By Jason Bush
About this time last year, Kremlin watchers had a hunch 2004 would be a pivotal year for Russia's post-communist development. Few doubted that in the March elections, President Vladimir Putin would be reelected for a second four-year term. The big question was what Putin's second term would bring -- a new wave of Westernizing reforms or more old-style crackdowns.
The answer so far is pretty unequivocal -- and a big disappointment for global investors and companies looking to get into the Russian market. Prospects for reforms are as icy as the Russian winter, as Putin's government asserts its control over crucial industries and sectors. "It's terrible," says the head of research at one Moscow investment bank, who asked for anonymity. "Russia will live on, but it knocks back the rise of investment. What's the long-term incentive to invest?"
The disappointment is all the greater because Putin's first term was, on balance, a great success. He restored political stability after the turbulent 1990s, and pushed through several important reforms, helping Russia to achieve impressive economic growth rates that averaged 7% in 2000-03.
Despite serious concerns about his policies toward Chechnya and the media, many Russians and transplanted foreigners, including most Western businesspeople, believed that outside critics exaggerated the problems. Support for Putin was remarkably broad, ranging from capitalist billionaires and pro-Western liberals to left-leaning voters nostalgic for Soviet days. As Russia's stock market went up 300% during Putin's first four years, investors smiled.
But since the reelection, just about everything that could go wrong has. The No. 1 vexation has been Putin's vendetta against the oil company Yukos, owned by Russia's richest man, Mikhail Khodorkovsky, who angered the President by becoming too heavily involved in politics. Instead of tensions quietly winding down after Putin's reelection, as many had hoped, the Yukos affair has escalated dramatically.
Although Yukos was considered one of Russia's best managed and most efficient companies, the Russian government has seized its assets and lodged preposterous tax charges of $26 billion against the energy giant. Putin hasn't stopped at the persecution of Khodorkovsky and his partners. A number of Western investments in Yukos have also been expropriated. The whole affair has been so arbitrary and vicious that it makes a mockery out of Putin's claims to support the rule of law. Even Yukos' lawyers are now under arrest.
HARDER TO GOVERN.
Investors still have hope that the Yukos fiasco will be a one-time settling of scores. But plenty of evidence points to a more systematic policy of autocratic control on Putin's part. International monitors condemned the March election, citing among other irregularities the state media's pro-Putin bias. Media control was tightened even further after the election, as two popular TV shows devoted to political discussion were suddenly dropped.
Then in September, Putin used the attack on a school in Beslan by Chechen terrorists as a pretext to push through a sweeping plan to reform Russia's political system, abolishing regional elections in favor of simply naming presidential appointees. Of course, no one can explain how exactly this is supposed to fight terrorists. Many political analysts believe Putin's concentration of power in the Kremlin will just make Russia even harder to govern.
The Russian President also has managed to upset Western opinion even more with his policies toward Ukraine. While international election monitors reported the widespread vote-rigging in Ukranian presidential elections in November, Putin immediately congratulated pro-government candidate Viktor Yanukovych on his supposed victory, resisted demands for a revote, and even condemned Western monitors for doing their job. By Jason Bush
In truth, investors in Russia don't necessarily mind Putin's autocratic ways. In fact many believed that more power for Putin might kick-start economic reforms. But here too, the predictions have proved wrong. Key Putin policies –- such as calls to restructure Russia's giant and inefficient state monopolies, overhaul the pension system, and slash bureaucracy –- have been blocked from within the government, the bureaucracy, and even the Kremlin itself.
Although dominated by Putin's supporters, the parliament has busied itself with laws that are irrelevant to economic reform: banning citizens from drinking beer in public, for instance, or making it harder to form political parties. Some now worry that Putin may have already lost his best chance to push through important economic measures. Yegor Gaidar, director of Russia's Institute for the Economy in Transition and a former Prime Minister in the 1990s, told me last December that "everything" would be decided about the course of Putin's new term from May to July of 2004. It's looking more and more like he was right.
The only comfort for business is that Russia's economy has remained relatively strong, buoyed by record high oil prices. But growth has slowed dramatically in recent months, as investment increases have plummeted. GDP growth is forecast to slow to 6.5% this year from 7.3% in 2003, and government officials fear it could fall to below 4% in 2005. That's well below the 8% Putin has targeted in order to double GDP in a decade.
"CLIMATE OF FEAR."
Frustrated by the snail's-pace of reform and the damaging Yukos case, Putin's economic advisers are in increasingly open revolt: "The most dangerous thing is the climate of fear, which didn't exist a few years ago," Presidential Economic Adviser Andrei Illarionov told Russia's Kommersant newspaper on Oct. 14.
The biggest fear was that the tactics used against Yukos would be extended to other top Russian companies. Sure enough, on Dec. 8, tax authorities presented blue-chip mobile phone company Vimpelcom with a $158 million back-tax bill for 2001, knocking $10 billion in value off Russian stocks in a day.
Local analysts believe the action against Vimpelcom is linked to a commercial dispute between Alfa Group, a core Vimpelcom shareholder, and a rival business group allegedly linked to Leonid Reiman, Russia's Telecommunications Minister and an old associate of Putin.
From the point of view of Russia's investment climate, the precise motives hardly matter. "Of course it's a complete banana-republic-type situation, where someone can persuade the tax authorities to become involved in a private dispute," says Matthias Westman, chief executive of Prosperity Capital Management, one of Russia's largest portfolio investors.
Maybe in 2005 Putin will have second thoughts and try to limit some of the damage caused by this year's string of controversies. But many in Russia are predicting worse to come, fearing that Putin will bend the constitution to extend his power beyond 2008 or try to exert control over other sectors.
The Russian President has repeatedly denied such intentions. But he also denied that he was out to destroy Yukos or to scrap regional elections -- and then proceeded to do exactly that. Those broken promises mean, whatever else Putin's second term brings, the most important achievements of his first years in office -- predictability and stability -- have already been consigned to the history books.
Bush is a correspondent in BusinessWeek's Moscow bureau