The $23 Billion Fund

7 March, 2005

The new economic policy emerging in Russia does not mean that foreign companies will be excluded. Quite the contrary.

Having conceded that Soviet central planning was a failure, the Kremlin is wooing big international companies for their expertise - on certain conditions.

The joint venture between Lukoil and ConocoPhillips is the template. Foreign investors have to show a long term commitment in the form of an equity stake.

Holdings

But their holdings will be limited to a maximum of 24 per cent, while management and financing is split on a fifty-fifty basis.

Foreigners will not get the best assets in strategic sectors, but will be allowed to hold majority stakes in smaller oil fields or 'non-strategic' sectors like food processing.

Example

The attempt by Siemens to buy 74 per cent of the heavy equipment producer, Power Machines, is providing a good example of a company that got it wrong.

The stake was simply too big.

The initial objection - that the firm has defence contracts - was overcome by spinning off that unit. The anti-monopoly commission, which has to sign off on the deal, was inclined to approve it in December.

But the company, which supplies most of Russia's generating equipment, now appears to have been classed 'strategic'.

The Industry Ministry wants a consortium of Russian companies to buy the stake, instead.

Fund

The increasingly powerful Siloviki faction is set to expand its area of operations to go beyond individual deals to interfere with policy in general.

Its members have been trying to get their hands on Russia's Stabilisation Fund, into which windfall oil revenues are siphoned.

After expanding fast, the Fund contains more than $23 billion.

By law, it can only be used if oil prices fall below $18 a barrel.

Prime Minister

Finance Minister Alexei Kudrin is jealously guarding the Fund, saying that the excess should only be used for the (non-inflationary) early repayment of Russia's external debt.

IMF and World Bank loans have already been paid off and negotiations over repaying the $44bn Russia owes to the Paris Club are ongoing.

However, Prime Minister Mikhail Fradkov, who is seen as the mouthpiece for the Siloviki, has ordered that the budget for 2006 should contain a cut in the rate of value added tax from 18 to 13 per cent - three points more than the IMF and liberal ministers suggest.

Fradkov is not saying how the $10billion knock in state revenue would be financed.

Most probably by a raid on the Stablisation Fund.

Growth

The tax cut will almost certainly boost growth from last year's 6.7 per cent to above the 7.1 per cent level needed to meet Putin's goal of doubling GDP by 2010.

But economists are warning that this will be 'low quality' growth, which will not help sustainable, long-term expansion of the economy.

The worry is that the Siloviki are intending to squander the very resources that the country needs for the sake of hitting an arbitrary target set by the President.

The backdoor subsidy will spur inflation - without restructuring, the economy is unable to absorb large infusions of cash.

Contemptuous of the idea, the liberals say buying growth will not fix Russia's problems.

Power

Though the liberal economic planners look very isolated, there are still a few voices on their side whispering in Putin's ear, such as Arkady Dvorkovich, a young Western-trained economist who belongs to the President's inner circle.

The tax issue has to be decided by the end of the Duma's spring session in May so there is a chance that President Putin may be induced to intercede.

Still, the fracas only highlights just how deep the rift has become between the men that delivered Russia's first strong growth since the 1970s and those who are, increasingly, exercising real power in the Kremlin.