Putin and Russia’s Big Business: From Unstable Stability to Stable Instability?

In the fall of 2011, Russia’s middle class joined forces with diverse opposition groups and a bohemian circle of writers, singers and prominent journalists to challenge the corruption of the electoral process in Russia. The protests notwithstanding, the pro-government United Russia party won a questionable victory in last year’s parliamentary elections.

However, the opposition rallies in Moscow succeeded in one critical regard: They questioned Mr. Putin’s medium- and longer-term ability to deal with Russia’s archaic and non-transparent political and economic system.

Putin responded in a predictable manner. He made promises of extra public spending and genuinely competitive elections, while painting a gloomy picture of political chaos if he were to be forced out. He positioned himself as the man of stability.

Ironically, contrary to what Putin seems to think, it is not Russia’s highly divided opposition movement and the nascent middle class, so vocal during the recent public demonstrations in Moscow, that are the real threat to his rule.

No, his two biggest challenges over the next few years will come from growing divisions within the political and business establishment, as well as potential new waves of mass discontent with unpopular economic reforms in Russia’s big industrial centers.

The combination of Russia’s WTO membership and the prospective liberalization of domestic gas prices could have a negative impact on the big industrial centers of the country. Traditionally, Russia’s industrial centers have benefited from government protectionism. Although WTO membership and liberalization policies are vital for Russia, their timing and sequencing may make the country politically unstable.

This makes Putin’s position over the next several years a potential replay of what happened to Boris Yeltsin in 1998-99, when a group of Russian political elites (led by regional governors and oligarchs) attempted to influence Yeltsin’s succession.

What this means for Putin’s third term is that the business and political elites who once viewed him as their protector will now be more concerned about how to protect their power and wealth in the post-Putin era.

Big business and political risk

The key dilemma for Russia’s billionaires is how to safeguard their assets in a politically volatile environment. Although 20 years have passed since the collapse of Soviet communism, property rights are still not protected in Russia. The country’s businesses, big and small, are still exposed to a highly corrupt legal system, arbitrary executive power and non-transparent political structures.

Moreover, Russian companies are regularly compelled to contribute a large share of their gross profits as corruption payments to the domestic regulatory, security and law enforcement agencies.

In the 2000s, in order to ensure long-term protection of their investments by the international legal system, Russian billionaires increasingly began relying on protection through partnerships with leading foreign investors (as was the case of the Russian-British joint venture, TNK-BP). They also set up elaborate offshore ownership structures, including Western contracts.

However, following the Yukos affair, leading Russian entrepreneurs opted to limit their political risks through establishing a good personal relationship with Vladimir Putin.

Between 2000 and 2008, during his first terms as president, Putin’s “power vertical” of centralized decision-making and high popularity ratings made him politically invincible. At the same time, rising global oil prices gave him domestic credibility as an effective economic manager and boosted his confidence in international affairs.

Since party politics and democratic legislative structures were of no importance, Putin positioned himself as the only force in the Russian political system that could maintain its stability.

Naturally, such a system lacked an institutionalized mechanism for the succession of political power, transparent interactions between economic and political players, and the long-term protection of property rights.

As a result (and quite ironically), the very leader who no longer enjoys high popularity ratings and can no longer fully rely on the highly-corrupt law enforcement apparatus to stay in power is fast becoming the system’s main liability in the eyes of the elites.

The loyalty of the elites

Putin’s primary problem is his loss of credibility as a leader of national unity who can effectively fight widespread corruption, modernize and diversify the economy, promote social mobility, and deal with growing social inequality.

Moreover, Dmitri Medvedev’s interim presidency, despite the limited impact of many of his policies, created certain expectations of change not only within the society, but also among the segments of big business that were banking on successfully modernization policies. In this respect, the return of Putin to the presidency has, therefore, become associated with a return to stagnation, not stability.

While in the fall of 2011 Putin averted political confrontation by allowing mass protests to run unhindered in Moscow, his condescending comments about the opposition rallies tarnished his image as a confident political leader.

And public remarks by Patriarch Kirill, the head of the Russian Orthodox Church, urged Putin to treat the opposition with respect further undermined Putin’s position as an unchallenged ruler. In a surprising “coincidence,” the Patriarch’s comments were immediately followed by a widespread campaign accusing him of living a lavish life-style and benefiting from government quotas for alcohol and tobacco imports and oil exports in the 1990s.

The Patriarch responded obediently, with his full backing of Putin’s presidential bid, while doing his part to undermine speculations about Putin losing the support of powerful members of the Russian elite.

Putin was also particularly worried that Russian billionaires would start financing the opposition movement in order to protect their assets during politically unstable times. He chose a simple, but seemingly effective strategy to secure the loyalty of the entrepreneurial elite.

In February 2012, he suggested that Russia’s big business should expect to pay a one-off windfall tax on the assets originally obtained during the “unequal privatization” of the 1990s. At first glance, this idea appears to be aimed at fulfilling his electoral promise of providing extra public spending while calming social instability and appeasing communist and nationalist groups within the opposition movement.

In reality, however, Putin merely used the windfall tax threat to ensure the loyalty of big business during the presidential electoral cycle and the growing political protest. In this context, Putin’s message to Russian billionaires was simple: “Support the opposition at the peril of losing your assets.”

Putin’s economic populism and political rhetoric, questioning the legitimacy of Russian privatization in the 1990s, could make the earlier privatized assets even more politically toxic and expose them to further demands.

Putin’s windfall tax idea has already created rifts within the domestic corporate and political establishment. It has been criticized by a former minister of finance, Alexei Kudrin, and businessmen Mikhail Prokhorov and Vladimir Potanin as dangerous for the country’s investment climate, as well as undermining the protection of property rights.

Even if the Kremlin decided to abandon the tax as too divisive for the elites, it would be difficult to prevent the debate on unequal privatization of the 1990s from dominating the domestic political agenda in the future.

The new privatization wave

The focus on the “unequal privatization” of the Boris Yeltsin-era has attracted public attention to the swift rise of Putin-era billionaires and the ongoing battle within the Russian government over the second wave of privatization.

Under Putin, several of his alleged friends from St. Petersburg emerged as the primary beneficiaries of profitable state contracts, particularly in Russia’s most lucrative economic sector, the oil and gas industry. People such as Gennady Timchenko and Boris and Arkady Rotenberg came to prominence as trading partners in Russia’s national energy firms, Gazprom and Rosneft.

Having generated significant capital, these new players have begun to acquire corporate assets, often from state-controlled companies at a considerable discount. For example, in 2008, the Rotenberg brothers bought Gazprom’s construction assets and subsequently merged them into a private corporation, Stroygazmontazh, Russia’s major pipeline building contractor.

Putin-era billionaires are also emerging as a decisive third force in the ongoing battle between the liberal and conservative wings in the Russian government over the future privatization of state-controlled oil and gas companies, such as Rosneft, Transneft, Transnefteprodukt and Zarubezhneft.

The liberal wing in the old Putin government — represented by Deputy Prime Minister Igor Shuvalov, Minister of Economic Development and Trade Elvira Nabiullina, and presidential economic adviser Arkady Dvorkovich — have argued that the state-controlled companies should be completely privatized (with the government retaining a golden share).

In the opinion of the liberals, this new wave of privatization will enable Russia to attract investments for industrial modernization and the promotion of greater transparency and efficiency of the state-dominated sectors of the domestic economy.

The conservatives do not completely reject future privatizations, but seek a delay until the external economic situation sufficiently improves to make the sale of the state’s corporate assets more profitable for the government.

These people, the siloviki, also highlight Rosneft’s strategic importance. It is pivotal for attracting foreign investment and technology for new large-scale projects in East Siberia and the Arctic and as a key tax contributor to the Russian budget. It also very much has the potential to become a globally influential asset — an organization that can promote Russian energy interests abroad.

One man’s popularity ratings

For all the speculation, now going back at least two decades, over who is up and who is down in Russian business, for the principals this is about far more than a horse race.

If they truly want to find a strategy to safeguard their assets, only one thing is for sure: As long as Russia does not have strong democratic institutions, such as free elections, a real multi-party system and free speech, as well as transparent and uncorrupted legal systems, private corporate assets will continue to be exposed to arbitrary demands of future Russian rulers and possible political storms.

In the meantime, Russia’s plutocrats “vote” with their families. Increasingly, they do not only seek to park their financial assets abroad, but their wives and children live abroad. That, to them, is the only effective way to be less “extortionable.”

This problem will remain until Russian elites realize that the stability of the domestic political and economic system cannot be based on one man’s popularity ratings, or his effective control over the highly centralized decision-making process and the law-enforcement apparatus.

Access to the international legal system, partnerships with Western companies and the use of Western contracts offer only short-term protection of property rights in Russia.

Without the establishment of strong democratic political institutions, effectively channeling interests and grievances of diverse social groups, corporate assets of Russian business elites cannot be reliably secure over the long term.

This realization may drive Russia’s big business towards lobbying Vladimir Putin for real political reforms. The question remains whether Putin will be able to meet these aspirations or will be coerced into cutting his presidential term short.

Author’s postscript: A new Russian Cabinet of ministers was formed on Monday, May 21. Elvira Nabuillina and Igor Sechin have left the government, while Igor Shuvalov retained his post. Sechin is likely to chair Rosneftegaz (the state holding company which controls Rosneft), while Arkady Dvorkovich has been appointed deputy prime minister in charge of the oil and gas sector.

The question remains whether Sechin, as a government outsider, and the siloviki group will still be able to resist the potential privatization of Rosneft by the liberal wing headed by Shuvalov and Dvorkovich.