Seems Russia's economy is headed for the poop box

LETTER FROM EUROPE
Investors of the World, Here's the Word on Putin Inc.
By ERIN E. ARVEDLUND

Published: March 2, 2005


OSCOW, March 1 - In recent weeks, President Vladimir V. Putin's politics have generated most of the worry in the West. He has been cutting welfare benefits for veterans and pensioners, clamping down on free media and meddling in the Ukrainian election. Even President Bush, who badly needs the Kremlin's cooperation in combating terrorism, the spread of nuclear weapons and narcotics trafficking, gently chided Mr. Putin about maintaining democratic standards when the two met in Bratislava last week.

But the president's concerns about democratic principles may miss the larger point. The real threat to Russia's future could lie in the economy. For now, its gross domestic product is booming, it boasts a budget surplus and a windfall from record high oil prices. But it is pursuing a model of corrupt, state-managed capitalism, economists and political analysts say, that is inimical to democracy and could condemn its economy to perpetual third world status.

Many here believe the turning point was reached last December, when Russia renationalized one of its largest private oil fields in a deal that Andrei Illarionov, an outspoken Kremlin aide, acidly called "the swindle of the year."

The transaction was an offshoot of the Yukos affair, the Russian government's campaign to dismember what was once Russia's largest private oil company and jail its billionaire founder, Mikhail B. Khodorkovsky. Having staggered the company with a questionable $28 billion tax bill, the Kremlin seized the oil fields and auctioned them for about half their worth.

The winner, a state-owned business named Rosneft, overnight joined the ranks of Russia's top oil companies.

Big oil fields changing hands at a cut-rate price recalls the rigged privatizations of Russia's robber baron era in the 1990's. But instead, it was the Kremlin cutting this deal, a parallel that for some here crystallized thinking on Mr. Putin's course for the country.

"Today, by our own decisions, we have done what is now, regrettably, clear to the outside world - we opted for the third world," Mr. Illarionov said after the auction. "We used to see street hustlers do this kind of thing," snapped Mr. Illarionov, who until recently was among Mr. Putin's most fervent supporters. "Now officials are doing it."

A few days later, he was relieved of his duties as Russia's Group of 8 representative; he still has an office in the Kremlin.

Exactly what Mr. Illarionov meant by third world is unclear. He would seem to be pointing to the developing world of the 1960's and 70's, with state-directed investment and rampant cronyism, rather than the more free market approach that became popular in the 1980's and 90's.

But the point was made. Instead of embracing free-market capitalism, Russia has veered away: renationalizing oil assets, weakening property rights and signaling to foreign investors that their millions - and their presence - are not entirely welcome.

"Illarionov was being colorful," said John Litwack, head of the Moscow office of the World Bank. "But if that is the new model - to destroy assets, expropriate the company and put the industrialist in jail - and if it's repeated, that's different than just renationalization. That's an environment more like the third world."

Even a former prime minister, Mikhail Kasyanov, who was dumped by Mr. Putin in 2003 and has talked about challenging him in 2008, told the Interfax news agency last week that the country "has taken the wrong turn, which harms the country's economic and social development."

Economists say it is uncertainty that is most damaging. Building blocks of a free market system - the courts, the tax agencies and law enforcement - have been corrupted during Mr. Putin's second term and by the Yukos case in particular, undermining investor confidence.

Russia's tax authorities, used by the Kremlin to undermine Yukos, have gone on a rampage. Vimpelcom, the country's No. 3 cellphone company, was served with a tax bill of $158 million late last year, linked by some Russian media reports to a vendetta by the telecommunications minister (who reportedly has investments in a competing company). Vimpelcom whittled that bill down to $17 million, but only after the intervention of the Norwegian government, whose state phone company Telenor is an investor.