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

By bne IntelliNews June 11, 2008

Graham Stack in Moscow -

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

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

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

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

Heard it before

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

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

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

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

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

Big business looks out for small

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

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

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

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

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

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

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