Putin's Russia

At an historic moment, it's emerging as a key U.S. ally

For two weeks after the September 11 attacks on the World Trade Center and the Pentagon, Russian President Vladimir V. Putin seemed to go into a deep sleep. True, he was the first world leader to call President George W. Bush to express his condolences. Afterward, though, Putin retreated to a luxurious dacha in the Black Sea resort of Sochi, frequented by Kremlin leaders since the days of Nikita Khrushchev. Leaving the day-to-day running of the government to Prime Minister Mikhail Kasyanov, Putin spent hours on the phone with global and regional leaders. Yet he kept silent as hard-line aides publicly set sharp limits on Russia's participation in the U.S.-led anti-terrorism campaign.

But as it later became clear, Putin was not hibernating. He was hatching a plan to back America. Some members of his own team, including those in the military, were left out of the loop--though U.S. diplomats at the American Embassy in Moscow, clued to continuing telephone conversations between Putin and Bush, knew where the Russian President was headed. "He's with us," a senior embassy official said on Sept. 24. "And he is all by himself." In a television address that evening, Putin jolted hard-liners by backing the basing of U.S. forces in former Soviet republics in Central Asia.

TURNING POINT. That was just the start of the surprises. At an Oct. 3 meeting at NATO headquarters in Brussels, Putin softened his own opposition to NATO expansion to the Baltic states, on Russia's border, and even expressed interest in Russia joining the organization created in 1949 to check Soviet expansionism. Then came his announcement that Russia would pull out of its cold-war era military bases in Cuba and Vietnam.

Now Putin is headed for a summit with Bush in the U.S. on Nov. 12-14. The meeting, held while the rubble still smokes at the World Trade Center, could prove an historic turning point in Russian-U.S. relations. Missile defense, arms treaties, cooperation on fighting terrorism, business deals--it's all on the table. And Putin is determined to make things happen. After months of warning the Bush Administration against abandoning the 1972 Anti-Ballistic Missile Treaty, he now appears willing to scale back the accord. Such a step, controversial at home, would give the green light to the Bush team's key foreign policy aim--to develop a missile defense system. Bush and Putin would also dramatically curtail the numbers of warheads maintained by America and Russia. The cutbacks--to as low as 1,500 on both sides--could save billions for Russia, which over the next quarter-century may need up to $2.5 trillion to replace outworn Soviet-era infrastructure.

Putin's push for closer security ties to the U.S. is part of a wider gambit. Putin wants to lead Russia closer to the West in a broad and urgently needed modernization--not just of its battered army but also of its economy, schools, and legal institutions. The goal is to create for post-Soviet Russia a lasting place in the family of nations to which Putin feels his country rightly belongs--even though it now lags behind by just about every conceivable measure.

It's hard to believe these bold gestures are coming from a man few in the West even knew just two years ago, when Putin emerged from the tumult of Russian politics as Boris N. Yeltsin's designated successor. And when his past became known, American policymakers immediately wondered if the steely-eyed, impassive Putin would engineer the return of the Soviet security state and deal Russian democracy a death blow. Here, after all, was a lawyer who had spent his career in the KGB, the intelligence agency that had waged cold war abroad and at home. Few in the West thought they could deal with this ex-spymaster.

QUIET EDUCATION. Yet for those who looked, the signs were already there that Putin was not an ideologue with a rigid Soviet mentality. A posting in East Germany in the 1980s gave him the chance to learn the differences between the Eastern and Western German economies and societies firsthand. Those lessons stuck: Putin was gradually won over to the side of capitalism. After the Soviet Union collapsed, he helped attract Western investment to St. Petersburg as a deputy in the mayor's office.

The upcoming meeting with Bush is a culmination of those formative years. But even now, it's hard to know how he will play his cards. Unlike the gregarious and impulsive Yeltsin, Putin tends to seek counsel only from trusted aides like Chief of Staff Alexander S. Voloshin, whom Kremlin insiders say encouraged the tilt to the U.S. after the September 11 attacks.

It may be through his martial-arts training that Putin acquired his trademark negotiating style--his ability to turn the strength of his sparring partner to his own advantage. "Judo is not just a sport," Putin said in First Person, a collection of interviews published last year. "It's a philosophy."

A philosophy that pairs nicely with his own realpolitik. Putin's calculation is that the best hope for a prosperous Russia lies in its greater integration into Western-led political and economic institutions, including NATO and the World Trade Organization. The deal is simple to understand, fiendishly difficult to execute. By cooperating with the U.S., Russia wins the respect of the West--an intangible advantage, but a real one. For as relations grow warmer, Putin hopes to convince investors that Russia is no longer the sinkhole it once was. And as Western investment accelerates, Putin can argue to Russians that the only way to keep the money flowing is to continue advances in corporate governance and transparency. As Putin declared on Oct. 21 at a news conference with Bush in Shanghai, "our priority is partnership, a partnership based on the common values of one civilization."

Yet if America is vital to Putin, Russia is important to Washington in a way that hasn't been true since the war on Nazism. Not only does Bush want a strategic tie-up that will allow the U.S. to move ahead with missile defense, he wants a U.S.-Russian alliance in the campaign against terrorism, which could last years. In a trip to Moscow slated for Nov. 3, U.S. Defense Secretary Donald H. Rumsfeld is expected to work out with the Kremlin plans for using Russian military bases, fuel supplies, and troops in search-and-rescue missions in the war in Afghanistan. Russia's territory is vital. It stretches from the Sea of Japan to the Gulf of Finland. Iran is just across the Caspian Sea. The KGB and its successor agencies have monitored the activities of Islamic groups on Russia's borders for years. The Bush team also sees Russia as a source for crude oil should U.S. relations with Saudi Arabia deteriorate. Pumping seven million barrels a day, Russia is second only to the Saudis in oil production.

STRONGER ECONOMY. One factor that could strengthen this new alliance is that Putin, unlike Yeltsin, is not coming to Washington with his begging bowl out. Flush with export revenues from oil, gas, and other commodities, Russia in October prepaid a $350 million installment on a loan from the International Monetary Fund due in 2003.

Instead, Putin is seeking to expand relationships with sophisticated players such as ExxonMobil Corp. (XOM ) and United Technologies Corp. (UTX ) And he's working to persuade them that they can make money in Russia, whose economy has grown strongly in the last two years after a decade-long depression. Elements of the post-Soviet kleptocracy have started to fade. Though the mob still exists, gangland killings--a fairly common occurrence in the early 1990s--seldom take place these days.

True, plenty of corporate chieftains still seek to win favors for their businesses through bribery and other means. But a growing number of companies are succeeding through savvy management and high-quality products. Moscow-based juicemaker Wimm-Bill-Dann, which got marketing advice from U.S. agribusiness giant Cargill in the early 1990s, is now a thriving exporter of beverages to the U.S., Europe, and the Middle East. "A lot of progress has been made in the past year and a half," says Christof Ruhl, chief economist at the World Bank's Moscow office. Attentive investors like Boeing Co. (BA ), aware of such improvements, are planning fresh commitments.

You can sense the change in the streets. Take a stroll along central Moscow's Tverskaya Street, where the commercial landscape is unrecognizable from a decade ago. Restaurants serve the latest in fusion cuisine. Boutiques display leather pants for the fast set. Neon billboards line the wide thoroughfare. Here, shoppers increasingly are buying improved domestically made goods from manufacturers including television-set maker Rubin and refrigerator maker Stinol.

WELCOME MAT. Of course, Bush and other Western leaders remain concerned about the nasty edges of Putin's Russia. They are well aware of Putin's disturbing efforts to chill criticism of such policies as his brutal military campaign against Chechen rebels. But Western leaders, too, are practicing realpolitik. "It is clear that President Putin understands that Russia's future lies primarily in the West," Secretary of State Colin L. Powell told the Senate Foreign Relations Committee on Oct. 25. "That's the source of inspiration, that's the source of technology, it's the source of capital, it's the source of security."

So Washington is rolling out the welcome mat. As a gesture to the Russian President before his departure for America, Rumsfeld on Oct. 25 announced a postponement of planned missile tests that the Administration said might have violated the ABM treaty. Resistance may even be softening to Putin's long-term demand for a formal treaty to codify any new security arrangement. "That would be a huge victory for Putin," says U.S.-Russia analyst Michael McFaul at Stanford University.

The big question is whether Putin's ever-balky country is ready to follow his lead. From Peter the Great at the outset of the 18th century to Boris Yeltsin in the last decade, Westernizing Russian leaders have stirred backlashes that have jeopardized their programs and sometimes their lives. Few in government dare criticize Putin openly. Yet a push is on within the military and security services to make Defense Minister Sergei Ivanov into a conservative counterweight to the President. Putin embarrassed Ivanov, a close associate, by overruling him on the decision to permit U.S. bases in Central Asia. "Opposition to his policy of bringing Russia to the West is growing," says Moscow political analyst Andrei A. Piontkovsky.

So the U.S. had better come up with enough concessions on security issues such as the ABM treaty, suggests a Kremlin aide, or the Russian President may be forced to change tack and again side with the hard-liners. "For the first time there is a gap between Putin and the bureaucratic consensus," says Sergei Rogov, director of the U.S.-Canada Institute, an independent think tank in Moscow. There is also a breach between Putin and the broader public, a majority of which opposes the U.S. air strikes in Afghanistan. This is an unusual spot for Putin, who cherishes the comfort of consensus.

Still, Putin is not entirely alone. He can call for backup from Russia's prominent business leaders. After a decade of robber baron capitalism that burned many Western investors, these bosses now say that these kleptocratic practices proved a dead end for a country with an annual gross domestic product of $300 billion, on a par with the Netherlands. "Russia tried to live by its own rules," says metals baron Vladimir O. Potanin, president of Moscow-based Interros. He's backing Putin's effort to accelerate Russia's entry into the WTO, which imposes rules for competition on its members. Some of the better companies know if they meet international standards, they can expand beyond Russia.

BACK ON TRACK. Putin can also count on youthful idealists who thirst for national renewal. Students are seeking a sense of "national dignity" for a country humiliated by the Soviet Union's collapse, says Andrei Isserov, a 21-year-old graduate student at Moscow State University whose focus is American history. Fluent in English and a devoted reader of the Western press, Isserov is not looking for Russia to become a copycat of the U.S. "But we would like to feel ourselves European," Isserov adds. Convinced Russia is getting back on track, Isserov and his friends plan to make their careers in their homeland. That's heartening news for a nation that has seen many of its brightest minds depart for Israel, America, and Europe.

Though Putin can rely on the urban elites, the rest of Mother Russia has yet to embrace the West. Russia's 145 million people are in many ways provincial and isolated. The Communist Party remains the biggest grassroots political machine and a font of anti-American rhetoric. Communist leader Gennady Zyuganov calls Bush's demand that nations stand with or against America on terrorism "blackmail."

One source of such hostility is the failure of U.S.-backed market reforms in the early 1990s. "It may not be beneficial for big American financial powers to see Russia strong and prosperous," says Alexander Sukharev, 33, an engineer who gets by with a job at a German tourist agency in Moscow. Such sentiments are unsurprising in a country where the average monthly wage is $115 and 35% of all people live below the poverty line, and where the impoverished hospitals cannot lessen the scourges of tuberculosis and AIDS. On military issues, cold-war attitudes are still widespread. "NATO is our enemy," says a 19-year-old Russian Army soldier stationed at the border with Estonia in northwestern Russia.

Putin's domestic challenge is immense--even if he does enjoy 75% approval ratings. That's why it's essential that Putin's pro-West policy has a quick economic payoff. The recovery has been a principal contributor to his popularity. Boosted by high oil prices, GDP last year grew by 8.4%. This year, even with softening oil prices, Russia is still one of the world's fastest growing economies, with GDP expanding at a 5.5% clip.

FLAT-TAX POLICY. Of course, the economy, as well as government tax revenues, remains dangerously dependent on one industry. Energy sales directly account for 16% of GDP and a third of federal budget revenues, sustaining equipment suppliers and providing income for the nation's banks, law, and advertising firms, retail outlets, and restaurants. Every $5 drop in the price of crude costs Russia about 1% of GDP. A sustained decline in oil prices would be "very dangerous for the economy" and would threaten Putin's political standing, says Oleg V. Vyugin, chief economist at Moscow brokerage Troika Dialog and a former deputy finance minister for Yeltsin. A slump would also endanger his drive to restore the schools.

No wonder Putin has tried hard to keep the momentum going. In a supply-side plan more radical than anything undertaken by President Ronald Reagan, Russia substituted a 13% flat tax on personal income for a complicated system of multiple brackets that many people evaded. Smart move: For the first half of 2001, personal income-tax collection rose by 50%. The economy is expected to get another boost from a cut in the corporate profit tax, from 35% to 24%, a Putin initiative passed by the Duma this year and slated to take effect on Jan. 1, 2002.

Those policy shifts will free up capital for companies bent on self-improvement. The most impressive gains have been in the oil patch. Starting in 1989, as the investment-starved Soviet economy effectively imploded, Russian oil production declined for 10 straight years. But in 2000, boosted by $5 billion in capital expenditures, output rose by 5%. This year, output is projected to climb by 7.5%.

The smartest companies, such as privately held Tyumen Oil, are turning to Western energy service companies for a boost. A Russian native and veteran of BP PLC, Tyumen president and CEO Simon G. Kukes has installed a 300-plus contractor team from Dallas-based Halliburton Co. (HAL ) to improve the productivity of its aging Samotlor field in western Siberia. Since 1998, pre-tax profits have doubled and are expected to reach $1.4 billion in 2001. "Since 1998, Russian producers have gone from not knowing what was depleted in a field to having production software that gives them real-time information at each wellhead," says Jamie Richard, portfolio manager at Firebird Management in New York, a Russia investment fund.

More Western resources are on the way. ExxonMobil has decided to increase its $600 million investment in its giant Sakhalin-1 oil and gas development project off the Pacific Coast by $4 billion over five years. Greater political consensus between the U.S. and Russia may also boost the chances for cooperation in building a pipeline from the oil-rich Caspian Sea to the West. BP, main developer of the proposed pipeline from the Caspian port of Baku to Ceyhan in Turkey, is huddling with Russia's Lukoil over possible participation.

Putin is also using pressure from foreign shareholders to push for management change at Gazprom (OGZPF ), which is 38%-owned by the government. Five months ago, he ousted Rem Vyakhirev as CEO of Russia's biggest and perhaps most corrupt company. Vyakhirev's replacement, Alexei B. Miller, a longtime Putin associate, is backing a plan to open Gazprom's monopoly pipeline system to all gas producers at reasonable rates and is ousting Vyakhirev's cronies in the face of opposition inside the company. "He is cleaning out the dinosaurs," says William Browder, managing director of Hermitage Capital Management, a Moscow investment fund.

Russia's oil and gas supplies could run out in 30 to 40 years. That's why it is essential that Putin's charm offensive lures in more Western capital to help diversify the economy. With a 15% rate of annual growth, the Russian information technology business is expanding nearly three times faster than the economy as a whole: Its companies hope to peddle cheap and reliable software code, much as India's software outfits have.

Leading the way are such companies as Moscow-based Information Business Systems (IBS), whose revenues are expected to climb by 23%, to $250 million this year. Its client roster, which includes IBM (IBM ) and Citibank (C ), should grow sharply. After September 11, 10 U.S. companies, including insurance giant American International Group Inc. (AIG ), approached IBS about the possibility of offshore programming deals. That is not only because tighter finances mean more companies are looking for discount programming but also because India is looking less stable because of its proximity to Pakistan. "U.S. companies are looking to Russia as a way of sharing the risk," says IBS President Anatoly Karachinsky.

TECH COOPERATION. Here, too, Western assistance could be crucial. There are plans, which may be announced when Putin gets to the U.S., to create a new U.S.-Russian working group on the IT sector. Also in the works is a $3 million joint venture between New Jersey-based M.E.C. Technology, which supplies engineering services and spare parts to the semiconductor industry, and Russian chip producer Mikron Corp., based in Zelenograd, a region Russians call "Silicon Meadow."

Such cooperation with the West could finally help Russia build a middle class, a crucial component for economic and political stability. As things stand, only Moscow and St. Petersburg can lay claim to a middle class of any real size. Moscow, in particular, has shed its Soviet skin to become a modern European city with a professional workforce in marketing, banking, public relations, law, and all the other service sectors of a typical capitalist economy. Middle-class shoppers, for example, throng Moscow's Sportsmaster chain for running shoes, tennis rackets, cross-country skis, and other equipment. Meanwhile, because of a boom in car ownership--from 79 cars for every 1,000 people in 1991 to more than 224 per 1,000 today--Moscow's roads are clogged with Ladas, Toyotas, Audis, and Jeeps.

Provincial cities should be so lucky. Places that used to draw much of their livelihood from the Soviet military complex, such as Pskov and Murmansk in northwestern Russia, are now crime-infested ghost towns. What's encouraging is that investment is finally starting to move into the regions. After expanding rapidly in Moscow and St. Petersburg, McDonald's Corp. (MCD ) is now building restaurants in provincial cities like Rostov-on-Don. In 1997, Moscow garnered 69% of all foreign investment, but that share is down to 40%.

But aren't investors going to get their pockets picked in Russia? Stewart P. Reich, a New Yorker and AT&T (T ) veteran who now heads Russia's Golden Telecom, spends plenty of time wrangling with provincial politicians--but that's life everywhere in the global telecom market, he says. "Russia is not unique," he says. But it's still perilous, especially for minority shareholders. Oil major Sibneft just disclosed the sale of a chunk of management-held stock to insider Roman Abramovich. Many investors concluded the deal amounted to an interest-free loan to Abramovich and knocked 20% off Sibneft's share price.

Yet such outrages are happening less frequently. One reason is that Putin's regime is setting deadlines for companies to adopt global auditing rules. "We are pretty optimistic about the improvement in the business climate," says Ruth R. Harkin, senior vice-president of United Technologies, which has invested more than $400 million in 25 projects, including a venture between Pratt & Whitney and Perm Motors.

Putin is not an unblemished leader: Just ask any Chechen family that has been savaged in Russia's war on that province. Or check with a former reporter for NTV, a once-caustic critic of Putin that has been largely tamed. The question for Bush is whether Putin's agenda is on balance a positive one. Based on the record so far, the case for backing him is strong. Putin, after all, has offered more help to the U.S. since September 11 than any other political leader with the exception of British Prime Minister Tony Blair. To give Putin political cover to keep hard-liners at bay, Washington could push to end NATO's ban on purchases of Russian weapons by NATO member countries, suggests Stanford analyst McFaul.

Of course, Putin, for all his tactical flair, is not bargaining from a position of strength. One reason he gave the green light to U.S. bases in ex-Soviet Central Asia, Kremlin aides acknowledge, is that Russia itself, with a pipsqueak annual defense budget of less than $8 billion, lacks the firepower to protect its soft underbelly from an Islamic insurgency.

It might be tempting for the U.S. to treat Russia as no more than a failed superpower that no longer matters. Tempting, but unwise. Not since Peter the Great chased the Swedes out of the Baltics 300 years ago has the West been able to ignore Russia for long. The country is simply too big to be cast into a corner. "We have endured much worse than anything we are facing now and have always found our way," notes Isserov, the graduate student. It's in the West's interest to help Russia on its journey.

By Paul Starobin, with Catherine Belton, in Moscow, and with Stan Crock in Washington

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