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Moscow Times
June 18, 2004
Fundamental Questions
By Christopher Granville
Christopher Granville, chief strategist at United Financial Group, contributed this comment to The Moscow Times.

Will the "Yukos affair" end in disaster for Russia's investment climate, so putting an end to continued fast economic growth and rising living standards? I think not.

But that burning question is not the only one that needs asking about the outcome. Even if the result looks better than today's worst fears, the whole sorry tale will also have highlighted a problem requiring an urgent solution if the country is to fulfill its potential. While so many of contemporary Russia's problems are due to the poisons left by the Soviet system, the Khodorkovsky-Kremlin conflict is a symptom of a more recent, but no less troublesome, legacy. This is the shadow of the 1990s. Building the confidence needed for dynamic development now requires protecting business from the risk of episodes from that notoriously wild first post-communist decade being dredged up to jeopardize property rights and balance sheets. Will the Putin administration, drawing lessons from the Yukos affair after it is all over, move towards drawing a much firmer line under the 1990s? The answer to this second question seems like being the same: "most unlikely."

To start with the first question on the immediate outcome of the affair, the stock market has recently been discounting the total ruin of Yukos. But Yukos' asset base is sufficient to avoid insolvency either in the face of the present 99 billion ruble tax claim or even any conceivable additional tax claim. So a true disaster scenario would have to involve more than mere procedures such as court-supervised asset sales by a temporary external administration of Yukos, and extend to an abuse of those "bankruptcy" procedures resulting in a state-sponsored asset-stripping of Russia's leading private oil group.

Any such outcome would fly in the face of all the evidence about the causes of the whole affair and President Vladimir Putin's track record of improving the investment climate. There is a mass of evidence that the attack on Khodorkovsky and his Menatep partners was triggered by a perception that they were buying control of the state -- in particular buying votes in the State Duma to block government policies (especially on oil taxation) of which they disapproved. Any such behavior, perceived or real, would violate the original state-oligarch deal -- unwritten, but very clearly spoken, notably in a meeting in the Kremlin in July 2000 -- whereby the privatizations were amnestied de facto in return for an understanding that the oligarchs would not use their controversially acquired wealth to privatize the state.

Seen in this perspective, the attack on Khodorkovsky could be viewed as upholding the rules of the game. But this stabilizing feature has been undermined by the choice of method for tackling that very real problem. The method is selective law enforcement. The kind of charges against Khodorkovsky from the 1990s, even if proven, could equally have been brought against very many others. This fact underlies fears that other, more sinister motives may also be at work -- including broader attacks on the oligarchs and their companies. But the simplest explanation remains the best: The aim is the political neutralization of Khodorkovsky, both as an end in itself and a lesson to others, by means of convictions for criminal wrongdoing and the corresponding penalties of prison sentences and large fines.

At first sight, the massive back tax claim against Yukos is the fact that sits least well with this analysis. If the aim is to neutralize Khodorkovsky, why bring a major listed company like Yukos under the present shadow of bankruptcy? Part of the answer must be that the low effective tax rates enjoyed by Yukos in recent years stemmed from the perceived abusive lobbying of the bureaucracy and parliament by the company's immensely wealthy core shareholders. In other words, recovering tax from Yukos is a remedy closely linked to the core project. It seems that the tax charge is also more broadly designed as a wake-up call to the whole business community about public-spirited tax compliance. It follows that Yukos will simply have to pay its dues, even if these end up being unjustly inflated by fines and penalties.

With that, the affair will close. Whether or not Khodorkovsky and his partners retain their controlling shareholding in Yukos, there will not be an abusive bankruptcy of the company -- as Putin said, to general relief, in Tashkent on Thursday.

But, to return to our second question on "the shadow of the 1990s," the danger is that the option of doing nothing proves irresistible. Keeping property rights in a poorly defined grey area would be the easy way to deter any oligarchs who may again be tempted in the future to try and privatize the state. But this is no answer to the challenge of improving the investment climate. A policy designed to sow uncertainty in the minds of tycoons would result in all types of investors feeling insecure.

Instead, Putin should legally entrench property rights once and for all. The neatest way of doing this could be to reduce the statute of limitations on challenges to privatization transactions from 10 years (as now provided in the Civil Code) to, say, three years. He could throw in measures to plug the loopholes -- exposed by the Yukos tax litigation -- in the existing three-year statute of limitations on tax claims. That would protect property from the predations of prosecutors -- whether acting as private entrepreneurs or as the hired hands of the executive branch or competing business groups. At the same time, no immunity from prosecution need be given to anyone. Proven wrongdoing would still be liable to whatever penalties are laid down in the Criminal Code. That would help avoid moral hazard, while also leaving the Kremlin with a powerful control lever over any over-mighty barons. Even this compromise -- like most compromises -- would be far from perfect. For one thing, it would not in itself rule out further selective law enforcement, which is the opposite of the rule of law. But this still seems a price worth paying for a fundamental breakthrough in Russia's investment climate.