Russia's Crony Capitalism

by Anders Aslund

  Overinvestment and excessive asset purchases have caused this poor financial profile. When it bought TNK-BP, Rosneft took on $40 billion of short-term debt, which it had great problems refinancing. In the spring of 2015, Sechin asked Deputy Prime Minister Arkady Dvorkovich to have the government allocate Rosneft $20 billion from the National Welfare Fund (more than a quarter of its total value). But the government stonewalled, attempting to force Rosneft to cut its capital expenditures. Instead, Rosneft issued a huge ruble bond that it had exchanged into dollars in a financial transaction that was blamed for the severe destabilization of the ruble in December 2014.74

  Unlike Gazprom, Rosneft has successfully closed major deals with foreign oil majors, notably BP and ExxonMobil, but also with Statoil and Total. The most important agreement is probably the continuing Sakhalin I joint venture with ExxonMobil. Sechin concludes such deals personally and usually in or around the Kremlin, involving the president. Conveniently, Rosneft’s headquarters are located in the premises of the former USSR Ministry of Oil Industry across the Moscow River from the Kremlin. Forbes cites one anonymous Rosneft manager as saying that Sechin sometimes goes to the Kremlin several times in a day because all major deals have to be agreed to by Putin.75

  Like Gazprom, Rosneft is pursuing foreign policy for the Russian state, though farther ashore. In May 2015, Rosneft and Venezuela announced that Rosneft had committed to a giant investment of $14 billion in Venezuela’s oil industry. Given Venezuela’s disastrous economic policy, this commitment made little commercial sense, but Sechin appears to be the main Russian emissary to Venezuela. When he visited Venezuela as deputy prime minister in 2009 he concluded arms deals with Venezuela. On April 28, 2014, the US government sanctioned Sechin as part of its Ukraine-related sanctions, and on September 12, Rosneft, too, was sanctioned.76

  Sechin’s appetite is insatiable. After the Bashneft “privatization,” the Moscow oil community asked, who’s next? Lukoil or Tatneft, the two remaining big private oil companies in Russia that do not belong to a Putin crony? Short of a genuine financial disaster in Rosneft, its ambition seems to be the re-creation of a Soviet Ministry of Oil Industry that can compete with Gazprom in inefficiency.

  Vnesheconombank, or VEB, is a strange creation, functioning as Putin’s slush fund for big projects and as a generous distributor of state funds. Its predecessor, the Bank for Foreign Economic Affairs of the USSR, was the Soviet foreign debt agency as well as the Soviet foreign trade bank. When the Russian Federation became independent, it established its own state-owned foreign trade bank, VTB (Vneshtorgbank of Russia), leaving the Bank for Foreign Economic Affairs of the USSR to handle the country’s foreign debt and claims. In 2007, the Bank for Foreign Economic Affairs of the USSR was replaced by VEB.

  Its website states: “State Corporation ‘Bank for Development and Foreign Economic Affairs (Vnesheconombank)’ operates to enhance competitiveness of the Russian economy, diversify it and stimulate investment activity. Vnesheconombank is not a commercial bank. . . . VEB does not compete with commercial credit institutions and participates only in those projects that cannot receive funding from private investors.” In spite of its name, VEB is not a bank; it has no bank license; and it is not subject to bank regulation. But what is it?77

  The official VEB history states: “On January 31 [2006], Russian President Vladimir Putin said that it was necessary to establish a National Development Bank with an authorized capital of 2.5 billion US dollars. In December, the Russian Government approved a federal draft law ‘On Development Bank.’” It continues: “State Corporation ‘Bank for Development and Foreign Economic Affairs (Vnesheconombank)’ was established in the Russian Federation. Russian President Vladimir Putin signed a Federal Law ‘On Bank for Development’ on May 17 2007.”78

  That one special law regulates VEB underlines its official government status: “Vnesheconombank is one of the key instruments of government investment policy. The Bank’s activity is aimed at overcoming infrastructure growth restrictions, upgrading and promoting non-raw materials economic sector, high-technology industries, encouraging innovations, exports of high-technology products, implementing projects in special economic zones, environment protection projects and supporting small and medium-sized enterprises.” Yet, legally VEB is a nongovernmental organization, and it is exempt from profit tax.79

  VEB has always been tightly linked to Russia’s foreign intelligence (SVR), as is evident from its CEO having been a senior foreign intelligence officer until 2018. VEB’s CEO from 2004 to February 2016, Vladimir Dmitriev, served at the Russian embassy in Stockholm in 1992–1993. He was expelled by the Swedish authorities in 1993 after having been identified as the SVR resident in Sweden. Dmitriev’s successor as VEB CEO was Sergei Gorkov, whose official résumé acknowledges that “in 1994, [he] graduated from the Academy of the Federal Security Service of Russia.” He was previously also vice president of Sberbank. A recent example of VEB engagement in intelligence is the VEB employee Evgeny Buryakov, who was arrested for spying in the United States in 2015 and sentenced to thirty months in prison. Buryakov was accused of having tried to recruit the former Trump campaign foreign affairs adviser Carter Page. Neither Dmitriev nor Gorkov was considered to be close to Putin. In May 2018, however, longtime first deputy prime minister Igor Shuvalov replaced Gorkov as CEO of VEB. Shuvalov is considered a very able technocrat, but he has been accused of several corruption affairs.80

  VEB has a supervisory board with nine members, including its CEO. Its chairman is by law the prime minister, while six other members are ministers, and the final member is Putin’s economic aide. As is obvious from its main operations, such as the 2008–2009 financial bailout and the Sochi Olympics, discussed below, VEB appears to take orders directly from Putin.81

  Given its status as an NGO, VEB does not publish an annual report, though it has issued financial statements to raise international bond issues. Neither is VEB subject to public auditing. Its international credit rating equals that of the Russian sovereign, since it is fully covered by state guarantees. Its assets are sizable, amounting to $60.4 billion in October 2017, and its loan portfolio at that time was $44.7 billion. Its central activity is to give loans to giant state investment projects while acting as an agent of the state. It also provides export credits and guarantees, offers government support to large enterprises, and gives some credits to small and medium-sized enterprises. Its export credits tend to be linked to major Russian state corporation export projects, notably those of Rosatom, for example, in Hungary.82

  In the past decade, VEB has been in charge of two major government operations: the bailout program of Russia’s big companies in 2008–2009 and the financing of the Sochi Winter Olympics construction. The Kremlin allocated $50 billion from the National Welfare Fund to VEB for its bailout program to suffering large state-owned and private companies.83

  Strangely, VEB also financed the Sochi Olympics with another $50 billion from its balance sheet; such public expenditures would normally have been financed from the federal budget. Once again VEB received money from the National Welfare Fund for its capitalization, but only $10 billion. For the rest, Putin’s decision to finance the Sochi Olympics from the balance sheet of VEB brought the bank close to bankruptcy, though the big devaluation of 2014 halved this debt in dollar terms. The outcome of the Sochi financing caused the retirement of CEO Dmitriev in February 2016 and the swift ouster of Gorkov. At present, Putin’s dilemma is that he seems unable to face up to the fact that VEB is his slush fund and not a development bank.84

  In the first half of 2010, after Viktor Yanukovych had been elected president of Ukraine, VEB spearheaded a mysterious Russian investment campaign in Ukraine. It bought one big private commercial bank, Prominvestbank, and financed the purchase of half of two large metallurgical companies, the Industrial Union of Donbas and Zaporozhstal. No known owner of the bulk of the Russian shares ever emerged, arousing speculation that Putin was the ultimate Russian owner, but Rinat Akh
metov, Ukraine’s leading businessman, stopped the Russian expansion in Ukraine by winning Ukrainian court cases, reportedly enraging Putin. Whatever the VEB design was, it never materialized. Instead, VEB lost about $10 billion in Ukraine. Ironically, it became a victim of the Russian military aggression in eastern Ukraine, which brought both the Industrial Union of Donbas and Prominvestbank to actual bankruptcy.85

  In 2014, VEB reported a net loss of $4.5 billion, and in late 2015, the need for a capital infusion of $20 billion was discussed, though that figure has gradually been reduced. In the end, the government has had to bail out the nongovernmental organization VEB. Just who benefited from VEB’s financing of the Sochi Olympics is a topic pursued in chapter 5.86

  Through the VEB law of 2007, the president granted himself a vast source of discretionary state funding—in fact, a slush fund. The president can legally disburse vast amounts of funding for any purpose without any accountability. The US government has realized this fact, and on July 16, 2014, it sanctioned VEB as part of its financial sanctions, depriving VEB of its access to international debt markets and thus tightening its financial constraints. Eyebrows were raised when Jared Kushner, the son-in-law of President-Elect Donald Trump, received VEB CEO Gorkov in the middle of December 2016. Yet the US sanctioning is of a mild nature. Like VTB Capital, VEB maintains an office in New York.87

  Rostec (short for Russian Technologies) is the most mysterious of the state conglomerates discussed here. Putin formed this state corporation in 2007 at the request of Sergei Chemezov, his old KGB friend from Dresden in the 1980s. Chemezov was Rostec’s creator and has been its CEO from the outset. He appears to be one of the men closest to Putin, to judge from their many publicized one-on-one meetings.88

  Commercially, Rostec makes little sense. Its website explains: “The corporation comprises 700 organizations that are currently part of 14 holding companies, nine of which operate in the military-industrial complex, and five in the civilian sectors.” But why have these disparate companies been assembled into one enormous conglomerate?89

  Russia’s best military-industrial companies are well known, but they do not belong to Rostec. The aircraft companies belong to United Aircraft Corporation, the rocket companies to Roscosmos, the naval shipyards to United Shipbuilding Corporation, the nuclear assets to Rosatom, and the eminent air defense rockets to Almaz-Antey. The only well-known military-industrial companies pertaining to Rostec are Russian Helicopters and Kalashnikov. Chemezov appears to have collected whatever leftovers he could find in the military-industrial sector to form a state corporation.90

  Worse, this corporation seems to lack a business idea. Its proclaimed mission is “to support Russian developers and manufacturers of high-tech industrial products in both domestic and foreign markets.” More specialized and sophisticated armaments companies do most of that work.91

  Like other state corporations, Rostec has a supervisory board and a management board, and its members are named on its website until 2017 after which they have disappeared. Its nine-person supervisory board consists of CEO Chemezov and eight top state officials, but curiously it does not name a chairman. Presumably, Chemezov fulfills that function as well. Rostec does not publish any financial reports, annual reports, or other detailed information about its business. This vast business empire of often secret companies is a nontransparent maze. Symptomatically, it abandoned its website in English in 2018 and stopped publishing much of the information offered here.92

  Rostec makes one thing clear, its dependence on the president: “The Rostec Corporation is governed by its supervisory group, executive board, and general director, who is appointed by the President of the Russian Federation.” Chemezov meets with Putin for key Rostec decisions, and these two men decide about this vast nongovernmental organization at will. In the public part of their annual meetings, Chemezov presents the preceding year’s operations and discusses new business ventures that win Putin’s explicit approval. Rarely does Putin appear as relaxed and chummy in public as when he is with Chemezov. When Dmitri Medvedev was president, by contrast, the meeting reports were minimal, showing the distance between them and that Rostec is subordinate to Putin as a person.93

  Chemezov offers only information about Rostec that is open to the public in his meetings with Putin. At his presentation to Putin of Rostec’s results for 2016, Chemezov claimed that his company “increased earnings [revenues] by 11 percent to over 1.2 trillion rubles” and that Rosoboronexport’s exports amounted to $13.1 billion. For 2015, he stated that labor productivity increased by 17 percent and employment “increased slightly (by 1 percent) to 445,000 people.” We possess no audited facts about Rostec’s finances.94

  Such a murky conglomerate could not possibly exist in a free market economy. It looks even worse than an old-style Soviet ministry, which had a clear specialization. This impression is reinforced by the names of departments, which include “fulfillment of state programs,” “defense of state secrets,” and “regional policy.” These are not corporate but state functions.

  Although Rostec is supposed to be an armaments company, it has branched out into various directions beyond armaments. Its three best-known companies are Russia’s biggest civilian car company, Avtovaz, its biggest truck company, Kamaz, and the outstanding titanium producer VSMPO-Avisma. Its real driver seems to be Chemezov’s empire-building ambitions.

  Rostec has been accused of illicitly taking over other companies through corporate raiding. In 2006, the two dominant owners of VSMPO-Avisma, Russia’s main titanium producer, were forced to sell their shares at a price they considered too low to Rosoboronexport, which later became part of Rostec.95

  During the financial crisis of 2008–2009, many of Rostec’s subsidiaries suffered, including Avtovaz and VSMPO-Avisma, but Rostec extracted significant state funds for its subsidiaries. On April 28, 2014, the US government sanctioned Chemezov as a member of the Russian leadership’s inner circle, and on September 12, it sanctioned Rostec as part of US sectoral sanctions.96

  Few companies as large as Rostec have so little to say to justify their mere existence. State secrecy is natural in the military-industrial sphere, but it grows ever greater, and the suspicion lingers that Rostec exists because Putin allows his good friend Chemezov to enjoy a good life. Putin also relies on Chemezov to maintain employment in Russia’s many small company towns that the Kremlin fears could breed popular unrest. Rostec looks like a big black hole that should not exist in a normal economy.97

  The Russian state has regained control of the “commanding heights” of the economy, as Vladimir Lenin’s phrase ran. It has recovered control of the main sources of rents and is gobbling up ever more good private enterprises. Yet the state control of these big enterprises is illusory because a small group of men loyal to Putin personally exercises this control. The state enterprises have expanded to the benefit of Putin’s cronies.98

  Formally, these state enterprises have supervisory boards and management boards. As a result of previous reforms, state companies such as Gazprom and Rosneft possess all the formalities of proper corporate governance: annual shareholders’ meetings, purportedly independent auditors, published annual reports, independent directors, and policies on corporate governance. The state corporations VEB and Rostec, by contrast, are nongovernmental organizations not subject to any external control or transparency.

  The power over state companies and state corporations alike rests in the hands of one man: Vladimir Putin. His closest associates are chief executives. Three state enterprise managers stand out, forming the second circle of Putin’s power after the FSB top: Sechin, Chemezov, and Miller. Each of them seems to be allowed to do virtually anything with impunity. All three have engaged in predatory corporate raiding that has undermined property rights in Russia.

  A few top state CEOs who were KGB officers and Putin’s contemporaries in St. Petersburg have recently been forced to retire. The most important is Vladimir Yakunin, CEO of Russian Railways from 2005 until his re
tirement in August 2015. He is a contemporary of Putin’s and a KGB officer from St. Petersburg, as well as a member of the famous Ozero dacha cooperative. Opinions vary on why Yakunin was ousted. A common view is that Yakunin engaged too aggressively in hardline foreign policy, and he might have been politically too ambitious, mentioned as a possible Putin successor. Yet he has not fallen out of favor altogether; Putin has received him officially following his retirement, and he has set up a well-funded think tank in Berlin pursuing orthodox ideas.99

  State capitalism is usually associated with long-term state plans of investment and technological development, but Russian state capitalism involves neither. Financial results seem almost irrelevant. The state companies prefer to keep most of their profits to themselves. As the Financial Times’s Neil Buckley observed, “It is becoming an annual ritual. Each spring, Russia’s government presses its state-controlled companies to pay out more of their profits in dividends. The companies then scurry to find loopholes or lobby for exemptions,” and successfully so.100

  The long tenures of Putin’s associates as chief executives indicate that economic efficiency, profits, innovations, and other economic performance criteria barely matter, whereas personal loyalty and the transfer of funds to friends do matter. No CEO of a large company in the world has destroyed more capital than Alexei Miller, who lost market capitalization of $310 billion from 2008 to 2018. The true beneficiaries are not the Russian state but Putin and his friends, and Putin has the legal power to transfer vast state funds to private companies or individuals at will.101