A Russian Reformer Sees Pitfalls Ahead

Former Prime Minister Yegor Gaidar on the Yukos controversy, Putin's politics, Russian elections, and what it means for investors

Recently, investor confidence in Russia has taken a series of knocks, linked to the arrest of Russia's top businessman Mikhail Khodorkovsky, former CEO of Russia's largest oil company, Yukos. For several months, Yukos and its managers have been under investigation for fraud and tax offenses, but many analysts see the campaign as a politically motivated attack orchestrated by the Kremlin, raising questions about the stability of Russia's legal and political environment.

Parliamentary elections on Dec. 7 also gave investors cause for concern. The United Russia Party, which backs President Vladimir Putin, topped the polls and will dominate the new parliament. However, two pro-Western liberal parties failed to make it into parliament, while two vocal nationalist parties did unexpectedly well.

Yegor Gaidar, director of Russia's Institute for the Economy in Transition and the architect of the first wave of Russian market reforms when he served as Prime Minister in the 1990s, recently spoke to BusinessWeek Moscow Correspondent Jason Bush about the significance of these events. Here are edited excerpts of their conversation:

Q: Many people are worried that Khodorkovsky's arrest and the investigations into Yukos will have negative consequences for the investment climate and Russia's economy. What's your view?


That story doesn't have extremely dangerous [short-term] implications for Russian macroeconomic developments.... The macroeconomic situation is stable, the reserves are big, the budget is in surplus, growth has increased, so there are no short-term consequences.

But if we're speaking about the longer term, the consequences could be important and harmful. The essence of what the government in Russia was trying to do in the last four years was to create the impression that Russia is a predictable –- in some ways dull –- country. And this strategy had started to work this year. If you look at the statistics for this year, you'll see a serious change in the quality of economic growth: Very high rates of growth in investment, machine-building, and machinery imports -- a change of trend in the dynamics of gross domestic product.

All these were evident signs we were starting to get investment-based growth rather than recovery-based growth. But the basis of investment-based growth is confidence that the rules of the game are predictable.

Investors are very pragmatic people. They are used to working under very different regimes. Not all of them are democratic. I don't think anyone would argue the Chinese regime is democratic, yet China is getting an enormous capital inflow. It's a big market, and it's regarded by investors as predictable. Maybe the rules of the game are not perfect, but they're well-known.

Q: How big a risk do you see?


Nobody can tell. A lot will depend on the further steps of those in power. I think the government will try to minimize the risks. But it is at least a big question mark.

Q: If we talk in general about Putin's second term, can we be confident that the basic reform philosophy of the government remains intact?


I hope that all the harm caused by this Yukos episode will be properly controlled, and I think that Putin and his next team will try to do it. I'm practically sure about this. How effective they will be –- we'll see. Everything will be solved between May and July, 2004. Then we will see how efficient government policy will be during the second term –- it will be the window of opportunity.

Q: What's the specific significance of those months?


It's the period when the President has the most possibilities for pushing all of the necessary legislative changes without worrying too much about the political damage.

Q: We've talked about the consequences of the Yukos affair. What do you think was the root cause of the affair?


I have a quite clear understanding –- though of course it's my understanding, [and] it may not be 100% correct. I work a lot in the Duma, and I know how the Duma process works. And I know that of course the oil lobby, led by Yukos, was the strongest lobby in the Duma. And sometimes this lobby was extremely helpful, and sometimes, of course, it defended its own interests.

I personally opposed the lobbying attempts of Yukos and the oil lobby many times. I thought that they were harmful, for instance, for the budgetary situation. But it's usual. It's the actions of political forces in all democracies.

There are a variety of possible ways to deal with these problems: meeting with the deputies, calling the leaders of the deputies' groups, etc. But when you're a very young democracy, there's an obvious possibility of not using the "usual ways." You see the problem.

If you analyze the legislation that was adopted in the last two months, you will see that there were a lot of sensible things which the government has tried to push through for a long period of time, but somehow they were unable to. Now they're adopted. But from my point of view, even if they're sensible and generally are good for the country, still I think that the harm from using [inappropriate] means to achieve some positive results is an enormous mistake.

Q: One striking result of the recent election is that neither of the pro-Western, liberal parties made it into parliament. Is this something people should be concerned about?


Generally it's a matter of concern, of course. Our constitution is very presidential, and that leads a lot of people to misunderstand the consequences and importance of the results of parliamentary elections in Russia. In post-socialist politics, there are enormous fluctuations. But these fluctuations can have serious consequences.

In 1993, there were serious discussions in the Russian political elite whether we should seriously accelerate economic reforms, and [then-leader Boris] Yeltsin was undecided on the issue. But when [Vladimir] Zhirinovsky [a hard-line nationalist politician] got 22% of the vote, of course the story about the next stage of radical economic reform was closed.

In 1995, when the Communists won the parliamentary elections, it practically brought the next stage of reforms to an end and made the 1998 financial crash inevitable. When, in 1999, the elections were regarded as a success for the pro-reform forces, we got this wave of liberal reforms of the first half of the Putin term -– including the flat income tax, the Land Code, the Labor Code, pension reform, etc.

Essentially, nothing radical has changed. Power in parliament is still in the hands of the pro-Kremlin factions, and they will do exactly what they are told by the Kremlin. But the success of pro-nationalistic factions –- factions which are prepared to use the tools of xenophobia and radical nationalism –- is, of course, giving a bad impulse for the dynamics of Russian politics. We shouldn't underestimate the importance.

Q: If you compare the situation today with 10 years ago, a lot of the ideas the liberal parties supported have become fairly mainstream. Is there an argument that these parties might be looking stale?


Well, to some degree that's the truth. Hearing the economic debate now, it's very difficult for me to imagine it [taking place] 11 or 12 years ago. But still, the specific feature of Russian politics is the existence of the so-called Party of Power: a party which is practically the working machine for those who are in the Kremlin. It's a very efficient machine. But it's useful as a way of promoting your solutions, it's not useful as a way of elaborating solutions –- or containing the government.

The key to the economic success of Europe and the U.S. was tying the hands of the government. And now the hands of the government are untied in Russia. And from my point of view, it's dangerous and bad.

Q: In general, are you still optimistic that Russia is on the right course?


Nothing is lost. I am, of course, disappointed by the results of the elections. I see the dangers. I hope that they will be contained.

Edited by Thane Peterson

Before it's here, it's on the Bloomberg Terminal.