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' Technoparks are about entrepreneurial spirit. They’re not about state funding or receiving grants.' NIKOLAI NIKIFOROV, IT AND COMMUNICATIONS MINISTER ITAR-TASS

Saturday, April 13, 2013

IN THIS ISSUE

International A raft of deals between Putin and Xi sends ripples through global energy markets

Russia, China Chart Energy Alliance

POLITICS & BUSINESS

Change at Central Bank New chief Elvira Nabiullina is set to focus on growth

Russia and China are kindling an energy alliance that could unite the world’s biggest fuel producer and its biggest consumer in “the best synergy on the planet.” BEN ARIS SPECIAL TO RUSSIAN BUSINESS INSIGHT

KOMMERSANT

PAGE 2

SPECIAL REPORT

Technology Tax Breaks How Special Economic Zones are attracting savvy investors PAGES 4-5

MONEY & MARKETS SERGEY GUNEEV/RIA NOVOSTI

Chinese Premier Xi Jinping’s recent visit to Moscow sealed a deal for Russia’s flagship oil company Rosneft to triple supplies to China to one million barrels a day. The increase will make China Russia’s biggest oil customer, while Russia has awarded the China National Petroleum Corp a share in eight previously guarded upstream projects in the Russia’s prized Arctic reserves. The announcement marks a strategic shift as President Vladimir Putin expands exports to the east, from the country’s traditional energy markets in Europe. And it secures vital resources for China, the world’s biggest energy consumer. China also agreed to underwrite a partnership between Rosneft and Britain’s BP by lending Rosneft up to $30 billion, to be repaid in oil. State-owned Rosneft desperately needs the funds to finance its $55 billion buyout of private Russian investors from the British-Russian joint oil venture,TNK-BP. That deal made Rosneft the world’s largest publicly traded oil company with almost 5% of global crude output, and it handed BP a minority interest in the Russian oil giant. New agreements were also announced in banking, energy and even cuniculture (rabbit husbandry). Kingsmill Bond, chief strategist at Citi in Moscow, described the Russian-Chinese relationship

A New Level of Finance Mezzanine deals are helping Russian companies to grow

Xi Jinping met with Vladimir Putin in Moscow for his first foreign visit as China’s new leader.

as “the best synergy on the planet” – Russia has the raw materials and energy China’s factories so desperately need, while Beijing has the market and the money Russia needs. This view was echoed by President Putin after meeting Premier Xi:“Both countries want to encourage reciprocal investment. We agreed to make more active use of the possibilities the Russian-Chi-

nese Investment Fund offers, and to pay particular attention to infrastructure and production projects in the Russian Far East.” Progress was also made on a key gas deal that has been stalled for over six years. Russia agreed to supply China from its east Siberian fields, rather than its own preference for using the west Siberian fields. In return, China agreed to

pay in advance for 30 years of gas. Gazprom was confident the last piece in the puzzle, an agreement on price, would be reached by summer.“I think that somewhere in June the price will finally be determined and by the end of the year all the contracts will be signed in regards to the supply, with the volume and price agreed,” Gazprom chairman Viktor Zubkov said.

Turning Swords Into Software A generation of IT whizzkids is boosting high-tech exports PAGE 6

FEATURE

A Taste of Old Russia: Science Russia’s once-closed cities are attracting interest from foreign investors

Technoparks: From Atom Bombs to Apple Stores

REUTERS

Go into any Apple store and you’ll discover a lot of Russian technology.

Floridean Kendrick White has spent the past 20 years helping to finance high-tech start-ups in Russia’s farflung regions. ARTEM ZAGORODNOV RUSSIAN BUSINESS INSIGHT

It was once unthinkable Kendrick White would be where he is. Nizhny Novgorod, Russia’s fifth-largest

city located 250 miles east of Moscow, was strictly off limits to foreigners during the Cold War as one of the Soviet Union’s centers of secret scientific study. It was a virtual prison for famous Soviet scientists like Andrei Sakharov, the Nobel Prize-winning father of the Russian atom bomb. Now, where Mr. Sakharov once

toiled to build Russia into a nuclear powerhouse, the American Mr. White is planting seeds he hopes will one day grow into Russian versions of Apple, Google or Facebook. Moscow officials aim to transform lands once known for hosting the Gulag Archipelago into a network of Russian Silicon Valleys. The plan involves coaxing investors with an array of incentives, from tax breaks to cheap office space. Mr. White is CEO of Marchmont Capital Partners, which he set up in his native Florida eight years ago after stints at the European Bank for Reconstruction and Development, PwC and as a privatization advisor in Nizhny Novgorod. After the Iron Curtain fell in the early 1990s, he moved to Russia, sensing opportunity. He has spent 20 years promoting entrepreneurship, horizontal integration and start-up financing for high-tech businesses in Russia’s regions. “As an entrepreneur, I’ve been interested in science and technology commercialization my entire life,” Mr.White says.“Mathematics, which

is the basic language of science, is in Russians’ genetic code — this is the logical place for me to be.” Following World War II, the Soviet government provided generous funding for national security-related research and closed cities (not unlike Los Alamos) flourished across the country. But while the U.S. had a matching wave of entrepreneurs ready to found startups and commercialize the offspring of state-funded research over the past two decades, Russia faltered at first. Following the end of the Cold War, many of the closed cities opened up and funding was slashed, but nobody filled the gap between science and the free market. In the past five years, however, Special Economic Zones (SEZs), technoparks and business incubators have sprung up, aiming to benefit from Russia’s vast scientific potential. “There are currently over 90 technoparks and Special Economic Zones offering various tax breaks and cheap office space,” Mr. White says about Russia’s regions. “Probably about half of them are ineffective, because federal and local officials sometimes approach their initial development as huge real estate projects without establishing the critical relationships between scientists, entrepreneurs, angel investors and venture funds.” CONTINUED ON PAGE 4

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Politics & Business

NEWS IN BRIEF

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Fiscal Policy Worry over independence of key regulator after Putin aide takes throne

• Levels of anti-American sentiment in Russia are low. A poll found that a mere 18% of Russians have negative impressions of the U.S., one of the lowest figures in the world. • The Kremlin renewed its crackdown on NGOs with raids that hit Amnesty International and for the first time targeted German non-profit groups, which have been more moderate in criticizing the government than some other foreign-financed NGOs. The raids were aimed at groups receiving foreign support and classed as “foreign agents” according to a controversial law passed last year.

New Central Bank Chief To Promote Growth HER STORY

• Most Russians are suspicious of wealth and dislike rich parliamentarians. 77% of Russians believe it’s either “indecent” or “criminal” for government representatives to be rich, a poll found. 82% were in favour of setting a limit on personal wealth for politicians.

Elvira Nabiullina PROFESSION: ECONOMIST CAREER: ECONOMICS MINISTER, 2007-11

• An autopsy concluded that self-exiled Russian businessman Boris Berezovsky died from hanging. The ex-oligarch’s body was found in his Berkshire home March 23. British police said there was no evidence of foul play.

Elvira Nabiullina, an ethnic Tatar, was born in Ufa, Bashkortostan, in 1963. After graduating from Moscow State University with an economics degree in 1986, she worked at the Russian Union of Industrialists and Entrepreneurs during the early 1990s before joining the economics ministry. From 2000 to 2003, she was first deputy to economics minister German Gref, the current president of Sberbank (the largest bank in Eastern Europe), whom she replaced as minister in 2007. Ms. Naibullina remained in this position throughout Vladimir Putin’s tenure as prime minister in 2008-12. Since Mr. Putin was re-elected to the presidency in 2012, Ms. Nabiullina has served as his economic advisor and was not viewed as one of the likely candidates to take over the Central Bank chairmanship. In June, she is set to become the first female Central Bank chief from Russia and within the G8.

REX/FOTODOM

• Georgian wine exports to Russia have resumed. Seventeen brands of Georgian wine and five brandies are due to be entered on the Russian state register, which will open the way for a return to the market. Georgian wines, spirits and water were banned in Russia on health grounds in the run-up to the Georgia-Russia war in 2008.

• Russia plans to stockpile 450,000 cubic meters of snow in sub-tropical Sochi ahead of the 2014 Winter Olympics - just in case.

TIM WALL RUSSIAN BUSINESS INSIGHT

As PresidentVladimir Putin’s nominee as Russia’s new Central Bank chief, former economics minister Elvira Nabiullina has pledged to maintain continuity, but hinted too that the regulator will do more to boost growth. She is also likely to align the regulator’s fiscal policy closer to the Kremlin’s. “Policy continuity should be maintained, because the credibility factor is very important in the banking system,” Ms. Nabiullina told reporters in Moscow on March 22. “But this doesn’t mean there won’t be changes, because life changes, new challenges appear, everything moves.” Economists have welcomed the choice of Ms. Nabuillina, who will become the first female Central Bank chief from Russia and in the G8, seeing strong positives in both her record on liberal reforms and her close position to the president. The outgoing Central Bank chairman, Sergei Ignatiev, is expected to be asked to stay on as an advisor to Ms. Nabiullina. But Ms. Nabiullina comes to the post at a difficult time. Mr. Putin’s administration is grappling with the twin challenges of trying to boost growth, while trying to curb rising inflation. Russia’s growth, at 3.2% in 2012, is currently the weak-

the prime minister’s post instead. Leading officials, including Putin, have hinted that a cut in interest rates could be on the cards to boost credit flows and growth, if inflation can be kept under control. Some economists say that such measures will probably only have limited effect in boosting growth. Anna Bogdyukevich, an analyst for Aton Capital, said that the Russian economy was“operating close to its long-term potential”and that “policies aimed at stimulating aggregate demand… would result in higher inflation rates while not affecting the real sector much.” She added that it was “difficult to say whether the Central Bank’s independence is going to be compromised by Ms. Nabiullina’s appointment,” but added that the regulator’s fiscal policy would not necessarily become “more accommodative.” Investment analysts from Moscow-based Sberbank said that the market “will likely expect monetary policy to become more dovish based on Ms. Nabiullina’s experience as economics minister, in which she particularly advocated for increased government spending to spur economic growth… [we] bear in mind that the fight against inflation remains a key priority for the government’s economic team.” Much will depend on the state of the economy by the time Ms. Nabiullina takes charge in June. Sluggish growth will increase the pressure for a cut in interest rates, but inflationary pressures and a further global downturn may restrict her room for maneuver.

IN FIGURES

3.4% was Russia’s GDP growth in 2012, first among G8 countries (2nd among BRICS) but rapidly slowing in 2013.

6.6% was Russia’s inflation rate in 2012, one of the lowest since the fall of the Soviet Union.

est since 2009, and year-on-year inflation in February, at 7.3%, is the highest in 18 months. The appointment of a politician is also raising questions about whether the Central Bank will be able to maintain the independence displayed under Ignatiev, who has resisted calls for a looser fiscal policy and higher spending. Ms. Nabiullina’s appointment was welcomed by former finance minister Alexei Kudrin however, indicating support for her across the political spectrum. “I believe this is a good candidacy, and I am sure she will be able to do the job,” Mr. Kudrin said at the Russian Business Week forum in London.“I believe she is among those most deserving this position.” Mr. Kudrin was touted as a possible Central Bank chief but is thought likely to be setting his sights on

IN HIS OWN WORDS

Martin Gilman EX-IMF REPRESENTATIVE TO RUSSIA, FROM AN ARTICLE IN THE MOSCOW TIMES

PHOTOXPRESS

• The government plans to draw up a ‘Guantanamo List’ if America’s Magnitsky Act goes into force. The U.S. list, named for the Hermitage lawyer, imposes entry bans and empowers the seizure of assets of Russian officials implicated in the case. Russia threatens similar measures against US politicians involved in the Cuban prison.

Elvira Nabiullina will probably increase government control over the regulator, but have to balance conflicting demands for looser monetary policy and lower inflation.

Nabiullina is a highly qualified technocrat. She is valued for her broad experience, competence under fire and hard work. Perhaps greater than any local political pressure to loosen the monetary reins, the real problem may come from an unlikely quarter: the Group of Seven central bankers have thrown away the rulebook and are printing money in a desperate attempt to revive their economies.”

Corruption Previously untouchable officials face firings, jail time

Kickbacks Down, Future Uncertain As entrepreneurs begin to reap benefits from a top-down war against corruption, its long-term effects on the business climate remain uncertain. ARTEM ZAGORODNOV RUSSIAN BUSINESS INSIGHT

Russia’s staggering annual $300 billion corruption market (according to the government’s own figures) permeates nearly every aspect of life, from registering a business to obtaining a spot in a state-run daycare facility. “Corruption is systemic, with plenty of unpunished criminals,” says Yelena Panfilova, head of Transparency International Russia. Moody’s recently blamed corruption for its decision not to upgrade Russia from its Baa1 long-term investment rating for the last five years despite low debt levels and a budget surplus. Six months ago big heads began to roll: ex-deputy minister of regional development Roman Panov went to jail over misuse of $93 million earmarked for preparation of the 2012 APEC summit in Vladivostok while former defense and agriculture ministers Anatoly Serdyukov and Yelena Skrynnik were embroiled in similar scandals. Russia jumped 21 places in Transparency International’s Corruption Perceptions Index (albeit from 154th place in 2010 to 133rd last year). The Group of States Against Corruption, a European

watchdog, praised authorities’ initiatives in a recent report. “The effects are already being felt by the average citizen and entrepreneur,” said Dmitry Butrin, business editor at Kommersant, a leading daily. “Municipal finances have become more transparent, and the average local traffic police chief is afraid to become involved in corrupt schemes.” But when the battle moved into Russia’s lower house of parliament, experts began seeing political motivation. Several deputies from the opposition Communist and Just Russia parties had their mandates

“Nobody knows where this will go, so officials at all levels are being more careful. The effects are positive.” revoked over alleged conflicts of interest. Then pro-government party United Russia came under fire when Vladimir Pekhtin, ethics committee chairman, resigned over alleged ownership of $2 million luxury properties in Florida. More resignations are expected. “The reasons are political,”Anton Belyakov, a member of parliament from Just Russia and chairman of the Public Anti-Corruption Committee, said.“After the last elections parliament members, including members of the ruling party, began

AFP/EASTNEWS

• The posthumous trial of Sergei Magnitsky began in Moscow. The late Russian lawyer, who worked for the British-based Hermitage Capital investment fund, is being prosecuted for tax evasion. Magnitsky died in pre-trial detention in 2009.

KOMMERSANT

• Russian investigators launched a probe into a $260,000 defense firm theft as part of a crackdown on corruption in the defense ministry. Investigators say managers at an aircraft plant in the city of Kumertau illegally diverted the funds under the guise of customs duties for imported equipment.

A Just Russia activist protests corruption. The sign reads “Stop Bribes.”

showing independence and disregarding the President’s position. His administration needed to show who was boss.” “The problem is their entire campaign is directed from above in each case and is not systematic,” said Butrin, adding: “The current culture of corruption is a very difficult thing to change. To kill [it] entirely would be to dismantle today’s system.” Jon Hellevig, founding partner of Moscow-based Awara Group, disagreed. “It’s incorrect to call what’s going on now a campaign because a lot of laws limiting bureaucracy and the power of inspec-

tors have been passed in the last five years and SMEs are beginning to reap the benefits. Those companies choosing not to engage in corrupt practices are now enjoying a more level playing field.” “We still have two major legislative loopholes that need to be addressed,” said Panfilova. “Officials found to have illegal incomes are usually just fired and don’t face any real punishments, and there are no real mechanisms to protect whistleblowers. People are afraid to speak up because they can face repercussions. The most famous such case is the scandal around Sergei Magnitsky.”

Business & Politics

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NEWS IN BRIEF

Energy Investors are calling for a reshuffle at the top and for the unwieldy gas giant to be split up

• Retail sales hit a 3-year low in February, as the economy continues to slow more than analysts were expecting. Real retail sales growth edged down to 2.5% year-on-year, increasing the probability that the Central Bank will start cutting interest rates in April. • January consumption figures disappointed. Retail trade growth decelerated sharply to 3.5% year on year after 4.5% in 4Q12. Consumption drivers also weakened; real disposable income growth was up only 0.7% year on year and unemployment rose to 6.0%. • Gazprom reported that gas export prices for Europe fell by 2.4% to $400 per 1,000 cubic meters in the first two months of the year, adding that it expects to see it fall to $366 through the rest of 2013. • A meteorite perfume will be launched in Chelyabinsk in the Urals, which was pelted by

ANATOLY MEDETSKY THE MOSCOW TIMES

For the benefit of the Far East and Eastern Siberia, Gazprom should be split up, according to RusAl CEO Oleg Deripaska. South Stream — at a time when its exports to the continent have dwindled. Another perceived misstep, which led to the decline in European sales, was the company’s refusal until last year to make

IN HER OWN WORDS

Julia Bushueva MANAGING DIRECTOR OF THE NEW KREMLIN FUND (ARBAT CAPITAL)

The renewal of Gazprom’s management is the ultimate dream among any entrepreneur investing in Russia; it would be a symbol of reform not only at the company, but in the entire country. Rumors of CEO Alexei Miller’s departure circulated this spring and led to a 10% increase in Gazprom’s stock during the last two weeks.”

IGOR GENERALOV-FINPARTY.RU

Calls are growing for radical change at Gazprom, Russia’s natural gas giant. Suggestions from the country’s business elite and investment community range from a reshuffle of top executives to a split of the company into two businesses in order to focus on European and Asian markets. Gazprom’s veteran CEO, Alexei Miller, in charge since 2001, has a contract to lead the company until June 2016. But the company is now facing a strong challenge to its position in the Russian gas market from the country’s oil champion Rosneft, and private gas producer Novatek, and European exports sank 7% to 139 billion cubic meters last year. “A company like Gazprom, where management has been incumbent for a long time, could probably benefit from a shake-up,” says Mattias Westman, founding partner at Prosperity Capital Management. “There are other Russian state-controlled companies that are better run than Gazprom.” Mr. Westman was referring to Rosneft, managed by former Kremlin and Cabinet heavyweight

Gazprom has in the past few years come under a barrage of criticism for its multibillion-dollar projects to build new pipelines to Europe — Nord Stream and

Igor Sechin, and Russia’s biggest lender, Sberbank, led by former Economic Development Minister German Gref. Also wading into the Gazprom debate has been Oleg Deripaska, CEO of Russian Aluminum, who has called for Gazprom to be broken up. Mr. Deripaska, normally reluctant to speak out in public on policy matters, said in a strongly critical interview with the Financial Times last month that Gazprom was too “preoccupied with its business in the West” at the expense of opportunities in Asia. “For the benefit of the Far East and eastern Siberia, Gazprom should be split” into Western and Eastern units, Mr. Deripaska says.

Gazprom has come under fire over its new pipelines to Europe at a time when its exports are falling.

A futuristic suite on the top floor of Gazprom’s skyscraper headquarters in Moscow

price concessions, regardless of the glut on the market. A reshuffle in Gazprom could send an encouraging message to the investment community, said Gennady Sukhanov, who helps manage the Russian oil fund at TKB BNP Paribas Investment Partners. “A change of the chief executive could signal a different policy,” he says. “If the new person had good reputation, it would be taken well by the market.” Gazprom’s stock could then as much as double in value, he says. “If I see that Gazprom is about to change its policy, I will mortgage my apartment and buy Gazprom shares,” Mr. Sukhanov says. Mr. Westman and Mr. Sukhanov said they were unaware of any changes in the near future. A reshuffle would appeal to investors only if it comes with a plan for Gazprom to spin off several companies, making it easier for investors to understand the business, says Pascal Menges, energy fund manager at Swiss investment firm Lombard Odier. According to Mr. Westman, the government could make Gazprom a more valuable asset by forcing it to allow other gas producers greater access to its sprawling pipelines. That would make it exercise more spending prudence as a result of increased competition, he says.

Oil With its takeover of TNK-BP now complete, Rosneft is set to be Russia’s energy champion

ANDREI REZNICHENKO SPECIAL TO RUSSIAN BUSINESS INSIGHT

CEO Igor Sechin directed massive growth for state-owned Rosneft in 2012, developing international partnerships in offshore projects, a merger with TNK-BP and a move toward direct long-term contracts. If Gazprom loses its monopoly on exports of liquefied natural gas, Rosneft could overtake it. In 2012, the net profit of Russia’s largest oil company, Rosneft, climbed 7.2% to a historic high of $11 billion, according to an IFRSbased company report. The former deputy prime minister, Igor Sechin, who took charge of Rosneft in May 2012, charted a course for growth in all areas and, by the end of the year, Rosneft’s share price on the London Stock Exchange had increased 41%. The company’s market value is now estimated at $90 billion, but its real capitalization could be up to $120 billion, as Mr. Sechin recently told President Putin. If so, Rosneft could leapfrog Gazprom ($115 billion) by 2016.

Welcome Offshore In the past two years, Rosneft has actively sought to bring Russian and foreign companies on board projects in the Arctic shelf, one of which is the U.S. company Exxon

Mobil. The list of offshore partners now includes Italy’s Eni and Norway’s Statoil. Rosneft is set to commence exploration of its offshore fields, categorically opposing any move by Russia’s government to allow private companies access to the continental shelf. “Rosneft has chosen a convenient method of operating offshore, sharing the risks with foreign companies, which will finance upstream prospecting, provide technology, and grant the Russian state company a stake in various overseas projects,” says analyst Andrei Polishchuk of Raiffeisenbank.

More Gas Rosneft plans to increase gas production to 100 billion cubic meters (bcm) a year. In 2012, it signed a contract with private gas company Itera to acquire 51% of a joint venture between the two firms. The deal raised $2.1 billion in revenue for Rosneft, essentially allowing it to post record net-profit figures. Last year, Rosneft also began an active search for gas consumers. In October, it signed a major contract with Inter RAO. Starting in 2016, the oil company is to supply up to 875 bcm of gas over 25 years, under “take or pay”conditions. Moreover, it expects to see a demonopolization of liquefied natural gas (LNG) exports. Only Gazprom is entitled to export gas at present. “Arctic gas could be sold for ex-

REUTERS

Rosneft Tops List of Biggest Oil Firms Rosneft is preparing to overtake Gazprom in the race to become Russia’s largest energy company.

BP’s Robert Dudley (L), now on the Rosneft board, with CEO Igor Sechin

The net profit of Russia’s largest oil company, Rosneft, climbed by 7.2% to a historic high of $11 billion. port only, which means that, sooner or later, other companies will receive the right to sell LNG abroad,”analyst Vitaly Kryukov of IFD Capital says.

Synergy With TNK-BP 2012’s largest deal was Rosneft’s buyout of Britain’s BP and Russia’s AAR Consortium in TNK-BP. Both deals are expected to close in the first half of 2013. Rosneft is to

PRESS PHOTO

Gazprom ‘Must Change’

pay BP $17.1 billion, plus 12.84% of government-owned stock. BP agreed to buy a further 5.66% of Rosneft shares for $4.8 billion ($8 per share). Taking into account its existing share package, BP’s stake in Rosneft will rise to 19.75%. Meanwhile, AAR’s 50% stake is valued at $28 billion. The synergy effect of optimizing the two companies’ production, refining, and marketing operations is valued by Mr. Sechin at $3.5 billion. Narek Avakyan, an analyst at AForex, put the synergy estimate higher, at $7.5 billion of additional profit and $60-$80 billion of extra revenue each year. However, he does not expect the merger of assets to take place before 2014.

space rock on February 14. Local businessman Sergei Andreyev has analyzed the rock to produce a perfume with “metallic and stony notes.” • Owner of mining company Metalloinvest, Alisher Usmanov, retained his position as Russia’s richest man on Forbes magazine’s 2013 list for the second year running. Estimated as having a fortune of $17.6 billion, he ranks 34th on the global list. • Russian outbound tourism was up 6% in 2012 as 15.3 million Russians traveled abroad. Turkey retained its place as the destination of choice for 2.5 million Russian tourists, followed by Egypt with 1.9 million visitors. • A new business watchdog, the Presidential Commissioner for Entrepreneurs’ Rights, has received upwards of 700 complaints since it started work in June 2012. Roughly 40% concerned the criminal prosecution of businesses, commissioner for entrepreneurs’ rights Boris Titov said. • The government has promised not to raise income taxes, but it is planning to introduce a new property tax in 2014 that may generate 120 billion rubles ($40 billion) of revenue a year, up from the current 20 billion rubles. The state currently owns about 70 million taxable properties that will be assessed at market valuations. • A luxury tax on expensive cars is being considered. Under the bill, the tax will be based on price and brand, not engine capacity, with cars costing over $195,000 liable. However, top-end BMWs and Mercedes favored by officials could be exempted. RUSLAN SUKHUSHIN

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Special Report

SPECIAL ECONOMIC ZONES & TECHNOPARKS

VIEWPOINT

Russian Innovation Saddled Up and Riding Fast Conor Lenihan SPECIAL TO RUSSIAN BUSINESS INSIGHT

erman statesman Otto von Bismarck once famously observed that the Russian cavalry were “slow to saddle up, but ride fast.” Nowhere is this saying truer than in the realm of innovation, where Russia has rapidly climbed up the rankings over the past five years. France’s Insead Business School recently placed Russia in 51st place in their innovation index, while a new Bloomberg ranking put the country as high as 14th worldwide in a measure that looked at R&D intensity, among other things. The collapse of the Soviet Union dealt a tough blow to the prestige and standing of Russian science. The resulting human capital flight, through the emigration of talented Russian scientists, engineers and technologists, was dramatic. Just ask Cisco Systems, now a strong promoter of Skolkovo, Russia’s flagship innovation project: they have no fewer than 700 Russian émigrés among their staff in Silicon Valley alone. The sharp increases in oil, gas and commodities prices in the 2000s also left an economy lopsided and in need of diversification, modernization and improved infrastructure – with a particular focus on growing small- and medium-sized businesses. The Organization for Economic Cooperation and Development has stressed the need to create alternative champions to Gazprom and Rosneft in the non-resource sectors. Of course these companies are vital for Russia’s revenues, but nimbler, more innovative small companies need to emerge from Russia’s research landscape. In response, the Russian government has launched a series of initiatives around innovation, including technology platforms, tax benefit-driven territorial clusters, Special Economic Zones and new development institutions such as Skolkovo, Rusnano, the Russian Venture Corporation and the Russian Direct Investment Fund. When fully built, Skolkovo will be a brand-new, high-tech city 19 kilometers southwest of Moscow’s Kremlin. It is the highest profile of these initiatives, and since its inception has already created a startup pipeline comprising more than 850 companies, in addition to the stellar presence of global corporates such as Samsung, Intel, Microsoft, Honeywell, Siemens, J&J, SAP and BP – all of whom are either locating R&D centers or venture-funding start-ups. All of this has been accomplished within three years of operational existence. In my native country, Ireland, the decision to ramp up R&D spending came about as a result of success with inward investment, and over a 10-year period commercialization began to occur. In Russia it is happening at a much sharper pace, because of huge investment from the state, the obvious technical talent and the valuable market opportunity that Russia represents for investor companies. Apart from the traditional locations of research excellence, a number of other technopark locations, including Skolkovo, are set to emerge. Locations such as Novosibirsk, Nizhny Novogorod, Tomsk, Ulyanovsk and Zelenograd are providing a competitive challenge in R&D terms. From Cold War days, Russia had a total of 11 “closed cities,” where research scientists worked mainly on Soviet defenserelated projects. Nowadays, those skills are being put to commercial use, pushing forward with interesting IP through Skolkovo. While Skolkovo will accommodate over 31,000 residents, Tatarstan is creating an innovation hub of some 150,000 scientists, engineers and IT professionals. Nikolai Nikiforov, the author of the idea, was last year appointed Russia’s Communications and IT Minister at the age of 29. MIT experts managing the development of the graduate-only Skolkovo Institute of Science and Technology, or SkolTech, hope that Russia’s rise up the research rankings will ensure that talented Russian technologists will not have to leave the country to pursue their careers elsewhere. SkolTech aims to instil values of commercialization, top-quality research and entrepreneurialism, with third-level institutions from all over Russia making a contribution. The ready availability of significant talent, funding and WTO accession are fueling an investment push toward Russia.

Conor Lenihan, a Vice President at the Skolkovo Foundation, is a former Irish Minister for Science, Technology and Innovation.

IN HIS OWN WORDS

Kendrick White FOUNDER AND C.E.O. OF MARCHMONT CAPITAL PARTNERS, A LEADING INVESTOR INTO RUSSIAN TECHNOPARKS AND HIGH-TECH STARTUPS

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Unfortunately, most Russian scientists are currently looking for orders from above while domestic industry seeks off-theshelf solutions from Western companies. Russian firms currently spend less than 1% of their budget on R&D, while they should invest four times this amount. But as more entrepreneurs turn to Russian science for solutions, it will create a new flow of product ideas and solutions.”

DOZENS OF HUBS ACROSS RUSSIA OFFER TAX BREAKS AND SOUND ADVICE FOR THE SAVVY TECH INVESTOR

ATOM BOMBS TO APPLE STORES CONTINUED FROM PAGE 1

The sprawling IDEA technopark in Kazan (500 miles east of Moscow on the Volga River) was set up on the grounds of an abandoned defense plant in 2004, with the aim of creating high-tech businesses. By providing two key services to local start-ups — cheap rent and sound business advice — the technopark graduated enough firms within three years to become selfsustaining; and by 2007, its companies were paying enough taxes into the local budget to repay the start-up capital. “For the last several years, we’ve been independent of the regional budget, and this is important,” says Sergei Yushko, IDEA’s general director [see interview, p. 5].“Our experience proves technoparks are a viable model for economic development in Russia.” Yushko explains that most of the companies at IDEA provide engineering services, software or web design. One such company, Smarthead, has scored top-notch clients as diverse as Honda and L’Oreal. After three years, graduates of IDEA have the option of leaving the technopark, usually securing bank loans independently to acquire office space, or moving into its business park, where rent is no longer subsidized. There, neighbors will include the local R&D branches of international behemoths such as GE and Siemens.“The foreign companies come first and foremost for the qualified personnel,” Mr. Yushko says. “I’m a believer in the unpopular notion that we don’t need factories in Russia,” Mr. Yushko says. “Production will eventually be moved to where you have cheap labor, like China. Our advantage is people and their ideas.”

Root of the Issue Mr. White believes that the government’s investment of billions of dollars into Special Economic Zones and technoparks is now paying off. “They’re starting to get to the root of the issue — how to get the flow of new companies into them and successfully commercialize science.”

“This will be the exciting phase over the next five years, because the officials in Moscow at Skolkovo, the Russian Venture Company and similar organizations now understand this. “Games and programming outsourcing have been the first signs of Russia’s emerging high-tech sector because you don’t need a lot of resources to make them, but I’m a lot more excited about projects in microelectronics, medical sciences, nanotechnology, chemistry, space and quantum mechanics that will gain global recognition in the coming years,” Mr. White adds. “If you go into any Apple store in the United States, you’ll discover that a surprisingly large number of their top 100 products come from Russia,”says PekkaViljakainen, an advisor to Moscow’s Skolkovo Foundation.“But most of them

“Games and programming outsourcing have been the first signs of Russia’s emerging high-tech sector.” “If you go into any Apple store, you’ll discover a surprisingly large number of Russian products.” have offices in California and hide their Russian origins. “Our EBRD Central Russia Venture Fund invested into the [St. Petersburg-based] Speech Technology Center, which is developing top-notch voice-recognition software, and Morion, Inc., which has produced quartz oscillators for projects as diverse as GPS and NASA’s Mars Odyssey mission.We successfully exited these high tech projects, setting into motion a new generation of success stories. This will only grow as a new generation of globally known brands emerges from this country.” For his part, Mr. White also singles out Kuzbass Technopark, in

IN FIGURES

Siberia’s coal-mining region Kemerovo, for developing coal-based sorbents to absorb oil spills, and the pharmaceutical cluster in Obninsk (“home of the peaceful atom”), where cutting-edge medical solutions are created.

Transferring Rights In the U.S., the Baye-Dole Act of 1980 played the “critical role of transferring patent rights from the government to universities and small businesses,” Mr. White says. “A Russian equivalent is under revision in the country’s parliament. This will be critical to support Russian innovators in advancing their ideas into the real marketplace. “What Russia’s leaders are beginning to realize is that it all has to be part of a comprehensive ecosystem,” he says. “In addition to building up the technoparks’ infrastructure, you need to link them with scientists in nearby universities and provide management training programs there. “You need a proof-of-concept center, like Von Liebig at the University of San Diego, to test the commercial viability of scientific concepts. Then you need an accelerator program that can contribute real money to developing a prototype, on the premises of a technopark, and paying lawyers to do patent protection. “Soviet tradition has most Russian scientists and entrepreneurs looking to budget-holders in Mos-

$1.3

billion

in revenue has been earned by the residents of Russia’s technoparks since their inception in 2006.

technoparks focus on innovation in fields as diverse as software and chemicals - in 36 Russian regions.

SEZs focusing on either Industry (6), Technology (5), Tourism (4) or Ports (2) are currently in operation.

$3.6

billion

in foreign direct investment (FDI) has been raised by SEZs since their inception in 2006. SOURCE: MINISTRY OF IT AND COMMUNICATIONS

cow for money, while what needs to happen is local horizontal integration between all these forces,” Mr. White says.“This is what we’re doing at the Lobachevsky University here in Nizhny Novgorod, and it’s what I see already happening all across the country.”

Startup Aims To Make Pirates Pay The creators of Pirate Pay, a Permbased start-up, say they can stop files from being illegally downloaded from torrent networks.

ELENA SHIPILOVA RUSSIAN BUSINESS INSIGHT

In 2009, brothers Andrei and Alexei Klimenko and their friend Dmitry Shuvaev created a file-sharing traffic management solution for an internet service provider network. Thanks to a $120,000 grant from Skolkovo, the company they founded, Pirate Pay, created a program that fights illegal torrent downloads which they are now marketing to Hollywood studios. Pirate Pay’s turnover shot up from $80,000 last year to some $400,000 in 2013. “After creating the prototype, we realized we could more generally prevent files from being downloaded, which meant that the program had great promise in combating the spread of pirated content,”said Andrei Klimenko, CEO of Pirate Pay. The technology prevents file sharing in torrent networks. These peerto-peer file sharing solutions allow large amounts of data to be transferred between individuals. “The underlying technology of Pirate Pay has no analogs in the world,”said Alexander Turkot, executive director of the Skolkovo In-

formation Technologies Cluster, explaining the decision to accept the company as a resident. Potential residents at Skolkovo, Russia’s government-supported answer to Silicon Valley, are assessed according to several criteria, including scientific innovation and the prospect of commercialization. Other sources have also invested including Microsoft Seed Financing Fund and the Bortnik Fund. “Hollywood is still skeptical about the technology, but we’ve earned a hefty profit through contracts with Russian film studios,” explained Mr. Klimenko.

Crackdown The problem of copyright infringement in Russia is extremely serious, and there is significant international pressure on the government to crack down on what is seen to be rampant piracy. Foreigners in Russia find they can obtain foreign films before their release dates in the U.S. According to various estimates, filmmakers lose about $500 million a year to piracy. Hundreds of thousands of gigabytes of illegal content are downloaded every day through file sharing services, including computer software, music and films. Threatening Internet users with legal liability or appealing to their

Dmitry Shuvaev, Andrei Klimenko and Alexei Klimenko (L-R)

conscience has largely failed. And that is why the company has begun to attract attention outside Russia as well as at home. In December 2011, when a film biopic about one of Russia’s most famous singers,Vladimir Vysotsky, was released, Pirate Pay protected it on torrent networks. “We used a number of servers to make a connection to each and every P2P client that distributed this film. Then Pirate Pay sent specific traffic to confuse these clients about the real IP addresses of other clients and to make them disconnect from each other,”Andrei Klimenko said.“Not all the goals were reached. But nearly 50,000 users

did not complete their downloads.” The company’s successful defense of the film brought in its first big paycheck. Company officials will not discuss exact earnings, but said that projects will cost clients between approximately $12,000 and $50,000 depending on the resources needed to mount a defense. “Skolkovo’s tax breaks have allowed us to invest in our newest product, Zilliondata,”said Mr. Klimenko.“It allows clients to not only block illegal downloads, but understand and analyze the audience making those downloads to target advertising at it. This constitutes a completely new approach in the battle for intellectual property.”

Special Report

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IN FOCUS

Special Economic Zones ALONG WITH INFRASTRUCTURE, SPECIAL ECONOMIC ZONES OFFER GOOD TAX BREAKS FOR THOSE WILLING TO INVEST IN ANYTHING FROM SOFTWARE TO SHIPPING.

Q&A SERGEI YUSHKO

How to Tap Into Scientific Talent Through Tech Hubs ally looking for is talent. Technoparks attract the best graduates of local universities and offer them an easy place to open a firm and find contracts from big industry.

The Russian government has invested billions into setting up innovation hubs across the country. The CEO of one of Russia’s leading technoparks explains how you can profit from this investment. ARTEM ZAGORODNOV RUSSIAN BUSINESS INSIGHT

What do technoparks offer to international investors? To maintain their leading positions in high-tech solutions and manufacturing, companies such as Siemens and Honeywell have to simultaneously conduct and implement the latest R&D across a wide spectrum of scientific fields. Doing this in-house is expensive and inefficient: they outsource, and this is where technoparks play a critical role. Russia’s rich scientific history makes it an attractive destination for those companies to network with specialists in everything from liquid dynamics to chemical compounds. The critical links between universities and global business

leaders are technoparks like IDEA, which provide a convenient platform for interaction between big corporations and small business. While nearly all technoparks provide some kind of subsidized utilities and concessionary leasing conditions for small companies, what the world’s best companies are re-

Can you give an example of a major corporation you work with? Siemens produces meters for Russia’s largest corporation, Gazprom (which, incidentally, produces more hydrocarbons than all of Saudi Arabia in terms of their total energy equivalent). But how do you apply their product and solutions to Russia’s atmospheric conditions, its freezing temperatures? How do you certify the meter to meet all the local legal rules and standards? This is where IDEA’s small businesses perform a critical function for Siemens’ operations in Russia. Which technoparks are the most attractive to investors? Investors should look at technoparks currently meeting European BIC standards, like IDEA in

Kazan and the Krasnoyarsk business incubator in Siberia (Skolkovo is also in the process of implementation). The profitability of the technopark and a small-to-nonexistent state ownership are also good signs of its vitality. What role can a foreign investor play at a succesful technopark? Since setting up IDEA, the value of our closed joint-stock company (i.e. it is not publicly traded on a stock exchange) has increased by a factor of 16 (some of our residents have grown even faster than that) and we have been looking for an outside investor for a possible buyout. In our case this niche has been filled by Rosnano (the joint stock nanotechnology company), but we are still eager to meet with foreign entrepreneurs interested in investing in a particular project. Our company’s profitability also means we have the funds to co-invest and share the risk.

t this year’s Davos Forum, the Russian government announced the launch of a new branding campaign entitled “Invest in Russia”. It has also hired Goldman Sachs as advisor to improve the country’s business image over the next three years. A major priority will be to accelerate the development of the country’s Special Economic Zones (SEZs). Having appeared in their present form only in 2005 (when U.S. companies alone invested $966.4 million into SEZs), Russia’s Special Economic Zones now count 57 foreign companies from 21 countries among their residents. In 2012, six U.S. companies came on board. Among them, General Motors invested $180 million, 3M $30 million and Armstrong (building materials) $75.4 million. “Our company faced a tricky choice: where to locate our production facilities, in Russia or some other Eastern European country? In the end, we got residency status in the Alabuga SEZ in Russia’s Republic of Tatarstan last December,” Alexei Zavalev, 3M’s head of legal, told Russian Business Insight. “Apart from tax breaks and other support, we were impressed after speaking with the SEZ managers, who represent a new breed of Russian officials with excellent English and business acumen.” The tax incentives are good: 3M will pay a 2% profit tax in the first five years, instead of the standard 20%. It will also be exempt from VAT, import duties on parts and equipment and enjoy free electricity. As a result, SEZs have raised $3.6 billion of foreign direct investment over the past seven years. Initially designed to stimulate innovation, the SEZs have facilitated the filing of over 350 patents in Russia and have expanded into industrial production, tourism and shipping transportation, and attracted the likes of Boeing and Apple. All SEZ residents must be approved via a supervisory board and the Ministry of Economic Development, a procedure now being simplified to dovetail with Russia’s aim to jump to No. 20 in the World Bank’s Ease of Doing Business ranking by 2018.

Learn more about the top startups emerging from Russia’s high-tech clusters and see profiles of the young entrepreneurs behind the most ambitious ventures. Read more at www.rbth.ru/startups

USEFUL CONTACTS - Russian Venture Company, leading state VC fund › www.rusventure.ru/en/

- SKOLKOVO, the state-sponsored tech hub nearing completion in southwest Moscow (in cooperation with M.I.T.) › www.sk.ru/en

How can I invest into a technopark? The management teams of IDEA and other leading technoparks are eager to hear from investors interested in tapping Russia’s vast scientific talent pool [see Useful Contacts]. Sergei Yushko is CEO of the IDEA technopark in Kazan. Set up in 2004, IDEA’s stock has increased by a factor of 16 as it has attracted investment from the likes of GE and Siemens.

- Russian Special Economic Zones › eng.russez.ru

- Marchmont Innovation News, a leading Englishlanguage resource on Russian technoparks › www.marchmontnews.com

- RUSNANO, the state-owned nanotech giant › www.rusnano.com ›

- Association of Technoparks (in Russian) › www.nptechnopark.ru

Money & Markets

AHEAD OF THE CURVE

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Banking Mezzanine debt allows deals to be financed that otherwise wouldn’t

IT Guys: Russia’s New Generation

Mezzanine Financing Takes Off

Mark Shmulevich SPECIAL TO RUSSIAN BUSINESS INSIGHT

ussian software exports soared to over $4 billion last year, from around $200 million at the turn of the century, with the sector recently enjoying annual growth of around 20% (well ahead of the economy as a whole). Meanwhile, another pillar of the high-tech economy, arms exports, also hit a record $15 billion last year. If current trends continue, however, software will soon overtake arms as one of Russia’s leading innovation exports. But this is not an end in itself; it is merely an indicator of how well the IT sector is developing and how well Russia is integrated into the global economy. While giants like Kaspersky Lab and ABBYY contribute a substantial share of these exports, outsourcing to Russia has become increasingly popular and attractive. This is where small and medium-sized businesses become the critical link. Take Ecwid, for example [a system that creates ecommerce platforms and has a strong working relationship with Facebook], or Prognoz [which produces analysis systems for companies] and Diasoft [which provides automation of banking and insurance systems]. There are many such examples, all of which offer internationally competitive products. Many of them were start-ups, but they have now found their niche. The only question is whether they are interested in staying in Russia or shifting their business to a neighboring country, Europe or the U.S., where the business environment is often more favorable. In fact, less than 1% of the Russian workforce is currently employed in the IT sector, compared with more than 4% in the U.S. and 3% in Europe. We already offer a preferential social tax – 14% instead of 30% – for companies where IT services and products account for 90% of business. While this is valid through 2017, we are working on having the deadline extended until 2020. But this is not enough: we recently held a roundtable about how to make the profession more popular and attractive to professionals. We want to make the IT specialist a symbol of Russia’s young generation. We can also learn from international experience. India liberalized its regulations on currency options, so we are looking at how this tactic could apply to Russia. We are also studying the special tax regimes in other countries (like the new Patent Box regime in the U.K.). A lot remains to be done in copyright protection. The fact that we are lagging behind gives us an advantage in, say, patent wars. When it comes to infrastructure, we are exchanging experience in the creation of technoparks with Singapore and Israel. All of these policies will guarantee dynamic growth for Russian IT over the coming years.

lend companies money for working capital,” says Andrei Abolmasov, managing partner at New Russia Growth, the country’s second-largest mezzanine fund. Russia’s banks have been unwilling to lend to anyone but blue chips since the 2008 crisis, and often set exorbitant collateral demands. “We did one deal to finance a banking acquisition as the client had raised a loan from one of the big state-owned banks, but it was

Russian entrepreneurs are learning about mezzanine deals as a way of avoiding being swallowed by the big fish. BEN ARIS SPECIAL TO RUSSIAN BUSINESS INSIGHT

Want to raise finance for your company, but don’t want to give up control to a bigger fish? That’s the dilemma many Russian entrepreneurs have been facing, particularly since the 2008 crisis, but now there could be a way out that doesn’t involve ending up as shark bait: mezzanine financing is here. “Mezzanine finance has taken off in Russia, but there are still very few people offering sophisticated finance products,”says AndreiYashunsky, managing partner of Moscow-based Hi Capital, a firm specializing in such deals.“We raised half a billion dollars each year for the last two years for 11 deals.” A niche has opened up in Russia for mezzanine financing, a structured product halfway between using a company’s equity to raise money and taking out a loan, as most Russian banks are not yet geared up for these kinds of deals. “Russian banks don’t know how to do it and the firms need to be educated as to how mezzanine finance works,” Mr.Yashunsky says. “The first two hours of any meeting I have with a target company is usually just explaining what we are offering.” So far, just a dozen mezzanine deals have been struck in Russia – mostly with second-tier companies looking to grow their business, buy a rival firm or buy out a partner. “Companies are using mezzanine financing to raise expansion money, but most banks are only willing to

Mark Shmulevich is Russia’s Deputy Minister of IT and Communications.

“Banks don’t know how to do it and the firms need to be educated as to how mezzanine finance works.”

SHUTTERSTOCK/LEGION-MEDIA

Mezzanine financing is being used by companies in place of other forms of borrowing as the main source of fund expansion. demanding a controlling stake in the target in exchange,” Mr. Abolmasov says.“Our deal allowed the acquisition to happen and, once it was completed, the client could easily refinance the debt from a bank at a better rate.” The size of the equity kicker is a big attraction. With mezzanine deals the owner can use a smaller equity stake to raise additional capital, without risking loss of control. But mezzanine deals come at a high price. In the West one will return as much as 25% for the organizer, but in Russia the returns on the debt part are usually 30%-40%. Selling back the equity kicker to shareholders or

ultimate beneficial owners can return 40%-50%. There’s another difference with Russian deals: in the West, the lender will often hang on to the equity kicker for several years, waiting to cash out with an IPO; in Russia the IPO deal flow is down to almost zero. So mezzanine lenders have been signing options with the target firm’s shareholders to unload the kicker anywhere from a couple of years to a few hours. With demand for mezzanine deals rising, other Russian banks are getting interested in developing them. Hi Capital’s Mr.Yashunsky says the deals he has done since starting two years ago are worth $1 billion in total, often financed by Russian banks and tycoons. While mezzanine finance is normally viewed as a way to round out a borrowing portfolio, in Russia it has become more mainstream, used by companies cut off from other forms of borrowing as their

main source to fund expansion. “It’s a bit confusing to call this mezzanine finance, as there are several subtle differences to those deals in the West,” says Mr. Abolmasov. “It’s better to think of this as structured subordinated financing, but this may change over time.” One of Hi Capital’s deals last year was for A5, a Russian pharmacy that wanted to buy Mospharm that the government was privatizing. A fast-growing company, A5 struggled to raise the $135 million asking price. Hi Capital lent them $95 million and helped them structure the deal to sell much of Mospharm’s valuable real estate that came as part of the package. “We closed the deal to take over Mospharm and on the same day sold the real estate,” Mr. Yashunsky says.“The beneficial owners of A5 bought back the equity kicker from us as well, and the total return on investment for that deal was 45%.”

STATE MATTERS

Banking Russian banks will suffer ‘relatively little impact’ in the Cypriot bailout, S&P says

Is This the End of the Oligarch Era?

Cyprus ‘Marginal’ for Russia IN FIGURES

Boris Mezhuyev IZVESTIA

$2.5 billion

Boris Mezhuyev is a Moscow-based political analyst.

in loans was extended to Cyprus last year by Russia; during the current crisis, President Vladimir Putin ordered the country’s Finance Ministry to restructure this part of the debt.

$30 billion out of a total of $68 billion held in Cyprus bank accounts belongs to Russian citizens or companies, according to Moody’s.

AFP/EASTNEWS

Cyprus’s then Finance Minister Michael Sarris faced tough talks in Moscow with officials unhappy about the levy.

While individual Russian investors may lose out on deposits in Cyprus banks, Russian banks as a whole will not suffer too much.

IN HIS OWN WORDS

Victor Gerashenko

BEN ARIS

EX-RUSSIAN CENTRAL BANK CHIEF

SPECIAL TO RUSSIAN BUSINESS INSIGHT

Tough capital controls imposed by crisis-hit Cyprus will have only a “relatively marginal impact” on Russian banks on the Mediterranean island, ratings agency S&P says. “Russians have a penchant for parking their deposits abroad, particularly in Cyprus, and in the aftermath of the eurozone crisis, the consequences are becoming clear,” the agency says in a March 27 report.“We view these events as having a relatively marginal impact on the consolidated financials of rated Russian banks with a presence in Cyprus. VTB Bank is the Russian bank with the most exposure to Cyprus, in our view.” But state-controlled VTB, Russia’s second-biggest bank, insists its exposure to Cyprus from a subsidiary, Russian Commercial Bank, is a maximum of 50 million euros. Russian businesses and individual investors are likely to take a bigger hit; those with more than 100,000 euros in Cyprus’s Laika Bank, which Cyprus is allowing to go to the wall, face the confisca-

There’s a lot of Russian money in Cyprus, and a lot of investments coming to our market under the guise of Cypriot companies. But this is our money. I think [Cyprus] hasn’t been an offshore zone at all since it joined the common [EU] market; there’s plenty of Russian and British money there. But the British are mostly represented by retirees. It’s a quiet island with good weather and wine. Our people [there] are sharp.”

he death of exiled oligarch Boris Berezovsky, probably due to suicide by hanging, came after he lost a $5 billion court battle against ex-business partner Roman Abramovich. Berezovsky belonged to the breed of people that can’t bear losing. To them, life is about winning. But the last few years Berezovsky was well and truly beaten by Vladimir Putin. All the people in Russia whom Berezovsky bankrolled either defected or stepped aside, or passed away. Berezovsky’s plans in former Soviet republics failed: the “Orange Revolution” he sponsored was a fiasco, while the main beneficiary of his financial support, former Ukrainian Prime Minister Yulia Tymoshenko, is in prison. Psychology alone cannot explain what happened. For example, Mikhail Khodorkovsky, the jailed oil tycoon, doesn’t give the impression of a psychologically crushed person. Russian revolutionary Leon Trotsky, with whom Berezovsky was often compared, also hated losing. But Trotsky fought against Stalin to the end, until his last breath. And Trotsky was fighting for Russia as the vanguard of the world revolution. Can we say with as much certainty what kind of Russia Berezovsky was fighting for? It would be simplistic to claim that Berezovsky had no ideals at all, and that he had only interests. I think deep in his heart he had his own dream of Russia. People like Berezovsky needed a weak Russia, a Russia without strong government. They could safely do business only in an amorphous, semi-federative disintegrating country – a kind of Eurasian Cyprus, hopelessly divided with low taxes and an ineffective government. Until recently – right up until the Cyprus financial crisis, in fact – Berezovsky could at least hope that, however morally bereft his ideal of a “weak” Russia may be, that ideal was shared by Russian entrepreneurs who sought refuge for their money in Cyprus. We can’t attribute Berezovsky’s sudden death and his mysterious repentance to the EU’s determination to sort out Russian investments in Cyprus. And yet, for Berezovsky, these events could have been history’s final diagnosis on the “weak Russia” ideal. Berezovsky was an ideal for thousands of adventurously minded Russians. Now they have realized that they made a fateful mistake in the 1990s by succumbing to the charm of an “enfeebled” Russia. Russian business today needs new, bold heroes, adventurers who are prepared to build a new “strong and sovereign” Russia, where there is still room for economic enterprise and political competition. This class, which despite all the risks is ready to bring its money back to Russia, will become the real infrastructure for a future nationally oriented capitalism.

tion of up to 40% of their deposits. No one is sure how much Russian money is in Cyprus; estimates range from $20-$35 billion. The Kremlin is clearly not happy. PresidentVladimir Putin has called the squeeze on Russian deposits in Cyprus“unfair,”while Prime Minister Dmitry Medvedev called it “theft.” Depositors in Cypriot banks can now only withdraw up to 300 euros from ATMs, and transfers abroad were limited to a mere 5,000 euros as Cyprus’s Central Bank strove to prevent a bank sector collapse.

“It is a given that no one in their right mind is going to make a transfer into Cyprus now,”says one Moscow banker with several million euros stuck in a Nicosia account. The collapse of Cyprus’s economy is likely to hurt Russian real estate investors too. “The real estate sector was booming as many Russians were buying property there, but the market has already collapsed.You can’t sell a property if you wanted to,”says Katya Thain, director of residential real estate at Chesterton Moscow, a high-end realtor that caters to Russian cli-

ents with properties in Cyprus. While the Kremlin rebuffed Michael Sarris’s desperate pleas for a new $7 billion loan during his trip to Moscow last month, it has not been entirely insensitive toward Cyprus’s pain. On March 25 President Vladimir Putin ordered Russia’s Finance Ministry to restructure a $2.5 billion loan to Cyprus. Russia may use funds from its development bank VEB to aid domestic companies with funds trapped on the island, however. For Russian businesses the loss of Cyprus as an offshore tax haven will be a major inconvenience, and will likely prompt them to look elsewhere for tax efficiencies, including nearby Latvia or the Balkans. The double taxation treaty between Cyprus and Russia meant money flowed quickly and easily from Moscow to Nicosia and on to the rest of the world. Despite allegations that Cyprus was a major money laundering hub for Russian money, the truth is more prosaic: Cyprus was a convenient and tax efficient conduit that connects Russia to the global financial system. Dividends paid on Russian shares registered in Cyprus are not liable to tax, nor is there any capital gains tax on money earned from asset sales; both are taxed in Russia.

Comment & Analysis

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THE PATH TO HEALTHY GROWTH Maxim Oreshkin ECONOMIST

NATALIA MIKHAYLENKO

CYPRIOT FLU CAN HURT OTHER NATIONS Alexei Kudrin EX-FINANCE MINISTER

remember how in 1998 then-Prime Minister Sergei Kirienko’s government advised that the preferential tax regime with Cyprus be terminated. It shocked the Cypriot leadership — the island stood to lose half its business. The Cypriot president got a private meeting with Boris Yeltsin and convinced him not to cancel the privileges. As compensation, Cyprus agreed to buy and host an S-300 missile system, which had been paid for but not delivered because of opposition from Turkey. In those days, Cyprus viewed Russia as a geopolitical ally. Even now, Cyprus provides services and support for Russian business. But the country cannot shy away from the fact that in 2004 it joined the European Union, and in 2008 the euro zone. Cyprus is no longer in control of its destiny. These past few days, German Chancellor Angela Merkel has spoken a lot about the country’s“dysfunctional”financial model, which has greatly undermined the credibility of the Cypriot financial system. The central indicator in all this is the ratio of banking-sector assets to GDP, which in Cyprus is seven to one. For comparison, in Luxembourg banking assets exceed GDP by a factor of 20, in Britain five, while in Germany the figure is at the European average of around three. Furthermore, the“dysfunctional” Cypriot model came about because local banks were forced to write off Greek debt. It is possible that Cypriot banks were not very fussy when it came to buying Greek bonds, but all EU policy was aimed at saving Greece. Investors were convinced that the euro zone would not let Greece, or any other member, fail.

And therein lies one of the major contradictions revealed by the current crisis: for political reasons, investors overvalued eurobonds in the zone’s periphery. Cyprus essentially became a victim of the spillover from the crisis in Greece. The situation in Europe is very fragile: Cyprus can infect other countries, not only because money will flee the island. The threat of a tax on deposits has spooked investors in troubled states, and the outflow of deposits from the entire European periphery could well accelerate. Of course, the sought-after sum of €17 billion ($22 billion) could be stumped up by the

If Cyprus exits the euro zone, the risk looming over all the peripheral European countries will increase. The crisis will intensify and it is just a matter of time before the next weakest link emerges. EU itself, but here it is instructive to note two circumstances. First, Cyprus must demonstrate the ability to save its own skin, which is perfectly logical because otherwise no country would bother to reorganize its financial system. The second circumstance is far less obvious: it is a politically motivated unwillingness to help the“Russians,”whose funds in Cyprus, according to the eurocrats, are of “dubious origin.” It is clear that European governments are finding it difficult to convince voters of the need to support peripheral countries. Cyprus is a

convenient case to show a tougher attitude. What the upshot will be for Cyprus itself, no one seems to know. The details surrounding the bankruptcy of Laiki and the rescue of Bank of Cyprus are still uncertain. What is clear is that even these measures will not raise the whole amount or eliminate all the risks. After Mrs. Merkel’s pronouncement, the island’s current status as a financial center is dead in the water. It remains to be seen how the financial flows will be affected, but in any case people’s standard of living will fall and many will be unemployed. Inadequate support on the part of the EU and the ECB may even cause Cyprus to exit the euro zone. In which case, the conversion of bank assets and payment of salaries in the local currency would undermine the financial sector and reduce the quality of life even more than if the euro were preserved. The main danger is that the risk looming over all the peripheral European countries will increase. The crisis will intensify, and it is just a matter of time before the next weakest link emerges. I believe that the EU bears full responsibility for ensuring the crisis does not spill over. Therefore, it must take all measures to rescue Cyprus. If not, overcoming the consequences of the contagion will be far more costly. Alexei Kudrin was Russia’s Finance Minister from 2000 until 2011 and was named Finance Minister of the Year in 2010 by Euromoney Magazine for channeling windfall petrodollars into a stabilization fund that helped Russia overcome the 2008 Global Economic Crisis. Originally published in Kommersant newspaper

SPENDING OUT OF AUSTERITY Vladimir Mau ECONOMIST

he Russian Central Bank has pursued a fairly tight monetary policy over the past three years, holding the base rate high at 8.25% in an effort to curb inflation. That was a vital objective; unlike most Western economies, Russia faced a serious risk of stagflation following the onset of the global economic crisis. But this policy has some limits because current inflation is detremented by institutional factors along with monetary ones. In other words, inflation is currently being driven not only by the interest rates or money supply policies, but also by the prices charged by the natural monopolies, as well as by weak business activity. Prices charged by the infrastructural monopolies are growing 10-15% every year, fueling growth in utility tariffs and related prices. Meanwhile, the economy is being sluggish to react to price stimuli. By mid-2012 output had returned to the pre-crisis level, but producer prices were up 32% on 2008. The economy now needs much greater coordination between monetary, structural and institutional policy. The Central Bank will have to adjust its strategy and try to find a better balance between financial stability and economic growth, even though, under the country’s Constitution, it is

responsible only for monetary policy and price stability (not economic growth). And there is no reason to expect any surprise moves or drastic policy changes when Sergei Ignatiev is replaced by Elvira Nabiullina as the Bank’s head. The main objective facing Ms. Nabiullina will be to plot a course that maintains macroeconomic stability while also fostering economic growth. It is a big challenge, but central banks

Russia was facing a serious risk of stagflation following the onset of the global economic crisis. in the developed world are increasingly beginning to target jobs and growth. The Russian Central Bank cannot ignore these problems, for economic as well as political reasons. The bank will also face colossal pressure from many quarters to sacrifice macroeconomic stability for the sake of economic growth. It may find it difficult to persuade its opponents that growth triggered by such a trade-off is unlikely to last, and that in the longer term it would almost certainly lead to a new bout of crisis. In the current institutional environment, an economic stimulus policy which includes high-

THIS SUPPLEMENT IS PRODUCED AND PUBLISHED BY ROSSIYSKAYA GAZETA (RUSSIA) AND DID NOT INVOLVE THE NEWS OR EDITORIAL DEPARTMENTS OF THE WALL STREET JOURNAL WEB ADDRESS HTTP://RBTH.RU E-MAIL US@RBTH.RU TEL. +7 (495) 775 3114 FAX +7 (495) 988 9213 ADDRESS 24 PRAVDY STR., BLDG. 4, FLOOR 7, MOSCOW, RUSSIA, 125 993. EVGENY ABOV PUBLISHER TIM WALL, ARTEM ZAGORODNOV EXECUTIVE EDITORS ELENA SHIPILOVA EDITOR PETER PURTON GUEST EDITOR OLGA GUITCHOUNTS REPRESENTATIVE (U.S.) ANDREY SHIMARSKIY ART DIRECTOR ANDREI ZAITSEV HEAD OF PHOTO DEPT MILLA DOMOGATSKAYA HEAD OF PRE-PRINT DEPT ILYA OVCHARENKO LAYOUT AN E-PAPER VERSION OF THIS SUPPLEMENT IS AVAILABLE AT WWW.RBTH.RU. TO ADVERTISE IN THIS SUPPLEMENT CONTACT JULIA GOLIKOVA, ADVERTISING & PR DIRECTOR,

er spending, lower rates, and pumping more liquidity into the banking system will produce the desired acceleration of growth. But any gains in economic output would then be lost to future financial turmoil amid growing systemic financial risks and structural imbalances. Several other social and economic problems will have to be addressed before Russia can enter a sustained period of growth. Macroeconomic stability is a top priority. The country’s “credit history”over the past two decades shows the government cannot afford to run the risk of financial and monetary destabilization. A new economic policy could be based on a transition from the ‘demand-side economy’ to the ‘supply side economy’. Stimulating demand (especially from the public sector) in current circumstances would mostly stimulate imports and inflation rather than domestic output. That is why the Russian economy does not need a loose monetary or credit policy, but a balanced development of the financial sector, which should be the facilitator rather than the main engine of economic growth. Sustainable growth should come from a radical improvement of the business climate, in the broadest possible sense. Vladimir Mau is an economist and Rector of the Russian Presidential Academy of the National Economy and Public Administration.

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ussia’s abundant natural resources and skilled labor force make it a nation of great potential and many in the investment community believed this would be enough to maintain strong growth rates for years to come. However, the success of the 2000s was brought to a halt by the crisis and has been followed by a period of weak growth. A paradigm shift in the energy markets – shale gas, the oil revolution in North America and booming oil production in Iraq – have limited the chances of future gains in oil prices. The consumption boom of the last decade, partly supported by skyrocketing oil prices, has come to an end. There are now many who are less optimistic about Russia’s prospects. The country has to prove it can use its potential to deliver strong and sustainable growth, without support from rising oil prices. From the macroeconomic point of view, Russia had the fortune to come out of the boom years in good shape. In stark contrast to developed and most emerging countries, Russia’s debt-to-GDP ratio stands at around just 10%. Indeed, if you take into account the money Russia has accumulated in different funds, the nation is free of debt. In the past couple of years Russia has run a balanced, and in some cases, surplus budget. The 2008-09 crisis proved the value of prudent macroeconomic policies – an area that Russia has continued to strengthen in recent years. Last year, Russia improved the long-term sustainability of government finances by introducing a new“budget rule,”setting a maximum spend based on long-term average oil prices. With this rule in place, any temporary increase in oil prices only results in a further build-up of the reserve fund, not an increase in budget liabilities. The major change was on the FX market, where the ruble has significantly increased its flexibility, while the Central Bank has concentrated on managing interest rates and controlling inflation. In recent years, discussions about

As Russia’s budget spending is ruble-denominated, what matters is not the dollar oil price but the ruble oil price. This means that government revenues are relatively isolated from global volatility. Russia’s economy have typically started with a question about the break-even oil price for the budget. However, with the more flexible exchange rate regime, the budget’s dependence on oil prices has decreased. As all Russia’s budget expenditures are ruble-denominated, what matters is not the dollar oil price but the ruble oil price. And as the ruble now weakens in response to declines in oil price, it means that the ruble oil price (and therefore government revenues and the budget balance) remains relatively isolated from global volatility. Improvements in the macroeconomic framework are not sufficient to achieve strong growth rates alone. This year, the economy is set to show a healthy yet modest growth rate of about 2%-2.5%. These are not remarkable figures – and there are also a number of challenges that will be difficult to overcome. For example, demographics remain the Achilles heel of the Russian economy and are almost impossible to remedy. Given the situation, growth must come from increasing productivity, strengthening investment and improving efficiency. But Russia’s potential growth is trapped below the 3% level by the poor quality of institutions and the investment climate. The positive news is that Russia has finally understood there are no free lunches and that reforms are crucial to reaccelerate growth. Last year, the country finally became a fully fledged member of the World Trade Organization and accession to the Organization for Economic Cooperation and Development is next on the list. Russia currently stands 112th in the World Bank’s Doing Business rating, and although it is ahead of Brazil and India in this league table, it has set the ambitious goal of moving towards the top 20 by 2018. Nobody is under any illusions about how hard it will be to achieve this target, but I expect Russia to break into the top 50 within five years. Russia now has to create a better institutional framework and improve the investment and business climate to build on the solid macroeconomic base. If it succeeds, Russia could re-emerge with a new, more robust growth model that is more stable and less dependent on the global commodity markets. We may never return to the high rates of the past, but events of recent years have shown once again that it is better to have lower and healthier growth. Maxim Oreshkin is chief economist for Russia at VTB Capital.

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Travel Book offers pictorial guide to Russia’s fairy-tale wooden churches from Moscow suburbs to the Arctic coast

The wonderfully wooded hilly park at Kolomenskoye, just 20 minutes south of central Moscow, has its own museum of log churches and castle stockades. Particularly lovely is the threedomed, 17th-century wooden church of St. George, originally built on the banks of a little tributary of the Dvina River. There is a working wooden church, dedicated to St Nicholas, in the “Kremlin” at the Izmailovsky craft market in eastern Moscow. Everything about the fairy tale landscape here is unashamedly fake. It was all built from woodclad concrete about 15 years ago, but it is still quite a scenic area, a great place to buy souvenirs and there are some genuine imperial remains on a nearby island, part of the view from the church’s observation platform. The intricate Church of St. Tikhon in Sokolniki Park in northern Moscow is also a working church with an interesting history and attractive surroundings. The current building is a reconstruction of a 19th-century structure, but its log-burning ceramic stoves and painted benches make it feel older. Another hidden gem in Moscow’s northern suburbs is the church of St. George in Voikovskaya. This thriving church was built in 1997 and closely modeled on the churches of the Russian North. It has five traditional“hipped”roofs with domes and a bell tower and serves the community in the densely populated Koptevsky area. (Take tram 23 from Voikovskaya metro to the market.) On the other side of the Timiryazevsky Forest, near Timiryazevskaya metro, is the Church of St. Nicholas. Modeled on designs by the great Art Nouveau architect Fyodor Shekhtel, the original church was consecrated in 1916, not a great moment for religious buildings. Many of Moscow’s incredible monasteries include wooden chapels, often a simple structure over a well. One such building can be found as part of a picturesque ensemble in the village of Kosino,

Karelia in Russia’s far Northwest, under two hours by plane from Moscow, offers the best glimpse of a vanishing form of architecture. PHOEBE TAPLIN SPECIAL TO RUSSIAN BUSINESS INSIGHT

Few things seem so typically Russian to foreign travelers as wooden buildings. For those people wanting to see old, wooden churches in remote and natural settings before it is too late, Richard Davies, the author of “Wooden Churches: Travelling in the Russian North” (White Sea) suggests staying in one of the northern towns or cities like Arkhangelsk, Kargopol or Onega. He also recommends Petrozavodsk as a base from which to visit the staggeringly beautiful churches at Kizhi. The Russian artist Ivan Bilibin wrote: “I have never seen such an architectural fantasy as at Kizhi.You can’t help thinking that you really are on the threshold of some fairy-tale kingdom.” Many of the churches Mr. Davies photographed are clustered around the White Sea coast or along the Dvina and Onega Rivers. More accessible are some of the museums of wooden architecture. Mr. Davies recommends the Malye Karely collection near Arkhangelsk. The five-domed Church of the Ascension and other gems of 17thcentury architecture have found a picturesque new home here, even if they have lost some of their authenticity. TheVitoslavitsy Museum nearVeliky Novgorod is another great collection in an evocative setting. Restored wooden buildings from across the region are ranged on the marshy shore of the Volkhov River. There are similar museums in Suzdal and near Vologda, in the village of Semenkovo, a short taxi ride out of town. This ethno-architectural museum has examples of wooden buildings from the past two centuries.

LORI/LEGION MEDIA(3)

A Taste of Old Russia: Wooden Churches Galore

Kizhi has preserved ancient Russian log cabins.

IN HIS OWN WORDS

William Brumfield PRESERVATIONIST, ARCHITECTURAL PHOTOGRAPHER AND PROFESSOR OF SLAVIC STUDIES AT TULANE UNIVERSITY

The rigors of the northern climate produced a shelter environment that excluded or reduced natural light. Hence the urge to create vivid forms that would catch and reflect the light, whether the tower and cupolas of a church or the decorative wooden carvings on the facade of a log house. Such forms, created from materials available in the northern forests, reaffirmed the survival of the community and the innate longings of the soul.”

east of Moscow. The wooden St. Tikhon chapel is nothing special, but the atmosphere of the cloistered, waterside garden by the Beloye Ozero (white lake) makes it worth visiting. You can catch a bus from Vykhino metro station and then walk around the lake. Suburbs like Kosino give an impression of

Church of the Transfiguration on the Island of Kizhi in Russia’s Northwestern region of Karelia.

village life, if you can ignore the noise of Moscow’s ring road, but for proper rural peace you will have to head further afield. For a day trip from Moscow you could try Melikhovo, where Anton Chekhov had his country house. The restored wooden church in the village is just a short stroll from his dacha.

See a guide to the finest wooden Russian Orthodox churches. Read the full story at www.rbth.ru/24091

Food & Drink An insider’s guide to the relatively new phenomenon of wine bars in downtown Moscow

Good Places to Eat, Drink and Learn nalists on Nikitsky Boulevard), Bontempi seems to be always booming with life – partly due to the current trend toward worshipping wine and food, but more because of the great, unconventional design of the main area of the bar, which is located below ground level. And if almost all other wine bars are generally sacrificing their food choices on the altar of extensive wine lists, Bontempi is the exception that proves the rule.

People don’t go to wine bars to be lectured by a sommelier. But they are still good places to learn about wine, albeit in a relaxed, hospitable and social setting. Here are short descriptions of three of the best wine bars to be found in Russia’s capital city. ANTON MOISEENKO SPECIAL TO RUSSIAN BUSINESS INSIGHT

Gavroche

www.barbontempi.ru

On a typical Friday evening, Gavroche is filled with creative hipster types, looking to get the weekend started in a relaxing atmosphere. The design of the place is a bit ordinary, but Gavroche could hardly ask for a better location, near Park Kultury metro in central Moscow. Some 25 wines – both whites and reds – are available by the glass and more than 100 by the bottle. The price for 150 milliliters of Hugel Gentil 2010 is around $9, which is fairly acceptable for Moscow. But the price of wines by the bottle is rather on the high side for this “democratic” wine bar. Most of the wines are French, but Italian bottlings are also in evidence – the Pinot Grigio Elena Walch 2011 is available for $45 – and a Jaquesson Cuvee Brut costs $143.

Grand Cru

Bontempi Although Marco Cevretti is not in charge of Bontempi’s extensive wine list, he’s the person that really makes this place work. Situated just in front of the famous DomZhur (House of Jour-

PRESS PHOTO(3)

www.thewinebar.ru

The best, but not the cheapest, wine-drinking establishments that Russia’s capital city has to offer: Bomtempi (1), Gavroche (2) and Grand Cru (3).

What lies behind Berezovsky’s death?

You can’t lose if you choose a wine bar from the Grand Cru chain. Most of them are actually just wine shops with occasional tastings (if you are lucky enough to be invited to one) and only two are “real” bars with places to sit and sip. The first one, which also features very good food, is on Malaya Bronnaya Street just beside Patriarch’s Ponds – the famous ponds featured in the Bulgakov’s “The Master and Margarita”. The wine bar is a creation of Maxim Kashirin and serves as the retail division of his Simple Wine importing company, which has a rather impressive fine wines and spirits portfolio – probably the best in Russia. Grand Cru is also famous for its connection with Spanish chef Adrian Quetglas, who controls the menu. The prices are not particularly cheap, but people come here for the high level of service and guaranteed wine satisfaction, no matter what their taste buds are up for. www.grandcru.ru

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