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“The problem of the ‘normalization’ of the monetary policy has not been solved, but remains in limbo.”

“The collapse of the price of oil, Russia’s key export, to less than half its value in early 2014, has been a heavy blow.”

KONSTANTIN KORISCHENKO, PROFESSOR, ECONOMIST

YAKOV MIRKIN, ECONOMIST

Dollar/Ruble

70 65

60

Aug 4

Distributed with The Wall Street Journal

Aug 18

Sep 1

55 Sep 29

Sep 15

Saturday, October 10, 2015

IN THIS ISSUE

Economy Like many big energy exporters, Russia is facing a budgetary shortfall and tough choices

BUSINESS & POLITICS

Russian Government Faces Budget Crunch

IKEA Gains in Russia The global retailer defies the recession PAGE 3

SPECIAL REPORT

The New TMT Russia’s tech and media sector transforms as competition rises PAGES 4-5

MONEY & MARKETS

Oil Firms Outperform Drillers are finding ways to survive the lean times REUTERS

REUTERS

Falling oil prices have put pressure on Russian tax revenues, raising concerns about the long-term viability of fiscal resources to fill the budget gap.

Russian officials are debating tough choices over how to handle a budget shortfall and mulling changes to pensions and tax policy.

DAVID MILLER SPECIAL TO RBTH

Russian officials are facing a looming budget crunch after the price of oil, the country’s key export, fell precipitously, slashing state revenues.

Russia, the world’s biggest exporter of energy, relies on taxes from oil and gas exports for about half of its government budget.

While state officials based budgetary plans on assumptions of an oil price of $100 per barrel a year ago, crude has since fallen to less than half that level. As a result, the

“difficult, but not critical.”

The Russian president has directed that the state deficit should not exceed 3% of the country’s gross domestic product next year.

The debate has led to a guessing game in Moscow over which measures the government might take to bridge the gap. A key deadline is approaching on October 25, when the government must send a budget to parliament.

“In recent years, budget drafts were readily voted into law by the Duma, but this time around the debate could heat up,”wrote analysts Alexander Isakov and Petr Grishin of the Moscow investment bankVTB Capital.

One politically sensitive question will be whether pensions, which account for roughly a quarter of Rus-

government is facing an upcoming annual shortfall of some $50 billion unless crude prices recover.

This year the state filled the gap by tapping its sovereign wealth funds, which are currently worth roughly $144 billion.

But Russian Finance Minister Anton Siluanov warned in September that the funds could be fully depleted in 16 months to two years if the state doesn’t reduce spending or take other measures to boost state income.

The result is that if oil prices don’t recover, sooner or later the Kremlin will need to make hard choices about government spending priorities.

At a meeting last week to address the issue, Russian President Vladimir Putin called the problem

sia’s budgetary outlay, will remain untouched. Another is whether to raise taxes on Russia’s most important firms: the oil companies. Reducing the firms’ income could hamper their ability to invest, thereby limiting future output levels.

A poll conducted by the Bloomberg news agency showed that 18 out of 23 economists believe the cabinet will eventually decide to pursue a diverse range of measures, including spending cuts, increased borrowing, raising taxes on oil and freezing pensions.

Russia spent 900 billion rubles ($13.7 billion) from its Reserve Fund, one of its two sovereign wealth funds, to support state budget expenditures between January and August 2015, Mr. Siluanov said in early September.

Chinese Tourists Descend on Moscow A cheaper ruble tempts destination shoppers PAGE 6

FEATURE

SpaceX Dragon vs Russia’s Zarya REUTERS

Russian TMT The Tech, Media and Telecom sector is maturing into a new stage of development.

Moscow Plans Tax Breaks For Investors in Tech Firms Russia’s tech and media firms are jostling with each other amid heightened competition as the government proposes tax breaks to bring in fresh investment.

ALEXEY LOSSAN RBTH

GETTY IMAGES

Russia plans to offer tax incentives to portfolio investors trading in stocks of technology firms in a bid to help the sector attract funds and expand.

The move comes as Russia’s Technology, Media and Telecommunications (TMT) industry enters a new stage of development. Telecom firms are battling market saturation and a recession, spurring competition for clients and market share. Mean-

Russian shoppers head online as Web connectivity expands.

while, Internet connectivity has expanded considerably throughout the country, creating new horizons for technology startups and e-commerce.

The result is a brave new world of challenges and opportunities for Russian tech firms. Despite the rising competition, a bitter recession and sanctions, many have seen gains: from the beginning of 2015 to the end of September, the MICEX Innovation Index has rallied 40%.

Now the Cabinet of Ministers is prepping plans to eliminate the capital gains tax on income from the sale of securities traded in the innovation and investment market sector of the Moscow Exchange, the Cabinet’s press services said.

Deputy Economic Development Minister Oleg Fomichev told Russian business newspaper Vedomosti that benefits would apply to both legal entities and to individuals, and would stay in effect until the end of 2022. In order to get the benefit, the investor must own the securities for at least one year.

Prime Minister Dmitry Medvedev told a cabinet meeting last year that innovative companies attract investors’ money by issuing securities for the period of their projects – typically for one or two years.

According to the Moscow Stock Exchange, benefits will be extended to the shares of 29 issuers, including the state-owned technology investment corporation Rusnano.

“In spite of the economic downturn, the activity of mobile phone and mobile Internet users continues to grow rapidly,” Hedge.pro’s Managing Director Ilya Buturlin told RBTH.

New Russian and American space vehicles share striking similarities — is it a coincidence?

CONTINUED ON PAGE 4

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NEWS IN BRIEF

Economy Russia has been drawing down on sovereign wealth funds composed of oil revenues

Kremlin to Spend Half of Reserve Fund This Year

• Moscow’s City Hall has raised the official subsistence income for residents of the capital to 15,141 rubles ($230) per month. The change will apply to the second quarter of the year, and is 25% higher than in the same period in 2014. It reflects the huge increase in the cost of living caused by Russia’s economic crisis and the collapse of the ruble. The subsistence level is adjusted quarterly, and rose 5.8% from January to March, when it was 14,300 rubles ($216) per month.

• The government has green-lighted the creation of a new bank that will be run through the Russian postal service, Russian Post. The bank will have a branch network more than double the size of the country’s biggest lender, Sberbank, and will guarantee the provision of banking services in remote areas. The arrival of Post Bank is part of a sweeping modernization at Russian Post that aims to transform the company, currently best known for its months-long delivery delays.

The Russian government will spend $38.1 billion this year from its national reserves compiled from oil and gas revenues. Analysts wonder how long the money will last.

ALEXEY LOSSAN RBTH

REUTERS

a mere 100 million rubles ($1.5 million), undercutting promises of support for local farmers to boost output, business daily Vedomosti reports. The money has instead been used to subsidize interest rates on short term loans. Demands on the Russian dairy industry have increased following bans on imports of dairy products from many Western countries last year — a response to sanctions imposed against Russia over its role in the Ukraine crisis.

• Illegal capital outflows between 1994 and 2012 cost Russia’s economy $1.3 trillion, accord-

DPA/VOSTOCK-PHOTO

Back in the heady days of sky-high oil prices in the mid-2000s, energy exporting countries like Russia faced a problem of plenty.

The concern, as oil prices approached levels near $150 per barrel, was that too much money sloshing around in the system would bring inflation.

Russia began socking away oil revenues into a rainy day account known as the“Stabilization Fund.”

One day, economic planners reasoned, when the country needed the money, it would be there.

That day, it seems, has finally come.

Now, a decade later, as oil prices languish below $50 per barrel and Russia trudges through a recession, the accounts are being drawn down hard.

The original Stabilization Fund was eventually split into two piles, now called the Reserve Fund and the National Wealth Fund.

In 2015, the Russian government foresees spending a total of 2.5 trillion rubles ($38.1 billion) from the Reserve Fund, which, as of early September 2015, totalled 4.7 trillion rubles ($71.58 billion), Russian Finance Minister Anton Siluanov said in September, the RIA Novosti news agency reported.

Mr. Siluanov said that figure includes 900 billion rubles ($13.7 billion) that has already been spent during the first nine months of the year.

The National Wealth Fund currently amounts to 4.9 trillion rubles ($74.6 billion). Together, the two funds are equal to about 13% of Russia’s total gross domestic product.

Russian Minister of Finance Anton Siluanov leaving a cabinet meeting.

funds could be depleted in as little as 18 months to 2 years if Russia doesn’t tighten its fiscal policy.

But Andrey Margolin, deputy head of the Russian Presidential Academy of National Economy and Public Administration, said that in a slightly more optimistic case, the Reserve Fund may indeed last for many more years to come.

Yet he cautioned, “for the optimistic scenario to come true, it is necessary to set in motion mechanisms for boosting investment” in the economy.

An analyst with the FINAM investment holding company, Timur Nigmatullin, points out that the government’s strategy for spending and replenishing reserve funds makes it possible to soften external economic shocks.

At the same time, the current system in Russia makes it difficult for administrators to spend the accumulated“safety cushion”too quickly, he said.

“If Brent oil prices remain at the current level, the Reserve Fund will last another one to two years, depending on how strict budget policy is,” he said.

According to Mr. Nigmatullin, replenishing the Reserve Fund at oil

the price of oil.

However, if the Reserve Fund is used mainly to close gaps in the budget in the event of a sharp fall in oil prices, the National Wealth Fund is primarily meant as an instrument for long-term investment.

In the first six months of 2015, the budget deficit in Russia reached 800 billion rubles ($12.18 billion), or 2.5% of GDP. At the same time, budget revenues in 2015 turned out to be nearly 3% higher than expected – 6.6 trillion rubles ($100.5 billion), 55% of which came from sectors other than oil and gas or mining.

The budget deficit is currently being covered with money from the Reserve Fund.

Currently, the Finance Ministry is forecasting that by the end of 2018, the total amount of both funds will be reduced to 2 trillion ($30.45 billion).

How Long Can it Last?

Fixing the Budget During times of high oil prices, the two funds get replenished from surplus oil revenues on the basis of a complex formula: the level of allocations to the funds is linked both to economic growth figures and to

Now, a debate is raging among Kremlin-watchers over how the government will handle the budget crunch, and how long the sovereign wealth funds can stay solvent.

In April, Mr. Siluanov said the

prices of $50 per barrel is sensible from the point of view of improving control over budget policy.

“Closer to the upper end of the $50-$60 range per barrel, it would be rational to replenish the fund.

In effect, the crux of the matter is not in the oil price but in the exchange rate. If oil prices rise, it would be logical to expect a strengthening of the ruble,” said Mr. Nigmatullin.

Maxim Kostrov, analyst at the financial firm Premier in Moscow, noted that using money from the Reserve Fund is a final resort for the government and that usually the budget deficit can be bridged through borrowing on the domestic and external markets.

“It is rather hard to calculate how long the Reserve Fund will last,” he said.

“A lot also depends on the situation in the world economy and in the Russian economy. If the latter stabilizes, reserves may increase,” said Mr. Kostrov.

The government’s task, he said, will be to strike a balance between the need to spend money on developing the economy and the need to save funds to create a “safety cushion.”

Recession More Russians are falling into poverty as the country’s economic troubles grind on

Poverty Rates Rise in Russian Downturn The number of Russians living in poverty is rising fast as the country’s economy contracts. But polls show most people don’t blame the government.

DELPHINE D’AMORA SPECIAL TO RBTH

Russia’s economic slump is hitting its most vulnerable citizens hardest, driving the number of Russians living below the poverty line up to nearly 22 million.

The trend poses a challenge to the Kremlin, whose popularity has long rested on its ability to deliver prosperity.

The number of Russians living on less than the state-determined living wage surged to 21.7 million in the first half of this year, up 5 million from the same period in 2014, state statistics service Rosstat said this month. This means 15.1% of the population is now living below the level of subsistence.

To make matters worse, the living wage cited by Rosstat — 10,017 rubles per month, or about $150 — may not adequately reflect the actual cost of living in Russia. A survey conducted in August by state-run pollster VTsIOM found the average Russian believes about 23,000 rubles, more than double that sum, is needed to get by.

This abrupt upsurge in poverty comes as the economy languishes in a recession fueled by a killer combination: a steep drop in oil prices — Russia’s chief export — alongside Western sanctions leveled against Moscow over its policies in Ukraine.

Economic Development Minis-

ter Alexei Ulyukayev said this month that Russia’s gross domestic product contracted 3.9% in the first eight months of the year, the Interfax news agency reported. As the economy shrinks, Russians’ jobs and wages are being threatened.

“Income from employment has gone down, which is a reliable criterion for saying that the economy is not turning a corner, that there really are very significant problems,” said Sergei Smirnov, head of the Institute of Social Policy at Moscow’s Higher School of Economics.

To make matters worse, as Russians’ income drops, the cost of living has shot upwards.Year-on-year inflation stood at 15.8% in August, fueled by a steep devaluation of the ruble, which tends to follow the price of oil. Russia’s ban last year on certain Western food imports also spurred inflation.

Due in part to the import bans, food prices have climbed faster than the rate of inflation, rising 18.1% in August compared to the same period last year, according to Rosstat.

The government has announced some initiatives to address these issues. Official documents published over the past month show that a total of about 680 million rubles ($10 million) has been allotted to supporting employment at certain “key enterprises” in five Russian regions. As for rising food prices, the Ministry of Trade and Industry has proposed introducing foods cards for the country’s most needy citizens, the ministry’s deputy headViktorYevtukhov told

© ARYOM ZHITENYOV / RIA NOVOSTI

• Russia’s Agriculture Ministry has reduced direct subsidies for milk producers this year to

ing to a report by Global Financial Integrity (GFI), a Washington-based organization that researches shady international transactions. An average of $70.6 billion was moved from Russia illegally each year over the period, or 8.3% on average of the country’s gross domestic product, GFI said. The largest movements of capital occurred during the oil boom of the early 2000s and the subsquent recession of 2009. In 2011 the annual illicit outflow accelerated to $141 billion per year.

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KOMMERSANT

02

The number of Russians living below the level of subsistence is rising.

news agency TASS on Sept. 15.

But while state efforts may alleviate some of the symptoms, poverty is unlikely to drop until the economy begins to grow again. And with growth still nowhere in sight, the question is: who are Russians going to blame?

Putin Escapes Blame So far, opinion polls suggest that the Russian government and President Vladimir Putin aren’t bearing the brunt of citizens’ ire.

“For now, the energy from Crimea is still enough. All the positive emotions from [the annexation of Crimea] are still not completely depleted,” Mr. Smirnov said.

Putin’s popularity soared following Russia’s annexation of the Crimean peninsula from Ukraine, which was extolled on airwaves even though supporting the region has required an influx of cash from the federal budget, which the gov-

ernment could ill afford. A poll conducted in August by the Levada Center, an independent pollster, found that 83% of Russians approve of Putin’s actions as president, 54% approve of the government, and 55% agree that Russia is “heading in the right direction.”

In another survey released by Levada in September, 76% of respondents said that mass protests against the decline in Russians’ quality of life were unlikely. The margin of error in both surveys did not exceed 3.4%.

But the Crimea effect won’t last forever, Mr. Smirnov said, adding that the government should be looking to avert a further rise in the level of poverty before the positive sentiments die down.

“Then the question will really be asked: who is guilty, why did it happen this way? And in the history of Russia, unfortunately, very often that doesn’t end well,” he said.

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NEWS IN BRIEF

Energy Russia is scrambling to develop underwater oil and gas deposits despite sanctions

• The Kremlin is creating a single federal agency to regulate intellectual property rights, sweeping away the more than 20 different government departments that currently — and ineffectually — enforce copyright. The new regulator will be established by the end of 2015 on the basis of the Russian Federal Service for Intellectual Property (Rospatent), the agency in charge of registering patents and trade brands. The move was triggered by the complexity of the current regulatory system. Twenty-four federal agencies police copyright in Russia. By contrast, in almost all European countries, patent law and copyright is regulated by one organization.

IVAN BRIZOV SPECIAL TO RBTH

Russia is seeking new partners to help it develop offshore oil reserves in hard-to-reach locations in the Arctic Sea as sanctions by the U.S. and Europe bar some of the biggest global energy firms from operating in the country.

Russia, one of the world’s biggest producers and exporters of energy, must venture into difficult new regions to keep output from falling as its traditional production base in Western Siberia flags.

Due to sanctions imposed on Moscow over its role in the Ukraine conflict, Russia’s traditional partners — American and European companies — are prohibited from providing services to explore and develop Russian offshore regions at a depth of over 150 meters.

Deputy Prime Minister Alexander Khloponin recently admitted that Russia has been slow to look for alternative suppliers of equipment, and needs to cooperate with other countries that have the relevant experience.

However, Mr. Khloponin added that Russia is eyeing cooperation with new countries that have not imposed sanctions.

Experts agree with his assessment. “Before the introduction of sanctions, Russian companies had cooperated with American, Norwegian and Italian suppliers. But now China and South Korea are also being named among the potential partners,” said Ilya Buturlin, managing director of trust management company Hedge.pro.

Future Production The future of Russia’s role as a global powerhouse producer of crude oil depends on the country’s ability to access these hard-to-reach reserves. The Ministry of Energy has called for Russia to source almost 10% of its oil output by 2035 from offshore sites.

The challenge facing Kremlin officials now is how to keep sanctions from halting the development of these reserves.

The recent collapse in the price of oil, which has lost over half its market value since late 2014, also challenges the economic viability of any expensive new project.

“The development of offshore

chenko, head of Russian operations for Freedom Finance Investment Company. “For its production and use to be economically viable compared to imports, it must be produced in large quantities, including for deliveries abroad.”

According to Mr. Vashchenko, only three customers can provide demand for the required equipment in Russia at the moment: Rosneft, the gas monopoly Gazprom, and the private oil firm Lukoil, which produces oil on the shelf of the Caspian Sea. According to Pyotr Dashkevich, an analyst with investment company UFS, the actual impact of sanctions on the development of

“Expensive development in the Arctic is simply unprofitable,” said Ilya Buturlin, managing director of Hedge.pro.

“Offshore drilling equipment has never been produced in Russia,” said Georgy Vashchenko of Freefom Finance.

fields has been stalled not only by sanctions, but also by a sharp drop in oil prices. With the current state of the energy market, expensive development in the Arctic is simply unprofitable,” said Mr. Buturlin.

offshore fields is not as significant as the effect of the fall in oil prices.

“Many of the projects announced were attractive due to high energy prices,” he said.

At the same time, says Mr. Dashkevich, some contracts with Western partners were signed before sanctions were imposed and, accordingly, do not fall under the restrictions. Almost all of these projects have now been delayed or abandoned, he said.

Exxon in the Crossfire When the U.S. and the EU banned imports of technology for use in Russian Arctic projects, Russia’s largest oil company Rosneft, and its American partner ExxonMobil had already discovered the Pobeda oil field in the far-northern Kara Sea and drilled a well. But with the introduction of sanctions, Exxon had to suspend its participation in the project.

“Offshore drilling equipment has never been produced or even designed in Russia,”said GeorgyVash-

The warming of Arctic waters has sparked a gold rush among governments and companies vying to lay claim to the immense and unknown fortune in minerals and enenergy reserves that is thought to lie in underwater areas that have been, until recently, unreachable.

Russia has submitted to the United Nations a revised application to claim the 1.2-million-square-meter (463,000-square-mile) underwater territory extending more than 350 nautical miles from the coast, according to an announcement posted on the Ministry of Foreign Affair’s website.

“For justifying its claim to this territory, Russia used a large collection of scientific data, accumulated in the course of many years of Arctic research,” reads the announcement.

Although unverified, undersea Arctic resources are estimated to be worth trillions of dollars.

Russia had applied to gain possession of a smaller part of territory — the Lomonosov Ridge — in 2001, but did not have the required proof that the territory was an extension of the continent and belonged to Russia, saidVera Smorchkova, professor of labor and social policy at the Russian Presidential Academy of National Economy and Public Administration (RANEPA).

In the new application, Russia lays claims to the Lomonosov Ridge, Alpha Ridge and Chukchi Cap, and to the Podvodnik and Chukchi Ocean Basins separating them. Russia’s application will not be reviewed in the near future for procedural reasons, but will be included in the provisional agenda of the 40th session of the Commission in February / March 2016, according to U.N. deputy spokesman Farhan Haq.

Search for Partners At the beginning of 2015, a draft plan developed by the Ministry of Industry forecast a reduction by 2020 of the share of imported equipment for offshore projects to 60-70%.

Retail Advancing sales in Russia help Sweden’s IKEA push revenue to record levels

EPA/VOSTOCK-PHOTO

ships to Egypt, ending months of speculation over their fate. Russia received a refund of almost 1 billion euros ($1.12 billion) for the ships, but was still left with 50 Ka-52 choppers that were specially adapted for service on the Mistrals.

• The value of goods imported by Russia from outside the former Soviet Union tumbled 39% in the first eight months of this year compared to the same period in 2014. According to preliminary data from the Federal Customs Service, Russia imported goods worth $103.9 billion over the period, down from $170.3 billion in January-August last year. The decline comes as the low price of oil shrinks the country’s income and worsens an economic slowdown.

ALAMY/LEGION MEDIA

Russia is turning to new sources for the equipment and expertise necessary to tap offshore energy resources in the wake of sanctions by the EU and U.S.

AFP/EASTNEWS

Moscow Seeks New Partners Offshore

• Russia has agreed to sell a group of 50 Kamov Ka-52 attack helicopters to Egypt to serve on board a pair of Mistral warships bought by the Middle Eastern country from France, the TASS news agency reported. The Mistrals were originally built for the Russian navy, but Paris canceled their delivery following Moscow’s annexation of Crimea and alleged support for separatists in Ukraine last year. France said it would sell the

• Pre-orders from Russia for the Bentley Bentayga, the British luxury carmaker’s new SUV, account for 10% of the planned global production of the vehicle, the head of Bentley Russia told the AP. The car reportedly will cost $221,600. Russia is one of the world’s biggest markets for luxury vehicles.

5 amazing reasons to travel to the Russian Far East

IKEA Boosts Sales in Russia, China IKEA, the world’s largest furniture retailer, increased sales in Russia by 10% in spite of the country’s recession and stark downturn in consumer spending.

IN FIGURES

$35.6

DAVID MILLER

billion is IKEA total sales revenue, a record, over the 12 months ending in August.

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MIKHAIL POCHUEV / TASS

Higher sales in Russia and China helped Swedish retailer IKEA post a massive 11% gain in overall sales during the year ending in August, showing that a bet made by the company on Russian consumers appears to be paying off.

The gains in Russia also defied the country’s overall trend: the company increased sales of furniture and home products even though Russia is struggling through a punishing recession. Russian wages adjusted for inflation fell by 9.2% in July compared to a year earlier, and national retail spending fell 9.1% year-on-year in August, according to state statistics.

Nevertheless, IKEA’s sales in Russia grew by 10%, the company said.

Total sales rose to a record 31.9 billion euros ($35.6 billion) during the 12 months through August, the firm said Sept. 10.

is how much sales of IKEA products in Russia increased during the year ending in August.

A Russian couple get ready to furnish their apartment at IKEA in Moscow.

tive said. Yet between the two countries, the Russian growth figures were more surprising.

To be sure, the slowdown in China’s economy has recently made headlines, but China is still set to expand this year by some 6%, according to official estimates. Meanwhile, economists broadly predict Russia’s economy will contract by more than 3% this year.

China, Russia “China and Russia are at the top,” IKEA Group Chief Executive Officer Peter Agnefjaell told Bloomberg News in an interview after the financial results were announced in September.

“Going forward, we don’t see any really big concerns when it comes to sales development,” the execu-

10%

Doubling Down on Russia The increase suggests that IKEA’s decision to plow fresh capital into Russia despite the recession is already paying dividends.

IKEA said late last year it plans to invest roughly 2 billion euros in its Mega brand shopping malls in Russia by 2020, upgrading exist-

ing facilities and opening new locations.

The firm has said that 40% of those funds would go to existing locations, and 60% would go towards opening new outlets.

Benefiting From The Crisis?

Yet sales in Russia appear to have also benefited from a one-time gain that, ironically, arose from the country’s financial difficulties. Analysts noted that Russians have been funneling cash into purchases of tangible items, such as cars and refrigerators, as the country’s economic condition worsened in late 2014 and the first half of 2015.

This is because the combination of rising inflation with a falling national currency is hiking the cost of consumer goods for average Rus-

sians, leading many shoppers to push forward plans to buy items sooner rather than later, before they become even pricier.

IKEA appears to have benefited from that sales bonanza. The company was even forced to halt sales of some big-ticket items, including kitchens and home appliances, last winter due to surging demand.

In China, IKEA’s sales rose 20% — largely thanks to an expanding middle class that has increased the population of cities and bumped up demand for furniture.

The firm plans to enter India next year, Mr. Agnefjaell told Bloomberg.

IKEA has been present in Russia for 15 years and operates 14 outlets in Russia. The firm has a 20% market share in the country.

IKEA has 18 stores in China.

Read more: travel.rbth.com

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INFOGRAPHICS

IN FOCUS RUSSIAN TMT

Moving personal data to Russia

RUSSIAN TECHNOLOGY FIRMS ARE BEING SUPPORTED BY TAX BREAKS FROM THE ADMINISTRATION AS COMPETITION GROWS

COMPANIES BEING REQUIRED TO STORE THE PERSONAL DATA OF RUSSIANS INSIDE THE COUNTRY’S BORDERS INCLUDE IT GIANTS LIKE GOOGLE, SAMSUNG AND IBM, AS WELL AS RETAIL AND ONLINE SERVICES LIKE EBAY, ALIEXPRESS, BOOKING.COM, PAYPAL AND VISA.

TECH, MEDIA AND TELECOMS FACE NEW ERA CONTINUED FROM PAGE 1

ALYONA REPKINA

IN FIGURES is how much the Russian MICEX-Innovations index has grown since the beginning of the year up to September 2015. This index includes Russian stocks traded on the MICEX Stock Exchange in the Innovation and Growth Sector.

40%

is the growth in revenue shown by the Tele2 communications company, one foreign competitor to Russian players, in the second quarter of 2015. The company is expanding to Russia’s biggest cities: Moscow and Saint Petersburg.

7%

Meanwhile, competition in Russia’s telecom sector is set to heat up further still amid an aggressive push by telecom operator Tele2 into the capital city, Moscow, in October.

The move poses a challenge to the country’s big three telecom firms: MTS, MegaFon and VimpelCom. “The operator will offer easy-tounderstand tariffs at low prices and without any hidden conditions to residents of Moscow and Moscow Region,”Tele2 said, in a short statement.

Tele2’s announcement comes a month after the firm opened a new contact center in the city of Saransk, which it said will handle customer enquiries following the launch of services in Moscow.

The Tele2 brand is still being used for mobile services in Russia despite the exit of its previous owner, Sweden’s Tele2, from the market last year.

The telco agreed to merge its Russian assets with those of fixed-line provider Rostelecom, and in August last year, the new joint venture was completed. Rostelecom owns 45% of Tele2 Russia while VTB Group and strategic investors hold the other 55%. The launch of services in Moscow should help Tele2 to build its market share. The telco serves 14% of the 242.3 million mobile subscribers in Russia as of the end of June, according to specialist consultancy Advanced Communications & Media (AC&M).

There were 40.2 million subscribers in Moscow in mid-2015, AC&M’s figures show.

The General Trend Most Russian companies in the telecommunications industry show

steady growth. In particular, the proceeds of Russia’s most popular social network VKontakte rose in the second quarter of 2015 by 41.4% and reached 1.4 billion rubles ($21.17 billion).

The company itself has said its growth is mainly due to the development of mobile and video advertising.

According to recent reports, the revenue of T2 RTK Holding (the firm operating the brand Tele2) increased by 7.1% year-on-year in the second quarter of 2015 and amounted to 23.6 billion rubles ($357 million).

“The Russian telecommunications industry has been under pressure since 2007,” said Teimuraz Vashakmadze.

“We register the growing demand for mobile data services,” said Ivan Tavrin, head of mobile operator Megafon.

“Tele2 shows good progress in the ‘new’ regions, the combined company’s positions are also strong in the key regions. But much will depend on how well the new operator will be able to compete with the big three in the ‘capitals’ – Moscow and St. Petersburg,”said UFS IC analyst Pyotr Dashkevich.

According to Teimuraz Vashakmadze, an associate professor of business and management strategy at the Russian Presidential Academy of National Economy and Public Administration, Tele2 is exhibiting growth but profitability

leaves much to be desired.

In turn, the companies in the sector that showed negative returns have suffered mainly due to the collapse of the ruble, however, they have improved their basic indicators. Thus, the net profit of the mobile operator MTS by international financial reporting standards decreased by 19% year-on-year to 28 billion rubles ($423.4 million) in the first half of the year.

The figure was also influenced by losses from foreign exchange differences due to the revaluation of debt denominated in foreign currency.

However, MTS’ income increased between January and June by 3.3% to 202.9 billion rubles ($3.05 billion). Moreover, the company’s subscriber base continued to grow and by the end of the second quarter amounted to 105.3 million subscribers (1% of the figure of the I quarter).

MegaFon’s revenue from mobile services increased by 0.8% and amounted to 66.8 billion rubles ($1.01 billion) for the second quarter of 2015, compared to the same period previous year, due to the fact that the company made a stake at the development of new technologies.

“We register a growing demand for mobile data services. Our optimal line of batch tariff plans contains an increased volume of mobile Internet, a wide variety of devices with support for 4G,” said MegaFon’s head Ivan Tavrin. He added that the number of 4G subscribers increased by 9% in the second quarter of 2015.

Undervalued Stocks Due to a range of factors, including international tensions and a drop in the ruble, the shares of Russian firms currently trade at steep

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discounts to their international counterparts.

“The Russian telecommunications industry has been under pressure since 2007. For example, Russian mobile operators MTS and VimpelCom have lost more than 80% of the capitalization since 2007,” says Mr. Vashakmadze.

Russian companies’ valuations are currently roughly between a third or half that of their foreign counterparts, he said.

According Mr. Dashkevich, an additional risk for the Russian TMT companies is posed by the need for the purchase of equipment in foreign currency while having their earnings in rubles.

Consequently, the companies of this sector bear all the risks of the Russian currency, which lost half its value against the euro and the U.S. dollar twice in the second half of 2014.

U.S. Tech Firms Get Data Reprieve Several big-name IT giants will get additional months to comply with a Russian law requiring them to store personal data about Russian citizens inside the country.

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Russia has given several major U.S. tech firms, including Facebook and Google, four extra months to comply with a controversial new law that obliges them to store Russian users’ data on servers located inside the country.

The move provides breathing room for negotiations between the tech companies, which have resisted the measure in part because of the cost of compliance, and Russian officials, who say the rule is meant to safeguard the privacy of Russian citizens. Critics have suggested the law would make it easier for the Russian state to snoop on its own people.

Before the law went into effect on Sept. 1, state media watchdog Roskomnadzor said it did not intend to check major technology companies’ compliance with the law until next year, business daily Vedomosti reported.

In other words, Facebook and Google will face no inspections until Jan. 1, the agency’s spokesman Vadim Ampelonsky told the newspaper.

Signed by Russian President Vladimir Putin in December 2014, the new law requires all companies that collect and process Russians’ personal data to hold that information on servers within the country as of Sept. 1 this year.

While the fines stipulated under the law are minor, the new rules also authorize Roskomnadzor to have the websites of violators blocked inside Russia.

Regulators claim the law will provide more security for Russians’ personal information.

“Up until now, your data was

Tech firms operating in Russia are now required to store user data locally.

Foreign Tech Firms React To Data Law Foreign companies’ responses to the personal data law have varied widely. Some, such as South Korean technology conglomerate Samsung and U.S. e-commerce giant eBay, have already agreed to comply.

U.S. tech titan Apple has also recently signed a contract with a Russian data center operator, Russian newspaper Kommersant reported earlier this month, citing unidentified sources.

But others — notably popular U.S.based social network Facebook — have yet to publicly take a stance.

A meeting between Alexander Zharov, an official with Russia’s media watchdog Roskomnadzor, and a Facebook representative in late August was followed by reports in local and foreign media that Facebook had refused to commit to using data centers in Russia.

collected and processed in foreign servers straight away — and no one asked your permission regarding the place where it was processed,” Roskomnadzor head Alexander Zharov said in an interview published on the agency’s website earlier this month.

Criticism of the New Rules But critics see the bill as part of a wider crackdown on Internet freedom that could give the Russian security services heightened access to information on citizens’ online activity.

Russia has passed a series of similarly divisive bills since the beginning of 2014, including a law banning “extremist” content online — which has been used to block opposition blogs and media — and another requiring bloggers with more than 3,000 daily readers to register with Roskomnadzor.

Western tech companies in particular have come under scrutiny from the Kremlin since protests organized on Facebook brought tens of thousands onto the streets of

Moscow in 2011. Russian President Vladimir Putin last year branded Google a “CIA project” and said that Russia must“fight for [its] interests” online.

The bill has raised objections in the wider business community as well. The Association of European Businesses, a Moscow-based business lobbying group, has urged Putin to delay enforcement of the law until Sept. 1, 2016, Kommersant reported.

“Many companies regard the law quite negatively, first of all because it is not clear how it is going to be enforced,” said Karen Kazaryan, chief analyst for the Russian Association of Electronic Communications.

The law lacks a clear definition of “personal data,” meaning it remains unclear whether the minimal information Facebook and Twitter gather on their users would qualify, Kazaryan said.

Anton Nosik, a prominent Russian blogger, excoriated the bill in a blog post for failing to clear up another basic question: how companies determine whether data actually belongs to Russian users.

“Simply put, no one knows exactly whose data is supposed to be transferred to Russian servers,” Nosik said.

Russia took center stage in the international debate over government digital surveillance in 2013 when it offered refuge to Edward Snowden, the former National Security Agency contractor who leaked documents unveiling the U.S. government’s mass domestic surveillance program.

Snowden has since repeatedly criticized his newfound host country for its Internet policies. Accepting Norway’s Bjornson prize for freedom of speech earlier this month, Snowden called Russia’s crackdown on Internet freedom“a mistaken policy” that “would be wrong anywhere.”

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VIEWPOINT Russia’s telecoms sector is set to explode as infrastructure expands and develops.

Russian Online Life Is Not Limited to Moscow Vladimir Korovkin EXPERT

S

ince the mid-2000s, Russia has been an increasingly prominent player in the global Internet. It is currently number six in the world in terms of online population, ahead of Germany, the U.K. and France. Russian comes in second among the languages used on Web sites. The country has several e-businesses valued at over $1 billion, the most famous of which is Yandex, the only non-Asian search engine holding its market leadership against Google.

Yet most of the online achievements of Russia are associated with companies headquartered in the capital, Moscow, or — in a few instances — in St. Petersburg, the country’s second city. A high degree of business centralization is the general feature of Russia, where an average region commands per capita gross regional product at the level of 30% that of Moscow’s.

To study this phenomenon, the Moscow School of Management-Skolkovo undertook a project aiming to research Russian regional online life at both the qualitative and quantitative levels. The key outcome of the research: yes, there is vibrant digital life all across Russia — at least in the big cities. Actually, Moscow came in only third on our Index measurement, and even St. Petersburg is only No. 2. The industrial capital of the Urals, Yekaterinburg, tops the list, and No. 4, Perm, is from the same geographical area.

The supply side of digitalization correlates highly with the economic development of a region: the greater its economic activity, the more digital initiatives are launched locally.

On the one hand, this is a fairly predictable finding. After all, digital start-ups need economic resource in order to be launched. On the other hand, much has been said recently about the capability

“The supply side of digitalization correlates highly with the economic development of a region — the greater per capita GRP, the more digital initiatives.”

YotaPhone, the Russian dual-screen smartphone, is revising its pricing strategy for the Chinese market and relocating its production facilities from Singapore to China.

KIRA EGOROVA RBTH

When Russian President Vladimir Putin met his Chinese counterpart Xi Jinping for a high profile meeting in November 2014, Mr. Putin handed the Chinese leader a YotaPhone 2 as a gift.

The device is Russia’s bid to stake a claim on the global smartphone market, and comes with a novel twist: two screens. One side is a regular smartphone screen, while the reverse boasts a black-andwhite display similar to that of an e-reader, which is always on and can display incoming texts or emails.

Mr. Xi examined the phone and, speaking through a translator, asked, “Do we have any cooperation on this?”

“There will be,”Mr. Putin replied.

From Russia With Text Now, the Russian company responsible for the gadget,Yota Devices, is doing its part to make good on Mr. Putin’s promise.

Indeed, after a rocky debut for its original model of the Russian smartphone, the company is hoping to tap Chinese consumers to give the device a lift through a revamp of its strategy.

This September,Yota Devices announced that it would relocate its manufacturing operations from Singapore to China and team up

with ZTE, the second-biggest manufacturer of telecom equipment and mobile phones in China.

The company expects that the relocation of production will allow it to cut the cost of YotaPhone by more than 30%.

“We have managed to come to an agreement with the new manufacturer about the level of production costs for the phones comparable with our competitors, which is a key factor in arriving at the ultimate price for the consumer,” the Yota Devices press service told RBTH. Prior to the change, the phone has been selling for $600. Cutting the price can be seen as part of the company’s long-term plans: Yota Devices had already said it was seeking to lower the price below $450.

However, the firm had been unable to reach the relevant agreement with the previous manufacturer, the Singaporean plant Hi-P, the company explained. Under the new deal, ZTE will assist with developing a prototype device, then begin mass production and distribution.

“After the phone was presented to the country’s leader, Xi Jinping, Chinese distributors of portable electronic devices began to show a lively interest in Yotaphone,” says Vitaly Polekhin, co-owner and managing partner of theVenture Angels investment fund and member of the board of QUMO, a manufacturer of portable digital devices. The latest reports about the relocation of production and YotaPhone’s cooperation with ZTE indicate that the issue

AFP/EASTNEWS

A Russian Smartphone Made for China

Russia’s Mr. Putin and China’s Mr. Xi examining the new YotaPhone 2.

of cutting the cost of production is a priority, he said.

“Of course, ZTE is not Foxconn, where production volumes start at 1 million items, but still, it will be able to ensure the necessary production rate and low costs while

“To get a small piece of that huge pie will be a big success for the Russian company,” said Oleg Remyga, China expert. retaining a decent quality, which will boost sales both in Russia and China,” Mr. Polekhin said.

Promotion in China According to IDC figures, in 2014 the leaders of the Chinese market were Xiaomi (13.7%), Apple (12.3%), Huawei (11%), Lenovo (9.5%), and Samsung (7.9%). Given how competitive this market is,YotaPhone can perhaps expect to gain only a small share of it.

The kicker, though, is that a small share Chinese mobile phone market accounts for 980 million mobile users with total annual value around 425 billion yuan ($66.7 billion).

“To get a small piece of that huge pie will be a big success for the Russian company,” says Oleg Remyga, head of China Studies Lab in Skolkovo.

But Yota Devices will need to spend money to make money, experts warned.

“To reach a serious level of sales, considerable investment is required,” points out Mr. Polekhin, noting that the leader in China’s smartphone market, Xiaomi, invests enormous sums in development to maintain its position.“For example, in December 2014, having evaluated itself at $45 billion, Xiaomi carried out an investment round, raising $1.1 billion and is now raising even more,” Mr. Polekhin said.

Yet the task of promoting Yotaphone in China has already received a considerable boost from free political publicity, said Vladimir Korovkin, head of Innovations and Digital Research Lab in Skolkovo.

“Chinese customers like to be part of some ‘big’ process. In that sense Yotaphone started going to China with a very good PR move - when President Vladimir Putin presented YotaPhone to the President Xi Jinping during the APEC summit,” Mr. Korovkin said.

of digital technologies to boost the development of less-resourceful regions by providing direct connectedness to global markets. We don’t see much of this in Russia yet. Interestingly, digital demand — people seeking for digital delivery of traditional services — shows little connection to economic indices, but correlates strongly with the integral quality of life, which includes such “softer” measures as the ecological situation and social cohesion.

This finding is truly important. The demography of Russia — with its overall long-term declining trend — pushes regions into strategic competition for human capital. Moscow has a sort of unfair advantage in the game, with its heavy concentration of economic, administrative and business power (18 out of the top 20 Russian companies are headquartered there). It is vitally important for the regional centers to find ways to stay competitive and keep their most entrepreneurial residents — and attract new ones. The degree of digitalization seems to become an important factor in this.

Another important area of digitalization is finance — in Russia just as elsewhere on the globe.

There is a lack of available, high-quality professional services. Small businesses cannot afford a full-time bookkeeper, but the part-time solutions bring risks. This may be ruinous for a business due to the substantial penalties for missing the tax reporting dates or misrepresenting the figures.

There are important challenges for regional online business in Russia. The system of venture funding across the country is thin at best. Many of the described projects were gathering initial funds from friends and relatives in the absence of professional providers. There is a brighter side to the issue though: the small Russian online start-ups from the regions have no other way to survive but to go cash positive in operations as early as possible.

Thus, they often come unexpectedly strong on economic model compared to their international peers who have deeper pockets of investors’ money. The Russian regions may not expand that quickly, preferring to get deeply entrenched on their home turf. However, a single Russian region can have an economy equal in size to that of Slovenia, Bolivia or Cyprus. Having a strong local grip in such circumstances can be quite a solid strategy.

Vladimir Korovkin is the head of innovation and digital research at Moscow School of ManagementSkolkovo.

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Oil & Gas Russian drillers are surviving in an era of lower prices, but face risks such as higher taxes

Opportunity Knocks as Investors Withdraw Funds

Russian Oil Firms Outperform in Drought

P

olitical tensions between Russia and the West, as well as the ensuing recession in the Russian economy, have led to a gradual exit of foreign investors from Russia. According to the findings of Emerging Portfolio Fund Research (EPFR), foreign investors continue to cut investment in the Russian stock market.

In the week of September 3rd, $86.6 million was pulled out from Russia, while $145 million left a week earlier. In just four months, foreign investors have pulled out a total of $1.5 billion from the Russian stock market.

According to the Russian business daily Vedomosti, the outflow of funds from the Russian stock market is close to the level of 2008.

It is difficult to determine which factor is primarily affecting investors’ expectations: the reduction of the monetary stimulus measures of the U.S. economy, the worsening geopolitical situation or deteriorating economic indicators in China.

Overall, a mass exodus of investors from developing countries has caused depreciation of their currencies. Currency devaluations have taken place in one form or another in Russia, China and Brazil.

Since the beginning of the year, all the developing countries have been losing investors. According to EPFR, they have lost more than $55 billion.

According to the Moscow Stock Exchange, the exit of foreign investors has led to a decrease in speculative interest in Russian shares.

In particular, foreign funds mainly covered short positions in the Russian market, which led to sharp volatility against the background of any political instability.

The Russian government sees attracting longterm investors as an alternative to this approach.

The Cabinet of Ministers, for example, is aiming to attract funds to the Russian telecom sector through tax breaks.

In turn, for the sake of increasing demand from the local population, the state has introduced a mechanism of investment accounts that yield the opportunity to invest in the shares for three years without paying taxes.

At the same time, Russian companies are still undervalued by most indicators. Comparative valuations indicate Russian firms trade at an enormous discount to their American or European competitors. But that’s still not enough to attract investors.

Citigroup analyst Jonathan Stubbs has noted that even though Russian stocks are getting relatively cheaper, they aren’t becoming more attractive.

But is everyone convinced? For the brave few willing to go against the crowd, this moment may be an opportunity. To wit: in the comments on the Web site below Mr. Stubbs’ forecast, some users said they would continue buying Russian shares.

Alexey Lossan is executive editor of Russia Beyond the Headlines for Business

“On our estimates, Russian oil valuations are at their lowest levels for many years and at a significant discount to global peers,”the analysts wrote.

Indeed, in the first quarter of 2015, two of the country’s biggest producers, state-owned Rosneft and privately-held Lukoil, saw significant increases in profitability compared to the first quarter of 2014.

Judging by metrics like cash flow and profit margins, Rosneft and Lukoil are outperforming Western majors like ExxonMobil, BP and Royal Dutch Shell.

“Russian energy stocks have every chance of outperforming global peers in a low oil price environment,” wrote analysts Alex Fak and Valery Nesterov at Moscow’s biggest lender Sberbank in a note to investors. “The development costs of the Russian majors are among the lowest in the world, allowing them to reduce investments with little sacrifice to growth and coast on high reserves when prices are low.”

Russian oil firms, subject to a sliding tax rate that rises and falls with the price of oil, are beating their global peers according to several metrics.

DAVID MILLER RBTH

In a world rocked by lower oil prices, Russian oil firms are proving surprisingly resilient.

Indeed, by several indicators, including free cash flow and profitability, Russia’s biggest oil companies are outperforming their foreign rivals amid the lean times for drillers globally.

Russia, the world’s biggest energy exporter, has had its economy and state budget buffeted by lower oil prices.

But the companies actually responsible for getting crude out of the ground have key structural advantages that have been helping them survive the glut.

First, taxes on Russian oil producers are set to respond to changes in oil prices. This mechanism means that large amounts of windfall profits get scraped away from the companies during years of high prices. But it also means that lower prices don’t hit profits as hard.

Second, Russia’s national currency, the ruble, has itself collapsed alongside oil prices as Russia has entered recession.

While a lower ruble has pushed up inflation and made many imported goods more expensive, it has also meant that oil exporters get extra rubles for selling barrels of crude that are priced in dollars.

As a result, Russian oil firms have, ironically, been been better protected from falling global oil prices than many of their global competitors in the U.S. or Europe.

Russian oil is still flowing through the pipelines despite the price drop.

Dynamics in oil price from 2011-2015

Taxes and Politics Russian oil producers also face political risks, however. Some, like Rosneft, have been hit by sanctions from the U.S. and European countries amid a continuing international dispute over the civil conflict in Ukraine.

Russian oil firms also face potential pressure from officials at home who are eyeing ways to fix a gaping budget gap between state income and expenditures.

The government must submit a 2016 budget to Parliament by late October, and a debate is raging in Moscow over how to fill the gap.

Some voices are calling for increased taxes on Russian oil companies in the event that energy prices stay low.

“We think if the Russian government embraces a ‘lower for longer’ oil price view, then Russian oil companies are likely to bear part of the burden via higher taxes,” wrote oil sector analysts Ildar Davletshin and Evgeny Stroinov at the Renaissance Capital brokerage in Moscow in a note to investors.

Russia’s economy may contract by roughly 4% this year, econo-

Top Performers “Russian oils have been top performers in the global energy universe, outperforming their integrated energy peers in the U.S., Europe and [emerging markets],”wrote analysts at the U.S. investment bank Goldman Sachs in a research note to investors in September.

The analysts called Russian oil companies’ stock prices relatively cheap, and recommended investors buy shares.

ALYONA REPKINA

RBTH

mists have estimated, as lower oil prices and sanctions from Western countries over the conflict in Ukraine damage economic growth and hurt the government’s income.

Russia relies on oil and gas for roughly half of its state revenue.

Russian Prime Minister Dmitry Medvedev rejected calls to raise the country’s mineral extraction tax for oil producers in late September. But his office said the government is considering reducing export duties on oil more slowly than previously, a move that would effectively amount to a tax increase compared to the current system.

Bashneft Messrs. Davletshin and Stroinov picked regional crude producer Bashneft as their top pick in the Russian oil patch, saying in a note

on Sept. 10 that “Bashneft, in our view, offers an attractive combination of volume growth… and dividend yield (with an average yield of 10% over the next five years) supported by cash-rich upstream assets.”

The analysts continued:“We believe Bashneft will be able to generate above-sector returns and growth rates, while it is trading on a par with the rest of the sector, implying to us that its superior qualities are not reflected in the share price.”

The analysts recommended selling shares of Russia’s largest independent natural gas producer, Novatek, however.

“Novatek offers little value on our estimates in the current macro environment,” Messrs. Davletshin and Stroinov wrote.

Tourism Russia’s tourism industry is getting a boost from Chinese visitors, with potential for more

The first six months of 2015 saw the number of Chinese tourists visiting Russia shoot up by almost half compared to a year earlier, as a weaker ruble lured travelers with a penchant for shopping.

said Ms. Pyatikhatka.

“More than half of the tourists say that their travel budget is mostly spent on shopping,”she said, adding that Chinese consumers tend to spend considerable sums buying brand items, which cost more in China than abroad.

According toYuri Polyakov, member of the board of directors of TsUM, Moscow’s central luxury department store, Chinese consumers currently account for 29% of worldwide purchases of luxury goods.

KIRA EGOROVA

Market is Adapting

Chinese Tourists Flock to Moscow to Shop RBTH

Chinese tourists are flocking to Russia in record numbers, exploiting a cheaper ruble and indulging in an eagerness to explore the two countries’ shared socialist past.

In 2014, more tourists came to Russia from China than any other country, surpassing longtime leader, Germany. Today, one in every five tourists in Russia is Chinese — a total of 1.1 million visitors last year. According to official data, in the first six months of 2015, tourist flows from China increased by a record of 52%.

On average, 35% more tourists have been coming to Russia from China every year for the past five years, according to the Russian Federal Tourism Agency “The big leap occurred in 2012.

During the Year of Russian Tourism in China, Russia carried out a large-scale campaign for promoting the country as a tourist destination. There was even a MoscowBeijing motor rally,” said Svetlana Pyatikhatka, executive director of the Mir Bez Granits (World With-

EGOR ALEEV / TASS

Alexey Lossan

DPA/VOSTOCK-PHOTO

VIEWPOINT

Chinese tourists visit a monument inside the Kazan Kremlin in Tatarstan.

out Borders) tourism company.

Room to Grow Officials are convinced that even the current numbers still leave

“More than half of the tourists say that their travel budget is spent on shopping,” says Svetlana Pyatikhatka. plenty of room for growth. Only 1% of Chinese tourists who traveled last year visited Russia.

“We expect that the volume of tourist flows between China and

Russia will be five million people and we are convinced that soon we will reach this figure,” said Liu Jianming, head of the Chinese diplomatic delegation for tourism at the 3rd Russian-Chinese Tourism Forum, which took place in Moscow on March 17.

According to data from market research company GfK, each Chinese tourist spends about 15,000 yuan (about $2,400) per trip. Mir Bez Granits says that in 2014, Chinese tourists spent a total of about one billion dollars in Russia.

Due to the weaker ruble, trips to Russia have become very advantageous for Chinese tourists, especially for those with an urge to shop,

Travel experts in Moscow said Chinese tourists have different spending priorities than other visitors.

“The Europeans and the Americans prefer to live in comfort, staying at four or five-star hotels. They spend less money on shopping and more on excursions, museums, theaters and other entertainment,”explained Elena Belousova, Deputy Director of Marketing and PR at Mir Bez Granits.

Chinese tourists are more likely to save on hotels and put more of their money towards shopping.

Interest in China has also grown within the official business world.

“We are feeling a wave of interest in the Chinese market, from tour operators and other players. Many representatives of central Russia know little about Chinese culture and traditions, which is why we are developing a special program for business called China Friendly.

It teaches people how to work with the Chinese,” said Ms. Pyatikhatka. So far, 23 Russian hotels have received the China Friendly certificate.

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OIL PRICES: COLLAPSE OR RECOVERY?

CENTRAL BANK POLICY — A DOUBLE-EDGED SWORD

DMITRY DOKUCHAEV EXPERT

IORSH

KONSTANTIN KORISCHENKO ECONOMIST

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ecently the entire world held its breath waiting for the Federal Reserve’s decision on whether or not to start increasing America’s key rate. When it received the information that the rate would remain unchanged, the world exhaled, but more with disappointment than with relief.

The problem of the normalization of the monetarycredit policy has not been solved, but remains in limbo.

Meanwhile, for the last year the Russian Central Bank has been trying to solve a major dilemma: how to reduce the key rate in order to stimulate the economy but at the same time prevent another wave of devaluation of the ruble. These efforts were appreciated by experts at Euromoney magazine, who named Elvira Nabiullina the best central banker of 2015. Nevertheless, Russian mass media is still highly critical of the Central Bank and its monetary-credit policy.

Yet the situation in the Russian economy today is highly complex. It seems that in 2016 the Central Bank will not be able to enact an active credit policy — that is to say, a quick growth of money volumes and a reduction of the key rate.

However, the consequences of the "overproduction of credit" in developed countries may become more painful for them than the issues that Russia is overcoming today.

One of the number of problems that has accumulated during the recent period of high oil prices has been the significant overvaluation of the ruble in real effective terms. This was the result of both the growth of export revenues and substantial inflows of capital, especially in the period from 2006-2008. The consequent decline of competitiveness and the growth of the private sector’s foreign debt provoked a deterioration of Russia’s balance of payments starting in 2011-2012. The recent sanctions against Russia, and the fall in oil prices have made the preservation of the old currency and monetary model practically unviable.

In 2014 the Russian Central Bank made a painful decision to adopt a floating exchange rate and a policy of inflation targeting. It set the ambitious aim, especially in current conditions, of decreasing inflation in the next two to three years to 4%.

The policy that the Russian Central Bank is currently carrying out is very cautious: the key rate is kept at a safe-looking level, the growth rate of the capital offer is very moderate, and there are no in-

M

terventions for increasing reserves or for annual refinancing in foreign currencies.

Such a policy can certainly be called severely anti-inflation. Nevertheless. inflation remains rather high at 12-14%. The problem is that the Russian economy is open and the conditions of both the balance of payments and the budget are extremely dependent on oil prices and the ruble-dollar exchange rate. This means that in the conditions of a freely floating Russian national currency, the ruble-dollar exchange rate must constantly adjust to the changing expectations of oil prices.

As a result, the benefits from devaluation are growing, and this then has an effect on prices. In turn, it supports high inflation expectations. And it is very difficult to fight this for a policy that is based on the management of the key rate. However, the Central Bank is still capable of maintaining this elusive balance: it is reducing the key rate very cautiously in order to restore credit for the economy and its growth.

Unfortunately, there are two problems that the Russian Central Bank may soon face.

First is America’s introduction of the quantitative easing policy to increase the key rate.

The second relates to Russia’s acceptance of the 2016 budget and the consequent establishment of an expected ruble price for oil in 2016. Each of these events may stop the process of further reducing the key rate or increase the risk of renewing the process of devaluation-inflation. The increase of world key rates, as is expected, may generate another wave of capital outflow from developing markets, including Russia. This can weaken the ruble and force the Central Bank to harden its policy in order to avoid further inflation.

The passing of the 2016 budget is creating heated arguments inside the halls of power, making several things very clear: it is impossible to guarantee an acceptable deficit, and preserving reserve funds can only happen at the expense of reducing expenses or increasing the ruble equivalent of export revenues.

If expenses are not reduced and in 2016 oil prices increase substantially, it is very likely that the ruble will weaken even more. Not having the status of a reserve currency, the ruble is deprived of the luxury that central banks from developed economies have: the active «printing of money» to restore their economies’ growth.

any energy experts and political figures in oil-dependent countries are warning that the price of oil may drop to $40 per barrel or lower. Recently, Kazakh President Nursultan Nazarbayev predicted $30 a barrel, and Russian Economic Development Minister Alexei Ulyukayev admitted the possibility of a range between $30-40. But the market is not so straightforward, and scenarios do exist that could change the direction of the downward spiral. Indeed, oil prices could recover as early as 2016, especially if OPEC decides to change its stance on oil production and global energy demand continues to pick up speed.

One recovery scenario, as highlighted by the International Energy Agency (IEA), is linked to increased global demand for oil. This growth, says the agency, has already begun, and could one day outstrip supply, making oil a scarce commodity once more. Daily demand for oil this year will rise by 1.6 million barrels, or 200 barrels higher than earlier forecasts.

Growth rates are at their highest in five years, not least due to the very fact that oil has become cheaper and thus more affordable.

The IEA asserts that the process of restoring the balance in the global market is underway, and given the right circumstances, demand will again match supply in about a year’s time.

Of course, the dynamics of demand could still be negatively impacted by the situation in China’s financial markets. In recent days, the Chinese authorities have taken unprecedented steps to weaken the renminbi in order to avert a stock market collapse and prevent the country from sliding into a full-blown economic crisis.

The devaluation will increase the local cost of commodities such as oil, which could hurt demand in China, the second largest consumer of petroleum in the world after the U.S. A possible slowdown in the Chinese economy will mean less demand for the black stuff, which, of course, could cause the price to drop again.

But things could play out differently. After all, the devaluation of China’s currency, as many financial market experts posit, could unleash a new currency war — in which central banks around the world experiment with lowering local currencies to breathe life into domestic economies. The weaker the currency, the more competitive the goods produced at home. If a race to the bottom ensues in the foreign exchange market, stock market players will turn their gaze on the oil market, which could push up the price of a barrel. And OPEC, which so far has preferred not to intervene in the «price-onomics» of the situation, could soon revise its intransigent philosophy. The fact is that falling oil prices are drilling a deep hole in the balance sheet of Saudi Arabia, the leader of OPEC and the global oil market.

Konstantin Korischenko is head of the stock market and financial engineering department at the Finance and Banking Faculty of the Russian Presidential Academy of National Economy and Public Administration, and a former deputy chairman of the Russian Central Bank.

Dmitry Dokuchaev is a journalist who specializes in economic issues. The article was first published on Russia Direct.

THREE POSSIBILITIES FOR THE RUSSIAN ECONOMY

CO N V E RT I N G M O N O LO G U E S I N TO D I A LO G U E

YAKOV MIRKIN EXPERT

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RUSSIA-DIRECT.ORG New Report

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s Russia suffers through recession and searches for new modes of economic growth, it is worth noting that the risk of a genuine crisis in this country poses a risk to other nations as well. It is enough to observe that Russia is a world power with strategic nuclear weapons that require strict controls and internal national stability, but this is far from the only reason the rest of the world should be concerned with the Russian economy.

How dire is the current situation? The collapse of the price of oil, Russia’s key export, has struck a heavy blow. Yet the main systems of society continue to function. There aren’t food shortages and certain areas of domestic production are even growing, thanks to the sanctions and the devaluation of the ruble. By the beginning of 2014, the country had accumulated a lot of foreign exchange reserves, so its economy is not threatened by default.

However, if the price of Brent crude oil drops further, to a permanent level of $30-$35 per barrel, this period of relative stability could be short-lived.

In addition, the farther oil falls, the more impact the EU’s policy of reducing Russia’s share in the market for raw materials will have. West-bound export volumes of Russian materials would begin to drop, and as for exports to the East, many billions of dollars are needed to finish building the necessary infrastructure for supplying China with raw materials.

Russia maintains as heavy a tax regime as that in Western Europe, while interest rates and inflation are at double-digit levels.

There are three scenarios ahead.

The first is stagnation. This involves a reduction of opportunities and results in an outdated, semiclosed economy with big ambitions and an increasingly greater concentration of resources in the military-industrial complex.

The second is the departure into a closed eco-

nomy, resulting in the mobilization and the ideology of the “ivory tower,” similar to the way Marxists described the Asiatic mode of production.

The third scenario is a new start. It is Russia 3.0.

It’s an attempt to make Russia’s own economic miracle, and release the energy of business and the middle class. It is an effort to place the quality and duration of life in Russia, as well as the growth of the property of families from generation to generation, at the center of economic policy.

Only the third scenario will radically change the situation, and create the opportunity to resolve the

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country’s geopolitical conflicts and stabilize the geopolitical space in Europe.

The first and second scenarios make economic and social stability increasingly fragile as years pass.

Therefore, what confronts us is the urgent need to finish what began in the 1990s — the construction of an open, social market economy, belonging squarely inside the group of developed countries.

Yakov Mirkin is head of the International Capital Markets Department of the Institute of World Economy and International Relations in Moscow.

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DECODING SOCIAL TRANSFORMATIONS IN RUSSIA Despite the steepest drop in incomes since 1998, Russians remain highly optimistic, and President Vladimir Putin’s approval ratings have skyrocketed. As the “fat 2000s” have given way to the current economic downturn, Russian society has somehow swung from protest to civic apathy. Can this all be explained by domestic propaganda and the authorities’ grip on public debate?

If not, then what?

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Outer Space The Russian media is full of speculation that the new SpaceX ship design borrows from the Soviet Zarya cargo vessel

Nevertheless, some Russian experts caution that since spacecraft are designed for essentially similar purposes, parallels in the design are bound to arise.

“They were created with the same tasks in mind, and the only difference is the shape of the capsule,” said Ivan Moiseev, scientific supervisor of Russia’s Space Policy Institute, noting that the Soviet design “sticks to the traditional form, while the Americans prefer cones.

As for the rest of it, the resemblance is not unusual, especially considering that both spacecraft were supposed to land using engines, which is pretty risky from the technological point of view. Normally, other solutions are preferable.”

In fact, given the incredible complexity of spacecraft, no country has ever managed to successfully execute a complete copy even a space rocket engine.

A recent matter involving the U.S. buying a license to manufacture Russian RD-181 rocket engines illustrates this point.

According to the agreement between the two countries, the Russians were supposed to assist their American partners with everything from constructing the plants to installing the engines on launch vehicles.

The whole endeavor, however, proved to be a waste of time and money because the entire technological chain of engine production was optimized for Russian industry and proved unsuitable for the U.S. In the end, the Americans chose to buy RD-181 engines from Russia.

“We received an offer to purchase the engines after [the Americans] unsuccessfully tried to produce them,” said Vladimir Solntsev, president of rocket manufacturer RSC Energia, in an interview with RBTH. “The current contract includes restrictions on the use of RD-181 engines for military purposes, and we will supply 60 engines worth a total of $1 billion.”

The Americans rejected the idea of producing the engines themselves since they would have to completely rebuild their industry.

“For instance, some components made of car-

Both Russia and the U.S. have a tradition of borrowing elements of spacecraft design from each other. Nevertheless, experts caution that direct replication of foreign technology is in fact extremely difficult.

ARAM TER-GHAZARYAN SPECIAL TO RBTH

A curious theory recently emerged in the Russian media after the failed launch of a Falcon 9 vehicle carrying a Dragon cargo spacecraft as part of a mission to the International Space Station.

Some Russian engineers claimed Dragon, developed by the U.S. company SpaceX, possessed several features similar to a craft called Zarya, a Soviet cargo vessel designed in the late 1980’s.

This is not the first time similarities between Russian and American spacecrafts have been noticed. To name just one example, the Soviet shuttle, Buran, bears heavy resemblance to NASA’s Space Shuttle.

But are these really borrowed technologies, or just coincidence?

Is Zarya Dragon’s Ancestor?

Dragon and Zarya do have a lot in common.

Both spacecraft are designed to be equipped with landing rocket engines, and with carrying capacity that exceeds 3,000 kilos.

Moreover, the crew capacity of Zarya and Dragon is similar. Dragon can hold up to seven crewmembers; Zarya can hold eight. Both also possess a conical re-entry capsule, and are reusable.

Led by the Soviet engineer Konstantin Feoktistov of the NPO Energia design bureau, the development of the Zarya spacecraft began in the 1980’s, but the project was eventually shelved.

Feoktistov himself believed the spacecraft’s design was not refined enough to guarantee the required landing precision.

Russian engineers have also pointed out that Dragon has a parachute braking system in addition to the engines — just like Soyuz, another spacecraft designed in the Soviet Union.

AP

SpaceX Dragon: Borrowing a Soviet Design?

The Dragon cargo spacecraft shares many similarities with a Soviet-era craft called Zarya.

bon fiber in the U.S. are made of metal here, while some of the alloys used in the production are also different,” said Ivan Moiseev.

“Even if some intelligence agency manages to steal the blueprints of a whole rocket, all it can really do is help engineers to come up with a couple of new ideas. But even that is highly doubtful — all the catalysts for any number of new ideas are openly available in textbooks on rocket science.”

V-2: The Rip-Off That Worked According to Russian scientists, some spacecraft designs have indeed been successfully replicated by foreign countries.

The most famous was theV-2, the world’s first

3 WAYS DRAGON IS LIKE ZARYA

1

Dragon and Zarya have the same design and equipment, which includes landing rocket engines. Both of them have the same carrying capacity, which exceeds 3,000 kilos.

long-range ballistic missile, developed by the German aerospace engineer Wernher von Braun during World War II. Both the U.S. and the USSR copied its design in the late 1940’s. Experts say the V-2 was the original role model for the first round of space rockets.

The V-2 missiles — both those captured in Germany after the War, and the modified versions — started the American Hermes missile program, as well as the counterpart Soviet projects, including those in the field of space exploration.

Moreover, the Donfeng-1, the first Chinese ballistic missile, was a licensed copy of the Soviet R-2 missile which was in turn based on the V-2.

2

The crew capacity of Dragon and Zarya is similar — seven and eight crewmembers, respectively. Both vehicles are reusable and also possess a conical re-entry capsule.

3

Besides resemblence to Zarya, Dragon has some similaraties with Soyuz, another Soviet-designed spacecraft — both utilize a parachute braking system.

Arctic Oil Russian researchers are refining techniques for finding and neutralizing mammoth icebergs that threaten offshore rigs

Russia Masters Art of “Iceberg Management” Kara Seas, where Russian companies are exploring and developing new fields.

Scientists from St. Petersburg’s Arctic and Antarctic Research Institute are developing new technologies to help protect Russian oil rigs from giant icebergs, enabling technicians to divert them away from work sites.

Drift Ice a Danger

NATALYA BYKOVA

PATRICK PLEUL

S&T RF

As Russia attempts to unlock new oil deposits along its Arctic coastline, Russian energy companies face a new and dangerous challenge: gargantuan icebergs, some the size of several city blocks, that could smash into oil rigs and cause both millions of dollars’ worth of damage to equipment and toxic, hard-to-reach oil spills.

Russian scientists, however, are already hard at work developing ways to cope with the problem. One of the biggest challenges in iceberg management is spotting the danger in time to react, and scientists at the St. Petersburg-based Arctic and Antarctic Research Institute (AANII) are developing new technologies that will make it possible to forecast the movement of ice floes in the Arctic several days in advance. The new methods will be tested as early as 2016 in the Spitzbergen archipelago and in the Barents and

Icebergs pose a major risk to Arctic drilling.

Even in warm waters like the Gulf of Mexico, stopping and repairing the damage done by an offshore oil spill is fraught with difficulties. In Arctic waters, an accident would be even harder to clean up.

Every year, thousands of ice floes break off from the ice caps of the Russian archipelagos of Spitzbergen, Franz Josef Land, and Novaya Zemlya. The ice floes, which can weigh several million tons, would easily pulverize an oil rig in a head-on collision.

“Our task is to notify icebreakers operating on the continental shelf of an approaching iceberg,” said AANII deputy director, Alexander Danilov, who is spearheading the iceberg-mapping project. “This threat is priority No. 1 for high-latitude oil and gas fields in the Barents and Kara Seas.”

The system Danilov’s team is developing will involve calculating the trajectory of troublesome ice formations spotted by satellites or drones on the basis of an algorithm that takes into account the perimeters of the iceberg, the

atmosphere, and water and ice dynamics.

When the system sees that an iceberg is on track to hit an oil rig, icebreakers will be directed to the scene. Workers on the icebreaker will corral the errant iceberg with speciallydesigned nets and cables, and the ship will then pull the iceberg to a distance far enough away that it will not float back into the area around the oil rig.

“The system will be easy to operate,”said Mr. Danilov. “One will not have to travel to the Arctic. Everything will be done from a single center either in Moscow or in another city. Then, information can be transmitted to the scene very quickly,” he said.

According to Mr. Danilov, Russian scientists gained experience in iceberg management in the summer of 2014 during drilling exploration in the Kara Sea when an oilfield called Pobeda (meaning “victory”in Russian) was discovered and that experience has informed the decisions made on this project.

As part of the project, the scientists will also develop monitoring instruments to forecast climate change, and land and water pollution, as well as dangerous geo-dynamic phenomena typical of the Arctic continental shelf and coast.

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