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### Viewing cable 07MOSCOW1442, RUSSIAN CORPORATE STATISM: WATCH THIS SPACE

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
07MOSCOW1442 | 2007-04-02 07:07 | 2010-12-01 21:09 | CONFIDENTIAL | Embassy Moscow

`

    VZCZCXRO1331
    PP RUEHDBU RUEHFL RUEHKW RUEHLA RUEHROV RUEHSR
    DE RUEHMO #1442/01 0920750
    ZNY CCCCC ZZH
    P 020750Z APR 07
    FM AMEMBASSY MOSCOW
    TO RUEHC/SECSTATE WASHDC PRIORITY 8840
    INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
    RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
    RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
    RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
    RHEHNSC/NSC WASHDC PRIORITY

` `

    C O N F I D E N T I A L SECTION 01 OF 04 MOSCOW 001442

    SIPDIS

    SIPDIS

    STATE FOR EUR/RUS; EUR/ERA; EEB/IFD
    STATE PLS PASS USTR FOR DONNELLY, MOLNAR
    NSC FOR KLECHESKI AND MCKIBBEN
    DOC FOR 4231/IEP/EUR/JBROUGHER

    E.O. 12958: DECL: 04/02/2017
    TAGS: ECON EINV EIND PGOV RS
    SUBJECT: RUSSIAN CORPORATE STATISM: WATCH THIS SPACE

    REF: 06 MOSCOW 1306

    Classified By: Ambassador William J. Burns for reasons 1.5 (b/d)

    ¶1. (C) Summary: The rise of corporate statism in Russia has
    been significant. Since 2004, the government has taken over
    the world's largest titanium business, consolidated its
    position in Gazprom, merged 10 aviation businesses into a
    state-owned conglomerate, and taken controlling positions in
    other firms. No less fascinating has been the mix of greed,
    politics, and business behind the expansion of the state into
    the economy. Looking ahead, our contacts are strongly
    divided. Some see troubling signs of continued state
    ambition. Others believe the process is essentially
    plateauing, and will stabilize at lower levels of state
    ownership in the economy after two-three years. In our view,
    the current trendline may quickly approach some rather
    natural limits, and the Kremlin will eventually have to bow
    to the market. In the meantime, we should reinforce
    market-driven approaches and the cadre of Russian
    policy-makers who doggedly keep these ideas in play. End
    Summary.

    ¶2. (SBU) This cable is based on dozens of conversations with
    contacts in industry and banking over the past six weeks,
    supplemented by Embassy-based research.

    The Breadth of State Ownership
    ------------------------------

    ¶3. (SBU) The march of the state into parts of the Russian
    economy over the past few years has been significant, with
    control of swaths of the natural resource, defense, and
    select other sectors consolidated in state hands. Annual
    revenues of Russia's ten largest state-owned or controlled
    companies reached an estimated 20 percent of GDP in 2006.
    State-owned or controlled companies account for one-third of
    the Russian stock market's capitalization, and in just the
    last year, the value of these equity holdings has almost
    doubled to an estimated USD 369 billion. And the process
    continues: Rosoboronexport is rumored to be in line to buy
    Russia's fifth largest steel producer, Mechel; further
    consolidation in the energy sector favoring Gazprom and
    Rosneft is likely; a new shipbuilding national champion is in
    the works; and diamond giant Alrosa has its eye on Norilsk
    Nickel, a USD 30 billion company with more than the half the
    world's palladium and one-fifth of global nickel output.

    Looking Behind This Latest Great Grab
    -------------------------------------

    ¶4. (C) The grab for Russia's resources is an old story, but
    contacts agree that traditional motives (greed, power) have
    been supplemented in this round with a nationalistic brand of
    commercial considerations. Greed in Russia shocks no one,
    but the rising value of Russia, Inc. (on the back of high
    energy prices) has made the current grab particularly
    profitable for some. Power considerations -- both
    geopolitical (as in the case of Gazprom) and in the context
    of Russia's domestic succession process -- are evident as
    well. New to this paradigm is the surprisingly strong role
    business considerations seem to be playing -- as the Russian
    Government tries to salvage a select few decrepit remains of
    Soviet industrial prowess before it is too late. Our
    contacts have a lot to say about all three motives; we
    summarize what we've heard here.

    ¶5. (C) Greed: The Kremlin leadership in the economy is in no
    small part about money, and the Sibneft takeover by Gazprom
    is perhaps the most blatant example of this (only about a
    quarter of the $12b selling price for the firm is said to
    have actually gone to owner Abramovich). In general, the
    insider offtake from M&A deal flows is said to be so large
    now that Swiss banks have told Kremlin cutouts (like
    gas-trader Timchenko) that they cannot accept further
    deposits without knowing the source of the money. The most
    lucrative transfers to the state (usually involving natural
    resources) may be wrapped in patriotic rhetoric, but include
    a healthy dose of financial opportunism. Yet, as ugly as it
    looks, our contacts remind, it is not so different than what
    happened in Indonesia and South Korea - and Mexico too. As
    one contact points out, "the bureaucrats got rich there too."

    MOSCOW 00001442 002 OF 004

    ¶6. (C) Power: Creating national champions and projecting a
    strong image for Russia abroad has been a leading factor in
    many state-connected takeovers and consolidations, including
    the removal of the Gazprom ring fence, the Rosoboronexport
    makeover, the RUSAL-SUAL deal, and the anticipated takeover
    of Norilsk Nickel by Alrosa. Some of what we are seeing is
    also is part of the ongoing succession process, putting
    individuals into deal flows and thus providing campaign
    finance and enhancing their public profile. The decision to
    put military hardware exports under Rosoboronexport is seen
    in some quarters as buttressing dark horse presidential
    hopeful and Rosoboronexport Chairman Sergey Chemezov. Recent
    portfolio changes are seen by some as giving First Deputy
    Prime Minister Sergey Ivanov a cash-laden institutional base
    like that enjoyed by his chief rival for the presidency,
    First Deputy Head of the Presidential Administration and
    Gazprom Chairman of the Board of Directors Dmitriy Medvedev.

    ¶7. (C) Nationalistic-Driven Commercial Considerations: Many
    believe that Putin and those around him are also driven by a
    sincere desire to right the excesses of the 1990s, or
    oligarchic plundering of once-proud, though ruinously
    inefficient, Soviet companies. The examples here are truly
    varied. In the case of Avtovaz, Rosoboronexport's move to
    take over the firm last year may be the only thing saving the
    car-giant from complete collapse in the face of global
    competition. The emerging Norilsk Nickel story is said to be
    as much about saving Alrosa (which experts say will run out
    of diamonds in ten years' time) as it is about keeping
    Norilsk's palladium and nickel output in Russian hands. And,
    as driven by national security concerns as the formation of
    the United Aircraft Company might be, also at play is a
    long-overdue consolidation of an industry largely on the
    verge of collapse. These examples are more about saving jobs
    and communities and creating viable competitive companies
    than personal enrichment. Although making money is not
    precluded here, both Avtovaz and UAC, not to mention plans to
    create a new shipbuilding national champion, sound more like
    cash sinks than cash cows.

    What Next?
    ----------

    ¶8. (C) Looking ahead, our contacts are divided about what to
    expect next. "Statist" believers argue that there are
    troubling signs that the trend is far from contained:
    state-owned companies are straying farther from their core
    business, eyeing the telecom and IT sectors, and expanding
    beyond traditional financial services. They point to
    Gazprom's movement into electricity; Svyazinvest's
    significant stake in privately-held telecom provider Comstar;
    and VneshTorgBank's overtures to brokerage house Troika
    Dialog (ultimately rebuffed). While no one is predicting
    another Yukos-style approach, there is a sense that the
    authorities can and will come up with new pretexts for
    control.

    ¶9. (C) In contrast, others argue the state's reach is
    plateauing, and the current mix of state-private ownership
    could start to reverse itself before long. They say national
    champions in the sectors that make sense have been created,
    and industries such as telecom and IT do not lend themselves
    to over-centralization. In gas and electricity, given supply
    shortfalls, the GOR has to promote private investment to meet
    demand and introduce efficiencies. A shrinking current
    account balance (on the back of lower oil prices) and the
    drive to diversify the economy only heighten the need for
    private capital and better corporate governance (which
    implies a move away from state ownership and control). The
    Kremlin will also find it increasingly difficult to control
    emerging interest groups, from the consumer sector to
    regional governments. Integration into the WTO and other
    western economic institutions will require greater
    transparency, better and more equal market access, and lower
    protectionist barriers - which will temper the state's
    ambition.

    ¶10. (C) Some take this latter argument one dark step further.
    They say that current GOR leadership, its successors and
    supporters, will need to find outlets for their accumulated
    wealth, much of which is said to be held in liquid assets
    abroad. The theory goes that these funds will start making
    their way back to Russia over the next two-three years, and
    that the target of the return flows will most likely be the

    MOSCOW 00001442 003 OF 004

    same assets that have been carefully squirreled away in state
    hands over the past few years -- thus spurring share
    offerings by Rosneft, spin offs at Gazprom, etc. These
    assets are profitable, and equity ownership in Russia carries
    less risk for this particular group of investors than the
    prying eyes of regulatory authorities abroad. Likewise,
    coming into Russia from an European investment platform, as
    one contact cynically noted, may make it less likely that
    zealous law-enforcement officials abroad would pursue
    criminal or civil cases for fear a U.S. or European firm
    could get tangled up in the investigation.

    Where We Come Out
    -----------------

    ¶11. (C) Looking at the three motives most obviously at play,
    two of them -- greed and nationalistic commercial
    considerations -- suggest equally valid reasons why we might
    see the state pulling back from its commanding heights over
    the next few years. Greed will tend to push those who have
    accumulated shares in state companies towards share
    cash-outs, just as it will push those who have accumulated
    "private" cash abroad to buy back into Russia's safest
    investments. Rosneft is a perfect example. We are watching
    to see who in the government argues the loudest for Rosneft's
    further privatization -- they more than likely stand to
    benefit from either the sell or the buy opportunity. For
    industries that are less obvious moneymakers, exemplified by
    Avtovaz and UAC, the state is even more likely to divest
    (wholly, in the case of Avtovaz) as the firms become
    commercially viable and need investment capital and strategic
    partners, and as they become less social land mines and
    resemble more the typical day-to-day slog of the business
    world.

    ¶12. (C) But pulling back does not mean exiting the field.
    XXXXXXXXXXXX does not expect the state  ever to
    relinquish its control of XXXXXXXXXXXX. Nor will the
    GOR  allow its stake in Gazprom to drop again below 50%,
    although  many predict it will shed non-core assets in the
    coming  years. Nor will the diamond trade or trade in metals
    likely  see a repeat of the halcyon days of private ownership
    in the  wake of loans-for-shares. UAC will likely never be
    more than  30% privately-owned.

    ¶13. (C) But even if every firm in the natural resources
    sector ends up in state hands, as significant as that would
    be, it would account for around 12% of the Russian economy.
    Add in state monopolies in the transport and communications
    sector, defense industries, and space, and state control over
    the economy rings in around 25% of GDP. As disturbing as
    this figure might seem, it is not wildly out of line with
    other market economies rich in natural resources. As
    recently as two years ago, the Norwegian state owned
    approximately 32% of the companies listed on the Oslo Stock
    Exchange, and still holds shares in 10-15 percent of
    Norwegian industry, including controlling shares in oil,
    telecoms, and the national airline. In Mexico, the state
    fully controls the oil, gas, and nuclear power industries and
    has reserved for the state in whole or part the
    telecommunications, air travel, and postal sectors.

    ¶14. (C) And these back of the envelope estimates ignore
    important counter trends to the movement toward greater state
    control. Whole swaths of the economy, our interlocutors
    again and again confirm, lie fully outside the ambitions of
    the state -- and are thriving. One seasoned businessman (who
    has had his hat handed to him on more than one occasion over
    the past 15 years) is back in Russia and growing fast, and he
    chalks up his current success to the booming service and
    retail sector, a place where he says he never comes in
    contact with the designs of the Kremlin. There are also
    instances, like with XXXXXXXXXXXX, where, despite the
    new ownership
    structure, the state has left the firm to run the business
    without Rosoboronexport grabbing off profits or instructing
    where production should go. Lastly, it would be
    irresponsible to ignore the progress being made toward the
    break-up and privatization of both the electricity and rail
    sectors. When all is said and done, these massive reforms
    will move some 2-3 percent of GDP from state to private hands.

    ¶15. (C) There is another reason why more of this economy
    will  likely move into the private sector. Economic
    modernizers,  as they have come to call themselves here, may still

    MOSCOW 00001442 004 OF 004

    ultimately get the upper hand. XXXXXXXXXXXX,
    XXXXXXXXXXXX, XXXXXXXXXXXX and  others
    recognize that only through greater private sector
    participation in the economy will Russia be able to attract
    the capital needed to sustain growth over the long run. This
    is also where working to bring Russia into international
    institutions will help drive policy here in the direction we
    favor. Locking the Russian Government into such institutions
    and exposing Russian companies to the discipline of the
    global market will reinforce the trends we seek to encourage.
    Doing so this year, before the election process starts to
    create new winners and losers, is a bet on the modernizers
    worth taking.

`