China’s rich panda challenges the poor Russian bear’s Turf

by Roman Kupchinsky

The Chinese financial and trade behemoth has begun to slowly make its might felt in the states of the former Soviet Union, a territory proclaimed by the Kremlin to be its scared sphere of influence.

These inroads are not only being made in countries close to China such as Turkmenistan where Beijing has signed important gas pipeline and purchase deals, but are now proceeding further Westward.

Belarus recently announced that it would pay China in Yuan for goods purchased from the People’s Republic. On July 29 the Chinese Central Bank transferred $3 billion worth of Yuan to the Belarus Central Bank in a currency swap.

In terms of local currencies, the Chinese swapped 20 billion Yuan for 8 trillion non-convertible Belarus Rubles. The Yuan will be used to pay China for imports such as potash fertilizers, spare parts, microchips and chip assemblies, chemical products and machine tools.

In 2008 Belarus-Chinese trade reached $2 billion.

One week before the parliamentary elections in Moldova, China, according to the Financial Times on July 28, signed an agreement to loan the “cash strapped, resource strapped country” $1 billion dollars.

The Financial Times noted “The money will be funneled through Covec, China’s largest construction company. It will ostensibly be put towards infrastructure and projects such as energy modernization, water systems, treatment plants, the industrialization of agriculture and the creation of high-tech industries, which Moldova sorely needs.”

Ukraine, meanwhile has avoided approaching China for a loan, but is looking to Asia for investments and on July 16 Prime Minister Yulia Tymoshenko arrived in Seoul, Korea, seeking to encourage Korean investments in Ukraine’s energy sector.

Tymoshenko promised that the Ukrainian government would form a special group of assistance to South Korean investors, which will be headed by Vice Premier Hryhoriy Nemyria.

"We will create special mechanisms of cooperation. A special group will be operating under Ukraine's government, which will be promoting your investments into the fields of cooperation with Ukraine," she said.

Nonetheless, Tymoshenko has also stated that Ukraine hopes to step up its trade and economic cooperation with China.

"We hope that our mutual relations will continue developing actively as well, but apart from that, we hope to step up cooperation concerning potential investment in Ukraine's economy by Chinese businessmen," she said at a meeting with Chinese delegates in Kyiv on June 26.

Chairman of the China Council for the Promotion of International Trade Wan Jifei, in turn stated that 2008 had been one of the best periods in the development of trade and economic relations between Ukraine and China.

Jifei said that representatives of 50 Chinese companies, representing such areas as engineering, the energy sector, electronics, and light industry, had arrived in Ukraine to attend various business forums and exhibitions.

"We consider today's meeting as one of the most large-scale events in recent years, and we hope to deepen our cooperation," he said.

How the Kremlin will react to Chinese trade and financial initiatives in the former USSR is unpredictable, but the possibility exists that it will be viewed with suspicion by a highly aggressive Kremlin looking to consolidate its regional power.

Budget Deficit to Devour Russia's Reserve Fund in 2010

by Alexander Melikishvili

On Monday, July 27, the Director of the Department of Budgetary Assessments of the Russian Ministry of Finances Alexei Lavrov held a press briefing in which he provided at least partial empirical confirmation of U.S. Vice President Joe Biden's remarks to the Wall Street Journal regarding the pitiful state of Russian economy. At the press briefing, which was organized on the eve of submission of the draft federal budget for 2010 for the approval of the Russian federal government scheduled for today, Mr. Lavrov presented the overview of the draft budget, which contained the following highlights:

- The Reserve Fund, one of the two Russian sovereign funds, is expected to be depleted by the end of 2010 because the government will use it to cover the growing budget deficit. It should be noted that as of July 1, 2009, the Reserve Fund amounted to 2.96 trillion rubles ($95.1 billion), but Prime Minister Vladimir Putin's decree issued on July 22 will decrease it by 1.36 trillion ($43.7 billion) to finance the state budget in the third quarter, and in 2010 the remaining 1.6 trillion rubles ($51.4 billion) will be spent for the same purpose. The Economist already called this measure "an astonishingly rapid depletion of a huge fiscal reserve."

- Russia's other sovereign wealth fund, the National Welfare Fund, which amounted to 2.8 trillion rubles ($90 billion) as of July 1, 2009, is expected to decrease to 2.3 trillion ($74 billion) by the end of 2010, and it will be further reduced to 1.6 trillion ($51.4 billion) in 2011, and to 940 billion ($30 billion) in 2012, according to the projections released by the Russian Finance Ministry.

- The state budget deficit this year will be equal to 9.4 percent of the gross domestic product, while in 2010 and 2011 it is expected to account for 7.5 and 4.3 respectively. As this exhaustive compilation of the Russian news reports of Lavrov's briefing indicates, the Russian Finance Ministry bases the aforementioned projections on a rather conservative estimate of oil prices, which are pegged at $55 per barrel in 2010, $56 in 2011 and $57 in 2012 (for comparison, on Wednesday the price was registered at $63.04 per barrel).

- Finally, for the first time since 1998, the Russian Finance Ministry will sell abroad 613.6 billion rubles ($20 billion) worth of Eurobonds in 2010 to finance the state budget shortfall. As Reuters reports, over the next three years the Russian government plans to borrow abroad $58.6 billion. As a result, by 2012 Russia's foreign debt will amount to 16.4 percent of the GDP.

Such a drastic reversal in the financial fortunes will invariably have an impact on Russia's foreign and, possibly, domestic policy over time. Undoubtedly much depends on the price of oil, but if the current trend continues, then the Kremlin may suddenly become more malleable and certainly more cooperative on the issues of importance to the United States and its Western allies, including strategic arms control, North Korea and Iran. While this does not necessarily mean the repeat of the 1990s, the more the Russian economy is dependent on Western financial infusions the more it is likely that the Kremlin will start to behave less as a spoiler on the international arena. In this regard, President Medvedev's surprisingly candid admission of Russia's inferiority in the strategically important area of supercomputers in his speech delivered at the National Security Council meeting on Tuesday, provides a rare glimpse at Kremlin's new found humility. However, as to whether this will force the Kremlin to abandon its idée fixe of the "sphere of privileged interests" (which the Russian officials repeatedly fail to define) in the post-Soviet space remains to be seen.

Russia Releases One of FBI’s Most Wanted Suspects

by Roman Kupchinsky

On July 27, Irina Dudukina, a spokeswoman for the Russian Interior Ministry’s Investigative Committee, announced that suspected organized crime boss Semyon Mogilevich, a man on the U.S. FBI’s most wanted list for fraud and racketeering had been released from prison. He and his co-defendant, Vladimir Nekrasov, had been released after signing statements that they would not flee the country.

Mogilevich was arrested in Moscow in late January 2008 along with Nekrasov, the owner of a chain of cosmetic stores, Arbat Prestige, on charges of tax evasion.

The FBI claims that Mogilevich headed a criminal organization based in Budapest in the 1990s which ran the so-called YBM Magnex scheme which defrauded U.S. citizens of hundreds of millions of dollars.

Mogilevich, and his co-conspirator, Igor Fisherman, fled to Moscow where they were safe from extradition to the U.S.

The Russian Constitution does not allow for the extradition of Russian citizens, even suspected organized crime bosses, and apparently insists on keeping them and their stolen wealth safe at home. The Kremlin, on the other hand, demands that indicted Russians living abroad be sent back to Russia from foreign countries to stand trial on often trumped up criminal charges.

In June 2009, a Moscow court refused to release Mogilevich on the largest bail ever offered in post-Soviet Russia – 120 million rubles per accused – on the basis that he might flee the country. However, on July 26, Dudukina said that the Interior Ministry had a sudden change of heart and decided that the charges “are not of a particularly grave nature so investigators had no particular reason to keep them imprisoned.”

The Mogilivich organization, according to the FBI director,was engaged in drug and weapons trafficking, prostitution, money laundering and stock fraud. He has been on the FBI’s wanted list since 2003. Ukrainian-born Mogilevich has denied U.S. allegations that he is a crime boss.

But,many experts believe that the real reason for Mogilevich’s arrest, has nothing to do with tax evasion for a chain of perfume outlets.

The WSJ reported on January 26, 2008: “In Washington, U.S. officials said they believe the arrest (of Mogilevich) is related to Kremlin intrigues involving the gas trade. The Justice Department's Organized Crime and Racketeering Section is investigating possible links between Mr. Mogilevich and a Ukrainian-Russian trading company that is central to the multibillion-dollar trade in Russian natural gas across Ukraine and on to Europe. His representatives and the companies involved have denied any ties.

“In Philadelphia, a federal court charged him in 2003 in a 45-count racketeering indictment and of masterminding a stock fraud using a web of shell companies in Europe. U.S. officials believe Mr. Mogilevich used $150 million of his winnings from the U.S. to invest in the gas business... "The arrest of someone this big had to come from the president himself or from the circle around the president," said Vladimir Ovchinsky, former director of Russia's Interpol bureau.”

The unnamed gas trader was RosUkrEnergo (RUE), the Swiss-based company which was 50 percent owned by Russia’s Gazprom and 50 percent by Ukrainian businessman Dmytro Firtash.

RUE, according to Ukrainian Prime Minister Yulia Tymoshenko, was linked to Mogilevich – thereby implicating Gazprom, Vladimir Putin, Dmitry Medvedev and others in the Kremlin of committing high crimes.

Eurasian Energy Briefs

UNIAN Press Agency

by Roman Kupchinsky

Ukrainian news agency UNIAN reported on July 25 that gas prices for domestic household consumers and communal energy companies will rise by 20 percent. The rate increase for communal energy will go into effect on October 1 and for household consumers on September 1.

The price increase was published on the website of the National Energy Regulating Committee; however UNIAN noted that the statement did not include the date this decision was reached.

The official announcement further stated that beginning January 1, 2010 there will be quarterly increases of 20 percent until the price of gas for consumers in Ukraine equals the price paid for imported Russian gas.

Currently Ukrainian’s pay between $51-$80 for 1,000 cubic meters of gas while the average annual price for imported Russian gas is $228/1,000 cubic meters. The difference is subsidized by the State budget.

The impact such an increase will have is many fold.

1. It will help clear the way for a loan of $1.2 billion from European banks to Naftohaz Ukrayina, the state- owned energy monopoly, and allow it to buy gas from Russia needed to insure reliable transit of Russian gas to the EU in the upcoming fall/winter heating season.

2. The price increase will help fill the coffers of Naftohaz which has been on the brink of bankruptcy for the past several years.

3. Higher prices often force a decrease in consumption. This is especially vital for Ukraine which is one of the least energy efficient countries in the world.

4. The increase was announced at the beginning of what promises to be a highly contested presidential election due to be held in January 2010. It might provoke a backlash from already impoverished consumers and work to the detriment of Prime Minister Yulia Tymoshenko, one of the major presidential candidates.

The financial woes of Naftohaz were the subject of a study on the Ekonomichna Pravda website

This study claims that if Naftohaz were to go into bankruptcy it would create a major legal problem as to who in Ukraine is legally entitled to buy Russian gas and who is responsible for fulfilling the binding transit contracts delivering Russian gas to the EU.

The largest creditors of Naftohaz are two Ukrainian banks –Oschadbank and Ukreksimbank - and they would stand to lose the most, even with an increase in the statutory fund of Naftohaz by the government.

Any attempt to bankrupt Naftohaz would need to have the approval of the Ukrainian parliament – an impossible task given the current divisions in that body according to the website.

“Clothing the Bear” and the Closing of Moscow’s Cherkizovsky Market

(visualrian.com)

by Roman Kupchinsky

For many years the largest and most popular open air market in Moscow was the Cherkizovsky. Filled with kiosks selling cheap clothing, electronics, carpets and shoes manufactured in China; imported to Russia by Chinese traders, it more then met the demand of Moscovite consumers but also supplied markets in Russia’s outlaying regions where consumers were constantly on the prowl for a good deal, even before the world economic crisis hit.

“Cherkizovsky was the biggest market in Eastern Europe, a sprawling bazaar where an estimated 5,000 buses arrived at the market every day; filled with shuttle traders who would buy up cheap goods in bulk and take them back to smaller markets in towns and cities across European Russia.” Its closing on June 29, 2009 has now become an international scandal.

The market place employed some 80,000 Chinese and Vietnamese citizens, many of whom were illegal immigrants. It was also known as the place where narcotics could readily be bought at cut-rate prices and that the Russian mafia was involved in this trade.

For years the Russian customs service suspiciously overlooked what was being imported for sale at the market. Apparently officials of the customs service were instructed to turn a blind eye to the legality of the imports and were handsomely rewarded for their lack of diligence by the traders – and their own bosses - who also allegedly took bribes. How far the bribes went up the ladder has not been revealed yet, but some are speculating that Moscow Mayor Yuriy Luzhkov might be implicated.

When the market was closed, some $2 billion in goods were confiscated by officials from the Ministry of Internal affairs. What became of these goods is now being questioned by high level Chinese officials who arrived in Moscow to investigate the case. The suspicion is that the Russian MVD will soon sell these goods on the black market and make millions of dollars.

According to the newspaper Vedomosti, Chinese authorities are mostly upset by the fact that the market was shut down without proper prior notice. The Russian Ministry of Internal Affairs however, insists that the closing of the market was not a discriminatory act again Chinese nationals. Despite this, the Chinese press and websites are outraged. One Chinese website stated that Russia has turned into a “naked bear” which will freeze in the first frost without Chinese made apparel.

The Chinese delegation which arrived in Moscow to investigate the closing of the market placed the blame for creating shady customs schemes on the Russian customs service and, according to Vedomosti, are threatening to retaliate by possibly reviewing the recent agreement to extend a major credit to Russia’s Rosneft.

In the midst of this conflict, Russian Prime Minister Vladimir Putin was only able to ask why nobody had been arrested – as if he did not know who was responsible for the scams.

Georgian-Russian Spy Row Preceded Vice President Joe Biden's Visit to Tbilisi

by Alexander Melikishvili

On Tuesday, July 21, on the eve of the U.S. Vice President Joe Biden's July 22-23 official visit to Tbilisi, the Georgian television company Imedi aired a news report in which the Secretary of Georgia's National Security Council Eka Tkeshelashvili stated that Georgia refused the entry to two unnamed Russian diplomats, who were supposed to assume their responsibilities at the Russian Federation's interest section* in the Embassy of Switzerland in Georgia as part of the regular cadre rotation. According to Tkeshelashvili, the Georgian government's refusal was based on the suspicion that the two were engaged in espionage activities and were affiliated with the Russian intelligence services. In her comments to Imedi regarding the diplomatic scandal, Tkeshelashvili noted,

"It is a sovereign right of any state to identify those people, who work at the diplomatic representations. Each country has the right to allow or to refuse the entry to diplomats, against whom there may be serious suspicions that they work for other services."

In response, the Russian side ordered two Georgian diplomats, including the Consul of Georgia in the Russian Federation, Zurab Pataradze, who was declared persona non grata, to leave Moscow. According to the Imedi news report, the diplomatic row took place two weeks ago. Although, later an unnamed Georgian government source told The Moscow Times that the reciprocal expulsions occurred in May.

However, the Russian side disputed the details of the diplomatic row and provided a pointed interpretation of why it was publicized by officials in Tbilisi. A Russian diplomatic source told the Russian news agency Interfax that the "exchange of diplomats" occurred in April and that neither of the two Georgian diplomats was declared persona non grata. Officially they were simply recalled and the two sides agreed not to use the incident for public relations purposes against each other, according to a source in Interfax with contacts in Russian diplomatic circles. On July 21, responding to Tkeshelashvili, the official spokesman for the Russian Ministry of Foreign Affairs, Andrei Nesterenko stated,

"Any action taken by this side or that, which deviates from customary practice, is, of course, regretful. A diplomat's work entails rotation of cadres and in this regard Russia follows the appropriate agreements. Usually in such cases, if a justification [for expulsion] is not based on logic or diplomatic explanation then, as a rule, adequate steps are taken in order to maintain the normal diplomatic parity."

The significance of the row can also be judged by the fact that the Russian Foreign Minister Sergei Lavrov found it necessary to comment on the sidelines of the 16th session of the ASEAN Regional Security Forum in Phuket, Thailand. Lavrov confirmed that the incident took place "some months ago" and added, "The Georgians had asked us not to publicize it, yet now they did it themselves and I have difficulties telling you why." Finally, the Russian Deputy Foreign Minister Grigory Karasin interpreted the diplomatic scandal as yet another demonstration of the Georgian government's anti-Russian policy timed to coincide with Vice President Joe Biden's visit to Tbilisi. Karasin derisively noted, "The Georgians are clumsily trying to use the spy theme to show their high-ranking guest their presumed strength and resolve."

* NOTE: Since the August 2008 war, diplomatic relations between Russia and Georgia have been significantly downgraded to the level of interest sections which mainly handle consular and limited diplomatic affairs. At present the Georgian interest section at the Embassy of Switzerland in Moscow and the Russian interest section at the Embassy of Switzerland in Tbilisi represent the only diplomatic presence of the two countries on each other's territory.

Reforming the Ukrainian Gas Sector

by Roman Kupchinsky

Can the Ukrainian natural gas sector be reformed? For the last two decades the Ukrainian gas business has been one of the least transparent and reportedly most corrupt and mismanaged sectors of the economy. Will this begin changing in 2009-2010?

Ukrainian policy makers and politician’s have resisted reforms tooth and nail because if they were implemented they would not only abolish a system which was so profitable for the political and economic elites, but would further impoverish an already poor population.

However, once the price charged for Russian gas reached European market levels in 2009; hastened by a debilitating shutdown of gas supplies to Europe in January 2009, the European Commission had had enough and began demanding immediate demonstrable reforms.

By June/July 2009 the European Commission finally had the leverage it needed to force Kyiv into taking action. Ukraine lacked the $4 billion needed to pay Russia’s Gazprom for gas to insure uninterrupted supplies to the EU during the fall/winter heating season. Prime Minister Yulia Tymoshenko had asked Russia for a loan - which was rejected - so she turned to the Commission with her request.

At the heart of the problem is the domestic pricing structure for Ukrainian produced gas which is sold to regional communal heating companies which supply heat and hot water to domestic consumers. The price currently charged communal heating companies is $154 per 1,000 cubic meters while the price of Russian gas is $228/1,000 cubic meters – a difference of $74 which is subsidized by the state budget.

On July 17, European banks demanded that these state subsidies end. According to the Commission spokesman Mark Grey, a decision on extending credits to Ukraine will be announced only after the Ukrainian government provides a definitive date when the subsidies will end.

Meanwhile the head of the Ukrainian National Regulating Commission for Power, Valeriy Kalchenko, stated the price of gas for consumers “does not make any economical sense”.

Yet Prime Minister Yulia Tymoshenko, immersed in an upcoming bitter presidential campaign, expressed doubts that the price of gas for Ukrainian consumers will rise in 2009. “Do not believe in rumors. I ask you to wait for the signing of a memorandum and then it will become clear if there will be a price increase or not”.

Earlier, Tymoshenko had promised to increase consumer prices in 2009 by 20 percent, a bare minimal which will not solve the problem according to experts. What is needed is a far greater increase, a proposition few in the Ukrainian government are willing to endorse at this time.

Are reforms likely? Many observers believe they will be postponed until 2010 or later. If so, Europe could well expect another gas delivery crisis this fall.