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P 020750Z APR 07
FM AMEMBASSY MOSCOW
TO RUEHC/SECSTATE WASHDC PRIORITY 8840
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY

C O N F I D E N T I A L SECTION 01 OF 04 MOSCOW 001442 

SIPDIS 

SIPDIS 

STATE FOR EUR/RUS; EUR/ERA; EEB/IFD 
STATE PLS PASS USTR FOR DONNELLY, MOLNAR 
NSC FOR KLECHESKI AND MCKIBBEN 
DOC FOR 4231/IEP/EUR/JBROUGHER 

E.O. 12958: DECL: 04/02/2017 
TAGS: ECON EINV EIND PGOV RS
SUBJECT: RUSSIAN CORPORATE STATISM: WATCH THIS SPACE 

REF: 06 MOSCOW 1306 

Classified By: Ambassador William J. Burns for reasons 1.5 (b/d) 

¶1. (C) Summary: The rise of corporate statism in Russia has 
been significant. Since 2004, the government has taken over 
the world's largest titanium business, consolidated its 
position in Gazprom, merged 10 aviation businesses into a 
state-owned conglomerate, and taken controlling positions in 
other firms. No less fascinating has been the mix of greed, 
politics, and business behind the expansion of the state into 
the economy. Looking ahead, our contacts are strongly 
divided. Some see troubling signs of continued state 
ambition. Others believe the process is essentially 
plateauing, and will stabilize at lower levels of state 
ownership in the economy after two-three years. In our view, 
the current trendline may quickly approach some rather 
natural limits, and the Kremlin will eventually have to bow 
to the market. In the meantime, we should reinforce 
market-driven approaches and the cadre of Russian 
policy-makers who doggedly keep these ideas in play. End 
Summary. 

¶2. (SBU) This cable is based on dozens of conversations with 
contacts in industry and banking over the past six weeks, 
supplemented by Embassy-based research. 

The Breadth of State Ownership 
------------------------------ 

¶3. (SBU) The march of the state into parts of the Russian 
economy over the past few years has been significant, with 
control of swaths of the natural resource, defense, and 
select other sectors consolidated in state hands. Annual 
revenues of Russia's ten largest state-owned or controlled 
companies reached an estimated 20 percent of GDP in 2006. 
State-owned or controlled companies account for one-third of 
the Russian stock market's capitalization, and in just the 
last year, the value of these equity holdings has almost 
doubled to an estimated USD 369 billion. And the process 
continues: Rosoboronexport is rumored to be in line to buy 
Russia's fifth largest steel producer, Mechel; further 
consolidation in the energy sector favoring Gazprom and 
Rosneft is likely; a new shipbuilding national champion is in 
the works; and diamond giant Alrosa has its eye on Norilsk 
Nickel, a USD 30 billion company with more than the half the 
world's palladium and one-fifth of global nickel output. 

Looking Behind This Latest Great Grab 
------------------------------------- 

¶4. (C) The grab for Russia's resources is an old story, but 
contacts agree that traditional motives (greed, power) have 
been supplemented in this round with a nationalistic brand of 
commercial considerations. Greed in Russia shocks no one, 
but the rising value of Russia, Inc. (on the back of high 
energy prices) has made the current grab particularly 
profitable for some. Power considerations -- both 
geopolitical (as in the case of Gazprom) and in the context 
of Russia's domestic succession process -- are evident as 
well. New to this paradigm is the surprisingly strong role 
business considerations seem to be playing -- as the Russian 
Government tries to salvage a select few decrepit remains of 
Soviet industrial prowess before it is too late. Our 
contacts have a lot to say about all three motives; we 
summarize what we've heard here. 

¶5. (C) Greed: The Kremlin leadership in the economy is in no 
small part about money, and the Sibneft takeover by Gazprom 
is perhaps the most blatant example of this (only about a 
quarter of the $12b selling price for the firm is said to 
have actually gone to owner Abramovich). In general, the 
insider offtake from M&A deal flows is said to be so large 
now that Swiss banks have told Kremlin cutouts (like 
gas-trader Timchenko) that they cannot accept further 
deposits without knowing the source of the money. The most 
lucrative transfers to the state (usually involving natural 
resources) may be wrapped in patriotic rhetoric, but include 
a healthy dose of financial opportunism. Yet, as ugly as it 
looks, our contacts remind, it is not so different than what 
happened in Indonesia and South Korea - and Mexico too. As 
one contact points out, "the bureaucrats got rich there too." 

MOSCOW 00001442 002 OF 004 

¶6. (C) Power: Creating national champions and projecting a 
strong image for Russia abroad has been a leading factor in 
many state-connected takeovers and consolidations, including 
the removal of the Gazprom ring fence, the Rosoboronexport 
makeover, the RUSAL-SUAL deal, and the anticipated takeover 
of Norilsk Nickel by Alrosa. Some of what we are seeing is 
also is part of the ongoing succession process, putting 
individuals into deal flows and thus providing campaign 
finance and enhancing their public profile. The decision to 
put military hardware exports under Rosoboronexport is seen 
in some quarters as buttressing dark horse presidential 
hopeful and Rosoboronexport Chairman Sergey Chemezov. Recent 
portfolio changes are seen by some as giving First Deputy 
Prime Minister Sergey Ivanov a cash-laden institutional base 
like that enjoyed by his chief rival for the presidency, 
First Deputy Head of the Presidential Administration and 
Gazprom Chairman of the Board of Directors Dmitriy Medvedev. 

¶7. (C) Nationalistic-Driven Commercial Considerations: Many 
believe that Putin and those around him are also driven by a 
sincere desire to right the excesses of the 1990s, or 
oligarchic plundering of once-proud, though ruinously 
inefficient, Soviet companies. The examples here are truly 
varied. In the case of Avtovaz, Rosoboronexport's move to 
take over the firm last year may be the only thing saving the 
car-giant from complete collapse in the face of global 
competition. The emerging Norilsk Nickel story is said to be 
as much about saving Alrosa (which experts say will run out 
of diamonds in ten years' time) as it is about keeping 
Norilsk's palladium and nickel output in Russian hands. And, 
as driven by national security concerns as the formation of 
the United Aircraft Company might be, also at play is a 
long-overdue consolidation of an industry largely on the 
verge of collapse. These examples are more about saving jobs 
and communities and creating viable competitive companies 
than personal enrichment. Although making money is not 
precluded here, both Avtovaz and UAC, not to mention plans to 
create a new shipbuilding national champion, sound more like 
cash sinks than cash cows. 

What Next? 
---------- 

¶8. (C) Looking ahead, our contacts are divided about what to 
expect next. "Statist" believers argue that there are 
troubling signs that the trend is far from contained: 
state-owned companies are straying farther from their core 
business, eyeing the telecom and IT sectors, and expanding 
beyond traditional financial services. They point to 
Gazprom's movement into electricity; Svyazinvest's 
significant stake in privately-held telecom provider Comstar; 
and VneshTorgBank's overtures to brokerage house Troika 
Dialog (ultimately rebuffed). While no one is predicting 
another Yukos-style approach, there is a sense that the 
authorities can and will come up with new pretexts for 
control. 

¶9. (C) In contrast, others argue the state's reach is 
plateauing, and the current mix of state-private ownership 
could start to reverse itself before long. They say national 
champions in the sectors that make sense have been created, 
and industries such as telecom and IT do not lend themselves 
to over-centralization. In gas and electricity, given supply 
shortfalls, the GOR has to promote private investment to meet 
demand and introduce efficiencies. A shrinking current 
account balance (on the back of lower oil prices) and the 
drive to diversify the economy only heighten the need for 
private capital and better corporate governance (which 
implies a move away from state ownership and control). The 
Kremlin will also find it increasingly difficult to control 
emerging interest groups, from the consumer sector to 
regional governments. Integration into the WTO and other 
western economic institutions will require greater 
transparency, better and more equal market access, and lower 
protectionist barriers - which will temper the state's 
ambition. 

¶10. (C) Some take this latter argument one dark step further. 
They say that current GOR leadership, its successors and 
supporters, will need to find outlets for their accumulated 
wealth, much of which is said to be held in liquid assets 
abroad. The theory goes that these funds will start making 
their way back to Russia over the next two-three years, and 
that the target of the return flows will most likely be the 

MOSCOW 00001442 003 OF 004 


same assets that have been carefully squirreled away in state 
hands over the past few years -- thus spurring share 
offerings by Rosneft, spin offs at Gazprom, etc. These 
assets are profitable, and equity ownership in Russia carries 
less risk for this particular group of investors than the 
prying eyes of regulatory authorities abroad. Likewise, 
coming into Russia from an European investment platform, as 
one contact cynically noted, may make it less likely that 
zealous law-enforcement officials abroad would pursue 
criminal or civil cases for fear a U.S. or European firm 
could get tangled up in the investigation. 

Where We Come Out 
----------------- 

¶11. (C) Looking at the three motives most obviously at play, 
two of them -- greed and nationalistic commercial 
considerations -- suggest equally valid reasons why we might 
see the state pulling back from its commanding heights over 
the next few years. Greed will tend to push those who have 
accumulated shares in state companies towards share 
cash-outs, just as it will push those who have accumulated 
"private" cash abroad to buy back into Russia's safest 
investments. Rosneft is a perfect example. We are watching 
to see who in the government argues the loudest for Rosneft's 
further privatization -- they more than likely stand to 
benefit from either the sell or the buy opportunity. For 
industries that are less obvious moneymakers, exemplified by 
Avtovaz and UAC, the state is even more likely to divest 
(wholly, in the case of Avtovaz) as the firms become 
commercially viable and need investment capital and strategic 
partners, and as they become less social land mines and 
resemble more the typical day-to-day slog of the business 
world. 

¶12. (C) But pulling back does not mean exiting the field. 
XXXXXXXXXXXX does not expect the state  ever to
relinquish its control of XXXXXXXXXXXX. Nor will the
GOR  allow its stake in Gazprom to drop again below 50%,
although  many predict it will shed non-core assets in the
coming  years. Nor will the diamond trade or trade in metals
likely  see a repeat of the halcyon days of private ownership
in the  wake of loans-for-shares. UAC will likely never be
more than  30% privately-owned. 

¶13. (C) But even if every firm in the natural resources 
sector ends up in state hands, as significant as that would 
be, it would account for around 12% of the Russian economy. 
Add in state monopolies in the transport and communications 
sector, defense industries, and space, and state control over 
the economy rings in around 25% of GDP. As disturbing as 
this figure might seem, it is not wildly out of line with 
other market economies rich in natural resources. As 
recently as two years ago, the Norwegian state owned 
approximately 32% of the companies listed on the Oslo Stock 
Exchange, and still holds shares in 10-15 percent of 
Norwegian industry, including controlling shares in oil, 
telecoms, and the national airline. In Mexico, the state 
fully controls the oil, gas, and nuclear power industries and 
has reserved for the state in whole or part the 
telecommunications, air travel, and postal sectors. 

¶14. (C) And these back of the envelope estimates ignore 
important counter trends to the movement toward greater state 
control. Whole swaths of the economy, our interlocutors 
again and again confirm, lie fully outside the ambitions of 
the state -- and are thriving. One seasoned businessman (who 
has had his hat handed to him on more than one occasion over 
the past 15 years) is back in Russia and growing fast, and he 
chalks up his current success to the booming service and 
retail sector, a place where he says he never comes in 
contact with the designs of the Kremlin. There are also 
instances, like with XXXXXXXXXXXX, where, despite the
new ownership 
structure, the state has left the firm to run the business 
without Rosoboronexport grabbing off profits or instructing 
where production should go. Lastly, it would be 
irresponsible to ignore the progress being made toward the 
break-up and privatization of both the electricity and rail 
sectors. When all is said and done, these massive reforms 
will move some 2-3 percent of GDP from state to private hands. 

¶15. (C) There is another reason why more of this economy
will  likely move into the private sector. Economic
modernizers,  as they have come to call themselves here, may still 

MOSCOW 00001442 004 OF 004 

ultimately get the upper hand. XXXXXXXXXXXX, 
XXXXXXXXXXXX, XXXXXXXXXXXX and  others
recognize that only through greater private sector 
participation in the economy will Russia be able to attract 
the capital needed to sustain growth over the long run. This 
is also where working to bring Russia into international 
institutions will help drive policy here in the direction we 
favor. Locking the Russian Government into such institutions 
and exposing Russian companies to the discipline of the 
global market will reinforce the trends we seek to encourage. 
Doing so this year, before the election process starts to 
create new winners and losers, is a bet on the modernizers 
worth taking.