Stratfor --------------------------- THE KREMLIN WARS (SPECIAL SERIES), PART 3: RISE OF THE CIVILIKI

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THE KREMLIN WARS (SPECIAL SERIES), PART 3: RISE OF THE CIVILIKI

Summary
The global economic crisis has led the Kremlin to examine its decisions about
running Russia's economy, financial sectors and businesses. A group of
intellectuals including Russian President Dmitri Medvedev, called the civiliki,
want to use the crisis as an opportunity to reform the Russian economy. The
civiliki's plan will lead to increased investment and greater efficiency in the
economy, but it will also trigger a fresh round of conflict between the
Kremlin's two powerful political clans.

Editor's Note: This is part three in a five-part series examining the Russian
political clans and the coming conflict between them.


Analysis


In the aftermath of the global economic crisis, Russian Prime Minister Vladimir
Putin has had to step back and examine the Kremlin's decisions on running the
country's economy, financial sectors and businesses and the effects of a
state-controlled system on investment, growth and the freedom of capital. In
response, a group of Russian intellectuals called the civiliki, who are trained
in economics, law and finance, have presented proposals on "fixing" the economy.
The civiliki (a play on words, since the Federal Security Service and other
members of the security class in Russia are called the siloviki) is a new group
of economically liberal-minded (by Russian standards) politicians and
businessmen. This group includes Russian President Dmitri Medvedev, Finance
Minister Alexei Kudrin (who is also a deputy prime minister), Sberbank chief
German Gref and many more.

The civiliki are not ideologues like the liberal Russian reformers of the 1990s
and understand that the Russian economy and institutions must maintain some
sense of balance with national security and national interests. But the civiliki
also see how much damage the siloviki's control of key power structures and
businesses has done to the Russian economy.

The civiliki's plan has one main goal in mind: to implement real structural
reform in Russia's major economic sectors. This will improve competition,
attract investment and purge waste and mismanagement. The plan has three parts
-- purge the non-business-minded siloviki from positions of economic
responsibility, introduce new pro-investment laws and partially liberalize the
economy. It is an incredibly ambitious plan that would reverse laws designed by
the FSB and Putin over the past six years. But the reforms are being spearheaded
by the one man Putin trusts on all finance and economic issues: the civiliki's
Kudrin.


Kudrin is an experienced official, being one of the very few to make the
transition from the Yeltsin era to Putin's Russia and having held a prominent
position in every one of Putin's governments. The reason for his longevity at
the Kremlin is simple: Rather than playing politics (to the extent usually seen
in Russia) he is a technocrat who makes decisions based largely on the economic
facts. His numbers-oriented mind, apolitical nature and competency as a manager
are at least as important to Russia's relative financial stability as the strong
energy prices of the past decade. Because of this, Putin values Kudrin's counsel
greatly. Kudrin has also been an important buffer between Deputy Chief of Staff
and First Aide to Vladimir Putin Vladislav Surkov and Deputy Prime Minister Igor
Sechin, the heads of the Kremlin's opposing clans -- until now.


Kudrin's Plan

Part 1: Purging the Siloviki

The most controversial part of Kudrin's plan is to purge the siloviki from
positions of control over businesses and economic institutions. The siloviki
clan, run by Sechin, took command of most of the Russian state firms over the
past six years, and has -- by Kudrin's technocratic reckoning -- run them
poorly. The siloviki run firms including oil giant Rosneft, rail monopoly
Russian Railways, Russian airline Aeroflot, nuclear energy company Rosatom and
arms exporter Rosoboronexport. The issue is that the siloviki have placed former
KGB agents as heads of industry and businesses though many have no expertise as
businessmen. According to Kudrin, it was largely Sechin's clan that sought
access to international credit before the global economic crisis hit. Some $500
billion flowed into Russia via such connections, flooding the Russian financial
sector with foreign capital. Sechin's clan spent the money as if it were free,
often on irrational mergers and acquisitions that increased the clan's political
power but had little economic purpose.

When the global recession occurred, all those funding sources dried up in a
matter of weeks. And as the ruble declined, all of those loans still required
repayment -- in the then-appreciated U.S. dollars, euros and Swiss francs.
Consequently, the Russian economy suffered a contraction worse than any other
major state in the world. The Kremlin was forced to bail out many firms,
particularly those linked to Sechin's clan, to prevent a broader collapse. As
part of the efforts to contain the crisis, the Kremlin also spent more than $200
billion on slowing the depreciation of the ruble so that the loans taken out by
corporations and banks did not appreciate so much that they would not be
repayable. From Kudrin's perspective, this was a huge cost to save companies
whose managers had no business being in business.

Kudrin's plan is to weed out the security-minded officials now occupying
leadership positions in industry and business, leaving only those who can
actually run their institutions properly. But in doing this, Kudrin would strip
Sechin's clan of massive economic and financial clout --something the siloviki
would not stand for.

Part 2: Making Russia Investor-Friendly

Next, Kudrin's plan calls for legal changes that would make Russia more
attractive to investors. One of the issues investors have with Russia is that
there is very little legal protection, which leaves them highly vulnerable to
hostile takeovers and becoming a target for the Kremlin or its power players.
Moreover, the few legal authorities that do exist -- like the Federal Tax
Service or the Audit Chamber -- often are tools for the Kremlin to help it
pressure Russian and foreign firms that the government wants to either destroy
or devour. The best-known case of this is the story of Yukos, whose owner
Mikhail Khodorkovsky had evolved from businessman to ruler of Russia's vast oil
sector and aspiring politician -- much to the Kremlin's ire. In 2004, the
government brought the full power of a reinvigorated state to bear against
Khodorkovsky and sent him to a Siberian prison. Other examples are of the
Kremlin targeting energy assets belonging to foreign firms like BP and Royal
Dutch/Shell to give those assets and/or control over projects to
state-controlled energy firms.

In theory, the new investors' rights laws would protect businessmen and
investors in Russia. The country has never had sound laws protecting investors'
rights. However, it is most likely that any new laws will leave the state plenty
of wiggle room to ensure that the Kremlin has significant control over
investors' actions.

The next step to creating an investor-friendly Russia, according to Kudrin's
plan, is to repeal the strict energy cap laws Putin put in place in 2007. These
laws affect strategic industries and clarify which assets would be off-limits to
foreigners. The sector affected most by these laws was energy. The laws limit
foreign firms' ability to own more than 40 percent of a project in the country
and forbid foreign firms from owning any projects involving the subsoil. These
laws have made Russia an unattractive environment for foreign businesses to
maintain or expand investments in energy projects, even though Russia is one of
the world's most energy-rich countries.

But Kudrin's plan involves more than repealing the energy laws and allowing
foreign firms to rush back in. There is a political side to the plan,
masterminded by Surkov. The changes in Russian energy laws will allow foreign
companies to own up to a 50 percent stake in projects, but if a foreign firm
wants majority control then it must "trade" assets outside of Russia with one of
the Russian energy behemoths. In essence, Russia will allow foreign companies to
own majority stakes in large projects like the new fields on the Yamal peninsula
in exchange for downstream projects in those companies' own countries. The goal
is for Russian energy companies to not only move more into the downstream
sector, but also have greater access to international markets -- something the
Kremlin can use later for political purposes. STRATFOR sources say deals like
this are already being negotiated with firms like BP, France's Total and EDF
Trading, and U.S.-based ExxonMobil.

Part 3: Reprivatization

The last part of Kudrin's plan is to reprivatize the vast number of companies
the Kremlin has taken over in the last few years. Under Putin, the Russian state
once again became the main driver of economic activity. Upon becoming leader of
Russia in 1999, Putin set a goal to reverse the massive privatization that
occurred during the 1990s -- like the housing and voucher privatizations and
loans-for-shares schemes -- that, in most Russians' eyes, wrecked the country.
Putin wanted to put the Kremlin back in control by consolidating its power over
a slew of economic sectors, including energy, banking and defense. As of this
year, the Russian state and regional authorities own approximately 50 percent of
Russian businesses, according to Kudrin.

In the short term, Russian state control over strategic sectors made sense. It
pushed out forces that were not too friendly with the Kremlin, like the
oligarchs and foreign groups. But it also allowed the state to marshal its
financial resources toward certain key domestic and foreign policy goals.
Russian economic consolidation under the state brought about a stability that
most Russians had longed for after the 1990s.

However, in the long term, the lack of non-state funding and private capital has
become a problem, creating inefficiencies across the board -- particularly in
areas where the state does not focus a great deal of its resources. Russia is
traditionally capital-poor; therefore, any major economic overhaul needs to
include the creation of an investment-friendly climate. The financial crisis
made this clear; when the state took on the burdens of the failing private
sector, it swallowed more businesses and industries but also took on their debt
and need for cash.

Kudrin's plan is for the state to step back and start reprivatizing some 5,500
firms over the next three years -- which would drop state ownership in Russian
firms by approximately 20 percent. The goal is to abandon some of the companies
currently draining the government's coffers, but this step will also generate
cash through the sales needed for the government to plug 2010's estimated budget
deficit. Kudrin also believes that once the government starts to reduce its
stake in companies, a more competitive environment will form in the Russian
economy, allowing it to become more diversified.

Kudrin wants to ensure that the next reprivatization looks nothing like the
feeding frenzy of the 1990s. In the minds of the civiliki, the failures of the
1990s were caused not only by investor greed but also by the state's failure to
create a rational environment for privatization. The Russian state in 2009 is
much stronger than it was in the 1990s, so Kudrin believes that the new round of
privatization would be controllable, and the fact that the Kremlin would know
who would gain control of each company would keep anyone hostile to Russian
(read: Kremlin) interests out. The last thing Kudrin wants is a new generation
of oligarchs.

Kudrin's plan would start with selling the state's stakes in companies purchased
during the financial crisis, such as telecommunications giant Rostelecom and a
series of banks, including Globex, Svyaz and Sobinbank. After that, the civiliki
would like to consider companies such as oil giant Rosneft, banking giant
Sberbank and railway monopoly Russian Railways for privatization -- a rather
bold move since many of these companies are run by the siloviki.

In Putin's mind, the state consolidated the economy during Russia's identity
crisis in the 1990s. Certain people, groups, influences and companies needed to
be purged, in his opinion. Now that this has been completed, the government can
step back and, in a highly controlled manner, start to reprivatize businesses.
Putin is starting to believe that this is all just a cycle.

Easier Said Than Done

Kudrin and the other civiliki's plans are a technocratic approach to a crisis
that has been long in the making in Russia but was exacerbated by the global
financial crisis. The civiliki's plans have very specific economic goals in
mind, leaving out power politics. The plan is actually not a new one, but it is
one that the siloviki have continually sidelined over the years as they placed
national interests above economic reform. The civiliki have also never been
powerful enough by themselves (even with one of their own as president of the
country) to push through any of their reforms.

What the civiliki needed was for one of the truly powerful clan leaders in
Russia to stand behind their reforms. Fortunately for Kudrin and the civiliki,
one such leader -- Surkov, who serves as Medvedev's deputy chief of staff and
first aide to Putin -- has done just that. However, Surkov is not interested in
Kudrin's plan in order to reform the Russian economy. He sees the plan as
something that will help him eliminate his rivals and consolidate his power.

Copyright 2009 Stratfor.