The Russian economy has responded positively to Boris Yeltsin's retirement and to a commodity boom. Can the bullish mood last or will reform get bogged down and Vladimir Putin's “strong government” put a straitjacket on enterprise? And does finance minister Mikhail Kasyanov have the breadth of experience to control the economy? We also look at Alfa, the only Russian bank to come out of the crisis stronger than it went in. Ben Aris reports There's good news from Russia. The economy is growing, albeit from a low base, and with high world commodity prices, public finances haven't looked this good for years. With a young healthy president just shooed into office, leading companies are cleaning up their act and the Kremlin has said — for the umpteenth time — “the worst is over”. Russia restructures: but is anyone going to believe it this time round? Following Boris Yeltsin's resignation, things could only get better. The business community has taken heart at the prospect of a new president, Vladimir Putin, who won't fall over every time he appears in public. Immediately after Yeltsin's resignation the leading RTS (Russian Trading System) stock index jumped some 60% and grew from 170 in January to around 224 in mid-March. Analysts are expecting it to climb again to between 300 and 500 by the end of this year. Goodwill in the stock market since Christmas has been backed by strong results in the economy over the first quarter. Industry has boomed, with production up 8.1% in 1999 and up 13% by the end of February year-on-year, according to state committee on statistics Goskomstat. The fastest-growing sector is light industry, where food production is the star. Expensive imports have been priced out and have given way, almost entirely in some cases, to domestic production. In addition, market research companies say that one of the psychological effects of the crisis has been that domestic products are now seen as of better quality than those with a foreign brand (even those foreign goods produced domestically). As a result, many Russian producers, despite spending virtually nothing on advertising, have seen sales boom as they overtake such multinationals as Procter & Gamble and Unilever. Many companies in light industry are working at full tilt, whereas a year ago average capacity utilization was little more than half. Goskomstat says that over the first two months of this year light industry production was up 47.9% year on year on a seasonally adjusted basis. Other sectors that have gained more than 25% are pharmaceuticals, ferrous metals, chemical and petrochemicals, and publishing. Only milling flour and microbiology fell: the former because of a bad harvest and the latter because it had grown so fast in 1999. As a result, upgraded estimates of Russia's GDP growth for this year are proliferating. Forecasts range between 2.5% and 5%, with the economics ministry guessing 1.5% to 3% GDP growth by the year-end. At the same time inflation, which many predicted would top 100% following devaluation, failed to materialize, ending 1999 at 37%. Investment is also on the rise. Al Breach, an analyst with Goldman Sachs, argues that investment is not a prerequisite for growth, pointing to Poland, which grew strongly for two years in the mid-1990s before investment began to arrive. In 1999 Russian capital expenditure rose by 4.5%, higher than initial estimates, and the growth appears to be continuing into this year. Even with these good results, Russia's economy still has a long way to go just to get back to where it was before devaluation. Assuming 5% GDP growth for 2000, it will still finish the year at around $160 billion, well below the $447 billion it created in 1997. Looking at it a different way, Russia's per capita GDP remains one of the lowest in the Commonwealth of Independent States (CIS) at $1,103, compared with $4,060 in Poland and $5,003 in the Czech Republic. Strong economic results since the beginning of the year have put Russia's public finances on their best footing for years and the new administration will inherit a country in much better shape than the one Yeltsin gave up in December. Despite the pain of devaluation, some economists think that it has forced a limited restructuring on the Russian economy after high levels of raw material exports had led to an overvalued rouble. Devaluation has meant the rouble is priced more realistically and has allowed domestic industry, which has been smothered for years, to boom. The visible results are a rise in tax receipts and a decline in wage arrears and the use of barter. A first-time budget surplus Tax arrears, long the bane of the Russian economy, are dwindling rapidly and at the end of February the finance ministry reported a budget surplus for the first time ever. Not only is the budget being fully met, there is cash left over since collection of taxes is regularly exceeding the budget plan. The collection in March was Rb40 billion ($1.41 billion), which was less than February, but still over the budgeted figure. More important than the actual amount collected is the fact that more than ever it is collected in cash. Struggling under non-payment since the beginning of the 1990s, the government has long accepted mutual write-off of debts as a form of tax payment. United Energy Systems is a good example: burdened with debts and unable to force regional producers to pay, UES has nevertheless managed to increase its cash component from 18% two years ago to more than 40% by the start of this year, a huge improvement. The most important “individual” taxpayers — as the state refers to the 10 biggest companies, which between them contribute more than half of all taxes paid to the budget — are also changing their ways. Of the Rb19 billion paid in February by the individual taxpayers, Gazprom paid Rb12.7 billion by itself, of which 40% was in cash. In the past these large companies have assumed themselves exempt from paying tax. This increase in tax collection is knocking on into hard-currency reserves, which have begun to rise. Foreign exchange reserves (including gold) rose to $14.3 billion by mid-March, having hit a low of $11.2 billion in May 1999. Russia's foreign exchange reserves have been precariously low for about two years and the growth will bring added stability to the economy. The budget predicted the rouble would fall to 32 to the dollar by March this year, when it actually started the month at around 28 and has appreciated marginally since the end of February. Analysts are also upgrading their predictions for hard-currency reserves to around $18 billion by the end of the year, a level not seen since late 1997. Profitable corporates restructure With the economy growing, Russia's industrialists have been making profits. But they know that it cannot last for ever, so since the end of last year a string of corporate consolidations have been carried through. All Russia's major companies are talking about reform and restructuring, with their sights firmly fixed on a return to the international capital markets later this year. In the utilities sector, UES has begun the process of splitting the transmission and generation functions at five important regional power generators (energos), in preparation for their eventual privatization. UES's reform programme has been on hold, waiting for a result in the presidential elections, but according to Caius Rapanu, a utilities analyst at Renaissance Capital, “the sector will be unrecognizable by the end of this year”. At Gazprom too there has been talk of an internal restructuring, which will also split the transmission from production facilities. Both these companies suffer from being their own best customers, a throwback to central planning. The fiercest action is in the oil sector, where the big companies all reported profits of around $1 billion at the end of 1999. Following several years of minority shareholders rights abuses, several of the most public disputes have been settled. A string of major oil companies have been consolidating their share structures, folding production units into holding companies to increase transparency and accountability. The most dramatic example is Yukos, controlled by oligarch Mikhail Khodorkovsky, long the bad boy of Russian oil. “We have a terrible reputation, I know,” says Hugo Erikssen, head of corporate communications at Yukos. “But we want to tap the international markets, to list our shares in the west, to be as western as any other international company. To do this, there are rules that you must abide by.” Marked by most Moscow brokerages as “avoid” for the past two years, Yukos never followed these rules in the past. At the end of last year it finally settled its differences with minority shareholder Kenneth Dart, who held stakes in three of Yukos's most important production subsidiaries. Dart claims that Yukos diluted his stakes and transfer-priced profits out of the subsidiaries into the holding company. A five-year legal battle between the two was brought to an end when Yukos bought Dart off in November for what was rumoured to be $120 million. In March, Yukos promised to clean up its act. The subsidiaries are to be folded into the holding company and the company has promised to be more transparent. “We want to create value for shareholders,” says Erikssen. Yukos is putting its money where its mouth is, promising to pay out approximately $100 million in dividends to shareholders by the end of this year. “The dividend payment is meant as a signal,” Erikssen says. “Those who own shares will get value back, not just in share price, but also in substantial dividend payments.” Yukos is not the only one. Surgutneftegas also began a (controversial) share consolidation at the beginning of the year. Sibneft reshuffled management last year and promised to increase transparency this year and is the first Russian company to adopt a corporate governance charter. And Tyumen Oil settled its differences with Sidanko and BP Amoco, after taking over one of Sidanko's major production facilities (see box). A concentration on productivity is a move that Russia's most powerful businessmen put off at the beginning of 1998, after they had already abandoned their banks and moved over to head industrial holding companies. At that time it was clear that the best games within banking — first speculating against inflation and then investing in GKOs and lucrative forward contracts — were coming to an end. Inflation was down into the teens and yields on GKOs had dropped to around 14% and looked to fall further. The only place to make big money was from the large industrial assets they controlled. “The change in corporate governance attitudes is either cyclical or structural,” says James Fenkner, a senior analyst with Troika Dialog. He argues that Russia is on the upswing of a commodity-driven cycle. As long as commodity prices are high, Russian companies will be well behaved. “Putin is inheriting a fantastic situation,” says Fenkner. “He won't be a known quantity for the first two years or so, but if oil prices stay up, Russian companies still want financing from abroad, and the government wants to float a Eurobond, things are going to seem better — better until Russia gets the money. Then look out.” Until Russia faces another crisis — and with virtually nothing being done to restructure the flagging banking sector, some predict that this could be as close as 18 months away — Russian companies will be well behaved. Everything depends on what the new president will do. Already smelling the change in the wind, the so-called oligarchs are taking refuge in their industrial assets. Political analysts believe that under Putin the oligarchs' influence over the Kremlin will fade. Nikolia Petrov, a political analyst with Carnegie Endowment, points out that Yeltsin never made use of all the formal levers of power at his disposal. He preferred to set up opposing interests — both in office and behind the scenes — and then break the resulting deadlock as a kingmaker. Putin is expected to have a more homogeneous team, but is likely to rely more heavily on the considerable power the 1993 constitution concentrates in his hands. He has said little about what he would do in office and gives out conflicting signals. You could take encouragement from the first warning shot he fired across the bows of Russia's entrenched interests in the last days before the elections. In mid-March he promised that the oligarchs would “cease to exist as a class”.