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Bloomberg Russians Mask Economy’s Weakness With Shopping, Building Frenzy

EXTRACT: In mid-November, government environmental inspectors vowed to revoke the licenses of oil giant Royal Dutch Shell Plc to continue work on a Far East oil exploration venture called Sakhalin 2, in which Shell has a 55 percent stake. Iskyan says the government’s motive is to win a controlling stake in the project for itself.

Browder doesn’t think any amount of scandal will deter investors so long as Russia’s oil billions keep flowing. “People will ignore my visa, people will ignore Kozlov’s assassination, people will ignore Shell’s problems as long as the money supply is going up, as long as asset prices are going up,” Browder says.


By James Brooke

Nov. 30 (Bloomberg) — In central Moscow, construction cranes loom over the Kremlin, as hotel and office towers rise up to accommodate Russia’s newly minted companies and the flood of foreign business visitors. Downtown apartments that cost $100,000 a few years ago now cost $1 million.

On weekends, shoppers by the thousands line up behind cash registers at the 150,000-square-meter Tyoply Stan suburban mall, loading up on home furnishings, televisions and cell phones. Stockholm-based Ikea, which owns the mall, reported that it received 52 million shoppers in 2005, making it the most-visited shopping center in Europe.

Moscow is adding 100,000 cars to its roads every year, and the congestion is so bad that on Oct. 31, players from Russia’s Spartak soccer team were forced to abandon their bus and take the subway to the stadium, arriving just in time for their Champions League match against Inter Milan. When Spartak lost, 1-0, the coach blamed the traffic.

Across Russia, consumer loans doubled in the first nine months of 2006 to $80 billion. The country has seen eight straight years of economic growth, with expansion for 2006 estimated at 7 percent, according to Economy Minister German Gref. That’s more than three times the rate in the European Union. Bankrupt a decade ago, Russia wrote $23.7 billion of checks on Aug. 21 to repay government debt run up during the 1998 ruble crisis, in which it defaulted on loans and bonds.

Must Diversify

Much of Russia’s new prosperity can be traced to a single source. “Russia’s economy is about oil,” says Natalia Orlova, chief economist at Moscow-based Alfa-Bank. Oil and gas account for 65 percent of Russia’s exports and 60 percent of federal tax receipts. With retail sales, services and construction now fueling Russia’s boom, “consumption is financed by oil revenues,” she says.

Russian President Vladimir Putin is the first to point out that this golden era of energy can’t last. “The main task of the government in the near term is to diversify our economy,” Putin said on Oct. 25 in a three-hour, nationally televised question- and-answer session. He returned repeatedly to this theme, calling it Russia’s “overarching task.”

Putin, 54, wants the country to be a top producer of autos, aircraft and other manufactured goods.

Russia is the world’s largest gas exporter and second- biggest oil exporter, after Saudi Arabia. The 92 percent rise in petroleum prices in the past three years has swelled the coffers of both the big oil and gas companies and the government.

The Kremlin’s hard currency reserves jumped more than 65 percent in the year ended on Nov. 17, to $279 billion, more than the reserves of the entire euro zone. Russia has also profited from high prices for aluminum, gold and copper. Oil, gas and other commodities now account for 80 percent of Russia’s exports.

Disaster: $30 Oil

The price of oil on Nov. 29, at $62, was down 19.5 percent from its Aug. 7 high of $77. “If oil went down into the $30 range, there would be a lot less cash in the economy, a lot less money flowing into equities, and consumer demand would trail off significantly,” says Kim Iskyan, co-head of research at Moscow- based investment house MDM Bank.

The government has tried to protect itself against such an event by setting up an offshore “stabilization fund” that held $77 billion as of Nov. 1, Iskyan says.

Putin says his government is striving to expand job opportunities in manufacturing, technology and other fields. By the end of this decade, Russia’s car production will double to 2 million units a year and up to 70 percent of parts for the cars will be produced in Russia, he predicts.

“Fifteen of the world’s largest manufacturers have announced the beginning of car assembly on our territory,” he said in his October talk.

Government Role

Putin, who says he plans to step down as required by law when his second term ends in May 2008, believes the government has a strong role to play in creating economic diversity. In his national Q and A, he called on the nation’s state- and privately owned aircraft makers to unite into one state-owned holding company.

One week later, the company he proposed, OAO United Aircraft Corp., was established in Moscow.

Putin’s government has also sought to cement a dominant role in the gas and oil industries for state-controlled gas giant OAO Gazprom and OAO Rosneft Oil Co. State-aligned companies in steel, aluminum and other commodities have received similar support.

In mid-November, government environmental inspectors vowed to revoke the licenses of oil giant Royal Dutch Shell Plc to continue work on a Far East oil exploration venture called Sakhalin 2, in which Shell has a 55 percent stake. Iskyan says the government’s motive is to win a controlling stake in the project for itself.

Greenspan Criticism

First Deputy Prosecutor General Alexander Buksman told the press in a November interview that preserving nature on Sakhalin Island is a real concern. “No one here is allowed to damage the environment with impunity,” he said. “The law will demand harsh repercussions for that.”

In mid-October, former U.S. Federal Reserve Chairman Alan Greenspan criticized Russia’s swing back to big state companies. “National champions, by definition, are those that don’t maximize profitability,” Greenspan, 80, told an annual investors’ conference in New York sponsored by Moscow-based investment bank Renaissance Capital. “Competition is critical.”

Elections could further swell the government’s outsized role in the economy. A parliamentary vote is scheduled for December 2007, and a presidential poll for March 2008.

Vladimir Gersamia, a fixed-income strategist and Russia expert at Merrill Lynch & Co. in London, says that while the two pro-Putin parties that control the Duma, the 450-seat legislature, are seen as easy winners in the parliamentary vote, the Kremlin is taking no chances. It’s pushing through a 26 percent increase in the federal budget for 2007.

High-Speed Trains

Among planned projects: a $2 billion highway linking Moscow and St. Petersburg and $24 billion in rail improvements, including the purchase of eight German-built high-speed trains.

“Russian fiscal discipline has been exemplary in recent years,” Gersamia says. “Now, with elections coming up, the general political impetus is to spend this money.”

According to the Federal State Statistics Service, Russia now has 1.5 million civil servants, about twice the number it had during the waning years of the Soviet Union.

Consumers are spending as prodigiously as the government. And they are increasingly buying imports. Russia was on track in mid-November to import $150 billion of foreign goods in 2006, double the amount in 2003. East of Siberia’s Lake Baikal, the foreign goods usually say Made in China. West of the lake, they originate in the U.S. or Europe.

Consumer Gold Rush

Andrew Somers, president of the American Chamber of Commerce in Russia, has a front-row seat for the gold rush. “I am briefing a substantial American company at least once a week,” he says.

Sales growth rates for consumer products produced by American companies such as Altria Group Inc. and Procter & Gamble, he says, “are a minimum 25 percent and often at 80-120 percent.”

The chamber of commerce, which has 800 member companies, says American companies have invested a total of $75 billion in Russia in the past 15 years. On Nov. 8, International Business Machines Corp. announced plans to expand from its Moscow base to an additional 20 Russian cities.

“Opportunities continue in almost every sector other than energy production,” Somers says. In energy services, companies such as Halliburton Co. and Schlumberger Ltd., both Houston based, “are doing fine,” he says.

There are so many foreign businessmen visiting Moscow that hotel space is at a premium. By 2010, Moscow will have 248 new hotels with 90,000 rooms, according to Grigori Antyufeyev, the city’s tourism director.

Five Star Face Off

The Kremlin’s north redbrick wall will be the backdrop for a five-star hotel duel. In March, the Ritz-Carlton Moscow, with 337 rooms, is scheduled to open on the site of an old Intourist hotel, with rooms starting at 650 euros ($830). In 2008, the Four Seasons Moscow will launch across the street from the Ritz.

U.S. investors still feel constrained by Russian trade barriers. In late October, executives at Chicago-based aircraft maker Boeing Co.; Dearborn, Michigan-based Ford Motor Co.; and 12 other companies sent a letter to Putin and U.S. President George W. Bush urging them to speed up Russia’s entry into the World Trade Organization so that tariffs on both sides could be reduced.

WTO Promise

In November, Bush and Putin announced an agreement on the terms under which the U.S. would approve Russia’s WTO entry, which must be sanctioned by every current member.

As the new Democratic-controlled Congress prepares to take office, it is unclear whether it will vote to lift cold war restrictions on trade with Russia. So even if Russia joins the WTO, American companies may not be able to take full advantage of lowered import tariffs.

Russia’s business image among foreign investors was dented in 2006 by several events. In the spring, William Browder, the largest single foreign investor in Russia, was denied a visa. Then, in September, Andrei Kozlov, first deputy chairman of Russia’s central bank, was gunned down while exiting a soccer game.

In October, award-winning journalist Anna Politkovskaya, who uncovered abuses against civilians in Chechnya, was killed in her Moscow apartment building. And in November, Alexander Litvinenko, a defector from Russia’s spy agency and an opponent of Putin, died in London, apparently killed by a rare poison, radioactive polonium 210. Investigations continue into the three murders.

Ignoring Scandal

Browder, a British citizen who’s chief executive officer of Moscow-based hedge fund firm Hermitage Capital Management, now runs his company’s $3.2 billion portfolio from London while he seeks a reversal of the Russian government’s unexplained decision not to renew his visa. Investigations continue into the Kozlov and Politkovskaya murders.

Browder doesn’t think any amount of scandal will deter investors so long as Russia’s oil billions keep flowing. “People will ignore my visa, people will ignore Kozlov’s assassination, people will ignore Shell’s problems as long as the money supply is going up, as long as asset prices are going up,” Browder says.

As of Oct. 1, 2006 incomes had increased by 17 percent, construction was up 15 percent and retail sales jumped 13.5 percent from a year earlier.

Russia’s oil bonanza has created a burgeoning middle class. Average annual per-capita income has increased 4.5 times during Putin’s seven years of running Russia, to $4,214 as of November, according to MDM Bank.

Conspicuous Consumption

Visitors to Russia are impressed by the conspicuous consumption in the tonier neighborhoods of Moscow and St. Petersburg. “Everyone is spending like crazy,” Gersamia says. “Moscow is like the Gulf emirates. People are spending huge amounts of money. Real estate is bizarrely expensive.”

Sales of Bentley autos, a luxury division of Volkswagen AG, were up 71 percent in the first seven months of 2006, according to Hermitage, helped by a glistening dealership a block from the Kremlin. DaimlerChrysler AG’s Mercedes-Benz sales jumped 91 percent in the same period, while sales of Bayerische Motoren Werke AG cars were up 225 percent.

Executives at BMW Russland Trading, which assembles the German automaker’s luxury cars in Russia, aren’t worried. “We tripled our sales in the last three years,” Christian Kremer, the company’s president, says. “We are quite optimistic about the future.”

Millionaire Fair

Moscow features a stream of consumer shows directed at millionaires. At one October exposition, called Extravaganza, Russia’s new rich inspected prospectuses for private jets, apartments in Dubai and townhouses in Knightsbridge, London.

“Our Russian clients could have 10 to 20 homes around the world,” said Shirley Humphrey, sales director for real estate firm Harrods Estates Ltd. “But many want to be in London because their children are going to university there.”

Humphrey was dressed in conservative clothes as she greeted prospective clients. Nearby, three models in leopard-skin bikinis pranced through the fair, advertising luxury safaris to Kenya.

It’s not just the oil and gas executives and entrepreneurs who are prospering in oil-soaked Russia. Federal prosecutor Buksman says corruption among public officials is rampant.

“By some expert estimates, the volume of corruption in our country is comparable to federal budget revenue and is worth $240 billion and more,” Buksman said on Nov. 7. “The size of bribes has reached such a level that, in a year, an ‘average’ corrupt civil servant can buy an apartment with a floor space of 200 square meters.”

Gusher Runs Dry?

An apartment of that size in Moscow would cost about $830,000, according to, a real estate Web site.

Even as Moscow parties on, Anders Aslund, a Russia specialist at the Peter G. Peterson Institute for International Economics in Washington, is predicting that the gusher will run dry.

One reason, according to Aslund: the government’s failure to invest in the very sector that has created its new wealth. Only 8 percent of total national investment is in gas and oil, Aslund says. With petroleum income above $25 a barrel taxed at 90 percent, he says, the oil companies themselves have no incentive to invest in new production. To raise gas production Russian Energy Minister Viktor Khristenko said Nov. 29 that he wants to raise now subsidized domestic gas prices to international export levels by the end of this decade.

Leaping sales of Beemers and Bentleys do not make a diversified economy. In his office-in-exile in London, Browder pulls out graphs showing that the rise in the price of Moscow real estate, along with the growth in the sales of art and other luxury goods, closely tracks the growth in Russia’s money supply, which is in turn driven by export revenues that come overwhelmingly from sales of gas and oil.

Clearly, he says, if the petroleum boom ends, so will the good times for much of Russia.

To contact the reporter on this story: James Brooke at

[email protected] .

Last Updated: November 30, 2006 01:55 EST and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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