Russia tycoons look to Kremlin for help

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Russian elite look to Kremlin as wealth dries up

Financial strains felt by tycoons could jeopardize an unspoken political pact

By Philip P. Pan

updated 3:18 a.m. CT, Fri., Oct. 17, 2008

MOSCOW - In April, Oleg Deripaska seemed unstoppable.

Forbes magazine had just named him the richest man in Russia, estimating his fortune at $28 billion. His mining and manufacturing empire was expanding, picking up assets around the world and launching a takeover bid for a huge nickel producer. The gossip pages tittered with rumors of his plans to buy racehorses and soccer clubs.

But the global financial crisis has not been kind to the 40-year-old tycoon and friend of the Kremlin. In recent weeks, he has been forced to surrender prized assets to creditors, including his stake in North America's largest auto-parts supplier, Magna International. His bank, Bank Soyuz, stopped lending and was downgraded by ratings agencies. The automaker GAZ, in which he holds a majority stake, temporarily shut down assembly lines.

With stock markets here down more than two-thirds from their May highs and continuing to fall, almost all of Russia's billionaires -- men and women who made their fortunes in the transition to capitalism after the Soviet Union's fall -- are hurting. According to one analysis, the wealth of the top 25 on the Forbes Russia list has plunged nearly $240 billion in the past five months.

These losses have been felt across the Russian economy, as the tycoons' businesses trim jobs, cut salaries and suspend projects, and have presented Prime Minister Vladimir Putin with a delicate political question: Should the Kremlin bail out the billionaires?

Emergency measures

Putin has already reached into the nation's huge reserve funds, the third-largest in the world, and announced one emergency measure after another in an attempt to end the turmoil that has gripped the Russian financial system. The government has pledged more than $200 billion thus far to bolster stock markets and banks, an amount equal to about 15 percent of the country's gross domestic product.

But it remains uncertain whether the money will be enough, how it will be distributed, and to what extent the Kremlin will try to use it to help friends and punish enemies. In a sign of growing dissatisfaction with Putin's handling of the crisis, an influential business group published an unusually blunt letter last week warning that the reserves could be exhausted within two years and urging the Kremlin to refrain from playing favorites as it distributes aid.

"The principles of providing state support to companies should be made public and transparent," wrote Alexander Shokhin, president of the Russian Union of Industrialists and Entrepreneurs, complaining that the Kremlin often only helps the few, privileged businessmen who can get meetings with officials.

The billionaires' plight is in some ways a reversal of the situation a decade ago, when the government was mired in debt while a handful of tycoons wielded such clout that they came to be called oligarchs. Now, the Kremlin is flush with cash, and the tycoons are struggling with debt.

The nation's second-richest man, Alexei Mordashov, is slashing production at steel plants in Russia, Italy and the United States. The third-wealthiest, Roman Abramovich, has seen his holdings lose as much as $20 billion in paper value. On average, Russia's 110 billionaires have lost half their wealth in the crisis, said Oleg Anisimov, chief editor of Finance magazine, which tracks and ranks the elite.

Politics could 'get tough'

Analysts said the financial crisis could strain the unspoken pact between Putin and the tycoons, who have been allowed to prosper as long as they do not challenge his rule.

"They're going to be fighting to get money from the Kremlin, and behind the scenes, people inside the Kremlin will be fighting to get control of assets," said Peter Boone, an associate at the London School of Economics who studied the Russian economy for investment banks. "That's when the politics get tough."

The financial crisis has hit Russian companies especially hard because they have grown dependent on cheap foreign credit in recent years. With the ruble strong and interest rates low, Russian banks and firms accumulated nearly $500 billion in foreign debt by mid-2008, up from $150 billion in 2002.

They relied on these loans to buy new properties and expand, and in many cases to finance daily operations. Now that credit has dried up, they have been left in the lurch. More than $40 billion in foreign debt must be paid off or refinanced by companies by the end of the year, according to the central bank.

Olga Kryshtanovskaya, director of the Center for the Study of Elites, said the crisis presented a political opportunity for Putin. With the tycoons weakened, he will be able to further consolidate the Kremlin's control of strategic industries that he believes never should have been privatized in the 1990s, especially the natural resources sector, she said.

"When it's over, the state sector will be bigger, and there will be redistribution in favor of the Kremlin's friends," she said, noting that one cellular service provider had already been taken over by a billionaire with ties to the administration.

Putin enjoys the advantage of huge reserves accumulated during the oil boom of the past decade -- about $530 billion held in foreign currencies and precious metals, including more than $180 billion in two rainy-day funds collected from taxes on windfall oil profits. This "safety air bag," as he calls it, has been critical to preventing a run on banks and a financial meltdown like the one that crippled the economy a decade ago.

Battle inside the Kremlin

But the crisis has heightened a battle inside the Kremlin over control of the funds and the proper role of the state in the economy, according to analysts and others close to the Kremlin. One faction, which supports greater state control, has fought to use the funds to promote growth and build infrastructure in Russia. But market liberals have succeeded for the most part in keeping the funds in government-backed bonds overseas, arguing that safeguards to prevent waste and corruption need to be developed before the state invests more in the domestic economy.

Both camps agree the funds need to be used now, but there are signs of discord over how much and how.

Several Russian newspapers have reported that Putin's finance minister, Alexei Kudrin, the leading market liberal in the cabinet, has come under fire for criticizing some of the bailout measures. In November, one of his deputies, Sergei Storchak, was arrested on embezzlement charges in what many analysts considered a move against Kudrin.

"There's a lot of pressure on him over the reserve funds," said Sergei Guriev, rector of the New Economic School and a board member of Russia's largest bank. "Every lobbyist wants the money invested in Russia."

Speaking to reporters in Washington this week, Kudrin dismissed reports that his job was in jeopardy and said he has not opposed the government's bailout measures.

There have also been signs of disagreement over a plan to use the funds to buy stocks in Russian firms and boost the markets. Putin settled the dispute last week by ordering the purchases to be made, a move critics regard as wasteful and risky.

Most of the funds offered by the Kremlin have been in the form of loans to big state banks, which are supposed to then provide credit to other banks and businesses. But the state banks have been slow to release funds, raising concerns about the banking system's ability to fill the vacuum left by vanishing foreign credit.

Flooded with loan requests

A senior state banking official, speaking on the condition of anonymity because he worried his remarks could rattle the markets, said big banks have been flooded with requests for loans but could not properly evaluate all of them for risk. As a result, they are trying to provide loans to a limited group of smaller banks, which they expect will pass the money into the rest of the economy.

Critics warn that the Kremlin is burning through its rainy-day funds and fueling inflation. At the same time, falling oil prices have forced the government to spend reserves to support the ruble and prevent a devaluation that would make foreign debt even more difficult for firms to pay off. The reserves plunged by more than $15 billion last week alone, after a drop of nearly $30 billion last month, the central bank said.

Andrei Illarionov, Putin's former economic adviser and an architect of the reserve strategy, said the Kremlin was frittering away the funds, directing them toward inefficient companies with political connections.

Meanwhile, the government has ignored what he says is the underlying cause of the crisis -- a collapse in investor confidence caused by the Kremlin's attempts to bully businesses and its Georgia war. "They think the problem is liquidity, but it's not," he said. "It's the political system."

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