Russia: A Big Chill For Business?

Putin's move against Khodorkovsky probably won't extend to others

Like all the oligarchs who amassed fortunes during the 1990s, Yukos Chief Executive Officer Mikhail B. Khodorkovsky is no angel. But in recent years, he has embraced Western standards of corporate accountability and responsibility at his giant oil company, setting a trend for other Russian businesses. President Vladimir V. Putin clearly welcomed that trend, which furthered his goal of integrating Russia more closely into the global economy. Why, then, have the Russian authorities -- presumably with backing from Putin -- arrested Khodorkovsky on charges of fraud and tax evasion and dumped him in a Moscow prison cell, triggering the biggest business crisis in Russia since the financial meltdown of 1998?

The simple answer is that Khodorkovsky angered Putin by providing funding for two opposition parties in the runup to parliamentary elections in November. That would imply that Putin, despite his desire to improve the business climate in Russia, prefers frosting foreign investors to brooking any real challenge to his authority. Yukos is Russia's biggest privately owned company -- and by far the most popular among foreign investors.

That looks bad. And it is. Many Russians think Putin is using the legal process in an arbitrary way to settle scores with a political foe. That's a big concern for both local businessmen and foreign investors, who would like to see an impartial legal system that's able to defend private property from political attacks. "The bad guys are back," says a Western executive who does business in Russia.

But the reality is more complex. Putin's wrath seems targeted at Khodorkovsky and Yukos, rather than being the first volley in a broad attack on Russia's business elite or market economy. Simply put, Khodorkovsky is being punished because he broke the pact that Putin struck with the oligarchs in 2000 soon after he came to power: If the oligarchs steered clear of politics, Putin would allow them to keep the lucrative assets they amassed during the chaotic rule of Boris Yeltsin. Oligarchs who follow the rules should be reasonably safe. "I've said many times that the results of privatization will not be revisited in Russia. As for the investigation of the criminal case concerning Yukos, this is a separate case," Putin told American journalists in late September.

That means that BP's John Browne probably doesn't need to worry that Putin will seize the assets of his Russian oil company, TNK-BP. BP's Russian partner, Mikhail Fridman, is sticking to business. It's even conceivable that, after things settle down, Yukos could sell a stake to Exxon Mobil Corp. (XOM ) -- with or without Khodorkovsky. "The sky is not falling in. One guy who has been having a fight with the Kremlin has got into trouble," says William F. Browder, CEO of Hermitage Capital Management in Moscow.


Besides, Putin had some good reasons to be worried about Khodorkovsky. The reform parties -- the Union of Right Forces (SPS) and Yabloko -- are just two of the parties with a string of Yukos people on their candidate lists. Vladimir Dubov, a key Yukos shareholder targeted in recent investigations, is running for parliament as a candidate for the main pro-Kremlin party, United Russia. Several Yukos figures are even running as Communist Party candidates. "Putin woke up one day and figured out that Khodorkovsky could control one-third of the State Duma," says an executive from a Western company.

Lining up a strong lobby of pro-Yukos deputies in parliament was Khodorkovsky's real goal. But it seems to have spooked Putin and his coterie of ex-KGB buddies. Yukos says it did nothing wrong. "Yukos, like any big company in Russia, will be using the legal resources at its disposal to lobby for [its] interests. No one has ever stated that it is illegal or unacceptable," says Hugo Erikssen, director of Yukos' international information department.

But before the prosecution of Yukos even started, the government had trouble getting its laws through parliament -- particularly laws that would have raised taxes for oil companies. "It was Khodorkovsky blocking tax proposals in the Duma relating to the oil business that was the final straw," says Christopher Granville, chief strategist at United Financial Group, a Russian investment bank. That, in turn, reflects a more fundamental problem: the excessive wealth and influence of the oligarchs. "This isn't some paranoid KGB fantasy," he says.

Most political analysts in Russia see the Yukos affair as part of a power struggle between two rival factions in the Kremlin: "the family," a group of businessmen and officials inherited from the days of Boris Yeltsin; and "the siloviki" (strongmen), former colleagues of Putin from KGB days who feel that the time has come to get a bigger share of power themselves. "The siloviki would like to become a new oligarchy. I think the Yukos affair is definitely connected," says Gleb Pavlovsky, a political analyst with links to "the family."

Few doubt that the siloviki are the main advocates of getting tough on Khodorkovsky. Yet they could hardly have acted without Putin's backing. Whatever his reasons for siding with his KGB chums, Putin has jeopardized two of his most cherished objectives: political stability and economic growth through foreign investment. Khodorkovsky's arrest has done more than anything else to set the factions within the Russian leadership at each other's throats, threatening political stability. As BusinessWeek went to press, there were unconfirmed reports in the Russian media that "the family's" leader, Putin's chief of staff Alexander Voloshin, had resigned in protest of Khodorkovsky's arrest. Meanwhile, abuse of the law for political ends has, at least for the moment, spooked investors.

If the plan was to make Khodorkovsky shut up, then it failed miserably. But Putin is not likely to halt the prosecution, which would be an admission that the whole thing was political. He may have more room to maneuver after the campaign season is over. There is talk of a compromise with big business, with companies accepting higher taxes in exchange for firmer property rights. And foreign investors have notoriously short memories. But Putin may well be wishing he tried persuasion rather than prison.

By Jason Bush in Moscow

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