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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES May 2005 MONTHLY BULLETIN Moscow 2005 Institute for the Economy in Transition, 1996. Licence, 02079 19 2000 .

5 Gazetny pereulok, Moscow 103918, Russian Federation Phone: (095) 203-88-16 Fax: (095) 202-42-24 E- Mail: todorov@iet.ru 1 The political and economic results of May 2005.................................................................................... 3 On the Development of Reforms in April-May 2005............................................................................. 5 Budgetary and Tax Policy....................................................................................................................... 7 Monetary policy.................................................................................................................................... 10 Financial markets.................................................................................................................................. 12 The Impact of New Primary Listing Requirements Issued by the Russian Federal Financial Market Service for Securities Intended for Pension Accruals Investment........................... 22 The Real Sector of the Economy: Factors and Trends.......................................................................... 28 IET Business Survey: Industry in May of 2005.................................................................................... 32 Foreign Trade........................................................................................................................................ 34 Positive Changes in Economic Provision of Reorganization of the Russian Military Institution on the Basis of a New Recruitment System......................................................................... 38 The public health care system: the reforms are over........................................................................... Issues discussed at the meetings held by the Government of the Russian Federation on May 12 and 26 of 2005..................................................................................................................... A review of regulatory documents concerning taxation which were made public in May of 2005...... An overview of economic legislation in May 2005.............................................................................. The political and economic results of May On the last spring day of 2005 the court verdict to Mikhail Khodorkovsky and Platon Lebedev was at last passed. The Khodorkovsky case has long been in the focus of public attention, simply because of the scope of the affair. The majority of observers had no doubts that the verdict would represent a judgment of guilt. Nevertheless, there were still some hopes. Some believed that, because of the new political declarations formulated in Vladimir Putins Adress to the Federal Assembly, the sentense would be much softer than the demand expressed by the State accuser (10 years of imprisonment at a general-regime labor camp).Others were hoping that the accusation was going to be formulated in such a way that the most absurd provisions, capable of making a very dangerous precedent for Russian business as a whole, would be eliminated. Mikhail Khodorkovsky and Platon Lebedev were found guilty by the court in having committed a double swindling (Article 159 of the RF Criminal Code (CC)), in having organized twice a malicious failure to execute the court decision that had come into legal force (Article 315 of the RF CC), were found guilty under Article 160 of the RF CC (Appropriation or waste), under Article 165 (Causing property damage to the owners in the absence of indicia of stealing, in having organized an evasion of the payment of tax on organizations on an especially large scale in nonmonetary forms of payment (Article 199 of the RF CC), and in having evaded the payment of the personal income tax (Article 198 of the RF CC). The court had dropped only one accusation that of the appropriation of the shares of the Murmansk company Apatit due to the expiry of the period of limitations. The verdict, indeed, was a demonstration of a certain liberalization as well as of its limits. The defendants were sentenced to deprivation of freedom for the term of 9 years in a general-regime labor camp.

We are not going to repeat here an analysis of the essence of the accusations. It should be noted, however, that the rendering of the verdict, extended over a whole month, and the ostentatious ignoring of the arguments put forth by the defense did confirm what had been said by Vlamir Putins assistant Igor Shuvalov about the demonstrative character of the Khodorkovsky case. The rounding-up of the Yukos affair has made it evident that the Russian authorities believe that they have the right to deprive anyone of property and personal freedom, which, as is believed, provides the incentives for submission. This would have really been so, had there been established formally or informally the rules of the game, or those limits that should not be crossed. Otherwise such goings-on either serve to suppress the business and civil activity in the country, or to settle the power issue whatever the cost (because any agreements thus become senseless).

None was able to explain why, in fact, Khodorkovsky was arrested, and his property expropriated.

He was by far the only one who had been investing in political projects. Khodorkovsky had no chances for promoting the election to the Duma of a number of deputies sufficient for ensuring his control even it the Right were indeed elected to parliament. We have no reason to believe that Khodorkovsky had refused to provide funding to those projects that were being funded by large businesses by way of a distribution list, and he paid more official taxes than many others. Khodorkovsky had not criticized Putin, and generally had been behaving loyally. (It is believed and not unjustly that the so-called Putins Charter of his first term consisted in providing guarantees to businesses on condition that they did not criticize the President and were ready to finance, by way of a distribution list, some especially pertinent projects like Constantine Palace, the institutes for Russian language studies, etc.).

Nevertheless, the end to the Yukos affair became a formal dividing line between the political system that had emerged in Russia and the notions of legality, law, private property, and liberal reforms. The liberal opposition (as well as some of the Left), civil rights campaigners, and the international community thus obtained a federal-level political symbol (similar, for example, to the case of the Kyrgyz politician F. Kulov), who had proved by being put into prison that he was faithful to his principles.

The Procuracys representatives declared that they were planning to put forth new accusations against Khodorkovsky this time of the laundering of money obtained by criminal methods. However, it is more probable that they are planning to accuse Khodorkovsky and his relatives (just as it had happened to Leonid Nevzlin) of having committed premeditated murders and some similar grave crimes.

There are enough lifers in Russian jails who will be ready to confirm this information, which, just as in the case of Nevzlin, would be sufficient for the rendering of a verdict. To depict Russian business as a bunch of gangsters is one of the few technologies still remaining at the authorities disposal.

The Yukos case was accompanied by an almost unnoticeable but also a rather important attempt on the part of the authority to once more narrow the space available for civil activity. There was a wave of mass-scale detentions of activists from opposition organizations and their sentencing to administrative arrest on forged reasons. On the day when the rendering of the verdict started (16 May) a sanctioned picket, organized in support of M. Khodorkovsky, was dispersed, and many participants detained and beaten up. Among the victims were some well-known federal-level politicians Deputy Chairman of Yabloko S. Mitrokhin and the leader of Committee-2008 G. Kasparov. However, the very fact that the latter, together with his bodyguards, managed to successfully repulse special police (!) and then leave the scene is an evidence that the power structures are also faced with serious problems.

On 25 May 2004 Moscow experienced its own blackout just as the northern regions of the USA and the southern provinces of Canada in 2002. Because of a failure in the operation of a power substation at the outskirts of Moscow, there developed a cascade of shutdowns with a chain of next-inline power substations becoming overloaded and disabled one after another, which resulted in a still greater overload of those that were still in operation, and so forth. The scope of the disaster was such that half of the capital was left without electricity, as well as the southern half of Moscow Oblast, Tula, etc. V. Putin expressed sharp criticism directed at the head of the Russian Joint-Stock Company Unified Energy Systems. Also sharply spoke not only Yu. Luzhkov, but also B. Gromov, who usually favors the power engineers. On the same day, the Procuracy General initiated a criminal case, and for several days both A. Chubais and Director of Mosenergo A. Evstafiev were called for interrogation.

This accident, no doubt, has weakened Anatolii Chubais position. However, it is believed that he is going to keep his office because, among other things, public disapproval is not a good enough ground for any decisions on cadres affairs to be based upon. The left oppositions attempt to refer the issue to the State Duma resulted only in an actual support for A. Chubais provided by a majority of the members of Yedinaia Rossiia (United Russia).

In May, the power structures interference with the operation of economic agents was continued.

Criminal cases were initiated against the top officials of ALROS and the former Deputy Minister of Finance Sergei Kolotukhin (which is believed to be a close ally of M. Kasianov); a search was declared for the top managers of Volgotanker. After a number of demarches (including threats to appeal to international courts), the owners of the largest independent operator on the gas market Nortgaz (F. Akhmetov and others), faced with the withdrawal of their key oil deposit licenses, made the decision to transfer the controlling block of Nortgaz shares to Gazprom (this asset, which had once belonged to Gazprom, was the object of a dramatic legal war, where Gazprom had been losing, but then managed to restore control by simply taking away the licenses).

On 17 May, Head of the RF Presidents Administration D. Medvedev repudiated one more of Vladimir Putins promises. Last year Putin promised that the State will give Rosneft to Gazprom in exchange for 10.74% of the gas monopoly owner by the latters subsidiaries. However, as a result of numerous financial operations effectuated by Rosnefts CEOs and their bosses, the deal failed.

Rosneft created for itself a well-defined legal position, thus making it possible to treat almost all of its decisions as null and void from the fraudulent sources for the financing of the purchase of Yuganskneftegaz to the refusal to assume the latters obligations. These circumstances indeed make Rosneft look like a dubious asset, and an optimal chance for its survival can be given by a clearly determined status of a state-owned company functioning outside the legal field and having nothing to do with it (in contrast to Gazprom, with its numerous private investors).

D. Medvedev (who has a reputation of a loyal supporter of A. Miller) declared that the two companies are not going to be merged, whereas the State will increase its stake in Gazprom to the size of a controlling block of shares, having bought shares for money, and this was going to happen prior to the next shareholder meeting scheduled on 24 June. The Ministry for Economic Development and Trade explained that the purchaser would be the state-owned joint-stock company Rosneftegaz, who would obtain also 100% of Rosnefts shares. As for the money, it was going to be borrowed from international financial institutions, and in order to repay this debt, a primary placement of Rosnefts shares was planned. This is rather improbable, in our opinion (more likely, Gazprom will attract credits), by the payment can be made from the resources of the Central Bank or the Stabilization Fund. Thus, the S. Bogdanchikov - I. Sechin group have preserved their operative control over Rosneft. As for Gazprom, no fundamental changes are expected in fact, at shareholder meetings the representatives of the State and the currently appointed governors already have a controlling block of votes, and besides, the Russian authorities are not interested in a liberalization of the share market.

It is possible that Gazprom will need money also for other projects. In May, head of the TNK-VR G. Braun declared that he was ready to discuss the sale to Gazprom of the stake in the TNK-VR owned by Russian shareholders; also, there are continuous rumors that Gazprom is going to buy Sibneft.

The RF Government submitted to Parliament a draft law concerning some changes in tax administration. Repeated audits are still mandatory for taxpayers, within the framework of supervision by a superior instance, although in respect to largest taxpayers registered at special inspectorates such audits are to be conducted by decisions of the Head of the Federal Tax Service and the RF Minister of Finance. The number of audits has been limited to two in one year, strict timelines are set for the extension of an audit (two months), whereas no closed list of the documents required from a taxpayer has been established. Considering that currently, at the RF Constitutional Court, the very notion of a period of limitations as applied to tax crimes is being disputed, and for the expropriation of Yukos to be justified, a positive decision is necessary, one can hardly speak of any serious liberalization.

At the political parties front, the Union of the Right Forces (URF) finally found a leader in May, after a year and a half of anarchy. This leader, as expected, was the 29-tear-old Vice Governot of Perm Oblast Nikita Belykh1 and Leonid Gozman became his Deputy. This construction had been born as a compromise, after a failed attempt to declare as the URFs leader the very unpopular Gozman.

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