Despite the Medvedev administration’s efforts to combat corruption, cross-country surveys show that corruption in Russia is perceived to be getting ever worse. The optimistic interpretation of this development would be that the perceptions are mistaken, while the pessimistic – and consensus – view is that anti-corruption policies are inadequate and/or futile. For investors in Russia, this discussion is not academic: corruption – both perceived and as experienced – caps asset prices.
President Dmitry Medvedev submitted to the State Duma in early June 2011 a set of amendments to Russia’s criminal justice legislation that – like the two previous rounds of amendments, in April 2010 and March 2011 – are designed to lighten the procedures and punishments facing people charged and convicted of economic crimes. These initiatives are a major development in the Medvedev administration’s continuing efforts to contain the corruption epidemic that blights Russia’s overall prospects.
The scale of the problem and the many ways in which it reduces investment returns have become so clear during Russia’s two post-communist decades that detailed background briefing seems unnecessary. Perhaps the best way to capture the dire picture in a nutshell is as follows: for all the difficulties of measuring the problem, corruption in Russia has reached a level that would ordinarily be associated with much poorer countries, but Russia’s 2009 GNI per capita of US$13,540, calculated using the World Bank Atlas method, places the country in the high-income bracket.
To make sense of the recent changes to Russian criminal law regarding “white collar” offences, it is necessary to understand their place in the broad framework of anti-corruption policies and assess them from this perspective. Criminal justice reform comes under the first of the two main components of the fundamental – and unchanged – agenda of the fight against official corruption:
With regard to the second of those components, we published in November 2009 a report that took an initial look at the hard evidence on this very necessary campaign of repression. In this new note, we update that assessment based on data provided by the Ministry of the Interior, the Legal Department of the Federal Supreme Court and the Investigative Committee (the state prosecution service, spun off from the General-Prosecutor’s Office).
As for the first and more fundamental part of the anti-corruption agenda, most policy efforts over the past decade aimed at limiting opportunities for corruption have focused on regulation – or more precisely, a combination of deregulation and improvements to remaining regulation that make the rules lighter and more consistent. This policy thread was taken up with some determination in the early stages of the Medvedev presidency (see our February 2009 report Corruption and the Crisis).
The rationale was and remains that unnecessary, arcane and contradictory regulations are the main instrument used by predatory bureaucrats for the purpose of extorting bribes and otherwise hounding businesses. Corrupt officials act as either principals or agents (that is, making money for themselves from issuing permits and licences or using their powers to penalize businesses on behalf of private-sector predators ready to pay for such bureaucratic “services”). But in more recent years, a second instrument of corruption has emerged – one that is more sinister and even more economically damaging. This is the use of law enforcement and the courts – above all, in the criminal sphere – to shake down business people and seize their property (“corporate raiding”, which involves tampering with share registers and switching the beneficiaries of land and real estate titles). Here, the term “state mafia” is precise and appropriate.
The core feature of this state mafia activity is putting business owners behind bars. Once charged, arrested and held in preventive detention pending trial (which, in practice, means up to two years' imprisonment), most businessmen will become pliable. An inspiring exception to this rule is entrepreneur Yana Yakovleva, who was arrested and detained for several months in 2008 on the basis of allegations by the Federal Drug Control Service that her chemicals business was a front for narcotics production. Yakovleva successfully held out and was vindicated in court; since her release, she has become a leading public campaigner for criminal law reform.
But while the charges against Yakovleva and thousands of business people like her are trumped up, the state mafia also prospers by exploiting genuine (if minor) wrongdoing for its own corrupt purposes. Immediately below we review the recent legislative initiatives designed to tackle this most serious of all forms of corruption.
1. Bail rather than pre-trial detention for businessmen
In December 2009 the State Duma passed amendments to the Criminal Procedure Code banning pre-trial detention for those accused of tax evasion. This was the Medvedev administration’s immediate response to the death of the 37-year-old lawyer Sergey Magnitsky in a Moscow prison the previous month while awaiting trial on tax evasion charges. We will not go into the detail of this scandal surrounding the Hermitage Capital Management fund, for which Magnitsky had been working (through the law firm that employed him). But one feature of this case is particularly relevant for this update on anti-corruption policy: Magnitsky had blown the whistle on a tax fraud perpetrated by high-ranking police officers, who took their revenge by constructing a criminal case around tax avoidance schemes pursued by the Hermitage fund in relation to its holdings several years previously of a (since abolished) class of Gazprom shares that were restricted to local investors. Whatever the rights and wrongs of Hermitage’s aggressive tax strategies, this was exactly the kind of mild objective vulnerability that the state mafia seeks to exploit. The answer – which the Medvedev administration has now taken up – must be to reduce the scope for the state mafia to take advantage of tax evasion and other such relatively mild offences even when this kind of wrongdoing has occurred.
The tragic scandal of Magnitsky’s death, which made headlines across the globe and provoked condemnation from many quarters, has done as much damage to the Russia’s investment climate as any episode since the Yukos affair. It drew attention in particular to the fact that each year thousands of people, mainly businessmen, have been held in pre-trial detention in Russia for many months or, in some cases, for one or more years after being charged with what are frequently minor offences. In April 2010 the Medvedev administration extended its initial policy response to Magnitsky’s death: the Criminal Procedure Code was further amended to prevent the pre-trial detention of those charged not only with tax evasion but with any of the 50 or so economic crimes listed in Chapters 21-22 of the Criminal Code – ranging from illegal banking activities to “swindling” and money-laundering.
The last two classes of crime are particularly significant. “Swindling” – moshennichestvo in Russian (Article 159 of the Criminal Code) – is a notoriously catch-all charge used by state mafia operators in Russian law enforcement. And these predators will not shy away from adding money-laundering to the charges drawn up against their targets in order to lengthen the potential prison terms following conviction. In a bid to clamp down on this practice, the definition of money-laundering in the Criminal Code was tightened in April 2010 to prevent prosecutors from so characterizing any spending by an individual with illicit income.
Under the April 2010 reforms, bail is to be routinely granted to those charged with the crimes listed in Chapters 21-22 of the Criminal Code (the minimum sum for bail on charges of minor and less serious offences is Rb100,000 [US$3,570] and on charges of more serious crimes Rb500,000 [US$17,860], with movable and/or immovable property, stocks and bonds allowed to serve as security besides cash). The significance of this measure lies not only in preventing the state mafia from threatening businessmen with pre-trial detention if the latter do not yield to pressure; it is also to be found in reducing the scope for corporate raids, many of which take place when the owners of the targeted businesses are being held in custody pending trial.
2. Fewer economic crimes to be punished with jail terms
In early March 2011 Medvedev signed into law another bill aimed at liberalizing criminal legislation, which he himself had introduced into the State Duma in the autumn of 2010. The new law, which takes the form of amendments to the Criminal Code, increases the number of relatively minor crimes for which prison sentences are not mandatory (or, more precisely, it removes the Code’s previous stipulation of a minimum term of imprisonment for the crimes listed in this amendment, thereby allowing trial judges to exercise their discretion when deciding whether those convicted of committing such crimes should be sent to jail). Of the 68 crimes that fall under this category thanks to the new law, almost half (32) are economic ones. In cases involving such crimes, prison sentences are to be handed down only when the level of the crime committed is deemed to be serious. Included among the 32 economic crimes for which prison sentences are no longer mandatory are the above-mentioned offence of “swindling” as well as “embezzlement”, which is the other Criminal Code article (No. 160) favoured by the state mafia for the purpose of extortion.
3. Businessmen to avoid prison altogether if they pay damages
The third recent reform initiative comprises amendments to the Criminal Code ruling out imprisonment for minor offences committed for the first time. Instead, more than half of the economic crimes listed in the Criminal Code would be punishable by community service and, especially, much heavier fines – of up to five times the losses caused by the crimes committed (in addition to direct compensation to be paid by convicted culprits to the victims of those crimes). The lighter, non-custodial penalties envisaged in this latest package – which, as we mentioned at the beginning of this note, was submitted to the State Duma in June 2011 – would not apply to crimes committed by an organized group and entailing large-scale losses (defined as exceeding Rb6 million [US$214,400]), money-laundering, the falsification of share registers or the disclosure of commercial secrets.
While the state security services are opposed to this latest initiative to amend the Criminal Code (especially the inclusion of goods smuggling among offences not punishable by imprisonment), the Kremlin is clearly determined to see it become law. If so, this will be the most significant measure to date under Medvedev’s presidency aimed at reducing the scope for the state mafia to shake down business. Faced with the prospect of paying a fine rather than being sent to jail, businessmen who are targeted by predatory officials are more likely to stand their ground. Over time, this will have the effect of weakening the state mafia’s grip over the business community and depriving it of one of its main sources of self-enrichment.
There are no data available on how many people have been taken into pre-trial detention on charges of economic crimes since the passage of the amendments to the Criminal Procedural Code designed to prevent this from happening. On the anecdotal level, it is clear that many prosecutors and judges took scant initial notice of these legislative changes but, as is typical of the Russian bureaucracy, ended up paying more attention to direct instructions from their superiors than to statute law (the instructions in question having been handed down by the Supreme Court).
Meanwhile, the Interior Ministry has provided quite detailed figures on indictments and court cases on charges of economic wrongdoing. Since Medvedev embarked on his campaign to liberalize criminal law, the numbers of people who have been tried for crimes listed in Chapters 21-22 of the Criminal Code have fallen off significantly (figures for convictions for these crimes are not available). Charts 1-2 below show that indictments were down 35 per cent and the number of defendants in court cases down 27 per cent, respectively, in 2010 compared with the previous year. Moreover, this steep downwards trend has continued in Q1/11.
Given that the state mafia most frequently uses the threat of swindling to extort from businessmen, it is worth paying particular attention to the available figures for this type of economic crime (see Charts 3 and 4 below). Here, the trend in both indictments and court cases is also downwards, but the fall-off is less steep than in the case of economic crimes in general (26 per cent and 9 per cent, respectively, in 2010 compared with the previous year). This is an indication of the difficulty of putting a stop to practices which have become as widespread as the use of Article 159 to harass and intimidate and which the most brazen bureaucrats will continue to pursue in defiance of any legislative initiatives.
The sobering scale of this problem emerges from figures provided by the Legal Department of the Federal Supreme Court. These show that during the period 2003-09 (the most recent available data), the number of those convicted of swindling almost tripled (see Chart 5 below). Of the 30,000 or so individuals convicted on this charge in 2009, more than one quarter (28 per cent) were given prison sentences ranging from less than one year to up to eight years.
Based on the Interior Ministry data summarized in Charts 1-4 above, it is safe to assume that there will also have been a drop in the number of convictions on charges of swindling in 2010.
Embezzlement of public funds may be a less economically damaging form of corruption than preying on business through extortion and expropriation (if only because much stolen public money will be recycled through the economy), but the scale of the problem remains vast. Kickbacks on state procurement contracts are the main means of this kind of plunder. In a televised exchange with Medvedev in early November 2010, Konstantin Chuychenko, who heads the financial oversight directorate in the presidential administration, estimated the total annual cost of this form of corruption to the state budget at Rb1 trillion (US$36 billion or 2.2 per cent of Russia’s GDP in 2010). Chuychenko’s estimate was an extrapolation of his team’s findings on the scale of graft surrounding the purchase of medical equipment. He also noted that regional authorities had been overpaying by up to three times the manufacturer’s price for sophisticated medical equipment, notably magnetic resonance imaging scanners.
In his annual “state of the nation” address later the same month, Medvedev deplored the staggering scale of this “theft” and called for work to begin in earnest on a new version of the 2006 law on state procurement. Although the very existence of this law is a significant improvement over the anarchic free-for-all that reigned previously in state procurement, and despite its having undergone numerous revisions over the past five years, the law continues to be widely criticized. But officials were unable to agree on a thorough overhaul by the April 2011 deadline set by Medvedev. The Ministry of Economic Development favours the adoption of a federal contract system like that used in the US and Europe, while the Ministry of Finance and the Federal Anti-Monopoly Service oppose that option and instead favour tightening up existing procedures.
In the meantime, there have been yet more amendments to the state procurement law to incorporate the few measures on which all three agencies have been able to agree so far. Aimed, above all, at improving the procedure for purchasing expensive medical equipment, those measures, which were passed in early April 2011, include requiring public bodies to justify the starting price of goods and services (publishing the relevant information on their websites) and providing for the possibility of prequalification (in the case of especially complex technical products). This last measure has already been criticized in some quarters as creating new opportunities for corruption.
A very positive related development over the past year or so has been the transition to electronic auctions: since July 2010 such auctions have been mandatory for most federal purchases and since January 2011 for regional and municipal ones as well. Moreover, since the beginning of this year a new official state procurement website (www.zakupki.gov.ru), which gathers and disseminates all information on orders for federal, regional and municipal needs, has been up and running (albeit with the inevitable teething problems). The resulting (and previously unimaginable) transparency in the state procurement process has produced some salutary public scandals, forcing various agencies (notably the Interior Ministry but also the Finance Ministry) to withdraw tenders for luxury furniture and the like.
Increased transparency is also at the root of an initiative proposed in mid-March 2011 by Prime Minister Vladimir Putin, who since leaving the presidency in 2008 has allowed Medvedev to take the lead on anti-corruption policy. Now, with the election season fast approaching, Putin has re-entered this policy arena by proposing a measure that goes beyond the existing requirement for all officials to declare their income and assets as well as those of their immediate relatives.
That radical requirement was introduced by Medvedev in 2008 and first implemented in 2009. Many declarations have received prominent and ironic press coverage highlighting discrepancies between officials’ salaries and their real estate and other assets (a discrepancy normally explained – and duly ridiculed in press commentary – as returns on financial investments or spouses’ business activities). Under Putin’s new proposal, officials would also be required to declare their expenditures – and to make such declarations at regular intervals over 12-month periods rather than simply once a year. The idea, clearly, is to reveal the wealth not disclosed in the existing income declarations. (Putin’s proposal is, in fact, not new: expenditure declarations were first discussed in 2008, when the State Duma adopted Medvedev’s first package of anti-corruption bills; and the idea was revived by a deputy prosecutor-general in August 2010 but did not lead to any action being taken.)
Critics point out that it has proved difficult to verify income declarations, and it will prove all the more difficult to verify expenditure declarations. At the same time, many officials have simply neglected to report their earnings – according to Prosecutor-General Yury Chaika, this applied to no fewer than 9,000 officials at the Interior Ministry last year. While the novelty of some light being shed on bureaucrats’ personal finances may not be a direct obstacle to abuse, it has the clear potential to make officials more careful and accountable in the face of increasing public intolerance of blatant corruption.
As regards the problem of verifying information supplied in declarations, Medvedev has come up with one possible (albeit partial) solution. He announced in late April 2011that his administration has submitted a bill to the State Duma that would require banks to provide information on the contents of officials’ bank accounts if asked to do so by a state agency. Furthermore, the same requirement would apply to individuals who wanted to join the state service.
Until recently, the maximum fine for taking small bribes (defined as up to Rb150,000) was Rb150,000 (US$5,360) and large bribes (more than Rb150,000) Rb200,000 (US$7,150). Now, under amendments to the Criminal Code and the Administrative Offences Code submitted to the State Duma by Medvedev in early January 2011 and signed into law by him in early May, the fine for accepting a bribe of up to Rb25,000 (US$890) is between 12 times and 60 times the amount of the sum received, while those found guilty of accepting bribes that exceed Rb1 million (US$35,700) will have to fork out between 80 and 100 times, with the maximum fine set at Rb500 million (US$17.9 million). The amendments also provide for prison sentences of up to three years and from eight to 15 years for small and larger-scale bribe taking respectively.
The rationale behind this initiative is that the most effective means of fighting graft is to hit offenders where it hurts most – namely, in the pocket. The higher fines will not replace or offer an alternative to prison sentences – hence well-heeled offenders will not be able to buy their way out of going to jail. Rather, they will supplement jail terms so that those who accept bribes face the threat of suffering substantial material losses as well as that of being deprived of their freedom. For some, the former threat could prove a more effective deterrent than the latter. That, at any rate, is the stated assumption of policymakers – and there is some logic to this view. Many corrupt officials may continue their rent-seeking habits calculating not only that the risk of imprisonment is low but that even in the worst case of having to serve a prison term, they (and their families) will still be wealthy for the rest of their lives.
These latest amendments introduce other significant innovations in the fight against corruption. Large fines will now be imposed on legal entities that pay bribes: although the amendments stopped short of introducing criminal liability for such entities, the new penalties for paying bribes are in line with those in countries that do enforce criminal liability. And large fines will also be handed down to those acting as intermediaries in bribery (for the first time in Russia, assisting in the giving and taking of bribes qualifies as a crime).
More officials are being convicted for corruption
As regards securing convictions on charges of corruption, the trend we identified in November 2009 has continued to intensify. In 2010 the number of convictions of officials found guilty of bribe-taking was up 18 per cent over the previous year, according to the Legal Department of the Federal Supreme Court. This compares with a 6 per cent increase year-on-year in 2009 (see Chart 6 below). Of those convicted in 2009, 25 per cent received a prison sentence of between one and 10 years (no equivalent figure is available for 2010).
Law-enforcement officials are not immune
For its part, the Investigative Committee recently released figures on clamping down on corruption among officials with “special legal status” – that is, lawmakers, mayors, judges, lawyers and criminal investigators, including those working for the Investigative Committee itself. More than 700 such officials were indicted on corruption charges in 2010. (No corresponding figures for previous years are available, nor are there data showing how many convictions resulted from those indictments.)
In our November 2009 report, we noted that while punishment of wrongdoing by officials at the regional level or municipal level was becoming more widespread, far fewer (if any) corruption prosecutions and convictions were occurring at more senior levels of federal officialdom. And precisely because they were so rare, prosecutions of high-ranking officials (such as the 20-year prison term handed down in 2006 to Vladimir Ganeyev, a former Deputy Minister for Disaster Relief) tended to be seen – rightly or wrongly – as the result of struggles between competing bureaucratic clans rather than the impartial and consistent application of the rule of law to senior officials.
Cleansing Moscow City Hall
Over the past nine months or so there has been an unusual rash of corruption cases involving high-ranking officials in the Moscow administration and within the federal government. At the Moscow administration level, this development follows from the ouster in September 2010 of the long-serving Mayor of Moscow, Yury Luzhkov, who presided over high levels of corruption even by Russian standards. That reality was most graphically reflected in the finding of the World Bank’s global business climate survey (“Doing Business 2011”) that there is nowhere in the whole world, except Eritrea, where it takes longer to obtain construction permits than Moscow (all the survey data for Russia were collected in Moscow).
Almost immediately after Luzhkov’s removal, Aleksandr Ryabinin, a deputy mayor of Moscow, was fired and charged with bribe-taking. More recently, corruption charges were brought against another senior member of Luzhkov’s team: Dmitry Gayev, who headed the Moscow metro from 1995 to February 2011, was charged in March 2011 with abuse of office, having allegedly embezzled some Rb112 million (US$4 million). Both of these cases are to be seen in the context of the “cleansing City Hall” process launched by Sergey Sobyanin, who, appointed by the Kremlin to succeed Luzhkov, has fired dozens of officials, mainly prefects and departmental heads, considered to have been close to the former mayor. (A third corruption case involving another high-ranking Luzhkov crony – the head of the Moscow advertising committee, Vladimir Makarov, who was sacked by Sobyanin in March – dates back to 2009.)
Senior Kremlin staffer jailed
At the federal government level, there have been two high-profile corruption cases during the same period. The first came in the wake of Chuychenko’s revelations about regional authorities overpaying for medical equipment (see above) and the investigation subsequently ordered by President Medvedev. Several high-ranking officials, including Andrey Voronin, a departmental head in the Kremlin’s financial control directorate, and Anna Usacheva, a Deputy Health Minister, attempted to cash in on that investigation by telling medical equipment suppliers that they had been blacklisted by the government and demanding a US$1 million bribe from each of these suppliers as the price for arranging for them to be removed from the purported list. Voronin was sentenced in early April 2011 to three years in prison for his role in the attempted extortion, having entered into a plea bargain to have his sentence reduced for helping to convict his co-defendants. The second case involves Alexander Bukov, who headed the government department for coordinating the fight against organized crime on the territory of the CIS countries. The Investigative Committee brought criminal charges against Bukov in January 2011 for allegedly attempting to extort US$46 million from a businessman in exchange for help in acquiring a controlling stake in the Volga Oil Tanker Shipping Line (Volgotanker).
Systematic data
Two or even four swallows do not, of course, make a summer. Much higher volumes of prosecutions of senior federal officials would be necessary to dispel the suspicion that politics rather than the rule of law is the main driver of the cases that are opened (in the case of the recently indicted Moscow City officials, the political agenda is clearly the continued discrediting of the ousted Luzhkov).
However, there is some evidence to suggest that prosecutions of higher-ranking officials are becoming more frequent. Data provided by the Legal Department of the Federal Supreme Court show that the number of people who were convicted for taking large bribes (defined under the version of the Criminal Code in force at the time as more than Rb150,000 [US$5,360]) was up 44 per cent last year compared with 2009 (no data are available for previous years). While the absolute number of large-scale bribery convictions remains small (just over 200 in 2010) and while there is no indication of how many were for bribes on the billion-ruble scale of those cited immediately above, it is reasonable to infer that law-enforcement agencies are becoming increasingly focused on fighting top-level corruption.
Most discussions about Russian corruption come out on a note that recalls the famous (albeit apocryphal) comments by opposing military staffs during a 19th-century battle: according to one side, the situation was “serious but not hopeless”, while for the other, the situation was “hopeless but not serious”. Despair might all too easily be prompted by cross-country survey findings that the state mafia rampage is perceived to be getting ever worse. Whatever the objective validity of such perceptions, the results of repeated annual surveys at least have some comparative value, and the deteriorating trend as regards Russia is unmistakable.
|
|
2007 |
2008 |
2009 |
2010 |
2011 |
|---|---|---|---|---|---|
|
Ease of doing business (1) |
96/175 |
112/181 |
120/181 |
116/183 |
123/183 |
|
Corruption Perceptions Index (2) |
143/179 |
147/180 |
146/180 |
154/178 |
|
|
Control of corruption (3) |
171/209 |
184/211 |
188/212 |
|
|
|
Competitiveness of institutions (4) |
|
|
110/134 |
114/133 |
118/139 |
|
Corruption – the most problematic factor for doing business (5) |
|
|
19.4% |
19% |
21.2% |
Sources: (1) World Bank’s “Doing Business” report; (2) Transparency International’s Corruption Perceptions Index; (3) Brookings Institution and World Bank’s “World Governance Indicators”; (4 & 5) World Economic Forum’s “Global Competitiveness Report”.
On this evidence, all of the Medvedev administration’s anti-corruption initiatives might seem futile. Investors might be tempted to conclude that the corruption problem is serious – to say the least – and that there is little hope of containment, let alone cure.
In our view, such a gloomy assessment misses two key points.
1. Deteriorating corruption perceptions carry a more hopeful message
A feature of all serious structural reform is that it entails short-term pain in return for longer-term gain. In the case of Russian anti-corruption policy, the up-front “pain” takes the form of the state mafia reacting against policies designed to counter existing corruption schemes by seeking new ways to extort. If left unchanged, bureaucrats’ rent-seeking habits can become – not least from the perspective of their victims (entrepreneurs, mainly) – familiar, predictable and hence more or less manageable. A good example might be the heyday of Luzhkov’s rule in Moscow (giving rise to the “hopeless-but-not-serious” view of Russian corruption). When the state mafia is forced to innovate – and corruption is an activity in which innovation is alive and well in Russia – the environment will seem more threatening. This gives rise to the paradoxical conclusion that new and more intensive anti-corruption policies are themselves a major cause of the perception that corruption has been getting worse during recent years.
2. Present policy mix shifts bureaucrats’ incentives
It follows that the desired effect of the various anti-corruption strategies will gradually materialize over time. But apart from heeding the obvious point that such dividends must be patiently awaited over many years, we believe that investors should consider the implications of the simple fact that the Kremlin is developing and sustaining vigorous and innovative anti-corruption strategies within the mutually reinforcing two-pronged strategy of reducing the scope for state mafia activities, on the one hand, and increasing repression of official wrongdoing, on the other.
The key implication has to do with the incentives of regulators and law-enforcement personnel. Although, as we have argued, policy moves against the state mafia can have a disturbing short-term effect of spawning new and sometimes even more aggressive displays of corruption, these policies have the clear potential to shift bureaucrats’ long-run incentives. Corruption can be reduced only by channelling bureaucrats’ energies from mafia activities towards normal business. That option should gradually be taken up by increasing numbers of officials in the face of the three important new developments reviewed in this note:
Our conclusion as regards perceptions of ever-worsening corruption is not that such views are somehow mistaken – on the contrary, there are obviously good grounds for them. Rather, they should be seen as a lagging indicator. On a forward-looking view, we believe that corruption risk is generally overpriced in present Russian asset valuations.
If this review of corruption risk yields an overall positive long-term conclusion for investment in Russia, two brand new policy developments support an immediate investment theme.
1. Procurement transparency procedures set to be extended to SOEs
Under a fresh legislative initiative, the move to inject some transparency into the state procurement process is set to be extended to state-controlled companies. Corresponding amendments to the law on state procurement passed in the first reading in the State Duma in May 2011. If this legislative initiative is not derailed, the “natural monopolies” and other big state companies will be obliged from 2012 onwards to use open tenders and auctions for procurement purposes. Although there have already been patchy improvements in transparency in the state corporate sector, this reform will force change in the most opaque companies, starting with Gazprom.
2. Medvedev’s new test for top SOE management
This reform appears all the more promising for dovetailing with a key item in Medvedev’s latest 10-point agenda for improving the investment climate. In his April 2011 speech in Magnitogorsk setting out that agenda, Medvedev said that the senior management of state companies would be expected to reduce operating expenditures by 10 per cent every year and he indicated that their jobs could depend on achieving these efficiency savings. Although media and market attention to Medvedev’s SOE agenda focused on another point in his speech – the removal of senior government ministers from supervisory boards – this call for efficiency has a far greater potential to create shareholder value.
Judging by the persistently inflated costs of capital projects such as pipeline or power grid construction by Gazprom, Transneft and the electricity distribution companies, management stock-option programmes in operation at Gazprom and some other large state-controlled companies have yet to make much tangible impact in reducing graft. The threat of being fired by the Kremlin should concentrate senior management minds more effectively. Incentives work best when the targeted behaviour and outcome is realistically achievable. The attractive potential of these new measures against corruption in SOEs lies precisely in their gradualism. Rather than setting some chimerical goal of curing all corruption immediately, the new approach calls for incremental objectives (the targeted 10 per cent annual efficiency gain) to be met and provides practical means of reaching that target in the form of more transparent procurement procedures.
In effect, management is being asked not to forego its corrupt rents (a challenge that would be more likely to produce a destabilizing reaction than miraculously changed behaviours) but rather to share some of their gains with shareholders. Given the existing scale of graft, there is plenty to share. So assuming, as we do, that other drivers for the big state companies will also turn positive – especially improved political visibility and lower inflation putting an end to erratic policymaking on regulated tariffs – anti-corruption policies should contribute to significantly improved share price performance by these companies on a one-year horizon.
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