Chris Weafer of UralSib -

On March 2, Dmitry Medvedev will be elected as Russia's third president and he will formally take office in early May. All opinion polls predict he will win between 65% and 75% of the vote. We also know that President Vladimir Putin will likely formally serve as Medvedev's prime minister and mentor. But Putin, of course, will be much more that this: he will remain the most important and influential member of the government, and he will use that position to ensure that his vision of Russia's future economic and social development remains on the course that he has laid out.

Medvedev has already publicly committed to pursuing Putin's main goals, and this combination, joining the new generation of Medvedev with the powerful Putin, is viewed by investors as almost ideal for sustaining economic growth and general stability in government. Indeed, this is also one of the more important assumptions in our very favourable outlook for the equity market in 2008 - once the volatility in global markets settles.

However, there are also some very obvious flaws and risks associated with this power-sharing arrangement. Differences in terms of handling problems and the prioritizing of reforms and spending are inevitable. If inflation is not reigned in and people's currently high expectations are not met, then this could provide a catalyst for just such a test in 2009.

Just as critical for the longer-term investment case will be how the new power structure in the Kremlin accommodates the Kremlin clique with links to the securities services, or how this so-called Siloviki adapts to this new regime. While the case for a 12-month honeymoon period is strong, the critical test for the new government structure will be how these issues are handled, and there effect on the viability of the new economic plan and the investment case for Russia generally.

Next phase of development

While Medvedev has committed to pursuing the main goals of Putin's vision for the country, there will, no doubt, be changes in the Kremlin's priorities with the advent of a new presidency. We are counting on that. For the past eight years the government has been focused on rebuilding domestic political control, on creating or restructuring national champions in the so-called strategic sectors and building up the country's financial reserves. With few exceptions, there have been no major spending programs outside of the social sphere and the defence sector over the past eight years - Putin has always made it clear that this next spending phase would not start until the government had completed the preparation phase. Now we are at the transition point and identify the Medvedev presidency as the start of the investment phase. This rebuilding assumption is also a big part of our assumption for the market and stock selection this year.

State companies likely to lead the next phase

While both Putin and Medvedev have identified the need to promote greater diversification in the economy to build up industries outside of extractive industries, and to reduce the state's involvement in big industries, the reality is that over the next few years the main investment drivers will be in the so-called strategic industries with the big state companies playing a key role. Alongside that we expect to see steady growth in the consumer and service economy as we have seen over the past eight years. But state investment in new industries, eg. nanotechnology and aviation, is expected to be slow because of the lack of any meaningful existing infrastructure. Those goals are more likely to be realized in the presidential term that follows from 2012.

Oil revenue dependency is increasing

The investment story in Russia today is even more vulnerable to the oil price, despite the current growth coming from industries outside of oil and gas, and both Putin and Medvedev declare the need to reduce oil dependency as a high priority. The reality is that the funding that helps pay for that growth, and which sustains the high confidence levels in the economy, is overwhelmingly oil and gas tax revenue.

Around two-thirds of the 2007 federal budget revenue came from oil and gas taxes. This year, the Finance Ministry has already raised the oil price forecast by $20/bbl to $74/bbl (Urals), the first time that the budget is based on a higher oil price than the actual average of the previous year. Coupled with the proposal to cut the VAT rate to around 13%, this will make the budget even more dependent - and vulnerable - on oil prices, as this new phase of the economy begins. Investors will hope that the goals of this new phase are pursued with much greater vigour than those of Putin's two presidential terms. The next government can hardly expect to get so lucky on rising oil and gas tax revenue.

The two presidents

Russia is about to face an usual period between March 2 and the May inauguration as, effectively, the country will have two presidents, a situation never encountered before, as Yeltsin resigned early. In practice, this is not unusual in other countries - for example in the US - and should pose no problems. But it is yet another unique event in Russia that will, at least, allow media and legislators a period of adjustment to the truly unique situation that is to follow. In no other country of significance has a popular president, with the constitutional right to return to the presidency at a future date, taken another role in government.

Medvedev has been very careful to point out that he intends continuing with Putin's strategy of reforming Russia's economy and improving the social backdrop. In recent speeches, he has focused on some elements of that plan to emphasize the country's need to increase life expectancy, tackle the high level of corruption, improve healthcare and education, etc. Putin also highlighted these issues in his speech to the State Council last Friday. Both men also emphasized the need to reduce the involvement of the state in the economy, with Medvedev stating that he believes a continued state role would risk a "crash" in the economy. During Putin's eight years as president, the state has focused on rebuilding a strong role in the so-called strategic industries and many of the biggest state enterprises are now headed by members of the Siloviki. That in itself is an interesting dynamic going forward and one of the potential areas of conflict in the future.

Timeline from here

1) In late January, president-in-waiting Medvedev set out major elements of his programme in speeches to business leaders and elected officials at two events in Krasnodar and in Moscow. These mainly concerned social developments, but also touched on his priorities of improving the business climate.

2) President Putin made his last major address on policy issues February 8 when he addressed the State Council in the Kremlin.

3) Putin as president will hold his last Q&A session with journalists on February 14. Many questions will undoubtedly try to tease out a better picture of how the relationship between Putin and Medvedev might work in the future.

4) Medvedev will address the Krasnoyarsk Economic Forum on February 15-16, and he is expected to set out his economic agenda more specifically. 5) Election date is March 2.

6) During March and April we expect to hear of any changes to cabinet positions, restructuring of government ministries and agencies, and perhaps at the top of state companies. The fate of the Economy Ministry, for example, is subject to frequent rumours, with many commentators expecting it to be split and allocated to other ministries.

7) Dmitry Medvedev will be inaugurated as the country's president in early May.

8) The Duma is expected to quickly approve his choice of prime minister.

9) Medvedev's first major foreign event will likely be the G8 summit in Japan in early summer.

Issues to be resolved

There are a number of issues that remain unresolved from the Putin presidency and we may see progress made on these in the "window" between the March election and the May inauguration. One obvious issue is the need to start raising domestic gas and electricity prices at a faster pace to generate extra revenue to fund the huge capital programs faced by the Generation companies and Gazprom.

The government has not approved these higher tariff increases, in election year, but cannot delay for much longer. The March-April period would be a good time to make the changes. We are also told that the government is considering a sort of windfall tax to claw back some of the estimated $25bn that gas producers will earn by virtue of the tariff hikes, and that will likely be disclosed at the same time. The state will likely use some of this extra revenue to subsidize residential consumers to help them pay for the higher tax bills. But, we also expect Gazprom to get substantial tax exemptions to help it fund the huge capex program it faces, while independent producers will likely only be allowed keep a small proportion of the extra revenue. There are also some other legacy issues, such as the long-expected state role in TNK-BP; this should also see some resolution during this window, and it would allow Medvedev to start the new phase with a relatively clean slate.

Both Putin and Medvedev are singing from same sheet

Medvedev has made two major speeches to date in which he spelled out some of the priorities for his forthcoming presidency. He addressed the RSPP in Krasnodar and he spoke at the Civil Forum in Moscow. In these speeches he set out his priorities in the social sphere (education, health care, demographics) and a promise to try and tackle the problem of corruption, the so-called "legal nihilism" and the excessive amount of bureaucracy in Russia.

Medvedev is expected to set out his main agenda for the economy at a speech later this week, during the Krasnoyarsk Economic Forum. In this address, he is expected to specifically address the issues below:

• Taxation policy

• Financial market development

• Property rights

• The general business climate.

• Getting support for its legislative program, but clearly will not be able to process all six hundred draft laws. Therefore, it will be a case of prioritizing those deemed the most important. In total, almost 450 out of the tabled 600 draft laws are thought to be a priority for the government, although the United Russia party - presumably in consultation with the Kremlin - is thought to be refining that to an even smaller number to ensure that the most important legislation is passed early this year.

• Economy. President Putin has already pushed the Duma into making changes to the proposed timetable for raising state salaries and pensions (bringing forward the date for planned increases from September to February. (See "issues" further down) In general, any legislation that is part of the government's economic and social programs can be expected to be fast tracked once introduced.

• Strategic Industry. This has been a very contentious piece of legislation since first muted over two years ago. Since then, various drafts almost made it to the Duma before being recalled or delayed for re-drafting. Clearly a major source of internal disagreement inside government, with a powerful faction looking to severely restrict foreign investor access to Russia's most important industries. However, the current legislation was introduced last September and is now a priority. Without this legislation in place it will be more difficult to attract the increased levels of foreign investment targeted for the next four years.

• Stock Markets. Draft legislation has been tabled covering a whole range of capital market regulations that are designed to bring Russia's bourses into line with international standards. For example, legislation covering the regulation of affiliated party transactions. Many large global money managers do not deal in the local markets, and trade only to ADRs and GDRs because of the absence of some key pieces of market regulation, Such practice limits full access to capital markets by Russia's enterprises

• National Projects. Investing in and progressing major national projects is an identified part of the new president's program. The enabling legislation is part of the priority package in the current Duma session. The "Basis National Projects" list breaks down into the following main categories: education, health care, housing construction, agriculture.

Chris Weafer is head of strategy at UralSib, Russia

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