Putin's Russia: Is the Economy Next?

Experts fear the President may clamp down on free-market reforms

How far will Putin go in turning back the clock? There's no doubt he's trying to centralize all political power inside the Kremlin. Hard on the heels of the Beslan massacre, he announced plans to abolish direct elections for governor in Russia's 89 regions, replacing them with direct presidential appointments, ostensibly to strengthen the Kremlin's hand in the fight against terror.

The names of the governors will have to be approved by regional legislatures, but this is sure to be a formality. There's no way an opposition could organize to block this move. National TV networks already are under government control, while Parliament is overwhelmingly dominated by pro-Putin parties. The Kremlin's concerted legal attack on the private oil company Yukos, whose boss, Mikhail B. Khodorkovsky, set himself up as a rival to Putin, also shows what happens when a prominent figure gets out of line. "Putin is all about salami tactics: cutting down one oligarch after another, one television channel after another, at a slow and deliberate speed," says Anders Aslund, director of the Russian and Eurasian Program at the Carnegie Endowment for International Peace in Washington.

The big question now is whether Putin will extend this steady concentration of power to the economy -- not a full-fledged return to Soviet-style economic management, but possibly a wide retreat from the free-market reforms Putin pursued during his first term, building on the legacy of his predecessor, Boris N. Yeltsin. If Putin does opt for more control, he risks killing the economic dynamism of recent years, which has been driven by the private sector.


The signs are not good. Here again the ultimate fate of Yukos, which the government has hit with a bill for back taxes of more than $7 billion, will provide a signal of how far Putin wants to return to the old ways. Most analysts are betting that Yukos' prime assets will be swallowed up by a new state oil-and-gas company, to be formed through the merger of government-controlled gas giant Gazprom and oil company Rosneft. The creation of this company was announced on Sept. 14, a day after Putin's dramatic move against the governors.

Putin's close associates are also strengthening their personal involvement in the management of key assets. Igor Sechin, a presidential aide, was recently made chairman of Rosneft. Gazprom Chairman Alexei B. Miller is an old Putin ally.

The President has helped sweeten the pill by approving a plan to let foreign portfolio investors buy shares in Gazprom. His team can argue that the Russian state's growing role in the strategic oil and gas industry is not so different from the situation in other large oil-producing countries. Foreign investors, for now, are buying the argument. BP PLC (BP ), for one, is upping its investment in Russia, while consumer-goods suppliers are still drawn by free-spending Russians. Guy de Sellier, a former vice-president of the European Bank for Reconstruction and Development who sits on the board of Norilsk Nickel and dairy company Wimm-Bill-Dann, doesn't see Putin's play for oil-sector control as putting a damper on foreign interest. "Controlling energy doesn't mean controlling everything else," he says.

But the worrying signs don't stop there. Since Putin's reelection in March, hardly anything has been done to push promised liberal economic reforms, such as measures to help small businesses by cutting back on red tape. Such moves are badly needed to diversify and strengthen the Russian economy. "The reforms haven't happened, and there's no evidence they're about to happen," says Chris Weafer, head of research at Russia's Alfa Bank.

To promote liberalizing reforms, Putin would need the support of private business lobbies to push back against the bureaucrats. But following the attack on Yukos, business is cowed and its political influence weakened, argues Carnegie's Aslund. He says Putin is becoming ever more dependent on the security services and their allies at the large state companies and banks.

In recent months these groups have been extending their influence not just in the oil industry, but in other key sectors. For example, the reform of Russia's pension system, which would have benefited private financial groups, has effectively been taken over by state-owned banks. "We have been shut out completely," complains Bernie Sucher, the chairman of private investment company Alfa Capital in Moscow. Other key privatizations, in sectors such as electricity and banking, have also been put on hold.


The other concern is that Putin's obsessive focus on political control and mastery of the state's biggest companies is diverting him from the badly needed reform of the government apparatus itself. After Beslan, the failure of Russia's bureaucrats -- among them the all-powerful intelligence service, the FSB -- is obvious. "The federal bureaucracy has proved itself totally incompetent," says Stanislav Belkovsky, director of the National Strategy Council think tank. Yet by centralizing political power, Putin risks undermining the very forces in society that could provide some sort of counterweight to the bureaucrats and press for change. Putin will probably choose more strongmen -- ex-generals, spies, and cops, known collectively in Russia as siloviki, or men of power -- to fill regional government slots. In practice they'll be accountable only to the President himself, who cannot possibly supervise everything.

Russia is not headed for an immediate economic calamity -- not with oil-fueled growth that could easily hit 7% this year. But there's an obvious risk that if Russia's rudimentary democratic institutions are curtailed, and the security services extend their influence over national life, economic liberalization will also suffer. The warning signals were there well before Beslan. Now they are ringing loud and clear.

By Jason Bush in Moscow, with John Rossant in Paris

— With assistance by John Rossant

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