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31 January 2017

Russia’s economy won’t be fixed by the removal of sanctions

It is the country's capacity to change from within that will determine its economic prospects.

By David Clark

Vladimir Putin has probably never looked forward to any year as much as he is looking forward to 2017. With Donald Trump settling into the White House and Europe in political disarray, the Russian President will feel that his decision to face down the west over Syria and Ukraine has been vindicated. His fortunes will continue to rise if, as expected, the French Presidential election in May becomes a run-off between two pro-Putin right-wingers, François Fillon and Marine Le Pen. With a bit of luck he might even see the back of his staunchest opponent, Angela Merkel, when Germany votes in the autumn.

After two years of recession, Putin has reason to hope that at some point this year western economic sanctions imposed after the annexation of Crimea will be eased, if not lifted altogether. Yet any euphoria would be misplaced. At best, sanctions relief will help Russia to return to the state of economic stagnation that prevailed before the Ukraine crisis when annual growth had already slumped to 1.3 per cent, despite high oil prices. The World Bank is currently projecting growth rates of 1.5 per cent to 1.8 per cent over the next three years – well below the global average and nowhere close to the 7-8 per cent growth that was typical of Putin’s first two terms in office. This will limit his ability to restore the domestic bargain by which Russians accepted the loss of political freedom in exchange for a rapid expansion of living standards.

Although, like all countries, Russia is affected by global economic conditions, its biggest problems are homegrown. Chief among them is a business environment that stifles enterprises and deters investment. The impact can be measured in net outflows of capital running to tens of billions of dollars each year. Put simply, those who make money in Russia try to move it abroad as soon as they can, while foreign companies willing to invest in Russia are too few to make up the difference. The result is that Russia is starved of the investment and technology it needs to modernise its economy and reduce its dependence on natural resources.

A major challenge to improvement of the Russian business sector is the weakness of property rights and uncertainty over the rule of law. Entrepreneurs are often reluctant to establish new businesses or expand existing ones in case they attract the attentions of criminals and opportunists who use powerful connections to seize property in a widespread practice known as reiderstvo, or corporate raiding. In contrast to the western-style of corporate raiding, in which hostile takeovers are pursued by legal means, reiderstvo relies mainly on a post-Soviet mix of corruption and criminality.

The typical raid involves the arrest of a business owner on false charges of tax evasion or some other economic crime, facilitated with bribes to local law enforcement officials. While the victim is safely out of the way in pre-trial detention, ownership is changed with the help of forged papers and a corrupt judge prepared to certify them. Sometimes armed thugs are hired to take physical control of the targeted business. By the time the real owner is free, their assets have been taken and no legal remedy is available.

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The scale of this problem is vast and apparently growing, affecting businesses of all sizes. As President Putin himself acknowledged, of the 200,000 economic crimes investigated in 2014, only 15 per cent resulted in a conviction while 83 per cent led to someone losing their business. He concluded: “The vast majority … got harassed, intimidated, robbed and then released.” Of course, the Russian President is hardly blameless. The two most infamous examples of reiderstvo – the seizures of Yukos Oil and Hermitage Capital – were orchestrated at the highest levels of the Russian state. While Putin clearly understands that the national economic interest demands an end to this epidemic of property seizures, nothing will change unless an example is set at the top.

Increasingly, cases involving reiderstvo make their way into western courts and international tribunals where property rights can be effectively enforced. London has become perhaps the main international centre for hearing cases of this sort because many Russian business contracts include clauses allowing disputes to be settled in the English Commercial Court or the London Court of International Arbitration. Ireland is another jurisdiction in which major reiderstvo cases, historic and current, have recently come to court.

The US Congress has also recognised the challenge this presents, not just to the Russian economy, but also to international judicial cooperation. Last autumn, the Lantos Commission for Human Rights, an official arm the House of Representatives, organised a briefing on Russia’s misuse of Interpol arrest warrants to harass and demoralise victims of corporate raiding in exile. Despite President Trump’s declared willingness to remove sanctions and restore friendly ties with the Kremlin, Russia’s corrupt business culture will remain a serious impediment to economic cooperation with the US.

In economic terms, Russia is now at a fork in the road. Alexei Kudrin, the former Finance Minister who retains some influence as an adviser to Putin, has proposed a reform plan designed to achieve average growth rates of 4 per cent through an expansion of the private sector. Central to Kudrin’s vision is the creation of a judicial system capable of defending property rights. A rival plan supported by prominent conservatives calls for higher borrowing to fund state spending without any serious structural reform. As long as Russian businesses feel the need to outsource the rule of law to foreign courts in the absence of a better domestic alternative, there will be a cap on growth and Russia will be unable to recover its status as an emerging nation. It is Russia’s capacity to change from within, not the issue of sanctions, that will determine its economic prospects.

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