19Section 5. Institutional Problems
5.1. Institutional development in 2000s
Among the formal terms and expressions that would characterize most precisely the year 2006, the following may be selected: "predictability", "stability" and "prevailing trends of the past years". The institutional trends of the several previous years, however, are pretty ambiguous. Moreover, by early 2007 some vague inconsistencies or, to be more precise, substitution of notions of institutional development that may play a principal role on a long-term basis came to the foreground.
5.1.1. Politics versus economy: asymmetry of mutual influence
All quantitative indicators of the development of the Russian economy in 2006 demonstrate an economic revival (for more detail see above)1. By late 2006 capitalization of the Russian companies was $908 billion; thus Russia may be considered one of the major developing markets, with China only being ahead for this indicator in 2006.
The dynamically growing Russian economy (by formal quantitative indicators) demonstrates higher economic (credit) ratings of the country. In 2006 according to the largest rating companies (Fitch u Standard&Poors), Russia had a "BBB+" credit rating denominated in foreign currency which meant that the country acquired a new "investment quality" at the international financial markets and reduced costs for Russian borrowers. Next expected step for Russia will be moving to A-level ratings. OECD Council at its meeting of January 26, 2007, included Russia in the 3rd (from the top zero down to seven) group of credit risks where such countries as South Africa, Israel, India, Thailand, Morocco, Latvia, Hungary, Bulgaria, Rumania and other states are present.
The economic growth coupled with higher financial indicators of the companies (the growth of consolidated returns and, according to the survey results of the Center of Economic Market Situation under RF Government, in December 2006, satisfaction of the companies with their financial position across the industry) was accompanied by an unprecedented increase of private capital net inflow. According to the RF Central Bank, in 2006 the net inflow of private foreign capital into Russia increased by almost 40 times vs 2005 ($41.6 billion including $25.1 into the banking sector vs $1.1 billion in 2005 and outflow of $8.4 billion in 2004). Repatri-
1 Herein and in sections 5.2 through 5.5. the sources used are official web-sites, pres-releases and interviews with the Leaders of the RF Ministry of Economic Development and Trade, Federal Agency for Federal Property Management, Federal Antimonopoly Service, Federal Service on RF Financial Markets and other federal government authorities; information materials of "Prime-TASS", "Interfax", "RBK", "lin.ru" Project, and regular publications such as "Commersant", "Vedomosti", Izves-tia", Vremya Novostey", "Finance", "Expert", M&A"; ratings of specialized agencies and organizations, corporate sites and other sources of 2006 - 2007. In writing this section of the report the author also used the relevant materials by A. Abramov, E. Apevalova, G. Malghinov, and K. Yanovsky and materials from numerous published research papers of Institute of Economy in Transition (IET) and Academy of National Economy under RF Government on the problems of institutional development (see: www.iet.ru).
ated Russian capital (see Section 5.4 describing the growth of investments from the traditional off-shores) apparently accounts for a considerable share in this inflow, however, no clear distinction can be made between residents and nonresidents. Nevertheless the assessments of direct foreign investments into Russia in 2006 are pretty close ranging from $28.4 bio (UNCTAD) to $31 bio (Bank of Russia).
The year of 2006 also saw an essential growth of external financing of largest banks and companies (IPO and corporate bonded loans at the internal and external markets). In 2006 the external debt of non-financial companies and commercial banks amounted to $135.4 billion and $78.5 billion, accordingly. The external debt of the Russian corporate sector jumped up to $57 billion against $54.5 billion in 2005. In 2006 the aggregate value of 18 major IPO (including Rosneft) was about $21 billion. Corporate bonds became a driver of debt market emission: their volume grew from RUR260.6 billion in 2005 to RUR465.3 billion in 2006 (or by 1.8 times). The overall amount of RUR-denominated bonds at the market including federal securities, corporate and regional bonds increased from RUR 1.5 trillion in 2005 to RUR 2.2 trillion in 2006 or by 1.4 times.
According to the analysts of some investment banks, in 2007 IPO total volume of the Russian companies may reach $20-$22 billion, and with account of Sber-bank and Vneshtorgbank - $30 - $40 billion. Around 60 Russian companies plan IPO in 2007, however, (due to the market situation) only some 30 companies will be able to do this realistically. There is a more pessimistic outlook: according to Citigroup Global Markets, in 2007 the Russian companies will not be able to exceed the 2006 indicators (2007 forecast: 32 IPO and $18.4 billion), after the 2008 presidential elections the situation will be close to that of 2005 (in 2005 - $5.2 billion, and 2008 forecast is 18 IPO and $4.7 billion). The current sharp growth of IPO is associated directly with the determination to be secured against risks of a new phase of the political and business cycle after March 2008.
The boom of initial public offering in 2006-2007 in the context of political risks finds its confirmation when the specific motivations of the Russian companies are being analyzed2. It is the consumer sector (about 80% of the IPO participants recently) that gets investments for its business development; this sector unlike the feedstock companies does not generate major cash nor has a simplified access to bank credits. The sector began to show its interest in IPO back in 2003 when the companies in the absence of a proper loan base and considerable debt burden had to look at stock placement. The major part of the consumer companies who were actually ready for IPO were using this practice. Another motivation for the companies with no bright prospects for development or those in need of finances to support deals on acquisition of new assets, compensation of "exit" of the partners/shareholders from businesses, etc. was the fixed value of the company and drawing up cash funds for the shareholders' needs. A huge number of major feedstock companies-issuers that have no need in getting investment resources via IPO strive to increase and fix their capitalization as an "insurance" against their exits if
2 Y. Korotetsky, L. Moskalenko, M. Talskaya. IPO is out of fashion // Expert, 2006, № 39, p. 19-27. 530
the largest shareholders will have to dispose their ownership due to adverse political reasons. Some of the companies have secured themselves already by fixing their values having sold part of the stocks and legalized the remaining assets. Apparently a bonded loan is a cheaper source of external financial resources, though it does no insure the company against political risks.
The global expansion of a large number of Russian major private companies (groups of companies) in 2005-2006 was associated not only with the rationale of corporate development, the desire to strengthen their positions on new markets and search of facilities for investment but also with their preparation for the upcoming political and business cycle in Russia.
These considerations apply to some larger state companies though the lat-ter's motivations may be different (see section 5.2). At the end of January 2007 the Head of the Federal Agency for Federal Property Management, announced a possibility of another public offering of Rosneft stock up to 25% (worth around $20 billion), however this announcement was almost immediately disowned by G. Gref, Head of the Ministry of Economic Development and Trade. These contradictory approaches, as some believe, are the evidence of more serious attempts to transfer the largest possible portion of the Rosneft state owned stock to private ownership by March 2008 with the subsequent legalization for the sake of a narrow group of the stakeholders.
The election cycle, according to some forecasts, will obviously push down the amount of direct foreign investments (where it is difficult to separate foreign and Russian repatriated funds) in 2007. The forecasts are unanimous concerning the expected decline however the driving factors are different. Standard&Poors believes the expected decline is linked to the ongoing processes of boom decline at the feedstock markets that stimulated investments into the feedstock assets of the developing countries and nationalization of energy assets in Russia, Bolivia, Venezuela and Ecuador. The Russian Union of Industrialists and Entrepreneurs explains the decline by future political risks related to parliamentary and presidential elections in Russia. There is also a problem of preparedness of the Rus-
3
sian companies .
Political risks that are not directly related to the election cycle are pretty essential for most conservative foreign institutional investors unlike the Russian owners.
One can give a reliable example of a rating developed for a number of years by one of the largest and most conservative global investors - U.S. Pension Fund -California Public Employees' Retirement System (CalPERS) which assets amount to $225 billion (see section 5.4.). Whenever CalPERS enters a developing market,
3 In 2006 Tatneft initiated delisting at NYSE. Tatneft example is indicative for the Russia's corporate sector. According to AIM (Alternative Investment Market) dataof London Stock Exchange, in 2006 shares of 7 companies of Russia and some other post-Soviet states were listed here while in 2005 there were 15 such companies. This is an outcome of the absence of adequate financial control required for listing (consolidated reporting, financial statements, etc). Thought 2007 trends are assessed as positive, the value results of 2006 will hardly be exceeded.
it gives to the market a certain "quality mark" attractive for other major institutional investors.
In 2006 out of four BRIC countries (Brazil, Russia, India and China), Russia and China received less that 2.0 scores (CalPERS method) meaning that these markets are shut down for investments. The 2007 forecast (1.9 scores) shows that Russia will remain at the previous year level while China's score increased from 1.6 to 1.7. The main problems of the Russian market in 2006 were: low political stability, imperfect labor laws and insufficient openness of the market. In assessing civil liberty where 1 means the highest level and 7 - no liberty at all, Russia was given 5 scores. In terms of independence of courts and legal protection Russia received 1 score out of 3 scores possible which is much worse than in China. Russia was assessed at lowest scores in terms of courts independence, legal protection of property rights, inefficient fight against organized crime and biased courts' pronouncements issued in favor of the government authorities.
CalPERS method could be equally indicative if we tried to assess the input of the key factors impeding further improvement of the investment climate in the country. With account of impact of certain factors in building up ratings, the negative impact of specific country (government) factors is increasing vs "market factors" quality.
Similar negative assessments of the civil society and political system in Russia may be found almost in all traditional ratings for 2006 regarding these problems (Freedom House ratings of civil liberty and mass media freedoms; World Economic Forum of global competitiveness; Oxford Analytica of creditors' rights compliance; the Heritage Foundation and Dow Jones Co; Indem Foundation; World Economic Forum, World Bank, Transparency International and others - of economic indicators). A number of ratings became much worse vs 2004-2005 (Table 1).
Tablel
Changes in the ratings of political stability, economic and civil liberties in Russia in 2005 - 2006
Rating
Civil liberties (by Freedom House) GCI, World Economic Forum (Global Competitiveness)
GCI, World Economic Forum (protection of property rights)
Economic freedom rating, the Heritage Foundation and Dow Jones & Company, Inc.
CalPERS rating (investment threshold is 2 at maximum 3)_
2005
5 - no liberty
53 rank
108 rank (in 2004 - 88)
4th group - no freedom at large
27.6
(in 2003 - 20.5)
Total 1.8 (in 2002 - 1.15)
Lower rank/scores or 2006 close to Russia (BRIC _countries)_
China (6)
Brazil (66)
China - 54.02 scores 119 rank
India - 55.60 scores, 104 rank
China - 1.6 scores
Political stability (by CalPERS, weight in country rating, %)
5 - no liberty 62 rank
114 rank
4th group - no freedom at large (54.01 scores out of 100, 120 rank)
29.2
(30.6 - for 2007)
Total 1.9 Country - 1.6
Source: Rating Developers formal websites.
According to 2006 economic freedom rating made by the Heritage Foundation and Dow Jones & Company, Inc., out of 157 states Russia ranked 120, getting
54.01 scores (maximum was 100) which was lower than the 2005 rank. Out of other BRIC countries China was placed 119 (54.02 scores), Brazil and India - 70th (60.89 scores) and 104th (55.60). Russia scored least in the following areas: no corruption (24.0%), free investments (30.0%), property rights protection (30.0%), freedom of finance (40.0%). Low score in "freedom of finance", according to the rating agency, was given because of inefficient banking system, deficiencies in banking supervision and transparency, and restrictions of access to banking and insurance business for nonresidents. The low rating in the property rights protection means that Russia does not ensure such protection properly: "the judicial system is corrupted and biased, and ensuring the implementation of contacts is a real challenge".
As for short-term trends, the situation is rather trivial. The developed asymmetry of economic and political factors of the Russian economic development has been obscured so far by general indicators of economic rise, instable feedstock market situation and government finance parameters (budget surplus, Stabilization fund, and gold and currency reserves), and also by indicators of extreme profitability of the Russian stock market.
The investors may describe this situation as "Clod Frollo dilemma" (section 5.4): a high profitability temptation up to a certain limit is stronger than the economic freedom, investors' rights and government interference concerns.
From the government point of view, economic wealth measured with formal current indicators and ratings proves the correctness of the selected political route (broadly, including the issues of protection of property rights, the judicial system, etc.).
It is worth noting that the Russian companies that as said above are most sensitive to potential political and business cycle risks are those that have least illusions.
The population is extremely perceptive of the abilities of the government authorities to take effective actions in the area of economic policy (Tables 2-3).
Table 2
Why there is no sizable economic growth in Russia now?
2003-2006 population survey results , in %
2003 2004 2005 2006
1. Red tape, corruption and bribery with the highest bodies of state authority 34 34 31 34
2. Plunderous policy of the major Russian businesses/oligarchs and their dis- 38 34 29 33
interest in the national economic revival
3. Incorrect economic policy of the government 27 22 34 32
4. The government does not have an economic program 22 22 29 27
5. Capital outflow from Russia/flight to off-shores 25 27 26 26
6. Theft of managers (profits withdrawal and appropriation) 28 20 21 24
7. Fixed assets worn-out 13 11 11 17
8. High taxes on entrepreneurial activity 15 10 13 13
9. Russian goods are not competitive with Western goods 9 10 10 12
10. No investments into the Russian economy 11 11 12 12
11.Business is not legally protected 9 7 7 9
Other 7 7 6 5
Difficulties in responding 12 12 9 11
Source: "Levada-Center", www.levada.ru.
As Table 2 shows, for the entire period of 2003-2006 the weight of such factor as "bureaucracy, corruption and bribery in the high echelons of power" remained unchanged (and the largest among all other 12 factors). At the third and the forth places are the factors "incorrect economic policy" and "the absence of the economic program" which were strengthening their significance in 2003 through 2006. The second factor - "the plunderous policy of the major Russian businesses/oligarchs and their disinterest in the national economic revival" - was losing its value in the same period. "The absence of legal protection for the business" is not significant for the community; this may be explained by confusion of notions (the respondents seem to mix up legal protection and corruption). Table 3 apparently demonstrates that during 2000 - 2006 not less than 2/3 of the population kept thinking that the Russian government was not able to develop a substantiated economic program for Russia4. In any case the data in Table 3 add up to the conclusion that the "government" and the "market" in Russia has been moving into opposite directions during 2000'es.
Table 3
Has the Government of Russia got a well defined economic program?
The 2000-2006 survey findings, in %
2000 2001 2002 2003 2004 2005 2006
May April August August August August April
The Government has got a well defined and thoughtful economic program There is no well defined program but only 22 21 16 18 21 19 24
very high-level outline of what shall be 38 37 39 38 35 40 33
done
There is no such program, and decisions are taken given current circumstances 22 30 33 34 34 31 33
Difficult to answer 19 13 12 10 11 11 10
Source: "Levada-Center" www.levada.ru.
The problem of asymmetry of economic and political factors of the development of the Russian economy becomes highly critical if viewed from a long-term perspective, moreover if to assume that the sources of the current economic growth, budget revenues and funds to support social programs are closely related to the market situation.
5.1.2. Political versus economic institutions: public polls and their problems
In the 1990'es which one could call a period of initial establishment of a new institutional structure of economy in Russia the following components (criteria) were typically used: privatization, legislation (the scope and quality of the new le gislatio n a nd t he I aw i nst itutions) banking sector status (independence of banks,
4 We'd like to cite a statement made during the period of launching the 2004 administrative reform: "...while the government authorities having decided to increase their impact on the economy, demonstrate certain incompetence. There is a simple explanation to this. The government has not been dealing with economy at least for twelve years. It was involved in solving budget-related issues. There are no people in the current government who might know the real problems of the economy and how to deal with those problems. Therefore any attempt of the government to remove private capital from the solution of strategic issues in the sectors where this capital operates would lead to stagnation " (T. Gurova, "Give me the wheel, Party" // Expert, 2004, No 15, p. 34). 534
islation and the law institutions) banking sector status (independence of banks, their business skills and practical distribution of credit resources, and also the level of supervision and the payment system), and the role of the government (whether it is market-oriented or not and how efficiently it manages the state owned sector). All subsequent additions were highly specialized, we believe. This standard was expanded in the 2000'es by including various assessments of "the corporate governance quality", of "economic and legal factors of the financial markets development" and "the boundaries of the institutional capacity". Apparently significant was also a growing interest to the problems of effective courts and enforcement in general5. The most acute current issue is a systematic problem of adequate quality of the political institutions.
Since various groups and individuals typically derive benefits by "exploiting" economic institutions, a conflict tends to arise between various options of the public choice which is eventually resolved in favor of the groups having more political power. The distribution of the political power in the society is defined by political institutions and depends on the distribution of resources. Economic institutions that promote economic growth emerge where political institutions, firstly, give the power to those groups that are interested in having a highly diversified ownership rights enforcement system, and, secondly ,where political institutions set up effective restrictions for the actions of the power authorities and , thirdly, where the power authorities have no possibility to generate considerable rent for themselves.6.
The said restrictions are true for assessing institutional changes in Russia during 1990-2000. In terms of application, the most important issue is how realistic is the today's discussion of the development of the above positive effects. Indeed we are not able to discuss the whole range of the functioning problems of the Russian political system in this paper. The above requirements to the quality of political institutions speak for themselves and apparently are the subject matter of the remote future for Russia.
Let us discuss only one issue as a possible argument - are there in the current Russian society any groups that could ensure the existence of a diversified system of ownership rights enforcement, given the above assumptions. Whatever approaches may be used, it makes sense to discuss primarily the problem of "the middle class".
There are various methodologies to identify "the middle class" ("normative" of "relative", "market-based" or property-education based", etc.). Using then one can receive a wide range of estimates. Even in the ex-USSR the quantitative estimates in the period of 80-90'es of the last century varied from 11% to 30% of the population. The estimates spread for Russia of the 1990'es is also large - from 6% to 25%
5 See, e.g.: The establishment of the institutional framework of the market-based economy, World Development Report, 2002. World Bank, 2002; From plan to market. World Development Report 1996. The World Bank. Oxford University Press, 1996; EBRD Transition Reports 1995-2006.
6 See.: Acemoglu D., Johnson S., Robinson J. Institutions as the Fundamental Cause of Long-Run Growth. - In: Aghion Ph., Durlauf St., eds., Handbook of Economic Growth, North Holland, 2004.
(prior to 1998 crisis). As for the period 2002 - 2004, the majority of estimates tend to coincide: 14% to 25% of the working population.7
According to Institute of Sociology of the Russian Academy of Sciences8, in 20032006 given the inflow of "oil dollars" into Russia, the size of the middle class keeps reducing - from 25% down to 20% (economically active urban population) 9. The marginal growth of the middle class up to 1/3 of the population size may take 10 -15 years (provided the structure of the economy remains unchanged). The authors of the report believe that the chances of the middle class to grow at the expense of "the old middle class" are close to zero since the latter is decreasing which is a paradox. In other words it becomes clear that in the developing economic model (of state monopoly type) there is a trend to reduce this middle sub-class. As a way out of this situation it is proposed to focus on the enhanced development of high technologies sectors rather than small and mid-size businesses. This trend likewise a growing social and economic indifference of the middle class has been noted by T. Maleva, Head of Institute of Independent Social Studies10. The specific mechanisms leading to this reduction are of secondary interest for us. What is essential for us is that in 2000 no positive dynamics of the potential social base was observed (supported by empiric evidences) for indirect (via political representation) formation of effective economic institutions.
Moreover, those institutions that in 1990-es opposed the expansion of demand for effective economic institutions are functioning today though in modified form. If prior to the early 2000'es (we recognize that the terms are conventional) the model of oligarchy capitalism was pursued, now we are typically speaking of the "state capitalism" in its Russian variation ( see below for details).
In this context the model of negative interaction (vs efficient market relations) establishes itself where some entrepreneurs (not a very representative segment) hold political power de facto or have a monopoly access to the center of political decision making. Afterwards these entrepreneurs using the judicial system as a tool against their competitors stop being motivated to establish and strengthen private property relationships 11.
7 See e.g.: E. M. Avraamova and others. Edited by T. Maleva. Middles classes in Russia: economic and social strategies. Moscow Carnegy Center. Moscow, 2003. ("the share" of the middle class is recorded at 20%). The data of All-Russia Center of Life Level and "KOMKON" (2004) go beyond the domineering estimates - 9%, and Rating Agency "Expert" which estimates of the middle class segment vary from 14% in 2000 up to 25%-30% in 2005.
8 "Urban middle class in modern Russia". Analytical report. M., Four criteria were used to identify middle class representatives: education, profession, income and integrated self-assessment of the social status. It should be noted however, that the income threshold for the middle class is only RUR10.5 thousand/month/household member. The report makes a distinction between "the old middle class" small businesses) and "new middle class (primarily top managers in the fuel and energy complex and other sectors of economy)..
9 A reverse trend prevails in the world: annual surplus of the middle class makes about 1%, according to some estimates.
10 Stagnation of the middle class. 24.01.2007, http://abarus.ru/news
11 Unequal distribution of wealth and relative inefficiency of production creates situations where most wealthy owners are not interested in solid protection of property rights: see Polishchuk L., Sav-536
According to the new institutional economic theory, the bureaucracy, its low productivity and absence of accountability which have been frequently criticized may be analyzed, on analogy with separation of property from control in a company, as a two-tier system of the principal and the agent where the government officials play the role of agents (controllers and employees) and the electorate that of the principal. However, unlike the corporate owner, the electorate may not have a clear common goal, and this restricts their abilities to organize an effective monitoring of the politicians and government officials12. This brings us back to the issue of the formation in modern Russia of an adequate social base that would be objectively interested in public control and monitoring and would have sufficient economic resources and the level of political power.
5.1.3. Protection of property rights versus finance
Primarily we should clarify why the idea of the protection of the property rights has been persistently placed at the core of any problem related to institutional development13. Recently in analyzing private property historical and geographical factors have been more often selected as a focus. By the beginning of the 21st century new-classic and new institutional researchers elected to determine the key features of the markets under their review at least partially by the established property relations and the system of enforcement of the property rights and the contractual obligations. The expansion of the new-classic models manifests in particular in the coverage of the 'in-depth" level (according to O. Williams) where the basic institutional structures like ownership and law enforcement are installed.
"The new comparative economics" that have recently claimed to be an independent trend of the new institutionalism made a thorough research of the genesis of the law systems and how they affect the property relations and their enforcement14. The following conclusions are proposed based on the findings of the econometric analysis in various countries:
vateev A. Spontaneous (non)emergence of Property Rights. - The Economy of Transition, 2004, Vol. 12, №1.S. Guriev and K. Sonin write: "While the rich have the advantage in setting up a private guards company and establishing good relations with the government officials, they are not encouraged to lobby the establishment of good government institutions, and therefore there is no demand for such institutions that would protect the property rights and moreover support competition. The problem is that the middle class (in this particular event associated with the small business) can not create the political demand for the good institutions due to the insignificant share it holds in the national economy and because of high costs on coordination". (S. Guriev, K. Sonin. The wealth and the growth // Expert, 2003, № 24, p. 46-47. See also: K. Sonin. Institutional theory of unlimited redistribution. // Issues of Economy, 2005, № 7, p. 4-18.
12 E. G. Furuboten, R, Richter, Institutions and the economic theory. - St-Petersburg, 2005, p. 547.
13 See also: works by V, Mau and K. Yanovsky in "Institute of Economy in Transition: research papers" dedicated to the regional and international comparison of the primary (basic) set of the political rights that absolutely prevail over any other political and economic freedoms such as life safety, security of property and independence of the judicial system and mass media.
14 For details see, e.g.: R. Enton, A, Radygin and others. Corporate governance and self-regulation in the system of institutional changes - M, IET, 2006, section 1.
- the higher is the level of development of the private property institutions (the level of guarantees that would not be expropriated by the government and the ruling class), the larger is their positive impact on the long-term economic growth, investments and the efficiency of the financial markets15;
- the improved implementation of the principles of the private property is an absolute requirement for more intensive development of the financial markets;
- protection of the property rights ensures preconditions for more intensive expansion of investments and higher rates of the economic growth16;
- in those countries where the courts enjoy more independence, the property rights are better protected and an improved environment is created for intensive economic growth 17;
- the successful transplantation of the legislative norms and law institutions is connected not only with the choice of a legislation system but rather with the law enforcing practices in the given country (as in Russia);
- the more corrupted are the government officials the smaller is the chance to strengthen market-related institutions and competition mechanisms (given that the administrative discipline remains at the same level).
The protection of the property rights (sometimes this notion is used as a synonym of the law enforcement) and the financial system are considered base economic institutions. Each of these is a subject for a separate study in terms of their relevancy and conformity of their current status in Russia to the economic rationale18. What is meaningful in the context of our analysis is that the mutual influence of those institutions in their current status seems to be negative.
A weak system for protecting property rights (due to the absence of a clear government strategy regarding state sector and privatization transactions, inertia meaning that the law is considerably behind economic activity; high degree of uncertainties and contradictions in the business law; low quality of judicial and law enforcing practices; the expansion of rights of the departments and ministries to interpret the law; poor government supervision; opposition to the establishment of self-regulating institutions; ongoing banks and corporate risks associated with protection of deposits and securities; absence of regulation in the area of new financial tools; current and long-term problems with land and real estate markets, etc.) , curbs back the development of the financial system as a key long-term tool of transformation of financial resources into capital.
In their turn, a high level of concentration, fragmentary and close nature of the Russian financial system in general, the absence of coordination and strategy of its
15 See.: Acemoglu D., Johnson S., Robinson J. Institutions as the Fundamental Cause of Long-Run Growth. - In: Aghion Ph., Durlauf St., eds., Handbook of Economic Growth, North Holland, 2004.
16 La Porta R., Lopes-de-Silanes F., Shleifer A., Vishny R. Legal Determinants of External Finance // "Journal of Finance", Vol. 52, 1997.
17 La Porta R., Lopes-de-Silanes F., Pop-Eleches C., Shleifer A. Judicial Checks and Balances // "Journal of Political Economy", Vol. 112, 2004.
18 See: Russian economy in 2005. Trends and prospects. M, IET, 2006, section 4. 538
development19, regular disproportions and non-transparency of the banking system, still high dependency of the Russian stock market on the international liquid cash flows and short-term portfolio investments tend to weaken long-term demand for a stable protection of the property rights (investors). The modern economic literature generally recognizes that in the assessment of the level of law enforcement and protection of the property rights the financial market plays a key role (since unlike the commodity market, long-term relations between the borrower and the lender are at stake).
According to the Frazer Property Index, Russia refers to the group of least developed countries. Its index value is between 4-5 (where 10 is the top value, and 0 - is the lowest), which is similar to the indexes of Nicaragua, Philippines, Syria, Pakistan and Ukraine.
According to IET this is in line with the current level of investments. Elasticity of the investment growth for Property Index statistically estimated on the basis of international comparison is 0.4 with a 5-year lag. In other words 1% Index growth results on average in 0.4% during the next five years. Thus for Russia with 4.4% Index growth (2004 estimate) up to 6 (this is the level of Greece, Korea, Slovakia and India) or 7-8 points (Mexico, Hungary, Hong Kong, Italy, Spain and Israel), the increase of investments by 2-3 points (of GDP) may be expected. Following the method of Index calculation we may assume that as a result of the development of the judicial reform (higher independence of courts via radical increase of costs of removal of judges appointed by the new procedure, and introduction of a new procedure of appointment of federal judges: qualification board with the participation of the entrepreneurs' trade union, law defenders and Human Rights Commissioners) the Frazer Property Index may grow by 3-4 points on the average ( up to 7-8 points).
It is worth noting that uncertainty both macroeconomic and institutional has always affected investments negatively. A number of empirical studies proves the existence of a stable negative link between the level of investments into GDP and institutional variables characterizing the degree of protection of the property
19 Modern economic literature traditionally divides financial systems into "banking" (bank-based financial system, relationship-based financial markets) and "market" (market-based financial system, arm's length financial markets); but this classification has becomes obsolete primarily due to the development of securities' markets within the traditional banking systems. The recent studies performed in 150 countries have not revealed any obvious advantages neither of the "bank loan model" nor of the "securities model". According to the financial services view, it is the quality and accessibility of financial services that have prime importance, and secondly, the structure of the financial system may have secondary importance since the banks and the securities markets deal with similar economic tasks; thirdly, banks and securities markets may effectively supplement each other and enhance competition in the area of corporate control by providing alternative options of funding investments; and finally, the division by the type of the financial system does not explain the differences in the rates of the long-term growth and establishment of new companies. However, the relationship between the law system and the financial system is an axiom. The review and the data by Expert, 2005, № 44, p. 70-76.
rights20. The review results of a large number of countries show that in the countries with the favorable situation in the area of the property rights the investment processes get accelerated with a time lag of 5 years. This means that the absence of institutional changes or moreover the aggravation of the investment climate by certain directions may lead to negative consequences for investments in the near future or serve as a limitation of investment growth into major capital of the Russian economy.
This is an endless topic; and only two examples will be discussed here. In 2006 during IPO process the Russian companies engaged not less than $17 billion from Russia and another $17 billion by placing ruble-denominated bonds. According to Rosstat, out of $17 billion received from the distribution of shares only $2.5 billion (or 14.7%) were invested into fixed capital. As for how the $17 billion generated from the placement of corporate bonds were used, statistics show that only $60 million (or 0.4%) were employed for the creation of the new fixed capital. Of course, one may account for inaccuracies of the official statistics, however the basic conclusion will hardly be changed: the funds received by issuing shares and bonds are not invested into fixed assets and therefore do not affect economic growth. One can assume that the core cash flow is used for refinancing and acquisition of debts from their current owners. There are processes at the current Russian stock market that are similar to those at the U.S market in the late 1980'es known as LBO (leverage-buy-out) transactions funded from the issuance of IPO and "junk" bonds. These transactions were actually mass-scale borrowing of funds at the stock market by using a credit lever to buy companies and their assets. The key risk of such transactions is a low efficiency of the acquired companies which may not be enough to repay the debts. In the U.S. this junk bond market crashed in 1989 with borrowing companies becoming bankrupt.
Here is another example: in 2006 the share of GDP market capitalization increased up to 92.7% against 61.5% in 2005. The same year Russia became one of the world leaders in attracted direct foreign investments. The internal loan share in GDP for the year which dropped in 2005 from 25.9 down to 20.6% of GDP, remained in 2006 almost at the previous year level. The gap between the indicators of capitalization and internal loan is an evidence of serious disproportions between the level of development of the banking system and the growth of the Russian companies (for more detailed analysis, see section 5.4).
The problem of mutual influence of the property rights protection and the financial markets may be also viewed in the context of transplantation of the legal norms. Some analysts believe that the legal system in the ex-USSR was least perceptible to such transplantation. The difficulties in that case could be explained not by that in the course of the post-communist law reforms ineffective legal norms were implemented at least from the viewpoint of economic efficiency. According to K. Pistor, M. Raiser and S. Gelfer, many former USSR states received technical as-
20 Clague C. Introduction, in Clague C. ed., Institutions and Economic Development: Growth and Governance in Less-Developed and Post-Socialist Countries. Baltimore: Johns Hopkins University Press, 1997. 540
sistance from the USA, and now can boast of remarkable protection of the investors' rights. On paper, if these documents are trustworthy, these rights are better protected than in some highly developed Western countries like Finland and Germany. It is unlikely that the level of development of the financial markets will correspond to such high level of legal norms support21.
5.1.4. Legislative system versus protection of the property rights
Two directions of this topic may be identified - quality and appropriateness of the law and constraints set by the systematic corruption that decrease efficiency of the law enforcement practices (in addition to the quality of the enforcement tools). This topic is highly comprehensive and diversified and we will discuss just a few representative trends.
In terms of the problems solved by the legislation, the evolution of objectives set in the mid-term programs of social and economic development during the 2000'es is very specific. (Table. 4).
Table 4
Basic objectives and tasks of the major institutional transformations in the 2000'es Programs of the Russian Government
Areas of the economic policy
Plan of Actions of the RF Government in the area of social policy and economy improvement for 2000-2001 approved by RF Government Resolution of July 26, 2000, No 1072-r _(with amendments)_
Program of a mid-term social and economic development (2002-2004), approved by RF Government
Resolution of July 10, 2001 r. No 910-r
Program of a mid-term social and economic development (2006-2008), approved by RF Government Resolution of January 19, 2006 r. No 38-r
2
3
4
Protection of the property rights
Privatization
Implementation of actions for active protection of the property rights to assist in the creation of the favorable business climate
Privatization of the major number of the federal government companies and federal government owned shares
Establishment of the favorable business climate based on protected property rights and actual mechanisms ensuring the transfer of the property rights
Privatization is founded on the principle of buyers' equality
Reliable protection of the property rights, reforming of the law protective and judicial system; development of independent and public mass media and institutions of the civil society
Increase of the efficiency of privatization and acceleration of the reforming rates of the state sector
State property management
Corporate Governance and protection of shareholders' rights
Increase of the efficiency of the state property management
Development of a Business Ethics Code
Qualitative increase of the efficiency of the property management and performance of the state enterprises
Creation of mechanisms for protection of the shareholders' property rights. Improvement of the applicable laws and formation of judicial tools for protection of shareholders' interests
Law improvement to optimize the state sector, and increase profitability of using property
Improvement of the mechanisms for protection of shareholders' rights.. The law sets the balance of rights and interests of various groups of shareholders
21 Pistor K., Raiser M., Gelfer S. Law and Finance in Transition Economics. - Economics of Transition, July 2000, Vol. 8, N 2, pp. 325-368
1
2
3
4
Bankruptcy and protection of creditors' rights
Development of a stock (financial) market
Development of a land and real estate market
Protection of the rights of creditors, owners, shareholders (participants) of the established and liquidated companies ликвидируемых организаций
Creation of the environment ensuring the development of investment institutions, increase of the number of financial tools. Development of infrastructure and tax treatment. Improvement of the tools for stock market regulation
Creation of the environment for effective use and development of real estate to meet the needs of the community and individuals
Formation of the legal environment ensuring effective protection of the interests of creditors and owners
Enhancement of the role of the stock market in attracting investments. Creation of the environment for development of institutional investors. Encouragement of investment activities. .
Development of infrastructure
Essential expansion of the legal framework for the real estate market development. Establishment of the system of legal federal and municipal regulation of the real estate market
Balance of rights, interests and responsibilities of the participants of the bankruptcy cases and procedures
Expansion of the range of financial tools. Creation of equal competitive and comfortable conditions for the financial market players.
Improvement of the system of market regulation, tax treatment and infrastructure.
Land and real estate are involved into business turnover
Indeed, the formal progress by specific directions of institutional transformations (that were also fixed in the mid-term programs as objectives and dealt with gradually in some way) is obvious. Among most remarkable achievements of the 2000'es is a modification of the Federal law "On the Joint-Stock Companies" (2001), new laws "On Bankruptcy" and "On the Federal and Municipal Unitary Enterprises" (2002), new wording of the law on competition (2005 - 2006); the Concept of improvement of the corporate laws by 2008 adopted in summer of 2006, several clauses of which have been implemented already (modification of Article 80 of the Law "On the Joint-Stock Companies"); the development of a number of procedural innovations in the area of corporate conflicts in 2006-2007, etc.
Nevertheless, as seen from Table 4, for 2000-2008 the basic objectives change but insignificantly. The general conclusion on the stagnation of the institutional transformations based on the formal grounds only would be ambitious, however, the comparison above gives grounds for the assumption of insufficient legal and regulatory support of the processes of the development of economic institutions in the long term period.
A list of several meaningful legal acts which need has been discussed since late 1990'es can serve as the evidence of this conclusion: "On the restructuring and liquidation of commercial entities", "On the affiliated persons", "On the responsibility for execution of transactions using confidential corporate information" ("On the insiders' transactions"), "On the self-regulating entities", "On nationalization in the Russian Federation", "On the central depositary" etc. The reasons for a long delay in passing these legal acts are diversified, however the need in the establishment of transparent legal framework on these issues remains acute.
There are some examples below of how the law lags behind the economic reality (protection of the property rights) (Table. 5).
Table 5
Inertia of the Law in 1990-2000
Issue Most acute period Legislative decision Basic (probable) grounds for the decision Impact
Minorities' stock dis- 1995- -2000 Amendments to the Consolidation in major The issue ceased
solved law "On the Joint-Stock Companies" , 2001 companies mainly completed being a problem due to economic reasons
Transfer prices 1995 - early Changes in the Tax Political reasons Selected pressure on
against minorities 2000' es Code early 2000 'es major companies
State-owned assets 1990'es - early 3Law "On the federal Strategic decision of grad- For those state en-
removed; no control 2000'es and municipal unitary ual liquidation of unitary terprises that have
over the state compa- entities" , 2002 enterprises the administrative
nies' management resource formal restrictions are introduced
Bankruptcy as a tool 1998- 2002 Federal Law 'On Public campaign against The appropriation
for company appro- bankruptcy", 2002 appropriations via bank- market use other
priation ruptcy instruments like courts, registers, falsification of documents, etc.
Raiders (unfriendly 2002 -now Draft amendments in Public campaign against -
acquisitions) the procedures, 2007 raiders
Unfriendly appropria- 2006 - mid- Current projects en- The issue of intensification -
tion of land (forecast)) term hance uncertainty and corruptions of conflicts in this area does not actually exist
10-year statute of 2000 now The period is reduced Demonstration of efforts to In court practices the
limitations for privati- to 3 years, 2005 r. strengthen property rights statute of limitations
zation transactions protection changes are easily overcome. The court decision is consid-
ered to be enough
Mergers and acquisitions called "raids" in the popular press is one of the most broadly discussed topics of today. Unfriendly acquisitions were not surprising back in the 1990'es, and the 2000'es were characterized by a stable growth of M&A transactions (with no state holdings). According to the available data, in 2006 the amount of mergers and acquisitions with the participation of Russian companies amounted to $55-$60 billion which roughly corresponds to the 2005 level (www.mergers.ru); Ernst & Young analysts speak of $65 billion (the growth is higher by 1/3 vs 2005). In 2007 the M&A market with the involvement of the Russian companies may increase by 25-30% or more if in 2007 there will be large-scale transactions with the shares of energy companies and abroad.
The problem of "alien acquisitions" (only those that do not refer to the corporate law and classic raid - which is a purchase of shares but based on falsification of documents, and therefore subject to the criminal law for corruption) is not significant. According to the Ministry of Internal Affairs, in 2005 the value of disputable assets was about RUR200 billion or 12% of the total amount of 2005 M&A transactions. However, it is these transactions that recently have been causing significant public (or pseudo public) protest. The RF Government introduced to the State Duma a whole set of amendments in the Arbitration and Procedural Code of Russia, RF Code of Administrative Offences, Tax Code and other laws in January 2007. (the notion of a corporate dispute was introduced; the possibility for minority share-
holders to join their claims into one "collective claim"; all the elements of a corporate dispute could be united into a sole process at the arbitration court at the place of registration of a claimant; settlement of security actions, etc). The problem, however, may not be solved in the framework of corporate and procedural amendments given criminal nature of most notorious acquisitions.
As many believe, in 2006-2007 the 'raider" problem became more serious in the area of land property. According to IET estimates (see section 5.3), the current legislation does not create proper conditions for taking land into private property but on the opposite has a trend to enhance ambiguity of interpretations and expand arbitrary actions of administrations. As an example let us see look at the most acute problems22 of appropriation of land under privatized enterprises:
- unjustified exclusion by the federal and regional authorities of the considerable number of land plots from the list of lands subject to buy-outs;
- unacceptable costs of land buy-out for the majority of the enterprises; absence of reduced prices for small and mid-size businesses, or payments by installments as well as crediting tools to provide access to land for a bigger number of enterprises;
- marginally high prices of land buy-outs established in some of the regions and overestimated cadastre values of land;
- administrative subjectivity in setting boundaries of land plots as a result of deficiencies in the urban development legislation;
- problems of interaction between the federal and regional authorities in the area of delineation of land ownership and distribution of revenues from land sales and rent.
The principle of distribution of authorities as a basis of a modern law-abiding state seems to play a most important role in the "political and legal infrastructure" as it ensures proper environment for a sustainable economic growth. The decisions of those authorities that in practice act as an arbitrator who supervises property sales, implementation of contractual obligations and rules of the market game should be the evidence of the "actual" independence of the courts from the executive power.
The formation of a "double standard" and various rules of the market game for different classes of the participants is a specific feature of the institutional development in 1990'es and 2000'es. Such double standard for private owners at the
22 Equally serious problems exist in other areas of land relations. In Moscow, for instance, in spite of the provided by the Housing Code rights of owners to the residential premises, it is so far unrealistic to "form" a land plot under a multi-storey building (with the privatized housing stock, not for a new development)in order to implement further the right of land common ownership. One of the formal invented reason to refuse to do this is the need to preliminary delineate Moscow territorial units. The city development plans of the Moscow administrative areas are not approved by the law in detail and for a long-term period which gives rise to "current" updates and amendments depending on the market situation and specific interests. In both cases this may lead to spontaneous development of lands including those that are currently under apartment houses. Well known are the conflicts in the 2000'es connected with enforced removal of residents from the buildings in the central zone of Moscow pretending these buildings are in the state of emergency. 544
federal and regional levels creates very serious obstacles on the way of the establishment of the favorable institutional environment and local institutional changes in the area of property rights protection, corporate governance, financial markets, budget limitations, etc.
In other words the existence of this "double standard" results in that the market mechanisms work well in the limited space which has a trend to reduce itself in the context of the concept of the formation in Russia of the "state capitalism model' (see section 5.2). Though the long-term objectives of creating sustainable and flexible institutional environment (applied to the market mechanisms) remain unchanged, an undisputable priority is the formation of basic pre-requisites for their implementation - legislative, judicial, procedural and regulatory framework to assure the unified market rules. It should be stressed that the only relatively effective limitation in application of various rules in the "double standard" system may be an independent institution of courts that would have to take over the function of unification of the rules for all market players. Therefore the prospect of the development of economic institutions encouraging economic growth in Russia to a great extent depends on the adequate functioning of the existing political institutions.
An ideal illustration of the "double standard" and of what is private property in Russia and how valuable is its relation with the supreme political power like in the ancient oriental countries (unlike in the modern Western world) may be two radically different alternatives of ending a business established by almost equal methods (though not always legitimate) during one and the same period (about 10 years) provided this business is quite solid and profitable. The first alternative is that the company gets destroyed and its assets are nationalized, with no discussion of the market price of the transaction and possible ways of moving the proceeds outside the country (like in 'Yukos" case). The second alternative is the transaction of acquisition of "Sibneft" by "Gazprom" where the beneficiary received $13 billion together with the opportunity to legitimately dispose the acquired assets both in Russia and abroad including new asset acquisitions in Russia in 2006. Between these two extreme options there is a wide range of possible compromises that are traditionally considered in Russia as "proposals which one can hardly decline". The said transactions can not be called market ones since they had only an illusion of a fair market price, and the government still keeps its arguments from the "Yukos" case.
Finally, one should mention corruption as a systematic factor that affected institutional changes during 1990 - 2000'es. As mentioned before, the higher level of corruption is in the government authorities, the least opportunities remain to strengthen market institutions and competition mechanisms.
These dependencies creating a vicious circle result from potential changes in the distribution network when the establishment of new political and economic institutions is opposed (directly or indirectly) by those officials who usually generate benefits (illegitimate) from the current norms and provisions. In certain cases effective market relations are substituted for competition at the "political markets". Naturally the players do not manifest their real aims. Therefore certain "regulators"
keep appealing to the interests of various groups while pursuing their own interests and aspirations.23.
One citation seems to be relevant here: "In characterizing the Russian economic and political system it is hardly enough to apply the "neutral" term "corruption". This term is senseless. One should describe the system as a mechanism functioning on the principles of corruptive loyalty". 24.
Presently there are various estimates of the corruption scale in Russia; and all the analysts speak of the corruption growth in the 2000'es. According to A. Buksman, Deputy, General Attorney of Russia, the corruption amounts to about $240 billion per year (the method of assessment is unknown). "Indem" Foundation believes that the intensity of business corruption in 2001 - 1005 dropped by 20% however its volume increased manifold (in 2001-2005 the gross amount of bribes was up to 90%); this is explained by the increasing involvement of the government in the economics and redistribution of rent.
5.1.5. State capitalism versus de-nationalization
The problem of interference of the government in the property relations is as old as the property itself 25. John Lock believed that political power represents the right "to create laws... for regulation and maintenance of property"26. According to E. Furuboten and R. Richter, an economic institution must recognize a key fact that the transfer of individual property rights should be made voluntarily. The basic constitutional rules therefore should be based on the principle of inviolability of the private property rights. The state, however, has the power which may be directed not only at the protection of private property but also at its withdrawal27. Therefore, the basic condition of the functioning of a market-based economy in addition to the constitutional framework is a valid commitment of the government to respect private property28. A successful market requires, in addition to the adequate system of property rights, a politically safe foundation that sets up rigid constraints to possible confiscation of wealth by the state29.
In the modern world the neoclassical (neo-liberal) approach to the state as a main source of economic instability becomes more and more exotic both in the
23 See: A. A. Yakovlev. Possible strategies of economic agents regarding corporate governance institutions. / Development of demand for legal regulation of the corporate governance in the private sector. Research Papers, MONF, № 148, 2003, p. 51.
24 K. Rogov. Loyalty mechanisms // Kommersant, 2006, 13 of November.
25 In D. North classification the first economic revolution took place when there was a transition from nomads to a settled way of life and when for the first time a centralized (at the level of first prototypes of the government establishment) protection (guarantees) of the property rights to land was required that would provide to the owners stimuli for higher productivity and efficiency. See:: North D. Structure and Change in Economic History. - New York and London: Norton, 1981, p. 81.
26 J. Lock. Works in three volumes. - M: "Thought" 1988, V. 3, p. 343.
27 E. Furuboten, R. Richter. Institutions and economic theoty. - STP 2005, p. 335-337.
28 North D.C. Economic Performance Through Time // American Economic Review, 1994, 84, pp. 359-368.
29 Weingast B.R. Constitution as Governance Structures: The Political Foundations of Secure Markets // Journal of Institutional and Theoretical Economics, 1993, 149, pp. 286-311.
English-American and European research tradition. "There are not many grounds to believe that the market can function in a situation with a non-state economy"30. A standard new constitutional set of the state functions well where the state receives, together with the right of enforcement in the respective areas including specifications and property right protection, minimization of the information asymmetry of the market players, provision of the material channels of the commodity and services exchange, judicial (and otherwise, in the role of "a third party") settlement of contractual and other relations, standardization of measures and weights and provision of public benefits (defense, science, education and healthcare). The government interference is reasonable even in those situations where a need arises to compensate for certain external factors and delineate "worthy" and negative public needs31.
By the end of 1990 - early 2000'es the government involvement in the corporate sector of Russia was quite unfocused and existed in the form of numerous scattered unitary entities with bad management or no management at all and blocks of shares of newly established joint-stock companies almost in all sectors of the national economy. Integrated structures formed by the state initiative and with the state participation at the initial stage of privatization functioned mainly in the fuel and energy complex and also in natural monopolies.
The period of 2000-2004 was characterized by certain actions to increase efficiency of management of the scattered assets by integrating them into state holdings in such sectors as nuclear energy, railways, defense industry, support to the air and marine transports and postal communications. Any increase of the government stake in the capital of individual companies outside the integration processes was an exception. Restructuring of natural monopolies began in parallel to this process.
In the same period the attempts to establish (expand) control over main financial flows of the Russian economy and to make business dependent on the state institutions became more pronounced in spite of the decisions to de-regulate, administrative reform and further privatization plans. The key feature of the period 2005-2006 was a shift in priorities in favor of direct government involvement in the economy32. The following trends may be identified in this process:
- increasing activity of the operating state holdings and companies that decided to expand their businesses and make it diversified through mergers and acquisitions ("Gazprom", "Rosneft");
- involvement of new players ("Rosoboronoexport", RAO EES of Russia");
30 E. B. Atkinson, J. E. Stiglits. Lectures on economic theory of the state sector. - M., Aspect Press, 1995, p. 18.
31 Cm.: Eggertsson T. Economic Behavior and Institutions. Cambridge, 1990; Transaction Costs, Markets And Hierarchies. Oxford, 1993 u gp.
32 For details see: A. Radygin. Russia in 2000-2004: on the path to the state capitalism? // Issues of Economy, 2004, № 4, p. 42-65; A. Radygin, G. Malginov. Corporate control market and the state // Issues of Economy, 2006, № 3, p. 62-85.
- the strategy of integrating scattered assets still owned by the state into holdings becomes secondary; however the new structures begin acting, though on a selected basis, at the corporate control market as independent entities;
- expansion goes beyond the fuel and energy sector, though it is still premature to talk about multi-sector conglomerates;
- the interests shift from the assets of "problematic" or "unfair" companies (from the viewpoint of the state) towards the assets of "neutral" or "loyal" owners;
- a more extensive practices of such methods as increasing shares in the charter capitals of the companies up to the amount allowing to make a decisive impact on the companies' activity;
- active participation of largest state banks (crediting, guarantees, direct purchase of shares) in the processes of expansion of the government involvement in the companies' capital;
- a need to get a political consensus regarding possible major deals inside the country and with involvement of foreign companies as a necessary component of such business decision.
Back in 2005, according to some forecasts, it was envisaged that in 2006 -2007 the following companies might become the subject of nationalization by the state companies: "Norilsky Nickel" (51 % of shares, $8 billion), "Promstroybank" ($1.5 billion), the Urals Mining and Enrichment Company - UGMK ($5 billion), "Suirgutneftegas" (62% of shares, $20 billion), "Vossibneftegas" ($130 million), "Tomskneft", "Samaraneftegas" "Achinsk NPZ", Angarsk Oil Petroleum Company (jointly $8.5 billion), Syzran NPZ, Kuybishev NPZ, NovoKuybishev NPZ ($0.5 billion), TNK-BP (50% of shares owned by the Russian shareholders:$9-10 billion), "Syloviye Mashiny" ($450 million), "Uralkaliy" ($2 billion), "Silvint" ($1 billion)33.
The bigger part of those transactions has not been executed, but this does not mean that in 2006 the state expansion weakened (see also sections 5.2 and 5.4). According to Alfa-Bank analysts, during one year the share of the Russian companies' stock owned by the state grew from 29.6% to 35.1%34.
"Gazprom" activity in 2006 (against the growth of the company's external debt) is quite expressive:
- Shtockman field development was monopolized;
- Shell, Mitsubishi and Mitsui consortium bought a control block in "Sakhalin-2" project under the threat to stop the project because of non-compliance of the environmental law (in 2006 it was announced that the right of development of all new fields of the energy carriers at the shelf would be granted to state companies only);
- The companies engaged in the development of a largest in Russia Yuzhno-Taibei gas field were taken over;
- Large blocks of shares of energy companies (RAO EES of Russia, Mosenergo, OGK-1, OGK-2, OGK-4, OGL-6 and others) were acquired;
33
33 Mergers and Acquisitions, 2005. № 12 (34). p. 13-15.
34 B. Grozovsky. Chief owner of the country. // Vedomosti, 13 of February 2007 548
- Early 2007 a control block of shares of the Siberian Coal and Energy Company (SUEK) producing 1/3 of the energy coal in Russia was acquired;
- "Gazprom" and "Rosneft" was offered to buy out the shares of the Russian shareholders in TNK-BP while "Gazprom" expressed interest in getting rights to a 75% block of shares in Kovykta gas condensate field (simultaneously the tax, environmental and other regulatory authorities should issue claims to TNK-BP). The analysts note an obvious slow down of the production rates in the oil and gas industry in 2005 - 2006 as compared to 2000-2004 as a result of the oil and gas assets placed under control of the state corporation35, and due to gas shortage for internal consumption in the national gas balance starting 2007.
One of the 2006 deals at the M& A market with the involvement of the state companies was the purchase by FGUP "Rosoboronoexport" last fall of 66% of shares of a leading titanium and magnesium producer (30% of the world production) JSC "VSMPO-Avisma"36 (the deal value is $700 million). In the shadow of this event was the acquisition by "Oboronprom", a "Rosoboronexport" subsidiary, of the control block in "LEPSE" (Electric Engineering Company in Kirov), one of the major Russian companies producing electric equipment for the defense and car building industries. Further plans of "Rosoboronexport" expansion may be related to metallurgy and not only in Russia. In summer 2006 the "Rosoboronexport" management raised the issue of the establishment of a state holding that would be a monopoly in the production of specialized steels. Early 2007 CJSC "Russpetcstal", a "granddaughter" of "Rosoboronexport" purchased 100% in JSC "Metallurgical Plant "Krasny Octyabr" (Red October) «in Volgograd. Among possible future acquisitions there may be Chelyabinsk Metallurgical Plant (JSC "Mechel"), Zaporoz-hie titanium and magnesium plant, Volnogorsk and Irshansk mining and enrichment complexes (GOKs) in Ukraine, Metallurgical Plants "Electrostal" (in the city of Electrostal of Moscow region), "Serp i Molot" ("Hammer and Sickle" (Moscow) that are producers of specialized steels for the defense industry.
Since "Rosoboronexport" increases control over the assets and diversifies the sector structure as a result of various profiles of the respective companies (helicopter manufacturing, metallurgy, car and defense industries), the company may be encouraged to restructure itself by setting up a managing company that would be completely owned by the state. The companies under its control including "Ro-soboronoesport" as an entity that received the monopoly right to exercise military and technical cooperation with foreign countries may become subsidiaries. In future some of the subsidiaries may issue shares additionally.
The functions of a major state financial institutions - Vneshtorgbank (99.9% shares owned by the Russian federation) - are not limited to the processes of expansion of the state into the banking sector where the total amount of the M&A transactions did not exceed $3.5 billion in 2006 (e.g. the take-over of "Promstroy-
35 V. Milov. The echo of ownership re-division. // Forbes, February, 2007, p 30.
36 In 1998 the control block of "Avisma" shares (Berezniki of Perm region) was acquired by Verchne-Saklinsk Metallurgical Production Consortium (VSMPO) in Sverdlovsk region after which two companies actually integrated.
bank" in St-Petersburg). In 2006 this bank participated in the buy-out of ALROSA shares and in the mergers made by "Rosoboronexport" structures.
During 2005-2006 privatization was noted for quite opposite processes. In the 2006 spring message to the Federal Assembly Russia's President confirmed again the need of privatization ("the state should keep in its ownership only the property which is absolutely required to perform its functions").
In spite of a formal number of blocks of shares put for sale and the decisions to reorganize unitary enterprises, the situation is close to critical. Every year not less than 50% of transactions is suspended due to the absence of demand, and the quality of management of the state owned property is hardly different from that of the 1990'es. It looks like the situation in this sector is closely connected with modification of views regarding the role of the state sector in the Russian economy37.
From the one hand, one of the tasks of 2006 - 2008 is to create at least the "illusion" of completing the privatization as a component of the institutional reforms - to sell federally owned blocks of shares and to restructure the sector of state unitary entities. -The effect of the process both for the government and the concerned entities is secondary as compared to possible political gains. On the other hand, the increasing state expansion which manifests itself either in the overall economic strategy, or a trivial re-division of property in favor of groups close to power, or opposition of the concerned ministries, objectively removes from the privatization process major and most profitable state owned assets.
5.1.6. Stability versus stagnation
The problem of stability of the ownership structures and the appropriation rules the reverse side of which is the protection of property rights is most critical in the present Russia. David Hume, a famous Scottish philosopher and economist, stated that no one can doubt that the agreement of the distribution of property and the stable possession of this property is the most needed condition, and after such agreement is concluded, not much is to be done. "Stability of possession" like "the transfer of property by consent" and "fulfillment of commitments" are three basic natural laws (in the terms of the natural right doctrine)38. The significance of stability of these relations for the economy in transition is reassured in certain cases by similarity of the institutional issues and the formation of a developed system of private property relationships.
The most pessimistic forecast of the development of the property-related relationships in Russia looks like the following39. Indeed there are no constructive decisions in Russia to go away from the power-property re-division reality40. The latter
37 In April 2006 Yu. Petrov, Head of RFFI, announced that as a result of the privatization some 30-40 major state holdings should appear in the strategic sectors of the Russian economy .
38 Hume D. A Treatise of Human Nature. Ed. by Mossner E.C. London, 1969, p. 578.
39 See: N. Popadyuk. Is the private property in Russia really private // Issues of economy, 2006, № 1, p. 152-153.
40 The notion of the "power-property" introduced by L. Vasiliev means primarily that this economic category applies to the entire society; this is "a syncretical integrity of the power and property where they are inseparable making a sole phenomenon which is "the power-property": the power (posses-550
has all the grounds to reproduce itself. All individual fluctuations of corporate or local business models similar to private property will, times and again, fall under this power-property continuum because of its immanent logics which sets up the behavior model of the so called private entrepreneurship. The practical logics behind this is like this: the property represented by particular persons will start linking itself with the power to realize its private interests and eventually merging with the power using the latter as a guarantee from possible "flaks", while the power, if the private property is "legitimate" in the country, will continue attempts to possess private property being caught in corruption and getting prestigious top management positions in the so called big private business. The Russian power-property may be called re-distributional because new teams of the government officials who periodically come to power with the help of "democratic procedures" resolve the previous problems in a more "fair way (transactions of privatization, even when the statute of limitations is reduced to 3 years, etc.). Such is the framework setting the rules.
In the modern new institutional economic theory the stability of the institutional environment is described by the following main criteria: 1) general stability of the established property structures and the appropriation rules during the entire period of long-term investments as a key feature; 2) political and legal stability; 3) valid capacity of the judicial system; 4) the culture of contracts and "commitments" inspiring confidence". None of the said criteria permits speaking about maturity of the institutions established in Russia during the last 15 years. On the contrary, all the above gives grounds for the following conclusions:
1) The asymmetry of economic and political factors of the development of the Russian economy in the 2000'es is obscured so far by the general indicators of the economic recovery, unstable feedstock market, and the indicators of the state finance (budget surplus, Stabilization Fund, gold and currency reserves), and of exceptional profitability of the Russian stock market. In the 2000'es a negative impact of the "state" factor increases while the quality of "the market factors" gradually decreases. The conclusion of the actions of the "state" and the "market" going into opposite directions in Russia during the 2000'es is confirmed by the data of sociological surveys and country ratings.
2) In a long-term perspective this problem of asymmetry of economic and political factors of the Russian economic development becomes critical primarily in the context of the roles of the political institutions required for the formation of effective economic institutions, if to assume moreover that it is the market that is the source of the current growth of the economy, budget revenues and funds for social programs support.
3) During the 2000'es a contraction of the potential social base for indirect (via political representation) formation of effective economic institutions is ob-
sion) generates the notion and the concept of the property while the property emerges as a function of the possession and power". (L. Vasiliev. History of the East. - M., High School, 2001, Vol. 1, p. 42.). The term "re-distributional property" is a variation of the "power-property" in the specific historical context of the Russian state.
served. Those institutional mechanisms that in the 1990'es opposed the expansion of demand for effective economic institutions are functioning now but in a modified form. If before the 2000'es (the terms are conventional) we talked about "oligarchy capitalism", presently the most common term used is the "state capitalism" in its Russian modification.
4) In the mid of the 2000'es the risks brought into entrepreneurship (in its legalized forms) by the institutions and regulative function of the government remained significant, however, the impact of a new factor became more pronounced: the government was obviously restoring its direct interference into the economy. There was also a strong probability of the relationship between the expansion of the direct and indirect interference of the government and the growing corruption in the 2000'es.
5) The mutual influence of such institutions as the property rights protection and the financial system in their present form is rather negative. The absence of institutional changes or aggravation of the investment climate by certain directions may have negative consequences for the investment dynamics in the near future or curb the investment growth into the fixed assets of the Russian economy.
6) During entire period of 2000-2008 the basic objectives of mid-term social and economic programs change but insignificantly. The general conclusion on the stagnation of the institutional changes based on such formal base only would be too ambitious, however the above comparison gives grounds to assume that the legislative and regulatory support to the processes of the development of economic institutions in the long-term is inadequate. One can talk of a chronic gap between the legislation and the economic reality.
7) A specific feature of the 2000'es institutional development is the formation of the "double standard" and different rules of the market game for various classes of the players. The establishment of the double standard at the federal and regional levels creates insurmountable obstacles on the way of the formation of the favorable institutional environment in general and also put brakes to local institutional transformations in the area of the property rights protection, corporate governance, financial markets, budget restrictions, etc.
8) By the end of the 1990'es - early 2000'es a situation emerged in the country where the economic laws were relatively well developed but the law enforcement remained very critical. In the mid 2000'es the focus apparently changed: though the diseases of the Russian system of law enforcement were still acute a certain shift took place in the framework of the economy legislation (and its interpretations) which, on the one hand, increased uncertainty of implications of various economic actions for the business in terms of the government reactions, while from the other hand, tightened the relations between the government and the private business. The problems of the Russian law enforcement system supplemented with the trends of expanding uncertainties and restoration of rigid legislative norms apparently increase the risk zone in the property rights area.
5.2. Public Sector Transformation and Property Relations Policy
5.2.1. Public Sector Status: Quantitative Aspect
Similar to the previous several years, public sector overall quantitative status as of mid-2006 was provided in the Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009 approved by the RF Government Directive No.1184-r of August 25, 2006. This document contains data on the number of Federal State-Owned Unitary Enterprises (hereinafter - FGUPs) and stock-holding companies with the RF Government participation as of June 1, 2006.
Let us review the last few years' quantitative dynamics of the entities with the above-mentioned organizational and legal status by each of the public sub-sectors at the federal level.
Federal State-Owned Unitary Enterprises
Table 6 below presents the dynamics and industry-based profile of FGUPs in 2003-2006.
Table 6
Dynamics and Industry-Based Profile of Federal State-Owned Unitary Enterprises in 2003-2006
as of June 1, as of June 1, as of June 1, .. . ____
2003 , 2004 , 2005 , asofJune 1 2006
% of the
Industry (sub-sector) num- % num- % num- % num- % number as of June 1 2005
ber ber ber ber
Nonmaterial sphere 4357 44,2 4069 44,1 3617 43,6 1817 25,3 50,2
Industries, incl. 2224 22,6 2064 22,4 1870 22,55 1624 22,6 86,8
- engineering 908 9,2 827 8,95 734 8,85 660 9,2 89,9
- soft industries 193 2,0 193 2,1 194 2,3 187 2,6 96,4
- construction materials manufacturing 81 0,8 80 0,9 68 0,8 55 0,75 80,9
- food-processing 60 0,6 61 0,65 55 0,7 55 0,75 100,0
- metallurgy 49 0,5 37 0,4 34 0,4 30 0,4 88,2
- chemical industry 46 0,5 43 0,5 39 0,5 34 0,5 87,2
- other industries 887 9,0 823 8,9 746 9,0 603 8,4 80,8
Agriculture 1329 13,5 1237 13,4 1111 13,4 913 12,7 82,2
Construction 1035 10,5 978 10,6 903 10,9 752 10,5 83,3
Transport, communications 851 8,6 809 8,8 725 8,75 612 8,55 84,4
Forest management 64 0,6 65 0,7 67 0,8 53 0,75 79,1
Other sub-sectors - - - - - - 1407 19,6 -
Total 9860 100,0 9222 100,0 8293 100,0 7178 100,0 86,6
Source: Federal Property Privatization Forecast Plan (Program) for 2004 and Key Areas of Federal Property Privatization for the period up to 2006; Federal Property Privatization Forecast Plan (Program) for 2005; Federal Property Privatization Forecast Plan (Program) for 2006 and Key Areas of Federal Property Privatization for 2006-2008, Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; estimates by the authors hereof.
As results from Table 6, the overall number of FGUPs has decreased by 2682 enterprises i.e., almost by 27% for the last 3 years (between June 1, 2003, and
June 1, 2006). In particular, during the period between June 1, 2005, and June 1, 2006, this number decreased by 13.4%. With this, during the period between June 1, 2005, and June 1, 2006, the absolute reduction of unitary state-owned enterprises (by 1115) was the biggest versus the reduction during the period between June 1, 2004, and June 1, 2005, (by 929), and during the period between June 1, 2003, and June 1, 2004 (by 638).
FGUPs industry-based profile benchmarking seems to be not 100% correct due to the fact that a new category ("Other Industries") appears in 2006, meaning the industries that do not fall under the basic classification of industries (and this category comprises 19.6% of all FGUPs). It is because of this that we can see significant reduction of non-material sphere unitary enterprises share: from 25.3% vs. 43.6% as of mid-2005. As for the industries falling under basic classification, the share of practically each of them has decreased slightly (agriculture, construction, transport & communications, forest management); the overall share of industrial production remaining at the same level. Out of heavy industrial enterprises the majority state-owned unitary enterprises belong to engineering (9.2%) and soft industries (2.6%), with the share of these sub-sectors growing slightly compared to 2005.
The greatest absolute reductions in the number of state-owned unitary enterprises for the period between June 1, 2005, and June 1, 2006, took place in agriculture (198 entities), construction (151 entities), transport & communications (113 entities). If we take the number of unitary enterprises as of June 1, 2006, as % of their number as of June 1, 2005, we may state that the most significant reduction (by over 15%) took place in such sub-sectors as forest management, construction materials manufacturing, construction, transport & communications41. And the number of state-owned federal unitary enterprises in food processing remained the same.
It is necessary to emphasize that analyzing the quantitative dynamics of FGUPs42 was based on their number as of specific date, which allows for judging only about the most general trend of that or another specific sub-sector shrinking. The available statistics data does not allow for evaluating the comprehensive demography of such business entities, the specific scale of their set-up, termination and transformation into entities with other organizational and legal statuses, i.e., does not allow for analyzing the whole totality of actions resulting in the specific number of such entities at a specific point of time. The outcome of industry-based profile of state-owned unitary enterprises is that if we do not focus on the changes in classification, than we can say that the share of entities belonging to compatible sub-sectors has changed insignificantly.
41 Without accounting for the nonmaterial sphere enterprises, which cannot be compatible due to segregating "Other Industries" category in 2006 (did not exist in 2005).
42 The same comment is relevant for analyzing the number of joint-stock companies with federal government interest.
Joint-Stock Companies with Federal Government Interest
Table 7 below presents the dynamics and industry-based profile of such entities in 2003-2006.
Table 7
Dynamics and Industry-Based Profile of Joint-Stock Companies with either Federal Government Interest or which are Subjects to the "Golden Share"
Regulation, 2003-2006
as of June 1, as of June 1, as of June 1, .. . ____
2!003 , ¡2004 , ¡2005 , as of June 1 2006
% of the
Industry (sub-sector) num- % num- % num- % num- % number as of June 1 2005
ber ber ber ber
Nonmaterial sphere 1918 45,6 1781 45,6 685 18,1 356 9,6 52,0
Industries, incl. 1350 32,1 1253 32,1 2078 54,9 1772 47,6 85,3
- engineering 225 5,4 209 5,4 187 4,95 663 17,8 354,5
- food processing 43 1,0 40 1,0 54 1,4 141 3,8 261,1
- metallurgy 34 0,8 32 0,8 28 0,75 101 2,7 360,7
- construction materials manufacturing 21 0,5 20 0,5 19 0,5 53 1,4 278,9
- chemical industry 19 0,4 18 0,5 46 1,2 98 2,65 213,0
- soft industry 16 0,4 15 0,4 9 0,2 27 0,75 300,0
- other industries 992 23,6 919 23,5 1735 45,9 689 18,5 39,7
Construction 492 11,7 457 11,7 287 7,6 380 10,2 132,4
Transport, communications 383 9,1 356 9,1 459 12,1 396 10,6 86,3
Agriculture 46 1,1 43 1,1 229 6,1 363 9,7 158,5
Forest management 16 0,4 15 0,4 45 1,2 99 2,7 220,0
Other sub-sectors 358 9,6
Total 4205 100,0 3905 100,0 3783 100,0 3724 100,0 98,4
Source: Federal Property Privatization Forecast Plan (Program) for 2004 and Key Areas of Federal Property Privatization for the period up to 2006; Federal Property Privatization Forecast Plan (Program) for 2005; Federal Property Privatization Forecast Plan (Program) for 2006 and Key Areas of Federal Property Privatization for 2006-2008, Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; estimates by the authors hereof.
As results from Table 7, the overall number of JSCs with federal government's share decreased by 11.4% during the period between June 1, 2003, and June 1, 2006, including by 1.6% during the period between June 1, 2005, and June 1, 2006. The absolute number of such JSCs eliminated during the period between June 1, 2005, and June 1, 2006, was two times lower than the similar number for the period between June 1, 2004, and June 1, 2005, (59 versus 122).
Similar to FGUPs, a new category was established for the industry-based profile of JSCs with federal government's share in 2006 ("other sub-sectors"), which does not fall under the classification of base industries (overall, there are 9.6% such JSCs). As a result, the share of JSCs qualified as related to nonmaterial sphere fell from 18.1% as of June 1, 2005, down to 9.6% as of June 1, 2006, which in absolute numbers means by 329 companies). In addition, another very important shift in the industry-based profile of JSCs with federal government's participation is worth noting: decreasing the share of companies belonging to industrial sector (from 54.9% as of June 1, 2005, down to 47.6% as of June 1, 2006), to transporta-
tion and communications sector (from 12.1% down to 9.6%). On the contrary, the share of JSCs belonging to some other sector has grown: construction (from 7.6% up to 10.2%), agriculture (from 6.1% up to 9.7%) and forest management (from 1.2% up to 2.7%).
At the same time we need to emphasize that the share of JSCs with federal government's participation decreased mainly due to establishing this separate new group of "other sub-sectors" which does not directly relate to those listed in the Table (metallurgy, engineering, chemical building, construction materials manufacturing, soft industry and food processing). And this separate group demonstrates a record reduction of contribution both in its relative share (from 45.9% down to 18.5%), and in absolute figures (by 1046 companies).
As for other sub-sectors and industries, the absolute number of JSCs with federal government's participation has grown, especially in engineering - by 476 companies. Quite significant increase was also observed in agriculture (by 134 companies), and in construction (by 93 companies). As for the growth rate dynamics among JSCs with federal government's participation as of June 1, 2006, vs. June 1, 2005, r. Engineering and soft industries took the lead demonstrating the annual growth rate of 3 and even more times.
Table 8
Dynamics of Joint-Stock Companies with Federal Government Participation (including application of special "Golden Share" Regulation), 1999-2006
Number of JSCs
Total Less than 25% 25% + 1 share -50% 50% + 1 share -100% - 1 share 100 % "Golden Share"
Date JSCs % JSCs % JSCs % JSCs % JSCs % Total Without shares
1999 January 1, 2001 January 1, 2002 3316/ 3896* 3524** 4407** 100 100 100 863 1746 2270 26.0 49.55 51.5 1601 1211 1401 48.3 34.4 31.8 470 506 646 14.2 14.35 14.65 382 61 90 11.5 1.7 2.05 580 ** 750**
January 1, 2003 June 1, 2003 October 1, 2003 4222 4205 4035 100 100 100 2152 2148 2051 51.0 51.1 50.8 1382 1339 1308 32.7 31.8 32.4 589 600 552 13.95 14.3 13.7 99 118 124 2.35 2.8 3.1 1076 640 118 148
January 1, 2004 June 1, 2004 March 1, 2005 3704 3905 4075/ 3791* 100 100 100 1769 1950 1697 47.75 49.9 44.8 1235 1183 1154 33.35 30.3 30.4 540 499 487 14.6 12.8 12.85 160 273 453 4.3 7.0 11.9 5 591 251 284
June 1, 2005 3783/ 3524** 100 1544 43.8 1093 31.0 474 13.5 413 11.7 259
June 1, 2006 3724/ 3481*** 100 1063 30.5 885 25.4 397 11.4 1136 32.6 243
* - 3896 business entities are mentioned in the context of State Property Management and Privatization Conception issued in 1999 (including 3611 Open Join6t-Stock Companies, 251 Closed Corporations and 34 Limited Liability Companies) as those with participation of the RF Government in share capital; 31316 is an estimate based on summarizing all shares (stocks, interest) mentioned in the Conception;
** - overall number of JSCs applying special "Golden Share" Regulation without specifying the JSCs in which the Government does not have stock packages;
*** - joint stock companies not accounting for 48 shares and packages in foreign-based companies;
**** - JSCs not accounting for 75 closed corporations and shares in LLCs charter capitals granted based on the RF Government Resolution No.545-rof April 2, 2002, "On Termination of State Participation in Charter Capitals of Credit Institutions", or received by ways of succession, gift or due to other reasons;
* - 3791 is an estimate number of JSCs having got shares owned by the Russian Federation, without accounting for 284 joint-stock companies to which the "Golden Share" Rule is applied (without a package of stocks). Percentage of JSCs with different number of government-owned stocks is made comparable with the previous periods data, for which it was calculated based on this number. For reference: as of January 1, 2005, the RF Federal Government owned shares of 3767 JSCs, not accounting for the already mentioned 284 JSCs with the "Golden Share" and for 24 000 LLCs with Government participation;
** - 3524 is an estimate number of JSCs having got shares owned by the Russian Federation, without accounting 259 joint-stock companies to which the "Golden Share" Rule is applied (without a package of stocks). Percentage of JSCs with different number of government-owned stocks is made comparable with the previous periods' data, for which it was calculated based on this number; *** - 3481 is an estimate number of JSCs having got shares owned by the Russian Federation, without accounting for 243 joint-stock companies to which the "Golden Share" Rule is applied (without a package of stocks). Percentage of JSCs with different number of government-owned stocks is made comparable with the previous periods data, for which it was calculated based on this number. Source: agency website www.mgi.ru; A.A. Braverman, Measures to Improve Efficiency of Federal Property Management and Criteria for Evaluating Such Efficiency // Bulletin of the RF Ministry for Federal Property Management No.1, 2003, pp. 13-14; Companies with Government Participation. Institutional and Legal Aspect, Efficiency Aspects. Collection "Analytical Reports: Independent Economic Analysis" No.155. - M.: Moscow Public Scientific Foundation; Association of Public Economic Studies, 2004, p. 47; Federal Property Privatization Forecast Plan (Program) for 2004 and Key Areas of Federal Property Privatization for the period up to 2006 // Bulletin of the RF Ministry for Federal Property Management No.4, 2003, pp. 4-5; Key Issues of Improving Federal Property Management Efficiency and Main Areas of the RF Dividend Policy // Bulletin of the RF Ministry for Federal Property Management No.4, 2003, p. 8; Federal Property Privatization Forecast Plan (Program) for 2005; Materials for the RF Government session of March 17, 2005, "On Measures to Improve Federal Property Management Efficiency"; Federal Property Privatization Forecast Plan (Program) for 2006 and Key Areas of Federal Property Privatization for 2006-2008; Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; estimates by the authors hereof.
Another important feature characterizing JSCs with federal government's participation was their distribution by the scope of government's participation (number of stock belonging to the Federal Government) (Table 8).
According to Table 8, the period between June 1, 2005, and June 1, 2006, was marked by a long-awaited drastic turnaround in the structure of stock packages owned by the federal government, increasing the number of JSCs in which the federal government has enough shares to decisively influence (control) the policy. During this period of time the absolute number of JSCs with 100% government interest increased by 2.8 times, which is definitely an evidence of certain progress in the process of FGUPs incorporation. As for the number of JSCs with less than 100% government interest, it decreased. It is especially obvious with relation to the number of JSCs with minority (up to 25%) federal government interest, which decreased by 1.5 times; as for the number of JSCs with blocking and controlling
packages owned by the RF government, their decrease was far more modest - by 20% and 16% respectively.
This resulted in the following structure of federal government portfolio as of June 1, 2006: the packages of up to 25% interest constitute circa 30% of all the JSCs with federal government participation, the blocking packages (between 25% and 50%) constitute about 1/4, and in 44% of JSCs the government could execute majority control (with that, the share of JSCs with 100% of government capital made 32.6% - three times above the share of JSCs in which the federal government owned majority stock but less than 100%). The share of JSCs with all stock owned by the federal government increased significantly compared to June 1, 2005, while as the share of JSCs with different sizes of government interest declined.
Comparing the structure of the federal government packages as of mid-2006, with the one the RF Ministry for Property Management was expecting after implementation of 2003 Privatization Program, we may state that the estimated target was achieved with more than 2-year delay (Table 9).
Table 9
Federal Share Packages Structure as of June 1, 2006 vs. the Expected Early 2004 Structure Resulting from Privatization Program Implementation
Share of federal packages in JSCs by their sizes and types, _% of the aggregated totality of the packages_
Type of package based on the shares of the Federal Government, %
- Minority (less than 25%)
- Blocking (between 25% and 50%)
- Controlling (between 50% and 100%)
- Complete (100%)
Total number of packages owned by the RF government
fact as of June 1, 2006
30.5 25,4 11,4
32.6
3724/3481*
Estimated upon implementation of 2003 Privatization Program (i.e., as of early 2004)
36 22 12 30
3613
* - without accounting for the joint-stock companies to which the "Golden Share" Rule is applied (without a package of stocks).
Source: Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; A.A. Braverman, Measures to Improve Efficiency of Federal Property Management and Criteria for Evaluating Such Efficiency // Bulletin of the RF Ministry for Federal Property Management No.1, 2003, p. 29; estimates by the authors hereof.
Thus, it had been planned to bring the share of minority packages down to 36% (de facto - 30.5%), of blocking packages - down to 22% (de facto - 25.4%). The share of complete packages had been expected at the level of 30% (de facto -32.6%). The actual number of controlling packages (11.4%) practically matched the estimated target (12%).
By that the obvious misbalance in the favor of packages not providing for the required level of government control inherited from the period of monetary privatization of early 90-ies was successfully eliminated, and the share of minority packages turned out to be even less than the number expected by early 2004. The actual absolute number of JSCs with government-owned packages by mid-2006
approximately matched the estimated number expected after implementation of 2003 Privatization Program.
A more ambiguous situation may be observed when comparing the structure of federally owned packages as of June 2006 with the absolute numbers of 1999 (according to the data presented in the RF State Property Management and Privatization Concept). The major trend here is significant (by 2.8 times) increase of the share of JSCs with 100% government capital, as well as of JSCs with the minority government-owned packages (by 4.5%), while the share of JSCs with different amounts of government capital decreased. The biggest decrease (by 1.9 times) was observed for JSCs with blocking packages owned by the RF government (between 25% and 50% interest), and as for JSCs with controlling government interest (between 50% and 100%), their share has also decreased, even though just by 3%. Having this said, we need to keep in mind, that 1999 data might be incomplete.
However, we may conclude, that the number of reported federal government packages under 25% as of June 1, 2006 (1063 entities) was 1.23 times higher than in 1999, with the maximum falling on early 2002 (2270 entities), after which a stable trend for decrease was being observed (except for H1 2004). The number of federal government packages between 25% and 50% in 2006 (885 entities) was by almost 45% less, than in 1999 (1601 entities), being higher in the beginning of 2002 (1401 entities), than a year before that (1211 entities), and afterwards it was demonstrating a stable decline trend. The number of federal packages between 50% and 100% in 2006 (397 entities) was approximately 15% less, than in 1999 (470 entities), though it was fluctuating within rather extended range during the analyzed period making 646 entities as of the beginning of 2002 and 600 entities as of June 1, 2003, after which this number was decreasing gradually. The number of JSCs with 100% federal government interest in 2006 was circa 3 times higher than in 1999. The minimum number of such JSCs was registered as of the beginning of 2001 (61 entities). Further on it kept growing, and between June 1, 2005, and June 1, 2006, this growth was of somewhat stick-slip nature by 2.8 times (i.e., by 723 entities).
The scale of the "Golden Share Rule" application to control JSCs reached its maximum in early 2003, when in addition 958 JSCs to which it was applied simultaneously with a certain federal government package there also were 118 JSCs without federal government participation (compare: in 1999 there were 580 JSCs to which such Rule was applied, while as in early 2002 - 750 JSCs). In 2003-2004 while the process of selling packages owned by the federal government proceeded, the number of such JSCs was decreasing (591 entities as of the beginning of 2004), however, the number of JSCs to which this special Rule was applied without government having any shares was growing: 284 entities as of March 1, 2005 (the maximum number for the whole period between 1999 and 2006), which is 2.4 times more than as of the beginning of 2003. The share of JSCs to which just the Rule was applied without simultaneous ownership of interest in the overall number of JSCs with the "Golden Share" was also growing: in early 2003 it was 11%, and as of the beginning of 2004 it already was over 42%. However, further on the decrease
in absolute numbers of JSCs to which the special Rule was applied without the government owning a package started to decrease: 243 entities as of June 1, 2006, versus 259 entities a year before (over 6% decline).
The dynamics of the ration between two major sub-sectors of the public sector at the federal level also looks pretty interesting (Table 10).
Table 10
Dynamics of decrease of FGUPs and JSCs with packages owned by the federal government during the period of 2003-2006, %
Period Federal State Unitary Enterprises (FGUPs) JSCs with shares owned by the federal government
June 1,2003, and June 1,2004 6.5 7.1
June 1, 2004, and June 1, 2005 10.1 3.1
June 1, 2005, and June 1, 2006 13.4 1.6
June 1, 2003, and June 1, 2006 27.2 11.4
Source: Federal Property Privatization Forecast Plan (Program) for 2004 and Key Areas of Federal Property Privatization for the period up to 2006; Federal Property Privatization Forecast Plan (Program) for 2005; Federal Property Privatization Forecast Plan (Program) for 2006 and Key Areas of Federal Property Privatization for 2006-2008; Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; estimates by the authors hereof.
As it follows from Table 10, the sub-sectors decrease in 2003-2006 was obviously erratic. The FGUPs sub-sector, initially being more extensive, decreased by over 27% in 3 years, while as the sub-sector of JSCs with federal packages decreased only by about 11.5%, i.e., 2.5 less than the FGUPs sub-sector. With that, if both sub-sectors decreased by an almost equal amount between June 1, 2003, and June 1, 2004, during the following years the decline of JSCs with the federal government interest was declining far less rapidly, the gap reaching over 10 times during the period between June 1, 2005, and June 1, 2006.
This data provides strong evidence of the growing process of FGUPs decline during the last several years, including the decline due to the growing scale of their incorporation. Of course, it needs to be kept in mind that the number of unitary enterprises declined not solely due to their incorporation, but also due to their liquidation and merging /aggregation. However, the rate of selling federal stock packages is clearly behind the rate of incorporating FGUPs, and it is due to this fact that the proportion between these two sub-sectors has changed (Table 11). The abrupt increase of JSCs with 100% federal government interest (Table 8) speaks about the same trend (these JSCs are mostly former FGUPs having been put under incorporation).
As is shown in Table 11, the number of JSCs with federal packages made about 52% of the number of FGUPs as of June 1, 2006, while as it was making 42.6% as of June 1, 2003. The same trend can be clearly observed in the industry-based profile. JSCs with federal packages are now constituting a higher percent of FGUPs number practically in every industry, and for industry overall (starting from mid-2005), as well as for forest management (starting from mid-2006) the number
of such JSCs exceeded the number of FGUPs. Inside the material sector the number of JSCs as of June 1, 2006, in metallurgy, chemistry, food processing was 2.53.4 times higher than the number of FGUPs, while as in engineering industry this number was practically the same. The non-material sector formed an exception, as its profile has been changed due to establishing the "other industries" category in 2006, so that the entities had to undergo a re-classification to be attributed to that or another sector, resulting in re-distribution of entities between the industries.
Table 11
Ratio between JSCs with government interest and FGUPs in 2003-2006, %
Industry (sub-sector) as of June 1,2003 as of June 1,2004 as of June 1,2005 as of June 1,2006
42.6 42.3 45.6 51.9
Nonmaterial sphere 44.0 43.8 18.9 19.6
Industries, incl. 60.7 60.7 111.1 109.1
- engineering 24.8 25.9 25.5 100.5
- soft industry 8.3 7.7 4.6 14.4
- food processing 71.7 65.6 98.2 256.4
- construction materials manufacturing 25.9 25.0 27.9 96.4
- metallurgy 69.4 86.5 82.4 336.7
- chemistry 41.3 41.9 117.9 288.2
- other industries 111.8 111.7 232.6 114.3
Agriculture 3.5 3.5 20.6 39.8
Forest management 25.0 23.1 67.2 186.8
Transport & Communications 45.0 44.0 63.3 64.7
Construction 47.5 46.7 31.8 50.5
Source: Federal Property Privatization Forecast Plan (Program) for 2004 and Key Areas of Federal Property Privatization for the period up to 2006; Federal Property Privatization Forecast Plan (Program) for 2005; Federal Property Privatization Forecast Plan (Program) for 2006 and Key Areas of Federal Property Privatization for 2006-2008; Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; estimates by the authors hereof.
The JSCs created through incorporation of state unitary enterprises naturally become subject to government management (the government being the shareholder) in compliance with relevant legal norms and procedures. The duration and the level of government's participation shall be in such case defined by the timeline of selling the government-owned package, as well as by the scale of this package. It's worth reminding that in JSCs where all voting shares are owned by the federal government (as a rule, they are former FGUPs), the authority of the General Shareholders Meeting is usually exercised by the RF Agency for Federal Property Management (FAFPM). The GSM Resolution shall be then issued in the form of FAFPM directive. The norms regulating the order and deadlines for preparing, calling and conducting General Shareholders Meetings shall not be observed in such cases.
The government sector profile in the near future will be to a great extent dependent on the degree the privatization program is implemented.
5.2.2. Outcomes of2006 Privatization Policy and Mid-Term Privatization Plans
As it is already known43, the Forecast Plan (Program) of Federal Property Privatization for 2004 and Key Areas of Federal Property Privatization until 2006 (approved by the RF Government Resolution No.1165-r of August 15, 2003) stipulated the following algorithm of actions: 2003 - privatization of government-owned packages of stocks comprising up to 2% of charter capital, 2004 - government exit from all companies with government share comprising less than 25% interest, 2005 -government exit from all companies with government share comprising from 25 to 50%, 2006 - government exit from all companies with government share exceeding 50%, which are not qualified as strategic businesses, 2008 - completion of privatizing federal property not being used for carrying out government functions of the Russian Federation. According to this scenario, by 2008 not more than 2,000 FGUPs and 500 different packages should remain under government ownership.
Certain adjustments were then introduced when adopting the Forecast Plan (Program) of Federal Property Privatization for 2005 and for the period until 200744: extension of federal property privatization perspective for 2007; completion of privatizing companies with government share comprising less than 25% interest by 2005; amending the industry-based profile of privatized federal property; introducing the "mid-term financial plan" concept into the federal property privatization planning.
The Forecast Plan (Program) of Federal Property Privatization for 2006 and Key Areas of Federal Property Privatization in 2006-2008 (approved by the RF Government Resolution No.1306-r of August 25, 2005) is even more careful in terms of quantitative indicators. According to this document, the key objectives of government property privatization policy in 2006-2008 are as follows: privatizing federal property not being used for carrying out government functions (authorities) of the Russian Federation, assuring phased reduction of the number of federal state-owned unitary enterprises (FGUPs), accelerating federal property privatization, forming the federal budget revenue basis. In 2006 government-owned stock packages not exceeding 50% of the respective JSCs charter capitals were to be offered for privatization. The limitations were related with excluding JSCs included into the strategic businesses list or participating in formation of integrated organizations, as well as packages of stock to be divested based on the needs of 2006 budget revenues planning and on the needs of mid-term financial plan for the period until 2008.
In reality the major trends of privatization dynamics continued to be the same 2006 (Tables 12-13):
- extremely slow process of selling minority (non-controlling) interest still remaining with the government45;
43 For details see: Russian Economy in 2005: Trends and Outlook. - M., IET, 2006.
44 The Forecast Plan approved by the RF Government Resolution No.1124-r of August 26, 2004.
45 According to certain estimates, in 2000-s no more than 10% of the annually offered minority packages were sold. The packages which were not sold during one year would be added to the offer of 562
- increasing number of JSCs with 100% government interest resulting from acceleration of FGUPs incorporation;
- stable decrease of privatization revenues share in the overall structure of revenues from state property management (in 2003-2006);
- lack of major privatization deals (even though Privatization Plan for 2006 stipulated selling stock packages of at least 2 major companies - 34% "KAMAZ" and 100 % "SG-Trans" with approximate value of RUR 23 billion);
- stable growth and domination of revenues from using state property in the overall structure of revenues from state property management (i.e., renewable sources);
- traditionally low rates of privatizing land plots occupied by privatized companies (see Section 5.3).
Table 12
Major Federal Property Entities and Privatization Program of 2000-s
1999* 2000 2001 2002 2003 2004 2005 2006 2007
Overall number of FGUPs ** 13 786 11 200 9394 9846 9275 8820 8293 7178 -
Privatized FGUPs per year:
- forecast - actual*** - 2 5 1652 102 970 571 1374 517 1245 741 1398 n/a 652
JSCs with the RF government interest** 3611 3524 4407 4 222 4 035 3905 3524 3724 -
Including the following
shares in charter capital:
- 100% 382 61 90 99 124 273 413 1136 -
- 50-100% 470 506 646 589 552 499 474 397 -
- 25-50% 1601 1211 1401 1 382 1308 1183 1093 885 -
- less than 25% 863 1746 2270 2 152 2051 1950 1544 1063 -
- "Golden Share" 580 - 750 958 640 284 259 243 -
Federal stock packages
sold per year:
- forecast - - - 1126 1965 1702 566 1350 927
- actual*** - 87 125 112 630 655 634 n/a -
* By the end of each year. 1999 taken as baseline accounting for adoption of State Property Management and Privatization Conception (approved by the RF Government Resolution No. 1024 of September 9, 1999).
** Without taking into account the special "Golden Share" Rule. In early 2000-s the overall number of unitary companies made c. 85,000, including c. 20,000 state-owned enterprises and c. 65,000 municipal enterprises. In 1995 government owned at least 15,000-17,000 various stock packages, in 1999 - about 3,100 "fixed" packages and 7,000-8,000 of non-sold packages (in the books of regional government property funds). In 1995 1004 JSC were qualified for the "Golden Share" Rule.
the following year. Thus, 2006 year plan stipulated privatization of 885 FGUPs and 422 stock packages (participatory interest). With this, according to the methodology used for developing privatization plans, the entities having not been sold during the previous (2005) year also needed to be included into 2006 plan, which meant additional 513 FGUPs and 928 stock packages (participatory interest).
*** Actual data on annual privatization of both stock packages and FGUPs cannot be interpreted correctly for a number of reasons: 1) lack of regularly supplied data supplied by RF Property Management Committee (Rosimuschestvo) and Russian Federal Property Fund; 2) as a rule, from 10 to 50% of deals are closed in different years, and the non-sold packages are "carried over" to the next year; 3) the "counter" process of FGUPs incorporation and other ways to increase the stock packages owned by the government; 4) reorganization going on in energy industry and in communications industry, contributing some of the FGUPs assets into charter capitals of some government holdings, formation of integrated organizations in defense industries, in railway sector, etc. Data ob FGUPs privatization are pretty conventional, because official privatization data includes FGUPs about privatization of which the initial decision was made or the ones having undergone the stage of transformation into JSCs. That is why the number of FGUPs may be reported higher than in reality. Source: data from RF Ministry of Economic Development and Trade, Federal Agency for Federal Property Management.
The share of privatization revenues b in the overall budget revenues has been steadily decreasing since 2003. As it is obviously demonstrated in Table 7, in 2003 the revenues from privatization deals made RUR 90.6 bln, in 2004 - RUR 61.8 bln, in 2005 - RUR 29 bln, in 2006 - RUR 17.6 bln. That means that annual revenues decrease makes at least 30%. According to the estimates by the Federal Duma Committee for State Property, privatization rates have decreased more than 2.5 times over the last 2 years.
The reasons for the minority government-owned packages of stock not being in big demand are well known: the insiders (the already existing holders of controlling packages) are not interested in buying additional minority packages; for many outside investors it is pretty senseless to purchase a package without acquiring real control; the situations are pretty common when even a 100% package is being offered for auction with the most profitable assets already divested, etc.
As it is known, the major portion of privatization revenues of late 1990-s -early 2000-s were generated by 1 or 2 major deals. Lack of such deals in 2006 was not related only with some objective factors. Indeed, the overall favorable situation with budget revenues (inherent for the effective privatization law), possibility to execute deals based on the general economic situation create favorable environment for flexible approach to execution of various types of deals. In relation with this the refusal from additional (non-renewable privatization) revenues to the federal budget looks pretty justified, especially with all these on-going discussions about the rational ways to use the growing Stabilization Fund.
At the same time sale of 100% of JSC SG-Trans stock (the company's assets are over 400 real estate entities) did not take place because a whole series of real property in the company's books (including some land plots) lacked registered titles. In its turn, this has lead to almost 50% decrease' of direct revenues from privatization in 2006 -RUR 17.6 bln vs. the planned revenue of RUR 31 bln46. In all likelihood, there is yet another important factor - an alternative (vs. privatization)
46 Press release by Federal Agency for Federal Property Management "On Major Outcomes of Rosimuschestvo Activities in 2006", December 29, 2006; Interview by V.L. Nazarov, Rosimuschestvo Director, "On Major Outcomes of Rosimuschestvo Activities in 2006", January 23, 2007, Interfax (www.mgi.ru). 564
possibility to hand over "SG-Trans" to "Transneft" company together with "Trans-nefteproduct".
In a broader context, one of the most fundamental causes for slowdown of privatization process in the Russian Federation over the recent years is the continuing growth of government involvement into Russian economy. On one hand, one of the key tasks for 2006-2008 is creation of at least appearance of privatization completion as an element of successful institutionalization reform - selling federal stock packages and transforming the state-owned unitary enterprises sector. The effectiveness of the process - both for the government and for the companies involved - is in this case of a secondary character versus potential political dividend. On the other hand, the on-going property expansion of the government (general economic strategy, a trivial re-distribution of property in favor of those close to the government, or opposition of certain ministries - stakeholders of the process47), excludes the most valuable or the most profitable and efficient government assets from privatization process. It is pretty demonstrative that in April of 2006 Yu. Pet-rov, Russian Federal Property Fund Director, stated that 30 - 40 major government holdings will be formed in strategic sectors of Russian economy as an outcome of privatization process. The key challenges for RF Ministry of Economic Development and Trade (MEDT) being responsible for privatization strategy starting from 2004 are pretty obvious: divestment of non-sellable "non-liquid" assets still remains the key task, however in the situation when the extracting industries have the strongest positions and budget revenues profile corresponds to this fact, it is rather difficult to justify sale of new highly profitable assets. This becomes even more problematic due to no clear understanding of the key areas of spending the accumulated federal budget revenues.
In the next several years we may expect the following change in the structure of non-renewable sources of revenues from state property management: revenues will grow at the expense of favorably located property - land plots that are of interest for the investors. According to the RF Federal Property Fund estimates, currently about 70% of the customers of the privatized land plots (including military towns, etc.) are smaller and medium-size businesses which are actually investing into the under-valued real estate understanding that currently the value of land still isn't being included into the purchasing price of the divested assets, however, new owners of businesses acquire the title for the land as well48. It is obvious enough,
47 According to the available data (Rosbalt, August 4, 2006), in 2006 different agencies were challenging the privatization decisions with regards of 448 JSCs and FGUPs already included into 2006 plan. Rosavtodor (Federal Agency for Roads - protested against privatization of 148 agencies), RF Ministry of Defense (protested against privatization of 81 entities), Rosenergo (Federal Agency for Energy - protested against privatization of 52 entities) and RF Ministry of Agriculture (protested against privatization of 46 entities) were the most active ones.
48 Article "Rasprodazha" // "Rossiyskaya Gazeta" newspaper, January 29, 2007. The growing number of released military property assets is also directly connected with land lots: 477 entities were divested during the first 2 quarters of 2006, while during the same period of the previous year only 200 similar entities were divested. Overall amount of 2006 revenues from selling military assets exceeded the 2005 revenues by almost 3 times making RUR 1.41 bln in 2006 vs. RUR 589 mln in 2005.
that some significant reserves for privatization revenues growth are available in relation with optimizing the legal framework of selling land. It is also worth noting that according to some estimates about 70% of real estate still belongs to the government.
In 2005 Rosimuschestvo decided to liquidate 16 FGUPs with over 600 real property sites on their books, including the ones in downtown Moscow. This decision caused some very serious doubts with regards to the feasibility of such liquidation - mainly because of serious risks of the state losing the most valuable sites without adequate financial compensation (e.g., by applying special schemes under which the most valuable assets are at first divested to other entities, and only "empty" legal entities are being publicly offered for sale). In October 2006 this decision was cancelled and 12 FGUPs including the companies managing Moscow real estate are to be merged with some FGUP called "Federal Computer Center for Exchange and Information Technology" ("FT-Center"), the title itself telling that this organization can be focused on practically any task. FGUP "FT-Center" is to be privatized as well, though its privatization has been delayed. Meanwhile, federal real estate shall be functioning within lease agreements.Different from privatization revenues, the renewable revenues sources demonstrate sustainable growth over the whole period of 1999-2006 (Table 7). According to the official 2006 data by the RF Agency for Federal Property Management, the total amount of federal budget renewable revenues administered by the Agency made RUR 67.3 bln exceeding similar revenues of 2005 by RUR 10.7 bln. The aggregated amount of distributed dividend made over RUR 23 bln exceeding the respective 2005 amount by 20%. Federal budget revenues from 19 major JSCs with government interest (excluding JSC Rosneft) increased by almost 2006 RUR 4.5 bln in 2006. In 2006 Rosimustchestvo switched to market-based lease rates (for 7507 Federal Property Leasing Agreements). The share of leasing agreements based on the rates calculated according to the "non-market" methodology of the former RF Ministry for Federal Property Management has decreased almost 2 times by the end of 2006. Revenues from leasing federal property including federal land have gone up by almost RUR 2.3 bln, making up to almost RUR 16.8 bln in 2006. The revenues from selling the right to execute leasing agreements for federally owned lands exceeded similar revenues of the last year by over 90%.
Another revenue source is relatively new but already of big significance - this is the revenue from cash recovered by Rosimuschestvo and its territorial divisions through a judicial proceeding on property disputes. During the first 3 quarters of 2006 RUR 2.63 bln were collected (vs. RUR 1.3 bln from the same source in 2005), the share of fully/partially sustained claims making 82.4%.
Even though the renewable revenues sources grew 8 times during the period of 1999-2006, not 100% of them are unimpeachable, which is especially important if we look into the future prospects for such sources growth. The process of switching to the market-based federal property leasing rates is undoubtedly economically feasible. On the contrary, "protection of the property rights of the Russian Federation" should not be focused merely at fiscal objectives of recovering re-
spective cash amounts via property disputes, especially in the context of the general trend towards increased government involvement (and respective application of this mechanism).
Table 13
Dynamics of Revenues from Privatization and/or Using Federal Property, RUR bln
C c to
c 0 '■p C3 N vi J2 « o CL (Q U. » ü S O c ■o w n g "O w 0 3 c 0 > 0 0 +J ■a c 0 W .Ï "E ra Q. £ > 0 . 0 ■a c TO m a. o u. . £ 0 o 4- O O 0 . >
'Ü c n J2 0 ü .a w" "O ■> 0 o . c c "w 4- O s ¡8 0 w < 1-
"Z CL O) .= '5 ra S 0 0 o 3 o 40 "w ra 0 ra 0 ^ c (3 fc 3 0 > o 1-
T™ = c 0 ra c 0 0 w oj 0 ■Q ^ ri "E 0 c
M Ü Ui ** en £ oi oj a. 0
rn 3 £ 0 oj
oi oi i= oj TT
oi o
1999* 8 547.4 8 547.4 - - 8 720.5 848.1 (600) 2 191.4 - - 5 675.0 17261. 9
2000 31 367.1 31 367.1 - - 18 790.1 3 675.1 (1050) 3 427.2 - - 11 687.3 50157.2
2001 10 110.6 9 990.6 - 120.0 29 122.6 6 478.0 (782) 4 896.1 3 917 209.6 (131) 13 621.9 39233.2
2002 14 700.7 12 703.8 - 1 996.9 36 762.2 10 402.3 (747) 7 657.9 4 400 914.2 (809) 13 388.8 51462.9
2003 95 237.3 90 660** 585 3 992.3 41 143.2 12 395.2 9 573.9 197.3 2 387.6 16 200 136380.8
2004 65 777 61 856.8 662.7 3257.5 53 710,3 17 222.0 (319) 11 928.8 901.7 2 538.1 17 199.5 119487.2
2005 34 882 29079.2** 522 5280.8 54 404 18 610 14 170 1 748 2 386 17 490 89 286
2006 plan 31 600 31 000 600 n/a 53 052 20 500 16 700 2 000 2 500 11 352 84 652
2006 actual 19 010 17 600 1410 n/a 67 363,6 23 000 16 800 n/a n/a n/a Over 86 000
2007 estimate 49 000 41 000 N/a 8 000 73 921,5 24 080 17 600 4 000 15 425 12 816,5 Over 120 000
* 1995-2002 dynamics is found in: Russian Economy in 2002: Trends and Outlook. - M., Institute of Transition Economy, 2003, p. 367.
** Revenues from selling 74.95% JSC "Slavneft" stock for the amount of RUR 59 161.95 mln in 2002 were included into 2003 revenues (over 60% of all received revenues). Revenues from selling 17.8% JSC "Magnitogorsk Metallurgic Plant" stock for the amount of RUR 21 928.2 mln in 2004 were included into 2005 revenues (over 60% of all received revenues).
*** Revenues from leasing federal land after demarcation. In the following years the line "Lease payments and revenues from selling the right for executing the lease agreements for federal land" is accounted.
**** Only those renewable sources are accounted here, which directly relate to managing federal property (administered by the RF Agency for Federal Property Management). According to the RF Law "On Federal Budget for 2007", total estimated revenues from using federal property should make RUR 100 bln in 2007 including, on top of the listed sources, revenues from balances on federal budget accounts, government loans interest rates, revenues from remitting a portion of the RF Central Bank income, etc. There is one significant revenue source, which was not included into Table 13, but still has substantial weight in the overall revenues amount - "revenues from leasing property managed by federal government agencies and their establishments or/and under economic jurisdiction of federal state unitary enterprises (FGUPs)" (overall RUR 16.6 bln). Source: statistics of RF Ministry for Economic Development and Trade, RF Agency for Federal Property Management, RF Law "On Federal Budget for 2007", estimates by the authors hereof.
Obvious reduction of federal budget revenues from JV "Vietsovpetro" activities also leads to certain questions arising: the actual decrease in 2005 made RUR 17.5 bln, and the planned decrease for 2007 is by RUR 12.8 bln (given current favorable situation at the energy market). Russian share in JV "Vietsovpetro" was contributed to the charter capital of JSC "Zarubezhneft" in 2006 (100% Russian Federation property). Respectively, starting from 2008 the federal budget from JV's activities should have been transformed into "Zarubezhneft" dividend payments (in case the decision on pay-out was positive).
The dividend policy of Rosimustchestvo is the biggest question. As it is known, current government policy in this sphere (given the lack of uniform dividend policy with regards to government holdings) means merely annual increase of net profits share allocated to dividend payouts. In 2004 this share made at least 10% (the minimum as per the RF Law "On Joint-Stock Companies"), in 2005 - at least 20%, in 2006 increase up to 25% minimum is expected. Contrary to the previous years, there may be a significant novelty of Rosimuschestvo requiring calculation of dividend amount as a consolidated profit share49.
The issue here is feasibility of increasing dividend payouts at the request of government shareholders, especially in the situation of a big challenge to find relevant funding sources for large-scale investment programs of major government holdings, especially infrastructure-related ones, while as 2006 budget has a surplus. On one hand, representatives of such holdings together with some experts believe, that higher dividend paid to the government impedes production growth and companies' capitalization. On the contrary, the position of Rosimustchestvo is in using cheap credit for up-grading the production, which, first of all, improves the company's discipline, and secondly - justifies government participation in managing these assets. Nevertheless, Rosimustchestvo understands the fact that some organizations have all relevant legal grounds to "decrease the paid amount of dividend by the amount allocated for capital projects"50. This is especially relevant for such organizations as Gazprom and Rosneft, which in addition to their investment programs are also active players at corporate control markets.
In 2007 and 2008 privatization revenues according to the optimistic forecast of Rosimustchestvo and RF Ministry of Finance shall make RUR 49 and 52 bln respectively. These monies together with estimated revenues from selling "Gokhran" (State Depositary for Precious Metals) resources (RUR 4 bln in 2007 and in 2008) shall be allocated to redeem internal and external government debt of the Russian Federation, as well as to compensate losses of 1991 to Sberbank investors.
49 In state-owned companies such as Rosneft which have not consolidated their subsidiaries the practice of dividend calculation based on the amount of non-consolidated profit of the parent company using Russian accounting standards is common. Transneft, for example, having showed in 2004 consolidated profit in the amount of RUR 1.43 bln according to International Financial Reporting Standards (IFRS) disclosed the amount of parent company's profits of RUR 5 bln when redistributing profits among the subsidiaries, in 2005 this amount made RUR 4.61 bln, for 9 months of 2006 - RUR 3.95 bln (Vedomosti, December 25, 2006).
50 Interview by V.L. Nazarov, Rosimustchestvo Director, "On Rosimustchestvo Performance in 2006", January 23, 2007, Interfax (www.mgi.ru).
Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009 approved by the RF Government Resolution No.1184-r of August 25, 2006, similar to the previous analogous documents, states that during the period of 2007-2009 stock packages of JSCs established within incorporation of FGUPs will be offered for sale, with the exception of packages of JSCs included into the list of either strategic JSCs or those participating in forming integrated structures.
The following packages will be proposed for privatization in 2007:
- stock packages not exceeding 50% of charter capital of the respective JSCs, with the exception of packages of JSCs included into the list of either strategic JSCs or those participating in forming integrated structures, as well as stock packages which will be sold based on the need to form the revenue part of 2007 budget and for the period up to 2009 in compliance with the mid-term financial plan;
- stock packages of JSCs of fuel-and-energy complex, energy-and-construction complex, construction complex, foreign trade organizations, civil aviation, healthcare, chemical, petrochemical and polygraph industries, geology, fishery, poultry industry, crop production, cattle production, timber complex, medical industry, as well as mechanic engineering JSCs (with the exception of strategic ones);
- federal state unitary enterprise of automotive in car building, road facilities, construction complex, civil aviation, geology, oil and gas complex, fuel industry, see and river transport, polygraph industry, healthcare, crop production, poultry and cattle production;
- property of the RF treasury not required for implementation of government functions.
The following major federal property entities are planned for privatization in 2007: JSC "VO Stankoimport", "Moskovsky Metrostroy", "Airport Salekhard", "Ufa International Airport".
Work on establishing integrated organizations in defense industry, aviation, ship-building, nuclear and aerospace industries will be continued in 2007-2009. All FGUPs not engaged in performing government functions of the Russian Federation, as well as stocks of JSCs established during incorporation of FGUPs will be offered for sale in 2008-2009.
To which extent and for how long government will remain a shareholder will depend on the success of selling 100% packages. With respect to this the privatization program for 2007 looks more than ambitious, especially given the background of actual privatization outcomes of the previous years (Table 14).
As Table 14 obviously displays, 2007 privatization program stipulates an abrupt shift in federal stock packages sales towards "full-sized" packages (100% interest), the share of which shall be over 86%. What is meant here are probably packages having appeared after noticeable increase of the rate of FGUPs incorporation. This number leads to many questions, especially after analyzing 2005 performance, when only 51 "full-sized" packages were sold (making less than 10% of
the total number of sold packages). It is also a big surprise to see sharp reduction of the share of minority packages planned for sales, considering that they constituted the major share of all packages sold in 2001 and in 2004 - 2005. It's worth remembering that as of June 1, 2006, federal government owned 1063 packages with up to 25% interest. It made over 30% of all federally owned packages.
Table 14
Dynamics and structure of selling federal stock packages based on their size: actual data of 2001 -2005 and 2007 privatization targets
Year Total up to 25% Between 25% + 1 share and 50% Between 50% + 1 share and 100 % - 1 share 100 %
entities % entities % entities % entities % entities %
2001 125* 100 78 62.4 45 36.0 2 1.6 **
2002 112* 100 51 45.5 56 50.0 5 4.5 **
2004 565 100 406 71.85 119 21.05 34 6.0 6 1.1
2005 521 100 360 69.1 81 15.5 29 5.6 51 9.8
2007 911 100 87 9.5 27 3.0 12 1.3 785 86.2
* - accounting for the outcomes of sales announced one year before, but the results were summarized only in that year;
** - data on 100% packages sales were not highlighted, they were accounted for within the category "50% and above".
Source: data from departmental website www.mgi.ru; Yu.M. Medvedev, RF Ministry for Property Management and its Territorial Branches Performance in 2002, objectives for 2003 // Bulletin of the RF Ministry for Federal Property Management No.1, 2003, p. 36; Materials for RF Government session on March 17, 2005, "On Measures to Improve Federal Property Management"; Report by RF Agency for Federal Property Management "On Federal Property Privatization in 2005" - M., 2006; Federal Property Privatization Forecast Plan (Program) for 2007 and Key Areas of Federal Property Privatization for 2007-2009; estimates by the authors hereof.
In addition to stock packages, 911 JSCs shall be privatized, as well as 7 packages of state-owned closed corporations (CJSCs) plus 233 entities of other federal property.
It is also worth noting that for the first time airports (in Ufa and in Salekhard) were among major federal property entities offered for sale, which, on one hand, means obvious depletion of reserves of significant government assets in traditional production sphere, on the other hand - it is within the streamline of government effort in infrastructure development including projects co-financed by private investors.
In addition to Ufa airport the list of RF Aviation Agency contains the following assets planned for liquidation, reorganization or divestment: airport Pulkovo (St.-Petersburg), International Nizhny Novgorod airport, Magas airport (Ingushetiya), Komsomolsk-na-Amure airport, Yuzhno-Kurilsk airport (Sakhalin Oblast), Stary Oskol airport (Belgorod Oblast), Irkutsk airport, Mama airport (Irkutsk Oblast), Sakhalin Okha airport, Magadan airport, Uray airport (Khanty-Mansy Autonomous District), Shakhtersk airport (Sakhalin Oblast), Ulianovsk airport, Leshukonskoye airport. According to certain sources, airports of Ufa and Nizhny Novgorod are for sale, and the majority of the above listed airports shall be transferred to regional governments. Pulkovo airport in St.-Pete is of special concern, the city government
wants to have 50% of its shares. However the decision is still not made with regards to the size of the package and the scheme of payment51.
There already have been some precedents of transferring regional airports to regional governments. Back in late 1990-s the blocking package of International Samara airport (25.5%) was among the sold packages. And in 2003 60.88% shares of Vnukovo airport (the 4th biggest in the country from the passenger traffic flow point of view after Domodedovo, Sheremetyevo and Pulkovo), became the property of the city of Moscow to compensate for the capital functions costs. Such transaction launched the airport development program funded both from the city budget and from external alternative sources.
In relation with including airports into 2007 privatization program it is also worth mentioning that one of the biggest recent privatization deals was acquisition of 100% package of Sochi airport at an auction in November 2007. The acquisition was made in the name of Strategiya-Yug LLC for the amount of RUR 5.503 bln (the starting price being RUR 3.504 bln). Strategiya-Yug LLC is believed to be an affiliated entity of "Bazovy Element" company which controls Southern Airports Holding through Russian-Asian Investment Company. This Holding already owns a whole series of core assets: Kuban Airlines, Krasnodar International Airport (having been previously divested from Kuban Airlines), Kuban Territorial Air Communication Agency, and Yugairstroy. In addition, Southern Airports Holding controls Anapa airport52 and is operating construction of a new airport in Gelendgik.
Acquisition of Sochi airport is quite streamlined with the increasing business activity of "Bazovy Element" in Southern Russia, in particular, it is associated with the estimated increase of passenger traffic to the Black Sea Coast and with Russia submitting an application for 2014 Winter Olympics to be held in Sochi. This event requires completion of Sochi airport reconstruction (frozen up back in 1989), which in its turn will require investment of circa $100m scale.53.
"Bazovy Element" is not the only company seeking acquisitions in airport business. For example, "Renova" company owns 45% stock of Koltsovo airport (Yekaterinburg), and Moscow River Navigation Company (through Eurasian airport company) owns 42% stock of Tolmachyovo airport (Novosibirsk) and 48% stock of Altai Aviation Company. Just like Anapa airport, Koltsovo and Tolmachyovo airports belong to the list of strategic JSCs. However, in Koltsovo the government share (34.56%) is less than that of private shareholders, but in Tolmachyovo the government is a majority shareholder (51%). Similar interest is reported towards Khabarovsk airport on behalf of Alliance Group, as well as the project to merge Yemely-anovo and Cheremshanka airports (Krasnoyarsk Krai) into a single transportation hub (this last one being initiated by AirUnion Holding created on the basis of KrasAir
51 Time to Build Airports // SNiP (Construction Norms and Specifications). Construction. Real Estate. Investments. Projects, N 02 (02), December 2006, pp. 18-22.
52 Anapa airport was included into the list of strategic JSCs (government share in charter capital constitutes 25.5%).
53 A. Dmitriev Targeting the Olympics // SNiP (Construction Norms and Specifications). Construction. Real Estate. Investments. Projects, N 02 (02), December 2006, pp. 28-30.
company, 55% shares of which will belong to private investors, and 45% - to the government).
According to some estimates, the reason for such growing interest on behalf of Russian business towards investing into major airports (with the "hub" capabilities) during the recent several years54 is competition for the budget money planned to be allocated for their up-grading and construction (primarily, of their airfield component, such as in Koltsovo, Sochi, Gelendgik)55.
However, private business participation in developing airports is not limited just to buying their stock. There may be an alternative of renting the respective asset. In this relation another important event needs to be mentioned: amicable agreement between East Line Group and Rosimuschestvo about Domodedovo airport lease was settled in October 2006. This was a resolution of three-year conflict having grown into litigation proceedings. The achieved settlement confirms the previously agreed lease term (75 years starting from 1998 - the year when the Lease Agreement was executed), under the condition of over 30-times increase of the annual rent (from RUR 3m up to RUR 92m) and the option of reviewing this amount every 5 years.
In the context of successful Domodedovo airport development (in which private investment plays a very significant role) the situation with construction of a new (Third) terminal at Sheremetyevo airport appears far less satisfactory. This project is managed by JSC "Terminal", which used to be fully owned by Aeroflot until very recently. Meanwhile government representatives (RF Ministry of Transportation) in the company management were consistently against Aeroflot implementing this construction project. However, in 2005 the company was able to raise funds in the amount of $150m loan, 2/3 of which was allocated for Sheremetyevo-III construction. Then due to the change in Aeroflot management and disagreement of government representatives this project was frozen up. In the summer of 2006 Vneshtorgbank became the owner of the blocking package (25% + 1 share) of JSC "Terminal", another package of 20% (minus 2) was acquired by Vnesheconombank, which allowed to open two more credit lines for the project. After the expected sale of yet another blocking package of shares to Sheremetyevo International Airport Aeroflot will no longer be the majority shareholder of JSC "Terminal". However, the deal between Aeroflot and Sheremetyevo International Airport has not yet been closed, even though the majority shareholding of the biggest Russian airline and 100% package of Sheremetyevo airport both belong to the government56.
54 International understanding of a "hub" is that of new airport with a significant amount of international and domestic airlines, providing immediate connections for the passengers and operating in compliance with up-to-date standards infrastructure and ground service standards.
55 The owners of airports plan to invest hundreds of millions USD into their modernization // SNiP (Construction Norms and Specifications). Construction. Real Estate. Investments. Projects, N 02 (02), December 2006, pp. 24-27.
56 In early 2004 Alfa-Sheremetyevo was selected as the managing company for Sheremetyevo airport based on the tender outcomes, despite the fact that Inter-Terminal LLC set-up by Aeroflot and its private shareholder (National Reserve Bank) participated in that tender.
5.2.3. Major Government Corporations' Activities
The most significant event of 2006 with regards to major government corporations' activities at the merges and acquisitions market57 was FGUP Rosoboronoex-port purchase of 66% stock of the leading titanium (30% of global production) and magnesium manufacturer JSC VSMPO-Avisma58 (transaction value making $700m). The fact of Oboronprom (subsidiary of Rosoboronexport) acquiring control over electric engineering plant LEPSE (city of Kirov), the latter being one of the biggest Russian manufacturers of electrical equipment for defense and automotive industries, stayed in the shade of the VSMPO-Avisma deal.
Further Rosoboronexport expansion plans may be related with metallurgy, and not just Russian metallurgy. In the summer of 2006 Rosoboronexport management raised an issue about the feasibility of setting-up a state-owned holding -a monopolist in the field of alloy-steel manufacturing. In early 2007 the "grandchild" of Rosoboronexport - "Russpetzstal" LLC acquired 00% of JSC Metallurgic Plant "Krasny Octyabr" (city of Volgograd). The following assets are named among its possible future acquisitions: Chelyabinsk metallurgical plant (JSC Mechel), Zaporozhye titanium and magnesium plant (Ukraine), Volnogorsk and Irshansk mining-and-processing integrated plants (Ukraine), such metallurgic plants as Electrostal (city of Electrostal in Moscow region), Serp-i-Molot (Moscow), which manufacture special alloyed steel for defense industry59.
Such activities of Rosoboronexport as accumulation of controlled assets, diversification of its sector profile due to different types of activities of the acquired enterprises (helicopter industry, metallurgy, automotive and defense industries) may provide incentives for possible reorganization of Rosoboronexport itself, which may take the form of setting-up a 100% state-owned managing company. Then the controlled assets including Rosoboronexport (being an organization with the monopoly rights for foreign cooperation in defense and technology) may become the subsidiaries of this newly established managing company. Some of the subsidiaries in future may issue additional stocks60.
At the same time a number of serious events relating to state-owned fuel-and-energy companies need to be mentioned. At the end of 2006 JSC Gazprom announced its plans to develop Shtockman gas field in the Barents Sea independently (without participation of foreign capital) and acquired 50% + 1 shares of Sakhalin Energy being the operator of Sakhalin-2 project for $7.45 bln. With this the interest of other project participants is being decreased almost two times: for Shell - from
57 See also paragraph about major corporate events of 2006 in Section 2.4.3 hereof.
58 In 1998 the controlling interest in JSC Avisma (city of Berezniki, Perm region) was acquired by Verkhne-Saldinsky metallurgic production association based in Sverdlovsk Region, upon which the two companies practically integrated.
59 K. Friskin. Chebol Russian Style // Kompaniya, No.48-49 (444-445), December 25, 2006, pp. 22-31.
60 www.lenta.ru, January 26, 2007
55% down to 27.5%, for Mitsui - from 25% down to12.5%, for Mitsubishi - from 20% down to10%61.
Rosneft performed IPO in 2006 which was recognized as pretty successful one (being the major IPO in Russia and the 5th biggest globally as of the moment of issue). Maintaining the government's qualified government's controlling interest of 75% (through JSC Rosneftegas) Rosneft distributed about 15% shares for the overall amount of $10.4 bln at the selling price very close to the highest ceiling ($7.55)62. Based on IP {O outcomes Rosneft's capitalization ($80 bln) has now turned it into the biggest petroleum company in Russia.
Nevertheless, the key (and a very special one) success factor was the fact of major investors counting on Rosneft's production capacity increase at the expense of YUKOS assets (YUKOS being engaged into bankruptcy procedure in 2006)63. Due to its administration resource Rosneft is assumed to become the main beneficiary when the key YUKOS assets are being distributed (and it might get at the underestimated price). The "political element" in the success of Rosneft's IPO provided for the fact that contrary to many other companies64 Rosnefts's quotations did not go down significantly. According to some sources, underwrites supported Rosneft's shares after IPO.
This special "proximity" of Rosneft to Russian power authorities provides for certain potential prospects. At the end of January 2007 V. L. Nazarov, Director of the RF Agency for Federal Property Management spoke about the possibility for yet another distribution of 25% package (c. $20 bln worth)65, however, this statement was almost immediately disowned by the RF Minister for Economic Development and Trade G. O. Gref (who supervises the RF Agency for Federal Property Management). At the same time, according to some experts, such controversy confirms the fact of increasing the efforts aimed at turning the maximum possible share of government interest in Rosneft into private property before March 2008 with future legalization beneficial for a pretty limited number of individuals.
Based on 2006 IPO outcomes the following foreign petroleum companies became Rosneft's minority shareholders: Petronas (Malaysia, $1.1 bln), BP (UK, $1
61 E. Samedova., O. Gavshina: Gazprom will divide Sakhalin by 50% // Gazeta, December 22-24, 2006, p. 1.
62 The IPO proceeds my not be regarded as privatization revenues because the formal Rosneft privatization was performed in 2005 when the RF Agency for Federal Property Management contributed 100% - 1 share of Rosneft into the charter capital of JSC Rosneftegas. Accordingly, the proceeds may be allocated to redeem the loan received by Rosneftegas to pay for the acquisition of Gazprom shares (10.74%).
63 According to Bank of Moscow estimations, the "fair price" for Rosneft shares considering its finan-cials and OGIP-in-place profitability index should be at the level of $5.7 per share (if future "premium" acquiring YKOS assets is not taken into account). One also needs to pay attention to a major debt still incurred by Rosneft and lack of investors' confidence in Rosneft being capable of quickly implement its plans of increasing own production up to 100 and more mln tons. See: A. Vinkov, I. Rubanov. Insider among the insiders // Expert, 2006, No.28, pp. 20-22.
64 By the end of 2006 shares of 10 Russian companies (out of total 34 companies having performed IPO) were sold below the placing price.
65 Interview to Intefax on January 23, 2007, www.mgi.ru 574
bln), CNPC (China, $500m). According to certain estimates, companies either controlled by the RF government or very close (loyal) to the government contributed at least $3.5-4 bln (Sberbank, Gazprombank, Millhouse Capital and others viewed as long-term strategic investors). On the contrary, institutional investors (investment trusts, mutual funds, etc.) are oriented towards primarily high returns so they did not participate in the buy-out. Contrary to strategic investors for the institutional ones over-estimated shares, corporate governance problems and the level of government control were the key negative factors.
That said, over 115 thousand of private individual investors subscribed for Rosneft shares ($700m). Some analysts66 are pretty ambitiously connecting this event with the beginning of the "third wave" of citizens' financial activity over the 15-year period of market-oriented reforms (after financial pyramid schemes of the early 1990-s and investing into commercial banks during the period preceding 1998 crisis). What is meant here, is that relatively big groups of citizens in the environment of US Dollar rates going down, relatively low interest rates on bank deposits, inaccessibility and high risks of real estate investment (including participatory construction of housing) are ready to convert their accumulated savings into secondary market securities. These citizens are usually oriented towards long-term possession of such securities and prefer lower proceeds with higher level of guarantees, which may be achieved due to direct ownership of shares (without any intermediaries or joint investment schemes). They also prefer shares of companies with high level of government participation viewing it as an additional guarantee securing their investment. On the other hand, the companies with a big number of private individual investors (citizens) due to additional issues of securities acquire the opportunity to use this fact as the grounds for government aid in case of various financial cataclysms.
Such attitude creates certain prospects for additional issues by Russian companies in future. The proceeds from government-controlled Sberbank IPO (3.5 mln shares) scheduled for early 2007 are estimated on the level of $11.9 bln. According to the RF government Resolution the RF Central Bank is entitled for the preferential right to acquire 892 601 shares (making c. $3 bln or RUR 80 bln), which will mean reducing its share down to 55.34%. At the same time the IPO amount (and the estimated price per share) is such, that potentially the share of individual private investors will not exceed the "quota" of Rosneft individual private investors (c. $750 mln).
One can already notice certain consequences of Sberbank's shares placement. First of all, such a significant amount will have a negative impact on the other IPO issuers. As per some estimates, IPOs of "Cytronix" and "Polymetal" companies (the last one with some very good estimated IPO potential) that took place in February 2007 did not find adequate demand on behalf of investors, which were at that time awaiting for Sberbank IPO and were withdrawing from other market segments. In the short-term, the deficit of financial resources caused by Sberbank IPO can impact IPO of electric power company OGK-3 (March of 2007) and of state-owned
66 V. Sednev, People's Capital and exchange markets. www.opec.ru, November 28, 2006
Vneshtorgbank (May 2007), which would require concentration of investors' funds at the expense of less attractive assets. Secondly, organizations closely associated with the government are increasing their activity in revising oil-and-gas portfolios in favor of Sberbank. According to certain estimates, RF Central Bank bought out c. $8 bln at the exchange in February 2007, of which a significant portion was offered by Gazprombank67. One may assume that the eventual (post-IPO) structure of Sberbank's assets will not be significantly different from the current one with regards to direct or indirect domination of the government - or government-controlled organizations.
As it has already been mentioned above, the first IPO of other key financial institutions of Russia - Vneshtorgbank (with 99.9% federal government interest) is scheduled for May 2007. The participation of this bank in current expansion of the government's ownership (besides issuing loans or direct participation in transactions with ALROSA shares and in acquisitions by Rosoboronexport) is directly linked to the government's effort to increase its presence in the banking sector, e. g., acquisition of Promstroybank (St.-Petersburg).
It is assumed that during Phase 1 Vneshtorgbank will be offering about one fourth of its charter capital (22-23%) within the limit of RUR 90-120 bln. The ration between domestic and foreign market should be based on parity principle (50 to 50%), and the share of individual private investors (RF citizens) may make up to 15% of the overall IPO amount. Additional issue is planned for 2010 in the amount between RUR 210 - RUR 250 bln, which will reduce the government's share down to just controlling interest (50% + 1 share). Similar to Sberbank, the optimistic estimate of Russian individual private investors is up to $700m, but it will be possible to say that Vneshtorgbank IPO is "for the people" only in case ideological objectives are set. It is especially difficult to forecast the situation after 2008 (considering the politics-and-business cycle).
A new aspect of electric power sector reform is currently being implemented by RAO EES (Energy Systems of Russia) related to new issue of shares by a number of power generating companies. In the fall of 2006 the management of RAO EES Holding announced significant success of the first additional issue of shares -14.4% shares of generating company OGK-568 were placed at the market allowing for raising $459m for investment purposes. At the same time the Holding is not rejecting other sources for capital investment: company revenues, loans, direct private investment including those based on the outcomes of divesting a number of power generating companies69.
Because the additional issue of shares by the companies having emerged due to reorganization means much more smooth and moderate option of admitting private capital into this sector, the issue of future distribution of subsidiaries' and af-
67 See: Kommersant, January 31 and February 9, 2007.
68 Main body of OGK-5 are Konakovskaya (Tver oblast)< Nevinomysskaya (Stavropol krai), Reftinskaya and Sredneuralskaya (Sverdlovsk oblast) hydro electric power stations.
69 Thus, in October 2006 12 percent of shares of Petersburg generating company, which belongs to "Lenenergo" were sold.
filiated companies' capital upon additional issues of shares remains very important and still controversial, as well as the issue of maintaining the level of participation by RAO EES and its shareholders (one of them being the RF government). In relation with this it's worth reminding that according to initial sector restructuring plans (upon RAO liquidation), the government wanted to keep packages of 75% interest + 1 share both in Federal Distribution Company and in the System Operating Company, as well as controlling interest in generating company created on the basis of hydropower industry assets. In order to bring the government's share in the above mentioned companies up to the planned level, direct budget investment or contribution of other assets will be required.
The RF government decision (made in November 2007) about gradual raise of gas and electric power prices in Russia over the next several years will have a significant impact over financial and economic situations of both Gazprom and RAO EES in the mid-term perspective. The forecast approved by the government stipulates price increase for gas by 15% in 2007, by 14% in 2008 and by 13% in 2009. The dynamics of energy tariffs growth will respectively be 10%, 9% and 8%.
Given these assumptions alongside with the global energy prices dynamics will in many aspects define the potential activities of state-owned corporations in fuel-and-energy sector at the M&A market. In 2006 some Russian media marked the interest of Rosneft towards Surgutneftegas,, of Gazprom - towards TNK-BP, subsidiaries of RAO EES and Svyazinvest. Gazprom has already undertaken some limited participation in buy-out of the above mentioned issue of OGK-5 shares. At the same time it was announced that Gazprom was to buy additional issue of Mo-senergo shares for the amount exceeding $2 bln, scheduled to be completed in the spring of 2007.70 We need to add here that Gazprom is already the holder of the blocking interest in Mosenergo.
Critical situation emerged at the alcohol market upon enactment of the RF Law "On Government Regulation of Distribution of Alcohol Beverages and Alcohol-Containing Products" due to temporary shut-downs of many manufacturers caused by the deficit in excise duty stamps and by the consequences of launching the Uniform State Automated Information System. Under these circumstances the issue of government monopoly was raised again which may require setting-up of State Alcohol Company (SAC).
FGUP "Rosspirtprom" has made a decision to manufacture the so-called "vodka for the people". The Rosspirtprom-branded vodka is to be sold at the price nit exceeding RUR 60 per half-litre bottle. The factory price will nit exceed RUR 53 at the factory gate which according to the company representatives will include just taxes and production cost. However, "Rosspirtprom" has even greater ambitions. They decided to improve the "vodka for the people" slate by introducing such popular brands as "Khlebnaya", "Pshenichnaya", "Rzhanaya", "Kedrovaya", "Solo-
70 A. Podymov, Plus Gasification of the Whole Country // Finansovy Kontrol, December 2006, No.12 (61), pp. 144-145.
dovaya". According to some experts, this may result in restructuring of this market segment as many manufacturers are weakened by the previously described crisis71.
Let us remember here that FGUP "Rosspirtprom" having been established back in 2000 currently administers the stock packages of more than 200 spirit-making and liquor factories (as of the beginning of 2003 - 118 entities). FGUP-controlled factories account for over 1/3 of all legal alcohol manufacturers in the country and control over 45% of spirit production and 26% of vodka/liquor production in Russia. The annual turnover of FGUP "Rosspirtprom" is estimated to make over $2 bln. Its business activity during the recent years was recognized as very inefficient (in particular, very high volumes of illegal alcohol products at the market may be regarded as a proof), government introduced fiscal claims against this FGUP (including those for non-payment of dividend), FGUP lost a number of valuable assets and some of entities controlled by it were put under bankruptcy proceedings.
The course towards forming integrated organizations continued by way of merging different government assets. After quite lengthy discussions on the matter, the Presidential Decree No.140 of February 20, 2006, initiated the set-up of United Aviation Corporation (UAC) which will integrate manufacturers of both defense and civil aircrafts. The government will have at least 75% interest in this newly established JSC. Start of the new company management operations was announced in November. Similar to many already existing corporations of national scale (Gazprom, Rosneft, RZhD [Russian Railways]), UAC Board of Directors will be headed by some top-level government officials (S. B. Ivanov, Vice-Prime Minister and Minister of Defense), and the managers of integrated assets will be engaged in daily operations of UAC. The former Director and co-owner of "Irkut" company A. Fedorov was appointed UAC President.
Prior to being integrated into UAC "Irkut" (the former Irkutsk aviation producing association) used to be the biggest non-government corporation72 in Russian defense industry specializing throughout the most recent years on exporting "SU" family aircrafts to Asian countries. It was able to acquire controlling interest in Taganrog aviation research and production complex named after Beriev, and in Yakovlev OKB (pilot design bureau) being specialized on exporting military aircrafts. There is a lot of evidence that "Irkut" together with "Sukhoy" aviation complex (with 100% government interest) are to become the most valuable UAC assets.
Deloitte & Touche - SNG performed the assessment of "Irkut" assets resulting in $940m only), while "Sukhoy" corporation was evaluated on the level of $2.2 bln. This assessment outcome is far more modest than it was expected to be, meaning that "Irkut" cannot claim more than 20% interest in UAC. Presumably in the spring of 2007 "Irkut" shareholders may be offered to exchange their shares with those of the newly created UAC or buy them out at some fixed price. Deloitte &
71 What Will "Vodka For the People" Lead To? // www.rian.ru, November 22, 2006.
72 The government does not directly belong to "Irkut" shareholders, one of the minority shareholders of "Irkut" is state-owned "Sukhoy" aviation complex.
Touche assessment results will most likely serve as the basis for defining the buyout price. And in the light of all this appointment of A. Fedorov to the top executive position of UAC may be regarded as a compromise required for integrating "Irkut" into this new corporation73.
Overall in the context of this aviation industry assets integration the government allocated additional funding to this sector in the amount of RUR 36 bln, because the current assets value (RUR 60 bln) was recognized as insufficient. The published UAC assets valuation made then $96 bln.
Setting-up UAC is scheduled for completion in the spring of 2007. It is also worth noting that adjacent enterprises manufacturing engines, equipment, etc. are not planned for integration with UAC. That is why we should recognize as most likely future creation of core integrated companies such as Avionika Group on the basis of existing research-and-production center "Technocomplex" (developing airborne equipment for defense and civil aviation, ground control systems to support operation of such complexes).
Currently the government has much less capacity for integrating companies with mixed capital compared to the period of 1992-1994, when it owned a significant (and in some sectors - the main) bulk of assets and the share capital profile was undergoing its formation stage. Currently the government is either a minority shareholder in many of such companies or owns a blocking package, which significantly decreases its control and management capabilities. Thus, out of total 9 aviation JSCs federally owned packages of which are to be contributed to UAC charter capital, only in 4 cases we can speak about packages exceeding 51% (including "Sukhoy" bureau 100% shares of which belong to the federal level74), in 2 companies, however, the federal share makes 38%, and in other 2 companies - 25.5%. This said, shares of 13 companies (including the above mentioned Taganrog aviation research and production complex and Yakovlev OKB) may be regarded as a contribution from government-owned shareholders. In 5 companies out of those 13 federal packages are contributed as government's input into UAC.
In early 2007 the law was approved allowing the creation of a major state-owned company based on the civil assets of Russian nuclear power sector with 100% government interest. United integrated company "Atomenergoprom" will become a complete-cycle corporation including uranium mining, production of fuel for nuclear power stations (NPS), energy generation, construction of NPS in Russia and abroad, nuclear engineering, R&D. The No.1 candidate for integration into "Atomenergoprom" "Atomenergoprom" is a 100% state-owned company producing fuel elements and being a majority shareholder of a whole series of core enterprises including Electrostal nuclear engineering plant (Moscow region), Novosibirsk chemical concentrates plant, Priargunskoye chemical-mining association (Chita region). In future "Rosenergoatom" association uniting all Russian NPSs +
73 K. Frumkin, Chebol Russian Styles // Kompaniya, No.48-49 (444-445), December 25, 2006, pp. 22-31.
74 100% shares of 2 JSCs created by way of transforming FGUPs (MiG and Kazan aviation production association named after S.P. Gorbunov) are also being contributed to UAC charter capital.
core R&D and design institutes may be integrated into the new Holding, as well as enterprises from United Engineering Plants (Obyedinenniye Mashinostroitelniye Zavody) Group.
The plans of establishing one more state-owned corporation (Bank for foreign economic activities and development of the Russian Federation) with total charter capital of RUR 70 bln on the basis of reorganized Vnesheconombank and acquired Roseximbank and Russian Development Bank in H2 2007 are along the same lines. The key objective of the newly set Bank will be to support those infrastructural and innovative projects which are not of particular interest for private capital by way of issuing loans to legal entities for the period over 5-10 years. This bank is not meant for dealing with citizens. The Supervisory Board to manage and control the new bank will be appointed by the government without involvement of the RF Central Bank.
As for air transportation and airports, plans of Aeroflot to acquire regional aviation companies were voiced, these companies not necessarily being 100% state-owned (e. g., "Dalavia", "Vladivostokavia"), as well as plans to create a United National Airport Management Company on the basis of 100% state-owned JSC Sheremetyevo International Airport. The following airports may be included into this government airports managing corporation: Pulkovo (St.-Petersburg), Tolmachy-ovo (Novosibirsk), Koltsovo (Yekaterinburg), Kurumoch (Samara), Yemelyanovo (Krasnoyarsk). The probability to implement this last scenario is not very high due to the above mentioned circumstances (preparation to privatization of Pulkovo with possible participation St.-Petersburg City government as one of the shareholders, interest towards Novosibirsk, Yekaterinburg and Krasnoyarsk airports on behalf of private businesses, limited number of shares in government's packages, etc.).
Besides, setting-up a new state-owned company for managing airports may require re-distribution of authority and assets among government organizations, because 2 FGUPs are already operating in the sphere of airports: State Corporation for Air Traffic Organization and Civil Airports Authority (established in 2001 on the basis of Bykovo, Vnukovo and Sheremetyevo assets not qualified for privatization with future prospects of consolidating the assets of not only Moscow-based but other civil airports)75.
Some options of creating major corporations covering certain segments of mechanical engineering (machine-building) industry on the basis of integrating government and private assets such as National Automotive and Power Engineering Companies + Ship-Building Holding (similar to UAC) were explored in 20052006, but have not been implemented so far. The project of combining Novorossiysk Marine Shipping Company (JSC Novoship with 50% government interest) and 100% state-owned "Sovkomflot" company was also frozen up in the summer.
75 It is necessary to state here that runways, taxi strips, ground control equipment and other assets directly associated with air traffic are not qualified for privatization and shall be still owned by the government, which requires operations of specialized government organizations. In case of privatization new owners shall be granted ownership of terminal facilities, and in some special cases - of the adjacent territory. 580
Certain perspectives of government ownership expansion may be associated with ALROSA company. As it is known, back in 2001 the President of the Russian Federation required to develop a set of measures to re-gain government's share in the company's charter capital. In 2007 - after 7 years of the federal government's attempts to restore the RF control and of friction with Yakutia, - the RF share is now likely to be increased from 37% up to 50% + 1 share. At the same time Vneshtorgbank will purchase a certain portion of shares through the secondary market with the purpose of handing them over to the federal government; and a portion of the RF share increase may be backed by additional issue. By the beginning of 2007 these processes were not 100% completed, however, the issue of establishing ALROSA's control over Norilsk Nickel has already been discussed in the media (and ALROSA management did not refute). The probability of Norilsk Nickel nationalization has been under review starting from 2005.
5.2.4. Changes in legal framework regulating government sector operations
Amendments and supplements to the effective RF Law "On Privatization of State and Municipal Property" introduced via the RF Law No.155-FZ of July 27, 2006, with the objective to re-adjust the procedure for increasing the charter capitals of JSCs established through privatization with 25% or more government interest became the key legal novelty of 2006 related with state property management.
The previous version of the Law allowed for increasing the charter capital of such JSCs only under the condition of maintaining the share of either state or municipality. According to the RF Ministry for Economic Development and Trade, such limitation in the growing economy environment impeded attracting investment to JSCs with government's interest, because in reality budget funds were not allocated, in the best case one could talk only about contribution of some assets to cover additional issue of shares and to support maintaining the existing capital distribution between different groups of shareholders.
The new version of the Privatization Law (Article 40) defines a number of power bodies (the President of the RF, the RF government, state power body of the respective entity of the RF, local self-government body) entitled to make a positive decision about increasing the charter capital of such JSCs with simultaneous reduction of the state/municipality share.
Now in case more than 25% (but accounting for not more than 50% of votes at the General Shareholders Meeting) of the shares of a JSC created within the privatization process belong to the state/municipality, its charter capital increase by way of additional issue of shares may be performed with simultaneous reduction of the state/municipality share provided such decision is made by the RF government, state power body of the respective entity of the RF or local self-government body under the condition that the state/municipality maintains the interest of 25% + 1 voting share. The same provision is applicable to the companies included into the List of Strategic JSCs, but the decision needs to be made by the President of the Russian Federation.
In case the state/municipality interest in a JSC created within the privatization process accounts for more than 50% of votes at the General Shareholders Meeting, its charter capital increase by way of additional issue of shares may be performed with simultaneous reduction of the state/municipality share only under the condition such decision is made by the RF government, state power body of the respective entity of the RF or local self-government body and only under the condition that the state/municipality keeps those 50% votes + 1 voting share. Similarly, for the companies included into the List of Strategic JSCs, such decision needs to be made only by the President of the Russian Federation.
Similarly, the state power bodies are empowered to define the government's interest in the charter capital in case of public offerings and listing of respective JSCs shares at capital market, both in Russia and abroad, including the situations when it is done by way of placing securities under international laws regulating foreign capital presence and certifying the rights with regards to JSCs shares (Article 40.1):
- increasing charter capital for companies from the List of Strategic JSCs and defining the government share in such charter capital shall be performed by the decision of the President of the Russian Federation;
- increasing the charter capitals of JSCs established through privatization with state/municipal interest accounting for more than 25% votes at the General Shareholders Meeting and defining the government share in such charter capital shall be performed by the decision of the RF government, state power body of the respective entity of the RF or local self-government body.
At the first glance this system looks pretty flexible combining the opportunity for JSCs with government interest to attract investment with assuring property control on behalf of the government. However, only future practice may show to which extent this instrument will work and what will be the demand for it.
The preceding Russian practice proves that in the current environment when corporate law provisions are difficult to enforce high concentration of shares is viewed by business community as the most acceptable guarantee from risks of investing into that or another company. This makes it very difficult or almost improbable to attract new investors simply by way of additional issue of shares as long as government stays the majority shareholder, even though with regards to certain attractive companies providing for certain benefits or having got some really interesting assets such scenario may be implemented. Investors shouldn't forget about general risks associated with government interference into business activities (risks of insufficient professionalism of government officials, poor incentives for them, and opportunities for them to get illegal benefits from such situations).
The first practical trial for such a scheme may take place with Foreign Trade Bank (Vneshtorgbank), which in the very end of 2006 by a special Presidential Decree was allowed to increase its charter capital by way of additional issues of shares and their phased offering with simultaneous assurance of maintaining the government interest of no less than 50% votes + 1 voting share at the General
Shareholders Meeting of this JSC. Respective amendments were introduced into the List of Strategic JSCs.
Amendments to Article 77 of the RF Law "On Joint-Stock Company" introduced by the RF Law No.146-FZ of July 27, 2006, will have really big impact for implementation of the above described novelty and for corporate governance in JSCs with government interest. These amendments are aimed at specifying the previous norm about participation of government financial control authority in defining the market value of the assets belonging to JSCs with state/municipal shares.
This norm shall be applicable to decision-making on the issue of defining the value (monetary evaluation) of assets, of the shares offering price and of the buyout price of the company. The Board of Directors (the Supervisory Board) of the company shall notify the federal executive body authorized by the RF Government (hereinafter referred to as the authorized body) about the decision made with regards to assets evaluation.
Besides, the new version of Section 3 of Article 77 of the RF Law "On Joint-Stock Companies" defines:
- the list of documents required for justification of the decision on assets evaluation;
- deadline for submitting the documents and the timeline for their review by the authorized body;
- right of appeal of the authorized body decision;
- expert evaluation of the report about defining the assets value;
- consequences for the company violating the procedure of defining the value;
- other matters.
In case the authorized body decides the value defined by the resolution of the Board of Directors (Supervisory Board) independently without engaging a third-party assessor does not correspond with the established market prices for the analogous assets, the Board of Directors (Supervisory Board) shall make a decision about rejecting the deal or decision to define the assets value with mandatory engagement of a third-party assessor and in compliance with the procedure stipulated by that Article.
In case the authorized body does not forward its statement within the established deadlines, the assets value shall be recognized as plausible and recommended for performing the closing the deal.
Provided the deal performed by the company violates the procedure set in the article hereof or not plausible as per the item hereof, it may be recognized as void through a law suit initiated by the authorized body within 6 months starting from the date the authorized body learned (or should have learned) about the closure of the deal.
Considering all the circumstances of the case the court shall be entitled to refuse in calling the deal void if the company proves that the committed violations are immaterial and that the deal has not caused any damages to the public, state or/and municipality.
On the whole, the fact of including the list of cases to which the norm about defining the assets value is applicable and the description of value agreeing mechanism is positive because it sets the subjects of the arising legal relations, as well the rights of both parties and ways of their exercising within the agreeing process. However, the novelty relates only to such JSCs in which state/municipality owns from 2% to 50% of the voting shares.
The List of strategic JSCs and enterprises was changed significantly in 2006.
First of all, it is necessary to state that due to setting-up UAC 2 FGUPs and 6 JSCs were excluded from the respective sections of the List. Further on 15 unitary enterprises and 2 JSCs operating in mechanical engineering and defense industry were excluded from the List as they were viewed as candidates for integration. In addition, Sochi airport was also excluded from the List, as its full package was, as has been stated earlier, sold in the end of 2006.
At the same time 2 FGUPs were added to the List (TV Technical Center Ostankino and Railway Transportation in-house security) together with 3 integrated companies in JSC format (including united industrial corporation Oboronprom76 in charge of consolidation of Russian helicopter industry77) and Novorossiysk Marine commercial port [with government interest of only 20%]).
At the end of December 2006 the RF Government Resolution No.782 introduced changes into the Charter of Russian Federal Property Fund, the limitation of its autonomy being the major change. Now its is directly stated that the RF Government is the constituent of the Fund, the RF Ministry for Economic Development and Trade assures coordination and control of the Fund's activities, and the Federal Agency for Federal Property Management performs the functions of the owner of all the assets being in operation management by the Fund as per the order and limits defined by federal laws, Presidential Decrees and acts by the RF government and the President of the Russian Federation.
With regards of performing the shareholder's authorities on behalf of the Government Russian Federal Property Fund is limited only by selling the shares of companies owned by the federal government and included into the forecast plan (program) for federal property privatization. Accordingly, this situation was reflected in the Regulations on managing the federally owned shares of JSCs and using the special right of the Russian Federation in managing JSCs (the "Golden Share").
Russian Federal Property Fund keeps the right of exercising business activities, however, all the respective proceeds should be stored at the account of the Fund with the Federal Treasury and the Fund may spend it only according to the revenues/expenditures estimate approved within the process defined by the Main Manager of Budget Funds within the limits of available balance at the Fund personal account. Previously Russian Federal Property Fund had the right to place temporarily available extra-budgetary funds at deposit accounts. The data about
76 In addition to the government which directly owns the controlling interest in Oboronprom, Rosobo-ronexpport is another major shareholder.
77 Thus, in 2007 the deal for buying out more than 20% of Kazan helicopter plant shares is scheduled to be closed.
584
rarily available extra-budgetary funds at deposit accounts. The data about the assets Russian Federal Property Fund purchases at the expense of its business proceeds should be provided to the RF Agency for Federal Property Management within one month period.
Previously the federal budget was the key funding source for Russian Federal Property Fund. The budgetary funds were allocated with the purpose of organizing and carrying out privatization of federal property, they were broken by established types of expenditures and the amount was set by the Government. However, the new version talks just about funds from the federal budget without any detail. The revenues/expenditures estimate of Russian Federal Property Fund is to be submitted to the RF Ministry for Economic Development and Trade.
Russian Federal Property Fund was deprived of another funding source. It used to be formed from charges on the value of sold goods distrained based on the resolution of either court or another agency empowered to decide about imposing a lien, and revenues from selling property confiscated based on effected court/judges judgments or on the resolutions by the customs agencies and duly recognized as ownerless, as well as from selling property seized by appropriate federal executive authorities - according to the norms and types of expenditures set by the RF government.
Thus, we may state that the conflict between the Federal Agency for Federal Property Management and Russian Federal Property Fund having emerged during Administration Reform and having received publicity in 2005 was resolved mainly within the framework of the proposals by the Agency, as amendments to the Charter of Russian Federal Property Fund have significantly limited its autonomy.
Certain novelties appeared in the "second-tier" normative acts about managing federal unitary enterprises. The key novelties are represented by the following:
List of the grounds for termination of FGUP Director's Employment Contract included into the RF Government Resolution No.234 of March 16, 2000, "On the order of executing employment contracts and certification of directors of state-owned federal unitary enterprises" was supplemented by the following important items:
- Director does not assure that FGUP's assets are used for the objectives established according with the areas of business activities set in the Charter of the enterprise, nor does assure that FGUP's assets are used for the established objectives within 3 months;
- FGUP Director violates Russian Federation legislation and FGUP Charter with regards to disclosure of data about related parties in the transactions, including those among the affiliated entities;
- FGUP Director violates Russian Federation legislation and employment contract provisions with regards to banning certain types of business activities.
It is also stated that the decision about terminating the employment contract with FGUP Director according to item 2 of Article 278 of the RF Labor Code shall be finalized only upon it is approved by the Certification Commission.
The tender commission for selecting candidates for FGUP Director position may from now on include the authorized representative of the President of the RF in the respective Federal District with the full right to vote. When candidates for Directors of defense FGUPs positions are reviewed, the commission shall also include a representative of the RF Ministry of Defense with the full right to vote, and a permanent member of Defense Industrial Commission with the RF Government appointed to the position of federal civil service under a special contract.
Similarly, when performing certification of defense-related FGUPs Directors, the Certification Commission shall include a permanent member of Defense Industrial Commission with the RF Government appointed to the position of federal civil service under a special contract with the full right to vote.
The Certification Commission shall also be entitled to approve draft resolution of the authorized federal executive body about termination of employment contract with FGUP Director in accordance with item 2 of Article 278 of the RF Labor Code.
The Resolution of the RF Government No.333 of June 6, 2003, "On Exercising Federal Executive Bodies' Property Rights with regards to State Federal Unitary Enterprises Assets" was supplemented with the provision about the need to agree transactions performed by the enterprise with regards to leasing real estate attributed to them on the basis of economic control rights and of value exceeding RUR 150m with the RF Agency for Federal Property Management taking into account the position of respective federal executive body on the matter.
Other amendments and supplements to legal acts were more of an editorial nature.
* * *
Overall, the year of 2006 in the property relations sphere demonstrated continuation of the preceding two years trends, though in a slightly weakened format. The number of FGUPs was decreasing and to a lesser extent the same happened to JSC with federal government interest. The abrupt increase of JSCs with 100% federal government interest was witnessed. In general, the federal government's packages profile (as per the share of government in JSCs charter capital) as of mid-2006 was more or less corresponding to the 2003 estimates of the RF Ministry for Property Management with regards to privatization outcomes. The same is true with relation to the absolute number of JSCs with federally owned packages.
The current situation with property relations in Russian economy is characterized by simultaneous implementation and co-existence of two trends.
On one hand, one may speak about continuation of privatization. The RF government annually sets forecast plans (programs) for federal property privatization for the next year, which include many hundreds of FGUPs and stock packages (shares) of companies operating in various industries and sectors of economy. However, the following needs to be taken into account:
Firstly, the planned privatization of FGUPs is performed (with some very few exceptions) by way of incorporation, i. e. at first a unitary enterprise is converted
into a JSC, and only after that (as a rule, beyond the current fiscal year) its shares are sold (probably - not 100%).
Secondly, up till very recently minority and blocking packages of mid-size companies were main subjects of sales. Such companies do not play any significant role in Russian economy, which lowers their attractiveness and level of interest towards them on behalf of investors. The approved privatization program stipulates abrupt shift of the focus towards selling complete (100%) packages, which many experts regard as a disputable and problematic decision. Inclusion of major companies into privatization program (similar to those privatized in 1990-s and early 2000-s) is not likely earlier than in 2008-2009, when a new political-and-business cycle is about to start in Russia. The most explicit candidate for privatization is a state-owned package of Svyazinvest, a telecommunications holding, selling of which was deferred a number of times during the previous years.
Thirdly, the actual scale of FGUPs incorporation and federal packages privatization is evidently behind the scheduled ones. This may be explained by low attractiveness of the offered packages due to their sizes and industry-based profile, by very long time required for incorporation of unitary enterprises, by challenges of controlling this process (resistance on behalf of the management, interdepartmental friction, parallel creation of integrated organizations, etc.).
On the other hand, increasing impact of the already existing major state-owned corporations on the process of establishing new holdings to integrate government assets is pretty evident, just like their growing activity at the M&A market (including privatization).
Thus, with the government sector appearing to be shrinking (which is reflected in the decreasing the number of FGUPs and JSCs with government interest), in reality it is expanding and deepening at the expense of the increased scale of business and via an expanded network of subsidiaries and affiliates. The state-owned companies performance is difficult to assess (just like performance of other holding organizations), because their subsidiaries, affiliated and controlled assets are not permanently fixed and often change, providing for significant impact over the activities of the Group as a whole. Another difficult task is accounting for the level of consolidation of assets with a holding (e. g., it is difficult to account for the contribution of enterprises and organization with participation of companies which are controlled by the holding not in direct, but rather in indirect manner, i. e. through a network of subsidiaries and affiliates). All this impedes evaluation of the overall scale of the government sector, its share in separate industries and in GDP as a whole.
With a big level of probability one may speak about continuation of the above described trends in 2007. With that certain adjustments need to be made based on oil prices fall and the beginning of the new political-and-business cycle.
5.3. Issues associated with buying out and leasing land plots of business entities
The problem of acquiring property rights (title) for the land plots owned by either state or municipal authorities and carrying buildings, structures and facilities owned by either business entities or individuals, has for the first time come up back in 1990-s due to starting the privatization process. The Presidential Decree No.301 of March 25, 1992, "On Selling Land Plots to Individuals and Legal Entities during Privatization of State and Municipal Enterprises" proclaimed that employees of the privatized entities were entitled to buy out the land plots carrying these entities assets. In reality the process of transferring land to private property did not start at that time, but the general principles for buying out land were established. The Situation changes upon enactment of the Presidential Decree No.1535 of July 22, 1994, "On Key Principles of Government Program for Privatization of State and Municipal Enterprises in the RF after July 1, 1994". Additional incentive for privatization process enhancement was significant decrease of the price for land plots to be bought out: it used to make 200 times land tax rate per area unit, but due to enactment of the Presidential Decree No.485 of May 11, 1995, "On Measures to Assure Privatization Revenues into the RF Budget" (item 7) it was brought down to 10 times tax rate. In May 1997 the price was again brought down to constitute 5 times land tax rate (item 4 of the Presidential Decree No.485 of May 16, 1997 "On Guarantees for Real property Owners about Them Being Able to Buy Out land Occupied by this Property) lost effect starting from March 29, 03, 2003).
The dynamics of privatizing the lands of residential areas during the period between 1994 and 2001 varied significantly from region to region78. In some local authorities did not allow or introduced significant impediments for buying out land, and at the same time regional authorities adopted respective legal acts to prohibit the land to be turned into private property. These regions shall be the following: Moscow City, Chuvashia Republic, Mordovia Republic, Kalmykia Republic, Bashkortostan Republic, Dagestan Republic, Kabardino-Balkarskaya Republic, Tyva Republic, Sakha (Yakutia) Republic, Penza Oblast, Kaliningrad Oblast, Kostroma Oblast, Kamchatka Oblast, Krasnodar Krai and some others.
In other regions the process of buying out land was either not active enough (Nizhny Novgorod Oblast and Samara Oblast), or got suspended after an active start (Astrakan, Volgograd, Orenburg and Leningrad Oblasts).
There was a third group of regions where the process of buying out land was rather intense. Nevertheless, the amount of land turned into private property of business entities even in St.-Petersburg - the leading region in this sphere - made only 0.5% of the overall city area in 1996 - 2000.
78 Here and further on the data used for assessing the situation in this sphere before early 2000-s is taken from an analytical report of Urban economics Institute "Analysis and evaluation of Land Relations Reform in the Cities", see: www.urbaneconomics.ru/texts.php. 588
More than 10 years of privatization of land plots occupied by business entities resulted only in 5% of lands being turned into private property of such entities79. The major bulk of business entities owners still do not own the land occupied by these entities. From microeconomics point of view such situation constitutes a barrier for owners to exercise their rights and creates for them a real threat of losing their assets in case of disagreement with the principal owner - the government on terms and conditions of land use. From macroeconomics point of view it impedes economic growth, investment into economy.
During the period when the majority of business entities do not have titles for the land they occupy, legal relationship between the state and businesses are regulated by the institute of permanent unlimited (free) use of lands, stipulated by the Land Code of RSFSR of 1991. Business entities were granted such a right based on the decisions of state/municipal authorities which together with the law defined the limitations for using the land law. They could be defined in various ways, however, all actions aimed at assuring disposal of land were either made impossible (e. g., divestment of land), or could be performed only under condition of agreeing them with the state (e. g., leasing land or converting it to free unlimited use (Article 268-270 of the RF Civil Code), cancelled by the RF Law No.201-FZ of December 4, 2006).
The land Code adopted in 2001 has legally fixed the exclusive right of business entities for either privatization of state-owned or municipality-owned land or for leasing it (Article 36). Besides, the new Code stipulated for abolition of unlimited free use of land starting from January 1, 2004. Prior to that moment owners of business entities had either to privatize the occupied land plots or to execute a lease agreement. Now from the day of enactment of the Code - i. e., from October 29, 2001 - privatization of buildings, structures and facilities (including buildings, structures and facilities of industrial use) without simultaneous privatization of land plots occupied by them is not allowed with the exception of cases when such plots are withdrawn from turnover or limited in turnover (RF Law No.137-FZ of October 25, 2001, "On Enactment of Land Code of the RF").
Resolution of the issue about privatization of land plots was challenged by a series of problems related with defining the group of land plots not allowed for privatization, borders of land plots, their status of federal or municipal property, lack of titles, terms and procedure of land value assessment. Impossibility to resolve those problems led to adoption f amendments to the RF Law "On Enactment of Land Code of the RF" in December 2003. These amendments allowed for extension of the mandatory conversion of user rights for land lots under business entities into ownership/lease rights starting from January 1, 2004, until January 1, 2006.
In the end of 2005 the deadline for converting the land-related rights was again extended until January 1, 2008 (RF Law No.192-FZ of December 27, 2005,
79 Presentation by the State Duma Committee for Property Chairman V. Pleskachevsky on I Congress on Land Property Relations in Russia / M. Vdovin, Uniform Tax and Cadastre Value of Land Plots: Reform News, October 17, 2006, see: www.domex.ru.
"On Introducing Amendments into Article 3 the RF Law "On Enactment of Land Code of the RF"").
Let us review here the key problems of transferring the land plots to the property of business entities, and analyze to which extent the ways to resolve them selected by government are justified and feasible.
1) Excluding certain land plots from those qualified for privatization.
The common norm is that turning down of requests to buy out land or to lease it is not allowed with the exception of cases stipulated by the law. Cases when land plots are not qualified for privatization are listed in item 8 of Article 28 of RF Law No.178-FZ of December 21, 2001, "On Privatization of State and Municipal Property in the RF". Most of the listed cases seem to be justified, however, the fact of including "lands which Master Plans of respective territories development allocate for use in state or public interests", destroys the illusion of fairness.
The Land Code contains similar norm stipulating that "reserving land plots for state and municipal needs may be the grounds for turning down the privatization requests" (item 4 of Article 28). It is especially important to note that the procedure of reserving land plots for such special needs is regulated neither by the Land Code nor by City Planning Code.
The arbitration courts practice includes hundreds of claims from the companies challenging the legitimacy of turning down the request for privatization of land plots based on the need to reserve this particular land plot for state/municipal purposes. Normally courts dismiss such claims because local authorities refer to various normative acts confirming the need to use the disputable land plots for public or government purposes. As of today, Master Plans for territorial development in some regions are adopted for very lengthy periods, which allows to include a large number of land plots required for the development purposes into such plans, thus removing them from privatization. For example, Moscow City adopted Master Plan for the period until 2020, Tyumen City - until 2040. Often the market players are absolutely unaware, which lands are included into such plans. As a rule, the fact of including land plots into Master Plans becomes public only on case-by-case basis when individual requests for privatization are filed and are turned down based on the Master Plans.
Draft law on the order of reserving land plots80 is currently under review in State Duma and has been enacted in first reading. It provides for the possibility to reserve any land plot by way of administration decision for undefined state/municipal needs for the period of 3 years. Such reserving excludes the possibility for buying out the respective land plots. The proposed mechanism stipulates the possibility of removing practically any piece of real estate (including privately owned ones) from the market turnover under the excuse of "creating the conditions required for implementing territorial development plans, in particular - for develop-
80 Draft RF Law No.321847-4 "On Introducing Amendments to Certain Legal Acts of the Russian Federation with Regards to Establishing the Procedure for Reserving Land Plots for State/Municipal Needs". Version enacted by the State Duma of the Federal Assembly in first reading on October 11, 2006. 590
ing engineering, transportation and social infrastructure and establishing special environment-protection zones"81.
The decision about reserving land plots may be made both at the federal and at the regional level by respective authorities, as well as by municipal governments. Special attention needs to be paid to the fact that the same authority that made the decision on reserving land may cancel it.
The draft law currently under review is aimed at limiting the rights of use, possession and disposal of land, thus contradicting with item 3 of Article 55 of the Constitution, allowing limitation of citizens rights "only to the extent it is required to protect the constitutional system, morals and health, rights and legitimate interests of other parties, assuring national defense and security of the state". Besides, item 2 of article 36 of the Constitution is being violated, which sets unconstrained right to possess, use and dispose land provided it does not damage the environment and does not violate rights and legitimate interests of citizens.
Effective legislation stipulates the possibility to withdraw a land plot only under several conditions, specifically: consensus with the owner of the land plot on terms and conditions of such withdrawal, on the buy-out price (Article 282 of the RF Civil Code), and in case the owner disagrees the adequate court judgment is required, as well as compensation of equal value for the land plot cost (item 2 of Article 55 of the RF Land Code).
The institute of reserving the land in the format it has been proposed in the draft law allows for limiting the rights of owners, proprietors and tenants without any formalities associated with registration/protection of their rights and legitimate interests. Such model of legal regulation creates the favorable pre-requisites for re-distributing land ownership in such regions where it exists, and for using administrative methods to distribute land in such regions where there is no private property for land (e. g., Moscow).
It is necessary to use this institute only for reserving land plots for state/municipal purposes so that the list of lands not qualified for privatization is fixed. The rights of tenants and other legitimate owners should be taken into account, and the grounds for reserving need to comply with effective legal norms.
Besides, the group of real estate owners entitled for buying out land plots was narrowed by the way the buy-out right was interpreted in clarifications issued by the Supreme Arbitration Court Plenum, which pointed to the fact that in case the real estate owner executes the Land Lease Agreement after October 29, 2001 (the date the Land Code was enacted), this owner forfeits the buy-out right due to the fact he/she had already exercised their right (Para. 3 of item 7 of the RF Supreme Arbitration Court Plenum Resolution No.11 of March 24, 2005, "On Some Issues Related to Application of Land Law").
The arbitration practice already includes court judgments based on exactly this interpretation of Article 36 of the Land Code stipulating acquisition of rights for state-owned or municipality-owned land plots (e. g., Resolution of 10th Arbitration Appellation Court of July 5, 2006, on case No. A41-K1-3420/06).
81 Proposed version of item 43.1 of the Land Code, Draft RF Law No.321847-4.
Taking into account the number of Lease Agreements executed during 5 years (from November 2001 to November 2006) in the territory of Russia, the number of applicants for buying out land will decrease significantly. Thus, administration of Nizhnevartovsk raion of Khanty-Mansy District (Yugra), for example, executed 233 Land Lease Agreements in 200582.
Besides, State Duma is currently reviewing the draft law introduced by the RF Ministry for Economic Development and Trade, related to terms and procedures of acquiring rights for state-owned and municipality-owned land plots . This draft law stipulates that the price for land shall be defined by the regional laws; at the same time, this price shall not exceed 20% of cadastre value. However, the right for buying out land will be granted to only those owners, whose right of private ownership with regards to this real property (or the analogous right of the preceding owners) "emerged due to divestment of this real estate from state or municipal property". "Other individuals and legal entities being the owners of buildings, structures and facilities occupying state-owned or municipality-owned land, may acquire land plots (only) at cadastre (market) value.
In case such law is adopted private businesses emerged not as result of privatization will be to a significant extent put aside from the process of buying out land. For many of them the price barrier will be absolutely overwhelming.
2) General payment for converting land lots into private property of business entities.
Requests for free conversion of land lots into private property have been filed for a pretty significant period of time. The advocates of this idea believe the land price was incorporated into the value of business entities when they were being privatized, so it would be illegal to ask to pay for one and the same thing twice.
Justification of such statements about the illegitimacy of selling land depends mainly on terms and conditions under which business entities were privatized, in particular:
- whether the land plot was incorporated into the divested/privatized asset;
- whether the cost of land plot was incorporated into the overall price paid for the business entity.
The RF Law No.1531-1 of July 3, 1991 "On Privatization of State and Municipal Enterprises" in Article 1 states the list of entities, acquisition of which by individuals or JSCs (partnerships) should be qualified as privatization, points out enterprises, shops, production facilities, shop areas, equipment, buildings, structures and some other sites. Land plots are not listed.
The second privatization law No.123-FZ of July 21, 1997 directly specified that it may not be applied to land privatization (Article 3).
82 "Land and Its Use". see: nvraion.ru/?part=stuff8&sub=zeml.
83 Draft RF Law No.347961-4 "On Introducing Amendments to Legal Acts of the RF with Regards to Specifying Terms and Procedures for Acquisition of Rights for State-Owned or Municipality-Owned Land Plots". Version enacted by the State Duma of the Federal Assembly in first reading on November 22, 2006.
As for implementation of these norms, it is worth noting that no matter enterprises were privatized through tenders84, or by way of auction85 land plots were never subjects of privatization. During privatization the owner of the business was granted only the user rights for the land plot.
With regards to the reasoning based on incorporation of land value into the value of privatized businesses it is worth noting that the procedure for defining the value of privatization subjects effective from February 20, 1992, until March 29, 2003, when defining the details of valuated assets includes just user rights for the land plots as part of fixed assets and investment 86.
Thus, there are no reasons to assume that the value of land plots was incorporated into the value of business entities when privatizing them. The Terms for privatization of business entities (set by the Federal Law) did not mention land as subject of property rights. The price paid when purchasing the enterprise (irrespective of the format of purchase: auction, tender) did not include the land plot value. In other words, there are no grounds to claim illegitimacy of the term about paying for land.
Nevertheless, in addition to legitimacy of legal provisions there are criteria of justification (including that from the economics standpoint) and feasibility of the government decisions. The decision about the need for everyone to pay for privatization of land does not comply with such criteria. There are a number of reasons for that:
First of all, Russian business entities, or at least - the majority of them, are not capable of buying out land at full value. Using the maximum rates the total value of lands to be bought out by businesses makes from $30 bln (according to Realtors Guild estimates) to $106 bln (according to Russian Union of Industrialists and Entrepreneurs estimates), which accounts for 1/4 of Russian GDP. According to the estimates of A. V. Sharonov, Deputy Minister of Economic Development and Trade, land to be bought out by businesses costs $34.8 bln. He believes this amount to be impossible for Russian companies87.
Buying out land is a problem even for major Russian corporations. Thus, RAO EES (United Energy Systems) of Russia estimated the value of land to be privatized by this Holding somewhat at the level of $800m. Buying out land occupied by production facilities of JSC AvtoVAZ (the area of the plant territory accounts for more than 900 hectares) may cost dozens of millions of USD88. And even for such giants of domestic business with their significant gross annual margins and availability of
84 Item 1.4 of Provisional Regulations on Privatization of State and Municipal Enterprises in the RF on a Tender Basis (Appendix No.5 to the Decree of the RF President No.66 of January 29, 1992). Effective from February 20, 1992, until March 29, 2003.
85 Item 1.5 of Provisional Regulations on Privatization of State and Municipal Enterprises in the RF through an Auction (Appendix No.4 to the Decree of the RF President No.66 of January 29, 1992). Cancelled by the Decree of the RF President No.832 of July 14, 1998.
86 Item 2.1 Provisional Methodology Guidelines for Privatization Subjects Valuation, Appendix No.2 to the Decree of the RF President No.66 of January 29, 1992.
87 Finance, 2003, № 18, p. 4.
88 News on real estate market, issue № 43, 10.11.2003 See: www.nrm.ru.
cash land privatization costs will be pretty noticeable. For the majority of businesses challenged by acute deficit of floating capital or investing heavily into business development, buying out land under the proposed conditions is practically impossible.
Secondly, impossibility for the majority of Russian businesses to buy out the lands carrying out their production facilities will lead to re-distribution of property rights for land and land titles in favor of major corporations, finance organizations, bureaucrats and their affiliated organizations. At the same time, part of the currently operating businesses shall be liquidated, and the economic status of other small and medium-size businesses will significantly decline. And if we remember the fact that 2/3 of national GDP is generated by private businesses, we may definitely claim that such liquidation may have a serious negative impact over the dynamics of economic growth.
Thirdly, using the land buy-out price as additional revenue source for regional budgets will have positive economic effect only in a very short-term perspective, with the exception of major financial intermediary centers. It is related mostly with insufficient floating capital and poor investment capacity of the majority of lands due to underdevelopment of the infrastructure. Increased concentration of capital, growth of corruption and abuse in the sphere of administrative decision-making about land may result from the need for everybody to pay for privatization of land.
Thus, introducing mandatory payment for privatization of lands for all business entities without any exception does not contradict with the legal framework, but is economically unjustified and unfeasible, as it impedes further development of the major bulk of market players and eventually - the economic development of the country. Paying for privatization of lands based on the market prices may also aggravate social problems, hurt the middle class and really private businesses which are not based on solely state-owned assets.
Given the current profile of energy prices, lack of system of government support to smaller and medium-size businesses, but simultaneously high taxation rates for such businesses, as well as insufficient development of the banking sector capable of providing financial instruments for buying out land, free privatization of lands for effective smaller and medium-size businesses would be feasible. The mandatory terms should be the following: conversion of production and land use purposes should be banned for a certain period (or allowed only for additional fee), as well as divestment of land and production reduction.
Transferring land at its nominal value or under long-time installments schemes may be a good enough interim option, so that the owners of businesses occupying the respective land plots have real possibility to buy out their lands and exercise preferential right for buying out land plots occupied by their assets.
3) High price for land plots buy-out.
The price for buying out land, specifically - its very high level, is one of the key barriers for land market formation. The following key reasons for such situation should be emphasized:
a) the entities of the Russian Federation (regional authorities) were granted the right to establish the level of buy-out price for land plots.
Having defined that the buy-out price for land shall be defined at the subnational level (item 2 of the RF Law No.137-FZ of October 25, 2001 "On Enactment of the RF Land Code" and item 7 of Article 28 of the RF Law No.178-FZ of December 21, 2001 "On Government and Municipal Property Privatization in the RF"), the legislator created exclusively favorable grounds for economically unjustified decisions targeted at receiving the maximum revenues from selling land, as well as an extremely favorable environment for regional officials abuse and unjust enrichment.
Thus, the entities of the Russian Federation were granted the rights to set the prices for land in residential areas making certain times to the regional land tax rate and based on the number of residents:
- above 3 mln people - in the amount from 5- to 30-times land tax rate per acreage unit;
- between 500 thou to 3 mln people - in the amount from 5- to 17- times land tax rate per acreage unit;
- under 500 thou people and beyond the residential areas borders - in the amount from 3- to 10- times land tax rate per acreage unit (as of the beginning of the current year).
(With this prior to RF entity setting the price for land the minimal land tax rate should be applied).
In the circumstance of the major bulk of Russian regions being subsidized from the federal budget and suffer from insufficient budget resources, receiving the right to charge land buy-out could be viewed as a chance to increase the regional budget revenues. As an outcome of such policy we can observe in practically every location setting the land prices at the maximum high level allowed by the law for cities and other residential areas with the respective number of residents.
Thus, in the absolute majority of regions where the number of population in cities and settlements including the regional capital city did not exceed 500 thou people, the price for land was set at the level 10-times above the land tax rate. On the other hand, there is a significant group of regions where the number of population in major cities exceeds 500 thou people, meaning that for the regional capital city the land price was set at the upper level of the second-tier scale, i. e., 17-times above the land tax rate, as for the other settlements and residential areas of the same region - it was set at the level 10-times above the land tax rate. The latter regions were (as of beginning of the H2 of 2002) Ryazan, Tula, Volgograd, Rostov, Nizhny Novgorod, Orenburg, Samara, Saratov, Ulianovsk, Omsk and Kemerovo Oblasts; Krasnodar, Altay and Khabarovsk Krais; Udmutiya Repblic.
Further on the inadequately overpriced land was reassessed in some regions and the priced were brought down. In some regions it was related with lobbying efforts of local business community (e. g., in Tomsk oblast, when the buy-out price was reduced from the level of 10-times above the land tax rate down to the level of 3-times above the land tax rate). In other regions the key reason for reducing the
buy-out price was the inspiration of many regions to keep as much as possible revenues from selling land with their regional budgets.
b) changing the procedure for allocation of the revenues received from selling land between different levels of budgets.
In periods, when the next year's federal budget would stipulate any change in allocation of revenues received from selling land in favor of the federal budget, the regions would set relatively low land buy-out prices to assure incentives for more sales, so that the region is able to keep the maximum possible revenues. By implementing such policy the regions were able to assure significant additional inflow of cash as transfers from upper-levels budgets.
Such methods were used, for example, in Kemerovo region, where the land buy-out rates were changed 6 times during the period of 15 months starting from the date of enactment of the new Land Code. Novosibirsk regional administration was applying similar tactics (the price for land in Novosibirsk was decreased from 17-times above the land tax rate down to 6-times rate), as well as Vologda regional administration (price decreased from 10-times above the land tax rate down to 3-times rate, and then raised again up to 10-times above the land tax rate).
b) defining the buy-out prices for land plots as "x"-times above the land tax
rate.
Starting from January 1, 2005 (item 2 of Article 7 of the RF Law No.95-FZ of July 29, 2004 "On Amendments to Sections 1 and 2 of the RF Tax Code") is also "to be set by legal acts of representative local representative bodies of municipal bodies, and in the cities of national status - Moscow and St.-Petersburg - by regional laws". The federal legislator merely defines, that with regards to land plots occupied by businesses the tax rate shall not exceed 1.5% (Article 394 of the RF Tax Code). In practice the entities of the federation (due to the above described reasons) set the maximum high rates.
r) land tax rate (and the resulting buy-out prices for land lots) is calculated based on the cadastre value of land plots.
According to the estimates by M. Mishustin, Director of the Federal Agency for Real Estate Cadastres (Rosnedvizhimost), the overall cadastre value of Russian lands constitutes RUR 23.6 trillion. 82% of overall cadastre value of Russian lands falls on the lands in residential areas, however, such lands constitute no more than 1.9% of the national territory89.
The cadastre evaluation of lands was undertaken between 2000 and 2006 leading to increase of the value for the land plots to which the cadastre evaluation methodology was applied, and this methodology depends not just the location of a land plots within a certain cadastre quarter, but also on their functional use capacity.
Thus, for example, cadastre evaluation of lands in Moscow took place in 2000-2002 and resulted in establishing 1516 cadastre quarters instead of previously existing 100 zones. As for the price for land itself, even in downtown Moscow it may vary between RUR 60,501 and 1,331 per 1 sq. m90. According to V. Damur-
89 See: realty.rbc.ru/regions/news.shtml/?url=2006/04/10/4303841@region=msk.
90 Appendix No.1 to Moscow City Government Resolution No.356-PP of May 24, 2005.
596
chiev, Director of Land Resources Department of Moscow City, by the beginning of 2006 the average cadastre value for Moscow land constituted RUR 180K per 1 hectare per annum, with the minimal level being RUR 1,800, and the maximum achieving RUR 900K per 1 hectare per annum 91.
According to the data provided by Leningrad regional Control-and-Accounting Chamber, the cadastre value of land in Leningrad region was defined above the market value of land. According to Auditor S. Gnilitsky, the deviation from the market price may constitute from $15 up to $560 per 100 sq. m92.
The totality of all these reasons defines the high level of high buy-out prices for land lots for businesses. Thus, the price of land plots in Moscow when putting them on sale is defined based on the 30-times land tax rate per acreage unit93 and on the fact the land tax rate being set at the level of 1.5% of cadastre value of lands. This is the maximum amount of buy-out price as per the RF Land Code. For businesses qualified as valuable for the city, the price for buying out their land plots is decreased down to 20% of their cadastre value.
The right to establish adjustment coefficients between 0.7 and 1.3 used for selling land plots and approved by the RF government (RF Law No.137-FZ of October 25, 2001) requires some special attention. Application of this norm in the environment of total corruption may become an additional key source for extra income of bureaucrats.
Currently the State Duma is reviewing the draft law introduced by the RF Ministry for Economic Development and Trade stipulating bringing down the buy out price only for privatized business entities down to 5% of cadastre value for all residential areas except for Moscow and St.-Petersburg, where the minimal price will constitute 20% of cadastre value94. According to the new law the buy-out price for all other business entities shall be equal to cadastre value, i. e., market price. In case such approach is applied, major companies or entities with that or another way of control on behalf of the government or demonstrating their loyalty to the government will have preferential rights for buying out land. Smaller and medium-sized businesses in need of privileges are in reality deprived of the possibility to buy out land due to being in capable of overcoming the set price barrier.
Maintaining the current legal framework on the matter or enactment of the above mentioned draft law will inevitably lead to new violations of the owners' rights (similar to what happened during privatization in 1990-s) in favor of the so-called national interest, such violations being performed (as it has become the practice of the recent years) by formally lawful methods. The real objectives of enacting such laws (distributing state property among a selected circle of people, maximizing budget revenues for regional budgets, as well as for bureaucrats participating in
91 See: www.bpn.ru/service/neus/13711.
92 See: novgorod.osean.ru/commercia/articles/?articl_id=15096@PHPSESSID= 014b3b10caf6ab74de7a 57d2eb172e40.
93 Moscow City Government Resolution No.532-PP of July 19, 2005.
94 Draft RF Law No.347961-4 "On Amending the RF Legal Acts with Regards to Specifying the Terms and Conditions, and the Procedure of Acquisition of Rights for the Land Plots Owned by State/Municipality". Version adopted by the State Duma after first reading, November 22, 2006.
decision-making on the mater of buying out land plots) shall stay beyond the public discussions, if only they do not result in some social conflicts.
4) The trend to limit the tenants' rights and increasing government regulation in land lese areas.
Execution of Lease Agreement proposed by the legislator as an alternative for buying land out has also its disadvantages.
The Land Code of 2001 introduced new terms and conditions for the long-term lease agreement (over 5 years) for a land plot being a state/municipal property (Article 22, item 9). In case of executing such an agreement the tenant actually receives the rights to dispose such plot within the period of the agreement validity without the content of the owner (re-assign the rights arising from such agreement to a third party, sub-lease the plot, pledge the lease rights, introduce these rights as a contribution to a charter capital of a business entity, etc.).
However, the draft law on buying out the land plots (introduced by the RF Ministry for Economic Development and Trade in 2006 and being currently reviewed by the State Duma) stipulates some new limitations of the tenants' rights95. First of all, re-assignment of the long-term leasing rights (over 5 years) shall be prohibited without authorization from a respective government/municipal official (today a mere notification of the respective authority is enough to re-assign the rights). It means bureaucrats would be empowered to dictate when executing deals with private businesses and individuals having premises located on the leased land plots. Secondly, the re-assignment of leasing rights for the land plots not carrying buildings, structures and facilities shall be banned completely. This is in obvious impingement of the rights of buildings and facilities owners, and this norm also has another implication: provides the bureaucrats with the right to arbitrarily cut the borders of the land plot.
The rent rates limits administratively leased plots are set as 2% of the cadastre value (in case of agricultural lands - not exceeding the land tax rate, and for land plots the circulation of which is limited - the amount of land tax). However, these limitations shall be effective only until the moment of delineation of state property for land. So based on some artificial reasoning one category of tenants -owners of buildings/facilities will pay rent comparable to the land tax, while another category of tenants will be charged based on the arbitrary decision of local authority. This situation may be explained by the fact that until July 1, 2006 the delineation covered the land plots qualified to be bought out and carrying private buildings and business facilities (based on whom the building/facility belonged to before privatization). So many of business entities without even being aware of that found themselves occupying land plots owned by the state. According to the new regulation (RF Law No.53-FZ of April 17, 2006) the land plots qualified to be bought out shall not be subject to delineation. 167 hectares of city lands were delineated as of January 1, 2005 (2.3% of total area). With regards to these territories currently making up to 6% of the city lands government officials will have the opportunity to establish arbitrary rates not based on market realities.
95 See: A. Lazarevsky. Land Coup/ "Expert" No.38, October 16, 2006. 598
Besides, for tenants the situation is aggravated by the fact that in some regions the rent for using a land plot will be calculated based on the performed cadastre evaluation of land, meaning the rate will grow significantly. Thus, in Moscow, starting from January 1, 2006, for all leases executed after this date the rate is calculated based on the real cadastre value of the respective land.
Lease rates in Moscow are established in accordance with the approaches to setting the land tax rates96:
- 0.1% - for land plots carrying housing and engineering infrastructure;
- 0.3% - for land plots carrying social assets funded from extra-budgetary sources, as well as "dachas" (country cottages);
- 1.5% - for all other categories of land plots.
What does that mean for land tenants? In Moscow the base land lease rate differentiated based on the tenants category and on the type of land use is within the range of RUR 1,800 per hectare and RUR 900, 000 per hectare. Its growth when calculating based on cadastre value will make from 8% to 110% dependent on the location and type of land use97.
Other challenge the tenants have already came across was selling premises owned by the entity of the Federation with the effective lease agreement. In most cases it results in bankruptcy of the tenant due to increase of the lease payments, or in the new tenant turning down the application for prolongation of the effective lease agreement. For example, the St.-Petersburg Committee for State Property Management is selling as priority No.1 the premises already refurbished by the tenants98. Most often this problem relates to smaller and medium-sized businesses which do not have relevant funding resources for buying out the leased premises. The situation is aggravated by the fact that KUGI does not prolong the effective lease agreements with the entrepreneurs prior to selling land plots.
5) Arbitrary definition of land plots borders.
The availability of cadastre map (plan) is a mandatory pre-requisite for acquiring the rights for the land plot carrying buildings/facilities of a business entity. This map needs to be attached to the application for acquisition of rights for the land plot which individuals or legal entities need to file with the respective executive agency or local self-government body with the purpose of buying out the land plot (item 5 of Article 36 of the RF Land Code).
In case cadastre map is unavailable, the borders and sized of a land plot shall be defined based on the effectively used area of the land plot and in accordance with land and city planning regulatory framework (item 7 of Article 36 of the RF Land Code).
According to the effective land use regulations, definition of the land plot borders and of the order of its use is to a great extent dependent of the City Planning
96 Appendix No.11 to Moscow City Government Resolution No.273-PP of April 25, 2006.
97 Interview by V. Damurchiev, Director of Land Resources Department of Moscow City // Revenue Formula, "Vechernyaya Moskva" No.12 of January 25, 2006.
98 "St.-Petersburg: Business Demands to Stop Auctions" /Alliance Media, December 27, 2006. See: allmedia.ru.
Regulations (Article 85 of the Land Code) defining the types of allowed land/capital infrastructure use, their normative (minimal and/or maximal) sizes, as well as limitations for using land/capital infrastructure (Article 30 of the RF Land Code).
The RF entities are empowered to enact their City Planning Regulations, and local governments usually decide on different issues of land use. In the environment of total corruption land owners or those who wish to become land owners, as well as tenants find themselves in the position of absolute hostages of bureaucrats at different levels as they are granted practically unlimited rights. In reality privatization of a land plot is often performed in the size of the foundation of the building/facility it carries, that is just the "foot" of the building is being sold without adjacent territory required for servicing, maintenance and normal operations of the building. And the remaining portion of the land plot is offered at a much higher buyout price.
6) Delineation of state property between different levels of government constitutes one more barrier for those who want to privatize land.
The RF Law "On Delineation of State-Owned Land" effective since January 2002 sets the following basic principles for such delineation:
- the already privatized land plots, as well as those granted to municipal or federal property or property of the entities of the RF shall be excluded from the process of delineation;
- the land plots may become property only of that subject of public power which owns (or used to won prior to privatization) real estate located on this land plot.
In reality the Federation and the entities of the RF often claim the same plots simultaneously. Contradictions between different levels of power, departments, agencies and individual bureaucrats lead to a lengthy procedure of coordination and registration of original ownership for land.
In addition, in certain regions governments are deliberately delaying land property delineation process. Until the property rights are not properly delineated, lease payments for the respective land plots are remitted to either regional or municipal budgets, thus providing counter-incentives for delineation process. Often the procedure of buying-out and registering the rights for land takes 2.5-3 years, and the certificate for state registration of title the business entity receives after 6 months or a year upon executing the sales-and-purchase agreement with regards to this land plot99.
The issue of delineation of state-owned lands became especially acute in Moscow. In April 2003 the decision about selling the land plot occupied by a privatized business entity was made for the first time after enactment of the Land Code. The plot of 1.7 hectares was evaluated at $500K, i. e., $30 per sq. m. However, the decision was made not by Moscow Government, but by Moscow territorial agency of the RF Ministry for Property Management. This decision became possible because the building occupying this plot used to be federal property before privatization.
99 "Land Relations Reform and Land Privatization in the Cities: Review and Evaluation" Analytical Report by the Institute of Urban Economics, pp.14-15. See: www.asdg.ru.
600
This transaction caused high-profile scandal with a broad resonance in the media. Top-ranking Moscow City officials claimed the deal to be illegal100, because according to them, "prior to delineation of federal and Moscow land ownership the RF Ministry of Property Management is not entitled to execute any deeds with land".
According to some estimates, lands occupied by business entities which used to be federal property prior to their privatization may constitute c. 40% of all Moscow land101. In case federal property management authorities deal with buying out these lands, the huge proceeds from such sales will be fully remitted to the federal budget. That is why Moscow government will be doing everything not to allow for a precedent which may cause a knock-on effect102.
7) Technical problems of exercising the right for land plot privatization.
The main challenge (besides those mentioned above) that many businesses are facing after applying with request for privatization of land is related with local governments turning down the applications. They may be basing their decisions on unavailability of cadastre map and refusal to make it, or on attributing these lands to the category which is not qualified for privatization.
As for the problem of unavailability of cadastre map for the respective plot, one needs to remember that as of today only 10% of the RF territory is covered by cadastre maps103.
In some cases attributing lands to a certain category (e. g., lands of general use) is confirmed by a directive of local administration, however, there are no effective legal documents to confirm this specific mode of using the given plot was established. This complicates the court review and making a judgment with regards to whether turning down of privatization request by the local administration was lawful or unlawful (e. g., Resolution of Supreme Arbitration Court Presidium No.322/05 of April 19, 2005).
In addition to this, exercising the right for privatization of land plot is to a great dependent on the correct definition of the government authority which is to decide on the matter. Currently there may be the following difficulties: according to the RF Law "On Enactment of the Land Code of the Russian Federation", the decision about privatizing land may be made by the local administration, under the jurisdiction of which the respective territories are. However, on the other hand, decisions about privatization of land plots carrying privatized business entities may be made only by the same government authorities, which had made the decisions on privatization of the assets located on those plots находящихся на этих земельных участках (item 14 of Article 43 of the RF Law "On State and Municipal Property Privati-
100 See: Izvestiya. April 24,2003; Vedomosti. April 25,2003; Gazeta. April 25, 2003.
101 Kommersant. January 29, 2002. P. 8.
102 "Land Relations Reform and Land Privatization in the Cities: Review and Evaluation" Analytical Report by the Institute of Urban Economics, p.36. See: www.asdg.ru.
103 «Drafting of recommendations on the development the real estate and land market with the aim of taking into account the interests of the small and medium size business (The role of Chamber of Commerce of RF and territorial Chambers of Commerce). Final report of the Chamber of Commerce of RF and of the information and consulting center "Business-Tezaurus), 2006, p. 12.
zation"). In some cases local administrations would review such applications through a general procedure, and in case privatization request is turned down, the respective business entity would institute a claim against local administration, and not against the government authority having executed privatization of the assets. This often leads to escalation of litigation costs (e. g., Resolution of the RF Supreme Arbitration Court Presidium No.992/04 of September 28, 2004).
The issue about the borders of land plots also remains difficult. No common uniform approach to defining the size of the land plot qualified for privatization has yet been developed in the practice of arbitration courts. When defining the size of a land plot some courts are based on the concept of "effectively used area of the land plot", understanding it as an area directly under the building; other courts are based on the total area of the land plot according to the map provided by the customer and certified by the respective territorial branch of the State Land Cadastre. The latter position seems correct and in compliance not just with the Law itself, but with the key principle underlying the concept of land privatization. Thus, the RF Supreme Arbitration Court in the Resolution on a specific case No.4345/04 of August 17, 2004, on calling void the decision of Klin raion administration of Moscow Region about turning down the application for buying out a land plot, stated that privatization of the full-size land plot was the thing to do in order to assure compliance.
The issue of collective buying out the land plot carrying buildings/facilities belonging to several business entities is very relevant for smaller businesses104. In the majority of cases a small business entity owns just a portion of premises inside a building, which it shares with other owners. Joint application to the respective authority will be required in such case in order to execute the sales-and-purchase agreement for buying out the respective land plot. In reality this is impossible to implement. As a rule, some of the smaller businesses occupying the premises are owners, and some are tenants. The owners are not interested in switching to the lease-type relations, tenants do not always have the resources required for buying out the premises and the land plot. Besides, the procedure of collective buy-out of a land plot is cumbersome and overcomplicated from the point of view of achieving the consensus on the terms of ownership and shares of the participants.
To summarize, the following needs to be emphasized: the idea itself of granting the rights for decisions on land privatization, on defining the value of land plots, on organizing cadastre registration of land and on some other related issues to the entities of the federation and local self-government bodies seems pretty feasible. However, real capabilities and inclinations of those who will be empowered with such a function need to be taken into account when implementing this idea.
The high level of corruption of Russian bureaucrats is widely known, as well as the fact that local self-government in Russia is underdeveloped, and regional budgets suffer from significant deficit. In such situation the impossibility to guarantee fair
104 «Drafting of recommendations on the development of real estate and land market with the aim of taking into account the interests of the small and medium size business (The role of Chamber of Commerce of RF and territorial Chambers of Commerce). Final report of the Chamber of Commerce of RF and of the information and consulting center "Business-Tezaurus), 2006, p. 45-46. 602
land privatization is obvious. The privatization mechanism itself as stipulated by the legislator (even disregarding the local normative acts) is designed in such a way, that a huge number of various officials from different organizations need to agree on privatization decision in order to make it happen. Such mechanism practically makes privatization of land impossible for business entities. The most major and meaningful businesses, either controlled by the state or loyal to the current government, may still count on positive decision being made on land privatization under acceptable terms and conditions (e. g., by enacting new laws reducing the buy-out price for such entities or by adjusting the land value in case the RF Government uses a reduction factor). But for smaller and medium-size businesses the situation may soon become a catastrophe. Implementation of the land privatization scheme currently stipulated by the law may result in future concentration of land property, as well as redistribution of land ownership rights among a very limited circle of stakeholders.
Implementation of the following measures may significantly improve the situation with land privatization:
1. minimize engagement of bureaucrats and the level of their arbitrary decision-making in the process of defining the value of the land plots and their borders, i. e., the maximum possible regulation of the matter at the federal level;
2. eliminate (or bring down significantly) the buy-out price for operational smaller and medium-size businesses;
3. exclude all norms stipulating violation of private property rights, as well as land ownership and disposition rights, from the RF Land Code, City Planning Code and from other legal acts of the Russian Federation and of the entities of the federation;
4. enact the law on land reserve excluding the possibility of reserving privately owned land and of violation of the rights of owners and other parties exercising lawful use and possession of land; stipulating for setting up a transparent process of putting state and municipal lands into a reserve category (prohibited for buying out);
5. enact legal norms assuring the lists of land plots included into Master Plans of the cities' development are mandatory for publication in the media;
6. introduceg a system of measures to provide the regions with the incentives to delineate land ownership rights and to increase the privatized lands share;
7. introduce legal banning with regards to changing the order of distribution of land privatization revenues between the federal budget and the budgets of the RF entities for a long enough period;
8. introduce legal banning for the RF entities to escalate the buy-out price for land plots occupied by business entities;
9. develop credit mechanism for business entities to buy out the land plots carrying their buildings/facilities to assure annual interest rate at no more than 3-5%;
10. introduce the long-term installments mechanism to pay for privatization of land plots;
11. provide for regional branches of the State Accounting Chamber to check the justification of cadastre valuation of lands in the regions, abolish laws and regulations of the RF entities approving cadastre evaluation above the market price.
5.4. Institutional Problems of Russian Capital Market
5.4.1. Russian Capital Market Dilemma
In his famous novel «The Notre Dame Cathedral" Victor Hugo described the excruciation of Clod Frollo - the priest balancing between the professional ethics principles and his lust towards Esmeralda the Gypsy. The Dilemma of Father Clod - this is how one can figuratively describe the current attitude of global investors towards Russian capital market. It has been quite explicitly worded in one or the Wall Street Journal articles. According to western business community, internal opposition was aggressively suppressed Russia during the recent few years, the rights of foreign investors were rudely violated, and energy-based blackmail was applied to some neighboring states. However, many of these western investors believe President Putin to be a hero merely because of one main thing: during 7 years of his presidency Russian capital market rallied impressively. Capitalization of Russian companies has grown from $74m in January 2000 to almost $1 trillion as of January 2007; RTS (Russian Trading Systems) index was demonstrating an average growth rate of 50% per annum105.
In general, the temptation of high profitability turns out to be stronger than concerns about economic liberties, investors' rights and government's interference with business. The story of Long-Term Capital Management (LTCM) failure in 1998 is an evidence of how difficult it is to withstand the temptation of high profitability of the emerging markets even for sophisticated institutional investors.106 LTCM - one of the major hedging funds - was established in 1994 by John Meriwether, former trading star in Salomon Brothers. Two very reputable people were among its directors -Robert Merton and Myron Scholes, the Nobel Prize winners in economics of 1997. They are justly recognized as scholars whose conclusions and estimates allowed for creating a formalized market for derivates at the USA exchanges. LTCM was specializing at very risky commercial strategies for the emerging countries bonds markets. Thanks to this very positive publicity of its leadership and high profitability level (in 1997 LTCM's annual profitability constituted 40%), its assets value has reached $7.3 bln by 1997. However, the irony of fate was such that even such champion managers did not provide for maintaining the due presence of mind when performing risk evaluation for investment into Russian economy. The crisis of August 1998 turned out to be completely unexpected for them; LTCM incurred the loss in the amount of half of its assets value, thus putting the USA at the edge of systemic financial crisis. The catastrophe was avoided only thanks to the immediate reaction of the US Federal Reserve System and of some major American financial institutions.
105 Chazan G. Investor Credit Putin As They Pile Up Profits. Hot Stock Makes Russian Leader a Hero With Money Managers. - Wall Street Journal. - January 22, 2007.
106 Dowd K. Too Big to Fail? Long-Term Capital Management and the Federal Reserve. - CATO Institute briefing papers. - September 23, 1999, № 52.
5.4.2. Evaluation of Russian Capital Market Using CalPERS Pension Fund Methodology
In order to fully understand the outcomes of Russian capital market 2006 performance and the difficult choice for many foreign investors, let's try to evaluate it using some traditional methods of institutional foreign investors. For example, we can use the public materials of one of the major pension funds of the US - California Public Employees' Retirement System (CalPERS). CalPERS's methods for analyzing the feasibility of investment into emerging economies may be considered relevant due to several reasons. CalPERS is one of the most major and most conservative global investors, and its current assets value is over $225 bln. Its interest towards that or another emerging market automatically means some sort of a "quality certification" for that market proving it to be safe for other foreign investors. CalPERS methodology is public and is based on some competent research of emerging economies, ratings of civil liberties and freedom of press by Freedom House, global competitiveness index by World Economic Forum, shareholders' and creditors' rights guarantees assessment by Oxford Analytica, economic liberty index by The Heritage Foundation and Wall Street Journal, analytical materials by Wil-shire Compass, stock exchanges and other sources of information. This methodology has been in use for a number of years, it may as well be used as an indicator of global investors' attitude towards that or another emerging market.
CalPERS methodology means assessing the possibility to invest into a specific emerging market based on two key factors - country risks and risks inherent to a specific financial market. The maximum possible score is 3. In case a county achieves the score of 2.0 and more, it is automatically included into the list of countries permitted for investing CalPERS assets. In any other case the country's financial market would be banned for investment for this pension fund.
Country risks are evaluated by CalPERS based on the following criteria:
• Political stability - the status of civil liberties, level of judicial system autonomy and political risk level;
• Openness of information (availability and accessibility of data) including freedom of press rating, level of disclosure of monetary policy and budget data, quality of stock exchange listing and International Financial Reporting Standards (IFRS) application efficiency;
• Labor Laws compliance with international standards of labor relations regulation - ratification of ILO Convention, labor law compliance with ILO standards, efficiency of law enforcement.
In other words, country risks stipulate evaluation of investment climate and institutions - the foundation of financial markets.
Second groups of factors stipulate evaluation of numerical and qualitative parameters of emerging capital markets, including the following indicators:
• Liquidity and volatility of capital markets, including assessment of market capitalization and its growth rates, the ratio between monthly trading turnover and market capitalization, growth of the number of listed companies, stock market volatility and risk/profitability factor;
• Efficiency of bank supervision and law enforcement at capital markets, the level of investors' and creditors' rights protection;
• Assessment of the extent the national economy is open to foreign investment, the extent to which bank and financial institutions regulations are liberal, assessment of limitations for buying securities at secondary capital markets;
• Evaluation of how efficient the calculating mechanisms at stock exchange are, of the level of transaction costs (mainly taxes) at securities market and when paying dividends to securities holder.
CalPERS's assessment of Russian capital market is extremely interesting both for certain domestic investors, which in general are still pretty cautious with regards to domestic investment. The fact that pension funds of retired government officials from the US are now coming into this market is a very serious event capable of convincing even the most conservative Russian investors in certain advantages of the domestic market.
Table 15 represents the final CalPERS evaluation of early 2006 compared with three emerging economies from BRIC Group - Brazil, India and China.
Table 15
BRIC Countries (Brazil, Russia, India and China) Rating with regards to Admissibility of CalPERS Investment in 2006
Weight of Investment banned Investment allowed Maximum
factor, % Russia China India Brazil score
1. Country Risk Factors:
1.1. Political stability 16.7 1.0 1.3 1.7 1.7 3.0
1.2. Openness of information 16.7 2.0 1.3 2.7 2.7 3.0
1.3. Labor relations standards compliance 16.7 1.7 1.0 1.0 1.7 3.0
2. Market factors:
2.1. Liquidity and volatility 12.5 3.0 3.0 3.0 2.7 3.0
2.2. Market regulatory framework / law enforcement / protection of investors' rights 12.5 2.0 1.7 2.3 2.3 3.0
2.3. Openness of capital market 12.5 1.3 1.3 1.0 1.7 3.0
2.4. Efficient calculations / transac-tional costs 12.5 2.3 2.0 2.3 3.0 3.0
TOTAL 100.0 1.9 1.6 2.0 2.3 3.0
Source: www.CalPERS.ca.gov.
In 2006 Russia and China (out of 4 BRIC countries) scored less than 2.0 and were included in the group of countries banned for CalPERS investment. The key problems of Russian market are predetermined by low political stability, poor quality of labor regulations and insufficient openness of capital markets. Table 16 presents more details about the value (weigh)of various factors which impeded Russia from getting the maximal 3 scores as per CalPERS methodology during the period of 2003-2006 and based on preliminary 2007 rating outcomes. With this we need 606
to emphasize that neither of emerging economies scored 3.0 in 2006; the countries that scored the highest were Hungary - 2.7, Poland, Chile and Czech Republic -2.6 each.
Table 16
Share (Impact) of Various Factors in Deviation of the Final Russian Score from the Maximum Score (3.0) for the period of 2003-2006
2003 2004 2005 2006 2007 (estimate)
1. Country Risk Factors:
1.1. Political stability 20.5 28.6 27.6 29.2 30.6
1.2. Openness of information 20.5 0.0 13.8 14.6 15.2
1.3. Labor relations standards compliance 20.5 28.6 27.6 19.0 19.9
Total Section 1 61.6 57.2 69.0 62.8 65.7
2. Market factors:
2.1. Liquidity and volatility 7.7 10.7 0.0 0.0 0.0
2.2. Market regulatory framework
/ law enforcement / protection of 7.7 10.7 10.3 10.9 11.4
investors' rights
2.3. Openness of capital market 15.4 21.4 20.7 18.6 14.9
2.4. Efficient calculations / 7.7 0.0 0.0 7.7 8.0
transactional costs
Total Section 2 38.4 42.8 31.0 37.2 34.3
TOTAL 100.0 100.0 100.0 100.0 100.0
Source: www.CalPERS.ca.gov.
Country risk factors in 2006 accounted for 65% of points underscored by the Russian Federation. The average country risk assessment for Russia makes 1.6 out of 3. This is predetermined by low political stability, insufficient openness of capital markets and poor quality of labor regulations.
Political stability
In evaluation the status of civil liberties and rights score 1 means the highest level of freedom and score 7 - complete lack of freedom. Russia scored 5. The level of judicial system independence and legal protection in Russia scored 1 out of the maximum 3, which is to a great extent below the level of China. Our country performed quite unsatisfactory in such areas as judicial system autonomy, legal protection for property rights, and favoritism towards government authorities when making judicial decisions, poor outcomes of opposing the organized crime.
Openness of information
In the area of information availability and accessibility Russia scored 2, which is enough to overcome the barrier and join the club of markets permitted for investment. Measures on disclosing monetary policy, budget system and companies exchange listing information received sufficiently high evaluation. At the same time the key gaps identified for Russia were insufficient freedoms for media and insuffi-
cient rate on introducing IFRS (IAS or US GAAP). To be fair we need to emphasize that Russia's score is still better than those of India and Brazil - about at the same level as for China.
Labor regulations
The quality of labor regulatory framework in Russia was evaluated to score 1.7 out of the maximum 3. This is below the passing score, but above China or India, about the same level as Brazil.
Contrary to the conservative evaluation of institutional factors, quantitative and qualitative parameters of Russian capital markets look pretty presentable. The average rank for risks associated with Russian capital markets made 2.14 in 2006 -above the passing score of 2.
Market liquidity and volatility
Russia scored the highest possible (3.0) with regards to market liquidity based on such indicators as capitalization, trading volumes, market capacity and volatility.
Market regulatory framework, protection of shareholders' and creditors' rights
For the quality of regulatory framework for banking and capital markets Russia scored at an average level of 2.0. Insufficient efficiency of bank supervision and law enforcement at capital market, as well as gaps in assuring the creditors' rights prevent Russia from getting a higher score.
Accessibility of capital market
Russian scored rather low (1.3) due to limitations for banks and insurance companies with regards to entering the market.
Efficient calculations / Transaction costs
Russian capital market scored pretty high at the level of 2.3 (it scored 3.0 in 2005) in the field of efficiency of calculations and level of transaction costs. The efficiency of calculation methodologies applied at capital markets scored as high as 3.0 even in the environment that there is no Central Securities Depository and Guaranteed Settlement System without advanced deposit of assets. However, the evaluation of transaction costs level reflecting the level of taxation imposed on revenues and securities transactions was pretty negative (1.0 score out of 3 maximum). 24% profit tax when selling securities was reported as a particularly strong deficiency (today it is especially hitting the non-residents buying shares of Russian companies, who are trying to avoid this by way of investing into Russian economy through off-shore zones) Another deficiency identified was higher taxation of dividends compared to other emerging economies.
Summarizing this review of various factors effecting the feasibility of CalPERS investment at Russian capital markets, one may notice that the key complaints relate first of all to institutional factors and investment climate in the context of country risks, as well as to the level of capital markets development with regards to taxation of investors' revenues, efficiency of bank supervision and law enforcement. Practically there is almost no potential room for further improving Russia's rating at the expense of increasing quantitative parameters of capital markets and improving
its infrastructure because Russia has already scored nearly maximum in these areas. So the activities of the regulators should be focused on the areas, in which Russia is behind other competing countries.
The outcome of applying CalPERS methodology to Russia are interesting also because of the fact, that both Russia and China scored almost 2 in early 2006, i. e., they are pretty close to the threshold level, starting from which both economies nay be qualified for CalPERS investment107. Now everything depends on the final evaluation expected about March or April of 2007. 'So far CalPERS web site displays the draft final evaluation, according to which Russia's score will remains on the level of the previous year (1.9), and China will improve the score from 1.6 up to 1.7. But in both cases it won't exceed the passing score of 2.0. In such conditions CalPERS Investment Committee will have to face the uneasy Dilemma of Clod Frollo already in spring of 2007.
The objective of this analysis is to try to provide an independent evaluation of changes at Russian capital market irrespective of CalPERS opinion and evaluation, but through a system parameters and criteria described above.
In 2006 the balance of various factors reflecting the status of civil freedoms, the extent of justice and courts independence and the level of political risks was unlikely to change for the better. The Report developed by an International NGO Freedom "Status of Freedom in the World"108 in 2006 states that the situation with civil freedoms in Russia has not changed compared to 2005. According to their criteria Russia scored 5, which means it was qualified as constrained country. According to Freedom House commentary, such a low score for Russia is based on the outcomes of these NGO experts assessing the processes of electing State Duma members in 2003 and the President of the RF in 2004, of reinforcing government control over media and of developing the government/opposition interface inside the country. According to Freedom House, 45 countries were qualified Among BRIC countries China scored 6 (constrained country), Brazil scored 2 and India - 3, which means recognizing them as unconstrained.
CalPERS's methodology of evaluating the level of judicial system autonomy and of legal protection of citizens/entrepreneurs from the point of view of their impact on competitiveness of the markets is based on global competitiveness indices (GCI) of the Global Economic Forum (GEF)109. In 2006 Russia sank from the 53-th position it had been awarded in 2005 down to the 62-d position. Our country found itself behind China (54), India (43), but ahead of Bolivia (66). According to GEF, pri-
107 CalPERS Report of December 18, 2006, states that the Fund's management has made a decision to allow investment in buying stocks of companies from China and other emerging economies". Reuters Statement of December 18, 2006, extends this CalPERS decision over Chinese and Russian companies. However, no new list of markets classified as acceptable for investment has so far appeared at CalPERS website. Draft final report on capital market research outcomes by Wilshire Consulting of January 2007 (used for defining the list of acceptable markets) so far has stated both Russia and China having below 2 rating (2 is the criteria for including these markets into the list of ones allowed for investment).
108 See: www. freedomhouse. org.
109 See: www. weforum. org.
vate businesses in Russia have serious concerns about independency of judicial system and delivery of true justice. Legal aid is not fast in Russia, not is it transparent or inexpensive. Protection of property rights in Russia is very weak and continues to go worth compared to global competitive economies. Russia's rating in this area has visibly dropped over the recent 2 years: in the group of 125 countries Russia moved from position 88 (in 2004) down to position 114 (in 2006) having been ranked as one of the worst countries. GEF Chief Economist and Global Competition Studies Director Augusto Lopes-Claros stated that "special attention needs to be given to reforms aimed at improving government institutions of Russia which are not in compliance with current standards, improving judicial and legal climate, protection of property rights, anti-corruption and anti-crime efforts"110.
Corruption problems in Russia redoubled in 2006, which may be confirmed by reports of such organizations as INDEM Foundation, Global Economic Forum, World Bank, as well as Transparency International index.
The year of 2006 was the year when major state-owned corporations were attacking property rights private investors - both Russian and domestic - in various areas. According to estimates of analysts from Alpha-Bank, during the last year the share of government's interest in Russian companies increased from 29.6 up to 35.1%111. Gazprom abandoned its initial plans to engage foreign investors to developing Shtockman field; a group of foreign investors comprising Shell, Mitsubishi and Mitsui was forced to remise the controlling interest in Sakhalin-2 project to Gazprom under the threat of terminating the project because of environmental regulations incompliance. Gazprom acquired companies involved into developing one of the biggest gas fields (Yuzhno-Tabeyskoye) from businessman Yu. Bogachev. In the process of reforming energy generating industry Gazprom has become the owner of major packages of generating companies' stocks (RAO EES [United Energy Systems of Russia], Mosenergo [Moscow Energy Generating Company], OGK-1, OGK-2, OGK-4, OGK-6 and others). In early 2007 Gazprom bought controlling interest of SUEC (Siberian Coal Energy Company) producing one third of all Russian power generating coals. In 2006 it was announced that the rights to develop new off-shore fields shall be granted exclusively to state-owned companies. Private corporation TNK-BP was challenged with numerous claims on behalf of tax, law enforcing and environmental authorities in 2006; at the same time various media published information that Gazprom and Rosneft had offered to buy out the share of Russian shareholders in this integrated company112, and Gazprom expressed its interest in acquiring 75% interest in Kovykta gas condensate field (currently owned by TNK-BP). At the same time analysts noticed oil-and-gas production decrease in 2005-2006 versus 2000-2004 as a consequence of respective assets being shifted to state-owned corporations113, as well as gas shortage in domestic consumption in 2007.
110 GEF press release of September 26, 2006.
111 B. Grozovsky, Chief Owner in the Country. - "Vedomosti", February 13, 2007.
112 "Vedomosti", November 22, 2006.
113 V. Milov, The Echo of Property Redistribution. Forbes - February, 2007. - p 30. 610
Another state-owned corporation (Rosboronexport) acquired control over Av-toVAZ (Automotive Plant, manufacturer of "Ladas") and over VSMPO-Avisma corporation, the world's largest titanium producer. The same corporation started acquiring metallurgic plants (JSC Metallurgic Plant "Krasny Oktyabr", Chelyabinsk metallurgic plant) with the purpose of creating metallurgic holding for special steel manufacturing.
According to The Heritage Foundation and Dow Jones & Company, Inc. Economic freedom rating114, in 2006 Russia got only 120th position out of 157 having scored 54.01 out of maximum 100, which is below the score of 2005. Taking BRIC countries, China took 119th position (scored 54.02 балла), Brazil and India - 70th position (60.89 scores) and 104th position (55.60 scores) accordingly. The evalua-tors believe that such a low score in the area of "financial freedom" is associated with inefficiency of the banking system, gaps in banking supervision and transparency, as well as limitations for non-residents to enter banking and insurance businesses. Low rating in the area of property rights protection means that property protection is very weak in Russia, "judicial system is biased and corrupt", and in such environment it is very difficult to assure contractual obligations are fully met.
In 2006 government was not able to propose clear rules in attracting foreign investors into strategic sites in the territory of the Russian Federation. Despite the fact of Russia chairing G-8 in 2006 and active dialogue in energy security, Russia and Western countries were not able to develop a common approach to resolve this problem. Russia rejected proposals to assure incentives to attract investment into oil-and-gas exploration, production and refining based on free market principles and fair competition between private companies; instead Russia accentuated the monopoly of state-owned companies and their expansion both at domestic and foreign markets115. Lack of mutual understanding between countries exporting energy and countries consuming those resources is a serious threat to both economics and politics of all these countries including Russia.
The year of 2006 did not bring any significant changes in the area of information openness of Russian economy. Media did not gain more freedom. On the contrary, during this year a number of central media changed their owners and were acquired by loyal-to-government business groups.
A number of positive changes were noticed in the area of listing. The required minimal liquidity standards for financial instruments and minimal capitalization
114 The Heritage Foundation and Dow Jones Co. develop the economic freedom index (www. heritage. org/index) based on evaluating the level of freedom in 10 areas: economy, trade, taxation, finance, monetary policy, investment, labor relations, independence from the government, protection of property rights and independency from corruption. Based on the final evaluation all counties are divided into 5 groups: free countries (80-100 scores), mostly free countries (70-79.9 scores), partially free countries (60-69.9 scores), mostly non-free countries (50-59.9 scores), non-free countries (0-49.9 scores).
115 On February 14, 2007, the 6-month FRS Report to the USA Congress stated, that one of the key reasons for global oil prices to stay at the high level was "limited investment in energy sector on behalf of international oil companies in some countries including Russia and Venezuela due to increased level of government control over the energy sector" (www. online. wsj. com).
standards for securities were strengthened, as well as minimum standards for the issuers with regards to the term of being in business operations to be qualified for listings, as well as standards of strengthening the role of exchanges in controlling corporate governance compliance on behalf of issuers. However, low level of Free Float of Russian issuers (the portion of freely circulating stocks) still constitutes a serious problem when Russian companies are listed at Russian stock exchanges. According to effective securities regulations and exchanges rules, the issuers included into quotation lists A1 and A2 need to have at least 25% Free Float, as for level B list, this requirement has been reduced down to 10%. Shares with low Free Float are to a greater extent exposed to price manipulations and are more volatile, which creates additional risks for investors. The problem is that out of 306 issues of stocks allowed for circulation at MICEX (Moscow Inter-Bank Currency Exchange) as of the end of 2006, only 16 were included into quotation list A1, and only 11 -into list A2. Thus, according to exchange listing requirements only every tenth of the companies offering their stocks should follow the minimum Free Float standards.
In 2006 Russia did not demonstrate sufficient progress in application of International Financial Reporting Standards (IFRS). Evaluation by CalPERS is based on the opinion of eStandardsforum and takes into account the fact that in July 2004 the respective authorized government body - the RF Ministry of Finance - stated that within the Accounting and Reporting Mid-Term Development Concept for the period 2004-2010 Russian companies shall be switching to IFRS on a mass scale. According to the above mentioned Concept, application of IFRS during preparation of consolidated financial reports by "business entities of public value" shall become mandatory in 2004-2007 (under "business entities of public value" joint-stock companies with publicly offered or floating shares are understood). Thus, the Ministry meant practically all companies with shares floating at stock exchanges. However, lack of law enforcement mechanisms does not allow for successful achievement of the set target.
Unfortunately, there are no recognized statistical data about the number of Russian JSCs using IFRS. According to our evaluation, the number of companies using IFRS is still significantly below the target level, and does not match the needs of not only foreign, but also of Russian domestic institutional investors. Thus, according to our estimates, the round of issues by Russian companies with interest of Russian mutual investment funds (MIFs) constitutes about 450-500 issues. And only on 200-250 issues the issuers provide reporting according to IFRS (less than in 50% of the cases). This is an evidence of the fact that in many instances investment into Russian companies' shares is often done at random (blindly), without sufficient level of investment strategy formalization. It is impossible to adequately evaluate the shares (from the point of view of their growth) issued by the companies which do not follow IFRS. Financial indices to classify companies' shares and investment funds portfolios may be calculated only on the basis of IFRS (e. g., according to the investment styles table - growth stock, value, combined). This may be of great significance for investors to gain awareness about profitability versus
risk with regards to different assets. Eventually even Russian domestic institutional and retail investors are forced to "fly without navigation equipment" (if we are to use aviation terminology), without adequately positioning themselves with regards to subjects of investment. It's not difficult to imagine what may be the result of such flights.
The stock exchanges capabilities are not fully employed in the process of promoting IFRS among Russian companies. According to the existing listing rules such reporting is required only for the companies of A1 and A2 categories. It actually means that only every tenth company entering the market is obliged to apply IFRS.
Thus, in 2006 institutional problems underpinning Russian capital market maintained and even redoubled. What does it mean for foreign and Russian investors? The key point is that the foundation for quantitative growth of financial market, its scale, debt instruments and liquidity level becomes more and more unsteady. Capitalization growth of major state-owned corporations is taking place at the expense of acquiring new assets on exclusive terms, but it is not accompanied by improving the efficiency of utilized assets/resources. Major corporations become the elements of government policy; their decisions can be less and less forecasted. Practically, there is no system of independent control on behalf of investors and civil society over the efficiency of managerial decisions in economics and finance. All this increases the systemic crises exposure for capital markets and creates the pre-requisites for violation of investors' rights.
5.4.3. Institutional and Structural Disparities and Growth Factors
The problems of investment climate in Russia in 2006 were surprisingly combined with high yield of Russian companies' shares, heavy growth of capitalization and liquidity of stock exchange market. It's been the second year in a row, which is a very rare event that Russian stock markets remain global leaders with regards to their growth rates (see Figure 1).
In 2006 RTS index increased by 70.83% vs. the end of 2005, the incremental growth of MICEX and MSCI-Russia indices was 67.5% and 52.9% respectively. Only Peru, Venezuela, Cyprus and China performed better as for stock indices. The profitability index of RTS was 2.5 times above the index of MSCI-emerging economies. Growth of stock yield in Russia was accompanied by significant strengthening of Ruble: by 8.5% vs. USD. This became another "plus' of Russian capital market for American and global investors.
Source: WFE (World Federation of Exchanges) data; WSJ publication data.
Figure. 1. Incremental growth of stock indices (%, December 2006 vs.
December 2005)
The growth of stock market liquidity caused noticeable growth of Russian companies capitalization and of stock prices volatility dynamics, as is shown in Figure 2.
o.(mh
Capitalization
Slock trading volumes at Russian exchange
Volatility (mean-square deviation ot RTS index profitability per day)
597 0,035
0,050
factor
0.030
0.025
0,020
0.015
o.oio
2002
2004
2005
Source: data by RosBusinessConsulting and Russian exchanges.
Figure 2. Capitalization, Liquidity and Volatility of Russian Stock Market
In 2006 capitalization of Russian companies grew from $472 bln up to $908 bln, i.e., 1.9 times; the stock trading volume at MICEX, RTS and St.-Petersburg increased from $180.2 bln up to $597.0 bln, i.e., 3.3 times. The mean-square deviation of RTS index per day, which reflects the volatility of "blue chips" prices, grew in 2006 and made 0.02 vs. 0.013 in 2005 meaning the risks of investment into stock increased by 1.5 times.
As per capitalization size Russian stock exchanges improved their position from 19 up to 15, leaving behind the markets of Korea Republic, India, Brazil and Taiwan (see Figure 3).
Source: WFE (World Federation of Exchanges) data; WSJ publication data.
Figure 3. Capitalization of 2006, USD bln
Russian companies' capitalization in 2006 made circa $908 bln, which reflects Russia's position as one of the biggest emerging markets. Only China was ahead of Russia as per this index.
The exchange market liquidity indicators growth rate exceeded that of capitalization in 2006. The global position of Russian capital market as per this criterion is presented in Figure 4.
Comment. * Russian data include indices of RTS and MICEX.
Source: WFE (World Federation of Exchanges) data; MICEX and RTS data.
Figure 4. Exchange Trading of Shares in 2006*, USD bln remove USD bln from the picture
The volume of stock trading in Russia reached $597 bln in 2006 vs. $180 bln in 2005, i. e. demonstrated 3.3 times growth. Compared to other emerging markets, Russia has given way only to China with regards to this indicator (similar to capitalization). However, Russia's breakaway from global markets with regards to liquidity has not become any more visible. Despite significant growth of quantitative indicators of Russian exchanges' liquidity in 2006, globalization of various international exchanges has become another serious challenge. NYSE and Euronext (leader of European term contracts and bonds market) integration is currently in its final phase, Tokyo Stock Exchange and Indian National Exchange are ready to join the alliance - all this symbolizes the beginning of the process of starting new global markets for stock, derivatives and other financial instruments. Market exchanges of Nordic countries have united into OMX. China has developed coordinated market exchange strategy oriented towards global interests in cooperation with Hong Kong, Beijing and Shanghai stock exchanges. Unfortunately, Russian exchanges are currently limited by domestic market only and are not undertaking any noticeable steps within the framework of world trading globalization. In a just a few years any national stock exchange, even a major one, is unlikely to be competitive enough compared to global exchanges from the point of view of traded instru-
ments, accessibility to different investors' resources, diversity of trading strategies and other parameters.
A visible increase of stock turnover rate has become a positive factor of Russian capital market in 2006. International practice of calculating this index is based on dividing average monthly stock exchange turnover by the total amount of market capitalization (see Figure 5).
Comment. * Russian data include indices of RTS and MICEX.
Source: WFE (World Federation of Exchanges) data; MICEX and RTS data.
Figure 5. Stock Turnover Rate in 2006, % remove second title
Russian stock turnover rate in 2006 made c. 5.5% vs. 3.2% in 2005. Russia is holding a mid-level position compared to other countries and visibly behind the leading markets, which is a clear evidence of a low level of Free Float for the shares of Russian issuers.
2006 provided for continuation of the 2005 trend for strengthening Russian capital market position with regards to stock and depositary receipts of Russian issuers, which is reflected in Figure 6.
Source: stock exchanges data (without NYSE).
Figure 6. Exchanges Share in Trading Russian Stock
In 2006 LSE share decreased from 45.9% down to 30.3% in the overall trading of Russian stocks and depositary receipts; MICEX (Moscow Inter-Bank Currency Exchange) share during the same period grew from 40.6% up to 62.0%; the aggregate share of RTS exchanges fell from 10.0% down to 5.6%. In 2006 Gazprom shares liquidity center was moved from RTS to MICEX. This has seriously knocked the bottom out of RTS position at spot stock exchange.
The term market growth continued in 2006, which is reflected by the data in Figure 7.
In 2006 trading volumes at Russian stock exchange markets made: for futures - $88.8 bln, for options - $11.5 bln, which meant exceeding the level of 2005 by 4.1 and 4.6 times accordingly. London Stock Exchange and Germany Stock exchanges announced their plans for establishing Russian term depositary receipts market during the current year.
Source: RTS data.
Figure 7. Trading Volumes and Number of Deals at RTS Term Market from September 1, 2001, to December 29, 2006
*GKO: State Treasury Bills **OFZ: Federal Loan Bonds ***GSO: State Savings Bonds
Source: data provided by RF Ministry of Finance, CBonds and Stock Exchanges.
Figure 8. Bonds Secondary Market, Trading at MICEX
Simultaneously with stock market growth 2006 displayed domestic bonds market growth. As shown in Figures 8 and 9, the secondary bonds market turnover and bonds trading volumes u overtopped T-bills (State Treasury Bills) market of 1996-1997 by a number of times.
Volumes of bonds trading at the exchanges in 2006 exceeded the maximum State Treasury Bills market liquidity (set in 1997) 6 times. During this year the volumes of trading corporate bonds at the secondary market (through exchanges) increased 2.9 times, regional and federal bonds trading - 1.7 and 1.1 times respectively. And the fact of most bonds issues having negative effective yield was not at all a barrier for their liquidity growth for their floating. This fact may be explained by banks and non-residents being major participants of this market - those who have enough capacity for using various speculative strategies to cover their potential losses from "passive" ownership of such securities116. Incremental liquidity flow into the Ruble bonds market will allow the issuers to successfully float new issues of bonds (Figure 9).
N00
700
600
2 500 a!
400 300 200 100
1993 1994 1995 1996 1997 1998 1999 20(h) 2001 2002 2003 2004 20(15 2006
□ G KO* -O PZ ** -GSO* * * ■ Regional bonds □ Corporate bonds
*State Treasury Bills **Federal Loan Bonds ***State Savings Bonds
Source: data provided by RF Ministry of Finance, CBonds and Stock Exchanges.
Figure 9. Volume of Bonds Float
The volume of bonds float in 2006 grew less than the respective secondary market turnover. Corporate bonds became the driving force for issues at debt mar-
116 One of the most popular strategy globally (including Russia) is «carry trade» - the one that stipulates, borrowing at low interest rates, possibly - in currency the value of which is going down, with the purpose of further investing those funds into financial assets with higher yield (e. g., bonds nominated in Rubles). 620
ket, their float volumes grew from RUR 260.6 bln in 2005 up to RUR 465.3 bln in 2006, i. e. 1.8 times. The amount of regional bonds issue in 2006 decreased down to RUR 51.7 bln compared to RUR 56.8 bln in 2005, i. e., by 9.9%. The overall amount of issues of Federal Loan Bonds and State Savings Bonds in 2006 made RUR 237.6 bln vs. RUR 167.2 bln in the preceding year, i. e., grew by 42.1%. Availability of sustainable revenue base for both federal and regional budgets makes government less interested in borrowing. However, contrary to the situation with the regional bonds, Federal Loan Bonds and State Savings Bonds are the key asset for investing the reserves of the RF Pension Fund (the part that is targeted at funding the financial defined contributions being managed by Vnesheconombank. Because of that the RF Ministry of Finance is forced to build up issues of government bonds even when federal budget has a surplus.
The overall amount of Rubles-valuated bonds, including federal securities, corporate and regional bonds, grew from RUR 1.5 trillion in 2005 up to RUR 2.2 trillion in 2006, i. e., 1.4 times.
Thus, despite serious problems in institutional sphere and with investment climate, Russian capital market is still of interest for foreign investors because of its yield and explosive growth of its quantitative parameters (liquidity, capitalization, capacity). However, this growth of quantitative parameters will not directly impact the score of Russia calculated based on CalPERS Methodology in 2007, because this score with regards to quantitative parameters is already the highest possible (3).
As it was shown in 2005 overview by the Institute of Economy in Transition, Russia still lacks transparency of information about financial market growth factors. Contrary to many countries, for some unknown reasons there aren't any financial accounts statistics in Russia (which would allow for accurate registration of the level of various investors categories' participation in Russian-issued securities). In such environment only indirect data may serve the basis for analyzing the level of impact various factors might have on capital market development.
Role of foreign investment at Russian capital market
2006 growth of stock market was based on heavy commercial activity by nonresidents, Russian public and domestic institutional investors. The non-residents dominated, just like in 2005. For them Russian capital market was attractive not only because of extremely high returns for investment into securities, but also because of such factors as stable macro-economic situation in the country in general due to high prices for exported raw materials, liberalization of Gazprom shares market, strengthening of Ruble versus US Dollar, cancellation of limitations stipulated in currency regulations and control framework, excessive liquidity of the global markets due to low interest rates. The impact of external factor on Russian capital market is represented in Figure 10.
Source: Balance of Payments of the Russian Federation.
Figure. 10. Net Import (+) / Export (-) of Capital into/from Russia, USD mln
2006 demonstrated unprecedented inflow of foreign capital into Russia. The demand for Russian companies' stocks on behalf of non-residents during the first 9 months of 2006 increased: net direct foreign investment - by $11.1 bln; portfolio investment - by $11.5 bln. Major investment flow from hedging funds and direct investment funds falls under the category of direct foreign investment, so this group of investment in Russia does not differ much from portfolio investment.
Increased influence of non-residents at MICEX stock exchange (constituting more than 95% of Russian exchanges turnover) is shown in Figure 11.
In 2006 the non-residents' share in the total value of sales-and-purchase transactions at MICEX stock exchange reached 25.4% exceeding the share of individual private investors (22.9%). The most noticeable increase of non-residents' participation at MICEX falls on the period starting from the date of canceling the limitations on transactions with the stocks of non-residents(previously established within the currency control and regulation framework).
It is necessary to state here that practically the role of non-residents in the transactions with Russian companies' stocks in the territory of Russia is even bigger. The thing is, many major brokers and banks purchase stocks at MICEX in their own names for further re-selling them to non-residents through off-shoe companies117. Such re-selling is normally qualified as deals beyond the stock exchanges, and their share in the market makes up to 20-30% of the stock exchange turnover
117 As it has been stated above, because of imperfectness of Russian tax regulations and some other factors, non-residents prefer to own stocks of Russian companies indirectly, i. e. - through offshore zones. 622
of shares. Non-residents themselves sell stocks also outside the stock exchanges. Taking this into account, we estimate the share of non-residents' participation in Russian stock exchange as almost 50%.
• - Transactions by individuals —O— Transactions by non -residents
Source: calculated based on MICEX stock exchange data.
Figure 11. Individuals' and Non-Residents' Share in Stocks Transactions at MICEX, %
The problem of Russian stock exchange market from the point of view of foreign portfolio investors' participation is that it so far has not yet become the key investment site for major global investment and pension funds focused at foreign retail investment. The funds specializing in Russia are usually low-capitalized ones, and most of them have a status of either hedging funds or funds focused on dealing with qualified investors (e.g., Hermitage Fund or funds managed by JPMorgan Fleming). According to the RF Statistics Agency, off-shore zones (Luxembourg, Cyprus, Virgin Islands and Cayman Islands) in 2006 accounted for 40% of accumulated foreign investment into Russia.
According to EmerginPortfolio.com, the value of portfolio funds' investment into Russia made c. $10 bln as of the beginning of 2006. Table. 17 represents the profile of foreign funds investing into Russian companies' securities.
Global investment funds specializing in emerging markets in Europe, as well as global funds of emerging markets are key investors for Russian JSCs. Investment funds registered in Luxembourg are dominating as for investment into Russia (they account for 47% of foreign portfolio investment into Russian companies' stocks), the funds registered in the USA account for 23%, Ireland - 8%, Austria -7%, and Cayman Islands - 2% 8. Almost 60% of assets are funds set up in offshore zones (Luxembourg, Ireland, Cayman Islands and Guernsey).
Table 17
Foreign Portfolio Investment Profile with regards to Russian Companies Stocks as of the beginning of 2006, %
Areas of specialization of global investment funds
Country of registration of global investment fund Global funds of emerging markets European emerging markets Europe, Far East and Africa International markets Total
Austria 10.8 6.8
Belgium 0.1 0.4 0.3
Bermudas 0.0 0.0
Canada 0.2 0.1
Denmark 1.1 0.7
France 1.9 1.9 1.8
Guernsey 2.7 0.0 0.9
Ireland 3.5 11.2 0.3 8.2
Jersey 0.4 0.0 0.1
Luxembourg 31.8 56.9 100.0 46.6
Switzerland 1.0 1.5 1.3
UK 9.2 4.8 0.4 6.0
USA 49.3 4.7 99.6 23.0
Cayman Islands 3.0 1.9
Finland 1.3 0.8
The Netherlands 0.7 0.5
Sweden 1.7 1.1
Total 100.0 100.0 100.0 100.0 100.0
Source: www.EmerginPortfolio.com.
These funds make package-based investments into emerging markets seeking to diversify their portfolios between different countries irrespective of macro-economic situations they are in. The fact that emerging markets are very attractive in general for investment dominates over characteristic features of any specific market, country-based approach usually dominates over the industry-based one118.
This domination of country-based portfolio strategy among foreign investors coming to Russia has a negative impact on the quality profile of the market for Russian companies' stocks, because it creates a phenomenon of simultaneous deviations of their prices irrespective of financial accounts of the companies themselves. This is reflected in the fact that Beta coefficients are close to 1 for most of the "blue chips", which characterizes the level of returns on investment into various securities dependent on stock exchange profitability indices. Table. 18 presents Beta coefficients for 15 issues with the biggest liquidity from MICEX list.
118 Brooks R., Del Negro M. The Rise in Co movement across National Stock Markets: Market Integration or IT Bubble. Federal Reserve Bank of Atlanta. - Working Paper 2002-17a, September, 2002. 624
Table 18
Beta Coefficients for Russian "Blue Chips" in 2003-2006
Beta Coefficients
2003 2004 2005 2006 2003-2006
Aeroflot (ao) 0.Б7 0.2Б 0.46 0.40 0.40
AvtoVAZ (ao) 0,64 0,52 0,40 0.76 0.62
RAO EES (United Energy Systems) 1.14 1.00 0.98 1.07 1.06
RAO EES (United Energy Systems) 0.9Б 1.00 0.86 0.99 0.97
Norilsk Nickel (ao) 0.87 1.19 1.04 1.06 1.05
LUKoil (ao) 0.91 0.86 1.03 0.98 0.94
Mosenergo (ao) 1.04 0.66 1.28 0.48 0.78
Rostelekom (ао) 0.98 0.82 0.87 0.6Б 0.81
Sberbank (RF Savings Bank) 0.7Б 0.71 0.79 1.07 0.8Б
Сберегательный банк РФ 0.Б4 0.60 0.99 1.00 0.78
Gazpromneft (former Sibneft) (ао) 1 .29 0.8Б 0.91 0.73 0.91
Surgutneftegas 1.22 0.90 1.13 1.21 1.11
Surgutneftegas 0.97 0.70 0.97 1.11 0.94
Tatneft (ао) 0.77 0.80 1 .32 1.12 0.97
Gazprom (ао) 0.7Б 0.6Б 0.71 1.03 0.81
Mean value 0.89 0.77 0.92 0.91 0.87
Standard deviation 0.23 0.23 0.26 0.25 0.18
Source: Russian stock exchanges data
For most of the issues Beta coefficients are close to 1, which is an evidence of high correlation between changes of their prices with MICEX profitability index. The average Beta coefficient for all issues of stocks made 0.92 in 2005 and 0.91 in 2006, which reflects the domination of synchronized dynamics of "blue chips" prices at Russian stock exchange119.
The synchronized dynamics of stocks does not only impede institutional investors and the public from using the advantages of portfolio justification at the domestic market, but also reflects the problems of management efficiency in major corporations. Portfolio theory evaluates the efficiency of managers through Alpha coefficient reflecting the deviation of actual profitability of portfolio from its potential profitability under the pre-set profitability of the basic portfolio (e.g., index) and Beta of the given portfolio. Table 19 represents application of this approach to evaluation of management efficiency in Russian companies.
119 It will be fair to emphasize that a number of analysts (e. g., A. Vernikov from "Anton-Line"), state that in early 2006 the trend of gradual destruction of synchronized stocks dynamics became noticeable, which is related with emerging new generators of the market growth represented by energy companies and banks (commentary in Quote. ru of January 29, 2007).
Table 19
Alpha Coefficients for Russian "Blue Chips" in 2003-2006
Alpha Coefficients
2003 2004 2005 2006 2003-2006
Aeroflot (ao) 0.13 0.22 -0.06 0.06 0.10
AvtoVAZ (ao) -0.07 -0.01 0.03 0.06 -0.01
RAO EES (United Energy Systems) RAO EES (United Energy Systems) 0.,05 -0.05 -0.06 0.12 0.02
0.12 -0.05 -0.04 0.15 0.04
Norilsk Nickel (ao) 0.27 -0.13 -0.04 -0.04 0.01
LUKoil (ao) -0.05 0.06 0.04 -0.09 0.00
Mosenergo (ao) 0.07 0.25 -0.31 0.00 0.03
Rostelekom (ао) -0.01 -0.09 -0.11 0.31 0.03
Sberbank (RF Savings Bank) -0.06 0.22 0.21 0.11 0.12
Сберегательный банк РФ 0.05 0.10 0.37 0.12 0.17
Gazpromneft (former Sibneft) (ао) -0.18 -0.02 -0.12 -0.11 -0.10
Surgutneftegas -0.02 0.05 -0.11 -0.15 -0.05
Surgutneftegas -0.04 0.09 -0.02 -0.17 -0.02
Tatneft (ао) -0.04 0.07 0.02 -0.13 0.00
Gazprom (ао) 0.03 0.26 0.21 -0.04 0.12
Mean value 0.02 0.06 0.00 0.01 0.03
Standard deviation 0.11 0.13 0.16 0.14 0.07
Source: Russian stock exchanges data
The average Alpha coefficient for 15 major companies in 2005-2006 was 0, which shows lack of their management's contribution into deviation of their stocks prices dynamics from index (the average market indicator). In 2006 several companies (Norilsky Nickel, LUKoil, Gazpromneft, Surgutneftegaz, Tatneft and Gazprom) had negative Alpha coefficient.
Interaction between stock exchange and banking system During 11 months of 2006 banks increased their investments into stocks by RUR 65.6 bln (or $2.4 bln), which is a pretty modest figure in the context of growth of capitalization and capital market liquidity. At the same time the gap between the level of capital market development and banking system potential continued to grow. Figure 12 represents the data about the share of bank loans, capitalization and direct foreign investment in Russian GDP u.
In 2006 the capitalization share in GDP increased up to 92.7% vs. 61.5% in the previous year. This was the year when Russia became one of the world leaders with regards to direct foreign investment. In this context the share of bank loans in GDP after having decreased in 2005 from 25.9% down to 20.6% in 2005 remained practically on the same level. The gap between capitalization and internal loans indicators is an evidence of serious disparity between the level of banking system development and growth dynamics of Russian companies.
Source: data received from Central Bank of Russia, Statistical Agency of Russia, World Bank and UN Conference on Trade.
Figure 12. Share of bank loans, direct foreign investment and capitalization in GDP of the Russian Federation, %
Growth of external debt of Russian companies
Lack of internal credit resources forced the banks and non-financial companies to borrow internationally. The banks were much more active in doing that, than non-financial companies. This led to significant changes of external debt of Russia and Russian companies in 2006 (see Figure 13).
135,4
□ Government bodies □ Monetary regulators
n Banks : 7] Noil - ' i:i. i-■.!.■ nnoi!.-
Source: data provided by the
Figure 13. Foreign Debt of the Russian Federation in 1999-2006, USD bln
In 2006 external debt of non-financial companies and commercial banks made $135.4 bln and $78.5 bln respectively. During one year the debt of non-financial companies increased by 8.4%, of banks - by 56.7%, i.e., the debt of banks was growing much faster than external debt of non-financial companies. As a result in 2006 serious disparities in the banking system assets and liabilities profile continued to build-up, which is reflected in Figure 14.
I-1 Exuess I ■ ). shortage (-) of foreign as-sets vs. laibilitics
-o- Deviation or USD nominal cxchangc rate
Source: calculations based on data provided by the Central Bank of Russia.
Figure 14. Excess (+) and shortage (-) of banks' foreign assets vs. liabilities (share, % of the value of assets / liabilities)
In 2006 foreign liabilities of Russian banks significantly exceeded the share of respective assets. That resulted from the banks implementing their strategy targeted at facilitated formation of their liabilities in foreign currency and their further re-investment into Ruble assets. For banks this policy is risky because in case of serious fall of Ruble, decrease of Ruble assets profitability or appreciation of foreign currency borrowing the banks may face the liquidity problem. The misbalance between foreign currency assets and liabilities of the banks was one of the main reason for 1998 crisis of major Russian banks in the conditions of abrupt devaluation of Ruble. In 2006 the misbalance between assets and liabilities of the banks exceeds the scale of similar misbalance before 1998 crisis. In 1997 it constituted 5.0% of the value of banks' assets (liabilities), and in 2006 it reached the level of 7.7%. This is an evidence of increasing risks associated with banks liquidity and of vulnerability of their financial status in case external factors change significantly at both foreign currency and credit markets.
Low level oof savings of the population in securities
As was shown in Figure 11, the share of individual citizens in stock exchange transactions at MICEX in 2006 was 20% (as for the total value). The public is one of the main drivers of e-commerce, the citizens are actively employing the possibilities of marginal debt financing to increase profitability and scale of capital market transactions. According to MICEX, the number of individual market players at the
end of 2006 made 250 thou persons, which exceeded the level of the beginning of the year 2.5 times.
However, the statistics of individual private investment into securities during 11 months of 2006 reflected in Figure 15 show that the public's contribution into capital market development was pretty modest in 2006.
D"And-savings" (loans)
I b 14 12 IU
I
53
«
4
2 0
-2
-4
-5,3
-6
Source: calculations based on data provided by the Central Bank of Russia and by Federal Statistics Agency.
Figure15. Public inclination towards savings 1997-2006
The share of citizens' income invested into securities in made 0.6% - 3 times below the level of 1998 (prior to the crisis). According to the RF Statistics Agency, the increment of net citizens' investment into securities in 2006 reached RUR 87.3 bln ($3.2 bln), which is 1/3 more than in the preceding year. Individual savings in securities in 2006 exceeded the increment of banks' assets in the form of stocks, however, in the context of annual capitalization increment in the amount of $426 bln and liquidity of stock exchange increment in the amount of $397 bln, these savings look pretty modest. The overall value of securities accumulated by the public in 2006 reached $20 bln.
It is also necessary to note that the preliminary 2006 data represented in Figure 15 show two negative trends with regards to the public inclination towards investing in financial assets in 2006: the indicator of the overall inclination towards savings fell from 11.7% of total revenues in 2005 down to 8.0% of income in 2006; at the same time the overall citizens' debt on bank loans, increased significantly in
11.2
1,7
4,2
1997 -0,3
Gl Foreign cash
□ R L R tash
□ Russian companies securities
I Foreign currency Je posits ill banks
□ < I !\ deposits in banks
4.6 M
1,7
l.i
1.*
H
I99N -0,3
.¡■,3 ■
2Y
1999 -0,3
1,6
2,fi
.«
+ 2,3*-
2000 _ -0,4
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]
2.0
+ 2.7+
2001 -0^9
|
!,8
Q.H
2002 --0,7
1.0
2.7
' t),K '
" 4.7+
2003
-1,8
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IJ
.0.7
£6
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-2,9
4,1
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2006 and reached 5.3% of individuals' income - practically equal to the amount of bank deposits in Rubles.
Heavy growth of capital market, attracting resources by way of corporate bonds float and IPO of shares in an ideal situation should promote the growth of investment and economic upswing. However, in order to make this correlation work, the investment attracted by companies through capital market need to become real investment, i.e., be utilized for creating new production capacity, fixed assets and production reserve. Emphasizing this kind of correlation between investment and economic growth, the Nobel Prize winner in economics neo-Keynesian P. Samuelson marked that "investment are materialized only in case real capital is created"120. In other words, fixed assets are real generators of economic growth.
With this regards, the puzzle of Russian capital market with its heavy growth of IPO and of corporate bonds float in 2005-2006 is in the fact that all this does not lead to real capital growth. Figures 16 and 17 show consolidated data on capitalization, liquidity and issue of Russian companies stocks and corporate bonds.
Note. * Evaluation takes into consideration 2006 market exchanges data and Russian Statistics Agency Report for 9 months of 2006.
Figure16. Russian Companies Equity Securities Market Parameters in 2006*
120 Paul E. Samuelson, William D. Nordhaus, Economics: translated from English.: 16th edition. "Williams" publishers, 2005. - p. 389. 630
Note. * Evaluation takes into consideration 2006 market exchanges data and Russian Statistics Agency Report for 9 months of 2006.
Figure 17. RUR Corporate Bonds Market Parameters in 2006*
In 2006 within the framework of IPO Russian companies attracted about $17 bln, and by floating their Ruble bonds - another c. $17 bln. According to the RF Statistics Agency, only $2.5 bln out of $17 bln received from floating stock (14.7% of the raised funds) were invested into fixed assets. The statistics about utilizing $17 bln received from floating corporate bonds is even more paradoxical. Only $60 MM out of this amount (0.4%!) was used to increase fixed assets. Of course, it is possible to refer to the inaccuracy of official statistics data, however, overall it is unlikely to change in any way the key conclusion: the funds received from issuing stocks and bonds are not re-invested into fixed capital, respectively - they do not have any impact on the economic growth.
One can speculate on the areas in which these resources are used. The major flow might be spent on re-financing of debt and acquisition of assets from their effective owners. The processes currently taking place at Russian capital market are similar to those in the USA in late 1980-s when LBO (leverage-buy-out) deals were funded at the expense of issuing junk bonds and IPO. The essence of such deals was massive borrowing at capital market using credit facilities to buy companies and acquire their assets. The key risk in such type of deals is poor efficiency of the acquired companies which may turn out insufficient to pay out the debt incurred to buy these companies. In the US the junk bonds market was finished with a loud collapse of the borrowers in 1989.
* * *
Thus, the "Clod Frollo dilemma" which foreign investors are currently facing when deciding about investment into Russian securities may be worded in brief. During the last several years Russian capital market has demonstrated remarkable
results as gper its profitability, liquidity and capitalization growth. This cannot be left without attention of the investors making them pretty excited. However, each time they need to make their decision about investment, they need to understand that when buying financial instruments from Russian issuers they are not acquiring managerial talent and skills, but the capacity of the government to assure high proceeds of the corporations it controls due to speculative demand for energy and other primary resources. At the same time the growth of securities' yield is often heated by new liquidity supply rather than by improving efficiency of the corporations' activities.
There are two ways out of such situation for major investors. One is an optimistic scenario. It stipulates transformation of the share of foreign strategic and portfolio investors in Russian-issued stocks and bonds into a positive corporate governance model, which eventually will facilitate establishing fair market competition in Russian economy. The second scenario is a pessimistic one and implies repetition of the LTCM story.
Another interesting question is about the decision CalPERS fund needs to make in Mart-April of 2007: whether to invest or not in Russian-issued securities? Our assumption is they will authorize investment at Russian capital exchange. This could have become an important positive sigh when Russia's overall perspective as an emerging market is being evaluated. After all, Clod Frollo could not resist Esmeralda's beauty.
5.5. The Housing Market
Last year, the housing market was advancing against a fairly favorable background formed by the country's positive socio-economic development.
The macroeconomic situation in Russia was influenced by deceleration of inflation rates, predictability of the RUR exchange rate, a continuous de-dollarization of the economy, solidification of the national budgetary system, and high growth rates of GDP. Last year, the advancement of the economy on the whole and the real estate market in particular was fueled by high oil prices, while the private sector boasted a record-breaking value of the indicator of net import of capital.
The above processes were complemented by a vigorous advancement of the stock market and the market for mutual investments, which also had a certain effect on the housing market. With the USD exchange rate depreciating, interest rates on bank deposits low, while investment in real estate (including share participation) remaining risky and inaccessible, quite a great part of the population transformed their savings in securities and became participants in mutual investment funds (MIFs).
This novelty was also steered by growth in the number of IPOs, which became fashionable among large companies with a government stake in them (such as Rosneft in 2006 and Sberbank and Vneshtorgbank 2007). They attracted quite a fraction of the population's savings, which otherwise potentially would be spent on housing. Evidently, individuals, as a rule, are keen to maintain a conservative, low-
interest strategy, which manifests itself in a direct (thus bypassing intermediaries and mutual investors) ownership of a stake in a company with the dominating government participation, which they regard as an additional safeguard for their investments.
By contrast to the stock market, the one for mutual investments is partially related to the housing. According to the National League of Managers, as of October 2006, there were as many as 610 MIFs in Russia, which attracted 300,000 private investors. The total volume of their assets accounted for RUR 404.9 bln., of which 64.9 bln (16%) falls on closed-end mutual investment funds which, since their rise in 2003, have channeled their funds to real estate, including housing121. The number of the closed-end mutual investment funds doubles annually. According to the data on the ten months of 2006, of 158 MIFs registered since the start of the year most were CEMIF, though in terms of cash inflow rates they somewhat lagged behind regular MIFs. The average size of a CEMIF tends to decline (RUR 634m. as of the end of the 3rd quarter 2006, while that of a regular one tends to grow (RUR 266m., as of the same date)122. The threshold to enter a CEMIF has been decreased, which makes them more accessible for private individuals.
The profitability rate of CEMIfs depends on their profile and relevant risks. It is leasing funds that operate in the area of real estate lease that reported the least profitability rates. By contrast, development and construction funds that build housing using attracted private resources boast a far greater return rate, while mortgage funds that operate with such instruments as encumbrances continue to hold their specific niche on the market. Interestingly, the "Mortgage Loan Housing Agency" has also started operations with encumbrances. So, being connected with the housing market, CEMIFs can become its competitors, thus diverting funds from the main segment of actual deals in the natural form. Hence, the factor of development of the financial markets (in a broad sense) should be undoubtedly taken into account while estimating prospects for development of the housing market over the years to come.
The current stability of the macroeconomic parameters has given a positive signal to operators and consumers on the real estate market.
5.5.1. Overall situation on the housing market and price dynamics in 2005-2006
The data of Table 20 can form a general characteristic of the situation on the housing market. The Table provides average offer prices for apartments in Russian cities in late- 2004, 2005 and 2006 (in USD equivalent), calculated on the basis of the data supplied by certified by the Russian Realtor Guild analysts of the real estate market123.
121 Krol N. Investor spit, a denezhki idut. Kvartirny ryad, 1-7 February 2007, # 4 (627) p. 10
122 Udvoyenie PIFov//CNIP. Stroitelstvo, Nedvizhimost, Investotsii, Proekty, # 02 (02), December 2006, p. 67
123 Computations were made on the basis of the data provided by G. Sternik and the noted certified by RRG analysts of the real estate market, including: A.Beketov, A. Sapozhnikov (independent ana-
Table 20
The Dynamics of the Average Offer Price for Apartments in 2004-2006
$/sq.m. Index
December December December
City (region) December December December 2005 / 2006/ 2006 /
2004 2005. 2006 December December December
2004 2005 2004
Moscow 1953 2658 4828 1.361 1.816 2.472
S. Petersburg 1083 1180 2593 1.090 2.197 2.394
Moscow oblast 908 1121 2522 1.235 2.250 2.778
Ekaterinburg 882 1062 2415 1.204 2.274 2.738
Ufa 766 997 2074 1.302 2.080 2.708
Izhevsk - - 1837 - - -
Novosibirsk 748 1012 1658 1.353 1.638 2.216
N. Novgorod 579 720 1650 1.243 2.292 2.850
Tymen - 864 1600 - 1.852 -
Rostov-on-Don 656 861 1550 1.313 1.800 2.363
Perm 680 882 1430 1.297 1.621 2.102
Tver 542 688 1370 1.269 1.991 2.527
Omsk 518 676 955 1.305 1.413 1.844
Penza - 543 890 - 1.639 -
Ulyanovsk 405 486 859 1.20 1.768 2.121
Shakhty (Rostov oblast) - - 480 - - -
Towns in Moscow oblast
Khimki 1237 1589 3254 1.285 2.047 2.630
Odintsovo 1128 1474 3228 1.307 2.190 2.862
Krasnogorsk 1050 1365 3071 1.300 2.250 2.925
Podolsk 832 1081 2461 1.299 2.276 2.957
Ramenskoye 753 979 2215 1.300 2.263 2.942
Solnechnogorsk 697 902 1922 1.294 2.131 2.757
Naro-Fominsk 705 843 1901 1.196 2.255 2.696
Serpukhov 571 695 1317 1.217 1.895 2.306
Mozhaysk 486 604 1110 1.243 1.838 2.284
Quite predictably, it was the capital regions (the city of Moscow, Moscow oblast and S. Petersburg) that were leaders between 2005 and 2006 in terms of absolute prices for housing prices, with Ekaterinburg following them closely. The leading group was followed by regional centers and towns located in Moscow oblast, where leaders were the towns in the closest proximity to Moscow (Khimki, Odintsovo, Krasnogorsk). In these towns, the Dec. 2004 price level (over USD 1,000/sq.m.) was already greater than the average one across the region, and it consequently overrun the price level of S. Petersburg in late-2005 and 2006.
In 2005 it was only Moscow oblast, Ekaterinburg and Novosibirsk that have overcome the psychologically critical barrier of USD 1,000/sq.m. In 2006, these localities were joined by the overwhelming majority of the cities presented in the sample in Table 20, except for Omsk, Penza and Ulyanovsk. In S. Petersburg,
lysts), V. Lutskov, L. Kazimir, N. Ascheulova (AKTS "MIEL-Nedvizhimost"( Moscow and Moscow oblast)), M. Bimon and S. Bobashev ("Bulleten nedvizhimosti" (S. Petersburg)), M. Khorkov, A. An-tasyuk (Ekaterinburg), A. Stepanova (SUN "Expert" (Ufa), A. Cheremnykh (UK "ASSA-Story (Izhevsk)), P. Smelov, M. Vysotskaya (Sibakademstroy Nedvizhimost), E. Ermolaeva (RID Analitik (Novosibirsk)), A. Chemodanov ("Triumph" (N. Novgorod)), V. Troshina (LEX (Tyumen)), A. Chumakov ("Titul" (Rostov-on-Don), R. davletshina ("Perspektiva konslating" (Perm), V. Kaminsky (TITAN (Tver)), S. Taruta ("Omskmedia" (Omsk)), S. Blinkova (IKPKG "Zhilye" (Penza)), E. gamova, N. Yarsina ("Tsentr nedvizhimosti"), M. Isaeva ("Zolotoy klyuch" (Ulyanovsk)), G. Eydlina ("Rielty" (Shal-hty, Rostov oblast)) 634
Ekaterinburg, Ufa and Moscow oblast (as a whole) and Podolsk and Ramenskoye the prices overstep the mark of USD 2,000/sq.m., while in Khimki, Odintsovo and Krasnogorsk - 2,000 and 3,000, and in the city of Moscow USD 3,000 and 4,000/sq.m., accordingly.
It should be noted that in Moscow, Moscow oblast, S. Petersburg, N. Novgorod and Tver prices are still quoted in USD, while Ekaterinburg and Rostov-on-Don have witnessed de-dollarization of the housing market. As concerns other locations presented in the sample, prices are still quoted in RUR there.
By the end of 2006 the housing prices posted grew more than twice in N. Novgorod, Ufa, Ekaterinburg, S. Petersburg and Moscow oblast (not only across the region as a whole, but in its most remote from Moscow towns, such as Serpukhov and Mozhaisk). In the towns in question, as well as in Tver, Tyumen, Moscow, Rostov-on-Don and Ulyanovsk, the price increment ranged between 70 and 100%. A more moderate price dynamic was noted in Penza, Novosibirsk, and Perm (6264%). Finally, the smallest rate of the price rise for housing was noted in Omsk (41%).
Such a rapid price rise has continued at least for two years, and in all the cities in question the 2006 growth rates were greater than those of 2005. As a result, between 2005 and 2006 the housing prices grew more than twice in all the cities of the sample (except for Omsk, where the price rise accounted for 1.84 times). The group of cities with the greatest growth rates (2.6-3 times) includes N. Novgorod, Ekaterinburg, Ufa, Moscow oblast (as a whole and most its towns, except for Serpukhov and Mozhaisk). The lowest growth rates were noted in Perm and Ulyanovsk (roughly 2.1 times). Meanwhile, Tver, Moscow, S. Petersburg, Rostov-on-Don, Serpukhov, Mozhaisk and Novosobirsk found themselves somewhere between the poles, as the price rise there over the two past years accounted for 2.2-2.5 times.
As a reminder, consumer prices grew by 9% last year. The USD average nominal exchange rate in December 2005 was 28.81 RUR, while in December 2006- 26.29 RUR. Accordingly, the 2006 USD inflation rate in Russia accounted for 1.195. Thus, USD continued to depreciate in Russia, with the decline rates of its purchasing power growing notably (in 2006 they made up 16%, or twice as much vs. the respective index of the prior year (7%) and slightly over the 2004 index (15%). While considering the two-year period (2005-2006), the RUR/USD depreciation accounted for 0.94, the USD inflation index - 1.286, and the USD purchasing power plunged by more than 22%.
As concerns the index of the real housing price (less the USD inflation and the RUR inflation) (ISG124), the respective data and ratios are presented in Table 21 below:
124 ISG is computed by the following formula: ISG=Ipr/Icp=Ip$/Ii$, where Ipr is price index for housing in RUR equivalent, Icp - consumer price index, Ip$- price index for housing in USD, Ii$=Icp/Ir$i -index of the USD inflation in Russia (relative to the consumer price dynamics, Ir$i - index of depreciation of RUR vs. USD
Table 21
The Dynamics of the Average Offer Price for Apartments in 2004-2006
Nominal price index IGS
December December December December December December
City (region) 2005 / 2006./ 2006 / 2005 / 2006 / 2006 /
December December December December December December
2004. 2005. 2004. 2004. 2005 2004.
Moscow 1.361 1.816 2.472 1.265 1.520 1.922
S. Petersburg 1.090 2.197 2.394 1.013 1.838 1.862
Moscow oblast 1.235 2.250 2.778 1.148 1.882 2.160
Ekaterinburg 1.204 2.274 2.738 1.119 1.903 2.129
Ufa 1.302 2.080 2.708 1.210 1.741 2.106
Novosibirsk 1.353 1.638 2.216 1.257 1.371 1.723
N. Novgorod 1.243 2.292 2.849 1.155 1.918 2.215
Tymen - 1.852 - - 1.550 -
Rostov-on-Don 1.31 3 1.800 2.363 1.220 1.506 1.837
Perm 1.297 1.621 2.102 1.205 1.356 1.634
Tver 1.269 1.991 2.527 1.179 1.666 1.965
Omsk 1.305 1 .41 3 1.844 1.212 1.182 1.433
Penza - 1.639 - - 1.274 -
Ulyanovsk 1.200 1.767 2.120 1.115 1 .479 1.649
Towns in Moscow oblast
Khimki 1.285 2.047 2.630 1 .1 94 1.713 2.045
Odintsovo 1.307 2.190 2.862 1.215 1.832 2.226
Krasnogorsk 1.300 2.250 2.925 1.208 1.883 2.274
Podolsk 1.299 2.276 2.957 1.207 1.905 2.300
Ramenskoye 1.300 2.263 2.942 1.208 1.894 2.288
Solnechnogorsk 1.294 2.131 2.757 1.203 1.783 2.144
Naro-Fominsk 1.196 2.255 2.696 1.111 1.887 2.096
Serpukhov 1.217 1.895 2.306 1.131 1.586 1.793
Mozhaysk 1.243 1.838 2.284 1.155 1.538 1.776
The greatest growth rate in the IGS 2006 value (over 1.9 times) was reported in N. Novgorod, Ekaterinburg, and Podolsk. In S. Petersburg, Ufa, Moscow oblast as a whole, as well as in Ramenskoye, Naro-Fominsk, Krasnogorsk, Odintsovo and Khimki its value found itself within the range between 1.7 and 1.9. Tver somewhat fell behind this group, with the real local prices for housing posting the 1.67 rise. In Serpukhov, Tyumen, Mozhaisk, Moscow, Rostov-on-Don, the real prices for housing grew 1.5-1.6 times, while those in Ulyanovsk, Novosibirsk, Perm, Penza and Omsk - less than 1.5 times. The smallest value of IGS (1.182) was registered in Omsk.
If one considers results of the two-year period of 2005-2006, the real prices for housing grew more than twice in N. Novgorod, Ekaterinburg, Ufa and across Moscow oblast (except for Podolsk and Mozhaisk).
The ISG value was slightly below 2 for the housing markets of Tver and Moscow. In all other cities presented in the sample (except for Omsk) the housing prices adjusted for inflation grew more than 1.5 times, while in Omsk the ISG value made up 1.433, thus making the city the lowest pole of the sample in terms of indices of nominal and absolute prices for housing. Atop the sample are Podolsk, Ramenskoye and Krasnogorsk, which have helped Moscow oblast to overrun the city of Moscow in terms of growth rate of housing prices in 2006. For reference, in 2003 and 2005 the situation was opposite, while in 2002 and 2004 both Subjects were even, so far as the housing price rise rates are concerned.
Whilst considering peculiarities of dynamics of the housing market in the capital region, one has to note that it is in the process of transition to a new phase of its development, that is, stabilization.
The prior moment of the reversing of the trend fell on June 2005, when after stagnation on the market, which had started in June 2004, the prices began to soar. Just a reminder, in the city of Moscow the price rise was spotted yet in the 1st half 2005, followed by its rapid acceleration (8-10% a month) in the 2nd half of the year. This tendency was in place through the end of the 1st half 2006, and the price rise consequently began to fade in the 2nd half of the year (until November, when it discontinued). In Moscow oblast, the price rise started between September and October 2005, followed by acceleration in its pace up to 12-14% through September 2006 and its discontinuation in December 2006.
The causes and factors underlying the renewal of the price rise on the capital market for real estate became evident yet between November and December 2005. The main cause behind a rapid price rise since 2005 was, on the one hand, the growth in the effective demand on the market fueled by a general rise in the aggregate demand and an explosion of mortgage and other forms of housing funding, and the declining offer generated by contraction in the volume of house building, which in turn mirrored effects of the 2004 micro-crisis on the construction market that were further intensified by the mess in the construction process in the wake of the enactment of Federal Act # 214 "On share construction...", on the other hand.
Experts projected a continuation of the price rise at an increasing pace in the 1st half 2006 and at a fading pace (down to zero) in the 2nd half of he year. Most analysts were unanimous in the assertion, but no one expected such dramatic growth rates (8-10% a month) which were noted in reality.
The growth rates began their gradual decline in the 2nd half of the year, though in Moscow oblast the process started only in the autumn. During the last two months of 2006 the absolute value of housing prices exceeded USD 4,800/ sq.m. in Moscow and 2,500/sq.m. in Moscow oblast and stabilized at these levels.
The causes behind the decline in the prices for housing, which started between July and August 2006, and a gradual transition to their stabilization became:
- fall in the number of buyers who could afford purchasing apartments at such high prices;
- worsening mortgage terms caused by shortages of offer;
- declining rates of return on apartment lease, as apartment owners saw lower rates of growth of the respective rates vis-à-vis purchase prices.
As well, since August the downfall in prices for energy sources has begun contributing to the process, too.
It was expected (and indeed occurred) that in autumn there manifested themselves effects from the fall in the price rise rates for housing, which at the same time could form causes for their possible stagnation and even adjustment:
- lower motivation to purchasing apartments for investment purposes, which previously was inspired by high price rise rates;
- possibility for capital outflow to more profitable sectors for the sake of investment;
- appearance on the market of apartments, which were purchased earlier for speculation or investment purposes;
- continuous impact of the downfall in prices for energy sources.
5.5.2. Housing as the priority national program.
The year 2006 has become the first full calendar year of implementation of the four national projects, one of which was entitled "Affordable and comfortable housing to the citizens of Russia". Its first outcomes appear fairly positive.
In 2006, real estate developers put in operation 502.m. sq.m. of total area of housing, or more than 1% over the respective index of the prior year. The volume of placement of housing in operation by individual real estate developers posted somewhat more moderate growth (13.9%), i.e. just slightly differing from its 2005 index. In all, developers have built nearly 605,000 apartments, while individual developers -nearly 140,000 individual houses. As many as nearly 22,000 young families and some 13,000 families of veterans, or families with disabled (and particularly disabled children) family members have improved their housing conditions125. The volume of mortgage loans disbursed in the framework of implementation of the federal targeted program (FTP) "Housing" exceeded RUR 220 bln., or 4.4 times greater than its 2005 index, proceeding from the data contained in the Program of socio-economic development of RF for the medium term (2006-2008) approved by the RF Government with its Resolution of January 19, 2006, # 38-p.126
Table 22
Placement of Houses into Operation in 1999-2005
Year
Sq.m. of total area
Growth rates, %
Vs. the prior year
Vs. 2000 r.
1999 32.0 104.2 105.6
2000 30.3 94.7 100.0
2001 31.7 104.6 104.6
2002 33.8 106.6 111.5
2003 36.4 107.7 120.1
2004 41.0 112.6 135.3
2005 43.6 106.3 143.9
2006 50.2 115.2 165.7
Source: Rosstat, authors' calculations.
The 2006 increment in the volume of housing placed in operation, indeed, became record-breaking not only for the period since the early 2000s, but in a longer retrospective. Thus, in the Soviet time, the 9.6% growth in construction reported in 1986 against the background of an attempt to boost economic growth rates was quite noticeable vis-a-vis the earlier performance. However, we should not forget the currently existing small starting base, as well as the fact that today's numerous
125 Padenko O. Vspleska tsen ne ozhidayetsya. Kvartirny ryad, 15-21 Feb 2007, # 6 (629), p.2
126 The estimate of the rise in the volume of mortgage loans disbursed in 2006 might be more moderate (2.9 times), as there are data on the volume of mortgage loans disbursed by banks, which accounts for RUR 76.5 bln. See: Zhit stalo ipotechnee! Kvartirny ryad, 7-13 Dec 2006, # 49 (620), p.6 638
construction projects in progress had been started prior to the launch of the national project.
At its meeting in Kazan in late-January 2007, the State Council argued that, despite certain success stories, even such a notable increase in placement of housing in operation failed to compensate for the overall aging of the housing fund, while the situation with its capital refurbishment was aggravating. The advanced (relative to the dynamic of the population's incomes) price rise for housing leaves yet smaller chances for citizens with small- and medium-level incomes. Despite a great capacity of the national mort gage loan market, which by 2010 can account for some RUR 700-900 bln. (as estimated by the International Financial Corporation) or even 1.3 trln., according to Russian experts, only 10% of the population can afford using a mortgage loan. Presently, there are as many as 600 banks operating on the Russian mortgage market, but nearly a half of its volume is formed by 10-12 of them127. The number of families that should be granted with apartments at the expense of the federal budget by 2010 (133,000 individuals) accounts just for 18% of those before whom the government have such an obligation128.
The situation in the industry of construction materials is ambiguous. Despite a drastic increment in output of most kinds of construction materials, at its meeting on Nov. 24, 2006, the Presidium of the Council for Implementation of the Priority National Projects noted that by 2008 the country would face shortages of construction materials. Today, some regions have already faced occasional shortages of individual kinds of construction materials (bricks, wood, etc.), which resulted in price hikes for those129.
This, on the one hand, raise questions, as the volumes of house building, to say nothing of production investment, so far have failed to reach the pre-reform level. On the other hand, the 2006 volumes of production of cement, module ferroconcrete items and constructions, bricks, large wall panels, soft roofing, etc. were lower than in 1970, those of non-ore construction materials - lower than in 1975, while production of ceramic and sanitaryware exceeded the 1990 level130.
Apparently, underlying such a situation is retirement of numerous production capacities in the construction materials industry in the period of the transformational slump of the 1990s and the pressing problem of maintenance of an adequate quality of production. Of some 500 house-building plants presently existing in the country less than one-third is afloat, while many of them, as well as concrete producers, have discontinued their operations and were re-profiled over the past 15 years, while the production base of the operating ones is outdated. That is why in pursuance of vertical integration many regions (Republic of Karelia, Leningrad, Kaluga, Tver, N.Novgorod, Ulyanovsk, Rostov, oblasts, Krasnodar krai, Bashkor-
127 Zhit stalo ipotechnee! Kvartirny ryad, 7-13 Dec 2006, # 49 (620), p.6
128 Domnin S. Skromnoye obayaniye natsionalnogo prioriteta. Kvartirny ryad, 14-20 Dec 2006, # 50 (621), p.2
129 Novosti. Krupnymi mazkami//SNIP. Stroitelstvo. Nedvizhimost. Investitsii. Proekty, #2 (02). Dec. 2006, pp. 74-80, 88-91
130 Sotsialno-ekonomicheskoye olozheniye Rossiii, 2006 god, M., Rosstat, p.21, 50-51; Rossiysky statistichesky sbornik. 2004: Sta.sb. m., Rosstat, 2004, p. 395
tostan, Sverdlovsk, Novosibirsk oblasts) are going to launch new production facilities, particularly at the expense of foreign investors and large real estate developers 131.
The introduction of such instruments of the national project as open auctions on sale of sites and government guarantees on development of urban engineering infrastructure caused grave problems. It is a common knowledge now that local authorities are ignorant of legal requirements concerning allocation of sites only on the basis of competition, and numerous violations required a vigorous interference of the Federal Anti-Monopoly Service. While since 2006 FTP "Housing", the major vehicle of implementation of the national project, has been back-upped by a new section entitled "Provision of sites with the public utilities infrastructure for the purpose of house building", the envisaged aid from the federal center to municipalities in the form of loans guarantees (worth a total of RUR 12.5 bln.) and subsidies (1.7 bln.) on the engineering development of the sites so far has failed to find consumers. The tenders have resulted in picking 110 projects, but the RF Ministry of Finance has not concluded any agreements on provision of the guarantees, and there were just 5 pretenders for the subsidies. The hopes for the mechanism of government guarantees were futile, as municipalities accumulated huge debts and cannot assume the respective obligations. Budgetary problems on the local level do not allow counting on the required co-financing of measures on preparation of the sites132.
The negative background for the expansion of the national project has been formed by the problem of the "cheated co-investors". According to Mr. Yu. Tyrty-shev, the Deputy Minister of Regional Development, real estate developers failed to honor over 70,000 agreements on co-financed construction and there were over 500 problematic objects in over 60 regions133. Over 80 actions were brought against legal entities and over 4,500 - against private individuals on deception of the private co-investors134. However, even these impressive figures are unlikely to adequately highlight the magnitude of the problem. Thus, the largest developer, "Sot-sialnaya Initsiativa" partnership, whose top executives were detained in late-2006, failed to fulfill its obligations before more than 50,000 private investors in 71 regions.
The work on solving this problem is still at the preliminary stage (creation of task forces, completing victim lists, etc.), but so far there have been no prospects for a governmental assistance to them, which can be largely explained by motivations of those who invested in such projects. Mr. Tyrtyshev asserts that just 10% of private co-investors contributed with their savings to get the only housing, while 40% simply invested their free resources, while the rest were keen to improve their
131 Novosti. Tsennye prutya. //SNIP. Stroitelstvo. Nedvizhimost. Investitsii. Proekty, #2 (02). Dec. 2006, pp. 74, 82-86
132 Nuzhny ne garantii, a dengi. Kvartirny ryad, 9-15 Nov. 2006, # 45 (616), p. 17
133 Pomogut chem. mogut. Kvartirny ryad, 1-7 March 2007, # 9 (632) p. 1
134 Pechalnye tsifry. Kvartirny ryad, 30 Nov- 6 Dec 2007, # 48 (619) p.2 640
housing conditions135. Should the government want to help the co-investors, its intents would face such obvious barriers as an additional unplanned pressure on the budgetary system (particularly in the case of regional and local budgets) and natural concerns that if the government assumes the private investors' risks, it may give a negative signal to the market.
There are certain success stories nonetheless, but only providing there were already built houses and the only problem was registration of property rights. The recommendation to attract other investors in such situations and to compensate for their damages by allocating other sites conflicts with the legal provisions that set the tender-based procedures of allocation of sites.
Regional and municipal administrations could help solve this situation, but in most cases they opt for the "wait-and-see" approach. The rare exceptions are the city of Moscow and Moscow oblast where the intensity of the problem has subsided and most "problematic" objects are being completed by new developers. The Governor of N. Novgorod oblast has also expressed his readiness to help the deceived co-investors.
Today, new amendments to the bankruptcy law are designed, which would allow extension for a year of bankruptcy proceedings that concern the fraudulent developers. The amendments, perhaps, would help lower the intensity of the problem. The authors of the amendments believe that an additional year is enough for a bankrupt corporation to attempt to attract additional investments or undergo financial restructuring procedures136. The task force of the Public Chamber also laid down a bill on restructuring of construction companies, which provides for establishment of a government agency with a mission to restructure construction companies that have failed to honor their obligations before private co-investors.
A positive example in this respect became the long-awaited amendments to Act # 214-FZ enacted by Federal Statute of July 18, 2006, # 111-FZ "On introducing amendments to the Federal Act "On participation in shared construction of blocs of apartments and other real estate objects and on introducing amendments to some legislative acts of the Russian Federation". The amendments in question facilitate procedures for developers and create conditions for boosting up volumes of house building, including the following:
- modification of procedures of cancellation of the agreement on participation in the shared construction both by private co-investors (in the part of limitations of possibilities for the unilateral refusal of the agreement) and developers (simplification of the agreement cancellation procedures), along with setting for the latter procedures of return of funds in the event of cancellation of the agreement;
- relief of the property developer of the absolute liability for any defects of the object of shared construction;
135 Pechalnye tsifry. Kvartirny ryad, 30 Nov- 6 Dec 2007, # 48 (619) p.2
136 A negative element of such a variant will become a greater diversity of the bankruptcy law, which already provides for peculiarities of pursuance of insolvency procedures with respect to strategic enterprises, agricultural, financial organizations, subjects of natural monopolies, etc.
-exclusion of the joint and several liability of the bank and the property developer with regard to obligations secured by a collateral under maintenance of equal rights of submortgagee banks and individual co-investors under satisfaction of their claims in the event of recovery of the collateral;
- cancellation of the obligation to publish in the media a project declaration, which should contain information on the property developer and the object of construction, while maintaining the developer's obligation to provide the declaration to any person and inform of earlier completed projects;
- introduction of obligations (housing certificates with a double face-value in terms of price and area) which fixes the owner's right for receipt from the issuer of domestic premises with the possibility for selling the securities in question and the developer's obligation to buy them with indexation);
- limiting the amount of monetary resources attracted from individual co-investors (together with loans received from banks) with the value of construction of the house, as per the project declaration;
- decrease of the amount of the penalty cost payable by the parties that participate in the shared construction for abusing their mutual obligations.
The new version of the law creates more favorable conditions of saturation of the housing market by encouraging investors who have tried to avoid risks associated with newly constructed housing. One can also hope for a better funding of construction projects, as the cancellation of the joint and several liability of banks and property developers should form an operative motive to the former to renew disbursing loans to the latter at the former scale. Plus, great hopes are laid upon issuance of obligations.
Meanwhile, there persists a whole series of still unresolved challenges. Many developers still ignore standards that regulate procedures of purchasing by private individuals of apartments in newly built houses. There persists the risk of double sales of housing, as the preliminary sale agreements are not subject to the state registration. As deals involving promissory notes, they likewise appear yet more exposed to fraudulent acts than the shared participation contracts. That is why the enforcement of the new version of the Federal Act "On participation in the shared construction..." is likely to imply limited effects137.
Another important legal novelty became amendments to the Town-Planning Code that took effect as of January 1, 2007. They are aimed at lifting administrative barriers and improvement of mechanisms of involvement in the economic turnover of sites designated for construction of housing.
Resolving numerous conflicts that have arisen around allocation of land for construction, they allow allocation of sites without holding tenders, provided the respective agreements had been concluded prior to the late-2004 or the placement of objects on the site had been approved before October 1, 2005. This grants the property developer with the right to develop earlier frozen sites. The amendments introduce criteria of recognition of the territory due to be developed for the
137 Pro "serye" skhemy I kvartiry v novostroykakh. Kvartirny ryad, 7-13 Dec 2006, # 49 (620),
p. 16-17
purpose of house building. The investor can acquire the right to conclude a territory development agreement at an auction or without holding that, provided the housing is to be built on the basis of placement of an order for the public or municipal needs. Local self-governance bodies now can enjoy the right to use sites owned by the municipality or falling under the category of unlocated property as collateral against loans for building local infrastructure. To encourage house building, it is suggested to introduce greater rental payments for land in three years after its allocation.
In addition, the noted amendments provide for formation of a uniform system of public evaluation of the project documentation and a single supervisory body in the construction sector138, to be formed by the Rosstroy and the RF Ministry for Regional Development. The goal is to reduce construction costs (in the part of the costs associated with reconcilement and approvals) and contraction of the length of conduct of evaluations.
In the circumstances, the government still sets the goal of boosting volumes of placement of new housing in operation, as they still are inferior to the pre-reform ones. In addition to the mortgage mechanisms, it raises the issue of development of a savings system, which should enable private individuals to buy housing via special savings banks, which should not require any liquid pledged real property. A part of the government guarantees should be diverted from municipalities straight to real estate developers in the form of banking loans. The State Duma will consider a document on the transition from the state licensing, which was extended through the 1st half 2007, to self-regulation. Should the Duma pass the bill, the greatest challenge should become the problem of amounts of contributions payable by participants in the self-regulated organizations (SRO) to a compensations fund to satisfy possible damages of individuals that may suffer from fraudulent activities. It is planned to spent RUR 5 bln. on modernization of the public utilities infrastructure and over 1 bln. - on rehousing of families from the untenable housing. One of the pools for funding the housing sector modernization will be formed using the USD 200m-worth loan from EBRD. To develop the industry for construction materials, it is planned to allocate sites for new production facilities and cancel import duties on a series of production equipment.
Like some other industry branches, the construction sector may become exposed to the expansion of the state not only as a regulator of the market, but a player on it. A great role in implementation of the national project on housing was assigned to the state-controlled Sberbank and Vneshtorgbank (the latter has recently taken over Industrial and Construction Bank (headquartered in Saint Petersburg). After taking over ICB together with its development subsidiary "ICB-Invest group", Vneshtorgbank is now in transition from its habitual role of creditor to huge construction companies towards implementation of its own development projects, which has already occurred in Saint Petersburg and announced in Leningrad, Kostroma and Kaluga oblasts, and Republic of Chuvashia. Today, Vneshtorgbank con-
138 This implies cancellation of some 10 kinds of evaluation and all other kinds of the government supervision in the sector, which steered quite equivocal comments
templates creation of a nationwide development division139. There also are voices advocating creation of a federal construction corporation, whose principal mission should be commissioning construction orders to contractors at a fixed return rate.
The national project should be further specified in the Program of socioeconomic development of Russian Federation in medium term (2006-2008) approved by Resolution of the RF Government of January 19, 2006, # 38-p. The Resolution contains a special section "Shaping the market for affordable housing".
The section reads that at the first stage the priority national project will be implemented along the following four avenues:
- ensuring a greater affordability of housing;
- fulfillment of the government obligations before individual categories of citizens;
- increase in the mortgage volumes;
- increase in the volume of house building and modernization of the public utilities infrastructure.
Each avenue suggests certain measures that imply development of the legal base, ensuring a balanced support to expansion of demand and offer on the housing market, and fulfillment of the government obligations on provision of certain categories of citizens with housing.
The main vehicles of implementation of the government support remain the federal targeted program "Housing" for 2002-2010 and its sub-programs.
To make housing more affordable for young families and the young specialists in the rural areas who are in need for housing or improvement of their housing conditions, the Program provides for the following measures:
- provision of housing subsidies to young families (including subsidies for the purchase of a private house or payment of the first installment in the event of a mortgage loan) amounting to 40% of the average cost of a standard housing, including 10% -at the expense of the federal budget and 30% - at the expense of a regional or local budget;
- insuring mortgage loans disbursed to young families for the sake of reducing the amount of the first payment in the event of a mortgage loan (formation of the authorized capital of the respective organization at the expense of the federal budget or subsidizing citizens' expenses on payment of the insurance premium);
- provision of young specialists residing in the rural areas with subsidies on construction of individual housing, including for the purpose of repayment of the first installment in the event of a mortgage loan (subsidizing between 10% and 50% of costs of the standard housing at the expense of the federal budget is differentiated across regions, provided a certain contribution by regional or local budgets).
The fulfillment of the state obligations with regard to provision of housing to individual categories of citizens is aimed at securing a possibility to purchase housing by the citizens before whom the Russian Federation has
139 Frumkin K. Chabol po-russki//Kompania, # 48-49 (444-445), 25.12.2006, p. 25-26 644
obligations on provision them with housing or improvement of their housing conditions. This avenue implies implementation of the following measures:
- provision of housing subsidies to the citizens before whom the state has the respective obligations (discharged military, citizens moved from "Baykonur" complex, out of the Northern Territories, compulsory migrants, and victims of nuclear accidents and catastrophes);
- fulfillment of state obligations associated with provision of housing to veterans and disabled who queue for improvement of their housing conditions, before whom the Russian Federation has assumed obligations to improve their conditions in the process of division of powers between different tiers of government.
To ensure conditions for increase of offer of housing in proportion to the population's growing effective demand and to enhance the quality of the provided public utilities services, the government recognizes the necessity to boost volumes of house building and modernize the public utilities infrastructure, including:
- provision of sites with the public utilities infrastructure, particularly by means of provision of government guarantees and subsidizing (up to 50%) of interest rates on loans granted on implementation of projects on equipping the sites with the public utilities infrastructure subject to conditions of co-financing of such projects by regional and local budgets; allocation of the federal budget resources subject to conditions of co-financing such projects by regional and local budgets, and private investors;
- establishment of a revolving fund, whose mission should be provision of support to municipalities and public utilities operators to obtain loans;
- contraction of the number of administrative barriers associated with granting real estate developers with access to the house-building market, as well as developing the market infrastructure, increasing the efficiency of town planning and modification of the anti-trust law in this particular area.
To boost up volumes of mortgage loans, it is imperative to ensure creation of conditions for the increase in disbursement of long-term mortgage loans to the population on the basis of development of a uniform mortgage loan refinancing system. This would become possible, should the following measures be implemented:
- a RUR 14.2 bln.-worth increase of the authorized capital of the "Agentstvo po ipotechnomy zhilischnomu kreditovaniyu" open-end joint-stock company in 2006-08 and provision of the RF government guarantees on the company's borrowings worth a total of up to RUR 58 bln.;
- completion of the legal base for the issuance of mortgage securities;
- crafting infrastructure for the mortgage loan system and the market for mortgage securities.
The RF Government's activities in this area should also pursue the following objectives:
- to capitalize on the mortgage loan refinancing system to boost up volumes of the co-financed construction of blocs of apartments and individual houses;
- to give a rise to housing-and-savings institutions (creation of house-building and savings banks);
- to lift the mandatory requirements to have mortgage papers secured with the RF government guarantee to make it possible to invest pension savings;
- to help new institutions of the housing market infrastructure thrive. These institutions include those involved in insuring mortgage loans, credit bureaus, and improvement of the system of state registration of the rights for real estate and account of real estate objects (enhancement of transparency, reliability and informational accessibility, lower costs of and shorter timelines for servicing);
- to set strict territorial planning procedures, along with introduction of town planning regulations and kinds of the permitted use of real estate at the level of municipalities;
- to ensure ransition towards the possibility for real estate developers to acquire property rights for formed sites at an auction and prior to the start of the construction and investment process. This measure should enable them to attract credit resources for construction of housing on security of the sites and the currently constructed housing.
The aforementioned medium-term Program notes that if these problems are resolved, it would allow the population's effective demand for housing to expand substantially and to increase offer of housing by means of boosting the volumes of house building, and to ensure affordability of housing to main groups of the population.
The measuring tool and main indicator, which should help judge the level of success in the Program implementation, should become an increase in the annual volume of placement of newly built housing in operation from 41.2m sq. m. in 2004 up to 70-80m sq.m. in 2010, given a triple (from the current 9% up to 25-30%) rise in the proportion of the population with incomes sufficient for buying a standard apartment using their own and credit resources.
The Government's action plan on implementation of the Program with respect to formation of the market for affordable housing provides for development of a whole series of legal acts, including amending Federal Acts "On mortgage securities" (in the part of specifying procedures of identification of the size of a mortgage backing, exclusion of privately owned assets from the composition of the mortgage backing, as well as payment of premiums on mortgage-backed obligations and mortgage participation certificates), "On mortgage", "On state registration of rights for real estate and transactions with it" (in the part of improvement of procedures of registration of title transfer by mortgages, and harmonization of the civil with the land law). The action plan also provides for amendments in the law, which concern regulation of securitization of financial assets and improvement of the procedure of allocation of sites for construction.
As concerns implementation of the national project in regional terms, it is possible to notice that volumes of placement of newly built housing in operation soar practically across the whole country. Out of 88 regions only 7 ones reported a fall in this respect (Kostroma, Samara, Irkutsk oblasts, Adygeya, Nenetsky, Evenk and
Chukotka autonomous okrugs). By contrast, the respective indicator grew over 1.5 times in Ivanovo, Kaliningrad, Murmansk, Novosibirsk oblasts, Altay Republic, Ust-Ordynsky and Aginsky Buryatsky autonomous okrugs.
Of 15 regions whose cities were represented in the housing price dynamics sample over 2004-06 (Table 20) the growth rates of placement of housing in operation were in excess of the average nationwide ones in 5 regions (Moscow, Tver, Penza, Novosibirsk and Omsk oblasts), while in another 3 regions (Rostov, Sverdlovsk, Tyumen oblasts) they roughly equaled to the latter. At the same time, in 7 regions (Moscow, Saint Petersburg, Bashkortostan, Udmurtia, Perm krai, N. Novgorod and Ulyanovsk oblasts) the respective indicator was below the average nationwide one, with Moscow and Saint Petersburg being at the bottom of the list (3.4% and 4.5%, respectively).
5.5.3. Implementation of the national project in the capital region
Whilst considering the situation in the house-building sector in Moscow and Moscow oblast in the nationwide context, it is worthwhile noting that the concentration of the house-building operations in the capital region has remained practically unchanged (Table 23).
Table 23
Volumes of Placement of Housing in Operation in Russia, City of Moscow
and Moscow Oblast in 1999-2006
Russia Moscow Moscow oblast Across Moscow and Moscow oblast, total
year Thos. sq.m. Thos. sq.m. As % of placement across Russia as a whole sq.m. As % of placement across Russia as a whole sq.m. As % of placement across Russia as a whole
1999 32017 3052.5 9.55 2728.6 8.5 5781.1 18.05
2000 30296 3342.3 11.0 2610.9 8.6 5953.2 19.6
2001 31703 3690.6 11.65 2827.8 8.9 6518.4 20.55
2002 33832 4274.1 12.6 3414.8 10.1 7688.9 22.7
2003 36449 4443.0 12.2 4136.4 11.3 8579.4 23.5
2004 41040 4578.6 11.15 5738.2 14.0 10316.8 25.15
2005 43609 4644.3 10.6 5271.4 12.1 9915.7 22.7
2006 50173 4804.5 9.6 6433.5 12.8 11238.0 22.4
Source: Rosstat, authors' calculations.
Moscow's proportional weight in the overall nationwide volume of house building fell by more than 1 p. p., thus sinking below 10%, however, the proportion of Moscow oblast has grown. As a result, the 2006 aggregate proportion of the city of Moscow and Moscow oblast accounted for 22.4% vs. 22.7% reported in 2005 and 23-25% registered between 2003 and 2004.
Table 24
Volumes of Placement of Housing in Operation in the city of Moscow and Moscow Oblast in 2000-2005
By Moscow builders in In the city of Moscow
the city of Moscow and In the city of Moscow (by the data of the Mos- In Moscow oblast year _beyond it_cow city government)_
Thos. As % to the Thos. As % to the Thos. As % to the Thos. As % to the
sq.m. prior year sq.m. prior year sq.m. prior year sq.m. prior year
2000 3530.2 104.8 3342.3 109.5 33342.3 2610.9 95.7
2001 3821.5 108.3 3690.6 110.4 3706.1*# 110.9 2827.8 108.3
2002 4469.6 116.9 4274.1 115.8 4310.9* 116.3 3414.8 120.7
2003 4703.2 105.2 4443.0 103.9 4441.9* 103.0 4136.4 121.1
2004 4794.7 101.9 4578.6 103.1 4576.8* 103.0 5738.2 138.7
2005 5224.1 108.9 4644.3 101.4 4644.3 101.5 5271.4 91.9
2006 5320.7 101.8 4804.5 103.5 4804.5 103.4 6433.5 121.5
Note. * - built in the city of Moscow by local construction companies,
# - there is alternative 2001 data, that is, 3,824.9 Thos. sq.m., thus the pace of increment relative to 2000 can be estimated at the level of 114.4%. Source: Rosstat, authors' calculations.
In 2006, the house-building sector in Moscow has certainly advanced, as after a fall in the pace of its increment in 2005 it has returned to the 2003-2004 indicators (the increment in the placement of housing in operation accounted for 3-4%). By contrast, its activity out of the city slightly fell, as the pace of increment in placement of aggregate volumes of housing by Moscow builders in Moscow and outside the city (1.8%) was roughly twice as lower vs. the respective index in Moscow (3.5). In Moscow oblast, the construction complex has recovered from its 2005 slump and advanced vigorously by boosting volumes of placement of housing in operation at more than 21%, thus bouncing back to the growth indicators characteristic of 2002-03. Interestingly, in the total volume of housing put in operation it was multistory housing whose proportion was on the rise in this respect, and the volume of apartment sales of (60,000 units) grew by nearly 15% vs. 2005. As the city of Moscow is now scarce of sites available for house building, Moscow oblast displays a good potential in this regard140.
In the city of Moscow, the local government approved a local three-year program of mortgage development for 2005-08. The program was approved by Resolution of the Moscow city government "On measures on development of mortgage in Moscow" of Nov. 8, 2005, # 881-PP. As well, with its Resolution # 994-PP of Dec. 13 2005, the Moscow city government approved the second stage of another program entitled "Affordable housing to young families".
Today, the Moscow city authorities test two optional types of social mortgage for local residents in need for improvement of their housing conditions. The first variant provides for a purchase of housing whose building will be commissioned by the city government at the production cost. The other variant rests upon a gratis subsidizing of the first installment, which, complemented by a bank mortgage loan and an individual's own cash, should enable the latter to buy an apartment at the market.
140 Chernyshov P. Ekonom-klass menyaet propisku. Kvartirny ryad, 1-7 Feb 2007, # 4 (627), p.5 648
Responding to problems that arose in conjunction with the co-financed construction, on June 22, 2006, the Mayor of Moscow signed Resolution # 1120 RP "On additional measures on protection of rights of the citizens that participate in the co-financing of house building in the territory of the city of Moscow". Its main provisions suggest imposition of restrictions on sales of housing until the construction of a house is complete, along with the investor's obligation to form a stock of unsold housing amounting to 15% of the overall area of the house, and introduction of a model contract on the citizens' participation in co-financing of house building in the territory of the city.
The aforementioned legislative novelties by the RF government and the Moscow Mayor's office, and a general improvement of the macroeconomic situation in the country generate necessary conditions for expansion of mortgage in the city, thus enabling the parties concerned to overcome the crisis situation noted in late-2005.
As a reminder, between 2001 and 2005 the situation on the mortgage market was characterized by a rapid rise in the volume of mortgage transactions141. Banks continued to lower interest rates and undertake other measures to improve loan conditions, while the population began overcoming specific prejudices and appeared more apt to apply for mortgage loans.
Notwithstanding the above, by late -2005 the number of transactions involving mortgage loans accounted for 50-80% of the number of approved loans, while real estate agencies reported a contraction in the share of mortgage loans in the overall number of transactions involving real estate.
To cite a specific example, "MIEL-Nedvizhimost", the biggest operator on the real estate market, reported that between early-2003 and the 2nd quarter 2005 there occurred a 10-fold rise in the volume of mortgage transactions up to 9% of its overall volume of transactions involving apartment purchase/sales. But since the 2nd quarter 2005 the process has discontinued and until the 2nd quarter 2006 the volume of mortgage-based transactions was stagnating in absolute terms, followed by a 6.9% decline in the 4th quarter 2006. In parallel with that, the length of the conduct of such deals began to extend (up to 4 months), as the time costs of the search for an apartment was growing, and in the 3rd and 4th quarters 2005 they accounted for 1.69 months and 2.3 months, respectively (vs. 1.46 months reported in the 2nd quarter 2006).
Some research142 demonstrated that the deceleration of the process can be attributed primarily to a catastrophic contraction in the volume of offer of apartments on the market and the rise of shortages, because of which sellers refused to work with mortgagers.
The reasons behind the contraction in volumes of new house building primarily lie with effects of the 2004 microcrisis on the market for newly built housing, which was caused by the outflow of buyers, property developers' melting resources and their decreasing capability to continue construction and repay loans.
141 See: Rossiyskata ekonomika. Tendentssii I perspektivy (Vypusk 27). M., IEPP. March, 2006.
142 Sternik G.M., Lutskov V.M., Korobkova M.V. et al. Rynok nedvizhimosti Moskovskogo regiona. Analiz razvitia i prognoz na 2006.- Analitichesky centr "MIEL-Nedvizhimost", Moskva, 2005.- 49 p.
As well, because of the nearly simultaneous banking micro-crisis, banks found themselves short of liquidity and had to cut down volumes of loans disbursed to the real estate developers. The situation further aggravated between 2005 and early 2006, owing much to scandals with real developers' scheming. Desperate as they were, private co-investors that suffered from fraudulent operations held numerous rallies in Moscow and some towns in Moscow oblast.
The mess in the house-building sector further grow upon promulgation of Federal Act #214 in April 2006, when construction companies found themselves unready to operate in newly established conditions and not only abandoned new projects, but had to freeze those already in progress. Hence, contraction in the volume of construction and offer of housing and restrictions on sales of newly built housing using mortgage mechanisms, except for the objects the permit to construct which had been granted until April 1, 2005.
The contraction of offer on the primary market for housing triggered a fall in the number of objects for sale on the secondary market (from 35,000 apartments in March 2005 down to 12,000 in January 2006 in the city of Moscow, and from 1012,000 to 6-7,000 in Moscow oblast, accordingly).
The situation drove prices higher at a constantly accelerated pace, which became notable since May 2005. That in turn increasingly limited the citizens' possibility to benefit from mortgage loans, for while the client was completing the mortgage loan procedures with the bank, the apartment he had picked went up in price, thus making his attempts vain.
The MIEL-Nedvizhimost's 2006 forecast of the dynamic of volumes of mortgage transactions suggested that a favorable macroeconomic situation, easier access to bank loans, improvement of the legal base, on the one hand, and the continuous decline in the volume of offer (despite the fall of its rate), coupled with rising prices, on the other hand, should contribute to growth in the volumes of mortgage-based transactions of the Company at no more than 10-30% compared with the prior year (vs. the 96% growth in 2005 to 2004 and 331% in 2004 to 2003).
The growth in an absolute volume of such operations has renewed only since the 3rd quarter 2006, with the growth rate accounting for 21% vis-a-vis the 3rd quarter 2005, while the proportion of transactions that involved mortgage in the overall number of transactions with apartments was on the rise yet since the 1st quarter 2005 and reached 17% in the 3rd quarter 2006.
The aforementioned legislative novelties have contributed much to the rise in the volume of the transactions in question.
In addition to the novelties whose effect should manifest itself in the medium term, there emerged certain factors that started boosting the offer volume up since the summer already; those factors were: a slowdown of the price rise on the secondary market, which compelled sellers to go to the market, while investors - to fix their profits by selling earlier bought apartments, among others.
Banks reacted by softening their requirements to the mortgager and many banks even reduced the amount of the first installment to zero. That also helped attract new mortgagers and, given the renewal of the rise of the volume of offer in the
3rd quarter in concomitance with a simultaneous slowdown of the price rise for housing, the volume of mortgage transactions and their proportion in the overall volume of MIEL's operations renewed its growth.
The prospects for the housing policy in the city of Moscow will be determined by Resolution of the city government of January 23, 2007 # 24-PP "On the medium-term housing program "Affordable housing to Muscovites" for the period between 2007 and 2009 and the order for 2010".
Its main avenues imply:
- protectionist measures towards Muscovites who are keen to buy housing;
- reducing the maximum length of queuing for improvement of housing conditions to 10 years;
- attraction to implementation of the housing policy of credit institutions and market professionals;
- getting families with children involved in programs that suggest an onerous basis, providing them, at the same time, with an additional social support, including linking up the housing purchase price with the use of mortgage and installment of date of debt repayment with the time during which the family has spent queuing for housing, and softening requirements to participants in the "Affordable housing to young families" program;
- creation of the local civilized market for apartments rent and exchange, including provision of assistance to those in the queue who have resorted to apartment rent from private individuals.
It is the first avenue that appears most problematic and hardly doable.
According to the Program, while announcing a tender on allocation of a site to build the so-called "budget" housing, the city authorities will take into account the percentage of apartments the developer would be ready to sell to Moscow residents and what should be a beneficial price at which he is going to sell apartments to the Muscovites who are officially registered as being in need for improvement of their housing conditions, have stayed in the queue and can realize their right just once. Basing on this, the city authorities are going to grant the rights for house building. If the real developer is discontented with the arrangement, the city government will take 80% of apartments (while the regular quota is 40%), thus leaving a meager 20% to him to go to the market. According to the Moscow city officials, they are guided by the aspiration to guarantee the genuine Muscovites' rights, as the local market is presently dominated by "outsiders" who often buy housing for investment purposes.
This arrangement can entail certain negative consequences: a fall in the volume of construction of the budget housing, for a part of investors would zero in on the "elite" segment, which is not subject to such Draconian regulation; the real estate developers' plummeting profits; renewal of the price rise for housing and the rise of various variants of re-selling the "beneficial" housing to the very outsiders with a consequent emergence of various legal conflicts, as the Moscow government's intents in the form they are fixed in the announced program to a certain extent conflict with the effective law, to say nothing of a great deal of corruption they may trigger. In prac-
tice, implementation of this particular avenue, as well as the others, will greatly depend upon concrete mechanisms of economic stimulation of real estate developers. In all fairness, such mechanisms may be quite sound, thus helping, provided they are introduced by separate legal acts, dumping any negative consequences.
It is envisaged that the 2007 volume of construction of housing for the queuing and young families eager to improve their housing conditions upon the onerous, albeit beneficial, basis should make up 370,000 sq.m. vs. 260,000 sq.m. reported in 2006. Overall, by all the 2007city housing programs it is planned to construct some 2m sq. m. of housing (with 400,000 sq. m. to be given away to the queuing), which, given the envisaged volume of placement of housing in operation in the city (4.7-4.8m sq.m.) should account for some 40% of its volume. The city government has ruled to allocate RUR 5.8 bln. from the local budget for subsidies on construction and purchase of housing.
5.5.4. Stages of development of housing in Russia
While monitoring the housing market in the capital cities (Moscow and St. Petersburg) since the early 1990s143, the dynamic series of average monthly prices for apartments give a chance for an objective examination of the market's behavior and main regularities of its advancement. Table 25 shows that the past 16-year-long history of the market allows identification of two notable stages of price dynamics. The first stage (between June 1990 and June 2000) had lasted for 10 years, while the second one, which started since mid-2000, has been lasting for more than 6 years already.
Table 25
Stages of Advancement of the Housing Market and Their Length in the Capital Regions in 1990-2006
Name of the stage Moscow St. Petersburg Moscow oblast
Start and take-off June 1990 - December 1991 -
March 1995 May 1994
Stabilization April 1995 -August 1998 * June 1994 -October 1998 **
Crisis September 1998 - November 1998 -
June 2000 October 2000
Post-crisis recovery July 2000 -December 2001 November 2000 -January 2003 July 2000 -February 2002
Stabilization January 2002 -August 2002 - March 2002 -July 2002
Jubilee growth - February 2003 - August 2003 -
Oil-driven growth September 2002 -June 2004 August 2003 - July 2004 August 2002 -September 2004
Stabilization July 2004 -July 2005 July 2004 -July 2005 October 2004 -September 2005
Speculative growth July 2005 -June 2006 August 2005 -September 2006 October 2005 - September 2006
Transition to stabili- July 2006 - September 2006 - September 2006 -
zation December 2006 December 2006 December 2006
Note: - fluctuating stabilization (with "rollback") asymptomatic stabilization (with "creep-up").
143 The respective observations in Moscow started in June 1990s, in St. Petersburg
while the data on Moscow oblast are available only since July 2000
652
- December 1991,
The main content of the first decade of existence of the legal real estate market became the start and take-off of its prices, followed by the transition to stabilization. While in Moscow the transition to stabilization displayed its fluctuating nature, along with an "overrun" and the fall to the level of USD 1,000-1,100/sq.m., the respective process in St. Petersburg was asymptomatic, with a "creep-up" and a gradual growth up to USD 600-650/sq.m. Then both markets faced the 1998-99 crisis.
In mid-2000, the real estate market of the Moscow region found itself at the bottom of the post-crisis cycle, thus signifying the end of the first stage of an unstable, fluctuating advancement of the market. At the time, the average price for housing was: in Moscow -USD 640/sq.m., in St. Petersburg and Moscow oblast -USD 335-350/sq.m. The next six years, up to date, the market has witnessed a constant price rise, with some short-term changes in the growth rates (up to a full stabilization).
The recovery stage of the market in the capital regions had been over by late-2001. At the time, the prices hit the pre-crisis level (some USD 1,000/sq.m. in Moscow and USD 470/sq.m. - in St. Petersburg and Moscow oblast). The market headed for stabilization, which was pretty short in Moscow and Moscow oblast.
Since mid-2002 Moscow and, a bit later, Moscow oblast began to experience a price rise that we call the "oil" one, as research conducted in early-2003 exposed a strong statistical correlation between world oil prices and the price rise in the city of Moscow144. By contrast, there was no price stabilization in St.Petersburg, which can be attributed to the inflow of budget and private investment due to the celebration of the city's 300th anniversary in May 2003. The gradual growth had been lasting until mid-2003, followed by the transition to the stage of "oil" growth.
The price rise discontinued in mid-2004, against the background of growing tensions between the state and business. Interestingly, the price stabilization took place in all the three regions practically simultaneously, while the new phase of price rise began at different times.
More specifically, Moscow saw the start of the price rise in the 1st half 2005. It consequently took an increasing pace (8-10% a month) through the 1st half 2006, followed by the reverse tendency in the 2nd half of the year. In Moscow oblast, the price rise began in September-October 2005, with a consequent acceleration of its rates up to 12-14% until September 2006 and the fall to zero in December 2006. In St. Petersburg, after the boom in the house building sector in 2003 and the consequent oversaturation of the primary market in 2004 the stabilization (and even a slight decline) phase lasted until spring 2006 and it was then replaced by 10-12% monthly growth rates until November-December 2006.
As concerns other cities represented in Table 20, they demonstrated price dynamics similar to that of the city of Moscow (Fig.18 and 19). Differences in the growth rates and lack of synchronism with regard to advancement of the price
144 See: Rossiyskata ekonomika. Tendentssii I perspektivy (Vypusk 24, 25). M., IEPP. 2003. 2004; Sternik G. Prognoz razvitiya rynka zhilya Moskvy do 2005 goda. Otchet AEKSIP, April 2003, www.realtymarket.org
situation on markets of different cities are determined by different levels of their socio-economic development, investment attractiveness, including the distance between each of them and Moscow, transport accessibility, the intensity of the conflict between regional authorities and mayors of the regional capital cities, among other factors.
Regions entered the stage of "oil" growth roughly a year later then Moscow did, that is, between the summer and autumn 2003. The phase ended up in some cities (N. Novgorod, Rostov, Tver) in summer 2004, and in spring- summer 2005 -in other cities (Ekaterinburg, Novosibirsk, Perm, Ufa).
The stabilization was, as a rule, short, and a new phase of price rise began in mid-2005 and continues up to now (it is only Tver that displays some signs of stabilization). In Penza, high price rise rates have been noted since spring 2005, in Ekaterinburg, Novosibirsk, N. Novgorod, Tver- since summer 2005, Omsk, Ufa-since the late-2005, and Perm- since spring 2006. There have been no price fluctuations in Ulyanovsk, where a gradual growth was in place until August 2006, and it was followed a rapid price rise at the monthly rate of 10-12%.
Figure 18 Dynamics of the Average Offer Price for Apartments in 7 Russian Cities in 2001-2006
Figure 19. Dynamics of the Average Offer Price for Apartments in 6 Russian
Cities in 2001-2006
It is interesting to explore the dynamics of correlations between average prices for housing in different Russian cities and those in Moscow.
Table 26
Correlation between the Housing Price Levels in 2001-2006, as % _(Moscow=100%)_
2001 . 2002 2003 2004 2005 . 2006
City (re- Decem Dece December De- Decem De-
gion) ber June mber June June cem ber June ber b June cem ber
Moscow (USD/sq.m.) 940 965 1096 1241 1610 1950 1953 2094 2658 4072 482 8
St. Petersburg 49.9 54.2 53.6 55.6 52.2 56.2 55.5 52.5 44.4 38.8 53.7
Moscow oblast 50.1 52.5 51.0 48.3 46.5 46.1 46.5 45.6 42.2 48.3 52.2
Ekaterinburg Ufa 51.5 52.8 47.4 41.7 35.4 38.7 45.2 45.3 40.0 34.7 48.0
36.6 32.3 39.2 40.2 37.5 38.3 42.9
Novosibirsk 48.0 45.6 39.6 40.4 32.5 30.7 38.3 41.6 38.1 28.5 34.3
N. Novgorod 32.0 36.7 34.7 30.9 28.4 27.4 29.6 29.0 27.1 21.9 34.2
Tyumen 36.7 32.5 27.5 33.1
Rostov-on-Don 36.8 39.5 37.7 35.0 30.7 30.9 33.6 35.8 32.4 25.1 32.1
Perm 43.5 38.4 35.9 30.6 25.5 23.3 34.8 37.9 33.2 26.1 29.6
Tver 28.5 31.8 28.6 26.3 22.4 27.2 27.8 27.7 25.9 25.6 28.4
Ulyanovsk 23.0 23.7 23.7 22.8 18.6 17.4 20.7 20.8 18.3 13.5 17.8
While fluctuating over time, in Moscow oblast and St. Petersburg this correlation has for long been within the range of 40-55% and 40-60%, respectively. Since mid-2005, once Moscow earlier than the others began a new stage of price rise, Moscow oblast and St. Petersburg experienced a dramatic fall in their levels relative Russia's capital city. However, consequently, Moscow oblast (since early-2006) and St. Petersburg (since mid-2006) accelerated their housing price rise rates and, (given the declining rates in Moscow) have closed the gap and returned to the usual levels that roughly account for some 50% of Moscow's.
In Ekaterinburg, the price level vis-a-vis Moscow was fluctuating within the range of 35 and 55%, in Novosibirsk - 30-50%, Ufa- 30-40%, Perm - 25-45%, Tyumen - 25-35%, N. Novgorod - 20-35%, Tver -25-30%, Ulyanovsk -15-25%.
Like in the capital regions, the lack of synchronism in changes in the pricing on the market led to the situation in which the range of price fluctuations in a given city relative to those registered in Moscow might reach considerable values. By late-2006 the average level was reached by Ekaterinburg and Tver, it was slightly exceeded by N. Novgorod and Ufa, while Novosibirsk, Perm, Rostov-on-Don and Ulyanovsk had not yet reached their average levels. No doubt, some cities have a certain capacity for a price rise similar to that noted in Moscow and Moscow oblast over the past 1.5 years, however, the realization of the capacity in question appears dependent largely on the nature and socio-economic development at the local level and policies pursued by local authorities.
Another characteristic feature of the advancement of the housing market at the second stage became the price dynamic relative to two basic periods (December 2001 and December 2004). As for the dynamic relative to December 4, it can be found in Table 20, while Table 27 below highlights the dynamics relative to December 2001.
Table 27
Price Dynamics for Housing in Russian Cities in 2001-2006
December December December December December
2001 2002 2003 2004 2006
City (region) USD./ Sq.m. USD./ Sq.m. As % to December 2001 USD./ Sq.m. As % to December 2001. USD./ Sq.m. As % to December 2001. USD./ Sq.m. As % to December 2001
Moscow 940 1096 116.6 1610 171.3 1953 207.8 4828 513.6
St. Petersburg 469 588 125.4 841 179.3 1083 230.9 2593 552.9
Moscow oblast 471 559 118.7 748 158.8 908 192.8 2522 535.5
Ekaterinburg 484 519 107.2 570 117.8 882 182.2 2415 499.0
Novosibirsk 451 434 96.2 524 116.2 748 165.9 1658 367.6
N.Novgorod 301 380 126.2 458 152.2 579 192.4 1650 548.2
Rostov-on-Don 346 413 119.4 494 142.8 656 189.6 1550 448.0
Perm 409 394 96.3 410 100.2 680 166.3 1430 349.6
Tver 268 313 116.8 360 134.3 542 202.2 1370 511.2
Ulyanovsk 216 260 120.4 300 138.9 405 187.5 859 397.7
Providing the December 2001 prices form a starting point, during five years prices grew 3.5-4-fold in Perm, Novosibirsk, Ulyanovsk; 4.5-4.8 times - in Rostov-
on-Don and Ekaterinburg, 5.1-5.5 times - in Tver, Moscow, Moscow oblast, N. Novgorod, and St. Petersburg.
Thus, these data prove the aforementioned regularity of the second stage of development of the Russian market for housing, that is, the non-stop (since 2000) price rise, without any drastic ups and downs. It is equally possible to expose yet another substantial regularity of the long-term development of the price situation on the regional markets, which became a consequence of the noted absence of synchronism in their advancement. In a nutshell, at the beginning of every stage of growth, there arises a fibration of price trends, while at the end of the phase, in the course of transition to stabilization, there occurred their consolidation. The trend of the first type was noted in 1990-1995, 1998-1999 (under the price downfall), between summer and autumn 2003 and autumn 2005; while the trend of the second type arose in 1996-1997, between late-2000 and early-2001, and in early-2005 and late-2006. This is another proof of an overall beginning of stabilization of housing prices in Russian cities.
5.5.5. Forecasts of development of the housing market
Since 1995 the annual forecasting of trends of price dynamics on the housing market of Moscow and other Russian cities rested upon economico-statistical models145. Until 2001 (including the post-crisis recovery stage) the models ensured a great accuracy of forecasting. But the models have failed to foretell a constant price rise at the second stage of development of the national housing market, and the 2003 and 2005 booms in particular. Effects of the stages were viewed as prerequisites for the growth and explosion of the "bubble" on the Moscow city housing market by analogy with suchlike scenarios that battered housing markets in the US, UK, USA, Canada, Australia, and some other countries, which local analysts used to regard as the most likely ones.
In conjunction with the above, there arise questions as to what this new, second, stage of the market development is, how the existing trends correlate with the cyclic phenomena characteristic of a market economy, and how probable the possibility for a new downfall in prices for Moscow housing is.
Given the persistence of the current state of affairs in the world markets for energy sources, which form major Russian exports, a continuous solidification of the national financial system, whose safety is warranted by the Stabilization Fund, a gradual diversification of the national economy, completion of formation of political mechanisms that ensure succession of the current socio-economic course, unforeseen circumstances (such as a world financial crisis, a war between the civilizations, a political crisis in the country, etc.) cannot be excluded, albeit their probability seems minimum.
Whereas the behavior of the real estate market is to a significant extent driven by external factors, that is, general economic conditions, it can be asserted that its main regularity and basic trend will be a sustained price rise for housing. One of the
145 Sternik G. "Statistichesky podkhod k progonozirovaniyu tsen na zhilye". Zhurnal RAN "Ekonomika i matematicheskoye metody", tom 34, vyp.1, 1998, p. 85-90
most investment-attractive sectors of the economy, the housing market should continue to grow along with the economy, with price rise rates for housing in Moscow advancing the general pace of the nation's economic growth.
Typically, there are several counter-arguments against the possibility for a manifold price rise for housing in Moscow.
The first argument is that, according to the basic postulates of the market theory, without any emergency circumstances, prices on the market cannot grow faster than at 20% annually (as they follow mostly the dynamic of the population's real incomes, or even once in two-three years), as rising prices fuel growth in offer, after which the prices discontinue to rise. But the real estate market is to a greater extent exposed to inertia effects, and it takes a few years to increase the offer. This is the phenomenon noted over the past 1.5 years in the course of implementation of the national project on affordable housing, when the state has been trying by all means to encourage growth in effective demand (a general growth in the population's incomes, mortgage, a direct support to individual social groups), but investments in stimulation of volumes of construction and offer can ensure effects only in three or four years later, which is why the project so far has skidded, while the housing prices have been on the rise.
The second argument rests upon recognition of the fact that the housing prices have their natural ceiling dictated by the population's income level and effective demand. Once the population fails to catch up with such a price rise, the demand goes down, which exercises a certain pressure on sellers, compelling them if not to lower, but, at least, not to increase their prices. From theoretical perspective, the probability of such a scenario is, indeed, great, however, like other regularities, this one is effective only within certain limits, beyond which there arise exceptions from the general rule. One of such exceptions undoubtedly is housing market in the capital city. Moscow isa gravity center to all residents of other Russian regions and Near-Abroad countries, and they arrive with new sources of investment in the local housing. The effective demand on housing in Moscow is loosely dependent on price levels. It just takes short (between 6 and 12 months) breaks, when the price rise for housing discontinues, and this lasts until next surge. Plus, in all the developed economies the costs of housing in capital cities are far greater than in other cities.
Potentially, a release of pressure of effective demand on the capital market for housing may become possible only in the long term, should there emerge other economic and cultural centers capable to ensure a certain quality of life146 comparable , at least, to those presently in existence in Moscow. In the conditions of the market model emerged in the post-Soviet zone this appears highly unlikely, as the model in question is characterized by social and cross-regional differentiation by main indicators, concentration of business activity in the capital,
146 Quality of life is a complex concept, which includes not only living standards that are determined by the current monetary incomes and accumulated property, but the level of development of various kinds of infrastructure, availability of qualitative educational and health care services, environmental and criminogenic situation, etc. 658
where the plexus of power and business under the transitional economy provided ample opportunities for huge incomes, particularly by means of rent-seeking behavior. One cannot reject, of course, a possibility for the towns that are satellites to Moscow (Khimki, Krasnogorsk, Dolgoprudny, Mytischi, Balashikha, Reutov) to gradually catch up with Moscow in terms of their attractiveness as microcenters for investment in real estate, thus forming a huge agglomeration. However, even in that case Moscow stays in the lead, while Moscow oblast (mostly the satellite towns) is retaining its "flown" position. It is worthwhile noting that all that would be in no way related to the possibility of a rise in Russia of centers comparable with Moscow.
The third argument, which rejects the possibility for a manifold price rise for real estate in Moscow in the long run, rests upon a thesis that prices for real estate cannot rise indefinitely and, as elsewhere in the world, they should stop and then go down. The record of developed nations witnesses quite the opposite, thus proving the logic of the price rise on the capital market. Thus, while real estate prices in Moscow grew 6-fold over the 6 years of steady growth, in California they grew 10fold over 10 years, and in London, Paris, Berlin and Melbourne - 8- to 10-fold over 10-12 years.
In anticipation of the start of bursting of the bubbles and the price downfalls by analogy with the stock market, the world actually witnessed just a sole example of this kind. That occurred in Japan: dragged into the orbit of the Asian crisis 199798, the country faced a relatively long-standing economic stagnation and saw some downfall in prices for real estate.
Back to the price dynamics on the capital city's real estate market over the past 6 years, it has to be noted that the trends therein caused the illusion of the absence of cycles on the market. That is why the common method of examination of dynamic price series limits our understanding of the market tendencies. Because of this, one suggests a new method of studying the market dynamics, aka the non-harmonic decomposition of price trends 147.
The method per se is a transition from the studying of the dynamic of the studied value (prices) to the examination of the first derivative (which is increments, or the rate of growth), then the second one (growth rate of the increments, or acceleration of price rise rates), etc. - dynamic series of growth rates of increments of values against an approximated function of the previous level.
Thus, one can speak of interaction between cycles of fluctuations of different lengths. A "long" cycle of fluctuations is determined by a complex of macroeco-nomic performance indicators of a country and city (region). To these basic trends one applies faster fluctuations that are determined by the construction and investment cycle, advancement of the infrastructure of the market for house building, citizens' consumer behavior, etc. These "medium", faster, cycles realize themselves not in price fluctuations, but in those of the first derivative, namely, growth rates in price increments. Short cycles in turn reflect fluctuations of the second de-
147 Sternik G., Krasnopolskaya A. Metod negarmonicheskogo razlozheniya tsenovogo trenda.-www,realtymarket.org, July 2006
rivative (pace of acceleration of the price rise) relative to the trend displayed by "medium" cycles. The short cycles can be determined by different factors, for instance, seasonal and calendar fluctuations, price fluctuations for energy sources, a drastic change in the balance of private capital outflow, among others148.
The forecast comprised three levels:
- short-term forecast - deceleration of price rise rates and transition towards stabilization until late-2006
- medium-term forecast (until late-2007) -price stagnation with a possible downward adjustment (at 3-5%);
- long-term forecast (10-20 years ahead)- sustained growth with the average annual rate of 20-25% (with prices quoted in the nominal USD) and fluctuations of monthly growth rates within the range between zero and 80-100%.
The actual price dynamics in the short run mostly proved the forecast.
Figure 20. Forecast of Average Prices for Housing in the City of Moscow, Moscow Oblast and St. Petersburg
In five months after the forecast for Moscow and Moscow oblast had been calculated it is possible to note that the actual prices proved to be slightly greater than the forecasted ones, albeit their growth rates decelerated: in Moscow - from 8% in May to 6.8% - 1.5% between June and October and zero in December; in Moscow oblast - from 14% in May to 5.8% in October and zero in December; in St. Petersburg - from 11% in October to 0.7% in December.
148 Sternik G.M. Tekhnologiya analiza rynka nedvizhimosti. M., AKSVELL, 2005, - 203 p. 660
The results of forecasting the price dynamics in Moscow through late-2008 showed that one can expect stagnation on the market analogous to that noted between late-2004 and early-2005. It should last at least until autumn 2007 and comprise a 5% price adjustment (relative to June 2006), the peak of which should fall on spring 2007 (by analogue with the spring 2005 adjustment in St. Petersburg). Overall, the year of 2007 will see stability of prices with probable minor fluctuations and transition towards a new cycle of price rise since spring-summer 2008. By late-2007 the price increment rate in Moscow should be close to zero and 65-70% - by late-2008.
The forecast for other regions shows that the 2007 price situation there will be analogous to that in Moscow: they should likewise expect their increment price rates to go down to zero, while stagnation (except for Moscow oblast and St. Petersburg) is going to start a bit later. The price rise should renew since spring 2008 and by results of the year should account for 90-95% in Perm and Tver, 85-90% in Moscow oblast, N. Novgorod and Novosibirsk, 60-70% - in Ekaterinburg and Rostov-on-Don, and 55-60% in St. Petersburg
Such dynamics would emerge under the impact of numerous groups of factors, including both those that drive prices upwards and the ones that block the rise (Table 28). The factors can be consolidated into two groups - external (relative to the real estate market) factors (political, macroeconomic, and factors associated with the interaction between the real estate market and the supplier/consumer markets) and internal ones (progress with the National Program "Affordable housing", rise in the population's spatial mobility, interaction with the respective segments of the real estate market).
As concerns the factors enumerated in Table 28, one should particularly focus on the political factor associated with the upcoming 2007-08electoral cycle and the price situation on the market for energy sources, as a rise in oil prices should contribute to the contraction of the length of the period of stabilization of housing prices, while their fall would contribute to the opposite tendency.
Hence, the analysis of the development of the national market for housing allows the following conclusions:
Last year witnessed a notable price rise for housing in numerous cities (particularly in St. Petersburg, Moscow oblast, N. Novgorod and Ekaterinburg). The outcomes of the first year of implementation of the national project on housing appeared fairly positive, however, there emerged some factors which in the future might seriously inhibit it (the advanced price rise vis-a-vis growth of the population's incomes, complexities associated with granting access to sites, constraints with respect to development of the public utilities infrastructure and the construction sector, fiscal challenges facing regional and local budgets, lack of confidence between market agents caused by some real estate developers' fraudulent acts).
Table 28
The Balance of Factors Which Determine the Medium-Term Dynamics
of prices for Housing
Categories of factors
External factors
Internal factors
Groups of factors
Political
Macroeco-nomic
Impact of factors on prices
Rise
Decline
Election campaign: additional funding of regional, Duma and presidential campaigns, effective demand on the rise fueled by fees payable to political "technologists", media and show-biz .
Maintenance of high world prices forr energy sources, which entails the capital inflow. The growth in budget revenues, a 1.5- 2-fold wage rise to budgetary employees and rise of pensions to pensioners over the upcoming two years. Continuation (albeit at a slower pace) of growth in GDP and the population's real disposable incomes. Russia's accession to WTO which would boost up the inflow of foreign corporations, funds and banks' capital
Factors of interaction with the respective markets
Progress with the National Program "Affordable Housing"
Rise in the population's spatial mobility
Interaction with the respective segments of the real estate market
Advancement of the national stock market, expansion of the IPO practices, as well as those associated with receipt of bonded loans and use of other means of external and domestic borrowing that help boost the investment inflow into the real estate market
Rising volumes of government support and disbursement of mortgage loans, while maintaining the already existing high volume of offer on the secondary market. Maintenance of volumes of placement of housing in operation in Moscow in 2007 at the level 4.7-4.8m sq.m., given that roughly a half of that would be re-assigned to the municipal programs, thus lowering the volume of offer on the primary market
f
Continuation of the advanced growth in investment in retail and construction of commercial real estate objects, transport and social infrastructure, which increases attractiveness of the housing market in particular regions, cities and municipalities.
Election campaign: possible destabilization of political situation, intensification of a conflict between power and business, federal, regional and municipal authorities, which decreases the country and regions' investment attractiveness
Downfall in the world prices for energy sources results in a decline in the capital inflow. Decline (in the conditions of a lesser inflow of foreign exchange and appreciation of the RUR) of growth rates and (even a drop) of the volume of money supply, resulting in a lower capacity of the banking system with regard to disbursement of loans to real estate developers and the population. Fall in the GDP growth rates which limits the government's possibilities for solving socio-economic challenges and maintaining the population's income growth rates.
Continuation of the rise in volumes of Russian investments overseas and foreign ones - in Russia. Decline in the inflow of speculative capital in the conditions of a growing attractiveness of financial instruments in the US and Europe
Advancement of the national stock market, the rise of diverse highly profitable financial instruments, which results in the capital flow out of the real estate market to supplier/consumer ones (partly -return of the capital via the real estate-based mutual investment funds).
Continuation of the consumer boom, which helps reduce the volume of the population's savings, which are spent on buying housing.
Growing volumes of house building in regions and offer of housing on the primary market
Outflow of the population with low- and mediumlevel incomes from Moscow to the market of the nearest to Moscow towns of Moscow oblast, which results in a lower level of effective demand in Moscow.
Investment flow to the market for commercial real estate (trade, office facilities, entertainment and recreational objects, logistics complexes, technoparks, etc.) in the conditions of the declined profitability rates of house building, and government regulation of town planning policies, as well as the policy of allocation of sites on the federal, regional and municipal levels._
Today, the national housing market has found itself at the second stage of its development, which started in mid-2000. Its main characteristic is a constant price rise, with no clear collapses and crises. Since early-2007 the market has stabilized after the period of its boom. Forecasts show that 2007 should become a year of stability in Moscow, Moscow oblast and main regional centers (with possible price
adjustments at +10/-5% in some of them). In 2008 (in the aftermath of the presidential election) the stagnation should be replaced by a new stage of acceleration of the price rise rates, thus driving the annual increment up to between 60 and 100%. This does not discredit a longer-term forecast (for the period of 10-15 years), namely a sustained annual rise (in nominal USD-denominated prices) at 2025%, with its rates fluctuating between zero and 80-100%.
5.6. The Defense Economy and the Military Security of Russia
5.6.1. The Major Results of the Military-Economic Activity in the Military-Social Sphere
The year 2006 was more successful as regards the achievements in the defense sphere than the preceding years, notwithstanding certain setbacks that occurred in implementing military reform, solving the social problems of the military and equipping the armed forces with modern weapons, which will be dwelt upon later in this paper. The RF President had every reason to positively characterize the level of the State's level of security and the efforts of the RF military establishment aimed at maintaining this level. Such an assessment was given by him at a conference held at the Ministry of Defense in November 2006. Judging from what one could find in the mass media, this opinion was shared by the majority of experts.
Such views are well substantiated. Russia did not get involved in any military adventures, was performing its peace - keeping functions on the territory of the post-Soviet space, was completing the withdrawal of its forces from Georgia as demanded by this country's leadership, and sent its military bridge builders to help Lebanon in restoring its transport communications destroyed by Israeli bombing. From the point of view of the strategic nuclear deterrent of potential aggression (it should be noted that a convincing demonstration of combat readiness is essential within the framework of this strategy) the launches of land-based and airborne ballistic missiles, and also the launches of high-precision airborne non-nuclear missiles were quite important. Apart from this, as a result of successful testing, the serviceable life of some strategic missiles was prolonged. Although their number was small, some new and modernized missile complexes did, indeed, find their way to the armed forces. A considerable number (by comparison with previous years) of exercises involving ground and airborne forces, as well as a lot of exercising aimed at achieving cooperation between the RF Armed Forces and the armed forces of other states, so as to prepare them for the conduct of anti - terrorist operations, were conducted. Combat training was improved, though military specialists can still discern some elements of show, especially when the RF minister of defense personally participates in the exercises.
The guarding of the country's frontiers and coastal waters is continued to be strengthened, and sterner measures are being taken in order to stop smuggling. The personnel of the Internal Forces and the Federal Security Service succeeded in preventing, in 2006, a number of actions planned by the terrorists, and most impor-
tantly, a number of the most notorious representatives of the terrorist underground, including Shamil Basaev, were liquidated. The remnants of the bands are being dealt with exclusively by the military personnel serving under contracts.
Russia has found the necessary resources to finance all these activities. Moreover, we can observe a certain strengthening of Russia's defense economy and a successful cooperation in the sphere of military technology, which has brought significant revenues to the budget.
The personnel policy of the RF military establishment became more coherent in 2006. Some major parameters, such as the general numerical strength of the Ministry of Defense, were clarified (the current nominal numbers are 1,130,000 -to be reduced, in the future, to 1 million), and it was announced that only 1% of officer assignments should be held by top - ranking officers. It was announced that henceforth officer assignments should be held mainly by graduates of military educational establishments, and that the number of military chairs at civil educational establishments was to be drastically reduced. Since September 2006 they have remained only at 31 of Russia's high educational establishments. Some civil higher educational establishments have already started, since the beginning of this year, to prepare specialists for the military establishment. This means that it will be possible to avoid replication in preparing specialists qualified in certain types of dualpurpose technologies. The RF Ministry of Defense has introduced additional grants for the students wishing to obtain an additional military education, on condition that they would take an obligation to serve, afterwards, no less than three years on officer assignments, under a contract. It is very important for such decisions to be taken voluntarily.
At the same time, some deferments were abolished, including those for the students who have started military education at military chairs but have not completed it because of the closure of the military chairs. According to the top brass, this will make it possible to improve the quality of the draftees, including those who will serve as soldiers (or sailors). However, these persons will be drafted on an obligatory basis, which can cause some negative effects.
The traditional autumn draft of last year was the last one to entail a two - year service. In the aggregate, the two drafts of the year 2006 have embraced less persons than those of the previous years. This fact is positive. But, bearing in mind the adoption of the amendments introducing the reduction of military service for draftees to one and a half year in 2007 and to one year in 2008, it has become clear that this country's citizens under question should prepare themselves for the volume of the draft to be increased. Moreover, the year 2008 will mark the beginning of a decline in the numbers of youths entering the enlistment age.
Thus, many of the old problems of personnel policy have remained unsolved. Also, there have emerged new problems causing the actions of protest on the part of the young which are not totally unjustified. If it is to be considered, as the RF President has said in one of his messages, that the draftees will spend half a year in training units and the second half of their term of service - in regular units, what will be the good of such a service? Is it, indeed, advantageous for society and the State
to impose this service, which does not require high qualification and does not result in any rise in combat readiness, on the young specialists who have obtained higher education? The situation can be further aggravated by the fact that the sergeants and warrant officers placed in charge of the graduates of higher educational establishments will be persons serving under contracts, and having no higher education. What kind of relations will evolve between them during the period of service?
Also, there is no absolute clarity as regards the staffing of military posts with the present-day personnel serving under contracts. In the military units of permanent readiness the number of such persons was on the rise, while in other military units it was decreasing. This situation was quite predictable, because the causes of it were of a socio - economic nature, as it was repeatedly pointed out in the IET's previous reviews.
2006 was the penultimate year in the program for the transition of the units of permanent readiness to the absolutely voluntary enlistment of citizens for military service under contracts. Therefore, there exists a legitimate interest to the results achieved within the framework of the corresponding federal target program (FTP) and to the quality of its implementation.
Let us start with analyzing the achievements. The number of military units and formations of permanent readiness, manned exclusively on the contractual basis, continues to grow in the armed forces. Also significant is the fact that the persons conducting their service as draftees no longer serve in the hot spots. According to the assurances of the head of the GOMU, draft has been completely abolished in Chechnya, and now only Chechens serve there - under contracts. Thus, the problem of switching over to voluntary principle of manning the armed forces has been reputedly solved not only on the scale of the military units included in the category of permanent readiness, but also on the scale of one of the regions of Russia. However, the question as to whether the creation of purely ethnic military units is beneficial can hardly be answered in a positive way.
So far as a more detailed analysis of the quality of implementing the federal target program is concerned, the assessment of the results achieved in a number of military units inspires no optimism. It is not by chance that the FTP adopted in August 2003 was repeatedly altered last year with the latest amendments having been introduced by the RF Government's Decree No. 549, of 7 September 2006. As a result of these adjustments, the list of military units being switched over to the system of contracting has become updated, a period of probation for assessing the servicemen's fitness for service has been introduced, and material sanctions have been established for those violating the terms of a contract. The summary figures of the FTP have also been changed. Judging from these figures, it becomes apparent that the expenditures on the program have increased, while the number of servicemen being switched over to the contractual system has been decreased. Instead of the previous 147,578 posts, only 138,722 posts in Russia's military establishment are planned to be held by persons serving under contracts, including 125,359 posts in the RF Armed Forces. The rest of the posts are in the Internal Forces of the Ministry of Internal Affairs and in the Frontier Service of the FSB. And
it should be noted as an especially positive fact that it has been announced that, starting from the year 2008, this service should be completely manned by persons serving under contracts. A similar announcement has been made with regard to engineering units as well.
The assessments of what is going on considerably differ - the minister characterizes it with optimism, while his subordinates, in particular the officers of the GOMU of the General Staff, are more pessimistic. The testimony to this is a number of publications in the mass media149. The reasons for such pessimistic assessments, one of which is formulated in the title of the publication we are referring to, are very real - in fact, they have been initially programmed by the General Staff itself150. And the collapse of the contract system is near not because the funds initially planned for the realization of the FTP,and then additionally allocated for the purpose of its implementation, were not spent on increasing the attractiveness of military service under contract. These funds are being spent on the infrastructure of military camps, combat training and other undoubtedly useful initiatives. Such expenditures are certainly necessary under any system of manning the armed forces, but their financing should be carried out under appropriate items of expenditure, not related to the FTP.
The other reasons for the stalling of the FTP have been exposed by the Committees of Soldiers' Mothers. It turned out that under conditions of unpopularity of voluntary service the army had resorted to the widespread practice of forcing the soldiers serving on the basis of conscription to sigh contracts. Also, in a number of military units, privates and noncommissioned officers are subjected to extortion, and their commanders violate their rights, as evidenced by a large number of facts included in the official report of human-rights organizations151 or published in the mass media. Military registration and enlistment offices also encounter difficulties in finding appropriate personnel for the armed forces, which are caused by the fact that the average wage is growing in the majority of the regions, and it is impossible to find anybody who would agree to serve for a lower pay offered for military labor involving a lot of hardships.
Money allowance. The personnel policy of the Ministry of Defense and the other power establishments is reflected in the size of money allowance (MA) of the servicemen ,which should be the major factor capable of ensuring the attractiveness of voluntary military service. The size of a MA depends on the status of a ser-
149 Mukhin, V. Krakh kontraktnoi armii (The collapse of the contractual army) // Nezavisimaia Gazeta, 24.08.2006.
150 Vorob'ev, E., Tsymbal, V. Krakh kontraktnoi armii zaprogramirovan (The collapse of the contractual army has been programmed) // Nezavisimoe voennoe obozrenie (The independent military review), 27.10-2.11.06.
151 Vakhnina, L. V. "Lishnii soldat: Nezakonnoe ispol'zovanie truda voennosluzhashchikh po prizyvu v tseliakh, ne obuslovlennykh ispolneniem obiazannostei voennoi sluzhby" (A redundant soldier: The illegal use of labor of servicemen enlisted by conscription, for purposes not determined by the implementation of the duties of military service). A report. Moscow: Vserossiiskaia koalitsiia "Za de-mokraticheskuiu AGS" (The All-Russian Coalition "For a Democratic Alternative Civil Service", 2006. 87 pp.
viceman, on the character of functional responsibilities, and numerous other indicators. Until recently, the functional dependence of MA on these indicators had been determined by numerous documents issued at different times, and had been open to different interpretations and subsequent abuse. Therefore Order of the RF Minister of Defense, of 30 June 2006, No. 200, "On the Approving of the Procedure for the Provision of Servicemen of the RF Armed Forces with Money Allowance" (hereinafter - the Procedure for MA), which was published in late September and came into force from 1 October 2006, is undoubtedly a very positive act.
The clarification of the Procedure for MA has not been altered in its previously established fundamental principles. The calculation of MA remains unchanged:
MA=MRMA + Z APi.
In this expression, the first summand is the monthly rate of money allowance MRMA = RPMR + RPMP, which consists of the rate of pay for military rank (RPMR), related to the twenty positions of the scale of military ranks, and the rate of pay for military post (RPMP), related to the fifty so - called "tariff classes". The second summand is the sum of additions to the MRMA.
The minimum value of the RPMR is 659.54 roubles / month; a marshal's maximum of the RPMR is 2,170.05 roubles / month; the spread of nominal values is 1,710.51 roubles / month; the spread of realitive values is 4.72. Correspondingly, the spread of values regarding the officers' ranks only amounts to 1,416.91 roubles, or 2.88 times.
The spread of nominal values of the RPMP is 4,352.87 roubles / month, while that of relative values is 4.41. Correspondingly, the spread of values regarding the officers' posts amounts to 3,586.97 roubles / month or 2.76 times.
The spread of both the values of these rates of pay and their amounts correspond to the RF servicemen's traditional notions of "justice".
There is no rigid correspondence between military ranks and "tariff classes" related to military posts, and no such correspondence can ever exist. In the Procedure for MA, only the ranks and posts of the officer's contingent are set apart from the ranks and posts of the contingent of privates and noncommissioned officers (PNOC). As far as the Army and Navy warrant officers are concerned, some documents (and even laws) consider them to be in one category with the officers, some consider them separately, and some - as belonging to the category of the PNOC. Nevertheless, for purposes of a comparison analysis of the MRMA and MA, some tentative correspondence between the ranks and posts is possible - for example, as is shown in Table 29.
Table 29
MR 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
R 1 2 3 4 5 6 7 8; 9 10 11 12; 13 14; 15 1618 1922 2430 3134 3546 4748 49 50
The upper row contains the consecutive numbers in the list of military ranks -from the private to the marshal. The second row contains the values and value ranges of the posts - related "tariff classes" approximately corresponding to them.
They were used in the further calculations of the tentative sizes of MRMAs and the additional payments related to them.
As is seen from Table 20, the scales of military ranks and "tariff classes" have different density: only 9 tariff classes correspond to the 8 ranks of the PNOC, while 41 tariff classes correspond to the 12 officer ranks. They are equally different in density as regards the officer ranks: approximately 5 tariff classes correspond to the four ranks of junior officers, approximately 15 tariff classes - to three ranks of senior officers, and 20 tariff classes - to the four general's and one marshal's rank taken together. Especially large is the scale of tariff classes for colonels, majorgenerals and lieutenant-generals. It can be assumed that this situation is determined not so mush by the existence of the so-called wage-bracket categories as by the influence exerted on the distribution of tariff classes by those officials who serve in the Central Apparatus (CA) of the Ministry of Defense, because it is precisely their posts that a considerable proportion of the tariff classes relates to.
If we compare the scale of military posts with the corresponding scale of civilian civil servants, we will find an approximate correspondence between the duties and working conditions stipulated for the top echelons of officials (of ministries and agencies), and at the same time will note the apparent underestimation of the role and importance of the private (or sailor), sergeant (or petty officer) and the junior officer. The fact that their service can be much more dangerous and difficult than the corresponding civilian civil service is not reflected at all in the tariff classes accorded to them.
However, at the present time, the basic part of a MA is determined not by the size of the MRMA but by the various bonuses.
It is not by chance that the long-service bonus is placed first on the list of all the forty bonuses. In the past it was also considered to be the most justified, and therefore was both substantial and regular. It is mentioned in a federal law of the RF. And the step - like dependence of its coefficient on time in service, established by a decree of the RF Government, characterizes the former financial policy, which reflected the need to stimulate the upward promotion, in particular, of the lower echelons of the military hierarchy. As the time in service grows, the relative value of this bonus lags behind. The accounting of the long - service bonus is a matter of fact for all present-day and former servicemen. The sum of the MRMA and the first bonus represents the so-called basic monthly rate of pay (BMP). As in the case with calculating the MRMA, our assessments are based on the rated (conventional) size of this bonus, because no precise coordination between the time in service and the posts can be achieved. The BMP is especially important for military pensioners, for the size of their pensions directly depends, first of all, on the BMP.
Our analysis shows that the size of servicemen's BMP differs approximately by 11,436 roubles / month, or by 7.3 times. And this does not contradict the traditional notions of what is just (shared by the servicemen), either.
As regards the most recent bonuses, it is clear that they have most radically changed the situation. The results of the MA analysis, which takes into account the major new bonuses, are shown in Figure 18. Plotted on the X-axis are the tariff
classes, while MA (in roubles / month) are plotted on the Y-axis. The graphs characterize the discrete growth of MA with a number of bonuses taken into account. The two lower graphs illustrate the MRMA - Row 1, the BMP - Row 2.
The upper graphs characterize the MA with allowance made for the social bonuses granted to all servicemen, which are calculated in proportion to the size of a corresponding MRMA (Row 3), the MA with allowance made for the universal 100%-bonus, which is proportional to the size of a corresponding MRMA (Row 4), and also the MA with allowance made for a more considerable bonus, which is granted only to the officers and warrant officers of the Central Apparatus (CA) of the Ministry of Defense (Row 5).
Especially important for the reform of the system of recruitment are the bonuses introduced for the servicemen of permanent-readiness units in connection with their switching - over to the contractual system. For the whole of Russia, they are characterized by the graph denoted as Row 6, while for Chechnya - by the graph denoted as Row 7.
It should be noted that it is precisely the difference in the size of MA, illustrated by the three latter graphs (as listed in the text), that most strongly dissatisfies the servicemen. And the case in point is not only the fact that the size of MA for the top brass (close to the 50th tariff class) has increased dramatically, but also that a warrant officer serving in the CA (the 8th tariff class) receives the same MA as his "equal in rank" in Chechnya, and his MA is larger than that received by many officers in regular forces (up to the 16th tariff class). The dissatisfaction among the servicemen has become known to the leadership. It is not by chance that the Army's mass media152 have published the information that the minister of defense has already instructed military financiers to start developing a new regulation concerning MA.
However, the problem of increasing the attractiveness of voluntary service under a contract must be solved immediately, without waiting for this new regulation to become ready, because servicemen will compare the MA of a military man serving under a contract with the average wage at the present-day Russian labor market, which has already exceeded 11 thousand roubles. Given the existing level of MA, neither the young people in general nor those who are to decide whether to prolong their contracts will have any financial incentive to serve in the ranks.
152 Shal'nev, E., Shcheblanin, V. Preiskurant na spravedlivost' (A price - list for justice) // Krasnaia Zvezda. No. 201. 31.10.2006.
Figure 21. The size of money allowance of servicemen in accordance
with the tariff class
Also, there exists a rather specific but very acute personnel problem - the training of personnel for the defense-industrial complex (DIC). At the present time, its employees of all levels (workers, technicians, engineers, designers of the highest qualification) have, on the average, reached the age limit - both with regard to pension parameters and the nominal duration of life in the RF. The search for solutions to the problem is continuing. One of the most interesting solutions currently under consideration153 is the creation of university complexes, including vocational training schools, specialized secondary schools, higher educational establishments, and centers of post-graduate education and branch science. As a result, there will emerge a single system of "installed" educational standards, which will envisage a contest-based transition of the students from one stage of education and practical activity to another. However, it is far from being certain that the leading educational establishments of the country will be able to rapidly switch over to this corporate system of education. This will require the pooling of the administrative and financial resources of various agencies and the management of the DIC's enterprises with different forms of ownership.
Housing. There is yet another potentially important incentive for military service which is still waiting to be materialized, that is, the provision of housing for the military personnel serving under contracts. This problem is being solved in the RF in a number of ways. Firstly, with the help of state residential construction (SRC) -for those who have been dismissed with a commitment to provide them with residential property. At present, the average rate of the value of one square meter of housing being used for calculating the cost of SRC amounts to 17,640 roubles. In Moscow, the upward coefficient is 1.2. Many servicemen justly complain that such norms infringe their interests and encroach on their rights. The second way - the provision of residential property for those who have been serving in the armed forces for a sufficiently long period of time. The third way is to provide temporary (service) housing for those who have signed their second contract since the year 2004.
In general, so far as the solution of the housing problem is concerned, the year 2006 can be considered more successful than all the previous ones. Even some additional resources were allocated - from the reserve fund of the RF President. While the situation which accompanied the withdrawal of troops from Germany in the 1990s was clearly lamentable, the personnel of the former garrison of Tbilisi, including 329 servicemen and 220 civilians, were provided with housing -this situation can be considered highly positive. Everybody was promised housing, including 92 officers out of 132, 16 warrant officers out of 49, and 28 servicemen serving under contracts who had decided to get demobilized.
The beginning of the materialization of the funded mortgage system (FMS) was disappointing. The Ministry of Defense, who had taken the allotted monies under its control, did not manage to efficiently place these funds. In 2005, 22.6 thou-
153 Ipatov, O. Gde vziat' kadry dlia oboronnoi otrasli? (Where can we get the personnel for the defense industry) // Voenno-promyshlennyi kur'er (The military-industrial messenger). No. 43. 14.11.2006.
sand persons became participants of the FMS, and 1,031 billion roubles was allotted for them, but it was only at the very end of 2006 that a contest between the asset managers was organized at the Ministry of Defense for the purpose of concluding the agreements of trust management of the servicemen's savings.
For the year 2006, it was planned to allocate 3,209 billion roubles to the FMS fund154. The leadership of the Ministry of Defense announced that it had selected 10 companies, had divided the savings among them on the principle of equality, and had introduced the index of fixed returns. But by the end of 2006 the Ministry of Defense had not announced any growth of the monetary means coming to the FMS fund. The attractiveness of the FMS in the eyes of the military had fallen sharply. In this connection, the Ministry of Defense and the Ministry of Finance issued a joint decision to the effect that, starting from the year 2007, the funded contribution should be increased to 82,700 roubles per year per each servicemen taking part in the FMS155.
The solution of the problem of providing the servicemen with service housing has been altogether postponed to a later period - that until 2012. The situation is further aggravated by the fact that, according to the Clearing House's auditor A. Piskunov, "while the existing demand is for 480 thousand apartments, today the military establishment lists more than 700 thousand apartments in its fixed assets. But about 70% of these apartments are occupied by persons totally unrelated to the Armed Forces"156.
5.6.2. The Major Results of the Military-Economic Activity Aimed at the Technical Equipment of the Armed Forces
The problems of material and technical equipment of the RF military organization and of the DIC development have recently become a major priority for the military and political leadership of the State.
Last year, the ratio between the RF Ministry of Defense's expenditures on the current upkeep of the Armed Forces and on their military equipment amounted, approximately, to 60: 30. In the past, this ratio was 70: 30, and the scope of progress makes it possible to hope that the planned level of 55.8: 44.2 can be achieved in 2007. However, as is shown in our report for the year 2005, the reputed optimality of this ratio has never been justified, nor is it confirmed by the practice of development of the armed forces abroad.
One could note a positive dynamics of the priority rates of expenditures on purchasing armaments and military and special equipment. As regards the manufacturing of military - purpose products (MPP), the work load of enterprises grew by 40%, and 75 thousand work places were additionally organized during the past
154 Yurov, D. Nakopitel'no - ipotechnaia sistema vystraevaetsia (The funded mortgage system is taking shape) // Krasnaia Zvezda. No. 241. 28.10.05.
155 Ipotechnye vznosy uvelichatsia [Mortgage contributions will increase] // Voenno - promyshlennyi kur'er (The military - industrial herald). No. 43. 8 November - 14 November 2006.
156Garavskii, A. U oborony schet osobyi (Defense calculates differently) // Krasnaia Zvezda. No. 3. 22.02.06.
five years157. But as in the past, the core of the DIC is represented by approximately 1,280 enterprises and organizations in 72 subjects of the Federation. Of them, federal state unitary enterprises account for 58%, joint - stock companies with a state -owned block of shares of no less than 50% - for 19 %, and joint-stock companies with a state-owned block of shares of less than 50 % - for 23 %. The register includes 63 enterprises of the RF Federal Agency for Nuclear Power (ROSATOM) and 191 enterprises of the Ministry of Defense158.
Nevertheless, the noted positive trends do not prevent the continuing ageing of the complex. The problem of its restructuring, the completion of which had been planned for the year 2006, was not solved. The state of the Defense-Industrial Complex's enterprises, the character and rates of their "development", and also the methods of building relations with their major customers (the State's power structures) are such that they are starting to pose a serious danger to the national security of the country. The technological and personnel degradation of the Defense-Industrial Complex can reach such a level that the lagging behind of Russia's Armed Forces in the sphere of technical equipment, in conjunction with its enormous territory and immense natural resources, would create combined preconditions for the emergence of military threats, which are as yet hidden.
And yet another circumstance should also be noted. The growth in expenditures on armaments and military equipment from 80 bn roubles in 2002 to 237 bn roubles in 2006, and the planned 302 bn in 2007, is not proportional to the growth in the level of availability of these armaments and equipment to the RF Armed Forces, especially when comparing the expenditures and the growth rate of production in Russia itself. It should be noted, for the sake of justice, that Russian armaments are still very popular in the world. The share of Russian exports on the international arms market amounts to 15%, or 6 bn USD.
After having noted that the volume of the state order for defense items for the year 2006 nearly by two times exceeds the annual volume of export of Russian armaments159, A. Piskunov, as an auditor of the Clearing House, puts a justified question: "Why until now we have been manufacturing more products, and frequently of better quality, for the foreign customer than for our own Armed Forces, whereas the costs are similar?"
The causes of this situation are differently explained by a number of specialists, whose access to information and whose levels of competence and responsibility also differ considerably. Thus, the Chief of the RF General Staff, Baluevskii, considers that the Army is unlikely to obtain armaments it needs, because "there is no coherent military-technical policy"160. But if any military-
157 Avdeev, Yu. "Oboronka" poka v oborone (The defense-industrial is still on the defensive // Kras-naia Zvezda. No. 214 (24734). 21.11.2006.
158 Chistova, V. E. Ekonomicheskoe upravlenie razvitiem oboronno-promyshlennogo kompleksa Rossii (The economic management of Russia's defense - industrial complex) / Doctor of Economic Sciences V. V. Bandurin, Ed.: Moscow: The "Krasnaia Zvezda" Publishing House. 2005.
159 Miasnikov, V. Voenno - promyshlennuiu vertikal' ukrepili slabym zvenom (The military-industrial vertical has been strengthened by a weak link) // Nezavisimoe voennoe obozrenie (The independent military review). 07.04.2006.
no coherent military-technical policy"160. But if any military-technical policy is missing, what are the rapidly growing allocations being spent on? The number of possible answers to this non-rhetorical question is limited. Answer 1: the armaments and military equipment are being purchased at enormously inflated prices, and therefore the expenditures are growing much faster than the level of availability of these armaments and equipment. Answer 2: we are witnessing a large - scale embezzlement of public funds. According to the RF Clearing House, the total sum of financial violations perpetrated between 1999 and 2002 amounts to 15.8 bn161. In all likelihood, both answers are correct.
At the All-Russian Scientific and Practical Conference "The Prevention of Bankruptcy of Strategic Enterprises and Organizations: the Practice and Problems", held in Moscow on the 25th-26th of April, the major cause of the negative financial and economic state of the defense industry's enterprises was found to be the low level of workload, amounting to just 40%. At the same time, in some industries, the workload under the state order for defense items amounts to between 9% and 30%. According to the Conference's participants, it is precisely this phenomenon that causes the uncontrollable growth in the prices of defense products, because all overhead expenses incurred by a given enterprise are included in the value of a limited output of products.
According to the Federal Tax Service, 198 strategic enterprises and organizations are displaying some or other signs of bankruptcy, and 170 of them are the DIC's enterprises. The tax authorities have issued orders that the arrears accumulated by 150 strategic enterprises should be recovered from them at the expense of their property. One third of the enterprises in the defense industry - which are strategic enterprises exceptionally important for Russia's security - can be sold at auctions either in whole or in part162. The RF Clearing House is also pointing to the clear discrepancy between the results of growth of the country's military potential and the rise in expenditures on defense163.
There exist some other objective and subjective problems associated with planning and implementation in the sphere of development and production of military - purpose products (MPP). The major ones are as follows: - the hard - to predict changes in the forms of ownership of the enterprises and organizations fulfilling the state order for defense items;
160 Sergeev, O. L. Monopolizm, lobbizm i otsutstvie chetkoi voenno-tekhnicheskoi politiki (Monopolism, lobbyism and the absence of a clear military-technical policy) // Nezavisimoe voennoe obozrenie (The independent military revie). 12.05.2006.
161 Miasnikov, V. Na vysote v armii - vorovstvo (The only thing which is up to the mark in the army is larceny) // Nezavisimoe voennoe obozrenie (The independent military review). No 16 (4114). 19.05.2006.
162 Miasnikov, V. Voennaia promyshlennost' spolzla za gran' bankrotstva (The military industry has slid beyond the verge of bankruptcy) // Nezavisimoe voennoe obozrenie (The independent military review). 28.04.2006.
163 From the audit of resources to the audit of results // Rossiiskaia Gazeta (The Russian Gazette. No 148 (4114). 11.07.2006
- the vagueness of the prospects of development of the DIS's enterprises as such;
- the irregular financing of the state order for defense items (SODI);
- lobbyism in combination with monopolism;
- the high corruption level of the processes surrounding the allocation of budget funds;
- the level of managerial culture of the enterprises' CEOs, which is inconsistent with market relations;
- the moral and physical ageing and deterioration of basic production assets;
- the ageing of the personnel of the DIS's enterprises, the lack of a sufficient inflow of young specialists, and the lack of skilled workers - all this against the background of a general population decline;
- the low level of innovation activity;
- low productivity;
- low capital productivity.
The task of improving the situation with the DIC has been delegated to the Military-Industrial Commission (MIC) created by the RF President's decree and headed by Vice-Prime Minister Sergei Ivanov. It has been announced that the most important function of the Commission will be to consider "the issues concerned with the efficiency of the use of federal budget funds for the purpose of ensuring the country's defense, the carrying out of law-enforcement activity, and the safety of the State..."164. The new structure has broad functions, powers and rights, but the area of its responsibility is rather vague. The traditional balancing of any managerial structure in the triad of "rights-duties-responsibility" is clearly biased in favor of "rights", while the responsibility - for the analytic and expert's maintenance of the Commission's activity is vested only in the chairman of the MIC's scientific and technical council.
On 14 October 2006, the President of Russia approved the State Program of Armament (SPA) for the years 2007-15. The SPA is the major planning document, which determines the long - and medium- term development (for 10 and 5 years respectively) of armaments and military equipment (AME). It represents the basis for mapping the programs and plans of development of the defense industry, while the state order for defense items, which is a document of short - term planning, must correspond, in its major parameters, to the Program's annual profile. For the years 2007-15, about 5 trillion roubles is to be allocated from the federal budget for the purpose of implementing to the State Program of Armament. It is planned to spend nearly two thirds of these funds (63%) on purchasing some new types of AME. In order to increase the efficiency of using these funds, a Center for orders and deliveries of armaments, military equipment and special materiel is being organized. In 2007, a Federal Agency for the Purchasing of Armaments, Military Equipment, Special Materiel and Means of Support will be created on its basis.
164 The Statute on the Military-Industrial Commission attached to the Government of the Russian Federation. Approved by Decree of the Government of the Russian Federation, of 7 May 2006, No. 278.
Also, there exists a federal service for managing the state order for defense items, which is designed to control and supervise the spending of the budget funds of the state order for defense items.
By and large, the measures being taken by the military leadership are rather ambiguous. Most likely, it is expected that the creation of the so-called "managerial board of a single customer", which represents the corresponding federal structures, will make it possible to take some positive steps towards a reasonable standardization of armaments and military equipment for the country's military establishment as a whole. However, the creation of vertically integrated industrial structures, on the one hand, results in monopolization and an inevitable growth of the price of military equipment, while on the other hand - in the increase of managerial costs and in a considerable part of income being uncontrollably managed by the asset managers in charge of these structures.
5.6.3. Military Expenditures of the Federal Budget
The federal budget for the year 2006165, including the State's military expenditures, was signed by the RF President on 25 August 2006, which, in principle, made it possible for the government to start implementing it from the very beginning of the year. However, the procedure for implementing the budget166 was determined only in late February, which, in its turn, gave rise to all the differences that accompanied, throughout the year, the attempts to timely implement the federal budget. In spite of this, as a result of the two changes introduced in July and December, the federal budget's expenditure was increased from 4 trillion and 270 bn roubles to 4 trillion and 431 mln roubles, respectively167, or by 3.8%. At the same time, the expenditures under the Section "National Defense" grew by 3.0%, and under the Section "National Security and Law-Enforcement Activity" - by 2.7%.
The values of the major military-expenditure items, in accordance with the final version of the federal budget, are shown in Tables 30-33 in 2005 prices.
Table 30
Direct Military Expenditures of the Federal Budget under the Section "National Defense"
Sections and subsections 2006, mln roubles / same in 2005 prices Change in 2006, by comparison with 2005, mln roubles / growth in % Share of expenditures, in % / change by comparison with 2005, in p.p.
in 2006 federal budget to GDP
1 2 3 4 5
National defense 686, 148 629,494 51, 143 8.12 15.48 -0.86 2.52 -0.23
Armed Forces of Russian Fed- 515, 363 51, 997 11.63 1.89
eration 472, 810 11.00 -0.26 -0.11
Mobilization - related and mili- 3, 517 -438 0.08 0.01
tary training for civilians 3, 226 -13.58 -0.02 0.00
165 Federal Law "On the Federal Budget for the Year 2006", No. 189-FZ.
166 Decree of the RF Government, of 22 February 2006, No. 101, "On the Measures Aimed at Implementing the Federal Law "On the Federal Budget for the Year 2006".
167 Federal Laws No. 136-FZ, of 26 July 2006, and No. 197-FZ, of 1 December 2006. 676
1 2 3 4 5
Preparation of economy for 3, 500 -289 0.08 0.01
mobilization 3, 211 -9.00 -0.02 0.00
Preparation of and participation in ensuring collective security and peace - keeping activity 60 55 -5 -9.01 0.00 0.00 0.00 0.00
Nuclear weapons complex 11, 430 10, 486 1, 793 17.10 0.26 0.01 0.04 0.00
Implementation of international obligations in sphere of military - technological cooperation 5, 943 5, 452 -663 -12.17 0.13 -0.04 0.02 -0.01
Applied research in sphere of 93, 271 -3, 832 2.10 0.34
national defense 85, 570 -4.48 -0.42 -0.01
Other items in sphere of na- 53, 064 2, 580 1.20 0.19
tional defense 48, 683 5.30 -0.10 -0.03
Source: IET estimates based on the data of Federal Laws No. 141-FZ, of 4 November 2005, and No. 197-FZ, of 1 December 2006.
Table 31
Direct and Indirect Military Expenditures under Other Items
of the Federal Budget
Sections and subsections
2006, mln roubles / same in 2005 prices
Change in 2006, by comparison with 2005, mln roubles / growth in %
Share of expenditures, in % / change by comparison with _2005, in p.p._
in 2006 federal budget
to GDP
Expenditures on military establishment under Section "National security and Law-Enforcement Activity"
Internal forces Security agencies
Frontier - service agencies
Recruitment, combat training, and material and technical support of Ministry for Emergency Situation's forces, and civil defense
38, 425 8, 292 0.87 0.14
35, 252 23.52 0.11 0.01
92, 818 17, 597 2.09 0.34
85, 154 20.67 0.19 0.02
50, 839 10, 594 1.15 0.19
46, 641 22.71 0.13 0.02
29, 739 4, 160 0.67 0.11
7, 2 284 15.25 0.02 0.00
Expenditures on military establishment under Section "Interbudgetary Transfers"
Federal subsidies, subventions and interbudgetary transfers Closed administrative and territorial units
16, 837 15, 447
-284 -1.84
0.38 -0.06
0.06 -0.01
Source: IET estimates based on the data of Federal Laws No. 141-FZ, of 4 November 2005, and No. 197-FZ, of 1 December 2006.
Table 32
Indirect Military Expenditures Related to Previous Defense Activity
Sections and subsections
Pension provision (Ministry of Defense) Sub - program "State Housing Certificates) for 2004 - 2010
2006, mln roubles / same in 2005 prices
78, 484 72, 004
7, 959 7, 302
Change in 2006, by comparison with 2005,
mln roubles / growth in
%
-684 -0.95
-2, 906 -39.80
Share of expenditures, in % /
change by comparison with 2005, in _p-p_
in 2005 federal budget
1.77 -0.28
0.18 -0.11
to GDP
0.29 -0.06
0.03 -0.02
Source: IET estimates based on the data of Federal Laws No. 141-FZ, of 4 November 2005, and No. 197-FZ, of 1 December 2006.
Table 33
The Aggregate Indices of Military and Associated Expenditures
Type of expenditures
Total expenditure, mln roubles
Share of expenditures, in % / change by comparison with 2005, in p.p.
in 2006 federal budget
to GDP
Aggregate direct military expenditures
Aggregate direct and indirect military expenditures related to current and previous defense activity Total expenditure on national defense, law-enforcement activity, and ensuring of state security Total direct and indirect federal expenditure related to current and previous defense and law-enforcement activity and ensuring of state security_
914, 807 1, 001, 250 1, 242, 485
1, 376, 371
20.65 -0.48 22.60 -0.87 28.04 -1.16
31.06 -1.61
3.36 -0.20 3.68 -0.28 4.56 -0.36
5.06 -0.45
Source: IET estimates based on the data of Federal Laws No. 141-FZ, of 4 November 2005, and No. 197-FZ, of 1 December 2006.
In conclusion of the analysis of budget funds allocation to purpose-oriented items and types of expenditure, it should be noted that, up to now, this allocation has been absolutely unrelated to the aims of military - sector development, the aims of budgeting and the problems being solved.
In the year 2006, the developers of the federal budget continued the tradition of increasing the secrecy of expenditures (see Table 34), as a result of which this secrecy grew not only in quantitative (on the whole, the percentage of classified expenditures rose from 11.3 to 11.8%) but also in qualitative terms - in the draft federal budget for the year 2007, classified expenditures appeared, for the first time, under the item "Interbudgetary Transfers" and under the sub-item "Applied Scientific Research in the Sphere of National Economy" of the functional classification of federal budget expenditures.
Table 34
The share of the classified expenditures of the 2003-2006 federal
budgets, in %
Code and name of item (or sub - item) that contains classified expenditures 2003 2004 2005 2006
1 2 3 4 5
Total expenditure of federal budget 9.73 9.83 1 1.33 11.80
01 ISSUES OF NATIONAL IMPORTANCE n/a 168 n/a 3.67 6.28
0108 International relations and international cooperation 31.88 18.04 - 0.01
0110 State material reserve 97.73 93.3 82.86 89.23
0111 Fundamental research - - 2.13 1.22
0115 Other issues of national importance n/a n/a 0.05 0.72
02 NATIONAL DEFENSE 37.22 38.40 42.06 42.77
0201 Armed Forces of Russian Federation 35.39 36.11 33.07 35.59
0203 Preparation of economy for mobilization 100.00 100.00 100.00 100.00
0204 Preparation for and participation in ensuring collective security and peace - keeping activity - - 100.00 100.00
0205 Nuclear weapons complex 100.00 100.00 100.00 100.00
168 Not applicable, because of changes in the structure of budget classification. 678
1 2 3 4 5
0206 Implementation of international obligations in sphere of national defense 100.00 41.05 45.22 46.90
0207 Applied scientific research in sphere of national defense n/a n/a 98.37 93.94
0208 Other issues in sphere of national defense n/a n/a 2.49 8.79
03 NATIONAL SECURITY AND LAW-ENFORCEMENT ACTIVITY 23.33 20.79 28.52 31.64
0302 Internal security agencies 3.40 3.01 4.76 6.31
0303 Internal forces 13.21 11.10 1 1.76 10.31
0306 Security agencies 100.00 98.91 97.80 95.49
0307 Frontier service agencies 19.73 22.88 100.00 98.97
0309 Prevention and liquidation of consequences of emergency situations and natural disasters, civil defense 43.69 41.74 59.02 62.39
0311 Applied scientific research in sphere of national security and law-enforcement activity n/a n/a 73.95 66.41
0313 Other issues in sphere of national security and law-enforcement activity n/a n/a 8.26 50.71
04 NATIONAL ECONOMY n/a n/a 0.05 0.02
0402 Fuel and power engineering 15.65 - - -
0411 Other issues in sphere of national economy n/a n/a 0.12 0.08
05 HOUSING AND UTILITIES SECTOR n/a n/a - 3.42
0501 Housing sector n/a n/a - 4.22
07 EDUCATION - - 2.76 2.69
0701 Pre-school education - - 2.03 2.17
0702 General education - - 1.51 1 .91
0704 Secondary vocational education - - 1.06 1.03
0705 Retraining and advanced training - - 16.85 15.78
0706 Higher vocational education - - 3.15 2.93
0709 Other issues in sphere of education - - 0.30 0.33
08 CULTURE, CINEMATOGRAPHY AND MASS MEDIA - - 0.17 0.17
0801 Culture - - 0.14 0.10
0804 Periodical press and publishing houses - - 13.46 7.45
0806 Other issues in sphere of culture, cinematography and means of mass communication - - 0.02 0.15
09 PUBLIC HEALTH CARE AND SPORT - - 4.30 3.99
0901 Public health care - - 5.61 4.66
0902 Sport and physical culture - - 0.28 0.26
Source: IET estimates based on the data of the 2003-2006 federal budgets (the data for the years 2003-2006 are presented under the corresponding items and sub-items of the existing budget classification).
There can be no doubts that this well-illustrated growth in the extent of secrecy of the federal budget has diminished the efficiency of the system of state administration and has reduced the transparency of the Russian economy as a whole. The declassification of these expenditures after the example of civilized states could help society in understanding the essence of many of the problems faced not only by the defense industry (and particularly by the defense-industrial complex), but also by the Russian economy in general.
The data concerning the implementation of budget expenditures are based on the Federal Treasury's monthly reports on the implementation of the consolidated budget and are presented in Table 35 and Fig. 20. And these data, in their turn, are absolutely unrelated to the aims of developing the military sector and to the problems which have been dealt with in this connection.
Table 35
Implementation of military and associated expenditures of the federal budget 2006, by month, bn roubles
Expenditure items
m u.
c
* o
si
>
n E
d e d n e m
ra (O
o o
m ■
m
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ra 5
i s
« O)
ra 2
p
<
>
ra S
> 3
s u w u
<
e
■O
m e
t p
e
W
3
r r n
r e e ■Q e ■D
.a m m 2 S
0 t e e np
u > U S »
O 0 z e Q O k. Ee >
0
2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
National defense 666.0 686.1 22.5 43.8 73.1 58.3 55.2 59.1 48.3 46.5 39.7 50.4 51.3 133.6 4.35
RF Armed Forces 497.8 515.4 20.0 34.7 53.4 43.3 41.6 44.9 37.3 36.1 32.2 36.9 40.1 91.9 3.01
Mobilization-related
and military training for 5.2 3.5 0.0 0.1 0.4 0.1 0.3 0.4 0.2 0.3 0.2 0.3 0.4 0.6 0.25
civilians
Preparation of economy for mobilization 3.5 3.5 0.0 0.1 0.2 0.3 0.4 0.6 0.1 0.7 0.2 0.5 0.3 0.2 -0.04
Preparation of and
participation in ensur-
ing collective security 0.1 0.1 - - - 0.0 0.0 0.0 - 0.0 0.0 0.0 0.0 0.0 -
and peace-keeping
activity
Nuclear weapons complex 11.4 11.4 0.8 3.3 0.4 0.7 0.6 1.0 0.8 0.9 0.4 0.6 0.6 1.5 -
Implementation of
international obliga-
tions in sphere of mili- 6.1 5.9 0.8 0.0 0.2 0.8 0.0 0.1 0.9 0.1 0.4 1.3 0.2 0.4 0.70
tary-technological
cooperation
Applied research in
sphere of national 92.9 93.3 0.6 3.7 11.5 8.8 8.6 8.7 5.5 5.5 3.6 5.7 3.4 27.5 0.23
defense
Other items in sphere of national defense 49.0 53.1 0.2 2.0 7.2 4.3 3.9 3.3 3.6 3.0 2.6 5.1 6.3 11.5 0.20
National security and
Law-Enforcement 541.6 556.3 27.9 36.3 43.9 43.1 39.9 47.3 42.4 42.3 43.7 44.8 48.4 90.2 6.10
Activity
Internal forces 35.8 38.4 1.3 2.5 2.9 2.8 2.7 3.3 3.0 3.8 3.0 3.5 3.6 5.9 0.04
Security agencies 91.7 92.8 5.1 5.9 7.1 7.2 6.0 7.0 7.6 6.5 7.1 7.8 7.9 16.3 1.28
Frontier-service agencies 45.0 50.8 1.7 3.1 3.0 3.8 3.6 3.4 4.0 3.5 3.5 4.3 5.0 9.8 2.04
Prevention and liquida-
tion of consequences
of emergency situa- 29.6 29.7 1.6 1.9 2.4 3.4 2.8 2.2 2.1 2.5 1.9 2.3 2.4 4.3 0.02
tions and natural disas-
ters, civil defense
Applied research in
sphere of national security and law- 3.6 3.6 0.2 0.2 0.2 0.2 0.2 0.3 0.2 0.2 0.3 0.3 0.4 0.8 0.02
enforcement activity
Other issues in sphere
of national security and law-enforcement activ- 2.7 3.4 0.2 0.2 0.2 0.4 0.2 0.1 0.9 0.1 0.2 0.2 0.2 0.5 0.01
ity
Source: IET estimates based on the data of the Federal Treasury.
Source: IET estimates based on the data of the Federal Treasury.
Figure 22. Implementation of expenditures on the development and upkeep of the Armed Forces of the Russian Federation in 2006
In May 2006, quite unexpectedly, the statistics on Russia's military expenditures became the focus of public attention. During the discussion that began after the annual President's message to the Federal Assembly, the quality of the statistical data on which the message was based became the object of sharp criticism, voiced by several professional economists, and thus certain doubt was cast not only on the political conclusions drawn from those data, but also, to a certain degree, on the legal competence of the Russian state mechanism169.
First of all, it should be noted that the terms "defense expenditures" and "military budget", which were treated as their meanings were identical both in the RF President's message and by the participants in the discussion, do, in fact, somewhat differ in their meaning and are not used, in principle, in the Russian documents concerning state administration. While the former one may, quite logically, be identified with the expenditures listed in the federal budget's section "National defense", the circumstances behind the latter are more complicated: although the military budget does not explicitly exist in the form of a document, the existence of a certain category of military expenditures, including, among other items, also the
169 See, e.g., the transcript of the live interview with A. N. Illarionov, posted at http://echo.msk.ru/programs/exit/43418/.
aforesaid expenditures listed under "National defense", is generally recognized, although there does not exist any universal standard as to what exactly should be long to that category.
Thus, the statistics on military expenditures, published by the NATO and the Stockholm International Peace Research Institute (SIPRI) and being made use of by a number of other international organizations (e. g., the World Bank), include the expenditures on the upkeep of the armed forces and the ministries of defense, including the money allowance of the military, the salaries of civilian employees and military pensions, current exploitation costs, costs of combat training, purchases of armaments and military technologies, their modernization, research and development, and capital construction. In this connection, the following items are not listed as part of military expenditures: the costs of civil defense, as well as the costs associated with military activities in the past-additional allowances to veterans of military operations, expenditures on the conversion of the military industry and the utilization of weapons.
For a number of years already (since 1998), the IET, when analyzing the statistical data on Russia's military expenditures, has been applying their definition introduced by UNO Resolution No. 35/142 B of 12.12.1980, and, similarly to the NATO and the SIPRI, has been taking into account all the expenditures on state paramilitary formations. However, in contrast to those organizations, we place the costs of civil defense in the category of military expenditures, because civil defense within the UNO's 1993 System of National Accounts is included in the section "Defense" of the functional classification of budget expenditures. Besides, the expenditures on the military industry and the utilization of weapons are also recorded as military expenditures.
With due regard to all these circumstances, we are now going to address once again the comparisons between defense expenditures of different countries. In Table 36, some data on the defense expenditures in 2006 in several NATO member states are shown.
Table 36
Defense expenditures in some NATO members in 2006
in national currency in % of GDP by parity of purchasing capacities, $ bn
UK 29.9 bn 2.3 55.1
US $ 511.1 bn 3.8 511.1
France T43.2 bn 2.4 54.0
Source: NATO - Russia Compendium of Financial and Economic Data Relating to Defense: NATO Press Release (2006) 999 — 18 December 2006. — P. 5,7.
Russia's allocations earmarked for the section "National defense" (2.5 % of GDP), indeed, differ only slightly from the defensey expenditures of the UK and France. However, due to the already noted discrepancies in terminology (NATO's defense expenditures, in fact, are fully compatible with the SIPRI's definition of military expenditures and incorporate military pensions and the costs of the upkeep of paramilitary formations), no direct comparison can be possible here.
When comparing defense expenditures, as they are understood in Russia, with those of NATO, it should be borne in mind that to the former the allocations earmarked to military pensions should be added, at least (in 2006, depending on the strictness of the approach being applied, these amount to 0.29-0,46% of GDP), which will already yield 2.81-2.98% of GDP instead of 2.5%.
And if the expenditures on the Internal Forces of the Ministry of Internal Affairs and the civil defense forces are also taken into account, then the share of Russia's military expenditures will become much higher than the corresponding expenditures of the UK and France (3.68% of GDP - see Table 33) and quite comparable to those of the USA. In absolute terms, with due regard to the purchasing capacity parity170, the Russian military expenditures become equal to $ 69,8 bn, which is by no means less than those of the USA by 25 times, or even by 10 times ...
Unfortunately, the "terminology" problem described above, which reveals itself mainly in domestic political dealings, is not the only serious problem relating to the national statistics on military expenditures.
Alongside the secrecy of federal budget expenditures, which is described above, and the degree of which has been constantly growing in recent years, since 2005 a new problem has emerged, which has to do with the transfer of a certain part of military expenditures to the budget's other sections and has resulted from the adaptation of the Russian budgeting practices to the international standards. There can be no objections whatsoever against the necessity of the latter - it is the actual implementation of this transfer that has given rise tocertain questions. Why, for example, secret expenditures have been moved to "peaceful" sections? Is it because the costs of the upkeep of servicemen and of the construction of military objects have been transferred there? How did it happen so that in 1998 the expenditures on public education and public health care, listed in the section "National Defense", constituted only 0.01% of GDP, while in 2006 the military expenditures on public health care, sports and public education became as high as 0.26% of GDP, being already outside of the section "National defense" ?
The estimated volumes of military-type allocations transferred to another sections of the federal budget (housing construction excluding) are shown in Table 37. For 2006, this will amount to 0.27% of GDP. Chairman of the Defense Committee of the RF State Duma, V. M. Zavarzin171, estimated the volume of military expenditures hidden in other sections of the 2006 federal budget 2006 as being equal to 132 bn roubles (or 0.54% of GDP), which can serve as yet another confirmation of the existence of this problem.
170 As estimated by the IET (linear trend of the Rosstat's statistics) - 14.34 roubles/USD in 2006; Rossiiskii statisticheskii ezhegodnik [Russian Statistical Yearbook] 2005: Coll. stat./ Rosstat. - M., 2006. - P. 785.
171 Voenno-promyshlennyi kur'ier [Military-Industrial Courier]. - 2006. - 12 - 18 April (No. 14). - P. 7.
Table 37
Military-type allocations transferred to other sections (Рз) of the functional classification of the federal budget after 2004, bn roubles, in current prices
P3 2005 2006
On the whole by other sections, 52.5 65.4
including:
Housing and utilities 5 1.5 1.7
Public education 7 31.9 38.5
Culture, cinematography and mass media 8 1.1 1.4
Public health care and sports 9 19.6 23.8
Source: IET estimates based on the data of Federal Laws No. 141-FZ, of 04.11.2005, and No. 197-
FZ, of 01.12.2006.
No less serious has become the problem of off-budget revenues and expenditures of the military organization. The improvised "investment schemes" devised in order to find solutions to the problem of housing, commercial flights of military transport aviation, commercial training at military educational establishments, commercial medical services provided by military outpatient units, hospitals and sanatoria, etc. are all contrary to the direct instruction issued by the RF President, being a constant source of abuses due to the complete lack of transparency of this area of the financial and economic activity of the Ministry of Defense, amd other military-type structures.
5.6.4. Current trends in the development of the RF's military economy and possible ways to find solutions to the military-economic problems
The year 2006 saw a continuing inflow of above-plan "underestimated" revenues - a total of approximately 1.5 trillion roubles. A substantial portion of these was transferred to the Stabilization Fund, the other part was distributed by the RF Government among the recipients of budget funding and spent as believed best by state officials, and then was entered in the federal budget in the form of amendments (ex post). Thus, to the needs of the Ministry of Defense, in excess of the approved budget, 17,6 bn roubles were allocated (see above the data on the implementation of the federal budget in the part of military expenditures, with later adjustments). Approximately the same strategy can be expected in 2007, and perhaps in later years, too. This is what determined the current trends. Below, we are going to discuss them along several directions.
1. Personnel policy
In the present context it has become impossible to affirm that the State does not have 30 bn roubles for increasing the MA of the servicemen serving under contracts at the lower levels of the military hierarchy (PNOC and junior officers), and therefore for improving the personnel policy, stimulating the transition to the new system of recruiting. And this shop talk has stopped altogether. There remains only one argument previously voiced by the head of the Main Administration for Mobili-
zation Organizing under the General Staff: "...in my opinion, conscription, as such, effectively unifies the nation"172.
Judging by the amendments to RF legislation adopted in 2006, the idea of "unifying the nation" by way of conscription (which is, in fact the idea of facilitating the illegal enrichment of corrupt officials who are exploiting the deficiencies of the recruitment system and the population's fear of the army based on conscription) is not going to be abandoned. This means that social tension will be steadily increasing, unless protest actions of the citizens in the course of the electoral campaign of the year 2007 do not force the authorities to change their position and, most importantly, to put in charge of the recruiting system reform persons who will be interested in its success, and an agency that will be under society's control.
2. The provision of housing to the military
The process of solving the housing problem, which has, after all, started in Russia, and the development of the system of mortgage credit lending for all citizens, which is designed to make housing universally available, will certainly facilitate the solution of a similar problem for the servicemen as well. However, it would be advisable to reveal the causes of the low efficiency of the FSM funded subsystem managed by the Ministry of Defense, to take decisive measures in order to eradicate them and, probably, to transfer the savings fund to the Pension Fund. Thus, simultaneously another problem will be solved - that of the allocation of pension contributions to the Pension Fund by the Ministry of Defense as an employer of those persons who will spend only part of their occupational life in military service under a contract.
3. The problem of transparency of the defense budget remains extremely difficult and painful. In recent years, the RF budget classification in the part concerning military expenditures has been progressively moving away from the corresponding UN standards. Budget is illegally made secret. Under these conditions there remains a strong possibility that the funds which are not controlled by either society of parliament will be blatantly embezzled. Therefore, the transfer of state-customer functions from the Ministry of Defense to a new civilian structure may fail to produce the expected results.
In this case, the emphasis of recommendations for the year 2007 concerning the possible ways of solving the existing military-economic problems should be re-addressed from the State to society. It is society that should initiate various forms of social influence on military-economic processes in order to put an end to corruption.
First, it is necessary to take under society's control the accelerated development of a new statute on the provision of money allowance to the servicemen of Russia's military establishment. It is equally important to increase the material attractiveness of military service under contracts. Not a single servicemen among those who serve voluntarily even in the lower echelons of the military hierarchy should receive a money allowance which is below the national earning level. In or-
172 V. Smirvov. An interview with the „VPK" weekly, No. 45 of 30.11-6.12.05.
der to achieve this it would be necessary to correspondingly adjust the 2007 budget and the forward financial plan for the next three years.
Second. In order to avoid irrational spending of financial resources, it is necessary to put forth the initiative that the data on the numbers of servicemen of different categories should be declassified, and the number of posts which are not vital for maintaining the combat readiness of the armed forces should be reduced.
Third. It is necessary to secure the inclusion of representatives of the public into the interdepartmental commission created for controlling the implementation of the present FTP. Any attempts at shifting the responsibility for the possible "collapse of the contractual system" from the Ministry of Defense to other agencies and society must be prevented.
Fourth. The recommendations to public organizations as regards the DIC are as follows: the failed strategy of restructuring and forced enlargement of the DIC should be replaced by the strategy of a voluntary amalgamation of enterprises into cooperative societies oriented to the execution of orders advantageous for the State, and to the efficient participation in competition on the civilian products market. Instead of being a smoke screen for corrupt officials, the classifying of the DIC's activity must guarantee the safeguarding state and commercial secrets.
