The Crisis Has Not Passed

Vladimir Milov on the current economic situation:

The basic problem remains the same: the fall of consumer purchasing power at the level of 5-6% year on year. Retail trade turnover dropped 5.9% in June, the real disposable income of the population by 4.8%. Rosstat is not publishing monthly investment data this year – only quarterly, but Economic Development Ministry officials predict a significant drop in the results of this year. Slightly better are the dynamics of real wages – up 1.4% in June, but overall the picture isn’t changing. There are nominal figures of small growth in industry, but actually the experts suggest that in fact behind them lies stagnation, and that growth in the extractive industries fell from 4-5% in February-March to 1.5% in May-June.

Further, he says:

The IMF reports that in the Russian banking system are hidden much more substantial bad debts than the banks show on their balance sheets, and in 2017-2018 a significant liquidity shortfall may take place in the banks.

Milov continues by noting that there is only $110 billion total left in the Reserve Fund and the National Welfare Fund (just 9% of GDP, where it was 11.2% at the beginning of the year – a loss of 2.2% of GDP).

The trade surplus in the first half of the year decreased threefold – import virtually ceased to fall, and exports have not grown due to low prices, so that in the future we can expect a new wave of pressure on the ruble.

And finally, he writes that “the government approved a budget freeze for 2017-2019…” This shows that they are acknowledging that there will be no improvement until 2020.

The crisis has not yet passed, Milov concludes.

Privatization Russian Style

There was a short post in The American Interest on Friday about the rumor that Rosneft is now off the list of potential purchasers of the government’s approximately 50% stake in Bashneft. And I want to clarify a few things.

First of all, Rosneft is still denying this story, as far as I know.

Here is what we know (or are being told). VTB Capital was given responsibility for the so-called privatization of Bashneft. They drew up a list of potential groups who might be interested / capable of making the purchase of Bashneft. Rosneft was on that list. In addition, there were several other state-owned companies who made the final cut that was presented to the Kremlin.

Lukoil has also expressed an interest in purchasing Bashneft, but says the price is too high. In fact, they are saying the whole company is worth about $4 billion, which is just a little more than what the government is asking for its 50% stake.

I do not see this as a political decision, to be honest. In fact, I would say it is more likely a way for Rosneft to bow out and save face. Rosneft is just as cash poor as any other corporation in Russia at the moment. They do not really have the money to buy anything. And they are under sanctions, which limits their access to capital markets, so borrowing money to buy a stake in Bashneft is problematic.

In the meantime, Rosneft is also supposed to be on the list of future privatization action. They are slated to sell a 19.5% stake in the company either this year or next year.

But I also want to explain the so-called “privatization” that the Russian Regime is currently carrying out. What is really happening is that the money and shares are being moved around. So it looks like Russia is making money, but in reality, all that is happening are trades.

Think of Russia as a giant conglomerate. Each of the state (and “private”) corporations are subsidiaries of the massive Russian Corporation. This “privatization” project is being carried out to make it look like these subsidiaries, and therefore the State, are more solvent than they actually are.

For example, VneshEconomBank (VEB) recently sold its stake in Gazprom back to the gas company (at market rate). Both are state corporations, so all that really happened was that both the money and shares switched hands from one subsidiary of the State to another.

And that is what will happen here again with the sale of Bashneft.


RBC had an update a few days ago about the situation at the state-run bank VneshEconomBank.

VEB has lowered the rate on loans to major borrowers, who built the Olympic facilities in Sochi, nearly four times, to 2.5% per annum, RBC found. This is a necessary measure in order to avoid defaulting on these loans, a source at the bank said.

Reuters had previously reported that this restructuring plan would be implemented back in late June, but had few details to offer. Now RBC gives more details:

The Supervisory Board of VEB approved the restructuring of loans that were opened for the construction of the Olympic facilities in Sochi. The Bank extended the term of floating credit from 5 to 25 years (until 2037). The interest rate on these loans amounted to 9% per annum, and the new rate will be lowered after restructuring by the “Market”, says VEB’s chairman Sergei Gorkov, but its size has not been stated.

A 5-year grace period on interest payments will also be granted, the article states.

The terms of restructuring will make the Olympic assets more “attractive” for investors, the bank’s deputy, Mikhail Poluboyarinov told RBC.

According to the paper’s source at the bank, “Only at this rate were investors willing to service the loans.”

The source continued:

…all the “Olympic” loans were issued in rubles. To finance the construction of the Sochi facilities VEB provided investors with 248.6 billion rubles, and in late 2014 the bank was faced with non-payment for the majority of the loans: 183 billion rubles were classified by VEB as problematic. Formally they were not overdue, but only because of the moratorium on repayment (that was introduced in 2014). In fact, it is a deferred loss, according to the rating agency Fitch.

The biggest investors in the Olympic construction who took loans from VEB were:

  • Vladimir Potanin’s “Interros” – approximately 70 billion rubles;
  • Oleg Deripaska’s “Basic Element” – more than 30 billion rubles;
  • Viktor Vekselberg’s “Renova” – about 15 billion rubles.

The 2.5% per annum is in fact “subsidized”. Now the Central Bank’s refinancing rate starts at 10.5%, while the rate in rubles for the best borrowers is between 10-10.5%, given that the market expects a rate cut…. In similar conditions [as VEB is currently in], the State allocates money from the National Welfare Fund: the minimum rate on loans from the NWF is “US inflation plus 1 percentage point, but not less than 2% per annum.” For example, in 2015 “Sibur” got $1.75B at this rate from the NWF for their project “Zapsibneftehim”.

For the bank such loan terms are “a loss in international accounting”, says [Rosbank’s] Olyunin, “the prolonging of a virtually interest free loan is de facto cancellation of the debt.”

However, VEB is not a bank in the classical sense [but rather a “State Corporation”], so it has no problems with the banking license due to the redundancy of these funds, adds Nordea Bank’s Mikhail Polyakov. He believes that the main reason for providing such favorable conditions is to prevent a default on these loans.

RBC continues:

On the need to make additional provisions for the “Olympic” loans in late June, Gorkov himself stated, “We do not see this as a big problem.” According to him, these loans were originally reserved by nearly 100%.

The bank ended 2014 with a loss of 249.7 billion rubles, due to the cost of the reserves in the amount of 326.1 billion rubles, the bulk of which came in loans for the construction of the Olympic facilities in Sochi. And by the end of 2015, VEB received 14.9 billion rubles in profit, but this happened with the help of the State – the bank “earned” on the deposit from the National Welfare Fund (the Fund placed on deposit with VEB more than $6 billion at a 0.25% rate), which was categorized in the report as “instant profit”.

What this means is that money from the NWF is being counted three times. The Ministry of Finance counts it as their own, the Russian Central Bank is including it in their “International Reserves”, and VEB includes it, and is making a profit off of it.

The Reuters piece from last month also noted that VEB is preparing to sell off its shares in state-owned enterprises: including Gazprom, and MICEX (Moscow’s stock exchange).

Yakunin Extends His Reach

When Vladimir Yakunin was sacked from his position as Chief of Russian Railways last year, it was hailed as this great anti-corruption victory. But I argued at the time that what had happened in fact was not as it was portrayed.

Earlier this year rumors started that Yakunin was planning on opening a think tank connected to his Dialogue of Civilizations forum. Kommersant reported:

“The key focus of Putin will now be building a new architecture of international relations… Now there is no think tank [analytical center], which deals with international themes, the demand is there.”

“Most likely, Putin gave Yakunin carte blanche for the formation of the analytical center. Yakunin will be quite satisfied with the role of curator of the new center and the ability to report regularly to the President on the implementation of Russia’s foreign policy.”

It is now pretty clear that the newly launched think tank had been in the works for quite some time. Likely since last year, when Yakunin was “ousted” from Russian Railways. It is likely that the Regime leaked the information in January, setting the stage for the opening that happened in Berlin last week.

However, the organization itself is not new. The Dialogue of Civilizations has been around since 2001. It came out of a speech from Iranian leader Khatami as a response to Samuel Huntington’s “Clash of Civilizations”.

According to the article on the Berlin launch:

But its ambitions appear to be growing. Though the DOC’s funding is not spelled out on its website (and the institute did not respond to a request for comment), “FAZ” reported that Yakunin himself is investing 25 million euros ($27.8 million) over the next five years, and plans to employ some 20 people. Its own stated aim is to be among the world’s “top 20 think tanks within five years.

The DOC’s own website explains that the organization is transforming itself, and that soon their website will be shut down, and merged with the new Institute’s website.

In the meantime, the DOC still plans to hold their annual Rhodes Forum in late September. The theme is: “The Choas of Multiplicity: an Urgent Call for Dialogue”.

Fighting the Last War

The Wall Street Journal had an article on Wednesday saying “New York’s top banking regulator is set to publish on Thursday strict and long-awaited anti-money-laundering regulations to take effect in 2017.”

You can read the statement from DFS here. Essentially it places the onus on the financial institutions (like Goldman Sachs, Deutsche, and others) to report on themselves.

In the WSJ article, the head of DFS stated:

“Management must set the tone of compliance from the top so that message is disseminated throughout the enterprise,” Ms. Vullo said. “With this new regulation, New York will lead both in the fight against terrorist financing and money laundering and in providing useful guidance to our regulated institutions.”

We are always fighting the last war. These were steps that should have been taken 20+ years ago after Bank of New York and the fallout from that, if not earlier.

And we are still only treating the symptoms. All the regulations in the world will not stop the illicit movement of cash. In the 70s, 80s, and into the 90s, people were moving money across borders in bags. I even came across a story a few weeks ago about a man in the mid-2000s who was still doing the same using his private airplane. And it would not surprise me if it was still happening.

Meanwhile, the professionals who are laundering money have adapted and moved on into new technologies. And they likely changed tactics about a decade ago, if my research is correct. And our law enforcement is only now waking up and reacting to it. It will take years to fully understand the damage done by the new ways of moving money, and law enforcement’s failure to react in a timely manner.

And so we’ll have more inquiries and finger pointing, but never find the real culprits. And we’ll just keep trying to treat the symptoms.

The Emperor Has No Clothes

I went on a bit of a rant this morning on Twitter, but somehow my tweets got out of order. So I’m putting them up here and adding a bit to my argument.

I have spent a lot of time researching Vladimir Putin and his government. And by “a lot”, I mean that I have been following his career since about 1998. I too bought into the “persona” that was created for him. But as time has gone on, I have realized that that is all it is. Just a character that was created for somebody (anybody?) to play. I’ve said before that you could have picked just about anybody off the street and gotten the same results as we got with Putin. And I still believe that.

But nobody wants to say this. Nobody wants to say that “Putin” is a fraud. And that the emperor has no clothes. Why? The conclusion that I am (reluctantly) coming to is that our politicians and pundits find “Putin” useful. They prop the character up as a kind bogeyman in order to distract from the fact that Russia itself is a genuine threat and a problem.

And people buy into it because they don’t want to believe that the Russian system is rotten to its core. And everybody is infected. It is easier to pretend that the problem is just down to one person: “Putin”. Then you don’t have to deal with the real issues that infect Russian society. The serf mentality. The gulag of the mind (to quote Nina Khrushcheva). The corruption that pervades daily life.

And this “kleptocracy” business is still just dealing with symptoms, not the root causes. I could tell you story after story of the corrupt practices like the one I put up on here on the blog last week, but that’s not the point. People want to imagine that the problem is just money. If you make the problem money, then it is fixable.

But the problem is not the money itself. As I stated last week, the Russian system is not a “kleptocracy”. Rather, it is neo-feudal. And what that means is that the money is being used by the State to pursue its own geopolitical ends.

I know this is an unpopular opinion, but I think it needed to be said. Because fighting the Russian threat is not as easy as ousting an individual person, or even a core group of so-called “kleptocrats”. And the first step in doing that is to realize that your analysis is wrong. And concede that the emperor has no clothes.

$50 Million Tax Free

In the middle of the unfolding Khodorkovsky drama, a story emerged that another Russian businessman was facing troubles with the government in Moscow. Nikolai Bogachyov had agreed to sell a stake in a project to develop the South Tambey field on the Yamal-Nenetsk peninsula to a consortium of three foreign companies: Spanish Repsol, Shell, and Petro Canada. Bogachyov held the production license for the field, which was estimated to contain reserves of 1.2 trillion cubic metres of gas.

The Russian state-owned natural gas company Gazprom sued, claiming that South Tambey had been theirs to begin with, and was given up in a shady deal by the company’s former leadership. The dispute was finally resolved in an out-of-court settlement in the middle of 2005.

Nikolai Bogachyov’s background is typical of the Soviet nomenklatura. Born in 1955, he lived in New York as a child while his father, Vladimir, worked at the UN as a journalist for TASS (a typical cover for the KGB at the time) from 1959 to 1964. Vladimir returned to the United States at least once after that assignment. He reportedly had an affair with the Communist artist, Alice Neel, in 1969.

The elder Bogachyov was later involved in the formation of Zhirinovsky’s Liberal Democrat Party of Russia (LDRP) in the early 1990s, but soon split off to form his own party, according to a 1994 article in the Washington Post.

Nikolai Bogachyov claimed he walked away with $20 million in exchange for his cooperation with Gazprom in 2005. He had allegedly previously demanded $50 million. Either of these amounts were mere pocket change when discussing the long-term potential of a field like South Tambey.

Whatever really happened behind the scenes is still unclear, but it most likely did not take place as reported. Filings with Companies House in the UK indicate that Bogachyov did walk away with nearly $50 million, tax-free.

Over a period of about 18 months, Bogachyov gave up his shares in exchange for a series “loans”. He first took a loan of $15 million from Switzerland-based commodities trader Glencore, using his shares in Yamal LNG as a guarantee.

Bogachyov then took $20 million from an arm of the Irish-registered emerging markets investment vehicle Ashmore. He again used the same shares as collateral. Using the second loan of $20 million from Ashmore, Bogachyov paid back the $15 million from Glencore. He was now ahead $5 million.

Over the next several months, Bogachyov continued to take loans from Ashmore using the same shares as collateral.

Tambey then transferred these loans to two shell corporations: one in Nassau, Bahamas, and the other in Moscow.  After an appropriate period of time, the two shell corporations were declared insolvent, meaning that the UK company could not pay back the original loan to Ashmore. The UK company then declared insolvency itself, effectively defaulting on the loan. The shares were then transferred to Ashmore, who presumably then transferred them to Gazprom.

But the scam was that both shell companies were associated with Bogachyov. The parent company of the UK-based Tambeygas was the Nassau company Prato Investments Limited. Prato was the recipient of $1,543,096 in loans from Tambeygas. The second company, Moscow-based Ruad Gas Limited received $46,142,618 in loans from Tambeygas. Ruad was also a subsidiary of Prato, and was registered at the same address where Bogachyov’s Yamal Energy Partners was registered.

In the end, Bogachyov walked away with a little under $50 million (less ~$2.3 million in fees), tax-free.

P.S. There is a second part to this story, but I am still trying to untangle it.


“Kleptocracy” is probably the most common word now used to describe the Russian State. The proponents of this theory argue that President Putin and his cronies are using money from state coffers for their own personal use. This, they say, is the primary goal of the “kleptocrats”: personal enrichment at the expense of the Russian taxpayer.

I’ve spent nearly the past two years looking at the way the Russian Regime is moving money, and I think that this narrative is false.

What is Russia then if not a kleptocracy? The State is not based on thievery for personal gain, though there is some element of that. Russia today is more of a neo-feudal system.

The people commonly referred to as “oligarchs” are not oligarchs in the traditional sense. Traditionally an oligarch has some power over the leadership of a country through his money. But in Russia today the so-called oligarchs are actually beholden to the State. In this sense, they are more like the boyars of old, during the Tsarist period.

At the end of the Communist period, the State gave the boyars their wealth through the dispensing of property (in this case, previously state-owned businesses, factories, etc.). It was up to the boyars to make the most of this gift. The boyars were then obligated to pay tribute to the State from their wealth.

This can take many forms, but one example is what happened at the Sochi Olympics. The boyars were required to pay for the venues, even though they (and everybody else) knew they were loss-making and would most likely never turn a profit. Did they get kickbacks for it? Of course. But the monetary cost was likely higher than any profit made. At the same time, however, the boyars showed their fealty to the State.

But if the State decides that the gift must be returned, the boyar must do as he is ordered. We have seen different cases of this. What typically happens is that the “boyar” has become arrogant enough to believe in his own press. That his wealth is of his own making. That he is not beholden to the State for his success. And that the State has no right to demand its return.

And what happens then? The recent case with the owners of Domodedovo Airport is a good example of how this plays out. An offer was made for the airport by a certain group on behalf of the State. The offer was rejected. And now the owners of Domodedovo are under arrest. They could have gotten some money out of the deal, and returned the airport. But they refused. And their imprisonment is the consequence.

I don’t mean to make the “boyars” sound like victims here because, just like everybody else in this story, they know what they signed up for. They made a deal with the devil. And the devil always demands his due.

But depicting the Russian Regime purely as a vehicle for personal profit greatly misreads the situation and leads to poor policy decisions. The portrayal of Putin and his cronies as some petty gangsters who somehow (!?) managed to make it into the Kremlin is a dangerous one on which to base policy.  In essence you are reducing the goal of the State to nothing more than theft by a small group. A group that you only have to oust to solve “the problem of Russia”.

But history has shown that this is a false narrative. We thought we were getting a better Russia in the 1990s, but as Chernomyrdin said, “it turned out like always”. And if we keep believing this false narrative we will only have ourselves to blame when it once again turns out the same.


Russia Is Not Going to Rio

Russia’s track and field team was barred from participating in the up-coming Olympic Games in Rio due to its collective use of banned performance enhancing drugs last week.

Russian track and field athletes have been suspended from international competition since last fall, after publication of a WADA report accusing the nation of an elaborate government-run doping program.

The International Olympic Committee is meeting today to decide on whether Russia will be banned from attending the events entirely.

Meanwhile, the Russian government has portrayed its athletes as the victims of some kind of massive conspiracy:

And the Kremlin’s Dmitry Peskov reiterated the same sentiments:

Russian MP Vladimir Zhirinovsky suggested that Russia boycott the games all together and hold a separate event in Russia.

By now we’ve all heard about the health and safety warnings surrounding Rio. The World Health Organization is under fire for its failure to take the risks seriously. In the same article from late last month:

The International Olympic Committee (IOC) has said it sees no reason to delay or move the Games because of the mosquito-borne disease.

Athletes from all over the world are dropping out of the Games. Others are freezing their sperm in case they acquire Zika while in Rio.

So I can’t help but wonder if the Russian athletes and Sports Minister Mutko aren’t a bit secretly relieved by the recent events.

How Long Will Putin Last?

There was a blog post in the Washington Post yesterday asking “How Long Will Putin Stay in Power?”

The author (whom I have never encountered before) did not really answer the question, only suggesting that Putin will manage to hold on through the 2018 “and beyond”. That is, barring a coup.

Now I know I’m the only one arguing this (in English anyway), but I don’t believe that Putin is really in charge of Russia. If a coup did take place, it took place a long time ago, and nobody realized it.

Putin is still useful to the Regime at the moment and will remain in place until they feel he is no longer useful to their purposes. I suspect what that means is that Putin will die in office, something the author of the blog post neglected to offer as an option.

Putin is part of a system that was created long before he was selected to be Russia’s president. And the system will remain in place long after he is gone unless the Russian people stand up and protest it.