Oil, Oligarchs and Opulence

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By Steven Pearlstein
Friday, July 6, 2007

MOSCOW

I celebrated this July 4 at the rooftop bar of the opulent new Ritz-Carlton hotel here, taking in the breathtaking views of the gilded domes of the Kremlin, where Soviet leaders plotted their war against American economic and military power. Across a skyline drenched by the late-setting sun, ultra-modern glass towers vie for attention with Stalin-era monuments. Below, a steady stream of fashionable shoppers emerges from the high-end boutiques that have rented space in the redeveloped GUM department store, where in Soviet days the limited selection of dour and shoddy merchandise would sell out every day.

The "Red Ritz" is in many ways a metaphor for the New Russia. Built at a cost of $350 million by Kazakh and Turkish investors, it is probably one of the most expensive hotels in the Ritz chain, with some rooms at $1,000 a night and a suite that goes for a cool $16,000. Under the able direction of a German general manager, it is staffed by hundreds of eager, young English-speaking Russians. The driveway in front is stuffed with shiny black Mercedes, Audis and BMWs that shuttle global executives and minor Russian oligarchs, along with their security contingents, around the traffic-choked city.

Although the source of this boom is the country's massive oil and gas reserves, concerns that Russia might turn into a one-dimensional petro-state have long been forgotten. Russians, who for decades had little money and nothing to buy, are not only spending every ruble of their growing paychecks but are also beginning to learn the joys of buying on credit, which local and international banks that borrow at 6 and 7 percent are only too happy to lend out at 25 percent or more. Direct investment is pouring in from international companies rushing to open retail outlets, modernize aluminum plants, build auto assembly plants or provide much-needed housing for a burgeoning middle class. And portfolio investors have been lustily snapping up shares in Russian IPOs that, as often as not, are floated not in Moscow but on exchanges in Frankfurt, London and New York.

A fair share of credit for this boom goes to President Vladimir Putin, who took over on Dec. 31, 1999, as the economy was still reeling from a currency crisis that had forced the country to default on billions of dollars in debt, rendered the banking system insolvent, wiped out equity investors and prompted scores of international companies to fold their Russian tents and go home. Much of what was left was largely in the hands of a couple of dozen oligarchs who had gained control -- through financial chicanery, thuggish intimidation and outright bribery -- of most of the business assets of the old Soviet system. Incomes fell, public services deteriorated and as much as half of economic activity was thought to be transacted in cash on the black market.

With help of rising energy prices, Putin managed to restore the country to financial health by paying debts and building up hard currency reserves that have now grown to $300 billion. After he stepped up tax enforcement and pushed through a flat 13 percent income tax, the government began to run a surplus that he wisely salted away into a $100 billion "rainy day" fund. He began courting foreign investment again, expediting approvals, setting up duty-free industrial zones and offering potentially lucrative joint ventures with state-controlled firms. Perhaps most important, he reined in the power of the Yeltsin-era oligarchs, demanding they end their violent ways, pay their fair share of taxes and energy royalties, and keep their hands out of politics and government. Those unwilling to play by the new rules soon found themselves in exile in London or jail in Siberia.

But it would be a mistake to conclude from these successes, the view from the Ritz, or the bullish pronouncements from corporate executives or financial analysts that Russia is a one-way bet or that it runs just like any other advanced economy.

The combination of a huge trade surplus and surge in capital investment has generated significant inflationary pressures, created a bubble in real estate and financial assets and caused an appreciation in the ruble that could invite another painful crash. The rush to make consumer loans has all the markings of a future banking problem. And with consumers and businesses spending like crazy on imported goods, and government spending now growing faster than tax revenue, Russia's trade and budget surpluses are expected to disappear in the next two years, even if energy prices remain high.

Economic growth is also constrained by basic infrastructure that is pretty much at the breaking point. From the waning days of the Soviet Union through the financial crisis of the late '90s, the country had underinvested in roads, rails, airports, planes, power generation, housing and electric plants -- and the basic materials to produce them. But while Russia now has plenty of money to invest in those areas, the fear is that most of it will wind up in a black hole if it is handed over to a government bureaucracy that remains notoriously bloated, corrupt and inefficient.

But perhaps the biggest threat to Russia's continued boom is Putin's campaign over the past two years to reassert direct government ownership and control over an ever-widening share of the economy. The breakup and seizure of Yukos has left much of the oil industry in the hands of government-owned Rosneft, while the recent "renegotiations" forced on foreign joint venture partners such as Shell and BP have effectively put the entire natural gas industry under the tight control of government-owned Gazprom. Although Putin defends these actions as protecting the national interest, or sound industrial policy, or compensating for past injustices, they certainly have served to reinforce a suspicion that Russia is governed by something other than the rule of law. And, as former prime minister Yegor Gaidar noted wryly, there is no evidence to suggest that the government will be a very efficient or effective owner of these crucial economic assets.

At the same time, Putin has consolidated the aerospace and arms industries under government-controlled firms, encouraged the consolidation of the aluminum industry by a single government-friendly firm and hinted that the nickel industry might have to be nationalized. The Moscow papers are also filled with stories of how present and former Putin ministers, or members of their families, are showing up as directors, executives or beneficial owners of various state-related enterprises.

Unfortunately, it seems that Russia's old oligarchs have now been replaced with a new political-economic oligarchy made up of officials and executives friendly with, or beholden to, Putin. They've already tightened their grip on key energy, metals and natural resources sectors, and more recently have begun to branch out into finance, real estate, telecommunications and even auto parts. And they haven't been shy about using Russia's corrupt and highly formalistic regulatory and legal system to gain advantage over competitors or drive them out of business.

If history is any guide, Russia will probably continue to slide back toward state-run capitalism as long as oil prices remain high, the political opposition is muzzled and international businesses are enthralled by the prospect of all the money they are about to make.

As one journalist put it to me, "What we have now is a corrupt system that works, delivering a better life than most Russians can ever remember. It's hard to convince us we have to change it right now."


© 2007 The Washington Post Company

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