COMMENT: The Kremlin shifts gear in 2007

By bne IntelliNews February 20, 2007

Roland Nash of Renaissance Capital -

For a regime facing its final year in power, President Vladimir Putin's Kremlin has been remarkably active so far in 2007. The reshuffle in the Kremlin power system late last week was a major shift in itself. As significant, though, was the context in which the changes were made.

Whatever one thinks of the aims and impact, the range and ambition of both domestic and foreign policy in recent weeks is striking. Domestically, a $189bn, 10 year overhaul of the military has been signed off by government; two new pro-Kremlin parties are being promoted; the four government financed National Projects have been started; state monopolies from UES to Sberbank are embarking on major investment projects; new charges have been made against Mikhail Khodorkovsky; the rouble has been made euro-clearable; and changes to the tax system have been mooted.

In better times

Less overtly, changes in ownership at Norilsk Nickel, movement in management at Alrosa, rumours swirling around Surgutneftegaz and bureaucratic pressure on BP all suggest another round of asset ownership redistribution. And internationally, the activity has been, if anything, even more pronounced. Rarely has a political leader of a significant state sent such a strong message in a public forum as that which was sent by Putin in Munich last weekend. From Davos to Delhi, the three big guns of the Administration, Putin, Sergey Ivanov and Dmitri Medvedev, have been on a mission to push Russian foreign policy.

It seems unlikely that the timing of the shift in power was coincidental. Set in the context of the recent spate of domestic and foreign policy activity, it seems that the Kremlin is setting itself up to utilize Putin's popularity and the centralized power structure built over the last seven years to push forward aggressively with the Kremlin's agenda - both official and unofficial - in the final year of Putin's constitutional presidency.

Reshuffling the deck

First, the reshuffle. The shift in power was concentrated in the military-industrial wing of government, where the interests of two factions were considerably strengthened at the expense of at least one other. The most obvious conclusion is that the elevation of Sergei Ivanov out of the problematic Defence Ministry to equal footing with First Deputy Prime Minister Dmitri Medvedev has provided him with a more secure platform for any future presidential ambitions. The first-year recruit whose legs were amputated after a particularly nasty hazing incident was just the most public of recent scandals to hit the dysfunctional defence sector. In his new position, Ivanov will have as yet unspecified responsibility over some part of Russia's booming economy, a far more rewarding proposition.

The other two promotions were of technocrats who fit well the usual mould of Kremlin appointees. Both have a background in St Petersburg and both are associated with the siloviki. The new defence minister, Anatoly Serdyukov, was promoted out of the Federal Tax Service, where his most high profile association was with the crippling of Yukos in 2004. Both his financial background and his proven ability to withstand enormous political pressure are likely the main qualifications he will bring to his new position.

In some ways the most interesting change was the promotion of Sergei Naryshkin from chief of staff of Prime Minister Mikhail Fradkov's government to deputy PM in charge of foreign trade, for two reasons.

First, it strengthens the position of Fradkov in government and consequently weakens his opponents, the liberal-economic axis of Kudrin and Gref. Fradkov has been rumoured in recent weeks as a potential consensus candidate to take over from Putin. This promotion adds some credence to that seemingly unlikely proposition. It also makes more likely the long-mooted exit of either Kudrin or Gref.

Second, it emphasizes the political importance increasingly associated with foreign trade. In his new position, Naryshkin is understood to be mainly responsible for trade with former Soviet Republics. Pipeline disputes and the hydrocarbon wealth now coming online in Central Asia have encouraged Russia to greatly increase the political significance attached to trade within the CIS. Elevating the trade position to that of deputy PM and giving it to a technocrat reporting to the siloviki wing in government serves to both increase the clout of trade within the Administration and reinforces its political significance.

One final intriguing point about Naryshkin is that he also happens to sit on the board of Rosneft. In recent months, Rosneft has been remarkably quiet, at least relative to Gazprom. The promotion of Naryshkin, his potential influence over trade and his association with thesiloviki in general and Rosneft Chairman Igor Sechin in particular, suggests that the friendly competition between the two hydrocarbon giants will continue.

The handover

Now, the context. As with almost every major government decision in Russia today (and many private), any shift in policy is partly a reaction to regime change next March. While there might be consensus in the West that Putin is in full control of his regime's electoral destiny, there is no such consensus in Moscow.

Characters as disparate as Vladimir Yakunin, CEO of Russia's Railways, and PM Fradkov, have been mentioned as possible successors in recent weeks. Everything remains in flux. A populist berating of the US, some pre-election fiscal largesse and the last minute reshuffling of asset control can help buy some alliances, or at least provide some financial security for those who may not have much after 2007.

But equally any new impetus should also be seen very much in the context of Putin's longer term ambitions for Russia. In fits and starts, and with success continually stunted by the limitations of the Russian bureaucracy, Putin has pushed to restore what he sees as Russia's traditional global position and influence. In loose terms, this has involved three policy planks.

First, to centralize authority in the Kremlin and make policy formation possible and therefore credible. In the Kremlin that Putin inherited, power was distributed so widely that policy commitments were simply implausible. Second, to generate economic growth commensurate with Russia's potential. The twin insights that a powerful Russia depended first and foremost on a powerful economy, and that a powerful economy was only possible in the modern world through the market and trade, were perhaps the most important ideas that Putin took into the Kremlin. Third, that large swathes of the Russian economy have social and political responsibilities and significance beyond just the economic. Hydrocarbons, commodities and parts of the military-industrial complex must, therefore, in the view of the Kremlin be under the control and influence of government, not just shareholders.

The interplay of these three strategic aims, with all of the inconsistency and conflict between them, in the context of a weak institutional framework and an inefficient and corrupt bureaucracy is what drives Putin's Russia. Recent policy initiatives should be seen in that context. Some of them are simply a New Year focus on old ambitions. Gref's promise of imminent WTO entry, a renewed assault on poor Mikhail Khodorkovsky, the promotion of new parties and more government pressure on the hydrocarbon sector are hardly new. But equally, much appears to be a real shift in the underlying direction of policy.

Domestically, the oil bonanza that has so far been so successfully pumped into the stabilization fund will increasingly be focused on government policy. Social spending and infrastructure investment are set to increase, financed both through the budget and via arm-twisting of those industries under the control of government. Every state company from UES to Transneft via Gazprom, Sberbank and Rosneft is set to ramp up investment. Private-public partnerships and the government sponsorship of selected industries will considerably increase the role of the government in the economy.

Internationally, reflecting both US weakness and Russian strength, the priority of a strategic relationship with the US appears to have been substantially demoted. Instead, Russia is looking for partners among the emerging economic powerhouses in Asia and its fellow commodity-rich countries in the Middle East and South America. Where this used to be done almost clandestinely through trade agreements with Iran, invitations to Hamas, arms deals with Venezeula and military manoeuvres with China, the strategy seems to have become much more open.

The message being sent depends on the audience. To India, China, the Middle East, North Africa and South America, the message is a call for partnership and the offer of access to influence on the global stage. To the EU, it is the usual ambiguity encouraging (successfully) a divided, and therefore largely ignorable, response. And to the US, it is a new level of provocation, popular at home, winning the respect of those countries wanted for partnership, and ultimately, believed to be relatively costless – the major non-military lever of the US is money, and if there is one lesson learned by Russia over the last decade, it is that private money flows in a very different direction from whatever is threatened publicly.

What is clearly not happening, despite the rhetoric in Washington, is a new "Cold War." Phrases that are charged with the sort of historical baggage clinging to the term "cold war when used out of context can be dangerously misleading. The Soviet Union, with a substantially larger economy than that of today's Russia, invested 30% of its GDP in its military. Even after this year's expected fiscal expansion, Russia's entire federal government is only just over half this size. Military spending is less than 8% of that of the US.

FDI into Russia last year was $25bn, and will likely rise further this year. One of Putin's major grouches is that Russian companies are prevented from investing more in the West. Russian companies in 2006 raised more money on international exchanges than any other country except China, the UK and the US, and the number of IPOs is expected to increase in 2007. The rouble last week became euro-clearable, which has already kicked-off a new leg in Russia's integration in global capital markets. One of the central economic ambitions for Russia in 2007 is to gain entry into the WTO. International companies consistently site Russia as one of the most lucrative markets globally. Imports have risen from $45bn in 2000 to $162bn in 2006. There is a burgeoning middle class in Russia which views foreign travel as a right. Russia has become immensely more integrated into the global economy under Putin.

Russia sees itself very much as part of the modern, global economy, albeit a country with unique assets and interests. The country competes for influence and authority, but competes with the same interests and the same goals, in the same forums and, largely speaking, according to the same rules as just one among many other countries. A very different situation from when the Soviet Union struggled with the US for entirely different ideological visions while the rest of the world looked on. Applying the term "cold war" simply encourages the antipathy and withdrawal that the term itself implies.

An ambitious Kremlin in the final constitutional year of a successful presidency looks set to push forward with a wide range of political and economic initiatives both domestically and abroad in 2007. Some of these, like the expansion of fiscal policy and the promotion of trade, will be official government policy. Others, like pressure on strategic firms and the promotion of various power groups, will be less ordered. The impact will be varied, but will at least involve heightened uncertainty, a more stimulative economic policy (watch steel, pipes and real estate) and a more assertive foreign policy agenda.

Roland Nash is Chief Strategist for the Renaissance Capital in Moscow

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