LNG carriers. Even in ice-class shipping, the pioneering role is held by Norwegian Aker-Kvaerner producing double-acting icebreakers (with a stern that can be deployed as an icebreaking bow). Aker-Kvaerner is already supplying freight ships to Norilsk Nickel for year-round shipping between Dudinka and Murmansk. Russian shipbuilding is going to need the sort of hidden protectionism the national champion policy implies, but the costs will be borne by the projects they supply.

In November 2007, the Ministry of Energy and Industry authored a federal target programme to support this technological transition, called “Development of civil marine technology 2009-2016”, which envisages R140 investment for this time period, of which around R100bn will come from the federal budget. The programme focuses on financing R&D and modernising testing and design bureaus. The funding is also sufficient to purchase foreign licences especially for LNG tankers. However, the programme does not foresee direct budget investment in upgrading the shipyards themselves.
The Kremlin’s grand plan thus hinges on creating a chain of ‘national champions’ to increase added-value generated in Russia from the resource sector, comprising Russian energy giants, Russian shipping giants, and a Russian shipbuilding giant. This chain can be extended into supplier sectors. For instance, ice-class shipping requires high-grade steels, of which steel giant Severstal is planning to increase production, launching an investment programme for this purpose worth R850m through 2009, in time for the start of construction of LNG and modern ice-class tankers in 2011.
What use is USC?

An additional question mark over USC is that market forces were already pushing the most efficient shipyards in this direction. Such shipyards are currently either ignoring the intervention of state officials, or regard them and USC as a threat to their efficiency. The most capable shipyards picked up on the new source of demand long before government officials. In recent years, for example, Admiralty shipyards has built five ice-class tankers for Sovcomflot and five for Lukoil. But it is precisely Admiralty shipyard management that has expressed deep misgiving about the corporation – and having to undergo a complex metamorphosis from unitary enterprise to joint stock company, entailing loss of decision making freedom.

Management is particularly troubled about how much freedom the company would retain to conclude contracts independently. In particular, since the USC is to have a two level structure, with separate shipping centres for the West (St. Petersburg and Kaliningrad), the North (Severodinsk and Murmansk) and the East (Vladivostok), united under the umbrella organisation USC, constituent companies are afraid of excessive bureaucracy and loss of the flexibility that is crucial to making effective business decisions.

Two of the most advanced shipyards in terms of producing for offshore projects are Petersburg’s Baltiiskie Zavody and Northern shipyard, both of which are affiliates of oligarch Sergei Pugachev’s United Industrial Group. There has been no attempt to strong-arm these companies into joining, which is in some ways a positive sign, but also questions the rationale behind the project.

Analysts argue that both these shipyards should comprise the core of any Petersburg-based shipbuilding holding. They have also been trailblazers in terms of restructuring, proving that private capital is more effective than government ministers in turning industry around: Baltiiskie Zavody is embarked on a complete relocation from constricted premises in Petersburg’s historical heart to the expanded facilities at out-of-town Northern Shipyards.

Baltiiskie Zavody is Russia’s main producer of nuclear and diesel powered icebreakers, and The UIG shipyards are active in moving into the Arctic shipping business, including preparation to build LNG tankers that are currently not built in Russia at all. Production is slated to commence in 2011, in time for start of operations at the Shtokman offshore gas field in the Barents Sea. In contrast, the state is dragging its heels on holding tenders for constructing shipyard facilities large enough to build ships over 80,000 tonnes, especially large LNG tankers.

Confirming this trend of efficient companies responding swiftly to energy sector demand, the to date largest shipbuilding contract resulting from the Shtokman field development – for two marine drilling platforms worth $2.5bn – went to the privately-owned Vyborg ship-building yard. Vyborg shipbuilding yard that hopes to secure four further such contracts, will also not be part of USC. Vyborg shipyard was recently acquired by influential Petersburg financial group ‘Bank Rossiya’, reputed, as is also Sergei Pugachyov, to enjoy some access to Vladimir Putin.

Further questions were then asked of the efficiency of state-owned yards when in February 2008 the Norwegian shipping concern Odfjell terminated a $500m contract with the Sevmash shipyard, based in Severodinsk, the Russian producer of nuclear submarines. Sevmash called the contract for twelve 45,000 tonne tankers the ‘deal of the century’ when it was signed in 2004.

Odfjell claims that the first tanker was slated for delivery in September 2007, but will not be ready until May 2009, and that the cost of the order has risen from $500 million to $544 million. Following termination of the contract, Sevmash will also be liable for damage claims.

Sevmash for its part argues that the soaring price of steel is to blame for the rise in costs, but in fact this is not Sevmash’s first failure of this kind. The yard also mismanaged a large Indian order to reequip the Russian aircraft carrier Admiral Gorshkov for sale to India. Originally planned for 2008, the handover has now been postponed to 2011, a delay that cost the previous Sevmash management their jobs.

The Sevmash case points again to weak management as a major problem for many state-owned shipyards, and it is unclear how the USC intends to improve this situation.

Conclusions

- The basic goal of boosting commercial production by former naval shipyards is positive, since, if successful, it will increase international economic integration of the sector and hinder the emergence of any ‘military-industrial complex’ lobbying for arms spending increases. The Arctic shipping / offshore niche has some real potential.

- The increase in state involvement should not be exaggerated. In shipping, there remain three major and expanding private shipping companies. In shipbuilding, the state has not yet tried to persuade or pressure private companies into joining the holding – even major ship-building companies with considerable defence significance such as Baltic and Northern shipyards remain in private hands.

- The selective use of criminal charges apparently to pressure former Novoship management into consenting to the merger is extremely disquietening.

- The new focus propagated for shipping and ship-building on offshore projects and the energy sector will add to Russia’s assertiveness in this area, in terms of ‘resource nationalism’. Multinationals are often regarded as reluctant to contract out to Russian suppliers, and the Kremlin is intent on maximising added value in the energy sector as part of its diversification strategy. Moreover, the increasing, and increasingly politicised, focus on the Arctic waters as being of strategic significance for Russia will lessen readiness to compromise on questions of demarcation of territorial waters.

- The developing system of ‘national champions’ is potentially detrimental to competition and the market mechanism, since it is likely that national champions, such as Gazprom and Rosneft, in the energy sector will prefer other (state-owned) national champions in shipping and ship-building, even where private companies are more competitive. Furthermore, state-owned companies that have proved themselves efficient outside of national corporations, such as Admiralty shipyards, or the Sukhoi holding in aircraft construction, risk being shackled to inefficient loss-making companies.

Rosoboronexport / Russian Technologies – Russia’s unofficial ‘Ministry of Deprivatisation’

Graham Stack, for  Radio Free Europe / Radio Liberty

Defence sector restructuring into sector-based holding companies was on the cards right from the start of Vladimir Putin’s presidency. What is striking is that the plan to establish holding companies largely failed to get off the ground during Putin’s first term. Apart from the establishment of the Almaz-Antei tactical missile and Sukhoi aviation holdings, the 2002 project to set up 74 state-controlled concerns and holdings remained entirely on paper due to bureaucratic infighting, conflicting visions, and above all widespread resistance from enterprises. Then even the Almaz-Antei merger plan hit an iceberg when new Kremlin-appointed manager Igor Klimov died in a hail of bullets in Moscow.

Put simply, the reasons for consolidating individual plants into sectoral holdings were also the reasons why there was so much resistance against this happening: the managements of the defence plants, both state-owned and private, feared losing control of ‘their’ companies and the connected financial flows. However, without consolidation, and separation of ownership from management, these enterprises would remain unable to attract the financial resources they desperately needed to develop.

Wholesale renationalisation was still firmly off the agenda during Putin’s first term. Restructuring plans were mostly connected with further privatization – but there was no political will for this.

The stalemate ended abruptly in 2004. Putin’s radical reshaping of government on dismissing the Kasyanov government one week before reelection saw a Federal Agency for Industry emerge with a remit for the entire defence sector, headed by Boris Alyoshin, an ardent proponent of the holding policy with an aviation industry background. The newly-created Federal State Property Agency was run by a contingent of Petersburgers committed to transforming federal state unitary enterprises into joint stock companies.

Moreover, in the course of 2004, federal power was considerably strengthened at the expense of business interests by the Yukos case, and at the expense of regional interests by the post-Beslan transition to appointed governors. In addition, the surge in oil prices, and the start of Putin’s second and final term in office shifted economic policy away from long-term institution building to state-accelerated economic diversification aiming at short-medium term results.

Rosoboronexport: More than just an arms exporter

Most importantly, in mid-2004 Sergei Chemezov took over as head of state arms export intermediary Rosoboronexport (ROE). He had long recognized that the company’s control over arms exports gave it enormous leverage over the defence sector, that could be used to achieve restructuring ‘by the back door’.

Two competing arms export organisations had been merged into ROE right in 2000, immediately following Putin becoming president. By 2004, ROE had a monopoly of export sales, except for four companies with their own export licences – including the aerospace legend MIG. In 2005, ROE sold $5.2 billion worth of arms, about 85% of all arms sales. However, Chemezov set about lobbying for a complete monopoly on arms exports for ROE, which was granted in 2006.

Since the Soviet collapse, arms exports had been the lifeline of the Russian defence industry, the only internationally competitive sector outside minerals and mining. Russian state arms procurement died during the nineties, and only slowly revived under Putin.

Because ROE assigned export orders to defence sector plants, it enjoyed potential leverage over the sector. Adding to this leverage was the Soviet system of internal competition in the defence industry, whereby a number of plants had duplicated production to stimulate competition. This means that ROE often has a real choice between plants when assigning export orders.

In addition, surging defence procurement later in Putin’s second term now provides the state with further means of persuasion for recalcitrant companies. Chemezov has clearly been able to influence defence ministry order assignment to facilitate renationalisation of companies.

Apart from these political levers, ROE takes 5-15% commission on arms sales, which rose from 5.5bn in 2005 to $7bn in 2007, meaning the company has considerable cash flow.

On the other hand, the company is formally merely a federal unitary state-owned company, and as such subject to a large amount of bureaucratic supervision and regulation: answering directly to the Federal Agency for State Property, the Federal Agency for Industry, the Ministry of Economic Development and Trade, the Ministry of Energy and Industry, the Ministry of Defence, and the Military-Industrial Commission.

The Chemezov Code: Back to the future

This is where the person of 56 year old Sergei Chemezov plays such a crucial role. Chemezov is an official Friend of Putin, and has a direct line to the Kremlin. It is this personal relationship, in the final analysis, that allowed ROE to act as an unofficial ‘Ministry of Deprivatisation’ independent of the government.

Putin and Chemezov’s acquaintanceship goes back to the time as KGB agents they lived in the same apartment block in Dresden in the 1980s. When Putin moved to work in the Kremlin administration in 1996, Chemezov moved to work under him, and has worked for him ever since.

Chemezov was involved in industrial espionage against the West, and his interest in industry, and catching up with the West in terms of technology, permeates his activities today: Chemezov is an ardent proponent of developing high tech production to diversify the economy away from its reliance on commodity exports.

“Our mineral deposits,” said Chemezov, in an interview with news magazine Itogi, “are finite. There are few remaining undiscovered gas and oil deposits in Russia. And they are non-renewable. But high tech, including for military use, can be refined without end, and its price is stable and predictable, whereas oil has fluctuated from $8 to $60 a barrel in the last ten years.”

“A state of the art fighter jet costing around 50 million dollars: This is the price of two and half tonnes of gold. Russia produces 166-180 tonnes of gold per year, enough for 65 fighters. Our Irkutsk plant alone will turn out 32 Su-30s in 2007– i.e. worth half of the gold mined in the country in the course of the year!”

“Everyone knows that we have to get away from our country’s dependency on commodity exports. We have to diversify our industrial production. Reforming Russian industry is simply a question of national security.”

Chemezov thus shares with many liberals the view that Russia has to diversify its economy, increase added value, and become globally competitive. However, the means he proposes to use are very different, and potentially mutually exclusive. Instead of long-term institutional reforms, he favours a state-led restructuring and repositioning of the technologically advanced defence sector as being the key – a restructuring based on renationalisation of much of the sector.

Chemezov sees the defence sector as crucial in this respect because of its potential for economic diversification and high tech. Chemezov’s goal is globally competitive Russian high-tech production – both military and commercial, He is not a militarist intent on turning Russia into a military superpower again.

Chemezov does not seem to regard the West as an enemy, but he views Western companies as competitors on global markets, enjoying strong backing from their respective states, which Russian companies should thus also enjoy.

Indeed, Chemezov sees Western markets as a huge untapped potential market for Russian commercial high tech, and the West as a crucial source of both investment and technology. ‘Diversification’ thus also involves diversification from military use into commercial use technology to access western markets closed to Russian arms.

Cutting the Gordian Knot

Chemezov’s political trademark has been to cut the Gordian knot in defence sector restructuring by renationalizing.

Whereas in Putin’s first term, talk of restructuring the defence sector envisaged ongoing privatization, Chemezov has done the opposite: buying back assets privatized in the 1990s from private owners or the stock market. This is partly due to desire to reassert state control over the sector, but also because it is simply the path of least resistance for restructuring the sector.

Inefficient and unstable insider ownership by management, often via complex cross-ownership of companies by their subsidiaries, was clearly throttling the development of the sector.

In many cases, management control of enterprises depended on the state as a minority shareholder playing a passive role.

However, when political will appeared, it was easy for the state to unseat management, simply by increasing the retained minority stake to a controlling one by ‘market methods’: by acquiring free-float shares; buying out private investors and management-owners or implementing asset swaps for ROE assets, especially with regional government stakes.

This is what ROE and its subsidiaries have set about doing, with the cooperation of further state instances, such as the Federal Agency of State Property.

Many of the plants ROE has taken control over had low market capitalization, so relatively small cash payments have been needed, especially where the state retained a share packet. For instance, to reassert state control over the famous Moscow Milya Helicopter Plant, all it took was to acquire the 20% stake held by Interregional Investment Bank for a mere $20m. The Tatarstan regional government was persuaded to simply swap its 30% stake in Kazan Helicopter Plant for 15% in ROE subsidiary Oboronprom.
ROE has acted with a minimum of publicity to avoid driving up prices of assets it wants. Secrecy has been a hallmark of its activities, in keeping with the KGB background of many of its managers, with the ‘unofficial’ nature of ROE’s restructuring activities. This means that the details of many details have remained unknown.
Vertical take-off for renationalisation

Only three weeks after Putin’s reelection in March 2004, Boris Alyoshin, as new head of the new Federal Agency for Industry, submitted a project for ROE subsidiary Oboronprom to unite all companies developing and building Mil-class helicopters in a special holding. This remit then broadened into creating a holding for all Russia’s producers of helicopters.

Oboronprom is the vehicle used by ROE to piece together its helicopter, and aviation engine, holdings, originally 51% state owned, 49% state owned. Its youthful former manager, 38 year old Denis Manturov, promoted in 2007 to deputy minister for industry and energy, enjoys Chemezov’s full trust, and is rumoured to be a former intelligence service colleague, who however had been working in the helicopter sector for almost ten years.

At the start of the process, the state had retained at the most blocking stakes in Russia’s main helicopter producers. The main producer of attack helicopters, Rostock helicopter plant (Rosvertol), was completely private, controlled by its management, and the legendary Kamov holding was owned by financial-industrial group AFK Sistema.

This is where ROE came into play, with the task of creating a holding ‘outsourced’ to the arms trader. In the predominantly state-owned plane-building and ship-building sectors, consolidation into holdings was official government policy. Helicopter sector consolidation, on the other hand, was ‘unofficial’ policy since it comprised large-scale renationalisation.

It was also a test case for renationalisation “by market methods”.

2004-2007 Oboronprom worked hard at gathering the helicopter industry under one roof. It acquired 31% of the Milya Moscow Helicopter Plant, 29.9% of the Kazan Helicopter Plant, 63% of Ulan-Ude Aviation Plant, 60% of the Stupino Machine Production Plant and 50.5% of Vpered Moscow Machine-Building Plant, and bought first a blocking, then a controlling consolidate a controlling stake in Rostvertol. It purchased from AFK Sistema 100% of the shares of Kamov-Holding, including the Kamov Design Bureau and the Kumertau Aircraft Building Plant and Arsenev Plant.

Integrating the major Kamaz Helicopter Plant (KVZ) proved to be the greatest political challenge, due to resistance from management owners backed by Tatarstan’s government. Only after President Shaimiev’s reappointment by Putin, wielding his new powers, in 2005, did Tatarstan cede its 29.92% stake to Oboronprom in return for a 15.7% stake in Oboronprom. It was not until 2007 that Oboronprom finally bought out the management stake, resulting in the abrupt departure of KVZ’s director of 17 years standing, its chief owner, and opponent of Oboronprom, Aleksandr Lavrant’ev.

The icing on the cake was an August 2007 presidential decree transferring the state’s stake in Bashkiria’s Kumertau plant and in the ‘Progress’ plant that produces the ‘Black Shark’ attack helicopters to Obronprom.

The operation was accomplished without any public scandals breaking out or overt pressure applied, and to the general satisfaction of stock market analysts. Oboronprom could thus call itself a model of how to create a state-run holding from out of privately-owned defence enterprises.

Oboronprom’s helicopter assets are now being integrated into a single company called “Russian Helicopters.” A new phase of integration was launched at the start of February, 2008: the management of Russian Helicopters took over running the Moscow Milya Plant, with the same to happen for all other companies in the holding in the course of the year. The goal, by 2010, is a single share, international accounting standards, and an IPO, leaving the state with just over 50%, and bringing in foreign investors.

On the same day in August 2007 that Putin signed a decree transferring the remaining state assets in the sector to Oboronprom, he inked a decree calling for four state-controlled holdings for producers of aviation engines.

This decree specifically tasked Oboronprom with setting up the largest of the holdings. The three other holdings comprises state-owned companies, but Oboronprom’s holding was to integrate the Saturn plant in Rybinsk, Ufa’s UMPO and Perm Motors – all of which are privately-owned companies.

Analysts regard Saturn as an exemplary thriving management-owned company, with large investments in R&D and retooling making it the technologically most advanced company in the sector. Saturn, in partnership with Snecma, a member of France’s Saffran aerospace group, developed the SaM-146 engine to be used for the much-hyped Sukhoi Superjet 100.

However, despite these services, first deputy chairman of the Military Industrial Commission Vladislav Putilin stated unambiguously, commenting the presidential decree: “Oboronprom must take control of companies where there is currently no state control.”

Titanium tempation

ROE has also taken control of plants in the metallurgy and mining sector it believes to be of strategic importance for the defence sector.

In late 2006, ROE subsidiary OboronImpex acquired 66% of Russian titanium producer VSMPO Avisma, which as supplier of 65% of Airbus titanium needs and 30% of Boeing’s has strategic significance for the global aviation industry.

VSMPO- Avisma, the result of a merger in 2005, had a rocky history in terms of ownership, with an ongoing dispute between Renova and Renaissance Capital over a 13.4% share packet. Soviet era management held a controlling stake, with 73 -year old general director Vladislav Tetyukhin and chairman Vyacheslav Bresht each with 30%.

In an interview with Vedomosti in February 2008, OboronImpeks director, the 40 year old Mikhail Shelkov said “ROE entered VSMPO Avisma and (car producer) AvtoVAZ for the same reason. Both companies are strategically important for the economy, and both had problematic ownership structures. At VSMPO there was a conflict between Tetyukhin, Bresht and Vekselburg, and the company was suffering.”
Chemezov has also argued that VSMPO-Avisma’s dependency on Boeing and Airbus meant there was a great risk of the company being acquired by foreign aviation concerns, to the disadvantage of Russian plane producers.
The real reason may have been to increase Russia’s leverage over Boeing and over Airbus producers EADS in order to deepen collaboration and technology sharing. Ultralight titanium components are crucial to the new generation of airliners, such as Boeing’s Dreamliner and EADS’s next generation Airbus – and global titanium supply is stretched. Both companies depend on Russia for supplies – and Russia depends on them for technologies and partnership.

The ROE takeover has thus strengthened the titanium producer’s partnership with Boeing. In August 2007, VSMPO Avisma formalised a joint venture with Boeing, Ural Boeing Manufacture (UBM), to manufacture components for the Dreamliner. Pressed titanium components made by a new UBM plant in the Urals, with startup slated for late 2008, will then be finished at a Boeing factory in Portland, Oregon. UBM will also supply titanium components to Airbus.

Oboronimpeks management claims the new owners have brought order to the plant implementing SAP for most business processes. A $1bn investment programme is intended to diversify production by 2012 and increase its added-value, ending production of titanium sponge in favour of higher-grade titanium ingots and also milled products. Market capitalization has grown following the company’s renationalisation.

In autumn 2007, the ROE acquisition conveyor belt started moving again – into mining. Citing a shortage of carnalite used in titanium production, ROE’s subsidiary OboronImpex acquired Kama Mining Company on parity basis with Silvinit. The JV plans to acquire a licence to develop the Polovodosk potassium and magnesium salt deposit, and to built a $1.5bn plant to supply VSMPO-Avisma on an exclusive basis with 500,000 tonnes of carnalite annually. It was also reported at the end of 2007 that ROE had engaged British-owned mining concern Aricom, a subsidiary of Peter Hambro Mining as advisers to help them develop mining assets.

The move into mining is indicative of the way ROE’s core business of weapons exports seems to effortlessly pan out like spilt beer across a table – from defence export, to producers, to metallurgy, to mining. There was thus little surprise when in early 2008, it was reported that ROE was laying claim to a 49% Russian state stake in Mongolian company Erdenet, Asia’s fifth largest copper producer.

ROE has not just staked a claim on exotic ultra-light materials like titanium. ROE started targeting ‘special steels’, i.e. high grade steels suitable for use in armour and other defence applications, in 2007. The vehicle for this is a specially created holding RusSpetStal holding, 100% owned by ROE. Its first acquisition was 100% of the Krasnyi Oktyabr metallurgical plant in Volgograd early in the year, and a couple of more minor purchases followed

Even Chemezov sometimes loses track of all he is after. Speaking at the Paris Airshow at Le Bourget in June 2007, Chemezov said RussSpetsStal had approached the Kulebaki metallurgical plant, the Volgograd machine-building plant, and Stupino Elektrostal plant. But this, Chemezov said, was by no means an exhaustive list. “In fact, I cannot even remember them all,” he admitted.

Saving private AvtoVAZ

Most controversially, ROE took control over giant car producer AvtoVAZ, based in Tolyatti in Samara region, in 2005, and analysts rubbed their eyes in disbelief at seeing the state arms exporter intervene in domestic car production.

A new ROE management team quickly took over running AvtoVAZ, replacing 65 year old Vladimir Kadannikov who resigned, apparently after a meeting with feared Kremlin deputy chief of staff Igor Sechin. The new management came backed by battalions of police dispatched from Moscow to eradicate of organised crime from the plant.

The car giant AvtoVAZ, valued at $2.270bn, with a workforce of 165,000 producing about half of Russia’s needs in passenger vehicles, was adrift in dire straits, with rapidly receding market share, as imports flooded into Russia.

The AvtoVAZ plant, ever since late Soviet days, has been a feeding trough for organized crime, with a death toll nearing 100. The new AvtoVAZ’s first task, apparently successful, was to put an end this. Chemezov claimed that in one year the new management was able to cut costs by almost a third and increase profit by 40% year on year simply by ending crime and theft.

Furthermore, a cross-ownership share structure crippled management incentives: Kadannikov controlled the plant without owning it. This structure also made it easy, given political backing direct from the Kremlin, for a new management team to come in and take over, with the aim of “unlocking” cross-ownership and attracting external investors.

Two years later, cross-ownership is on its way out, and will be wound up by June 2008, facilitated by the technical expertise of investment bank Troika Dialog, ROE’s partners of choice. Share price has spiralled, but not profits or sales.

In the course of 2007, a number of personnel changes cemented ROE’s role in AvtoVAZ’s future. Most notably, Putin appointed the new AvtoVAZ CEO Vladimir Artyakov, a close associate of Chemezov, governor of the wealthy Samara region. Boris Alyoshin, head of the Federal Agency for Industry, then took over as general director of AvtoVAZ.

2008 will see AvtoVAZ’s reanimation move onto a new level. In December 2007, AvtoVAZ and Renault signed a memorandum of understanding declaring the intention to “to renew the lineup, exchange technologies and promote the Lada brand.” Renault is likely to pay over $1.3 billion for a blocking stake in AvtoVAZ.

In February 2008, it was declared that Carlos Ghosn, CEO of Renault would join AvtoVAZ as chief operating officer, with members of his Renault team becoming CFO, managerial accounting director, product planning director and chief engineer: the same team that turned around Nissan’s operations effectively.

Raiders of the lost rotorcraft

Vladimir Putin signed off November 26th 2007, on a bill setting up a state corporation Russian Technologies, to be headed by Chemezov, Two days later Putin signed a bill transferring ROE and all its assets to the new corporation, and ordering the government to draw up a list of further state assets to be transferred.

One week later, hitherto unknown businessman Oleg Shvartsman gave an interview Kommersant business daily that detailed his role in a dirty tricks campaign that was an integral part of renationalisation “by market methods’.

Shvartsman described the renationalisation crusade as a state-sponsored ‘velvet revolution’ aiming in particular at defence-related enterprises. In language reminiscent of Chemezov’s, he called this “a state task to develop the innovation sector, to transform Russia from a raw materials producer into a progressive innovation power”. He also claimed to have been acting under direct orders from the Kremlin hawks known as ‘siloviki’, to which Chemezov belongs.

Much of the credibility of what Shvartsman said comes its strong fit with observable trends:

“Generally we use voluntary-compulsory instruments to lower market capitalisation, by blocking growth, and using all sorts of administrative methods,” Shvartsman explained in the interview. “But, as a rule, people understand where we are coming from. In fact, usually we are talking about conflicts that are already smouldering somewhere, already the centre of attention for existing companies. They only need to come to an arrangement with our older colleagues and reach some sort of agreement. As a rule, it is the lower rung of the market value. But we’re not talking about another YUKOS case – the people do get reasonable money.”

The impact of the Shvartsman interview was due to its plausibility, as many commentators observed. The ROE deprivatisation campaign features use of ‘administrative resource’ , i.e. law enforcement and tax organs, and courts, to exert pressure on recalcitrant owners – and these are only the rare cases that come to light.

In August 2007, long before the Shvartsman scandal broke, Konstantin Makienko of Moscow’s Centre of Analysis of Strategies and Technologies (CAST) wrote baldly that “basically the story of the nationalisation of VSMPO Avisma and plane producer Irkut and of the helicopter producers shows that if the state takes a fundamental decision to restore control over specific assets, this will happen, sooner or later. Private owners display two reactions to nationalisation. The first is the “Tetyukhin reaction”, the second the “Bresht” reaction (the two former majority shareholders of VSMPO Avisma). The first reaction offers to cooperate with the nationalisation plans, as a result of which the owner retains a management position, a small share packet and financial compensation. (…) The second reaction leads to the private owner or his close relatives finding himself in trouble with the law enforcement organs, and ultimately his share packet reverting to the state and him being forced out of the business without adequate compensation.”

An obvious instance of such pressure while buyout negotiations were under way in 2006, was, for example, that tax inspectors suddenly filed back tax claims against the company. A judge handling the case expressed perplexity at how Avisma might be credited with R10.6m of tax overpayment on March 13, 2006, and then, out of the blue, significant tax arrears all of two weeks later.

However, analysts agree that in the case of helicopters producers, ROE did not employ much coercive pressure, since it already had strong levers of influence through control of export orders and state procurement. According to analysts, not only foreign export orders, but also state procurement orders stopped going to companies with less than 50% state ownership.

Yury Lastochkin, owner-manager of the Saturn aviation engine producer, is publicly resisting renationalization, as demanded by the August 2007 presidential decree on setting up state-owned holdings for engine plants.

As a counter move, Lastochkin is pursuing a voluntary merger with Ufa’s UMPO, while stalling on talks with Oboronprom. He argues that this fulfils the spirit, if not the letter, of Putin’s decree. When, however, Kommersant asked Denis Manturov if he agreed with this interpretation, Manturov called Lastochkin’s position ‘destructive’ and said threateningly, ‘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.” He stated Oboronprom would ultimately require 100% control over Saturn, although the state’s current stake is 37%, with management holding 57%.

The conflict escalated in late December 2007 with Saturn’s purchase of 20% of UMPO, and start of buyout talks. Lastochkin told Vedomosti that state ownership was irrelevant. “The state already has all the levers of influence it needs. The main thing is the efficiency of the consolidated companies being created.”

In the same interview, Lastochkin discussed the fact that the Yaroslav regional section of pro-Putin party Edinaya Rossiya ‘only’ took 53% of the vote in the December 2 Duma elections, 11% less than the national average. This caused Yaroslav governor Anatoly Lisitsyn, a Lastochkin ally, to resign days later. Lastochkin is himself a member of the regional party council, demonstrating how entwined the “Putin party”, the economy and the state are becoming.

Saturn is Russia’s largest and most technologically advanced aviation engine maker, with a workforce of 40,000. Lastochkin said stingingly that “to hand over assets we have been developing and structuring for over 10 years to complete nobodies is beyond a laughing matter.”

Asked by the interviewer if he did not fear law enforcement or other state agencies would attack the company’s market capitalisation a la schvartsman, Lastochkin hoped the state would be clever enough to avoid such “experiments” that could disrupt the finely-tuned process of designing and producing advanced technology.

An second major headache for Oboronprom in setting up the engine-producer holding is the case of Motor Sich, the Ukrainian plant that supplies 80% of Russia’s helicopter engines, and 80% of Motor Sich production is exported to Russia. Oboronprom has held acquisition talks with Motor Sich, but they were broken off without results in August 2007.

Referring to Ukraine’s Nato membership bid, on February 5, 2008, Industry and Energy Minister Viktor Khristenko called for future substitution of Motor Sich imports by Russian-produced equivalents. 80% of Motor Sich components come from Russia.

Many analysts agree that the immediate motive here was to attack Motor Sich’s capitalisation and facilitate a Russian buy out: duplication of production would costg $300m-400m and take 5 years.

Immediately following the announcement, Motor Sich shares lost 14% of their value. One week later, Denis Manturov, former Oboronprom CEO, now deputy minister of energy and industry, again proposed that Motor Sich join the future Russian state holding.

Russian Technologies: L’etat, c’est moi

In June 2007, Sergei Chemezov first publicly spoke of fitting ROE a new legal status, “disposing of the full legal rights of an integrated economic subject, plus the rights of state procurement for certain types of military exports. Something between a unitary enterprise and a joint stock company.” He referred surprisingly in this context to the ARKO agency set up in 1999 to restructure banks following the 1998 financial crisis. Specifically for this purpose, a peculiar legal form called “state corporation” was created in 1999 as a non-commercial organisation, and had since fallen into disuse.

Putin, in his state of the nation address in April 2007, mentioned setting up a state corporation for the nuclear sector. However, it was assumed this meant a state-owned joint stock company analogous to the United Aircraft-builders Corporation or United Ship-builders Corporation created 2006.

It turned out that ‘state corporation’ meant precisely ‘state corporation’ as legislated for in the obscure 1999 amendment to the 1996 “Act on Non-commercial Organizations”, and mentioned nowhere in the Civil Code.

‘State Corporation’ (SC) went on to become the hit of the year, with SCs being founded for nanotechnology, Winter Olympics, housing reform, road building, the entire nuclear sector, both military and civilian – and for Russian Technologies (RT), aka Rosoboronexport: with its purpose defined as assisting the development, production and export of high-tech industrial production by supporting Russian organizations on domestic and foreign markets, and attracting investment to different industrial sectors, including the defence sector.

Nowhere in the special law on setting up RT is there any definition of what constitutes high-tech production. In this way, RT has carte blanche to intervene in any sector of the economy.

RT will also perform state functions “in the implementation of the state’s export and import policy and state policy concerning military-technological cooperation with foreign states. The list of functions can be extended by other acts or presidential decisions.”

In fact, the whole ‘state corporation’ concept is riddled with anomalies that create huge accountability and corruption issues:

Bizarrely, a “state corporation”, as laid down in the law, is neither state-owned nor a corporation: it is a non-commercial organization established by the state for a specific purpose – social or “managerial”. It is, however, not owned by the state. Property transferred to the SC belongs forthwith to the SC, and the state has no further claims to it.

An SC is strictly speaking not for profit, but there is a lot of leeway allowed; any profit it makes must be reinvested towards the purpose for which it was created, which however is vaguely defined. Similarly, an SC can act entrepreneurially if this serves the goals for which it was established.

In contrast to federal unitary enterprises such as ROE, SCs have the right to borrow domestically and internationally, to issue bonds and give guarantees. A SC can also establish joint ventures and other partnerships with the private sector.

On February 20, 2008, the Russian Federation Council published a devastating critique of SCs as part of its annual review of federal legislation. Among the points listed were: There is no restriction placed on the purpose and function of SCs; property and funds transferred to the SC become its property and the state has no further rights or claims on them; each corporation is regulated by a separate law, meaning they exist outside any unified legal framework, in a legal grey zone.

Most significantly, according to the Federation Council report: the law contains virtually no control over the activities of SCs. There are no evaluation criteria for SC goal fulfilment; no procedures for medium or long term planning; no sanctions for non-fulfilment of goals.
Astonishingly, considering the ROE story has been all about bring the defence sector back under state control, SCs are explicitly freed from all government oversight and intervention, excepting the power of the president to appoint management and supervisory board.
As stated above, SC assets do even not belong to the state, which makes a mockery of the ROE mantra of ‘bring defence assets back under state control’. In order to transfer ROE to Russian Technologies, it will be de jure privatised. In preparation for this, the state arms export monopolist was removed from the list of strategic state-owned companies in late 2007.
The Federal Council report concludes that SCs create “the perfect chance to transfer state property to the non-state sector with no financial benefit for the state and at the risk of uncontrolled use and alienation of assets.”
Less diplomatically, Kommersant wrote in December 2007, referring to the fact that SCs are formally non-profit organizations, that 2007 had seen “a $20bn donation to charity by the Russian state, the largest ever in human history.”

In fact, the complete lack of government oversight apart from presidential appointment, combined with far-reaching rights of disposal over assets, means that Chemezov’s claim to have restored state control over strategic assets only holds water if he claims ‘l’etat c’est moi’. Given the personalisation of power and property that has taken place under Putin, this claim would not be far from the truth.

There has been no government explanation for such wide use of the SC legal form in the last few months of Putin’s presidency. Chemezov has adduced a couple of reasons: that taking ROE outside the state allows him to pay managers a market-level salary, and that it reduces risk of US sanctions applied to ROE affecting ROE subsidiaries, which will probably now be transferred to direct ownership by RT.
These reasons hardly justify the sweeping and unsupervised disposal of property, and coercive power over whole swathes of the economy, that Chemezov will now enjoy.
However, it could be much worse. Even Chemezov has not seen all his wishes come true. He originally lobbied for ROE to implement the state arms procurement programme, which would have given him control of around $20bn revenues per year, turning RT into a Gazprom of the defence sector, but with even less accountability. This proposal was excluded from the RT bill. However, it is still open for the future – along with the option of transfer to RT of the state’s controlling stakes in the United Aircraft-builders Corporation and the United Ship-building Corporation.
Chemezov has until now worked mostly to nationalise private business, but the establishment of RT indicates he is increasingly set on privatising the business of state. The extent he achieves this under a Medvedev presidency will be a test of whether the incoming president’s public commitment to liberalism holds any water, and whether he can break with his predecessor.

Back to the future: The Kremlin takes control of Russia’s aircraft producers

By Graham Stack, for Radio Free Europe / Radio Liberty

Diversification of the economy has long since been a watchword for Kremlin officials. During Putin’s first term, the path to diversification was seen as the institutional reforms drawn up by German Gref’s Ministry of Economic Development and Trade. The state’s task was to establish an institutional framework supportive of diversification.

During Putin’s second term, soaring oil prices made diversification an issue of concern for Kremlin hawks as well as liberals. The former saw it as a matter of national security, that had twice over twenty years been compromised by sharp drops in the price of oil. However, their commitment to patient institutional reform was less marked than for the liberals.

At the same time, the financial resources accruing to the Russian government encouraged a pro-active policy towards industry and investment. Kremlin power increased respective to business interests as a result of the Yukos affair, and respective to regional interests as a result of the post-Beslan transition to appointed regional governors, expanding policy options.

Kremlin hawks and industrialists argued that Russia was already diversified, possessing a hi-tech defence sector and also civil aircraft construction sector that were still widely state-owned, and only just recovering from the collapse and chaos of the 1990s. The then defence minister Sergei Ivanov and the head of the state arms exporter RosOboronExport, Sergei Chemezov, among others, argued that diversification could be achieved through activating this resource. They advocated state-driven restructuring of the defence / aviation industries in connection with a rearmament programme making good for a decade of minimal arms purchases combined with an aggressive export strategy.

Defence sector privatisation: Disaggregation instead of rationalisation

The privatisation of the defence sector in the 1990s was a major political feat for reformers. There was an intrinsically political element to the way privatisation broke the sector up into its myriad individual component enterprises: reformer saw this as putting an end to the reactionary political lobbying power of the ‘military-industrial complex’.

Privatisation disaggregated the sprawling defence sector, but did not rationalise it. This was partly a result of the structure of the Soviet defence industry: for instance, design bureaus and production facilities were mostly separate entities, and the Soviet system of internal competition meant that many of the new semi-privatised defence companies duplicated each other’s production lines.

Furthermore, due to political backlash against privatisation and increased attention to strategic concerns, privatisation remained only partial, with the state retaining controlling or blocking stakes in almost all corporatised defence companies. Defence companies regarded as strategically vital and / or financially unviable remained in 100% state ownership as Federal Unitary State Enterprises (FGUP).

Combined with the general economic collapse, this meant that the defence and also civil aircraft construction sectors mutated into a sprawling archipelago of companies languishing in a limbo between state and private management. Since the state remained the single main owner of the defence sector, it was predestined to become the main actor driving on its restructuring, as soon as the necessary political and financial resources materialised.

Aircraft builders in post-Soviet Russia

Military aviation, in particular Russian fighter jets such as the Su flanker jet series and the MiG fighter jets, constitute Russia’s only globally competitive hi-tech production. Key enterprises such as Sukhoi, MiG and Irkut survived the 1990s by exporting their planes to non-Western countries. With an economic revival now well underway, the state procurement budget is now starting to play an important role again. But this does not compensate for the fact that Russia’s most technologically sophisticated and competitive production is barred from the enormous Western markets for obvious strategic reasons.

Russian civilian aircraft production, on the other hand, was devastated by the economic collapse of the 1990s, failing to compete even on the domestic market. To the insult of a massive collapse in demand was added the injury of Soviet production being outcompeted by Western models far cheaper to operate and compliant with international requirements. Not only did Russian and CIS carriers stop buying Russian planes, they actively started to phase them out especially on international routes, discarding their Tupolevs and Ilyushins for Boeings and Airbuses.

However, along with economic revival, passenger numbers are increasing 8% per year, generating demand for new, modern planes from Russian carriers. In a huge country like Russia, plane travel is quickly becoming again the dominant means of medium and long range passenger transport, and it is also a matter of national pride that Russian planes fly in Russia.

Setting up the UAC: Policy

Extrapolating from these structural conditions, and manifold policy statements, the Russian government’s goal in setting up UAC was to restructure and rationalise existing capacities in order to leverage this strong domestic demand (commercial and military) to produce globally competitive planes.

A key idea was to combine military and civillian production – separated in Soviet times – in one holding to create synergies and commercial spin-offs of military technology. The focus of the UAC is firmly on creating competitive commercial aircraft. There is thus a double diversification involved – from commodity export to high-tech production, and from military production to commercial.

The presidential decree on setting up the United Aircraft Corporation (UAC) was signed February 2006. The decree called for the UAC to be set up in three stages, the first stage being the establishing of the holding’s capital from the state’s shareholdings:100% of Sukhoi Holding Company (which owns 50.1% of the Sukhoi design bureau, 74.5% of the Komsomolsk-on-Amur KnAAPO plant, 74.5% of Novosibirsk’s NAPO plant, 11.63% of the Irkut Corporation, 38% of Beriev design bureau and 87.9% of Sukhoi Civil Aircraft); 25.5% of KnAAPO; 25.5% of NAPO; 86% of MAK Ilyushin (which owns 81% of Ilyushin Company and 30% of Voronezh-based VASO plant); 90.8% of Tupolev (which owns Tupolev Design Bureau and 73.5% of the Ulyanovsk-based Aviastar-SP plant); 38% of the Sokol aircraft plant in Nizhny Novgorod, 38% of Ilyushin Finance (IFC) leasing company; 58% of Finance Leasing Company; and 15% of the Aviaexport foreign trade company.

38% of the Irkut company was contributed by Irkut management, in return for a stake in UAC. The state was to own 90% of UAC.

Setting up the UAC: Politics and actors

A lot of the groundwork for setting up a consortium of aircraft constructors was performed ‘from below’, by companies themselves, especially by the managers and shareholders of the Irkut concern, such as Alexei Fyodorov, president of Irkut and owner of ca. 18% of the company. Fyodorov’s success in managing Irkut led to his being named head of the state-owned MiG and charged with turning the company around. Closely associated with Fyodorov was another Irkut manager and shareholder, Valery Bezverkhny, who became head of the non-commercial partnership United Aircraft Consortium, set up in 2005 without state involvement to coordinate sectoral activities, and which lobbied for sectoral consolidation through privatisation of the state’s shareholdings.

The subsequent success in establishing an aircraft producers’ holding thus owes a lot to its organic nature. However, these initial efforts were also a victim of their own success. State actors, mainly Defence Minister, and later First Deputy Prime Minister Sergei Ivanov, a possible successor to Vladimir Putin as president, Sergei Chemezov, head of state arms export Rosoboronexport, and Boris Alyoshin, head of the Federal Agency for Industry, hijacked the idea, and turned it into a vehicle not for privatisation of state shares in defence companies, but for consolidation of state assets in a state-owned holding, and, where necessary, deprivatisation of private owners. This move towards governmental creation of ‘national champions’ also fitted telegenically into Ivanov’s heightened profile as potential presidential successor.

This ironically made the position of the Irkut management, who had initiated the push for consolidation, precarious. Irkut was commercially by far the most important company in the sector, with sales figures for 2006 matching those of MiG and Sukhoi combined, and comprising half of the total order book for the entire Russian aviation sector.

Moreover, Irkut was a public company that had even conducted an IPO in 2004. Post-IPO the management stake had dropped from 70% to 44%. 32% was held by institutional and private investors. The state only retained 12% owned by the state-owned Sukhoi holding. A 10% stake in Irkut was held by the European aerospace champion EADS. EADS thus held only a slightly smaller – but more direct – stake than the Russian government did – in Russia’s most successful military aviation company.

Irkut management said as late as July 2006 that they expected to receive as much as 30-40% in UAC in exchange for their 38% stake in Irkut – since their consent was crucial to the UAC going ahead. However, to general surprise, state officials valued the Sukhoi Holding at $2-2.2bn, аnd Irkut at a mere $940m, despite the company’s having a market capitalisation of $1.12bn and outstanding financial results. As a result of what was widely regarded as a deliberately depressed evaluation, Irkut management were entitled to less than 10% of UAC for their 38% of Irkut – ensuring the state would own over 75% of the holding, securing it control.

Irkut management owners consented to this evaluation, since the government coopted Alexei Fyodorov, owner of 18% of Irkut, and Bezverkhnyi by appointing them head and deputy head of UAC respectively. At the same time, fraud charges were brought against another of Irkut’s owners and board members, Sergei Tsivilev who was apparently less willing to cooperate. The charges were immediately dropped on the deal going ahead, pointing to their being politically motivated.

Having acquired Irkut management’s 38%, UAC submitted a binding offer to Russia’s Federal Financial Markets Service (FFMS) on the buyout of Irkut 49.9% of Irkut charter capital, which was finalised in March 2008. Negotiations with EADS, owners of a 10% stake in Irkut, resulted in EADS agreeing to convert its stock into UAC shares (see below). This clears the way for UAC to switch to a single share with Irkut in 2008.
Currently the process of the putting the UAC together is still ongoing – with the corporatisation of MiG and Kazan APO taking longer than planned. On March 19th, 2008, MiG’s transformation into a joint stock company was finally completed.

Plans

The government’s plan for the development of the UAC up to 2025 was presented to President Vladimir Putin for his approval February 20, 2008. The ambitious plan envisages UAC supplying 10-15% of global demand for regional and medium-stretch passenger planes, and 20-30% of global demand for military and transport aviation.
Regarding civil aviation, UAC is to focus on three vectors: modernisation and serial production of Soviet Ilyushin and Tupolev models; development of the Sukhoi Superjet and the new MS21 narrow body passenger jet. Military aviation hopes are pinned on the launch in 2015 of Sukhoi’s 5th generation fighter jet.
The program as presented will require $20bn in investment, of which $10bn will come from the budget. The share of military aviation in profits should drop to 40% from the current 80%.
On the same day the plan’s parameters were announced, Aeroflot’s general director Valery Okulov in an article in business daily Vedomosti criticised the focus on continuing modernisation of Soviet models originally developed in the 1960s. “It is not modernisation of obsolete models that will secure sustainable development of our plane building industry, but the development and launch of competitive new planes tailored to demand on the global market. Modernisation of models currently produced only targets marginal markets. But such markets do not offer steady demand and profits. This is not a plan for catching-up development, but a path to growing backwardness.”
Okulov’s words capture the basic dilemma inherent in the UAC. Is it intended to revive Soviet-era aviation producers such as Tupolev and Ilyushin or to create new, globally competitive products that represent a break with the Soviet aviation legacy? As a state-owned holding cobbled together from companies in very different financial and technological positions, containing both competitive and obsolete technologies, there is an inherent risk of political lobbies prioritising the latter at the expense of the former, and the UAC achieving the opposite of what it was intended to achieve: blocking out new development.
A fresh start: Sukhoi Superjet 100

UAC has, however, received valuable ‘start capital’ towards its strategic goal from the Sukhoi subsidiary, Sukhoi Civil Aircraft (SCA), in the form of the Superjet-100. The Superjet 100, designed and built by Sukhoi Civil Aircraft (SCA) is a regional passenger jet carrying max. 100 passengers with a range of 4,550 km and designed to compete with Brazil’s Embraer E-Jets and Canada’s Bombardier C-series.

In contrast to Soviet-style autarky, the Superjet is the result of extensive international collaboration, in which Sukhoi has played the part of system integrator. The plane flies with SaM146 engines designed and produced by Powerjet, a joint venture between Russia’s NPO Saturn and France’s Snecma. The electronics are supplied by France’s Thales, and Boeing has acted as project consultant. Besides receiving large Russian subsidies, the regional jet has been subsidised by the French (€140m) and Italian governments (€92.3m), and recently took out a 10-year $100m loan from the European Bank of Reconstruction and Development (EBRD).

Moreover, in May 2007, 25% of Sukhoi Civil Aircraft, was provisionally sold to Italy’s Alenia, a 100% subsidiary of Finmeccanica SpA, partly state-owned and also a member of the Eurofighter consortium. Alenia has also founded a joint venture with SCA to provide global after-sales and maintenance support – likely to be the plane’s main weak point. A presidential decree January 2008 sealed the deal and cleared the way for foreign nationals to become members of the SCA’s managing bodies, although only a Russian national can be head of Sukhoi Civilian Aircraft.

Sukhoi’s Superjet represents a completely new departure for Russia’s aviation industry. The plane’s main selling point is ironically – considering the Soviet gas-guzzlers the Soviet Union churned out – its operating costs being 10-15% lower than Embraer or Bombardier. Sukhoi is billing it as the most ecological in its class, so that airlines buying the plane will potentially claim Kyoto carbon credits. Moreover, a wider cabin offers more comfort – another break with Soviet tradition – and priced at $27.8m, it will be 18-22% cheaper than competitors, which could compensate for perceived lack of after-sales and maintenance network.

By mid-October 2007, SCA had 73 firm orders placed. Only ten of these were from outside Russia – placed by Italy’s Itali regional carrier, and a large number were for state-owned Aeroflot. However, at the end of October 2007, new SCA contracts were reported for 128 Superjets, worth $3.6bn in total, including orders from India’s Omega Airlines, Indonesia’s Merpati and China’s S.A.T. 350-400 Superjets must be sold for the project to break even.

The speed and smoothness of the Sukhoi regional jet’s development has surprised and impressed many observers who initially held the project for a pipe dream. Indeed, the the regional jet has proved the continued viability of Russian aircraft production and thus lent impetus to the creation of the UAC.

The EADS dilemma

UAC’S next major new commercial development is MS-21 narrow-body medium range airliner to be built by Irkut. The 130- to 170-seat MS-21 twinjet family is intended to replace the Soviet-era workhorse Tupolev Tu-154s and to compete with Airbus A320 and Boeing 737NG. The MS-21, however, is still very much on the drawing board, with main parameters still unclear and an engine still to be chosen.

Moreover, the plane is slated for serial development not before 2015. This poses a problem in as much as Aeroflot, for instance, plans to retire all Тu-154s by 2010, meaning that a gap in the market will open up inevitably to be filled by Airbus А-320 and Boeing В-737, making life very hard for the MS21 when it does eventually appear.

In fact, the issue of UAC acting as system integrator for any commercial planes larger than the Superjet is tightly bound up with UAC’s future relations with EADS. The main question is whether the EADS will deliver Russia an assembly line for the next generation A320, EADS’ mid-range liner. A320 NG would be a direct competitor of the MS-21. If EADS were to do so, UAC would be likely amend or drop the MS-21 plans.

UAC does not deny how crucial the relationship to EADS is. UAC head Fyodorov is looking to create a long-term partnership with EADS, including cross-ownership. Some degree of cross-ownership looks increasingly acceptable to EADS, despite initial alarm at the purchase of 5% of the company by Russian state-owned bank VTB in 2006. In December 2007, VTB announced it would sell the EADS stake to UAC in 2008. According to Sergei Ivanov, EADS is also ready to convert its 10% stake in Irkut for an approx. 2% stake in UAC.

EADS would then be free to increase its stake in UAC during an IPO in Russia of 10-15% of UAC stock to be held 2009-2010.

Military collaboration with India

In the sphere of military aircraft development as well, UAC is looking to develop strategic international partnerships, with India likely to play the main role as partner in developing the fifth generation fighter jet. Fifth generation fighters combine versatility with new developments such as thrust vectoring, composite materials, stealth technology, integrated avionics. Currently only the US F-22 Raptor is the only fully-fledged fifth generation aircraft operating.

In October 2007 it was reported in the Russian and Indian press that the much-hyped fifth generation fighter would be developed together with India on equal terms in a $10bn project. Indian involvement will initially be financial, but the models will subsequently be adapted by Indian engineers for Indian airforce needs. It is unclear exactly what the time frame of the project is, with estimates varying between 2010 and 2015 for production to start.

The Multi-role Transport Aircraft (MTA) is another important Indian-Russian joint that has currently hit a snag in the Indian demand that Russia reinvest in the project $10bn of Indian debt to Russia. However, both sides have considerable interest in moving on. In March 2008, it was announced that Irkut would withdraw from the project to concentrate on the MS21, leaving the MTS project wholly to Ilyushin.

In early March 2008, the Indian airforce demonstrated its trust in Russian as a strategic partner, placing a nearly $1bn order for upgrades to MiGs, despite the fact that in February Algeria had returned to Russia fifteen MiGs supplied, at a value of around $1.5bn, due to alleged inadequacies.

Backdoor protectionism: State-ownership of passenger airlines

The state has also retained considerable airline assets, including global giant Aeroflot (51.17%), and other large carriers such as GTK Rossiya (100%), Sibir (25.5%) and Krasair (50%). In 2007, it was decided to fold Krasair into a merged company called AirUnion together with four smaller regional carriers, in which the state would retain a blocking stake, and Boris Abramovich, owner of 40% of Krasair, would hold a majority stake, thus effectively privatising Krasair. The merged company would be Russia’s third largest in terms of passengers.

Obviously these extensive holdings give the state considerable leverage in supporting domestic aircraft production – simply by insisting that state-controlled carriers buy a certain quota of Russia-built planes. Of particular concern is that domestic regional carriers provide a launching pad for the Sukhoi Superjet.

In December, 2007, the state corporation Russian Technologies (RT) was established on the basis of state-owned arms export monopolist RosOboronexport, headed by Sergei Chemezov, an old friend of Vladimir Putin’s from industrial espionage activities in Dresden in the 1980s. Chemezov was predictably named head of the corporation, charged vaguely with promoting Russian hi-tech production, both defence-linked and civilian, domestically and internationally.

Russian Technologies has now laid claim to these state-owned airline assets, clearly to leverage them to promote the revival and technological upgrading of the aircraft production industry. It has not yet been finalised what assets Chemezov’s state corporation will get. Although apparently Chemezov requested that the State Property Committee transfer RT the Aeroflot stake, this is unlikely to happen. However, a Deloitte Touche revaluation of the assets of the merged AirUnion company established that the airline assets held privately by Boris Abramovich would not be sufficient to give him a controlling stake in the merged company, as was originally planned, despite Abramovich having placed orders for 20 Sukhoi Superjets.

Instead it is likely that Russian Technologies will end up with a controlling stake, thus preventing the privatisation of Krasair, and instead effectively nationalising the smaller regional airlines Abramovich merged into AirUnion. The method employed – an inflated valuation of state-owned assets relative to private assets when configuring a merger, was also used in the Irkut case described above.

If Chemezov established control over AirUnion, it is likely he will set up a holding for all the air carrier assets transferred from the State Property Agency, buying out Abramovich completely if necessary.

This latest development yet again illustrates how the policy of setting up state-controlled holdings has knock-on effects all down the line. The project of regenerating Russia’s aircraft-building industry under state supervision has prompted renationalisation of assets in metallurgy, especially titanium producer VSMPO-Avisma, as well as now seemingly in regional aviation carriers. Although the consolidation of extreme fragmentation across most sectors resulting from privatisation (there are 173 air carriers operating in Russia) should bring benefits, the fact that this is taking the form of a league of state-owned ‘national champions’ eliminates market elements, and thus stimuli to efficiency – as well as increasing the predominant power of the Kremlin vis-à-vis business and society.

However, there are increasing signs of resistance especially to Chemezov’s seemingly endless appetite for assets. With the Kremlin liberal wing encouraged by the coming Medvedev presidency, there have been sporadic attacks on ‘state capitalism’ and state corporations by policy makers, and indeed Medvedev himself. Moreover, March 18th, Sergei Ivanov himself criticised in front of the Federation Council the idea of Russian Technologies owning producers of finished products, arguing instead that the state corporation should concern itself with restructuring defence-sector suppliers of components and materials. His comments might also indicate that Chemezov had been lobbying for the United Aircraft-builders Corporation and the United Shipbuilding Corporation to be transferred to RT.

Conclusion

- The policy of uniting commercial and military aircraft producers in one holding, with a focus on production of commercial aircraft for international markets, and embedded in a system of international collaborations, is a positive sign for Western policy makers, since it will create important disincentives for Russia to sell military aircraft to internationally isolated regimes – especially as in the case of Sukhoi, when the same company seeks to sell commercial aircraft on Western markets. In the 1990s, with the aircraft sector struggling to survive, there was a policy of beggars can’t be choosers, leading Russia to export to which ever country was able to pay. The UAC’s express focus on developing and producing commercial aircraft is thus to be welcomed.

- Increasing state involvement here should not be regarded as particularly problematic. Many Western countries have or have had state involvement in aircraft production, especially for defence purposes, and the state is to a large extent merely reorganising more efficiently holdings it had retained. State direction is likely to lead directly to increased involvement of risk-sharing foreign partners and investors, and thus the long-term international embedding of the Russian aircraft production industry. This is the policy expressly being pursued. Again, this international context will dictate against the development of an autarkic ‘military-industrial complex’ that lobbies for spiralling defence spending with aggressive militaristic arguments.

- The UAC, benefiting from increases state attention and funding, will probably make more efficient use of resources to create new military aviation models retaining some degree of international competitiveness in Russian military aviation technology. However the role of international partnership (especially with India) is likely to grow here too.

- The apparent readiness of Russian authorities, when engaging in such restructuring, to exert pressure on individual owners to sell up by bringing criminal charges, even if substantiated, to bear against them, undermines the impartiality of the justice system and institution of private property.

- The policy of creating national champions has some justification especially in the aviation sector. However, it looks to be triggering a domino effect all down the line – from airlines to aircraft producers to engine producers to metal suppliers. In each segment, state-owned national champions are being formed, including straightforward cases of nationalisation such as the purchase of titanium producer VSMPO Avisma, supplier of Boeing and EADS, by Rosoboronexport. Not only does this increase the state’s share in the economy, it also squeezes out the market as coordinating mechanism, as, on the one hand, national champions, such as Aeroflot, are leant on to ‘buy Russian’, and on the other, state-owned companies are preferred as suppliers to private companies.

Russia Steps On The Gas

Graham Stack for Russia Profile

Germany is Russia’s most prominent European partner, and now Germany’s most important Russia specialist has published a snapshot of Russia and its ambivalent relationship to Europe, containing a wealth of insider information and hot off the press.

Alexander Rahr is almost as well connected in Moscow as he is in Berlin. The foremost German Kreminologist, and member of Germany’s leading foreign policy think tank the German Society for Foreign Policy (DGAP), he is policy makers’ close adviser in the country Russia sees as its natural ally in the West. In particular, he has the ear of former chancellor Gerhard Schroeder and of current foreign minister Franz-Walter Steinmeier. As such, many doors are open to him in Moscow. Including those of the Kremlin.

Rahr’s thesis in his book “Russland Gibt Gas,” published to coincide with the Russian electoral campaign, is a bold one: Russia and Europe need each other deeply in a purely pragmatic, geo-political way, and this basis can be used to build trust and to nurture common values. Rahr sees Russia as actively seeking such a pragmatic interdependence, but in the case it is turned down, it may reorient itself towards Asian giants such as China and India.

His book does not mince words in describing Russia’ many shortcomings – a weak rule of law, lack of media freedom, and human rights abuses. However, in contrast to so many other accounts, it is not primarily a critique of Russia, but of European policy toward its neighbor.

The new Ostpolitik: a pragmatic approach to Russia will bear normative fruit

Rahr argues that Europe’s security depends too much on integrating Russia geo-politically, and this can’t be postponed until European values take over in Russia. Rahr’s thesis is that whether you like it or not, Russia holds the solution to Europe’s energy security problem. Europe has to recognize this pragmatically, and achieve energy supply security by offering the Russians demand security and markets.

If Europe does not do this, Russia could well turn toward Asia. If Europe does do this in a pragmatic way, increased Russian security might well lead to accelerated voluntary value changes in Russia.

Russia may be far from perfect, argues Rahr, but it’s not Saudi Arabia. The fact that Europe, unlike the United States, sources its energy needs from a neighbor with so much shared culture, should be regarded positively in European capitals, rather than as a source of apprehension.

Moreover, Rahr believes the potential for value transfer, once such a deepened long-term pragmatic partnership is established, to be considerable.

It’s no coincidence that this argument comes from a German: the idea takes intellectual roots in the Allies’ post-war strategy of Westbindung of the Federal Republic of Germany. The policy that pragmatically began with the France-Germany coal and steel union, created precisely to defuse the resource question, was the seed of today’s “value community” of the European Union.

The second inspiration was West Germany’s 1970s Ostpolitik (eastern policy) of de-escalating the cold war in Europe by building up trading relationships with the Soviet Union, culminating in the gas pipelines so bitterly opposed by the United States. Again, the pragmatic approach became a non-confrontational channel for value transfer during Perestroika. The historic paradigm that inspires Rahr is thus Wandel durch Handel, change through trade.

The crux of Rahr’s argument is that Russia will be far more open to European values if it is freed from suspicions that these are merely a foil for geopolitical motives, that European “preaching” is simply a pretext for geo-political sidelining and exclusion.

Precisely now that the Russian economy is up and running, Russia is desperately looking westwards for opportunities – markets and investment – to diversify its economy away from the resource base. Such a diversification is both in Europe’s interest and in Europe’s power to support. However, should Europe shut itself off from reciprocal economic engagement of Russia, Moscow could turn east – and take its energy resources with it.

The urgency of the matter means, according to Rahr, that Europe has to lower its suspicion threshold for Russian expansion into European markets. Russia wants access to end customers in Europe for its energy resources, as well as increased cooperation in the high tech area (especially aviation) and in logistics. Russia also wants its companies to be allowed to buy into European ones.

This is hard for Europe to swallow, because Russia’s competitive advantages are in the strategically sensitive areas of energy and defense / aviation, where there is great suspicion of collaborating with Russian state-owned companies. In addition, because of the size of the largest Russian companies and their formal or informal links to the state, Russian acquisition of European companies in almost any sector could be deemed to have some strategic goal.

Rahr, however, argues that Europe must have more confidence in the strength of its own institutions to absorb and “tame” Russian corporations, whether state-owned or private.

It must also be made clear to the Russians that there is no question of Europe loosening its ties with the United States for Russia’s sake. The choice is not whether Europe ties itself to Russia rather than the United States, but that Russia binds itself tighter to Europe than to China.

At the same time, “New Europe” must be convinced that a defensive attitude toward Russia based on Cold War resentment is self-defeating in the long run, and that engagement of Russia is the best path to defusing tensions.

Face to face with the siloviki

Along with the geopolitical analysis, Rahr’s book intrigues readers with its vivid accounts of face to face meetings with top officials in the Putin administration. He tells of a two hour interview with Sergei Ivanov, Putin’s friend of thirty years, KGB colleague and long-serving defense minister, who was widely expected to succeed Putin in office – until the choice fell upon Dmitry Medvedev.

The anglophile Ivanov tells Rahr he sees Russia’s future in a two-party system, as in the Anglo-Saxon world. With Putin having established a strong conservative party, Ivanov calls on the Russian Communists to transform into a social-democratic party as in other post-socialists states, and for the EU to overcome its divisions, so that it can become an anchor of stability for Russia.

Rahr also meets with Viktor Ivanov, one of the top-ranking “siloviki,” former KGB officials working in the Kremlin. Viktor Ivanov takes a piece of paper and sketches for Rahr the tangled maze of channels that were used by oligarchs to bypass the Russian tax authorities, including even the Baikonur Cosmodrome endowed with tax privileges in the cash-strapped 1990s.

Above all, Rahr meets Putin himself regularly in the framework of the Valdai Club of western Russia experts. Their most recent meeting was held in Sochi in October 2007, culminating with a stroll along the beach and Putin calling on the EU to step out of the U.S. shadow as an independent actor.

But this star-studded cast is upstaged by a dacha drinking session among FSB top brass, which Rahr faithfully records – and a debate pitting the “conservative” Viktor against the “superliberal” Yevgeni. The opposing sides reveal how the centuries-old opposition between Russia’s adherence to a special path and Russia’s convergence with Europe divides even FSB generals.

For the FSB general referred to by Rahr as Yevgeni, Russians went to the barricades in 1991 to fight “against the Communist putsch and to win freedom for their motherland. The Russian people’s triumph in 1991 was in terms of historical significance far greater than the Orange revolution in the Ukraine. For Russia, the overthrow of dictatorship during the days of the putsch was the entry ticket to Europe.”

His ideological opponent Viktor counters immediately: “The West has regarded us as an enemy for a thousand years. At best as a supplier of raw materials; nowadays oil and gas, five hundred years ago woods and furs. Tsar Alexander I liberated Europe from the Napoleonic occupation. In the Second World War, Russia defeated Hitler’s fascism. And what thanks did we get? Following the Vienna Congress in 1815, Europe united against us, allied with the Ottoman Empire to try and expel us from Europe in the Crimean war. Western historiography simply ignores our victory in the Second World War and even labels Russia the enemy of Europe. And Europe regards Putin’s Russia as her enemy as well.”

In view of this clash at the very heart of the FSB, it is surprising that Rahr follows the conventional approach in ascribing so much block weight and corporate loyalty to the ex-FSB “siloviki.” Whether anything really unites the siloviki beyond Putin, whether they have a shared ideology rooted in “the corporation,” is all a matter of speculation. The popularly-pedaled version of the story is little more than a conspiracy theory. Exactly how the allegedly pervasive silovik influence has led to Dmitry Medvedev being named as favored presidential successor is anyone’s guess.

The Medvedev candidacy, however, does prove Rahr’s general point: Medvedev personifies Russia’s renewed bid to align itself with Europe. With 2007 marking an economic breakthrough in terms of soaring fixed capital and foreign direct investment resulting in 8.2 percent economic growth, Russia can now claim to have put its house in order after the unsustainable 1990s. Now, in the person of Medvedev, according to Rahr, the West is being given “another chance to take up the idea of an intensive strategic partnership.” Medvedev, a 42 year old corporate law scholar, is in terms of political identity “a European” in his own words, and has a greater chance to achieve such a breakthrough than Ivanov, whose KGB roots would inevitably be held against him.

Will Europe take up the offer?

A positive outcome might depend on a factor that Rahr neglects to consider: the 21st century phenomenon of Russian consumerism.

Rahr, for all his relatively liberal view of Russia, completely excludes society and largely excludes the economy from his analysis. The word “Internet” does not feature in the index, and there is no discussion of how the explosive growth in real disposable incomes across the board, the shrinking of poverty and the very real emergence of a middle class have combined with technological (internet, mobile) and generational change to alter society and lifestyles.

Put simply, for all the democracy and law-and-order deficits, Russia is becoming a European society at a very fast rate – on its own. Reassuring Russian elites that Europe is not intrinsically hostile to Russia through establishing a strong strategic win-win partnership would, as Rahr argues, be the best way for Europe to support this process.

Tracing the rise of Medvedev’s network – Russia’s “civiliki”

Graham Stack for business new europe

Dmitry Medvedev, Russian President Vladimir Putin’s endorsed successor, is likely to ask a slew of old university friends round to the Kremlin when he moves in later this year. Not to party, but to work. Much as Putin has relied on a string of friends from St Petersburg formerly with the KGB, the so-called siloviki, Medvedev has hauled up into high positions a network of friends and colleagues from the St Petersburg State University civil law department: the “civiliki,” as it were.

“Relations between state and business are like a seesaw – they tip to one side and then to another. There was a time when the state had lost influence over business to the extent that it practically handed out indulgences for non-payment of taxes. Now we are in tougher times. Perhaps the seesaw has even tipped too far in the other direction, and it is time to re-determine the correct balance between business interests and state authority.”

When the chairman of Russia’s Supreme Arbitration Court, 42-year old Anton Ivanov, interviewed by business daily Vedomosti on December 25, came out with the above statement, Russian political observers took notice: only two weeks before, Ivanov’s friend and colleague of 25 years standing, Deputy Prime Minister Dmitry Medvedev, had been picked by Putin to succeed him as president. The presidential elections are due on March 2.

Medvedev and Ivanov studied together at what was then Leningrad University’s faculty of law from 1982-1987. Following graduation, both went on write PhDs and teach at the faculty in the civil law department. Their PhD supervisor was none other than law professor Anatoly Sobchak, leader of St Petersburg’s surging pro-democracy movement, elected mayor of Petersburg in 1990, and Putin’s boss until 1996.

Medvedev and Ivanov’s professional partnership extended to co-authoring, together with other faculty members, an acclaimed civil law textbook that’s still widely used in Russia, and also jointly founding a legal consultancy in St Petersburg in the early 1990s.

At every stage of Medvedev’s subsequent rise to the top since then, Ivanov has followed him at a short distance. And not only Ivanov. From Medvedev and Ivanov’s class of ‘87, a cluster of names such as Konstantin Chuichenko, Valeriya Adamova, Vladimir Allisov, Ilya Eliseev, Mikhail Krotov and Nikolai Vinnichenko have accompanied Medvedev and Ivanov’s dizzying rise.

Just as during Putin’s presidency saw the previously obscure siloviki members such as aide Igor Sechin and state arms trader Sergei Chemezov rise to become national figures, in the same way some of the above names are likely to figure large in the still-nascent art of “Medvedevology.”

First stop: Gazprom

Dmitry Medvedev was named head of the supervisory board of Gazprom in June 2000, immediately after Putin’s inauguration as president. The civiliki were quick to follow him to Gazprom.

In July 2004, Anton Ivanov was appointed first deputy head of Gazprom Media, Gazprom’s structure for managing its media assets which had been expropriated from exiled media oligarch Vladimir Gusinsky.

A number of his former classmates had already been installed at Gazprom.

Konstantin Chuichenko, class of ‘87, had in March 2001 become head of Gazprom’s legal department, and in 2002, he became a member of the Gazprom management board and chairman of the supervisory board of Gazprom Media. As of 2004, Chuichenko has been a managing director of the controversial gas trader RosUkrEnergo, the murky intermediary for Russia’s sales to Ukraine of Turkmen gas that was at the centre of the “gas wars” scandal in 2006.

Valeriya Adamova, also class of ‘87, became vice-president of the legal department of the Gazprom chemicals affiliate Sibur in April 2003. Adamova played an active role in helping Gazprom to reclaim assets transferred to Sibur under the 1990’s management. Vladimir Alisov, again class of ‘87, was head of the legal department of Gazprom’s newly-created subsidiary, Gazpromregiongaz, which handles gas distribution in Russia.

One year after Ivanov’s move to Gazprom, Ilya Eliseev, Medvedev and Ivanov’s former classmate, faculty colleague and co-author, was appointed deputy chairman of the management board of Gazprombank, Russia’s third largest. Finally in April 2005, Mikhail Krotov, class of ‘85 this time, former faculty colleague and co-author, succeeded Ivanov as deputy general director of Gazprom Media. Putin had chosen Ivanov to chair the Supreme Arbitration Court, Russia’s highest commercial court.

Civiliki go to court

Ivanov became chairman of the Supreme Arbitration Court in 2005 despite his never having worked before as a judge. He was tasked with launching a systematic reform of the commercial court system – and quickly built up a public profile thanks to frequent media appearances.

Ivanov appointed as his deputy, Elena Valyavina, a university classmate and then faculty colleague, who in the 1990s worked under Ivanov in the St Petersburg city justice department. Adamova moved from her post at Sibur in 2005 to become deputy chairman of the very important Moscow Arbitration Court in 2005.

Nikolai Vinnichenko, class of ‘87, a friend of Medvedev and Ivanov, had risen through the state prosecutor’s office to become state prosecutor for Petersburg in 2003. In October 2004, he was appointed director of the Federal Service of Court Bailiffs.

Vinnichenko’s long-standing deputy in St Petersburg prosecutor’s department, Aleksandr Konovalov, a 1992 graduate of the St Petersburg law faculty, and then faculty colleague of Medvedev and Ivanov, moved to become chief state prosecutor for Bashkiria in 2005, and in the same year was promoted to the post of presidential representative for the Volga region.

Finally, in November 2005, Medvedev’s faculty colleague and co-author Mikhail Krotov moved from Gazprom Media to become the presidential representative to the Constitutional Court.

Civiliki at the Kremlin gates?

How quickly Medvedev will promote his own people to important posts will only become clear if he wins the presidential election and after he is inaugurated as president in May.

It’s also too early to say how the civiliki might impact on the country’s politics. But it would be wrong to expect fundamental democratic impulses from them. Not only are legal scholars inclined to favour technocratic solutions over the cut and thrust of democratic politics, but more importantly at Gazprom Media the civiliki were implicated in the effective de-privatisation of formerly independent TV station NTV, and it was after Anton Ivanov’s move to the Supreme Arbitration Court that the crippling tax claims against Mikhail Khodorkovsky’s now-bankrupt oil company Yukos were enforced.

For the civiliki to tilt the seesaw back towards society, they will first have to discard a lot of ballast.

All the Next President’s Men: Dmitry Medvedev’s Civiliki

Graham Stack for Russia Profile

Roll over siloviki, the civiliki are on their way.

Dmitry Medvedev, United Russia and Vladimir Putin’s presidential candidate, is not a member of the dreaded siloviki network. Instead, he is the leading member of the “civiliki,” a network of St. Petersburg civil law scholars whom he has pulled up into high positions in Gazprom and the Russian court system.

One of Sovietologists’ most treasured analytical tools was to spot networks between officials – usually regional networks – and trace their progress across the Soviet political firmament. In post-Soviet Russia, “networkism” is an equally fruitful political resource and analytical tool. London sociologist Alena Ledeneva has described contemporary Russia as a “network society:” Networkism, a more inclusive, sometimes more productive, form of nepotism, determines both individual opportunities and identities.

The classic example of networkism is, of course, the siloviki network attributed to Vladimir Putin, comprising former KGB operatives from St. Petersburg. Sociologist Olga Khryshtanovskaya has described prolifically how the siloviki have been taking over at the top, occupying post after post in the economy and government.

So there was considerable surprise last week when Putin threw his support behind First Deputy Prime Minister Dmitry Medvedev who does not belong to the siloviki. The West sighed with relief, or even disappointment, as Medvedev, whose small stature and large brown eyes give him more of a resemblance to a teddy bear than a Russian bear.

So if Medvedev is not a silovik, who is he? What network does he belong to?

Dmitry Medvedev is a textbook civilian, a civil law scholar who co-authored an award-winning textbook on the Russian civil code that was first published in 1991. His co-authors included Ilya Yeliseyev, Anton Ivanov and Mikhail Krotov, a few threads in the network that has risen in Moscow alongside Medvedev. The anointed successor, Yeliseyev, Ivanov and another friend, Vladimir Alisov, were classmates from 1982 to1987 at the Leningrad State University law department. They formed a band of four, according to fellow students and staff, spending both their study time and free time together. Medvedev, Ivanov and Yeliseyev then continued on to postgraduate study and eventually taught in the department. Krotov, who also lectured in the department, graduated two years earlier.

Another classmate from 1987 was Konstantin Chuichenko, but, instead of going into academia, he chose the more adventurous path of joining the KGB.

The Businessmen

Dmitry Medvedev was named head of the supervisory board of Gazprom in June 2000, immediately after Vladimir Putin’s inauguration as president.

Not surprisingly, considering the number of ex-KGB men moving into leadership roles, the first of Medvedev’s classmates to take a high position at Gazprom was Chuichenko. In March 2001, Chuichenko was appointed head of Gazprom’s legal department, and in April 2002, he became a member of the Gazprom management board. From January 2002 to June 2004, he was chairman of the supervisory board of Gazprom Media, the holding company created to handle assets expropriated from media oligarch Vladimir Gusinsky.

In July 2004, Chuichenko became one of three managing directors of the controversial gas trader RosUkrEnergo, the intermediary for Russia’s sales of Turkmen gas to Ukraine and the center of the “gas wars” scandal in 2006. In March 2005, Chuichenko also was elected to the supervisory board of Sibneft, after Roman Abramovich bought it from Gazprom.

Other Medvedev classmates were quick to follow Chuichenko, taking up positions at Gazprom affiliates. In April 2003, Valeria Adamova, class of ‘87, was named vice-president of the legal department of Gazprom’s chemicals affiliate Sibur. Gazprom was busy reclaiming assets transferred to Sibur under the 1990s-era management, and Adamova played an active role in court cases.

In July 2004, Anton Ivanov, Medvedev’s co-author and close friend was appointed first deputy head of Gazprom Media, a member of the management board, and a member of the board of directors of television stations TNT and NTV.

In 2004, Alisov, the fourth in the group of Medvedev’s friends and classmates, became head of the legal department of Gazprom’s newly-created subsidiary, Gazpromregiongaz, which handles gas distribution in Russia.

In 2005, Yeliseyev was appointed deputy chairman of the management board of Gazprombank, Russia’s third largest bank.

Finally in April 2005, Krotov, an acclaimed legal scholar with a number of state awards for jurisprudential excellence, was appointed deputy general director of Gazprom Media, succeeding Ivanov, who had moved on to chair the Supreme Arbitration Court in January.

The civiliki go to court

At the time of his appointment to Russia’s highest commercial court and in light of his judicial experience, he was charged with launching a systematic reform of the commercial court system, and quickly developed a public profile in this capacity through frequent media appearances.

Ivanov appointed Yelena Valyavina, Leningrad law department class of ’88, as his deputy on the court. She had been his first deputy in the St. Petersburg city justice department in the 1990s. Valyavina, like Ivanov, had no experience in court work, and Dmitry Fursov, a Moscow Region court judge with far better qualifications, unsuccessfully protested her appointment in court.

Ivanov then started to bring the next generation of St. Petersburg legal scholars to work for him. Igor Drosdov, class of ‘99, moved from his job as assistant to Minister of Economic Development and Trade German Gref (who is also a graduate of the Leningrad law department) to head the administration of the Supreme Arbitration Court. Dmitry Pleschkov, another of Ivanov’s Ph.D. students, became head of the court registry.

Nikolai Vinichenko, class of ’87, had risen through the state prosecutor’s office to become state prosecutor for St. Petersburg in 2003. In October 2004, he was appointed director of the Federal Service of Court Bailiffs.

Finally, in November 2005, Krotov moved from Gazprom-Media to become the president’s representative to the Constitutional Court.

True to their roots

The civiliki are as proud of their faculty ties as the siloviki are of their ties to the “corporation.” Asked in 2006 how close he was to his “former colleague” Anton Ivanov, Mihail Krotov replied, “Why former? We both continue to teach. Anton Alexandrovich lectures and I still work with Ph.D. students and post-docs.”

After their move to Moscow, the St. Petersburg civiliki set up shop in the faculty of civil law at the esteemed Higher School of Economics. Ivanov is head of faculty; Drosdov is deputy head. Other faculty members include Yeliseyev, Krotov, and Pleschkov.

Medvedev, receiving an honorary degree from St. Petersburg State University in 2006, promised to return to give a lecture in the same year: “But not about the National Projects or strengthening the Russian state. I’ll lecture to you about Roman law, because Roman law is the foundation of everything else,” he said.

Friends in high places

The civiliki have a number of associate members who have made their way independently to top positions.

Alexander Konovalov, presidential envoy to the Volga Federal District, graduated from the law department of St. Petersburg State University in 1992 and went on to lecture in civil law alongside Ivanov, Krotov and Medvedev while working in the municipal state prosecutor’s department.

From 1997 to 1998, he served as a deputy to Nikolai Vinichenko as a district prosecutor in St. Petersburg, and between 2001 and 2005, he worked as deputy state prosecutor for St. Petersburg.

In 2005, he became the state prosecutor for Bashkortostan, where he investigated the Blagoveschensk police brutality scandal, and won some acclaim from human rights activists. He also investigated the privatization of the region’s oil companies by structures close to the political leadership. In November 2005, he replaced former Prime Minister Sergei Kiriyenko as presidential envoy to the Volga Federal District.

Minister of Regional Development Dmitry Kozak was a classmate of Mikhail Krotov, graduating from the Leningrad law department in 1985. He worked in the St. Petersburg prosecutor’s office and was the deputy mayor of St. Petersburg between 1996 and 1999. He is considered a political heavyweight and reformer, someone whom Putin has used to handle emergency situations.

Lovers of law, distrustful of democracy

It is too early to say what impact Medvedev’s civiliki will have on Russian politics. It was only towards the end of Vladimir Putin’s first term that the influence of the siloviki became decisive in Kremlin policies, and it also took Medvedev time before he started to actively promote his own people to Moscow posts.

The first round of reshuffling following the presidential elections in March will show how intent Medvedev is on appointing his classmates to top government positions. The most likely for promotion to the government or Kremlin administration, is Anton Ivanov, who has achieved some public prominence, including TV appearances alongside Vladimir Putin.

It would be wrong to expect fundamental democratic impulses from the civiliki. Legal scholars are inevitably distrustful of the cut and thrust of democratic politics, as it threatens to impair the “perfection” of draft laws. Noticeably, none of the civiliki, for all their legal expertise, has chosen to engage in legislative politics on either the regional or national level.

Now, with Medvedev assured of complete control of the Duma after United Russia’s landslide victory, the civiliki will have carte blanche to draft legislation according to all the textbook procedures. But can scholarly erudition compensate for a complete absence of political competition in making good laws?