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Russia's Uncertain Business Climate

More Than Yukos Worries Investors

By Peter Baker
Washington Post Foreign Service
Saturday, August 21, 2004; Page A13

MOSCOW, Aug. 20 -- Russia has sent a series of negative signals to foreign investors in recent months in addition to its high-profile effort to take over Yukos Oil Co., reflecting what may be a growing rift within the government over its commitment to economic reform and international business.

The government has held up or canceled several major American projects, promoted new legislation that would weaken minority shareholder rights and launched an investigation into foreign investments in the state natural gas monopoly. Russia has also shrugged off entreaties from Washington to broaden its energy relationship with the United States, in light of the rise in oil prices and feared instability in the international economy.

U.S. Defense Secretary Rumsfeld, left, discussed foreign investment with Russian Defense Minister Sergei Ivanov. (Alexander Demianchuk -- Reuters)

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Many analysts said the moves threaten to impede a recent takeoff in foreign investment. American and European companies have been moving in to capitalize on Russia's massive energy reserves, expanding consumer market, booming stock exchange and modernizing economy.

The policy debate inside the government spilled into public view last week when Prime Minister Mikhail Fradkov sparred at a cabinet meeting with two ministers over market policies and the Russian media gave detailed reports.

"Unfortunately, the situation is unstable and the government should clarify its position," said Boris Fyodorov, a former finance minister who founded a leading investment bank. President Vladimir Putin often praises the value of foreign investment, "but when it comes to practice, we don't have enough strong policies to make investors" feel confident, Fyodorov said.

The situation has grown increasingly worrisome to top officials in Washington. Defense Secretary Donald H. Rumsfeld privately warned his counterpart, Russian Defense Minister Sergei Ivanov, during a visit to St. Petersburg this month that Russia could damage its international image as a reliable business partner, according to a U.S. official.

The uncertain investment climate belies an economy on the march. Once in near financial ruin, Russia in the last few years has expanded at about 7 percent annually. Buoyed by high oil prices, the country has stabilized the ruble, brought down inflation, eliminated delays in wage payments, built a substantial trade surplus, paid off many international debts and accumulated sizable currency reserves.

Foreign investment grew by 50 percent in the first half of the year to $19 billion, while direct investment in specific projects and companies grew by 35 percent to $3.4 billion, according to the government.

GE Consumer Finance bought a Russian credit card group. Heineken N.V. bought two Russian breweries. The French-Spanish firm Altadis S.A. bought Russia's leading independent cigarette maker. France's BNP Paribas bought half of Russia's leading consumer lender.

But foreign investment remains a fraction of that elsewhere in Eastern Europe, reflecting the lingering risks of doing business in Russia, where corruption infects every level of government. Putin's promises to reform the natural gas, electricity and banking sectors, among others, have been stalled.

The Yukos case put into stark relief the dangers of doing business in Russia. Yukos's chief shareholder, Mikhail Khodorkovsky, is on trial on charges of tax evasion and fraud while the state dismembers his company to satisfy a back-tax claim, moves widely seen as political retribution against a Putin rival.

"The investment climate has been substantially undermined by the Yukos affair and the fears of minority investors," said Julia Kochetygova, head of governance services for the Moscow office of Standard & Poor's, the credit rating agency.

At the same time, major foreign companies have grown frustrated over delays in dealings with Russian officials. Alcoa Inc. and Siemens AG have been held up by the government's anti-monopoly agency in separate plans to buy facilities in Russia. Marathon Oil Corp.'s joint-venture talks with Russia's state-owned Rosneft Oil Co. were abruptly cut off last month. Cargill Inc. has had trouble reclassifying land for a project in Russia, according to business leaders. ExxonMobil saw its license for a development project on Sakhalin island stripped away.

"No one has gotten a big deal through, post-Yukos," said an American corporate executive who is having trouble in Russia and declined to be identified for fear of angering the government. "It's a miracle in some ways that there are people willing to look at Russia after Khodorkovsky. The government says, 'That's a one-off. . . . That's an aberration.' At the same time, we and other companies have yet to see the Russian government approve a major transaction."

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