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IN THIS ISSUE

Hi-tech Russia spends billions abroad in an effort to stimulate innovation-led growth at home

Russia Sinks $1.5 Bn into U.S. Tech Firms

POLITICS & BUSINESS

Antigraft Wins Votes Pro-business platform wins support in regional elections PAGE 2

MONEY & MARKETS

Can ‘Russia’s Google’ Survive its Loss? Ilya Shegalovich dies

PHOTOXPRESS

Who Benefits from a Falling Ruble? Retailers to profit as ‘Made in Russia’ becomes cheaper © IAKOV GLINSKY / RIA NOVOSTI

A robot struts at Russia’s 2013 Innoprom industrial trade fair. State-owned companies are funneling money into high-tech start-ups at home and in the U.S.

Russia aims to boost technologyled economic growth at home by pouring money into technology start-ups and venture funds — including $1.5 billion in the U.S. DAVID MILLER SPECIAL TO RUSSIAN BUSINESS INSIGHT

Investment companies owned by the Russian government have funneled $1.5 billion into U.S.-based technology startups and venture capital funds in an effort to build business ties and lure expertise and private capital toward Russian industry. The spending is part of a multibillion dollar effort to rev up Russia’s own high-tech corridor and diversify its economy away from oil and gas exports. Rusnano, a $10-billion technology enterprise set up by the Russian state, is responsible for the lion’s share of the U.S. spending, or about $1.36 billion. Another stateowned fund of funds called the Russian Venture Company, or RVC, has injected about $100 million, accord-

ing to representatives of the companies. “For us, the investors, the numberone goal is to make money,”said Dmitry Akhanov, CEO of Rusnano’s American unit, Rusnano USA.“For the Russian government, one of the main goals was to support the commercialization of technologies in Russia.” RVC has also established a Boston subsidiary that helps Russian entrepreneurs navigate the tricky waters of American finance and commerce.The unit has helped groom Russian businesses for Boston’s MassChallenge, the world’s premier startup competition, and donated $100,000 to this year’s event. “Our mission is to build an economic bridge between the U.S. and Russia,” says Axel Tillman, head of the Boston office. “RVC-USA is a beachhead.” RVC USA is pushing to enhance Russia’s presence broadly among American startup and biotechnology communities. Russia submitted the second-highest number of ap-

plicants to the 2013 MassChallenge event, after only the United States and twice as many as in 2012. Fiftyfour Russian start-ups applied out of a total 1,200 startups from 39 countries, and four Russian teams made the grade. “RVC’s goal in the U.S. is primarily to create relationships between the Russian innovative ecosystem and the U.S. venture community,” Igor Agamirzian, CEO of RVC, said in an emailed response to questions. “Partnership with U.S. venture investors is an important vehicle for increasing business expertise and fostering technological vision among Russian startups.” Rusnano has made similar investments in the U.K. ($300 million), China ($253 million), Israel ($54 million) and Italy ($58 million), according to a Rusnano presentation. The firm has invested about $4.2 billion inside Russia. The company has so far invested a total of about $6.3 billion into over 100 hi-tech ventures worldwide, in sectors including life sciences, mi-

croelectronics, clean technology, energy efficiency and advanced materials. Spending in the U.S. has been concentrated in life sciences and electronics, with a smaller share going towards energy and nanocoatings. The firm has invested in 18 portfolio companies and partnered with four venture capital groups in the U.S. Russia, the world’s biggest producer of crude oil and natural gas, is seeking to parlay its natural resource wealth into support for innovationled economic development. Officials hope to kick-start a Russian answer to Silicon Valley while nurturing a fledgling venture capital community to fund the inventors. “The Russian venture capital market is growing fast, but it is still lacking experience and business expertise,” RVC’s Agamirzian says. Developing ties with U.S. firms should help make up for the deficit, he said.

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FEATURE

Sochi Ahead of the 2014 Olympics

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Snow Caps and Palm Trees: Check out the Seaside, Subtropical Home of the Winter Games PAGE 8

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Special Report This summer, Russia’s car market became the largest in Europe

Higher Oil Prices Fuel Nationwide Automobile Boom ANDREI SHKOLIN SPECIAL TO RUSSIAN BUSINESS INSIGHT

Higher prices at the pump don’t typically make Americans want to throw down the drop-top and hit the open road. But in Russia, things are a little different. Years of high oil prices have fueled rising incomes here in the world’s second-biggest crude exporter, unleashing an explosion of car ownership that propelled the country into Europe’s top automobile market during the month of August, following three years of growth above 10%.

Russians’ average monthly incomes have increased sixteen-fold in the past decade, to about $800 last year. Coupled with a burgeoning credit market and a baby boom, Russia has already become Europe’s leading market for items ranging from cell phones to children’s goods. Russia powered ahead of Germany in August to claim the top spot, as new auto registrations fell 5% in Germany year-on-year to 214,100 passenger cars, the German industry association, VDA, says. Russian analytical agency Autostat reported that 235,000240,000 vehicles were sold in Russia in August. Analysts caution that growth is expected to cool, but Russia’s car market – with just 250 cars per 1,000 people, compared with 750

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While sales in the EU decline, Russia overtakes Germany to become Europe’s largest car market in August, on the back of rising consumer purchasing power.

The U.S., Russia and Syria: What Happens Next?

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A car boom has led to higher traffic in Moscow and other cities.

per 1,000 in the U.S. – is far from saturated. Car ownership in Russia is still only about half as high as it is in Germany. The Russian auto boom is partly a reaction to decades of pent-up demand. Back in the Soviet era, domestic automobile production satisfied less than half of the country’s demand.Yet imports from capitalist countries were banned. Then, in the 2000s, Russian oil and natural-resource output re-

gained momentum that had been lost when the Soviet Union collapsed, and crude reached an alltime high of $145 per barrel in 2008. Now, even though Russia’s GDP growth has slowed since the financial crisis and doubts have been raised over how long the auto boom can last, oil is back at over $100 per barrel. Meanwhile, Russian consumers are still spending. CONTINUED ON PAGE 4

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Politics & Business

NEWS IN BRIEF

Finance Russia to bring in Basel-3 standards at the same time as United States and EU

Small Banks Brace for New Basel-3 Standards

• In an attempt to quell some of the criticism of its new nongovernmental organization law, the Kremlin handed out hundreds of millions of rubles in grants to domestic NGOs including the Memorial human rights organization. This money is intended to replace some of the foreign funding these groups received that got them branded as “foreign agents” under the new law. • Russia’s federal communications agency, Roskomnadzor, will block file-sharing website Opensharing.org under a new anti-piracy law, RAPSI’s sister agency Digit.ru reported. The Kremlin has focused on improving its protection of intellectual property rights as it prepares to invest heavily in the domestic film production industry in an attempt to return it to its Soviet-era glory. • The head of Russia’s largest social networking company VKontakte has offered Edward Snowden a job protecting users’ data after he was granted temporary asylum in Russia. The decision by Russia’s immigration authorities sparked a diplomatic row with the U.S.

Basel-3 requirements may trigger consolidation among Russian banks, as small and medium-size players struggle to comply with the new rules. MARINA MAXIMOVA SPECIAL TO RUSSIAN BUSINESS INSIGHT

REUTERS

• Russia and China plan to collaborate on developing a wide-body long-haul passenger airliner Russian Deputy Prime Minister Dmitry Rogozin said. The project is only financially viable as a collaboration, as Airbus and Boeing already account for 80% of Russia’s long-range passenger aircraft market, Mr. Rogozin said. • Eighteen Russian universities made it onto the list of the top 800 schools in the world for 2013, according to the Tenth Annual World University Rankings compiled by QS Quacquarelli Symonds. Moscow State University remains the topranked Russian institute, but fell four spots from 116 to 120.

• Belarus put Russian billionaire Suleiman Kerimov on Interpol’s international wanted list, as the fight over the potash partnership with Russia gets messier. Kerimov is a major shareholder in Russian fertilizer producer Uralkali. Prior to the venture with Belarus having fallen apart, it had been the world’s largest potash producer. • Alisher Usmanov became the first Russian to be named among the world’s 50 most influential people by the Bloomberg. The magazine placed the country’s richest man alongside Amazon founder Jeff Bezos, Berkshire Hathaway’s CEO Warren Buffet and Yahoo! CEO Marissa Mayer.

Vladimir Klimov, the owner of a small bank in the Urals, has been wrestling over the fate of his business all year. By law, on January 1, 2014, Russian lenders must adopt Basel-3 international standards. To comply, Mr. Klimov’s bank must raise additional capital it doesn’t have. The aspiring young banker says he has exhausted all but two options: either sell the bank to a deeppocketed investor for little more than the value of its capital, or sell his customer base and return his banking license to the Central Bank.

Big global banks looking for an entry point into Russia may be able to take advantage of the current situation.

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• Online U.S. behemoth Amazon is embarking on a “massive” expansion in the Russian books market and has already begun signing contracts with the largest publishing houses.

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“Selling to an investor will be the lesser of two evils,” says Mr. Klimov. The adoption of Basel-3 in Russia, intended to increase transparency and head off potential future banking crises by forcing lenders to raise capital ratios, may spark a wave of consolidation as owners of small and medium-size banks sell out rather than face up to the new rules, according to Mikhail Kuzmin, executive director of the Center for Economic Research at Synergy University. The change may also create a new opportunity for foreign banks to snap up new assets in Russia, analysts are saying. “Many small and medium-size banks are not ready for this transition,”saysViktor Chetverikov, the general director of the National Rating Agency.

“They lend to borrowers and projects that are of poor quality, unlike the major banks, [which] enjoy cheap funding and lending rates.” Following the collapse of the Soviet Union, small banks sprang up in Russia like so many mushrooms – and foreign banks raced to enter the country, with varying degrees of success. Today, while many of the smaller players persist, Russia’s banking scene is dominated by two domestic giants. Sberbank, a revitalized incarnation of the Soviet Union’s national savings bank, accounts for almost half of the country’s retail deposits. VTB24, the former Soviet foreign trade bank, has about 7.3% of the country’s retail deposits and has made significant moves into investment banking. International firms such as Citibank, Austria’s Raiffaissen and Italy’s UniCredit succeeded in establishing large operations in Russia, but other global players have found the country more difficult to enter. Britain’s Barclays acquired Expobank in 2008, but sold the unit for less than the buying price during the subsequent financial crisis. HSBC retreated from its retail banking operations in Russia in 2011, as part of a large-scale international reorganization, after only two years there. Big global banks still looking for an entry point into Russia may be able to take advantage of the current situation, as otherwise profitable regional banks look for buyers, said Pavel Loginov, chairman of the management board of Metcombank. According to Russian law, foreign banks cannot open branches directly inside the country. But they are allowed to maintain fully owned subsidiaries, which makes acquisition an appealing option compared with starting afresh. To be sure, many larger Russian banks are also said to be facing difficulty raising liquidity ahead

GETTY IMAGES/FOTOBANK

Big banks like VTB stand to benefit from the new reform.

How Basel-3 is Being Introduced in Russia This summer, the Central Bank’s chairwoman, Elvira Nabiullina, announced that Russia would introduce Basel-3 requirements synchronously with the EU and the U.S., at the start of 2014. Under Ms. Nabiullina’s leadership, the Central Bank has decided to partially ease the requirements for Russian banks: requirements for common equity will be set at the level of 5%, capital assets at 5.5% (with an increase to 6% beginning January 1, 2015), and aggregate capital at 10%. “In contrast to the banking systems in Europe and the U.S., asset structure

in [Russia’s] banking sector remains comparatively basic, without the critical dependence of bank capital on hybrid instruments. And, on the other hand, the balance-sheet structures are from the financial derivative market,” says Mikhail Nikitin, a credit analyst at VTB Capital. “Capitalization is higher in [Russian] banks than in European ones. Considering the higher volatility of the Russian economy and tempo of growth of the banking sector, our banks need to be stronger to match the level of risk,” says Svetlana Pavlova, assistant VP at Moody’s.

of the new rules. According to Fitch, the international ratings agency, four of Russia’s largest banks in terms of assets will face a scarcity of capital – VTB, Alfa Bank, NOMOS Bank and Russky Standart – as well as up to 20 medium-size banks. Meanwhile, the biggest banks will be helped by their shareholders - primarily the Russian state

or extremely high-net-worth individual investors, analysts say. Small and medium-size banks will have to survive on their own. Mr. Chetverikov says he believes the introduction of Basel-3 could mean that Russia winds up losing its medium-size banking business sector, in favor of the largest players and subsidiaries of foreign banks.

Politics Pro-business and anti-graft platforms are sweeping politicians into power for the first time

Anti-Corruption Ticket Wins Votes The fight against graft has emerged as a rallying cry for Russia’s nascent opposition, yielding victories in local elections. Analysts hope business benefits. ARTEM ZAGORODNOV RUSSIAN BUSINESS INSIGHT

PHOTOSHOT/VOSTOCK-PHOTO

Dmitry Bykov, the charismatic Russian TV host-turned-opposition leader, stepped to the podium in downtown Moscow and surveyed the crowd.The sight before him was a historical rarity: thousands of Russians gathered in the freezing rain to protest allegations of rigged parliamentary elections. “A real civil society has been formed in Russia, and it won’t disappear,” Mr. Bykov told the cheering throng, whose very appearance confounded political commentators’ longstanding assumptions about the apathy of Russian voters.“Never before in Moscow was there such a feeling of unity and determination.” Nearly two years after that chilly afternoon, Mr. Bykov and his allies believe the momentum is still in their favor. Although President Vladimir Putin continues to enjoy widespread approval in opinion polls, analysts say opposition figures are capitalizing on the rising prominence of one issue in particular, frustration with corruption. Pro-business and anti-corruption platforms helped propel opposition figures to previously unimaginable recognition and importance in regional elections this month, including a significant showing in a mayoral vote in the capital. “Russia’s economic growth and societal development over the last decade has reduced tolerance for corruption,” says Dmitry Butrin,

Alexei Navalny gathered an impressive following fighting corruption.

IN THEIR OWN WORDS

Chris Weafer SENIOR PARTNER AT MACRO ADVISORY, MOSCOW-BASED RESEARCH CONSULTANCY

The protests of late 2011 and early 2012 are starting to deliver a positive legacy. Investors, far from fearing political trends may lead to instability, should be encouraged that they may soon start to add a greater focus on promised reforms.”

business editor at leading daily newspaper Kommersant. The electoral results will put pressure on the Kremlin to keep Russia’s economy healthy, says Chris Weafer, senior partner at Macro Advisory, a Moscow-based research consultancy.

“The protests of late 2011 and early 2012 are finally starting to deliver a positive legacy,” says Mr. Weafer.“Investors, far from fearing political trends may lead to instability, should be encouraged that they may soon start to add a greater focus on promised reforms.” In Moscow, anti-corruption activist lawyer Alexei Navalny initially gained prominence after alleging that billions of dollars had been stolen at major state-owned corporations.This month, he emerged as the de facto leader of Russia’s fragmented opposition after garnering an impressive 27% of the capital’s vote, taking second place. Mr. Navalny has filed suit, claiming electoral fraud. But many Kremlin critics said the elections appeared to have been more open than expected. “I was impressed. Fair elections have returned to Moscow,” wrote

Yulia Latynina, prominent Kremlin critic and talk show host, in Moscow’s English-language daily newspaper, The Moscow Times. InYekaterinburg, Russia’s fourthlargest city, Yevgeny Roizman, a prominent anti-drugs campaigner, won the mayoral election. Mr. Roizman is a member of billionaire businessman and New Jersey Nets owner Mikhail Prokhorov’s Civic Platform party. An opposition candidate, Galina Shirshina, also won the mayor’s seat in Petrozavodsk, capital of Russia’s Karelia region. And the Russian Republican Party, which has struggled for nearly a decade to earn support for its pro-business platform, took seats in the Yaroslavl legislature. In Moscow, Mr. Navalny led a USlike grass roots campaign, delivering over 100 speeches in the month before the vote across Moscow’s districts. His slogan read:“We’ll change Russia. We’ll start with Moscow.” Leonid Polyakov, Head of the General Political Science Department at the Higher School of Economics, says the public’s rising frustration with corruption in Russia could have long-term economic benefits. “Fighting corruption was a priority for many politicians who attracted support from voters, so pressure on corrupt officials is likely to increase,” Polyakov said. “The fact that the elections were conducted fairly and openly also raises the legitimacy of the entire political system. Nothing will be turned upside down overnight. But both of these factors will have a positive effect and provide new opportunities to business.” Butrin of Kommersant agreed, noting change takes time.

Business & Politics

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NEWS IN BRIEF

Russia Sinks $1.5 Bn Into U.S. Ventures

• Russia’s MAKS international airshow went well with a string of orders for the newly created Russian SuperJet totaling $12 billion, a $55 million deal to sell India MiG fighters and a groundbreaking purchase of Russian helicopters by the U.K. • The cost of the flooding in Russia’s far east is estimated at $260 million, Russia’s Agriculture Ministry said. More than 627,000 hectares of agricultural land, or 40% of crop areas, have been affected by the floods. • Russia will liberalize LNG exports by the end of the year, deputy PM Arkady Dvorkovich announced Aug. 9. Currently, only Gazprom has exposure to LNG, but both Novatek and Rosneft are planning to construct plants.

IN THEIR OWN WORDS

Viktor Vekselberg

• International online payment giant PayPal has overcome the legal barriers to full entry to the Russian online payment market and is ready to launch into the increasingly lucrative market. From Sept. 17, PayPal account holders will be able to top up their accounts and transfer funds to Russian banks in local currency.

PRESIDENT SKOLKOVO FOUNDATION

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" ITAR-TASS

CONTINUED FROM PAGE 1

Where Rusnano Invests its Money

• The state-backed Russian Direct Investment Fund made its first investment into IT together with the CapMan Russia II Fund. The EBRD is also an investor to buy into Maykor, the leading Russian IT outsourcing and service provider. The three partners will invest up to $100 million in a series of stages over the coming years.

Igor Agamirzian

• The Moscow City government is planning to invest heavily in Gorky Park to make one of the best parks in the world. The city is planning to add 50km of new paths and extend the riverside walks in a development that will run to 2017. Russian oligarch Roman Abramovich has already invested 2 billion rubles ($62 million) to transform the park.

C.E.O. RUSSIAN VENTURE COMPANY

PHOTOSHOT/VOSTOCK-PHOTO

The Russian state has also spent billions on the Skolkovo Foundation, a non-profit established by the government with a mandate to foster innovation-based economic growth and build bridges with foreign academics and researchers. Headed by billionaire investor Viktor Vekselberg, Skolkovo has established an English-language graduate and research university in conjunction with the Massachusetts Institute of Technology, or MIT, near Moscow called the Skolkovo Institute of Technology, or Skoltech. More than 30 global corporations including Boeing, Cisco Systems, General Electric, Samsung, and Johnson & Johnson have signed research and development partnership deals with Skolkovo, and 28 of those — more than half American — have pledged to invest a combined $500 million. “Skolkovo is a massive government-led effort to diversify the Russian economy away from its dependency on natural resources,”Vekselberg said in an emailed statement.“Skolkovo’s American partners play a vital role in this effort.” The $500 million will be used in part “to establish corporate research and development centers at Skolkovo,”Vekselberg said. Skoltech aims to have 300 fulltime faculty by 2020, Vekselberg said.

REUTERS

We are partnering with a dozen American venture companies, scholars and businesspeople. However, I would like to emphasize that we need American expertise even more than investments. Skolkovo’s American partners play a vital role in this effort.”

Visitors admire a touring Rusnano exhibition inside a train, a joint project with Russian Railways.

Thanks to these and other measures, nine out of 24 drugs approved by the U.S. Federal Drug Administration in the third quarter were clinically tested in Russia. Rusnano is led by Anatoly Chubais, the redheaded former Deputy Prime Minister who played a key role in privatizing Soviet industries back in the 1990s. The company, whose name derives from its mandate to invest in nanotechnology, was set up in 2007 by an act of parliament and converted into a joint-stock company in 2011. Rusnano’s web site says the company aims to boost nanotech business activity in Russia up to an annual sector-wide turnover of $30 billion by 2015. Rusnano has teamed up with Princeton, New Jersey-based Domain Associates LLC, a healthcare-focused venture capital firm that has raised over $2.7 billion, according to the firm’s web site. The two firms have targeted a combined co-investment of about $760 million into approximately 20 U.S.-based healthcare companies.

U.S.-Russian Operations Capital commitments from Rusnano have been paired with agreements by the target companies to establish manufacturing or research operations in Russia, Akhanov said. Joint ventures set up by Rusnano and its partners have commissioned 30 research and production facilities across Russia.

In July, Rusnano, Domain Associates and other investors injected $55 million into ReVision Optics, Inc., a California-based firm which is researching solutions for age-related eyesight deterioration.

Research Partnership Rusnano invested $52 million into two Boston-area biopharmaceutical research companies, BIND Biosciences and Selecta Biosciences, with additional funds from private investors. As part of the deal, BIND and Selecta established subsidiaries in Russia to research technology and run clinical trials. Selecta is researching a vaccine against nicotine addiction. BIND is developing therapeutic nanoparticles that target cancerous tumors. Dixon Doll, co-founder and partner of the Menlo Park, California-based venture capital firm DCM, said in an interview that government action can indeed help spur venture activity. But he said the state’s most important role should be creating space

for private capital to flourish. “The government can be very helpful in stimulating a vibrant entrepreneurial ecosystem,” Doll says. “If Russia wants a good model, it should look long and hard at what China did,” he said, pointing to a series of Chinese laws allowing foreign investors to put money into offshore vehicles that could easily and securely invest in Chinese startups. Rusnano, RVC and Skolkovo hosted the second annual Russian Innovation Week conference in Boston on Sept. 17 and in Silicon Valley on Sep. 19-20, attended by Chubais,Vekselberg and Agamirzian. “Judging from the first day of the conference, there seems to be a lot of enthusiasm for Russian ideas from American business,” said Rinat Dosmukhamedov, Russian Trade Representative in the U.S. “We need American expertise even more than investments,”Vekselberg said.“We have big plans, and working together with American partners, we can make these a reality.”

SputnikBot

Russian Entrepreneurs Compete In Boston

A game that aims to teach kids the basic language of computer programming. The player must reprogram a robot whose job is to maintain a spaceship after a collision with a meteor.“We decided to create a game where players can program a robot and see the results immediately,” says Ksenia Kopylova of Sputnikbot. sputnikbot.com

Russia fielded more entrants to this year’s MassChallenge, the world’s biggest start-up competition, than any country besides the U.S. Russia’s four finalist teams are now competing with 128 start-ups for $1 million. During the June to October program, applicants get mentors, free office space, access to funding sources and a tutorial in how to launch a business. Meet Russia’s new crop of entrepreneurs.

Qbaka

Zet Universe, Inc.

A program designed to alert web service managers to client-side glitches that may go unnoticed by providers. Qbaka is building a tool for tracking errors, monitoring performance and testing automatically.“We track errors on the Web sites and tell developers about them so that [they can] fix them,”says Daniil Gitelson of Qbaka. qbaka.com

The team at Zet Universe aims to revolutionize the idea of the computer-user interface by reorganizing information into “visual clusters”inside spacious environments that can be shared, dispensing with today’s computer folder.“Interfaces are stuck back in the 1970s,”says Alexander Popov of Zet Universe. zetuniverse.com

Dressformer, Inc.

PRESS PHOTO

Dressformer is pioneering 3D fitting technology that aims to take the guesswork out of buying clothes online. The company’s virtual fitting rooms are based on 3D ava-

tars and the fitting technology aims to increase retailers’ profitability by addressing fitting and likability issues simultaneously, reducing the odds of a returned purchase.

“We want online retailers to sell more, and we want shoppers to find the right size when they shop online,” says Vagan Martirosyan of Dressformer. dressformer.com

RVC’s goal in the U.S. is primarily to create relationships between the Russian innovative ecosystem and the U.S. venture community. Partnership with U.S. venture investors is an important vehicle for increasing business expertise and fostering technological vision.”

• Russia’s new financial mega-regulator came into being on Sept. 1. The government will fully eliminate stock market watchdog the Federal Financial Markets Service and convert it into a department of the central bank by January. Observers have hailed the new regulator as an improvement. • Russia is encouraging neighboring countries to join its Customs Union ahead of an EU summit in Vilnius in November. Armenia unexpectedly signed up to the Russian-led economic bloc, while food imports from Ukraine and Moldova have faced delays on the Russian border. • Russia will spend $650 billion for the rearmament and modernization of its armed forces up to 2020, Russian Deputy Prime Minister Dmitry Rogozin said. Another $100 billion will be spent on the technical modernization of defense enterprises.

Special Report

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AUTO MANUFACTURING

VIEWPOINT

Russia in the WTO: Equality at long last, but fraternity?

RUSSIA BECOMES EUROPE’S LARGEST AUTO MARKET AS FOREIGN COMPANIES SET UP SHOP LOCALLY

THE INTRODUCTION OF A “SCRAPPAGE TAX” LEADS THE EUROPEANS AND JAPANESE TO THREATEN RUSSIA WITH LEGAL ACTION AGAINST “PROTECTIONISM.”

hen Russia’s record 18-year-long bid to join the World Trade Organization concluded successfully last year, one of the last major stumbling blocks concerned car import tariffs. For the past decade, Russia’s government had skilfully been using a carrot-and-stick approach to get major auto giants to produce cars (and, eventually, car parts) in Russia, which was suddenly under threat. The negotiators reached a compromise: duties on imported cars would decrease from 30% to 15% and on buses from 10% to 5% by 2018, making the country’s burgeoning $70 billion auto market more available than ever to Europe’s producers.

HOW RISING OIL PRICES FUELED AN AUTO BOOM CONTINUED FROM PAGE 1

ITAR-TASS

The ‘scrappage tax’ protects domestic manufacturers, like GAZ, from used foreign imports.

But there was a catch: last September (2012 was dubbed the “Year of Ecology” by Vladimir Putin), the country’s parliament passed a law implementing a car recycling, or “scrappage”, tax on all imported autos. The EU cried foul, saying it amounted to nothing more than veiled protectionism. Fredrik Erixon, director of the Brussels-based European Center for International Political Economy, called the tax “blatantly discriminatory,” adding “Russia is going to find itself being sued by a lot of different countries,” in an interview with Reuters. None other than former GM executive Bo Andersson takes credit for encouraging the idea to Putin. “I said to Mr. Putin, ‘Why are you solving Korea and Germany’s problems by buying their four-yearold buses?’,” he told The Wall Street Journal.The tax ranges from $550 for certain new cars up to $55,000 for old trucks (the amount increases with age and recycling cost). The move brought over $200 million into Russian coffers in the first two months after implementation alone, according to AForex analyst Narek Avakyan. This is not surprising, given the country’s generally old car fleet: 22% of cars on the road are over 20 years old. Meanwhile, scrappage rates stand between 1% and 3% – less than half Europe’s 6% average – making car recycling and ecology an urgent issue for Russia’s booming car market. Russian producers have been exempt as long as they committed to setting up an auto recycling dropoff center in every region with over 500,000 residents. In some remote parts of the country, car manufacturers have teamed up to set up the centers, reports business daily Kommersant. However, the EU doesn’t believe that local automakers will ever implement this commitment and that they therefore enjoy an unfair advantage in price. “[After Russia joined the WTO] Europe had expected a real cut in duties,” explains Sergei Udalov, director of the Autostat analytical agency. “But com-

International car-makers are looking to Russia to help fatten their bottom lines as sales tumble elsewhere in Europe. Car sales in Russia rose 12% year-on-year to 2.9 million in 2012, according to the Association of European Businesses. Meanwhile, in the EU, sales dropped 8.2% to 12 million units, the lowest in 17 years, according to the European Automobile Manufacturers’ Association. German car sales fell 2.9% to 3.08 million cars last year. Russia’s government has favored policies that promote the localization of manufacturing inside the country, such as a 30% import duty on new cars (instituted prior to Russia’s WTO membership last year), coupled with low duties on auto parts. Foreign companies have teamed up with Russian manufacturers to build vehicles inside the country for the domestic market, and even to export to the West. Volkswagen and Ford are now the fourth and fifth-largest carmakers in Russia, respectively, while General Motors has partnered with Russian manufacturer GAZ to produce Chevrolets near St. Petersburg. Ford was the first to move, opening a $150 million plant in Vsevolozhsk, outside St. Petersburg, in 2002. It was followed by France’s Renault in 2005; Germany’sVolkswagen and Japan’s Toyota in 2007; General Motors in 2008; a partnership between France’s Peugeot, Citroen and Japan’s Mitsubishi in 2010; and Hyundai in 2011. A legacy of shoddy Soviet craftsmanship means that many Russians prefer to buy foreign brands when they can afford them. Indeed, sales of new cars under

Russian brand names dropped from a peak in 2002 of 920,000 to 580,000 last year, as Russians opted for foreign models. Yet the share of cars made in Russia is rising. The number of domestically assembled foreign cars sold in Russia increased to 1.22 million in 2012, from 290,000 in 2007. Meanwhile, the number of imports rose more slowly over the same period, to 970,000 in 2012 from 750,000 imports in 2007. International auditor and consultant PricewaterhouseCoopers predicts those figures will hit 1.33

The number of locally assembled foreign cars sold in Russia increased to 1.22 million in 2012, from 290,000 in 2007. “The top-selling models – both domestic and foreign – are all compact, economical cars,” says Sergei Litvinenko of PwC. million units manufactured domestically, along with 990,000 imports this year, creating a market worth $70 billion. The most popular foreign brands are the Hyundai Solaris, the Ford Focus, and the KIA New Rio, according to the Association of European Businesses. “The top-selling models – both domestic and foreign – are all compact, economical cars,” says PricewaterhouseCoopers’ Russia auto specialist, Sergei Litvinenko. “But in the past 18 months this segment has stagnated and SUVs have shown the highest growth, especially crossovers like the Renault Duster, thanks to rising incomes and falling technology costs.”

Russia’s auto industry passed another milestone when AvtoVAZ announced in March it would begin exporting its economy-class Lada Granta sedan to European countries such as Germany, France, Serbia, Bulgaria and the Baltic states. Contracts signed by foreign carmakers between 2005 and 2007 had modest localization requirements up to 30%, and low volumes, typically starting around 25,000 cars annually, allowing foreign giants to test the Russian market. But agreements in 2011 with Renault-Nissan, GM, Ford and Volkswagen required that local components reach 60% and output be 300,000 cars annually each. They also mandated that 30% of foreign cars produced in Russia should have Russian engines and gearboxes. In return, the companies were promised duty-free import of components until July 1, 2018. This is no minor concession: Russia had negotiated hard with the WTO to maintain higher duties on new cars and buses, which are set to drop from 25% and 10% in 2012, to 15% and 5% by 2018. As a result, the country’s auto components market grew to $41.8 billion last year, up 8% on the previous year. Russia’s car market is also expected to benefit from falling lending and insurance costs. Loan rates are currently around 15%-17% and annual insurance costs Russians 5%-10% of the price of a car, compared to 3%-5% in more developed markets. “Insurance in Russia is expensive, because of the bad climate and poor roads,” says Mr. Litvinenko. “Financial services are also expensive, because of the high cost of funding, but this situation is changing for the better. Long-term I expect Russia’s market to become like the rest of Europe, thanks to better roads and parking, which

ITAR-TASS

IN FIGURES

$70 billion is the estimated size of Russia’s car market, which this August overtook Germany’s to become the largest in Europe.

4 million cars will be produced in Russia by 2020, predicts Russia’s Ministry of Industry and Trade.

means that small and compact cars will win out.” Russia’s Ministry of Industry and Trade predicts continued growth of the country’s market to 4.17 million cars by 2020, of which 3.75 million are expected to be made in Russia. PricewaterhouseCoopers is more conservative, predicting 3.5 million, still 20% more than today.

‘Made in Russia’ Picks Up Steam: Majors Go Local The production of car parts is booming in Russia, as global auto giants invest in Russia’s rapidly growing market. ANDREI SHKOLIN

REUTERS

SPECIAL TO RBTH

Ex-Minister of Economy Elvira Nabiullina (left) after signing Russia’s W.T.O. accension in 2011.

panies that don’t have their own factories in Russia have gained nothing from the reduced rate [because of the recycling tax]. Europe fears that the recycling guarantees offered by local companies will not affect the prices of their cars.” In response to the criticism, Russia’s government recently announced that all manufacturers would have to pay the tax by year’s end. “The ideal option from the point of the WTO would, of course, be no charge whatsoever,” adds Mr. Udalov. A total removal of the charge is out of the question because it also protects local players, mostly represented in the lower price segments, from imported used cars, for which the tax is higher. “This is a critical issue for the country’s truck companies, which have actually done well since the Soviet collapse,” says Bogdan Zykov of BKS Express. “Russian policymakers are eager to combine the WTO’s interests with those of domestic manufacturers,” says senior Nord Capital analyst Roman Tkachuk. “The interesting thing now will be to see if any WTO members challenge the new policies under the organization’s rules.” Prepared by Fedor Kikta

Every morning a giant sea-tanker arrives in the harbor of Kaliningrad, Russia’s tiny enclave on the Baltic Sea, carrying hundreds of BMWs assembled in the U.S. The engines, mirrors, bumpers and wheels have been removed in Germany. In Kaliningrad, those finishing touches are added back on. The car is stamped“Made in Russia,”and now it’s ready to be sold as a nonimport in what is fast becoming Europe’s largest automobile market. Yet the situation is set to change in ways that will make tactics like this one passé. International automobile giants are bringing technology and manufacturing capabilities to Russia, attracted by access to its $70 billion market and the country’s recent admission to the World Trade Organization. “The current goal is to localize the full cycle of automobile production – from windshields to engines – entirely in Russia, and import the relevant technology,”says Kirill Tachennikov, a Moscow-based UBS analyst. When Ford became the first international giant to set up its plant in Russia 11 years ago, it was making

25,000 cars per year almost entirely out of assembly kits. According to its agreement with the Russian government, however, by 2018 the factory should be producing 600,000 cars annually, made 60% from local parts. Volkswagen and Renault-Nissan, which came to Russia later, are bound by similar agreements: 30% of all cars produced at their factories will be equipped with Russianmade engines by 2018. “Since we opened our factory, we [imported] the bulk of auto components,”says Sergei Kirillov, vice president of U.S.-Russian joint venture Ford Sollers.“I wouldn’t say [this is] because Russian suppliers are worse than foreigners, but our existing partners know our business better and understand how they can be integrated into the production processes.” “The problem with Russian suppliers has traditionally been quality control,” says Vladimir Bespalov, a VTB Capital analyst in Moscow.“In the past, the international companies operating here would rely on them for simple parts, like tires and plastic components, while importing the more added-value stuff themselves.” But that is changing. Russia’s GAZ Group is launching production of Mercedes-Benz engines at its Yaroslavl plant this year, while Canadi-

an-based Magna International has agreed to build up to six full-cycle assembly operations and 15 automotive components plants in the Kaliningrad region, capable of servicing production of up to 250,000 vehicles, by 2018. Magna already operates five plants outside St. Petersburg and in the Kaluga region, employing over 2,000 people, which make everything from dashboards to radiator grills. Its investments into the Kaluga region alone are over $100 million, as factories there supply parts toVolkswagen, Skoda, Renault and Peugeot

Citroen. Magna’s commitment to St. Petersburg came on the heels of Hyundai’s decision to open a plant in the region three years ago. Magna invested nearly $150 million to supply over three million parts annually to GM, Nissan andVolkswagen, as well as Hyundai.“Global auto giants are pushing their suppliers to set up shop in Russia because of their commitments before Russia’s government,” says Sergei Litvinenko of PricewaterhouseCoopers in Russia. In December 2012, the Volkswagen Group switched to full-cycle pro-

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Flying Soviet Trucks: A Legacy Name Goes Global Mikhail Gzovsky, Daniil Zhelobanov, Fedor Kikta SPECIAL TO RUSSIAN BUSINESS INSIGHT

Russia’s Most Popular Selling Brands

ITAR-TASS

Kamaz’s “flying trucks” are a rare example of a Soviet brand success story, having taken the entire pedestal at this year’s Dakar Rally.

Number of Cars Produced in Russia

n 1996, during the gloomy days of post-Soviet Russia’s economic depression, a beaten-down, hometown underdog scored an international victory. Kamaz, the heavy truck maker, stormed the prestigious Dakar rally, beating both Mercedes and Ford. It won the following year. And the year after that. Cue the Rocky theme song. Soon Kamaz became the Lance Armstrong of Dakar (without the doping charges), taking first place 11 times since 1996, a world record. The “flying trucks,” a nickname they earned for their 100-mph leaps through the air, took first, second and third places at this year’s rally. Today, Kamaz has grown into one of those rare animals: a Soviet brand that survived the transition from command economy to free market and now thrives on the international stage. “Kamaz is the most successful homegrown automobile story,” says Oleg Datskiv, general director of leading online car retailer auto-dealer.ru. Daimler bought a 10% share of Kamaz (estimated at $250 million) in 2008, as the truck maker began exporting to new markets in Latin America and Asia. Today, with annual revenues at $4 billion, Kamaz sells over 46,000 trucks annually to domestic and international clients, including the Russian military, and is the largest truck producer in the territory of the former Soviet Union. The deal with Daimler allowed Kamaz to modernize its fleet, which now runs on Cummins engines and other parts from ZF Friedrichshafen AG and KnorrBremze, with trucks priced in the range of $50,000$100,000 (about 30-40% lower than its European and American counterparts). The company has successfully positioned itself as a maker of more economical versions of classic four-wheelers in emerging economies. “The Kamaz brand is well-known not only in the former USSR, but other dynamically growing markets like India and Turkey,” said Nord Capital analyst Roman Tkachuk. “They have a lot of potential to increase their market share in those countries, which they can do if this investment and technology from Daimler allows them to compete in quality against top heavy-truck producers.” Moreover, the 2008 economic crisis had the knockon effect of boosting the truck-maker’s share of the domestic market (the largest in Europe) to a peak of 38.4% from 28.1%, as local firms switched to cheaper trucks in an effort to cut transportation costs. According to Kamaz, Russia’s market for trucks in its own 14-to-40-ton segment grew by 17.1% in 2012 to 117,000 units. Last year the company also exported 7,400 trucks, mostly to countries that used to belong to the USSR like Kazakhstan, Turkmenistan and Ukraine, where it is the market leader. “Kamaz never relied on politicians in Moscow to shelter it from foreign competition,” Datskiv says. “Now Russia has joined the WTO, [Kamaz] is one of the few that knows how to rely on its own R&D [research and development] and marketing for developing and promoting new quality products.” As Russian consumer preferences evolved from price to quality, Kamaz announced an ambitious $2 billion modernization program in conjunction with Daimler, to develop a new line of pricier, upmarket trucks scheduled to hit dealerships in 2015 or 2016. Kamaz will also launch production of Daimler cabins and, eventually, engines. “In the future, [Daimler and Kamaz] plan to manufacture axles in Russia through a joint venture,” Daimler said in a press release. “We will be ideally equipped to benefit from the growth of Europe’s largest truck market,” says Hubertus Troska, head of Mercedes-Benz Trucks, a unit of Daimler. Kamaz has been operating joint factories with Mercedes-Benz Trucks Vostok (MBTV) and Fuso Kamaz Trucks Rus (FKTR) since 2010, producing thousands of Mercedes-Benz Actros, Axor, and Atego and Fuso Canter vehicles. “Through our technological expertise and skill, we are helping Kamaz to expand its strong position on the Russian market,” says Daimler Trucks representative Stefan E. Buchner. Kamaz plans to increase total sales of its own brand to 80,000 trucks a year, a quarter of them tagged for export, and annual earnings to almost $12 billion within the next seven years. “Kamaz has every chance to offer American-quality trucks in a few years at a substantially cheaper price,” says Sergei Udalov, executive director of the Avtostat research agency.

IN FIGURES

38% was Kamaz’s peak share of the Russian market during the height of the crisis in 2009, when companies switched to cheaper, home-made trucks for their transportation needs. The company plans to produce 80,000 trucks annually.

$12 billion duction of the SkodaYeti.The Skoda Octavia and VW Jetta are next. The total local output is expected to reach 130,000 cars a year. The Volkswagen Group plans to invest $320 million by 2015 in a 150,000-per-year engine plant, close to the company’s full-cycle plant in Kaluga. “Engine-block casting and crankshaft manufacturing could be next,” says Michael Obrovsky, CFO ofVolkswagen Group Russia.“All will depend on how prepared the local manufacturers are.” Sergei Udalov of Avtostat analyt-

ical agency says,“I recently attended a trade conference that left me solidly with the impression that auto-component manufacturers are prepared to push full-steam ahead.” The dock workers in Kaliningrad aren’t worried. By 2020, the parts they assemble into BMWs and Cadillacs will be produced locally — and the finished products may be destined for markets apart from their own. Andrei Shkolin is Editor-in-Chief of thinktwice.ru, a web-based resource focused on finance and investment.

is the expected annual earnings of Kamaz in seven years. The company “has every chance to offer European and American-quality trucks at a substantially cheaper price,” said Sergei Udalov of Avtostat.

$2 billion is being invested by Daimler and Kamaz into modernizing the truck giant’s production facilities with higher-end trucks due to hit dealerships in 2015-16.

Money & Markets

AHEAD OF THE CURVE

Russia: Surprising on the Upside David Gray SPECIAL TO RUSSIAN BUSINESS INSIGHT

ike an analyst giving a share tip, I think I should start by admitting that, despite being an Englishman, I am “invested” in Russia. I have lived in the country for almost 19 years, work here and even have a Russian wife. Nevertheless, let me come out fighting and state that Russia is actually a well-kept investment secret and represents a tremendous opportunity for those with the vision to see beyond the stereotypes and short-term challenges. Of course, there is a fine tradition of pessimism in Russia. So why am I optimistic? Well, after waiting for 19 years for the country to fall apart, I am convinced that Russia has fundamentally changed for the better and that it will continue to progress. Let me pick out a couple of examples: the transformation of summertime in Moscow and the Universiade in Kazan. This summer, Moscow finally started to look and feel like a modern European capital. From the creation of new parks and the program of pedestrianization to the introduction of effective parking restrictions to combat congestion and the new city bike scheme, Moscow has been transformed this summer into a cool city with a thriving sidewalkcafé culture. The rapid pace of improvement in the city was brought home to me when a colleague, who last visited the city two years ago, was rightly positively “shocked” at the changes wrought to the city since his last visit. And contrary to the old saw that it’s “just Moscow” that has progressed (those pessimists again!), my experience is that changes are also transforming cities around the country. The most spectacular example of this is perhaps Kazan, which in July hosted the 27th Universiade, or student Olympics. As usual in Russia, ahead of the games the pessimists were rubbing their hands in an ecstasy of expectation, foretelling an embarrassing catalogue of logistical disasters, poorly prepared, sub-standard, empty stadiums and frustrated spectators and athletes. In the event, everything about the Universiade was a triumph, from the moment that you arrived at the gleaming new airport terminal and were greeted by a phalanx of enthusiastic volunteers, the whole experience was a joy. The opening and closing ceremonies were only marginally less impressive than those staged in London 2012. This was a new and improved Russia, one that was open, friendly and modern. Now, for the benefit of the pessimists, things could get worse from here. But with Sochi 2014 up next, I have a feeling that Russia is on a roll and that we are all going to have to get used to Russia surprising on the upside.

David Gray is Managing Partner at PwC Russia.

STATE MATTERS

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Stocks Experts say Russia’s market-leading search engine will continue to steam ahead

‘Russia’s Google’ Pushes On After Losing Founder Ilya Segalovich, visionary cofounder of NASDAQ-traded Yandex, died in July. Analysts say the company will persevere. DAVID MILLER RUSSIAN BUSINESS INSIGHT

Technology companies depend on the vision of their founders. So it was a heavy blow to Yandex, dubbed the “Russian Google,” to lose Ilya Segalovich, the man sometimes called the Russian Steve Jobs. YetYandex, which handles more than twice as many searches in Russia as Google, may be so far ahead that it can continue to hold its lead, market-watchers say. “The loss of Segalovich was a big loss for the company,”says Anna Lepetukhina, a Moscow-based Sberbank analyst. “[But it] has a very strong position in Russia, and I think it can continue growing. This is underpinned by the fact that new initiatives and new launches they made this year have already translated into revenue growth.” Segalovich, who died of meningitis in July at age 48, co-founded the company in 1997, the year before Google launched, with his partner, Arkady Volozh. He also coined the name “Yandex,” which stands for “Yet Another Index.” Today, the company claims 62% of Russia’s rapidly expanding search-engine market, compared with Google’s 26% share. Web advertising in Russia rose 35% last year and analysts say it may rise 32% in 2013. In February,Yandex overtook Microsoft’s Bing as the world’s fourth most popular search engine, after Google, Baidu and Yahoo, according to figures from comScore, a U.S. Internet analytics company. Shortly after announcing Segalovich’s death, Yandex posted financial results for the second quarter, which beat analyst expectations, with net income rising 48% to 2.92 billion rubles ($89 million). The company also forecast that 2013 revenue would rise as much as 38%, faster than previously expected. In the past 12 months, Yandex shares have risen about 40%. Google rose by roughly a quarter in the same period, and Apple has fallen roughly by a third. Nevertheless, since Segalovich’s death, Yandex shares have fluctuated. While the changes have been roughly in line with the broader Russian stock market, the moves

Ilya Segalovich (left), who co-founded Yandex with Arkady Volozh in 1997, died this summer at age 48.

Yandex vs. Apple: 2013 Stock Performance YNDX 40%

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its new CEO, Tim Cook, to use more cash to buy back shares. “I believe Yandex can continue growing and developing without Segalovich, because the company still has Volozh,” Ms. Lepetukhina says. “Volozh has the vision, and he’s behind the company strategy. The company has also built up a strong product-development team.” Other analysts agree. Yandex“remains ideally positioned to benefit from growth in the Russian online advertising market, with leading positions in its most valuable part, the context-based advertising market,” Moscow-based

have brought speculation as to what lies ahead for the company. Segalovich’s death drew comparisons betweenYandex and California-based Apple, whose visionary founder, Steve Jobs, died in October 2011. Strong financial results continued to propel Apple shares upwards for a year after Jobs’ death, from about $400 per share to an all-time high of $705. But in late 2012 Apple fell back below $400 as investors fretted over slowing growth and a lack of new products. This year, Apple has swung between $400 and $500, as activist investor Carl Icahn urges

financial corporation Uralsib noted after Yandex’s second-quarter results were posted. Yandex’s position is“secured by leadership of the online search market and supported by the boost provided by mobile Internet users, where it continues to outperform its competitors, including Google,” Uralsib said. Analysts also cite Yandex’s international positioning as a factor making the stock more attractive to Western investors. While the company’s business focus is Russia, the firm is legally registered in the Hague and trades on NewYork’s NASDAQ stock exchange as an American Depository Receipt. Yandex is also making inroads beyond Russia’s borders: it accounts for some 33% of searches in both Ukraine and Kazakhstan, and 43% of searches in Belarus. Analysts at TheStreet.com upgradedYandex from“hold”to“buy” on August 27. “The company’s strengths can be seen in its robust revenue growth, largely solid financial position with reasonable debt levels by most measures, notable return on equity, expanding profit margins and good cash flow from operations,” they told investors. The analysts also cited a “very high” gross profit margin of 77%. Yandex raised $1.3 billion in an initial public offering on NASDAQ in 2011.

Natalia Orlova

Who Benefits Most From the Falling Ruble?

Local retailers and food producers will be big winners of ruble devaluation.

Ruble/Dollar Exchange Rate 40 35 30 25 20 15 10

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Economists predict the falling ruble will boost exports and tax revenues and provide a fillip to carmakers and other local vendors. Some economists predict that the ruble, now trading around 33 to the dollar (down from 30 at the start of 2013), may sink to 37 by year’s end. Factors behind the fall range from concerns about the end of quantitative easing in the U.S. to statements by Russian Finance Minister Anton Siluanov that a weaker ruble would have benefits for Russia. Sluggish performance in the European Union, Russia’s largest trading partner, and lessthan-rosy forecasts for GDP growth at home have also had an effect. Today’s slide is not as dramatic as that of 1998, however, when the ruble went from six to the dollar to nearly 30, and when Russia’s oil companies made windfall profits by selling crude in dollars while booking profits in rubles. Oil companies will not benefit to the same degree this time, because new tax rules mean the state will collect most of the surplus oil profits. “The real beneficiary [this time] is the state budget,” says Chris Weafer, founding partner of Mos-

2002

RUSSIAN BUSINESS INSIGHT

2001

ARTEM ZAGORODNOV

cow-based Macro Advisory. And with the government, yield-hungry investors looking for fixed income with low risk as tax receipts buttress Russian sovereign debt. Other beneficiaries should include domestic producers as the costs of imported goods increase. “One of the biggest winners will be Russia’s burgeoning auto industry,” says Mr. Weafer. A recent World Bank study ranked Russia as Europe’s largest economy, and the world’s fifth-largest in terms of purchasing power. Local winners could include Russian food retailers like Dixy; Russia’s only publicly listed meat-producer, Cherkizovo; and Magnit, the firm some call “Russia’s Walmart.” Exports should also benefit from a cheaper ruble. “A Russian company called VSMPO-AVISMO is Boeing and Airbus’s largest supplier of titanium,” says Mr. Weafer.“The aircraft manufacturers are now getting that input cheaper.” The weaker ruble also means Russia’s food exports to the U.S. – like caviar and crab legs (valued at $175 million in 2012, according to the U.S. Census Bureau) – will be less expensive. And this could be a great time to buy a diamond for that special someone. “Russia’s Alrosa is the world’s second-largest diamond exporter after South Africa’s De Beers,” says Mr. Weafer.

2000

A weakening currency could strengthen the outlook for many of the country’s retailers, carmakers and manufacturers.

1999

Natalia Orlova is Chief Economist at Alfa Bank in Moscow.

Currency A weaker ruble benefits sectors of the Russian economy that target local consumers

1998

lthough Russian economic growth slowed to a mere 1.4% year-on-year in the first half of 2013, the domestic consumer trend remains solid. Russia’s current economic growth model relies heavily on consumption. There is good reason to expect this trend to continue, thanks to low unemployment, strong income growth, retail lending expansion, and the social focus of the Russian state budget. Indeed, retail trade expanded 3.8% in the first seven months, supported by faster-than-expected real disposable income growth of 4.3% and a strong real wage increase of 5.5%. The first and key reason why the consumer trend looks likely to continue is rapid income growth, resulting from a sharp decline in unemployment. Russia’s strong economic performance in 20012008 was in part due to the 6% increase in its labor force, to a peak of 76 million people. However, since then the figure has been stable, contributing to a decline in the unemployment rate to a historical low of 5.1% at the end of last year. Companies have therefore been forced to increase wages, despite slower economic growth. There is little reason to expect the labor market to turn more favorable for companies. Based on official demographic forecasts, the workforce is set to shrink by 2 million people, or 3%, by 2017 owing to the demographic decline of the 1990s. The number of young people under 20 dropped to 30 million in 2012, from 44 million in 1989, limiting the number of new entrants to the labor market. Therefore not only is income growth strong, but it is likely to remain so. The social focus of Russia’s budget policy is also an important factor behind the strong consumer sentiment. Social expenditures make up 33% of consolidated budget spending in 2013, versus 24% in 2007, a share that will likely rise in future. Of the country’s population of more than 140 million, the state takes care of around 40 million pensioners and 18 million public-sector employees, meaning a substantial 40% of the population relies directly on state support. Finally, retail lending is still expanding at a pace of 30%-35% year-on-year. The combination of relatively high income growth and a strong preference for consumption opens up new opportunities on the consumer market, despite the slowing economy.

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Opinion

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This summer, Russia Beyond the Headlines launched Russia Direct (RD), an online discussion forum. “Our articles will provide the nuanced understanding required by those with a profound interest in U.S. and Russian foreign policy.” said RD Chief Editor Ekaterina Zabrovskaya.

SAVE THE G20: TRY A REAL RESET OF U.S.-RUSSIA RELATIONS Ivan Tsvetkov SPECIAL TO RUSSIA DIRECT NATALIA MIKHAYLENKO

A BETTER WORLD FOR THE LITTLE GUY Alexander Ivlev ECONOMIST

here is a growing recognition among the G20 countries of the invaluable role played by entrepreneurs in economic development, and indeed, many countries have introduced a range of programs designed to help boost entrepreneurship. Here at Ernst & Young, we took the occasion of the G20 summit in St. Petersburg to examine how these efforts are progressing. We looked at all 20 countries in five different categories: access to funding; culture of entrepreneurship; tax and regulation; education and training; and coordinated support. I’d like to take a moment to share some of our findings about the country that played host to the G20: Russia. Compared with past years, we see the Russian entrepreneurial community showing more energy. It is creating new associations, and we see stronger activity in regional organizations. In short, things are improving. This progress is illustrated by indicators such as time to start a business, and the number of hours spent on administrative and tax issues. We have also seen improvements in corporate governance and immigration law. Russia performs particularly well in the category we call “coordinated support,” ranking above any other G20 country in this area. It is important to note that this doesn’t mean Russia offers the highest-quality entrepreneurial support in the G20. It means that entrepreneurs in Russia were the most likely to report an improvement in support over the past three years.

Russia has three major development institutions that are actively involved in investing state funds in entrepreneurship development: Russian Venture Company (RVC), Rusnano and Skolkovo Foundation. RVC makes investments through private venture-capital funds formed jointly with private investors. The number of these funds now stands at 12 (including two in a foreign jurisdiction), worth a total of $850 million. RVC’s share is over $500 million. At the beginning of 2013, 139 innovation companies had been financed by RVC venture capital funds. Rusnano was created in 2007 and has invest-

We see the Russian entrepreneurial community showing more energy. It is creating new associations and self-regulatory organizations, and we see stronger activity in regional organizations. ed over $4 billion in more than 90 companies. The benchmark is $10 billion in sales proceeds for these project companies using advanced technologies. The state-funded Skolkovo Foundation, formed three years ago to support the best innovation projects, has already provided tax preferences and grants to hundreds of new ventures. Since 2010 the Skolkovo Foundation has received about $1 billion in state funds. Of the 832 Skolkovo residents, 184 have received foundation grants worth a total of $300 million.

Industrial parks are among the most effective business development initiatives in Russia. At the end of 2012 there were 303 such parks in total, nationwide. This figure is set to expand considerably, with 50 new projects announced in 2012 alone. About one in four entrepreneurs says access to business incubators has greatly improved over the past three years. Seed funding has been less available, but the Government has just announced its support for a $200 million fund to invest in Internet startups (FRII). This fund will pay a lot of attention to businesses at the very earliest stages of development. Its purpose is not only to provide them with money, but also to build all the necessary infrastructure for the successful development of the Internet industry in Russia. Another area where Russia demonstrates significant progress is tax administration. One example is the time it takes for businesses to deal with taxes: Russia’s three-year average is 262 hours, but as of 2012 this had fallen to 177 hours. For over 10 years Russia has had a 13% flat tax on income – among the world’s lowest. Currently, small-and-medium-size enterprises (SMEs) account for roughly 20% of new jobs in Russia. The President clearly expressed his expectation that the Government develop policies to help increase the SME share of GDP to 50%. To achieve this, the right steps must be taken across many areas, in order to improve the regulatory framework and the entrepreneurial environment in Russia. It is extremely important that the Government listens to what businesses have to say. Alexander Ivlev is EY’s country managing partner for Russia.

TWO PATHS TO GROWTH Ben Aris JOURNALIST

ussia today is a very different place from during the boom years.With growth well down from the pre-crisis 6%-8% it was enjoying, this year has been particularly disappointing. Russia has just turned in the sixth consecutive quarter of slowing growth, meaning expansion in the first half of the year was 1.4% versus the 4.5% in the same period a year earlier. The 3.5% widely forecast for 2013 at the start of the year is now clearly unattainable. There is a lot of confusion over what is causing Russia’s slowdown. Capital flight and low levels of investment are surely factors. High interest rates and poor corporate borrowing are also having an impact, as are the lack of internal structural reforms and external drag caused by the pan-European malaise. If the causes are external, then despite the recent poor results the Kremlin should be buoyed, as Europe’s economic recovery seems to be gathering momentum. If the causes are internal, Russia watchers should also be encouraged. The Kremlin’s anti-corruption drive and President Putin’s new raft of administrative reforms are designed to lift Russia to 20th place on the World Bank’s “Doing Business”

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index by 2018, from its current 120th slot. Whatever the reasons, the economy is widely expected to recover in the second half of this year. Domestic-demand growth accelerated in July, retail sales rose 4.5%, capital investment reversed its previous fall to gain 2.5%, and inflation slowed to its lowest pace in eight months of 6.5%, down from a high of 7.4% in May. Russia’s critics are dismissive both of the anticorruption campaign and the Kremlin’s ability to push through meaningful reform, so they fore-

Russia’s $500 billion cash pile and borrowing capacity give it unrivalled spending power. cast a lackadaisical performance. But what the naysayers miss is that, uniquely in Europe, much of Russia’s slowdown is a self-inflicted wound. While other European countries have been forced to slash interest rates to almost zero and push up their debt levels to unsustainable levels to finance spend-to-grow policies, Russia has kept interest rates high, and cut real spending for the first time in two decades. Russia has foregone the policy of throwing money at the economy that passes for a rescue

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strategy on the rest of the continent, because Russia’s financial policy-makers believe it would only create bubbles, or drive up inflation. Unlike any other European country, Russia’s $500 billion cash pile and massive borrowing capacity gives it unrivalled spending power. Perversely, it is the fact that the authorities have chosen to introduce a “fiscal rule” which in effect ties spending to historic oil prices. Likewise, the rest of the central banks in Europe have been forced to slash rates to next to nothing. The Central Bank of Russia (CBR) has confounded repeated predictions of a rate-cut and kept interest rates high at 8.25%, being more concerned with bringing inflation down than boosting economic activity. Inflation, however, is now falling. The CBR has turned a deaf ear to the shrieks of pain from oligarchs who complain about the high cost of borrowing and even rebuffed President Putin’s calls to reduce interest rates. Indeed, the only practical policy it has adopted to boost growth is to allow the ruble to significantly weaken. How the rest of the year will play out is still not clear, but the Kremlin has the luxury of being able to turn on the spending spigot at any time if things get too difficult. Ben Aris is Editor-in-Chief of Business New Europe, a magazine focused on opportunities in Eastern Europe and the former USSR.

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ast week’s G20 Summit in St. Petersburg elicited greater interest around the world than was originally expected – and it all happened because of the worsening situation in Syria. Though some analysts suggested that Russia would be disappointed because political issues overshadowed its meticulously prepared economic agenda, Russia’s President Putin didn’t appear upset. Before and during the summit, Putin commented on a possible U.S. military operation against Assad’s regime in Syria with great rhetorical emphasis and barely disguised satisfaction. However, no matter how comfortable the president of the country hosting the summit feels, observers could not get rid of the impression that the G20 had somehow turned into another“nonstarter”summit. What once promised to become a new international dialogue format a few years ago now seems to be one of the many organizations where style takes precedence over substance. No, things were apparently not as bad as might have been feared. At the St. Petersburg Summit, the participants declared their support for many important areas of cooperation designed to overcome global economic problems. However, the circumstances of the G20 meeting in St. Petersburg added no confidence in terms of their future implementation. While it may be coincidence, the“golden years” of the G20 were the years of the“restart”of Russian-American relations. The atmosphere of trust and cooperation that occurred between Obama and Medvedev, limited though it was, allowed not only agreements on joint actions within the G20, but also ensured compliance with the agreements reached in 2009– 2011. The sense of an upcoming global financial collapse may have also helped. It would be an exaggeration to say the question of the success of this international institution, which includes representatives of the world’s 20 most developed economies, is decided only in Moscow and Washington. But we should not ignore this very significant factor. Today, the G20 is trying to claim the role of a new hub in the system of global governance. As has been demonstrated by Russia’s chairmanship, Moscow takes the G20 seriously, and is ready to use this new mechanism to solve a variety of problems. However, the Syrian crisis interfering with the broader economic agenda has clearly demonstrated that the G20 is unlikely to succeed in the face of a deep political divide between participants. Plans developed today are not guaranteed by anything besides good will. Although the voices for and against the attack on Syria are divided almost evenly, Russia clearly acted as the principal opponent of the Obama Administration’s intentions. Even China, which has the same right of veto in the United Nations Security Council as Russia, chose not to make its own arguments, and in fact only agreed with the statements of Putin. Should the Russians feel happy with such developments? The answer to this is not obvious at all. This effective opposition to the U.S. raises the authority of Russia and its President in the eyes of many. Demonstrating the superpower strength of Russia, even if only by biting phrases, serves as a psychological doping for the Russian people, which is necessary to overcome the longing for lost grandeur. And Vladimir Putin, who has been noticed romanticizing the Soviet era more than once, willingly performs this function of a therapist for voters who feel nostalgia for the Empire. However, like any drug, such imperial antiAmericanism has its price, and it may have adverse health consequences. While, as we saw in St. Petersburg, Russia remains very interested in the success of the G20, it could fall victim to the overuse of this confrontational rhetoric. Although Moscow prefers conflict scenarios in its relationship with Washington, as we have seen many times in recent months, the need for cooperation on global economic governance may, under favorable circumstances, give rise to changes in the prevailing paradigm. Some hope comes from the fact that, almost simultaneously with the new wave of harsh criticism of the United States from the Kremlin, a few voices were heard on a hypothetical possibility of a new restart of Russian-American relations. And it is no coincidence that this happened in the days of the G20 Summit. Ivan Tsvetkov is Associate Professor of American Studies, International Relations Department, St. Petersburg State University. Read more opinions and analysis from Russia experts on the website and subscribe to special analytical reports for free.

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How to Get There...Before, During or After the Games

Olympics Russia’s subtropical resort is gearing up to host next year’s Winter Olympics

Sochi Beyond the Games: Rent out Stalin’s Villa and Try the Cheesy Bread Russia’s Black Sea town of Sochi is fast appearing on world travel maps ahead of its hosting of the 2014 Winter Games. RBI reveals the secrets of this unique tropical ski resort. ANASTASIA MARKITAN SPECIAL TO RUSSIAN BUSINESS INSIGHT

Get here early enough this year and you can catch Autumn in the city’s main landmark, the Sochi Arboretum. Founded in 1892 by a publisher named Sergei Khudekov, the 123-acre arboretum now boasts a unique collection of 2,000 species of exotic trees and flowers imported to Sochi from all parts of the world.

Stalin’s villa President Vladimir Putin himself maintains a summer residence in Sochi known as Bocharov Ruchei. But tourists aren’t exactly encouraged to drop by the place, so the next best option is Stalin’s villa.You can even shake the host’s hand – that is, his wax figure’s hand. The compound includes Stalin’s house, which has been turned into a museum, as well as a residential area with 12 apartment suites available for rental. The groundswoman with the iron voice is in fact a former KGB employee. She’ll meet you at the entrance and give you the history. The mansion was built in 1937 (the peak of Stalin’s purges), and, since that time, it has not been renovated – all the furniture and décor are authentic. In Chimney Hall, Stalin hosted receptions but “never drank with the guests.” In his office, the dictator’s wax figure sits at the table. There you can see the hefty leather coach where he watched movies alone. Remember not to pat the host or touch his pipe: the gravel-voiced exKGB host will reprimand you for misbehavior in the presence of “the Great Leader.” If you aren’t afraid of ghosts and don’t mind spending $450 for a night in Stalin’s suite, you are basically guaranteed to come away with the best story at your next cocktail party.

Where to Eat

Local Cuisine Nothing makes a tourist happier than exotic local delicacies at reasonable prices. Whatever you do, try the Khachapuri. It’s a baked cheesy bread that at first glance seems like the long-lost eastern cousin of pizza, minus the tomatoes. Cuisine from the country of Georgia, just a few miles from Sochi, is among the bestkept secrets of the former Soviet world. Don’t be scared by dishes with names like shashlyk, khinkali, matsoni, satsivi. Just point at the menu, and be brave.

BELYIE NOCHI - 9 ORDZHONIKIDZE STREET Belyie Nochi (“White Nights”) is the number one restaurant in which to try Georgian khinkali – a kind of dumpling usually filled with beef and pork. They have them fried and boiled in Belyie Nochi, with a wide range of sauces. Then there’s the sturgeon soup, or “ukha,” which has traditionally been considered a Tsar’s meal. STARIY BAZAR - 4 NESERBSKAYA STREET Just a couple of minutes from Sochi’s central seaport, there is Stariy Bazar (“Old Bazar”), which attracts both tourists and locals with its democratic prices and tasty food. This is where you try the khachapuri. For extra points, opt for the kind known as the Adjarian khachapuri, in which the dough is made into the shape of an open boat and topped with a softboiled egg and butter. CHAIKA - 1 VOYKOVAYA STREET Unlike the majority of Sochi restaurants with their traditional food and Caucasus-inspired interior, Chaika (“The Seagull”) serves mainly European cuisine and looks rather Mediterranean. It’s worth a visit. Built in Stalin’s grand imperial style, there is a magnificent sea view from the terrace. AFP/EASTNEWS

Sochi Arboretum

The upper grounds resemble a wonderland rainforest: palm trees, cypresses, magnolias, cedars and pines. The smell alone is astonishing, a unique, exotic mixture of herbs and flowers. The lower part of the arboretum is a place to relax in the ivy alley and watch black and white swans ply the waters of the pond.

SHUTTERSTOCK/LEGION-MEDIA

When the decision to hold the 2014 Olympics in Sochi was announced, many outside Russia were surprised to learn the country that boasts the vast frozen lands of Siberia had suggested using a subtropical beach town full of palm trees for the winter games. In fact it is the dual nature of Sochi, where the Caucasus Mountains crash into the Black Sea, that makes the place interesting. The city is 90 miles of coastline flanked by rows of snowcapped peaks, crisscrossed by palm tree-lined promenades. Sochi became a fashionable resort town for Soviet citizens under Josef Stalin, who maintained his favorite country house in the city and oversaw the establishment of sanatoriums and neoclassical buildings meant to represent socialist ideas about how to have fun on vacation, Soviet-style. Today, of course, it’s also a $50-billion dollar construction site, as teams of workers scramble to prepare facilities and get ready for the Games.The event is a once-in-a-lifetime chance for Sochi to reinvent itself, and the city is going hell-for-leather to seize the opportunity. Those wishing to visit the town and do more than watch the Games can discover the city’s eccentric mix of Soviet history, vivacious restaurants, Russian chanson music, traditional Caucasian dishes and colorful locals. Definitely try the local food. Caucasian cuisine, especially the stuff that comes from the nearby country of Georgia, isn’t nearly as wellknown in America or Europe as it should be.

Sochi’s brand new international airport offers regular service to both domestic and international destinations as diverse as Yakutsk and Istanbul. Around the time of the Winter Games (February - March 2014), Lufthansa and Scandinavian Airlines will offer direct connections to Frankfurt and Oslo. At the time of writing, Turkish Airlines offered a winter roundtrip ticket from NYC to Sochi with a single stopover in Istanbul for $865 (fees, taxes included), while Aeroflot (incidentally, selected Best Airline in Eastern Europe at the 2013 Airline Awards) offered a faster trip via Moscow for another 50 bucks. The only other airline flying to both US locations and Sochi is Transaero, which priced in a similar range. High-speed rail between Moscow and Sochi won’t be launched for at least another four years (too late for the 2014 Winter Games), so travelers interested in seeing (and experiencing!) more of Russia have the option of flying to Moscow and taking a 24-hour ride to the Black Sea. Roundtrip rail tickets are currently available starting at $200 (coach class) on Russian Railways’ English-language website (pass.rzd.ru/main-pass/public/en).

PHOTOSHOT/VOSTOCK-PHOTO

Less than half an hour by commuter train from hilly downtown Sochi (second picture from top), the ski resort of Rosa Khutor (top) is nearing completion as it seeks to attract clients from worldfamous rivals like Courchevel in the French Alps. Officials hope the area’s unique blend of downhill skiing (second picture from bottom) alongside beachside fun (bottom), boosted by a recent $50 billion investment into tourist infrastructure, will continue to bring tourists from all over the world long after the Games have passed.

Caucasian cuisine, especially the fare that comes from the nearby country of Georgia, isn’t nearly as well-known in America or Europe as it should be. travel.rbth.ru

MIKHAIL MORDASOV (2)

Bolshoy Kamenny Bridge

St. Basil’s Cathedral

This vehicle and pedestrian bridge spans the Moskva River near the Kremlin’s main gateway through Borovitskaya Tower. It is considered the principal bridge of the capital. Despite its name, which translates as the Great Stone Bridge, it is made of concrete and steel.

Bagration Bridge This pedestrian bridge, which also houses kiosks and cafes, is part of the Moscow International Business Center (Moscow City). Named after the Russian Napoleonic-era general Pyotr Bagration, the two-level bridge was inaugurated in 1997 to mark the 850th anniversary of Moscow.

Patriarshy Bridge

Kremlin

This relatively new pedestrian bridge across the Moskva was built in 2004 to connect the Christ the Saviour Cathedral with downtown Moscow. For four years in a row from 2008 to 2012, Patriarshy Bridge was used as the shooting location for Russian president Dmitry Medvedev’s New Year address to the nation.

Borodinsky Bridge This vehicle and pedestrian bridge across the Moskva is situated near Kievsky Railway Station not far from the Kremlin. The original arched bridge was erected in 1911-12 to commemorate the 100th anniversary of the Battle of Borodino, the decisive battle in the Russo-French War of 1812. The structure has since been rebuilt twice.

Kievskaya

Krymsky Bridge

Hotel Ukraine

Gorky Park

This suspension bridge was erected in 1938 and links Krymsky Val Street with Krymskaya Square. With its river span measuring 500 feet in length, Krymsky Bridge ranked among the top five longest European bridges in the early 20th century.

Novodevichy Convent

Pushkinsky (Andreyevsky) Bridge

Frunzenskaya

This pedestrian bridge was built in 1999 with structural elements left over from the Andreyevsky Railway Bridge, an architectural and engineering monument located upstream between 1907 and 1998, when it was demolished.

Want to learn more? go to travel2moscow.com