MOSCOW BLOG: Throw money at it

By bne IntelliNews November 2, 2011

bne -

Russia needs investment - a lot of it. But it's not arriving. So the Kremlin has launched a raft of initiatives to attract more capital. The trouble is, rather than fixing the fundamental issues that are keeping investors away, the Kremlin is throwing huge amounts of money at the problem. But if you step back and look at the scale of the job at hand, all the tens of billions of dollars being put on the table is just a drop in the ocean.

The most high profile initiative was the creation of the $10bn Russian Direct Investment Fund (RDIF) that was launched at the Kremlin's annual investment jamboree in St Petersburg this summer. On the face of it, there is little to complain about. The fund will co-invest in interesting sectors with leading foreign funds and take a minority role. It is run by Kirill Dmitriev, a sharp, young manager who cut his teeth at the US-backed private equity fund Delta Capital before going on to run his own highly success $1bn fund Icon. In short, Dmitriev "gets it" when it comes to creating the kind of investment opportunities that will appeal to western investors. His focus on strong returns and squeaky clean corporate governance will be music to foreign fund managers' ears. The chances are that the RDIF will work: it should bring in billions of dollars of foreign capital.

The second big addition to this initiative is the International Financial Corporation-run Russian banking fund, which compliments the RDIF that can invest into everything except banks. Both funds are backed by the state development bank-cum-debt agency Vnesheconombank (VEB), which has committed $10bn to the RDIF and $250m to the IFC fund.

The bank fund's manager, the IFC's Timothy Krause, is now on the road pitching the fund to sovereign wealth funds and other big investors. And as an old Russia hand with several very successful bank investments under his belt, the chances are Krause will manage to raise the extra $500m that he's looking for.

However, critics argue that there is a fundamental contradiction at the heart of these funds. "Look at the logic of these funds," says one senior fund manager who didn't wanted to be quoted criticising the Kremlin. "What they are saying is if you invest together with the Kremlin, then you are safe. But flip that around: if you don't invest with the Kremlin, you are not safe. Is that what you want to be telling investors? So will these funds improve the investment climate? After all that is ultimately what they are there for."

And these two funds are only the latest addition to a slew of Kremlin-backed initiatives designed to kick start investment. In 2008, the then president Vladimir Putin personally backed the creation of the Russian Venture Company (RVC), which was supposed to unleash Russia's intellectual talent by providing it with access to about $1bn of capital. (As the former chairman of Russia's Venture Capital Association, Dmitriev was also involved in creating this.) But the company has been a failure and is yet to produce a single marketable product.

The same is true of Nanotech, the state-backed technology company. Heavy hitting Russian politician Anatoly Chubais was hired to run the company, which is supposed to finance the development of technology that will put Russian science at the leading edge modern science. But it too has yet to produce a single sellable product.

Or Skolkovo, the business school and technology park, which is rapidly turning into another white elephant; Russia's productivity is a third of the US' and a World Bank study found that 60-80% of the gap is simply due to bad management. Russia doesn't need one elite $1bn business school; it needs a hundred to train a generation of managers how to run a business efficiently.

And this is not to mention all the national champions the state has set up such as the United Aviation Company, VTB group in banking, Sovkomflot in shipping, Avtovaz at the centre of the automotive sector, to name a few - although some of these champions have made some real progress and produced real products and services.

The Kremlin correctly identifies the problems, but its knee-jerk solution is to throw money at them. It is an expensive way to go about remaking Russia and despite the tens of billions spent on these programmes, they pale into insignificance in comparison to Russia's investment needs, which run into the trillions of dollars. But thanks to oil and gas, Russia has buckets of money to spare and so it doesn't matter if these plans are wasteful; they allow those in power to point at these structures and say they are doing something about Russia's problems.

So while Dmitriev might "get it" when it comes to structuring a fund and a deal to make it attractive for foreign investors, he is just one bright, young manager (from a growing cadre of real professionals that are gradually moving into positions of power in the Russian government). His bosses in the Kremlin, however, don't get it.

Better uses

Far more effective would be to take all this energy and put it into fixing the underlying system, so that investors don't need the backing of the Kremlin to plough through the corruption, bureaucracy and economic volatility to make successful investments.

So is real Russian reform condemned to wait until the current ruling elite retire or die? "The Russian [stock] market is worth about a trillion dollars, which means that companies could use it to raise about half a trillion," says Alexander Ikonnikov, chairman of Russia's Independent Directors Association. "But if you double the value of the market to 2 trillion, then companies could raise 1 trillion - there you have it: the money the government needs to pay for all the investment that it wants to do. The new direct investment fund has $10bn, but in the grand scheme of things, it is only a drop in the ocean."

To be fair, the Kremlin has started on this more difficult task with the International Financial Centre (IFC) project headed up by the Micex stock exchange chairman Ruben Aganbegyan (who at 39 years old is another one of Russia's Young Turks). But as the former head of the stock market regulator Igor Kostikov pointed out in an interview with bne, even this reform is being done top-down and ignores the broad problems facing small investors who are the key to making this reform work. "The trouble is, we don't have the experts in government to develop the market," says Ikonnikov. "They focus on the strategic sectors that will generate money and then use that to push the economy forward. In the USA they are very good at attracting capital and do everything to promote their markets. That is what we need to do."

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