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Russian business in a bind as war enters second year

Hello! This is Alexandra Prokopenko with your weekly guide to the Russian economy — brought to you by The Bell. In today’s newsletter, we’ll look at how Russian business has fared in one year of war and what it expects in the coming months. We’ll also discuss Russia’s suspension of its membership in New START and Xi Jinping’s visit.

Business expects financial pressure, repression in second year of war

Russian President Vladimir Putin is continuing his efforts to consolidate Russia’s elite. In his state-of-the-nation address Tuesday, he spoke directly to the country’s major businessmen, saying their dependence on the West was a strategic threat to Russia and warning they would always be regarded as “second-rate outsiders” in the U.S or Europe. These businessmen often admit in private that they do not support the war. However, they are not willing to make any public statement to that effect — and are gloomy about the future.

What signals is Putin sending?

Putin lavished attention on business at the very start of the war. Within a few hours of the invasion, the Kremlin had summoned about 40 Russian businessmen to a face-to-face meeting. “We will support our businesses in spite of sanctions, and you must be patriotic,” one source familiar with the substance of the meeting described the tone to The Bell.

The real motivation behind this event now seems to have been to cut off any escape route for those in attendance. For example, invites were handed to the heads of Russia’s tech companies such as Ozon and Yandex, who are not usually involved in this kind of gathering. The price of attendance at the meeting was Western sanctions (Oliver Hughes, head of Tinkoff Bank, for example, did not attend the meeting and has not been sanctioned).

In advance of the invasion, the Kremlin repeatedly tried to reassure businesses, warning of “possible turbulence” but adding there would be no long term problems. “It will take a few months, six months at most,” was how a source described Putin’s words at a meeting with business in early February, 2022. “Even participants with the most vivid imaginations could not imagine where this might lead,” another source familiar with one of these meetings told Frank RG. Sberbank head German Gref led a group of technocrats who warned Putin of the economic consequences of war, but they were ignored, the Financial Times reported. “Most people have already moved on from the shock and horror of those first months, but they feel deceived,” said one executive from a state-owned company.

After Western countries imposed sanctions on Russian businessmen in the wake of the invasion, the Kremlin expected this to generate support for Putin. Such a “rally round the flag” effect has worked in other contexts. In particular, when the business community swung behind the Iranian leadership after Western sanctions, it contributed to a rise in domestic production and import substitution. And in 1990s Yugoslavia, sanctions reinforced the popularity of Slobodan Milosevic’s regime and were generally regarded as an attack on the Serbian people. Serbian state television fueled that feeling. Russia’s leadership and its propaganda outlets use similar language about the current sanctions.

Putin has used several public events to issue a rallying call to business:

Three weeks after troops entered Ukraine, Putin spoke of a “fifth column” and “national traitors” at a government meeting. “The freezing of foreign assets and the accounts of Russian companies and individuals is a lesson – you need to invest in your own country,” the president said.
In a speech at the Petersburg International Economic Forum, Putin urged businessmen to “dedicate their futures, and the futures of their children, to Russia.”
In December, Putin declared that people who “take money out” of Russia represent a danger to the country.
And in his state-of-the-nation address this week, Putin said that big business in the country is responsible for strategic enterprises and determines the situation in the regions. Therefore owners’ dependence on the governments of “unfriendly” countries is a threat to Russia and “cannot be tolerated.”

What does business think?

Judging by the mood among Russian businessmen, the signal is getting through. However, the country’s business elites are also tired of the war.

Some businessmen are trying to free themselves and their assets from sanctions — which means steering clear of Russia. Others are trying to avoid drawing attention to themselves, adopting a wait-and-see attitude in the hope that somehow things will improve.

“Forget about business as usual. The task is literally to stay alive and save the business. Or, if your side has already been chosen for you, you need to show your loyalty to reap the benefits,” said one Russian tycoon. “Nobody can be allowed to leave because this demonstrates the failure of the system,” said a top government official.

Many continue to hope that sanctions can be lifted on an individual basis. Indeed, the unexpected lifting of sanctions on former Sevastopol governor Dmitry Ovsyannikov and singer Grigory Leps fuels these hopes. In reality, though, businessmen who spoke with The Bell have had little success in even getting close to achieving such a thing. One major Russian financier recounted his surprise that none of his old contacts among former — and current — European officials would speak to him.

Another top businessman spoke of his frustration with the U.S. legal system: for months, he said, the U.S. authorities have ignored his lawyer’s questions about his inclusion on the sanctions list and U.S. citizens cannot do business with him. “I’m continuing to pay several million dollars worth of taxes in Ukraine, but nobody cares about that,” he said.

Another businessman who has escaped personal sanctions said he has been tarnished by his position on the board of a state corporation before the war. As a result, nobody in the West wants to do business with him (“I can’t even open an account at Revolut,” he said). With each new partnership he has to prove that he has not been to Russia since the start of the war, that he is not earning money in the country and that he pays no taxes there. The only thing that helps is distancing himself from Russia.

Nonetheless, given the choice between sanctions and the “devil they know” some have chosen the latter. “For the last 20 years we’ve learned what to expect from the chief [one of Putin’s nicknames] and his inner circle… Neither regulators nor lawyers can explain how to remove them [sanctions]. At least things are clearer here,” said one federal official. “We are the little people,” said a state banker. “What kind of hero would I make?”

Storm clouds on the horizon

The government and the Central Bank managed to stabilize the economy last year, achieving a GDP contraction of only 2.1%. But this success was based on business quickly adapting its logistics — and, crucially, high energy prices. This year, the authorities are already preparing ways to raise more money: in particular, changes in the formula for calculating oil and gas taxes and discussions about one-time contributions from businesses. In his speech, Putin steered clear of any expensive promises.

The proposal by the government that businesses make a total one-time payment of 200-300 billion rubles provoked a stormy response. Instead, businesses suggested a one-off increase in income tax — many businessmen fear that a “voluntary payment” would create a “blood bond” between entrepreneurs and the Russian Armed Forces. “Paying tax is a sacred duty, any lawyer would agree with that, but how could you go to the Hague and prove the compulsory nature of a voluntary payment?” asked one businessman. However tax increases risk being ineffective — lobbyists can find loopholes or obtain exemptions.

Officials initially said they were categorically opposed to any tax increases. In the end, though, Finance Minister Siluanov said that the funds would be gathered via a “tax mechanism” in the form of a compulsory payment. The money raised will either go directly into the budget, or to the National Wealth Fund to be spent on social or infrastructure projects. Next month will see the annual congress of the Russian Union of Industrialists and Entrepreneurs (RSPP), which brings together Russia’s biggest businesses. Putin usually takes part. Putin’s aide Maxim Oreshkin has suggested that Russian business might take the opportunity to cheer up the president with a new contribution to the state’s coffers.

However, nobody in Russian business anticipates a swift conclusion to the war. A few, who were close to Putin, have apparently managed to negotiate their freedom — billionaire Alisher Usmanov, for example, recently resigned from the RSPP and announced he was retiring from business. Prior to the war, Usmanov sold his VK internet company and now he is seeking a buyer for his other assets, especially in telecoms.

Most understand that the war is the new normal and could even be used as a pretext to redistribute assets (the authorities in Crimea, for example, last year “nationalized” 700 pieces of real estate that apparently belonged to Ukrainian tycoons.

The Bell has interviewed several business owners who said that they were still afraid to publicly state their dissatisfaction with the war because of the risks to themselves and their businesses. Businessmen and officials alike said that they expect to see “disloyal” colleagues exposed and punished over the course of this year.

Why the world should care

One year on from the outbreak of war, Russian businessmen have not yet found the strength to openly oppose the war. First and foremost, they are concerned for their personal safety and the safety of their businesses. However, they are not rushing to rally around Putin, either. They have little hope that the fighting will end this year.

Russia suspends its participation in New START

Russia is suspending its participation in the Strategic Offensive Arms Treaty (New START) — the most recent agreement between Moscow and Washington on reducing nuclear capabilities. Putin announced this in his state-of-the-nation address, suggesting that the U.S. was preparing for nuclear tests — and that if the U.S. did so, Russia would follow.

The Soviet Union conducted its last nuclear test in 1990. Russia has never tested a nuclear weapon. In 1996, Russia signed up to the Comprehensive Nuclear Test Ban Treaty, ratifying the treaty in 2000. The U.S. also signed the deal, but never ratified it. However, Washington has adhered to a moratorium on conducting tests.

The main implication of Russia’s suspending its participation in the treaty is that it becomes impossible to verify the size of Russia’s nuclear arsenal. New START imposes the following limits: 700 units for deployed inter-continental ballistic missiles, submarine-launched ballistic missiles and heavy bombers; 1,550 units for the warheads on them; plus a further 800 units for deployed and non-deployed ICBM and submarine launchers.

Why is this important?

Stéphane Dujarric, a representative of the U.N. Secretary General put it best in comments to Russia’s TASS news agency: “A world without control over nuclear weapons is more dangerous and unstable, with potentially catastrophic consequences. Every effort should be made to avoid this outcome, including an immediate return to dialog."

Xi Jinping is coming to Russia

One of the big stories of the week was the planned visit of Chinese leader Xi Jinping to Russia. First reports of the trip appeared in the Wall Street Journal and were confirmed by Wang Yi, head of the office of China’s Foreign Affairs Commission, when he was in Russia.

Yi visited Moscow at the start of a tour of Europe, which included the Munich Security Council. There, Yi met U.S. Secretary of State Anthony Blinken and Ukraine’s foreign minister, Dmitry Kuleba. Observers began discussing China’s burgeoning plans to act as a peacemaker in the war between Russia and Ukraine. Beijing wants to redouble its peacekeeping efforts as part of a plan to improve its relations with the West, according to the WSJ. On the other hand, China is concerned that military failure for Russia in Ukraine could seriously weaken Moscow. In the Russian capital, Yi met with Security Council Secretary Nikolai Patrushev, Foreign Minister Sergei Lavrov and Putin.

In reality, China is “imitating peacekeeping activities to enhance its reputation in Europe and among developing countries,” said senior fellow Carnegie Endowment for Peace Alexander Gabuev. “We have yet to see any peace plan, but it is likely the wording will be quite vague,” he said. At the same time, Gabuev told The Bell the ultimate goal is to “put the U.S. in an even more difficult position as an aggressor supplying Ukraine with weapons, while also showing Europe and the global south that China is only seeking a peaceful solution.”

Key figures

Industrial output in January was down 2.4% year on year and by 0.6% month by month. Meanwhile, industries associated with the military-industrial sector showed growth: finished metal parts grew 3.6% year-on-year, electronics and optics grew 5.5%;
Inflation in Russia is slowing: from Feb. 14 to Feb. 20 prices increased 0.06%, compared with 0.18% the week before, according to the Ministry of Economic Development. At the same time, annual inflation fell from 11.6% to 11.36%.
In 2022, 17,000 Russians applied for refugee status in the EU, according to figures from the EU Migration Agency. That’s more than twice as many as 2021.

What to watch this week:

The Central Bank reports on the inflationary mood and consumer expectations (Feb. 27)
Weekly inflation in Russia (March 1)