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IN THIS ISSUE

PAGES 4-5

PAGE 2

PAGE 8

POLITICS & BUSINESS

SPECIAL REPORT

FEATURE

Change at Central Bank

New chief Elvira Nabiullina is set to focus on growth

Technology Tax BreaksHow Special Economic Zones are attracting savvy investors

A Taste of Old Russia: Wooden churches galore

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Turning Swords Into Software

A generation of IT whizzkids is boosting high-tech exports

It was once unthinkable Kendrick White would be where he is. Nizh-ny Novgorod, Russia’s fi fth-largest

is the basic language of science, is in Russians’ genetic code — this is the logical place for me to be.”

Following World War II, the So-viet government provided generous funding for national security-relat-ed research and closed cities (not unlike Los Alamos) flourished across the country. But while the U.S. had a matching wave of en-trepreneurs ready to found start-ups and commercialize the offspring of state-funded research over the past two decades, Russia faltered at fi rst. Following the end of the Cold War, many of the closed cities opened up and funding was slashed, but nobody fi lled the gap between science and the free market.

In the past fi ve years, however, Special Economic Zones (SEZs), technoparks and business incuba-tors have sprung up, aiming to ben-efi t from Russia’s vast scientifi c po-tential. “There are currently over 90 technoparks and Special Eco-nomic Zones offering various tax breaks and cheap office space,” Mr. White says about Russia’s regions.

“Probably about half of them are ineffective, because federal and local officials sometimes approach their initial development as huge real estate projects without estab-lishing the critical relationships be-tween scientists, entrepreneurs, angel investors and venture funds.”

Science Russia’s once-closed cities are attracting interest from foreign investors

Floridean Kendrick White has spent

the past 20 years helping to finance

high-tech start-ups in Russia’s far-

flung regions.

Technoparks: From Atom Bombs to Apple Stores

ARTEM ZAGORODNOVRUSSIAN BUSINESS INSIGHT

CONTINUED ON PAGE 4

city located 250 miles east of Mos-cow, was strictly off limits to for-eigners during the Cold War as one of the Soviet Union’s centers of se-cret scientifi c study. It was a virtu-al prison for famous Soviet scien-tists like Andrei Sakharov, the Nobel Prize-winning father of the Rus-sian atom bomb.

Now, where Mr. Sakharov once

toiled to build Russia into a nucle-ar powerhouse, the American Mr. White is planting seeds he hopes will one day grow into Russian ver-sions of Apple, Google or Facebook. Moscow officials aim to transform lands once known for hosting the Gulag Archipelago into a network of Russian Silicon Valleys. The plan involves coaxing investors with an array of incentives, from tax breaks to cheap office space.

Mr. White is CEO of Marchmont Capital Partners, which he set up in his native Florida eight years ago after stints at the European Bank for Reconstruction and Develop-ment, PwC and as a privatization advisor in Nizhny Novgorod. After the Iron Curtain fell in the early 1990s, he moved to Russia, sensing opportunity. He has spent 20 years promoting entrepreneurship, hori-zontal integration and start-up fi -nancing for high-tech businesses in Russia’s regions.

“As an entrepreneur, I’ve been in-terested in science and technology commercialization my entire life,” Mr. White says. “Mathematics, which

Go into any Apple store and you’ll discover a lot of Russian technology.

Xi Jinping met with Vladimir Putin in Moscow for his first foreign visit as China’s new leader.

Chinese Premier Xi Jinping’s re-cent visit to Moscow sealed a deal for Russia’s fl agship oil company Rosneft to triple supplies to China to one million barrels a day. The in-crease will make China Russia’s big-gest oil customer, while Russia has awarded the China National Petro-leum Corp a share in eight previ-ously guarded upstream projects in the Russia’s prized Arctic reserves.

The announcement marks a stra-tegic shift as President Vladimir Putin expands exports to the east, from the country’s traditional en-ergy markets in Europe. And it se-cures vital resources for China, the world’s biggest energy consumer.

China also agreed to underwrite a partnership between Rosneft and Britain’s BP by lending Rosneft up to $30 billion, to be repaid in oil. State-owned Rosneft desperately needs the funds to fi nance its $55 billion buyout of private Russian investors from the British-Russian joint oil venture, TNK-BP. That deal made Rosneft the world’s largest publicly traded oil company with almost 5% of global crude output, and it handed BP a minority inter-est in the Russian oil giant.

New agreements were also an-nounced in banking, energy and even cuniculture (rabbit husband-ry). Kingsmill Bond, chief strate-gist at Citi in Moscow, described the Russian-Chinese relationship

International A raft of deals between Putin and Xi sends ripples through global energy markets

as “the best synergy on the planet” – Russia has the raw materials and energy China’s factories so desper-ately need, while Beijing has the market and the money Russia needs.

This view was echoed by Presi-dent Putin after meeting Premier Xi: “Both countries want to encour-age reciprocal investment. We agreed to make more active use of the possibilities the Russian-Chi-

nese Investment Fund offers, and to pay particular attention to in-frastructure and production proj-ects in the Russian Far East.”

Progress was also made on a key gas deal that has been stalled for over six years. Russia agreed to supply China from its east Siberi-an fi elds, rather than its own pref-erence for using the west Siberian fi elds. In return, China agreed to

Russia, China Chart Energy AllianceRussia and China are kindling an

energy alliance that could unite the

world’s biggest fuel producer and

its biggest consumer in “the best

synergy on the planet.”

BEN ARIS SPECIAL TO RUSSIAN BUSINESS INSIGHT

pay in advance for 30 years of gas. Gazprom was confi dent the last

piece in the puzzle, an agreement on price, would be reached by sum-mer. “I think that somewhere in June the price will fi nally be determined and by the end of the year all the contracts will be signed in regards to the supply, with the volume and price agreed,” Gazprom chairman Viktor Zubkov said.

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Politics & Business

NEWS IN BRIEF

• Levels of anti-American sentiment in Rus-

sia are low. A poll found that a mere 18% of Rus-sians have negative impressions of the U.S., one of the lowest figures in the world.

• The Kremlin renewed its crackdown on NGOs

with raids that hit Amnesty International and for the first time targeted German non-profit groups, which have been more moderate in criticizing the government than some other foreign-financed NGOs. The raids were aimed at groups receiving foreign support and classed as “foreign agents” according to a controversial law passed last year.

• Most Russians are suspicious of wealth and

dislike rich parliamentarians. 77% of Russians believe it’s either “indecent” or “criminal” for gov-ernment representatives to be rich, a poll found. 82% were in favour of setting a limit on personal wealth for politicians.

• An autopsy concluded that self-exiled Russian businessman Boris Berezovsky died from hang-

ing. The ex-oligarch’s body was found in his Berk-shire home March 23. British police said there was no evidence of foul play.

• Russian investigators launched a probe into

a $260,000 defense firm theft as part of a crack-down on corruption in the defense ministry. Inves-tigators say managers at an aircraft plant in the city of Kumertau illegally diverted the funds under the guise of customs duties for imported equip-ment.

• The posthumous trial of Sergei Magnitsky

began in Moscow. The late Russian lawyer, who worked for the British-based Hermitage Capital investment fund, is being prosecuted for tax eva-sion. Magnitsky died in pre-trial detention in 2009.

• The government plans to draw up a ‘Guan-

tanamo List’ if America’s Magnitsky Act goes into force. The U.S. list, named for the Hermitage law-yer, imposes entry bans and empowers the sei-zure of assets of Russian officials implicated in the case. Russia threatens similar measures against US politicians involved in the Cuban prison.

• Georgian wine exports to Russia have re-

sumed. Seventeen brands of Georgian wine and five brandies are due to be entered on the Rus-sian state register, which will open the way for a return to the market. Georgian wines, spirits and water were banned in Russia on health grounds in the run-up to the Georgia-Russia war in 2008.

• Russia plans to stockpile 450,000 cubic me-

ters of snow in sub-tropical Sochi ahead of the 2014 Winter Olympics - just in case.

As President Vladimir Putin’s nom-inee as Russia’s new Central Bank chief, former economics minister Elvira Nabiullina has pledged to maintain continuity, but hinted too that the regulator will do more to boost growth. She is also likely to align the regulator’s fi scal policy closer to the Kremlin’s.

“Policy continuity should be maintained, because the credibil-ity factor is very important in the banking system,” Ms. Nabiullina told reporters in Moscow on March 22. “But this doesn’t mean there won’t be changes, because life changes, new challenges appear, everything moves.”

Economists have welcomed the choice of Ms. Nabuillina, who will become the first female Central Bank chief from Russia and in the G8, seeing strong positives in both her record on liberal reforms and her close position to the president.

The outgoing Central Bank chairman, Sergei Ignatiev, is ex-pected to be asked to stay on as an advisor to Ms. Nabiullina.

But Ms. Nabiullina comes to the post at a difficult time. Mr. Putin’s administration is grappling with the twin challenges of trying to boost growth, while trying to curb rising infl ation. Russia’s growth, at 3.2% in 2012, is currently the weak-

Russia’s staggering annual $300 billion corruption market (accord-ing to the government’s own fi g-ures) permeates nearly every as-pect of life, from registering a business to obtaining a spot in a state-run daycare facility.

“Corruption is systemic, with plenty of unpunished criminals,” says Yelena Panfilova, head of Transparency International Rus-sia. Moody’s recently blamed cor-ruption for its decision not to up-grade Russia from its Baa1 long-term investment rating for the last fi ve years despite low debt lev-els and a budget surplus.

Six months ago big heads began to roll: ex-deputy minister of re-gional development Roman Panov went to jail over misuse of $93 mil-lion earmarked for preparation of the 2012 APEC summit in Vladi-vostok while former defense and agriculture ministers Anatoly Serdyukov and Yelena Skrynnik were embroiled in similar scandals.

Russia jumped 21 places in Transparency International’s Cor-ruption Perceptions Index (albeit from 154th place in 2010 to 133rd last year). The Group of States Against Corruption, a European

Fiscal Policy Worry over independence of key regulator after Putin aide takes throne

Corruption Previously untouchable officials face firings, jail time

TIM WALLRUSSIAN BUSINESS INSIGHT


est since 2009, and year-on-year inflation in February, at 7.3%, is the highest in 18 months.

The appointment of a politician is also raising questions about whether the Central Bank will be able to maintain the independence displayed under Ignatiev, who has resisted calls for a looser fi scal pol-icy and higher spending.

Ms. Nabiullina’s appointment was welcomed by former fi nance minister Alexei Kudrin however, indicating support for her across the political spectrum. “I believe this is a good candidacy, and I am sure she will be able to do the job,” Mr. Kudrin said at the Rus-sian Business Week forum in Lon-don. “I believe she is among those most deserving this position.” Mr. Kudrin was touted as a possible Central Bank chief but is thought likely to be setting his sights on

the prime minister’s post instead.Leading officials, including Putin,

have hinted that a cut in interest rates could be on the cards to boost credit fl ows and growth, if infl a-tion can be kept under control. Some economists say that such measures will probably only have limited effect in boosting growth.

Anna Bogdyukevich, an analyst for Aton Capital, said that the Rus-sian economy was “operating close to its long-term potential” and that “policies aimed at stimulating ag-gregate demand… would result in higher infl ation rates while not af-fecting the real sector much.”

She added that it was “difficult to say whether the Central Bank’s independence is going to be com-promised by Ms. Nabiullina’s ap-pointment,” but added that the reg-ulator’s fiscal policy would not necessarily become “more accom-modative.”

Investment analysts from Mos-cow-based Sberbank said that the market “will likely expect mone-tary policy to become more dovish based on Ms. Nabiullina’s experi-ence as economics minister, in which she particularly advocated for increased government spend-ing to spur economic growth… [we] bear in mind that the fi ght against infl ation remains a key priority for the government’s economic team.”

Much will depend on the state of the economy by the time Ms. Nabiullina takes charge in June. Sluggish growth will increase the pressure for a cut in interest rates, but inflationary pressures and a further global downturn may re-strict her room for maneuver.

New Central Bank Chief To Promote Growth

HER STORY

Elvira Nabiullina

Elvira Nabiullina, an ethnic Tatar, was born in Ufa, Bashkortostan, in 1963. After graduating from Moscow State University with an economics degree in 1986, she worked at the Russian Union of Industrialists and Entrepre-neurs during the early 1990s before joining the economics ministry. From 2000 to 2003, she was first deputy to economics minister Ger-man Gref, the current president of Sberbank (the largest bank in Eastern Europe), whom she replaced as min-ister in 2007. Ms. Naibullina remained in this position throughout Vladimir Putin’s tenure as prime minister in 2008-12. Since Mr. Putin was re-elected to the presidency in 2012, Ms. Nabiullina has served as his economic advisor and was not viewed as one of the likely candidates to take over the Central Bank chairmanship.In June, she is set to become the first female Central Bank chief from Russia and within the G8.

Elvira Nabiullina will probably

increase government control over

the regulator, but have to balance

conflicting demands for looser

monetary policy and lower

inflation.

As entrepreneurs begin to reap

benefits from a top-down war

against corruption, its long-term

effects on the business climate

remain uncertain.

Kickbacks Down, Future Uncertain

was Russia’s GDP growth in 2012, first among G8 countries (2nd among BRICS) but rapidly slowing in 2013.

was Russia’s inflation rate in 2012, one of the lowest since the fall of the Soviet Union.

3.4%

6.6%

IN FIGURES

watchdog, praised authorities’ ini-tiatives in a recent report.

“The effects are already being felt by the average citizen and en-trepreneur,” said Dmitry Butrin, business editor at Kommersant, a leading daily. “Municipal fi nances have become more transparent, and the average local traffic police chief is afraid to become involved in cor-rupt schemes.”

But when the battle moved into Russia’s lower house of parliament, experts began seeing political mo-tivation. Several deputies from the opposition Communist and Just Russia parties had their mandates

revoked over alleged confl icts of interest. Then pro-government party United Russia came under fi re when Vladimir Pekhtin, ethics committee chairman, resigned over alleged ownership of $2 million luxury properties in Florida. More resignations are expected.

“The reasons are political,” Anton Belyakov, a member of parliament from Just Russia and chairman of the Public Anti-Corruption Com-mittee, said. “After the last elections parliament members, including members of the ruling party, began

showing independence and disre-garding the President’s position. His administration needed to show who was boss.”

“The problem is their entire cam-paign is directed from above in each case and is not systematic,” said Butrin, adding: “The current cul-ture of corruption is a very diffi-cult thing to change. To kill [it] en-tirely would be to dismantle today’s system.”

Jon Hellevig, founding partner of Moscow-based Awara Group, disagreed. “It’s incorrect to call what’s going on now a campaign because a lot of laws limiting bu-reaucracy and the power of inspec-

tors have been passed in the last fi ve years and SMEs are beginning to reap the benefi ts. Those compa-nies choosing not to engage in cor-rupt practices are now enjoying a more level playing fi eld.”

“We still have two major legis-lative loopholes that need to be ad-dressed,” said Panfi lova. “Officials found to have illegal incomes are usually just fired and don’t face any real punishments, and there are no real mechanisms to protect whistleblowers. People are afraid to speak up because they can face repercussions. The most famous such case is the scandal around Sergei Magnitsky.”

A Just Russia activist protests corruption. The sign reads “Stop Bribes.”

“Nobody knows where this will go, so officials at all levels are being more careful. The effects are positive.”

IN HIS OWN WORDS

Martin Gilman

"�Nabiullina is a highly qualified technocrat. She is valued for her broad experience, competence

under fire and hard work. Perhaps greater than any local political pres-sure to loosen the monetary reins, the real problem may come from an unlikely quarter: the Group of Seven central bankers have thrown away the rulebook and are printing money in a desperate attempt to revive their economies.”

EX-IMF REPRESENTATIVE TO RUSSIA,FROM AN ARTICLE IN THE MOSCOW TIMES

PROFESSION: ECONOMISTCAREER: ECONOMICS MINISTER, 2007-11

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03


Business & Politics

NEWS IN BRIEF

• Retail sales hit a 3-year low in February, as the economy continues to slow more than ana-lysts were expecting. Real retail sales growth edged down to 2.5% year-on-year, increasing the prob-ability that the Central Bank will start cutting in-terest rates in April.

• January consumption figures disappoint-

ed. Retail trade growth decelerated sharply to 3.5% year on year after 4.5% in 4Q12. Consumption driv-ers also weakened; real disposable income growth was up only 0.7% year on year and unemployment rose to 6.0%.

• Gazprom reported that gas export prices for

Europe fell by 2.4% to $400 per 1,000 cubic me-ters in the first two months of the year, adding that it expects to see it fall to $366 through the rest of 2013.

• A meteorite perfume will be launched in

Chelyabinsk in the Urals, which was pelted by

space rock on February 14. Local businessman Ser-gei Andreyev has analyzed the rock to produce a perfume with “metallic and stony notes.”

• Owner of mining company Metalloinvest, Alish-

er Usmanov, retained his position as Russia’s

richest man on Forbes magazine’s 2013 list for the second year running. Estimated as having a fortune of $17.6 billion, he ranks 34th on the glob-al list.

• Russian outbound tourism was up 6% in

2012 as 15.3 million Russians traveled abroad. Tur-key retained its place as the destination of choice for 2.5 million Russian tourists, followed by Egypt with 1.9 million visitors.

• A new business watchdog, the Presidential

Commissioner for Entrepreneurs’ Rights, has

received upwards of 700 complaints since it

started work in June 2012. Roughly 40% concerned the criminal prosecution of businesses, commis-sioner for entrepreneurs’ rights Boris Titov said.

• The government has promised not to raise in-come taxes, but it is planning to introduce a new

property tax in 2014 that may generate 120 bil-lion rubles ($40 billion) of revenue a year, up from the current 20 billion rubles. The state currently owns about 70 million taxable properties that will be assessed at market valuations.

• A luxury tax on expensive cars is being con-

sidered. Under the bill, the tax will be based on price and brand, not engine capacity, with cars costing over $195,000 liable. However, top-end BMWs and Mercedes favored by officials could be exempted.

Igor Sechin, and Russia’s biggest lender, Sberbank, led by former Economic Development Minister German Gref. Also wading into the Gazprom debate has been Oleg Deripaska, CEO of Russian Alu-minum, who has called for Gaz-prom to be broken up.

Mr. Deripaska, normally reluc-tant to speak out in public on pol-icy matters, said in a strongly crit-ical interview with the Financial Times last month that Gazprom was too “preoccupied with its business in the West” at the ex-pense of opportunities in Asia.

“For the benefi t of the Far East and eastern Siberia, Gazprom should be split” into Western and Eastern units, Mr. Deripaska says.

Gazprom has in the past few years come under a barrage of criticism for its multibillion-dol-lar projects to build new pipelines to Europe — Nord Stream and

South Stream — at a time when its exports to the continent have dwindled. Another perceived mis-step, which led to the decline in European sales, was the compa-ny’s refusal until last year to make

Calls are growing for radical change at Gazprom, Russia’s nat-ural gas giant. Suggestions from the country’s business elite and investment community range from a reshuffle of top executives to a split of the company into two busi-nesses in order to focus on Euro-pean and Asian markets.

Gazprom’s veteran CEO, Alex-ei Miller, in charge since 2001, has a contract to lead the company until June 2016. But the company is now facing a strong challenge to its position in the Russian gas market from the country’s oil champion Rosneft, and private gas producer Novatek, and European exports sank 7% to 139 billion cubic meters last year.

“A company like Gazprom, where management has been in-cumbent for a long time, could probably benefi t from a shake-up,” says Mattias Westman, founding partner at Prosperity Capital Management. “There are other Russian state-controlled compa-nies that are better run than Gaz-prom.”

Mr. Westman was referring to Rosneft, managed by former Kremlin and Cabinet heavyweight

Energy Investors are calling for a reshuffle at the top and for the unwieldy gas giant to be split up

Gazprom has come under fire over

its new pipelines to Europe at a

time when its exports are falling.

price concessions, regardless of the glut on the market.

A reshuffle in Gazprom could send an encouraging message to the investment community, said Gennady Sukhanov, who helps manage the Russian oil fund at TKB BNP Paribas Investment Partners.

“A change of the chief executive could signal a different policy,” he says. “If the new person had good reputation, it would be taken well by the market.”

Gazprom’s stock could then as much as double in value, he says.

“If I see that Gazprom is about to change its policy, I will mort-gage my apartment and buy Gaz-prom shares,” Mr. Sukhanov says.

Mr. Westman and Mr. Sukhanov said they were unaware of any changes in the near future.

A reshuffle would appeal to in-vestors only if it comes with a plan for Gazprom to spin off several companies, making it easier for in-vestors to understand the business, says Pascal Menges, energy fund manager at Swiss investment fi rm Lombard Odier.

According to Mr. Westman, the government could make Gazprom a more valuable asset by forcing it to allow other gas producers great-er access to its sprawling pipelines. That would make it exercise more spending prudence as a result of increased competition, he says.

ANATOLY MEDETSKY THE MOSCOW TIMES

Gazprom ‘Must Change’

CEO Igor Sechin directed massive growth for state-owned Rosneft in 2012, developing international partnerships in offshore projects, a merger with TNK-BP and a move toward direct long-term contracts. If Gazprom loses its monopoly on exports of liquefied natural gas, Rosneft could overtake it.

In 2012, the net profi t of Russia’s largest oil company, Rosneft, climbed 7.2% to a historic high of $11 billion, according to an IFRS-based company report. The former deputy prime minister, Igor Sechin, who took charge of Rosneft in May 2012, charted a course for growth in all areas and, by the end of the year, Rosneft’s share price on the London Stock Exchange had in-creased 41%. The company’s mar-ket value is now estimated at $90 billion, but its real capitalization could be up to $120 billion, as Mr. Sechin recently told President Putin. If so, Rosneft could leapfrog Gazprom ($115 billion) by 2016.

Welcome OffshoreIn the past two years, Rosneft has actively sought to bring Russian and foreign companies on board projects in the Arctic shelf, one of which is the U.S. company Exxon

Mobil. The list of offshore partners now includes Italy’s Eni and Nor-way’s Statoil. Rosneft is set to com-mence exploration of its offshore fi elds, categorically opposing any move by Russia’s government to allow private companies access to the continental shelf.

“Rosneft has chosen a convenient method of operating offshore, shar-ing the risks with foreign compa-nies, which will fi nance upstream prospecting, provide technology, and grant the Russian state com-pany a stake in various overseas projects,” says analyst Andrei Pol-ishchuk of Raiffeisenbank.

More GasRosneft plans to increase gas pro-duction to 100 billion cubic meters (bcm) a year. In 2012, it signed a contract with private gas compa-ny Itera to acquire 51% of a joint venture between the two fi rms. The deal raised $2.1 billion in revenue for Rosneft, essentially allowing it to post record net-profi t fi gures.

Last year, Rosneft also began an active search for gas consumers. In October, it signed a major contract with Inter RAO. Starting in 2016, the oil company is to supply up to 875 bcm of gas over 25 years, under “take or pay” conditions. Moreover, it expects to see a demonopoliza-tion of liquefi ed natural gas (LNG) exports. Only Gazprom is entitled to export gas at present.

“Arctic gas could be sold for ex-

port only, which means that, soon-er or later, other companies will receive the right to sell LNG abroad,” analyst Vitaly Kryukov of IFD Capital says.

Synergy With TNK-BP2012’s largest deal was Rosneft’s buyout of Britain’s BP and Rus-sia’s AAR Consortium in TNK-BP. Both deals are expected to close in the fi rst half of 2013. Rosneft is to

Oil With its takeover of TNK-BP now complete, Rosneft is set to be Russia’s energy champion

Rosneft is preparing to overtake

Gazprom in the race to become

Russia’s largest energy company.

ANDREI REZNICHENKO SPECIAL TO RUSSIAN BUSINESS INSIGHT

pay BP $17.1 billion, plus 12.84% of government-owned stock. BP agreed to buy a further 5.66% of Rosneft shares for $4.8 billion ($8 per share). Taking into account its existing share package, BP’s stake in Rosneft will rise to 19.75%.

Meanwhile, AAR’s 50% stake is valued at $28 billion. The synergy effect of optimizing the two com-panies’ production, refi ning, and marketing operations is valued by Mr. Sechin at $3.5 billion.

Narek Avakyan, an analyst at AForex, put the synergy estimate higher, at $7.5 billion of additional profi t and $60-$80 billion of extra revenue each year. However, he does not expect the merger of assets to take place before 2014.

Rosneft Tops List of Biggest Oil Firms

BP’s Robert Dudley (L), now on the Rosneft board, with CEO Igor Sechin

The net profit of Russia’s largest oil company, Rosneft, climbed by 7.2% to a historic high of $11 billion.

For the benefit of the Far East and Eastern Siberia, Gazprom should be split up, according to RusAl CEO Oleg Deripaska.

A futuristic suite on the top

floor of Gazprom’s skyscraper

headquarters in Moscow

IN HER OWN WORDS

Julia Bushueva

"�The renewal of Gazprom’s man-agement is the ultimate dream among any entrepreneur invest-

ing in Russia; it would be a symbol of reform not only at the company, but in the entire country. Rumors of CEO Alexei Miller’s departure circulated this spring and led to a 10% increase in Gazprom’s stock during the last two weeks.”

MANAGING DIRECTOR OF THE NEW KREMLIN FUND (ARBAT CAPITAL)

PRESS PH

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Special Report

The sprawling IDEA technopark in Kazan (500 miles east of Mos-cow on the Volga River) was set up on the grounds of an abandoned defense plant in 2004, with the aim of creating high-tech businesses. By providing two key services to local start-ups — cheap rent and sound business advice — the tech-nopark graduated enough firms within three years to become self-sustaining; and by 2007, its com-panies were paying enough taxes into the local budget to repay the start-up capital.

“For the last several years, we’ve been independent of the regional budget, and this is important,” says Sergei Yushko, IDEA’s general di-rector [see interview, p. 5]. “Our ex-perience proves technoparks are a viable model for economic devel-opment in Russia.”

Yushko explains that most of the companies at IDEA provide engi-neering services, software or web design. One such company, Smart-head, has scored top-notch clients as diverse as Honda and L’Oreal.

After three years, graduates of IDEA have the option of leaving the technopark, usually securing bank loans independently to ac-quire office space, or moving into its business park, where rent is no longer subsidized.

There, neighbors will include the local R&D branches of internation-al behemoths such as GE and Sie-mens. “The foreign companies come fi rst and foremost for the qualifi ed personnel,” Mr. Yushko says.

“I’m a believer in the unpopular notion that we don’t need facto-ries in Russia,” Mr. Yushko says. “Production will eventually be moved to where you have cheap labor, like China. Our advantage is people and their ideas.”

Root of the IssueMr. White believes that the govern-ment’s investment of billions of dol-lars into Special Economic Zones and technoparks is now paying off. “They’re starting to get to the root of the issue — how to get the fl ow of new companies into them and successfully commercialize science.”

SPECIAL ECONOMIC ZONES & TECHNOPARKS

DOZENS OF HUBS ACROSS RUSSIA OFFER TAX BREAKS

AND SOUND ADVICE FOR THE SAVVY TECH INVESTOR

“This will be the exciting phase over the next fi ve years, because the officials in Moscow at Skolko-vo, the Russian Venture Company and similar organizations now un-derstand this.

“Games and programming out-sourcing have been the fi rst signs of Russia’s emerging high-tech sec-tor because you don’t need a lot of resources to make them, but I’m a lot more excited about projects in microelectronics, medical sciences, nanotechnology, chemistry, space and quantum mechanics that will gain global recognition in the com-ing years,” Mr. White adds.

“If you go into any Apple store in the United States, you’ll discov-er that a surprisingly large num-ber of their top 100 products come from Russia,” says Pekka Viljakain-en, an advisor to Moscow’s Skolko-vo Foundation. “But most of them

have offices in California and hide their Russian origins.

“Our EBRD Central Russia Ven-ture Fund invested into the [St. Pe-tersburg-based] Speech Technol-ogy Center, which is developing top-notch voice-recognition soft-ware, and Morion, Inc., which has produced quartz oscillators for projects as diverse as GPS and NA-SA’s Mars Odyssey mission. We suc-cessfully exited these high tech projects, setting into motion a new generation of success stories. This will only grow as a new genera-tion of globally known brands emerges from this country.”

For his part, Mr. White also sin-gles out Kuzbass Technopark, in

The creators of Pirate Pay, a Perm-

based start-up, say they can stop

files from being illegally

downloaded from torrent networks.

ELENA SHIPILOVARUSSIAN BUSINESS INSIGHT

Startup Aims To Make Pirates Pay

In 2009, brothers Andrei and Alex-ei Klimenko and their friend Dmi-try Shuvaev created a fi le-sharing traffic management solution for an internet service provider network. Thanks to a $120,000 grant from Skolkovo, the company they found-ed, Pirate Pay, created a program that fi ghts illegal torrent downloads which they are now marketing to Hollywood studios. Pirate Pay’s turnover shot up from $80,000 last year to some $400,000 in 2013.

“After creating the prototype, we realized we could more generally prevent fi les from being download-ed, which meant that the program had great promise in combating the spread of pirated content,” said An-drei Klimenko, CEO of Pirate Pay.

The technology prevents fi le shar-ing in torrent networks. These peer-to-peer fi le sharing solutions allow large amounts of data to be trans-ferred between individuals.

“The underlying technology of Pirate Pay has no analogs in the world,” said Alexander Turkot, ex-ecutive director of the Skolkovo In-

conscience has largely failed. And that is why the company has begun to attract attention outside Russia as well as at home.

In December 2011, when a fi lm biopic about one of Russia’s most famous singers, Vladimir Vysotsky, was released, Pirate Pay protect-ed it on torrent networks.

“We used a number of servers to make a connection to each and every P2P client that distributed this fi lm. Then Pirate Pay sent spe-cifi c traffic to confuse these clients about the real IP addresses of other clients and to make them discon-nect from each other,” Andrei Kli-menko said. “Not all the goals were reached. But nearly 50,000 users

formation Technologies Cluster, ex-plaining the decision to accept the company as a resident. Potential residents at Skolkovo, Russia’s gov-ernment-supported answer to Sil-icon Valley, are assessed according to several criteria, including sci-entifi c innovation and the prospect of commercialization.

Other sources have also invested including Microsoft Seed Financ-ing Fund and the Bortnik Fund.

“Hollywood is still skeptical about the technology, but we’ve earned a hefty profi t through con-tracts with Russian fi lm studios,” explained Mr. Klimenko.

CrackdownThe problem of copyright infringe-ment in Russia is extremely seri-ous, and there is signifi cant inter-national pressure on the government to crack down on what is seen to be rampant piracy. Foreigners in Russia fi nd they can obtain foreign fi lms before their release dates in the U.S. According to various es-timates, fi lmmakers lose about $500 million a year to piracy. Hundreds of thousands of gigabytes of ille-gal content are downloaded every day through fi le sharing services, including computer software, music and fi lms.

Threatening Internet users with legal liability or appealing to their

CONTINUED FROM PAGE 1

Dmitry Shuvaev, Andrei Klimenko and Alexei Klimenko (L-R)

“Games and programming outsourcing have been the first signs of Russia’s emerging high-tech sector.”

“If you go into any Apple store, you’ll discover a surprisingly large number of Russian products.”

did not complete their downloads.”The company’s successful defense

of the fi lm brought in its fi rst big paycheck. Company officials will not discuss exact earnings, but said that projects will cost clients be-tween approximately $12,000 and $50,000 depending on the resourc-es needed to mount a defense.

“Skolkovo’s tax breaks have al-lowed us to invest in our newest product, Zilliondata,” said Mr. Kli-menko. “It allows clients to not only block illegal downloads, but un-derstand and analyze the audience making those downloads to target advertising at it. This constitutes a completely new approach in the battle for intellectual property.”

Conor LenihanSPECIAL TO RUSSIAN BUSINESS INSIGHT

German statesman Otto von Bismarck once famously observed that the Russian cav-alry were “slow to saddle up, but ride fast.”

Nowhere is this saying truer than in the realm of innovation, where Russia has rapidly climbed up the rankings over the past five years. France’s Insead Business School recently placed Russia in 51st place in their innovation index, while a new Bloomberg ranking put the country as high as 14th worldwide in a measure that looked at R&D inten-sity, among other things.

The collapse of the Soviet Union dealt a tough blow to the prestige and standing of Russian sci-ence. The resulting human capital flight, through the emigration of talented Russian scientists, engi-neers and technologists, was dramatic. Just ask Cisco Systems, now a strong promoter of Skolkovo, Rus-sia’s flagship innovation project: they have no fewer than 700 Russian émigrés among their staff in Sil-icon Valley alone.

The sharp increases in oil, gas and commodities prices in the 2000s also left an economy lopsided and in need of diversification, modernization and improved infrastructure – with a particular focus on growing small- and medium-sized businesses. The Organization for Economic Cooperation and Devel-opment has stressed the need to create alternative champions to Gazprom and Rosneft in the non-re-source sectors. Of course these companies are vital for Russia’s revenues, but nimbler, more innovative small companies need to emerge from Russia’s re-search landscape. In response, the Russian govern-ment has launched a series of initiatives around in-novation, including technology platforms, tax benefit-driven territorial clusters, Special Econom-ic Zones and new development institutions such as Skolkovo, Rusnano, the Russian Venture Corpora-tion and the Russian Direct Investment Fund.

When fully built, Skolkovo will be a brand-new, high-tech city 19 kilometers southwest of Moscow’s Kremlin. It is the highest profile of these initiatives, and since its inception has already created a start-up pipeline comprising more than 850 companies, in addition to the stellar presence of global corpo-rates such as Samsung, Intel, Microsoft, Honeywell, Siemens, J&J, SAP and BP – all of whom are either locating R&D centers or venture-funding start-ups. All of this has been accomplished within three years of operational existence.

In my native country, Ireland, the decision to ramp up R&D spending came about as a result of suc-cess with inward investment, and over a 10-year period commercialization began to occur. In Russia it is happening at a much sharper pace, because of huge investment from the state, the obvious tech-nical talent and the valuable market opportunity that Russia represents for investor companies.

Apart from the traditional locations of research excellence, a number of other technopark locations, including Skolkovo, are set to emerge. Locations such as Novosibirsk, Nizhny Novogorod, Tomsk, Uly-anovsk and Zelenograd are providing a competi-tive challenge in R&D terms. From Cold War days, Russia had a total of 11 “closed cities,” where re-search scientists worked mainly on Soviet defense-related projects. Nowadays, those skills are being put to commercial use, pushing forward with inter-esting IP through Skolkovo. While Skolkovo will ac-commodate over 31,000 residents, Tatarstan is cre-ating an innovation hub of some 150,000 scientists, engineers and IT professionals. Nikolai Nikiforov, the author of the idea, was last year appointed Russia’s Communications and IT Minister at the age of 29.

MIT experts managing the development of the graduate-only Skolkovo Institute of Science and Technology, or SkolTech, hope that Russia’s rise up the research rankings will ensure that talented Rus-sian technologists will not have to leave the coun-try to pursue their careers elsewhere. SkolTech aims to instil values of commercialization, top-quality re-search and entrepreneurialism, with third-level in-stitutions from all over Russia making a contribu-tion. The ready availability of significant talent, funding and WTO accession are fueling an invest-ment push toward Russia.

Conor Lenihan, a Vice President at the Skolkovo Foun-dation, is a former Irish Minister for Science, Technol-ogy and Innovation.

VIEWPOINT

Russian Innovation Saddled Up and Riding Fast

IN HIS OWN WORDS

KendrickWhite

" Unfortunately, most Russian scientists are currently looking for orders from above while domestic industry seeks off-the-

shelf solutions from Western companies. Russian firms currently spend less than 1% of their budget on R&D, while they should invest four times this amount. But as more entrepreneurs turn to Russian science for solutions, it will create a new flow of product ideas and solutions.”

FOUNDER AND C.E.O. OF MARCHMONT CAPITAL PARTNERS, A LEADING INVESTOR INTO RUSSIAN TECHNOPARKS AND HIGH-TECH STARTUPS

$1.3�billion in revenue has been earned by the residents of Russia’s technoparks since their inception in 2006.

88�technoparks focus on innovation - in fields as diverse as software and chemicals - in 36 Russian regions.

17�SEZs focusing on either Industry (6), Technology (5), Tourism (4) or Ports (2) are currently in operation.

$3.6�billionin foreign direct investment (FDI) has been raised by SEZs since their inception in 2006.

IN FIGURES

cow for money, while what needs to happen is local horizontal inte-gration between all these forces,” Mr. White says. “This is what we’re doing at the Lobachevsky Univer-sity here in Nizhny Novgorod, and it’s what I see already happening all across the country.”

Siberia’s coal-mining region Ke-merovo, for developing coal-based sorbents to absorb oil spills, and the pharmaceutical cluster in Ob-ninsk (“home of the peaceful atom”), where cutting-edge medi-cal solutions are created.

Transferring RightsIn the U.S., the Baye-Dole Act of 1980 played the “critical role of transferring patent rights from the government to universities and small businesses,” Mr. White says. “A Russian equivalent is under re-vision in the country’s parliament. This will be critical to support Rus-sian innovators in advancing their ideas into the real marketplace.

“What Russia’s leaders are be-ginning to realize is that it all has to be part of a comprehensive eco-system,” he says. “In addition to building up the technoparks’ in-frastructure, you need to link them with scientists in nearby universi-ties and provide management train-ing programs there.

“You need a proof-of-concept center, like Von Liebig at the Uni-versity of San Diego, to test the commercial viability of scientifi c concepts. Then you need an accel-erator program that can contrib-ute real money to developing a pro-totype, on the premises of a technopark, and paying lawyers to do patent protection.

“Soviet tradition has most Rus-sian scientists and entrepreneurs looking to budget-holders in Mos-

ATOM BOMBS TO APPLE STORES

SOURCE: MINISTRY OF IT AND COMMUNICATIONS


WWW.RBTH.RU

05


Special Report

What do technoparks offer to interna-

tional investors?

To maintain their leading positions in high-tech solutions and manu-facturing, companies such as Sie-mens and Honeywell have to simul-taneously conduct and implement the latest R&D across a wide spec-trum of scientifi c fi elds. Doing this in-house is expensive and inefficient: they outsource, and this is where technoparks play a critical role.

Russia’s rich scientific history makes it an attractive destination for those companies to network with specialists in everything from liquid dynamics to chemical com-pounds. The critical links between universities and global business

The Russian government has

invested billions into setting up

innovation hubs across the country.

The CEO of one of Russia’s leading

technoparks explains how you can

profit from this investment.


How to Tap Into Scientific Talent Through Tech Hubs

leaders are technoparks like IDEA, which provide a convenient plat-form for interaction between big corporations and small business. While nearly all technoparks pro-vide some kind of subsidized util-ities and concessionary leasing con-ditions for small companies, what the world’s best companies are re-

ally looking for is talent. Tech-noparks attract the best graduates of local universities and offer them an easy place to open a fi rm and fi nd contracts from big industry.

Can you give an example of a major

corporation you work with?

Siemens produces meters for Rus-sia’s largest corporation, Gazprom (which, incidentally, produces more hydrocarbons than all of Saudi Arabia in terms of their total en-ergy equivalent). But how do you apply their product and solutions to Russia’s atmospheric conditions, its freezing temperatures? How do you certify the meter to meet all the local legal rules and standards? This is where IDEA’s small busi-nesses perform a critical function for Siemens’ operations in Russia.

Which technoparks are the most at-

tractive to investors?

Investors should look at tech-noparks currently meeting Euro-pean BIC standards, like IDEA in

At this year’s Davos Forum, the Russian gov-ernment announced the launch of a new branding campaign entitled “Invest in Rus-sia”. It has also hired Goldman Sachs as

advisor to improve the country’s business image over the next three years. A major priority will be to ac-celerate the development of the country’s Special Economic Zones (SEZs).

Having appeared in their present form only in 2005 (when U.S. companies alone invested $966.4 million into SEZs), Russia’s Special Economic Zones now count 57 foreign companies from 21 coun-tries among their residents. In 2012, six U.S. com-panies came on board. Among them, General Mo-tors invested $180 million, 3M $30 million and Armstrong (building materials) $75.4 million.

“Our company faced a tricky choice: where to locate our production facilities, in Russia or some other Eastern European country? In the end, we got residency status in the Alabuga SEZ in Rus-sia’s Republic of Tatarstan last December,” Alexei Zavalev, 3M’s head of legal, told Russian Business Insight. “Apart from tax breaks and other support, we were impressed after speaking with the SEZ managers, who represent a new breed of Russian officials with excellent English and business acu-men.”

The tax incentives are good: 3M will pay a 2% profit tax in the first five years, instead of the stan-dard 20%. It will also be exempt from VAT, import duties on parts and equipment and enjoy free elec-tricity. As a result, SEZs have raised $3.6 billion of foreign direct investment over the past seven years.

Initially designed to stimulate innovation, the SEZs have facilitated the filing of over 350 patents in Russia and have expanded into industrial pro-duction, tourism and shipping transportation, and attracted the likes of Boeing and Apple.

All SEZ residents must be approved via a su-pervisory board and the Ministry of Economic De-velopment, a procedure now being simplified to dovetail with Russia’s aim to jump to No. 20 in the World Bank’s Ease of Doing Business ranking by 2018.

Special Economic ZonesALONG WITH INFRASTRUCTURE, SPECIAL ECONOMIC

ZONES OFFER GOOD TAX BREAKS FOR THOSE WILLING TO

INVEST IN ANYTHING FROM SOFTWARE TO SHIPPING.

IN FOCUS

USEFUL CONTACTS- Russian Venture Company, leading state VC fund › www.rusventure.ru/en/

- SKOLKOVO, the state-sponsored tech hub near-ing completion in southwest Moscow (in coopera-tion with M.I.T.) › www.sk.ru/en

- Russian Special Economic Zones › eng.russez.ru

- Marchmont Innovation News, a leading English-language resource on Russian technoparks › www.marchmontnews.com

- RUSNANO, the state-owned nanotech giant › www.rusnano.com ›- Association of Technoparks (in Russian) › www.nptechnopark.ru

Kazan and the Krasnoyarsk busi-ness incubator in Siberia (Skolko-vo is also in the process of imple-mentation). The profi tability of the technopark and a small-to-nonex-istent state ownership are also good signs of its vitality.

What role can a foreign investor play

at a succesful technopark?

Since setting up IDEA, the value of our closed joint-stock company (i.e. it is not publicly traded on a stock exchange) has increased by a factor of 16 (some of our resi-dents have grown even faster than that) and we have been looking for an outside investor for a possible buyout. In our case this niche has been fi lled by Rosnano (the joint stock nanotechnology company), but we are still eager to meet with foreign entrepreneurs interested in investing in a particular project. Our company’s profi tability also means we have the funds to co-in-vest and share the risk.

How can I invest into a technopark?

The management teams of IDEA and other leading technoparks are eager to hear from investors inter-ested in tapping Russia’s vast sci-entifi c talent pool [see Useful Con-tacts].

Sergei Yushko is CEO of the IDEA tech-nopark in Kazan. Set up in 2004, IDEA’s stock has increased by a factor of 16 as it has attracted investment from the likes of GE and Siemens.

Learn more about the top startups emerging from Russia’s high-tech clusters and see profiles of the young entrepreneurs behind the most ambitious ventures.

Read more atwww.rbth.ru/startups

Q&A SERGEI YUSHKO


WWW.RBTH.RU

06


Money & Markets

Want to raise fi nance for your com-pany, but don’t want to give up control to a bigger fi sh? That’s the dilemma many Russian entrepre-neurs have been facing, particu-larly since the 2008 crisis, but now there could be a way out that doesn’t involve ending up as shark bait: mezzanine fi nancing is here.

“Mezzanine fi nance has taken off in Russia, but there are still very few people offering sophisticated fi nance products,” says Andrei Yas-hunsky, managing partner of Mos-cow-based Hi Capital, a fi rm spe-cializing in such deals. “We raised half a billion dollars each year for the last two years for 11 deals.”

A niche has opened up in Rus-sia for mezzanine financing, a structured product halfway be-tween using a company’s equity to raise money and taking out a loan, as most Russian banks are not yet geared up for these kinds of deals.

“Russian banks don’t know how to do it and the fi rms need to be educated as to how mezzanine fi -nance works,” Mr. Yashunsky says. “The fi rst two hours of any meet-ing I have with a target company is usually just explaining what we are offering.”

So far, just a dozen mezzanine deals have been struck in Russia – mostly with second-tier compa-nies looking to grow their busi-ness, buy a rival fi rm or buy out a partner.

“Companies are using mezzanine fi nancing to raise expansion money, but most banks are only willing to

Tough capital controls imposed by crisis-hit Cyprus will have only a “relatively marginal impact” on Russian banks on the Mediterra-nean island, ratings agency S&P says.

“Russians have a penchant for parking their deposits abroad, par-ticularly in Cyprus, and in the af-termath of the eurozone crisis, the consequences are becoming clear,” the agency says in a March 27 re-port. “We view these events as hav-ing a relatively marginal impact on the consolidated fi nancials of rated Russian banks with a pres-ence in Cyprus. VTB Bank is the Russian bank with the most expo-sure to Cyprus, in our view.”

But state-controlled VTB, Rus-sia’s second-biggest bank, insists its exposure to Cyprus from a sub-sidiary, Russian Commercial Bank, is a maximum of 50 million euros.

Russian businesses and individ-ual investors are likely to take a bigger hit; those with more than 100,000 euros in Cyprus’s Laika Bank, which Cyprus is allowing to go to the wall, face the confi sca-

IT Guys: Russia’s New Generation

Is This the End of the Oligarch Era?

AHEAD OF THE CURVE

STATE MATTERS

Russian software exports soared to over $4 billion last year, from around $200 million at the turn of the century, with the sector recently enjoying annual growth of around

20% (well ahead of the economy as a whole).Meanwhile, another pillar of the high-tech econ-

omy, arms exports, also hit a record $15 billion last year. If current trends continue, however, software will soon overtake arms as one of Russia’s leading innovation exports. But this is not an end in itself; it is merely an indicator of how well the IT sector is developing and how well Russia is integrated into the global economy.

While giants like Kaspersky Lab and ABBYY con-tribute a substantial share of these exports, out-sourcing to Russia has become increasingly popu-lar and attractive. This is where small and medium-sized businesses become the critical link. Take Ecwid, for example [a system that creates e-commerce platforms and has a strong working re-lationship with Facebook], or Prognoz [which pro-duces analysis systems for companies] and Diasoft [which provides automation of banking and insur-ance systems].

There are many such examples, all of which offer internationally competitive products. Many of them were start-ups, but they have now found their niche. The only question is whether they are interested in staying in Russia or shifting their business to a neigh-boring country, Europe or the U.S., where the busi-ness environment is often more favorable.

In fact, less than 1% of the Russian workforce is currently employed in the IT sector, compared with more than 4% in the U.S. and 3% in Europe.

We already offer a preferential social tax – 14% instead of 30% – for companies where IT services and products account for 90% of business. While this is valid through 2017, we are working on hav-ing the deadline extended until 2020. But this is not enough: we recently held a roundtable about how to make the profession more popular and attrac-tive to professionals. We want to make the IT spe-cialist a symbol of Russia’s young generation.

We can also learn from international experience. India liberalized its regulations on currency options, so we are looking at how this tactic could apply to Russia. We are also studying the special tax regimes in other countries (like the new Patent Box regime in the U.K.).

A lot remains to be done in copyright protection. The fact that we are lagging behind gives us an ad-vantage in, say, patent wars. When it comes to in-frastructure, we are exchanging experience in the creation of technoparks with Singapore and Israel. All of these policies will guarantee dynamic growth for Russian IT over the coming years.

Mark Shmulevich is Russia’s Deputy Minister of IT and Communications.

The death of exiled oligarch Boris Berezovsky, probably due to suicide by hanging, came after he lost a $5 billion court battle against ex-business partner Roman Abramovich.

Berezovsky belonged to the breed of people that can’t bear losing. To them, life is about winning. But the last few years Berezovsky was well and truly beaten by Vladimir Putin. All the people in Russia whom Berezovsky bankrolled either defected or stepped aside, or passed away. Berezovsky’s plans in former Soviet republics failed: the “Orange Rev-olution” he sponsored was a fiasco, while the main beneficiary of his financial support, former Ukraini-an Prime Minister Yulia Tymoshenko, is in prison.

Psychology alone cannot explain what happened. For example, Mikhail Khodorkovsky, the jailed oil ty-coon, doesn’t give the impression of a psychologi-cally crushed person. Russian revolutionary Leon Trotsky, with whom Berezovsky was often compared, also hated losing. But Trotsky fought against Stalin to the end, until his last breath. And Trotsky was fighting for Russia as the vanguard of the world revolution. Can we say with as much certainty what kind of Russia Berezovsky was fighting for?

It would be simplistic to claim that Berezovsky had no ideals at all, and that he had only interests. I think deep in his heart he had his own dream of Russia. People like Berezovsky needed a weak Rus-sia, a Russia without strong government. They could safely do business only in an amorphous, semi-fed-erative disintegrating country – a kind of Eurasian Cyprus, hopelessly divided with low taxes and an ineffective government.

Until recently – right up until the Cyprus financial crisis, in fact – Berezovsky could at least hope that, however morally bereft his ideal of a “weak” Russia may be, that ideal was shared by Russian entrepre-neurs who sought refuge for their money in Cyprus. We can’t attribute Berezovsky’s sudden death and his mysterious repentance to the EU’s determina-tion to sort out Russian investments in Cyprus. And yet, for Berezovsky, these events could have been history’s final diagnosis on the “weak Russia” ideal.

Berezovsky was an ideal for thousands of adven-turously minded Russians. Now they have realized that they made a fateful mistake in the 1990s by succumbing to the charm of an “enfeebled” Russia.

Russian business today needs new, bold heroes, adventurers who are prepared to build a new “strong and sovereign” Russia, where there is still room for economic enterprise and political competition. This class, which despite all the risks is ready to bring its money back to Russia, will become the real infra-structure for a future nationally oriented capitalism.

Boris Mezhuyev is a Moscow-based political analyst.

Mark ShmulevichSPECIAL TO

RUSSIAN BUSINESS INSIGHT

Boris MezhuyevIZVESTIA

Banking Mezzanine debt allows deals to be financed that otherwise wouldn’t

Banking Russian banks will suffer ‘relatively little impact’ in the Cypriot bailout, S&P says

BEN ARISSPECIAL TO RUSSIAN BUSINESS INSIGHT

BEN ARISSPECIAL TO RUSSIAN BUSINESS INSIGHT

Russian entrepreneurs are learning

about mezzanine deals as a way of

avoiding being swallowed by the

big fish.

While individual Russian investors

may lose out on deposits in Cyprus

banks, Russian banks as a whole

will not suffer too much.

Cyprus ‘Marginal’ for Russia

Mezzanine FinancingTakes Off

tion of up to 40% of their depos-its. No one is sure how much Rus-sian money is in Cyprus; estimates range from $20-$35 billion.

The Kremlin is clearly not happy. President Vladimir Putin has called the squeeze on Russian deposits in Cyprus “unfair,” while Prime Min-ister Dmitry Medvedev called it “theft.”

Depositors in Cypriot banks can now only withdraw up to 300 euros from ATMs, and transfers abroad were limited to a mere 5,000 euros as Cyprus’s Central Bank strove to prevent a bank sector collapse.

“It is a given that no one in their right mind is going to make a trans-fer into Cyprus now,” says one Mos-cow banker with several million euros stuck in a Nicosia account.

The collapse of Cyprus’s econo-my is likely to hurt Russian real estate investors too. “The real es-tate sector was booming as many Russians were buying property there, but the market has already collapsed. You can’t sell a property if you wanted to,” says Katya Thain, director of residential real estate at Chesterton Moscow, a high-end realtor that caters to Russian cli-

ents with properties in Cyprus. While the Kremlin rebuffed Mi-

chael Sarris’s desperate pleas for a new $7 billion loan during his trip to Moscow last month, it has not been entirely insensitive toward Cyprus’s pain. On March 25 Pres-ident Vladimir Putin ordered Rus-sia’s Finance Ministry to restruc-ture a $2.5 billion loan to Cyprus.

Russia may use funds from its development bank VEB to aid do-mestic companies with funds trapped on the island, however.

For Russian businesses the loss of Cyprus as an offshore tax haven will be a major inconvenience, and will likely prompt them to look elsewhere for tax efficiencies, in-cluding nearby Latvia or the Bal-kans.

The double taxation treaty be-tween Cyprus and Russia meant money fl owed quickly and easily from Moscow to Nicosia and on to the rest of the world. Despite al-legations that Cyprus was a major money laundering hub for Russian money, the truth is more prosaic: Cyprus was a convenient and tax efficient conduit that connects Rus-sia to the global fi nancial system.

Dividends paid on Russian shares registered in Cyprus are not liable to tax, nor is there any capital gains tax on money earned from asset sales; both are taxed in Russia.

Cyprus’s then Finance Minister Michael Sarris faced tough talks in Moscow with officials unhappy about the levy.

“Banks don’t know how to do it and the firms need to be educated as to how mezzanine finance works.”

Mezzanine financing is being used by companies in place of other forms of borrowing as the main source of fund expansion.

lend companies money for work-ing capital,” says Andrei Abol-masov, managing partner at New Russia Growth, the country’s sec-ond-largest mezzanine fund.

Russia’s banks have been unwill-ing to lend to anyone but blue chips since the 2008 crisis, and often set exorbitant collateral demands.

“We did one deal to finance a banking acquisition as the client had raised a loan from one of the big state-owned banks, but it was

demanding a controlling stake in the target in exchange,” Mr. Abol-masov says. “Our deal allowed the acquisition to happen and, once it was completed, the client could easily refi nance the debt from a bank at a better rate.”

The size of the equity kicker is a big attraction. With mezzanine deals the owner can use a small-er equity stake to raise addition-al capital, without risking loss of control. But mezzanine deals come at a high price. In the West one will return as much as 25% for the organizer, but in Russia the returns on the debt part are usu-ally 30%-40%. Selling back the equity kicker to shareholders or

ultimate benefi cial owners can re-turn 40%-50%.

There’s another difference with Russian deals: in the West, the lend-er will often hang on to the equity kicker for several years, waiting to cash out with an IPO; in Russia the IPO deal fl ow is down to al-most zero. So mezzanine lenders have been signing options with the target fi rm’s shareholders to un-load the kicker anywhere from a couple of years to a few hours.

With demand for mezzanine deals rising, other Russian banks are getting interested in develop-ing them. Hi Capital’s Mr. Yashun-sky says the deals he has done since starting two years ago are worth $1 billion in total, often fi nanced by Russian banks and tycoons.

While mezzanine fi nance is nor-mally viewed as a way to round out a borrowing portfolio, in Rus-sia it has become more mainstream, used by companies cut off from other forms of borrowing as their

main source to fund expansion. “It’s a bit confusing to call this

mezzanine fi nance, as there are sev-eral subtle differences to those deals in the West,” says Mr. Abol-masov. “It’s better to think of this as structured subordinated fi nanc-ing, but this may change over time.”

One of Hi Capital’s deals last year was for A5, a Russian phar-macy that wanted to buy Mos-pharm that the government was privatizing. A fast-growing com-pany, A5 struggled to raise the $135 million asking price. Hi Capital lent them $95 million and helped them structure the deal to sell much of Mospharm’s valuable real estate that came as part of the package.

“We closed the deal to take over Mospharm and on the same day sold the real estate,” Mr. Yashun-sky says. “The benefi cial owners of A5 bought back the equity kicker from us as well, and the total re-turn on investment for that deal was 45%.”

in loans was extended to Cyprus last year by Russia; during the current cri-sis, President Vladimir Putin ordered the country’s Finance Ministry to re-structure this part of the debt.

out of a total of $68 billion held in Cyprus bank accounts belongs to Russian citizens or companies, ac-cording to Moody’s.

$2.5 billion

$30 billion

IN FIGURES

" There’s a lot of Russian money in Cyprus, and a lot of invest-ments coming to our market

under the guise of Cypriot companies. But this is our money. I think [Cyprus] hasn’t been an offshore zone at all since it joined the common [EU] mar-ket; there’s plenty of Russian and Brit-ish money there. But the British are mostly represented by retirees. It’s a quiet island with good weather and wine. Our people [there] are sharp.”

IN HIS OWN WORDS

Victor GerashenkoEX-RUSSIAN CENTRAL BANK CHIEF

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Comment & Analysis

SPENDING OUT OF AUSTERITY

CYPRIOT FLU CAN HURT OTHER NATIONS

The Russian Central Bank has pursued a fair-ly tight monetary policy over the past three years, holding the base rate high at 8.25% in an effort to curb inflation. That was a vital

objective; unlike most Western economies, Russia faced a serious risk of stagflation following the onset of the global economic crisis.

But this policy has some limits because cur-rent infl ation is detremented by institutional factors along with monetary ones. In other words, infl ation is currently being driven not only by the interest rates or money supply policies, but also by the prices charged by the natural mo-nopolies, as well as by weak business activity.

Prices charged by the infrastructural monop-olies are growing 10-15% every year, fueling growth in utility tariffs and related prices. Mean-while, the economy is being sluggish to react to price stimuli. By mid-2012 output had re-turned to the pre-crisis level, but producer pric-es were up 32% on 2008. The economy now needs much greater coordination between mon-etary, structural and institutional policy.

The Central Bank will have to adjust its strat-egy and try to fi nd a better balance between fi nancial stability and economic growth, even though, under the country’s Constitution, it is

I remember how in 1998 then-Prime Minister Sergei Kirienko’s government advised that the preferential tax regime with Cyprus be termi-nated. It shocked the Cypriot leadership — the

island stood to lose half its business. The Cypriot president got a private meeting with Boris Yeltsin and convinced him not to cancel the privileges. As compensation, Cyprus agreed to buy and host an S-300 missile system, which had been paid for but not delivered because of opposition from Tur-key. In those days, Cyprus viewed Russia as a geo-political ally. Even now, Cyprus provides services and support for Russian business. But the country cannot shy away from the fact that in 2004 it joined the European Union, and in 2008 the euro zone. Cyprus is no longer in control of its destiny.

These past few days, German Chancellor An-gela Merkel has spoken a lot about the coun-try’s “dysfunctional” fi nancial model, which has greatly undermined the credibility of the Cy-priot fi nancial system. The central indicator in all this is the ratio of banking-sector assets to GDP, which in Cyprus is seven to one. For com-parison, in Luxembourg banking assets exceed GDP by a factor of 20, in Britain fi ve, while in Germany the fi gure is at the European average of around three. Furthermore, the “dysfunction-al” Cypriot model came about because local banks were forced to write off Greek debt.

It is possible that Cypriot banks were not very fussy when it came to buying Greek bonds, but all EU policy was aimed at saving Greece. Investors were convinced that the euro zone would not let Greece, or any other member, fail.

responsible only for monetary policy and price stability (not economic growth). And there is no reason to expect any surprise moves or dras-tic policy changes when Sergei Ignatiev is re-placed by Elvira Nabiullina as the Bank’s head. The main objective facing Ms. Nabiullina will be to plot a course that maintains macroeco-nomic stability while also fostering economic growth. It is a big challenge, but central banks

in the developed world are increasingly begin-ning to target jobs and growth. The Russian Central Bank cannot ignore these problems, for economic as well as political reasons.

The bank will also face colossal pressure from many quarters to sacrifi ce macroeconomic sta-bility for the sake of economic growth. It may fi nd it difficult to persuade its opponents that growth triggered by such a trade-off is unlike-ly to last, and that in the longer term it would almost certainly lead to a new bout of crisis.

In the current institutional environment, an economic stimulus policy which includes high-

er spending, lower rates, and pumping more li-quidity into the banking system will produce the desired acceleration of growth. But any gains in economic output would then be lost to fu-ture fi nancial turmoil amid growing systemic fi nancial risks and structural imbalances.

Several other social and economic problems will have to be addressed before Russia can enter a sustained period of growth. Macroeco-nomic stability is a top priority. The country’s “credit history” over the past two decades shows the government cannot afford to run the risk of fi nancial and monetary destabilization.

A new economic policy could be based on a transition from the ‘demand-side economy’ to the ‘supply side economy’. Stimulating demand (especially from the public sector) in current circumstances would mostly stimulate imports and infl ation rather than domestic output.

That is why the Russian economy does not need a loose monetary or credit policy, but a balanced development of the fi nancial sector, which should be the facilitator rather than the main engine of economic growth. Sustainable growth should come from a radical improve-ment of the business climate, in the broadest possible sense.

Vladimir Mau is an economist and Rector of the Russian Presidential Academy of the National Economy and Public Administration.

And therein lies one of the major contradic-tions revealed by the current crisis: for politi-cal reasons, investors overvalued eurobonds in the zone’s periphery. Cyprus essentially became a victim of the spillover from the crisis in Greece. The situation in Europe is very fragile: Cyprus can infect other countries, not only because money will fl ee the island. The threat of a tax on deposits has spooked investors in troubled states, and the outfl ow of deposits from the en-tire European periphery could well accelerate.

Of course, the sought-after sum of €17 bil-lion ($22 billion) could be stumped up by the

EU itself, but here it is instructive to note two circumstances. First, Cyprus must demonstrate the ability to save its own skin, which is per-fectly logical because otherwise no country would bother to reorganize its fi nancial system. The second circumstance is far less obvious: it is a politically motivated unwillingness to help the “Russians,” whose funds in Cyprus, accord-ing to the eurocrats, are of “dubious origin.”

It is clear that European governments are fi nding it difficult to convince voters of the need to support peripheral countries. Cyprus is a

Russia’s abundant natural resources and skilled labor force make it a nation of great poten-tial and many in the investment commu-nity believed this would be enough to main-

tain strong growth rates for years to come. However, the success of the 2000s was brought to a halt by the crisis and has been followed by a pe-riod of weak growth.

A paradigm shift in the energy markets – shale gas, the oil revolution in North America and booming oil production in Iraq – have lim-ited the chances of future gains in oil prices. The consumption boom of the last decade, part-ly supported by skyrocketing oil prices, has come to an end. There are now many who are less optimistic about Russia’s prospects. The coun-try has to prove it can use its potential to de-liver strong and sustainable growth, without support from rising oil prices.

From the macroeconomic point of view, Rus-sia had the fortune to come out of the boom years in good shape. In stark contrast to devel-oped and most emerging countries, Russia’s debt-to-GDP ratio stands at around just 10%. Indeed, if you take into account the money Rus-sia has accumulated in different funds, the na-tion is free of debt. In the past couple of years Russia has run a balanced, and in some cases, surplus budget. The 2008-09 crisis proved the value of prudent macroeconomic policies – an area that Russia has continued to strengthen in recent years.

Last year, Russia improved the long-term sustainability of government fi nances by intro-ducing a new “budget rule,” setting a maximum spend based on long-term average oil prices. With this rule in place, any temporary increase in oil prices only results in a further build-up of the reserve fund, not an increase in budget liabilities.

The major change was on the FX market, where the ruble has signifi cantly increased its fl exibility, while the Central Bank has concen-trated on managing interest rates and control-ling infl ation. In recent years, discussions about

Russia’s economy have typically started with a question about the break-even oil price for the budget. However, with the more fl exible ex-change rate regime, the budget’s dependence on oil prices has decreased.

As all Russia’s budget expenditures are ru-ble-denominated, what matters is not the dol-lar oil price but the ruble oil price. And as the ruble now weakens in response to declines in oil price, it means that the ruble oil price (and therefore government revenues and the budget balance) remains relatively isolated from glob-al volatility.

Improvements in the macroeconomic frame-work are not sufficient to achieve strong growth rates alone. This year, the economy is set to show a healthy yet modest growth rate of about 2%-2.5%.

These are not remarkable fi gures – and there are also a number of challenges that will be difficult to overcome. For example, demograph-ics remain the Achilles heel of the Russian econ-omy and are almost impossible to remedy. Given the situation, growth must come from increas-ing productivity, strengthening investment and improving efficiency.

But Russia’s potential growth is trapped below the 3% level by the poor quality of institutions and the investment climate.

The positive news is that Russia has fi nally understood there are no free lunches and that reforms are crucial to reaccelerate growth. Last year, the country fi nally became a fully fl edged member of the World Trade Organization and accession to the Organization for Economic Co-operation and Development is next on the list. Russia currently stands 112th in the World Bank’s Doing Business rating, and although it is ahead of Brazil and India in this league table, it has set the ambitious goal of moving towards the top 20 by 2018. Nobody is under any illu-sions about how hard it will be to achieve this target, but I expect Russia to break into the top 50 within fi ve years.

Russia now has to create a better institu-tional framework and improve the investment and business climate to build on the solid mac-roeconomic base. If it succeeds, Russia could re-emerge with a new, more robust growth model that is more stable and less dependent on the global commodity markets.

We may never return to the high rates of the past, but events of recent years have shown once again that it is better to have lower and healthier growth.

Maxim Oreshk in i s ch ie f economis t fo rRussia at VTB Capital.

Russia was facing a serious risk of stagflation following the onset of the global economic crisis.

THE PATH TO HEALTHY GROWTH

Maxim OreshkinECONOMIST

Alexei KudrinEX-FINANCE MINISTER

Vladimir MauECONOMIST

convenient case to show a tougher attitude.What the upshot will be for Cyprus itself, no

one seems to know. The details surrounding the bankruptcy of Laiki and the rescue of Bank of Cyprus are still uncertain. What is clear is that even these measures will not raise the whole amount or eliminate all the risks.

After Mrs. Merkel’s pronouncement, the is-land’s current status as a fi nancial center is dead in the water. It remains to be seen how the fi nancial fl ows will be affected, but in any case people’s standard of living will fall and many will be unemployed.

Inadequate support on the part of the EU and the ECB may even cause Cyprus to exit the euro zone. In which case, the conversion of bank assets and payment of salaries in the local currency would undermine the fi nancial sector and reduce the quality of life even more than if the euro were preserved. The main danger is that the risk looming over all the peripheral European countries will increase. The crisis will intensify, and it is just a matter of time before the next weakest link emerges.

I believe that the EU bears full responsibil-ity for ensuring the crisis does not spill over. Therefore, it must take all measures to rescue Cyprus. If not, overcoming the consequences of the contagion will be far more costly.

Alexei Kudrin was Russia’s Finance Minister from 2000 until 2011 and was named Finance Minister of the Year in 2010 by Euromoney Magazine for channeling wind-fall petrodollars into a stabilization fund that helped Russia overcome the 2008 Global Economic Crisis.

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As Russia’s budget spending is ruble-denominated, what matters is not the dollar oil price but the ruble oil price. This means that government revenues are relatively isolated from global volatility.

If Cyprus exits the euro zone, the risk looming over all the peripheral European countries will increase. The crisis will intensify and it is just a matter of time before the next weakest link emerges.

Originally published inKommersant newspaper

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Feature

Kizhi has preserved ancient Russian log cabins.

Church of the Transfiguration on the Island of

Kizhi in Russia’s Northwestern region of Karelia.

Few things seem so typically Russian to foreign travelers as wooden buildings.

For those people wanting to see old, wooden churches in remote and natural settings before it is too late, Richard Davies, the author of “Wooden Churches: Travelling in the Russian North” (White Sea) suggests staying in one of the northern towns or cities like Arkhangelsk, Kargopol or Onega.

He also recommends Petrozavodsk as a base from which to visit the staggeringly beautiful churches at Kizhi. The Russian artist Ivan Bilib-in wrote: “I have never seen such an architec-tural fantasy as at Kizhi. You can’t help think-ing that you really are on the threshold of some fairy-tale kingdom.”

Many of the churches Mr. Davies photographed are clustered around the White Sea coast or along the Dvina and Onega Rivers. More ac-cessible are some of the museums of wooden architecture.

Mr. Davies recommends the Malye Karely col-lection near Arkhangelsk. The five-domed Church of the Ascension and other gems of 17th-century architecture have found a picturesque new home here, even if they have lost some of their authenticity.

The Vitoslavitsy Museum near Veliky Novgorod is another great collection in an evocative set-ting. Restored wooden buildings from across the region are ranged on the marshy shore of the Volkhov River.

There are similar museums in Suzdal and near Vologda, in the village of Semenkovo, a short taxi ride out of town. This ethno-archi-tectural museum has examples of wooden build-ings from the past two centuries.

Travel Book offers pictorial guide to Russia’s fairy-tale wooden churches from Moscow suburbs to the Arctic coast

The wonderfully wooded hilly park at Kolo-menskoye, just 20 minutes south of central Mos-cow, has its own museum of log churches and castle stockades. Particularly lovely is the three-domed, 17th-century wooden church of St. George, originally built on the banks of a little tributary of the Dvina River.

There is a working wooden church, dedicat-ed to St Nicholas, in the “Kremlin” at the Iz-mailovsky craft market in eastern Moscow. Ev-erything about the fairy tale landscape here is unashamedly fake. It was all built from wood-clad concrete about 15 years ago, but it is still quite a scenic area, a great place to buy souve-nirs and there are some genuine imperial re-mains on a nearby island, part of the view from the church’s observation platform.

The intricate Church of St. Tikhon in Sokol-niki Park in northern Moscow is also a work-ing church with an interesting history and at-tractive surroundings. The current building is a reconstruction of a 19th-century structure, but its log-burning ceramic stoves and painted benches make it feel older.

Another hidden gem in Moscow’s northern suburbs is the church of St. George in Voikovs-kaya. This thriving church was built in 1997 and closely modeled on the churches of the Rus-sian North. It has fi ve traditional “hipped” roofs with domes and a bell tower and serves the community in the densely populated Koptevsky area. (Take tram 23 from Voikovskaya metro to the market.)

On the other side of the Timiryazevsky For-est, near Timiryazevskaya metro, is the Church of St. Nicholas. Modeled on designs by the great Art Nouveau architect Fyodor Shekhtel, the original church was consecrated in 1916, not a great moment for religious buildings. Many of Moscow’s incredible monasteries include wood-en chapels, often a simple structure over a well. One such building can be found as part of a picturesque ensemble in the village of Kosino,

east of Moscow. The wooden St. Tikhon chapel is nothing special, but the atmosphere of the cloistered, waterside garden by the Beloye Ozero (white lake) makes it worth visiting. You can catch a bus from Vykhino metro station and then walk around the lake.

Suburbs like Kosino give an impression of

village life, if you can ignore the noise of Mos-cow’s ring road, but for proper rural peace you will have to head further afi eld.

For a day trip from Moscow you could try Melikhovo, where Anton Chekhov had his coun-try house. The restored wooden church in the village is just a short stroll from his dacha.

A Taste of Old Russia: Wooden Churches GaloreKarelia in Russia’s far Northwest, under two

hours by plane from Moscow, offers the best

glimpse of a vanishing form of architecture.

PHOEBE TAPLINSPECIAL TO RUSSIAN BUSINESS INSIGHT

The best, but not the cheapest, wine-drinking establishments that Russia’s capital city has to offer:

Bomtempi (1), Gavroche (2) and Grand Cru (3).

GavrocheOn a typical Friday evening, Gavroche is fi lled with creative hipster types, looking to get the weekend started in a relaxing atmosphere. The design of the place is a bit ordinary, but Gav-roche could hardly ask for a better location, near Park Kultury metro in central Moscow.

Some 25 wines – both whites and reds – are available by the glass and more than 100 by the bottle. The price for 150 milliliters of Hugel Gentil 2010 is around $9, which is fairly ac-ceptable for Moscow. But the price of wines by the bottle is rather on the high side for this “democratic” wine bar.

Most of the wines are French, but Italian bot-tlings are also in evidence – the Pinot Grigio Elena Walch 2011 is available for $45 – and a Jaquesson Cuvee Brut costs $143.

www.thewinebar.ru

BontempiAlthough Marco Cevretti is not in charge of Bontempi’s extensive wine list, he’s the person that really makes this place work. Situated just in front of the famous DomZhur (House of Jour-

Food & Drink An insider’s guide to the relatively new phenomenon of wine bars in downtown Moscow

Good Places to Eat, Drink and LearnPeople don’t go to wine bars to be lectured by a

sommelier. But they are still good places to learn

about wine, albeit in a relaxed, hospitable and

social setting. Here are short descriptions of

three of the best wine bars to be found in

Russia’s capital city.

ANTON MOISEENKOSPECIAL TO RUSSIAN BUSINESS INSIGHT

IN HIS OWN WORDS

William Brumfield

"�The rigors of the northern climate produced a shelter environment that excluded or reduced natural light. Hence the urge to create vivid

forms that would catch and reflect the light, wheth-er the tower and cupolas of a church or the decora-tive wooden carvings on the facade of a log house. Such forms, created from materials available in the northern forests, reaffirmed the survival of the com-munity and the innate longings of the soul.”

PRESERVATIONIST, ARCHITECTURAL PHOTOGRAPHER AND PROFESSOR OF SLAVIC STUDIES AT TULANE UNIVERSITY

nalists on Nikitsky Boulevard), Bontempi seems to be always booming with life – partly due to the current trend toward worshipping wine and food, but more because of the great, unconven-tional design of the main area of the bar, which is located below ground level.

And if almost all other wine bars are gener-ally sacrifi cing their food choices on the altar of extensive wine lists, Bontempi is the excep-tion that proves the rule.

www.barbontempi.ru

Grand CruYou can’t lose if you choose a wine bar from the Grand Cru chain. Most of them are actu-ally just wine shops with occasional tastings (if you are lucky enough to be invited to one) and only two are “real” bars with places to sit and sip.

The fi rst one, which also features very good food, is on Malaya Bronnaya Street just beside Patriarch’s Ponds – the famous ponds featured in the Bulgakov’s “The Master and Margarita”. The wine bar is a creation of Maxim Kashirin and serves as the retail division of his Simple Wine importing company, which has a rather impressive fi ne wines and spirits portfolio – probably the best in Russia.

Grand Cru is also famous for its connection with Spanish chef Adrian Quetglas, who con-trols the menu. The prices are not particularly cheap, but people come here for the high level of service and guaranteed wine satisfaction, no matter what their taste buds are up for.

www.grandcru.ru

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CONTACT US : For ed i tor ia l i nqu i r ies , p lease , contac t u s @ r b t h . r u For par tnersh ip o r adver t i s ing contac t s a l e s @ r b t h . r u ph . +7 (495) 775 3 1 14

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