President Dmitry Medvedev published a striking essay titled Russia, Forward! Far from extolling his countrys virtues, as national leaders usually do, Medvedev decried its shortcomings, criticizing Russia for its humiliating raw-material dependence and chronic corruption. He called on his citizens to join him in a modernization campaign that would make the country richer, freer, more humanitarian.
Stanislav Voskresensky, a 34-year-old deputy minister of Economic Development, is trying his best to do just that. Voskresensky is in charge of improving Russias woeful energy efficiency, one of five sectors Medvedev has targeted for his national leap forward. (The others are information technology, pharmaceuticals and medical equipment, telecommunications and nuclear power.) To that end, the young apparatchik last year devised a series of pilot projects to replace conventional incandescent lightbulbs with light-emitting diodes, only to hit a snag. One sentence buried in a tome of regulations churned out during the chaotic 1990s flatly forbade the use of LEDs in Russia, regarding them as dangerous.
Voskresensky lobbied government colleagues and lawmakers in the Duma to convince them of the conservation benefits and safety of LEDs. His efforts paid off. In November 2009 the Duma passed an energy law that phases out incandescent bulbs by 2014 and sets new energy standards for buildings and appliances, in a bid to green an economy that currently burns more than three times as much energy per unit of GDP as countries in the European Union.
Such nitty-gritty, wonkish changes are the stuff that will make a better Russia, Voskresensky asserts. Our reforms are less sexy than what Yegor Gaidar did 20 years ago, he tells Institutional Investor, referring to the prime minister who unleashed shock therapy on Russia in 1992. But they are more important.
Voskresensky is not well known, even in Russia, but that may change if his reform efforts succeed. He is part of a coterie of government ministers and advisers who are seeking to turn Medvedevs modernizing vision into reality. These reformers include Arkady Dvorkovich, 38, a Duke Universityeducated economist who is Medvedevs chief economic adviser. He is leading a charge to sell shares in state companies and expedite the countrys long-delayed entry into the World Trade Organization. Another key player is Igor Shuvalov, 43, a lawyer who is currently first deputy prime minister and is shepherding the kind of microreform efforts that occupy officials like Voskresensky. Shuvalov, who took on a new role this fall as ombudsman for foreign investment, says the government has halved the number of customs documents and lifted civil-service pay to discourage corruption.
Several luminaries from outside the Kremlin have also joined Medvedevs crusade. Viktor Vekselberg, a magnate who made billions in aluminum and billions more in oil, has volunteered to oversee the development of a new high-technology center, a sort of Russian Silicon Valley, in the Moscow suburb of Skolkovo. Alexander Voloshin, Kremlin chief of staff under both Boris Yeltsin and Vladimir Putin, the former president who now serves as prime minister, is steering efforts to establish Moscow as an international financial center. Ruben Aganbegyan left his post as president of investment bank Renaissance Capital to head the Micex Stock Exchange, which aims to become a pillar of that financial center. And Yevgeny Yuriev, an entrepreneur who sold his Moscow brokerage, Aton, to an arm of Italys UniCredit for $424 million in 2007, recently became Medvedevs adviser on pensions and social policy.
These men hail from different backgrounds, but they share a belief that Russia can end its age-old dependence on commodities and engage the nations intellectual prowess to generate new sources of growth and innovation.
A naive dream? Perhaps. Many commentators outside Russia dismiss Medvedevs reformist rhetoric as a smokescreen for the autocracy of his mentor and presumed boss, Prime Minister Putin. Many Russians think so too. They believe current oil prices of more than $85 a barrel will enable the government to keep the economy afloat and avoid the tough changes that could boost the countrys productive capacity. The most likely prognosis is what I call the 70-80 scenario, says Sergei Guriev, rector of the New Economic School in Moscow. If oil stays at $70 to $80 a barrel, Russia will stagnate like the Soviet Union did in the 1970s and 80s. Investors seem to be similarly skeptical, judging by their valuations. Russian stocks trade at an average price-earnings ratio of about 8, compared with 18 for India, 16 for China and 14 for Brazil.
Many observers doubt that the reformers have the backing and the time they need to implement fundamental changes in the economy. A real modernization project takes five years at least to start showing results, says Ruben Vardanian, chief executive of investment bank Troika Dialog, who has announced he will step down in the next few years to work on civic projects such as developing Russias nonprofit sector. Medvedevs current term ends in 2012, and its not yet clear whether he will be nominated for a second term that would allow him to see his program through. Nothing is certain about the succession except that the final call will come from Putin, who heads United Russia, the political party that is almost sure to win the election. The supreme leader often talks up the need for new thinking in Russia. Modernization is, in the largest sense, the question of our national future, he said in an address to the Russian Academy of Sciences last spring. But Putin is also the architect of much that Medvedev seeks to change from overweening police power to overweight state industry.
Voskresensky rejects the supposed dichotomy between the modernizing Medvedev and the statist Putin. He dates the dawn of the new reform era to a speech delivered by Putin himself in February 2008, just before leaving the presidency. Putin lambasted Russias lagging labor productivity, which was four times lower than the Wests, and called for large-scale modernization of all sectors of the economy. As Voskresensky puts it, Even with oil above $100 per barrel, it was absolutely clear that if we kept on the same path, our growth would not be what we needed.
Medvedev, who was elected in March 2008 and took office in May of that year, didnt hesitate to grab the modernizing banner. Six days after his inauguration, he ordered a federal audit of all regional governments energy-saving efforts. The idea of reform took a backseat when the world financial crisis ripped through Russia in September 2008. But one year later, as the first signs of recovery began surfacing, Medvedev put modernization back on the agenda by publishing Russia, Forward! through the Internet news service Gazeta.ru. With that manifesto, he also signaled his determination to carve his own political profile after a career spent clinging to Putins coattails. A lawyer and son of a university professor from Saint Petersburg, Medvedev first went to work for Putin in 1991, when the latter, a former KGB officer, was a deputy mayor in that city. He followed Putin to Moscow in 1999 as deputy chief of staff and had never run for office before he was nominated for the presidency.
Medvedevs reform drive was well timed. The financial meltdown had exposed Russias economic weaknesses for all to see. The country experienced the sharpest contraction in Europe aside from the Baltic states, with output plunging by 7.9 percent as prices for oil and other commodities sank. The drop would have been much steeper had the government not pumped in an estimated $150 billion, or 9 percent of GDP, from a fiscal reserve fund and from state banks like Sberbank and VTB Bank to keep foundering corporations afloat. Capital flight reached $130 billion in the last three months of 2008, according to the Finance Ministry.
The economic collapse focused attention on the stunted development of Russias small and midsize businesses, held down by corruption, high interest rates and established competitors with official backing. The Kremlin had no choice but to prop up ailing enterprises in dozens of Soviet-built monocities that had never fostered much entrepreneurial undergrowth. One of Russias key problems is the missing middle, says Erik Berglof, chief economist at the European Bank for Reconstruction and Development in London.
The crisis also ended a decade of fiscal virtue for Russia. The government had recovered quickly from its 1998 bond default as buoyant oil prices helped it run consistent budget surpluses and build the worlds third-largest pool of currency reserves, which peaked at $557 billion in August 2008. The Reserve Fund, a rainy-day stash fueled by windfall oil receipts that hit a high of 4.9 trillion rubles ($155 billion) in January 2009, will be depleted by next year, Putin said recently. With increases in social payments outpacing tax revenues, the state will run a deficit of 4.6 percent of GDP this year, according to Finance Ministry estimates. The weak budgetary position increases the urgency of generating growth from noncommodities sectors and raising cash with a new privatization program.
Today reform efforts like those pursued by Voskresensky are proceeding on a modest scale. Bureaucratic harassment of small business has dropped off sharply, for instance, following an amendment to the administrative code that requires inspectors to get a prosecutors permission before barging onto a companys premises. Weve seen some pretty good results over the past year and a half, says Vladislav Korochkin, vice president of Opora, a lobbying group for small and medium-size enterprises. Most agencies basically dont touch the smallest entrepreneurs anymore.
That may seem like a minor achievement, especially considering that Russia recently ranked a lowly 154th out of 178 nations in Transparency Internationals 2010 corruption perceptions index, tied with Kenya and trailing Iran and Libya. But some reformers feel the wind shifting tentatively their way. Before Russia, Forward! the likelihood of a modernizing path was maybe 15 percent, says Evgeny Gontmakher, an economist at the Institute of Contemporary Development, an archliberal think tank that Medvedev founded just before taking office. Now it is more, though still less than 50 percent.
You cannot go far in the country today without hearing some important person voice support for the Russia, Forward! doctrine. The future of Russia depends on modernization and innovation in the economy, proclaimed Andrei Kostin, chief executive of VTB, the countrys second-largest bank by assets, at the opening of a Moscow investment conference in October.
As Medvedev pushed his reform message beyond the Kremlin walls, he began searching for outsiders who could help. His biggest catch so far has been Vekselberg, a 52-year-old tycoon whom Forbes ranks as the worlds 113th-richest person, with a net worth of $6.2 billion.
The Russian government began drawing up vague plans for a series of high-tech parks around the country as early as 2006. But it was only in March 2010 that Medvedev picked Skolkovo, a suburb just a few kilometers west of the capitals Ring Road, as the do-or-die project for Russias advanced industrial future and recruited Vekselberg to oversee it. It is important for Skolkovo to inherit the spirit that exists here, Medvedev said during a visit to the real Silicon Valley in California a few months later. This cannot be achieved through a presidential decree.
The president intends to partner with private investors on the $7 billion or so that Vekselberg says it will cost to build a city of innovation, or innogorod, from scratch on Skolkovos gently rolling hills. A stout, dapperly attired figure with a trademark salt-and-pepper beard, Vekselberg established his reputation, and wealth, during the buccaneering days of Russias transition from Communism, privatizing and renovating decrepit aluminum plants in Siberia during the 1990s. But he is known as a diplomat among oligarchs.
In 2006 he steered his Siberian-Urals Aluminum Co., or SUAL, through a merger with bitter rival Rusal and Swiss-based trader Glencore International to form the worlds top aluminum producer, under the Rusal name. Vekselberg also helped calm a protracted dispute at oil company TNK-BP, where he and other Russian shareholders clashed with the British supermajor for control of the 50-50 venture. The confrontation ended with a new board and CEO, and a healthier company that is now buying assets that parent BP has to sell to pay for cleaning up its massive well blowout in the Gulf of Mexico.
Vekselberg is the right guy for the job, says Drew Guff, a partner in New Yorkbased private equity firm Siguler Guff & Co., which has about $1 billion invested in Russia. He is a heavyweight who can get the attention of global CEOs. One of Guffs own companies, DataSpace Partners, has pledged to invest $250 million in data centers at Skolkovo, assuming Medvedev and Vekselberg will provide electricity.
Vekselberg showed off the strength of his Rolodex during a presentation at the VTB conference. In six months on the job, the oligarch reported, he had won firm commitments from Boeing Co., Cisco Systems and Siemens to site design or research facilities at Skolkovo. Microsoft Corp. and Nokia Corp. have come on board since. The Massachusetts Institute of Technology signed an agreement that could lead it to build a satellite campus at the innovation city. We already have 28 technology centers, and still many of our specialists leave for the West, Vekselberg said. The Skolkovo ecosystem needs to change that.
The next A-list recruit to the modernization campaign was Alexander Voloshin, whom Medvedev tapped in May to captain efforts to turn Moscow into an international financial center and to consider ways to elevate the ruble to reserve currency status. Medvedev had floated the idea of developing a financial center while waiting to take office in April 2008, seeing the initiative as a way to reverse the flow of Russian IPOs and related banking employment to London.
Voloshin, 54, brings a record as a master of bureaucratic compromise. He started his career as a lieutenant of now-exiled oligarch Boris Berezovsky. In 1999, when Berezovsky was a leading power broker inside the Kremlin, he arranged for Voloshin to become chief of staff to then-president Yeltsin. Voloshin all but ran the Kremlin while an ailing Yeltsin finished out his term. He stayed on as chief of staff for nearly four years under Putin, acting as a mediator in the tense interaction between the new president and the oligarchs who had dominated the economy under Yeltsin. He left Putins administration in late 2003 when that relationship frayed over the arrest of Mikhail Khodorkovsky, then the billionaire head of oil company Yukos. But Voloshin maintained good relations with the man who succeeded him as chief of Putins staff, Dmitry Medvedev.
After quitting the Kremlin, Voloshin acted as board chairman of the giant state power utility UES. Observers credit his mediation between UES chief executive Anatoly Chubais, a pugnacious veteran of Gaidars reform team, and Chubaiss many enemies in government as a key factor in the reform of the power monopoly, which was broken up and largely privatized in 200708. This could never have happened without Voloshin, says David Geovanis, an American investor who sat on the UES board for several years.
Voloshin has little markets experience, and he seemed a bit at sea laying out the specifics of the financial center drive at the VTB conference this fall. If weve waited 15 years to pursue this project, I guess we can wait a few more months to figure out what we are doing, he said. But enthusiasts are counting on his backroom acumen to help push through the legal and regulatory reforms required under a 200-odd-page blueprint drawn up by Voskresenskys colleagues at the Ministry of Economic Development in December 2009. The priorities include beefing up market infrastructure with new mechanisms for clearing and netting; increasing liquidity by making it easier to issue, securitize and repo stocks or bonds; and luring more foreign investors by eliminating special accounts for them and easing Russias devilish visa procedures.
One important fan is Ruben Aganbegyan, who left his banking career to head up Micex a few weeks after Voloshin took the financial center post. To make the changes necessary within this organization, a lot of things need to change around it, Aganbegyan tells II in an interview. I thought this was something the government is committed to do.
More than a year after Russia, Forward! Medvedevs modernizing brain trust is managing to push through a steady stream of reforms. In September the Duma approved a law that exempts companies at Skolkovo from corporate profit, value-added and real estate levies. Next year the legislature will vote on measures to slash the social-needs payroll tax for all IT companies from 34 percent to 14 percent, eliminate capital gains taxes for private equity investments held more than five years and nix corporate income taxes for companies in health care and education.
Aganbegyans pet achievement is the recent lifting of a ban on any investor owning more than 20 percent of a stock exchange. This helps clear the way for one of his key objectives: a merger between Micex and its rival, the Russian Trading System, and the possible forging of an alliance with an international exchange operator.
The subtle tide of change has encouraged veteran government liberals to go back on the offensive after years of increasingly autocratic rule. Finance Minister Alexei Kudrin has joined Medvedev adviser Dvorkovich in pushing a new privatization program to sell assets ranging from VTB, of which the government owns 86 percent, to wholly state-owned Russian Railways, and raise as much as $60 billion over the next five years. Talks between Medvedev and U.S. President Barack Obama in September ended a 17-year impasse over Russias WTO accession, which U.S. officials now expect to happen sometime in 2011. The WTO agreement has so far survived the scrutiny of congressional Republicans, who are refusing to ratify the START nuclear arms treaty that Obama signed with Russia in April.
Outside the economic complex, a key modernizer is Anton Ivanov, 45, a college classmate and onetime business partner of Medvedevs who became chairman of the Supreme Arbitration Court, the countrys top commercial court, in 2005. Since his patron stepped up to the presidency, Ivanov has made a series of changes aimed at greater professionalism and transparency, ranging from creating a new patents court to bolster intellectual property rights to launching Presidium Online, a streaming service that will feature real-time Internet transmission of arbitration court cases starting next year.
All these disparate measures add up to an overhaul of official Russia that will gather strength regardless of Medvedevs own political future, Voskresensky contends. People like to create an artificial opposition between the Kremlin and the government, he says, using insiders code for Medvedev and Putin. This has no relationship to reality. We are all one team.
This viewpoint gets some support from outside observers. Putin always made it very clear that he was working on a 20-year development program and would turn to modernization after consolidating control, says Christopher Weafer, chief strategist at investment bank Uralsib Financial Corp. in Moscow. Medvedev is phase two of the Putin program. Others are more skeptical and believe that reform will wither without Medvedev. Basically, Putin thinks everything is all right in the country and we can continue on the current course for a long time, economist Gontmakher says.
In any case, Medvedev has created a situation where Putins dumping him would look like a crippling blow to modernization. So Kremlin watchers are dusting off their old podium-watching skills, squinting for signs of fissure in what is thought to be a genuine 20-year friendship between the president and the prime minister. Medvedev does not want to fight with Putin, but some of his circle are pushing him to flex his muscles, says Alexei Mukhin, director of the Center for Political Information in Moscow.
Putin, who at 58 is approaching a grandfatherly age by Russian standards, has watched benignly as his much-younger protégé raises his profile in word and deed. Medvedev took a big political step forward in October by firing Yuri Luzhkov, the longtime Moscow mayor who was a well-known thorn in Putins side during his own presidency. Luzhkovs replacement, Sergei Sobyanin, has firm ties to both national leaders. A stout Putin loyalist whose previous job was deputy premier, he was also deputy chairman of the Commission on Modernization and Technological Development, a council on reform policy that Medvedev chairs. The president also aligned himself with the popular cause of environmental protection this summer by halting a Moscow-toSaint Petersburg superhighway project after protests about forest destruction. Those protests triggered a backlash that included the near-fatal beatings of an activist and a journalist who supported the opposition.
Some Russian political observers doubt that Putin wants to be president again. He is said to be tired of the globe-trotting and ceremonial hobnobbing that post entails. Yet allowing Medvedev to have a second term one extended to six years by a 2008 constitutional amendment would likely spell the beginning of the end for Putin as ultimate power. Vladimir Putin will not commit political suicide, Mukhin declares. His personal scenario has Putin staying on as prime minister and picking a new, younger technocrat as president, while Medvedev accepts the consolation prize of heading the Russian court system and waging war on what he has famously called legal nihilism. Other analysts see Putin backing Medvedev for reelection and staying on as prime minister. Few see him yielding power entirely in 2012.
Even if Dmitry Medvedev were tsar, he would face a tough struggle forcing innovation and competitiveness upon an economy dominated by rent-seeking bureaucrats. Lack of necessity has bred a lack of invention among Russias elite, a complacency hard to shake with commodity prices rebounding from their postcrisis lows. If you are getting so much money from oil and gas, there is no urgency to do anything else, Troikas Vardanian observes. Ordinary Russians remain traumatized by the chaos and falling living standards that marked the late 1980s and 90s, and they crave a little peace and quiet. Most of the people are against modernization, economist Gontmakher admits. It makes them fear for stability.
Voskresensky would say that is exactly why his teams changes are deliberately unsexy. Putting LED lighting in a hospital or selling a logistics subsidiary of Russian Railways to investors is not going to upend any babushkas life. But reproduced a thousand times, it just might make a better country for her grandchildren.