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"Russia is both a European and an Asian state," President Vladimir Putin once told a Chinese interviewer. "It is like a bird that can only fly well if it uses both wings." Watching the signals coming from the Kremlin in recent months, one gets the impression the Russian bird thinks it's been flying lopsided for too long.
Amid worsening relations with the West, Putin has taken a series of political and business steps aimed at boosting Russia's ties with Asian nations, in particular emerging economic powerhouses China and India. And in moves analysts say could hurt western economic interests in Russia, Putin appears to be increasingly looking to the East both for business partners and for inspiration on how to run the Russian economy. "In a world where Putin wants to rebuild Russia's importance on the political stage, it makes a lot of sense for him to strengthen relationships with China and India," says Chris Weafer, chief strategist at Moscow's Alfa Bank. "Putin is also looking at the Chinese economic model and liking what he sees: a strong state role in an economy that's attracting a lot of investment."
Moscow's political relationship with the West has been on a downward spiral since Putin's election to a second term last March. Initially seen in the West as a stable and reliable partner--a welcome change after the turbulent final years of Boris Yeltsin's rule--Putin is now coming under increasing fire for his autocratic methods. The United States in particular has changed its tune. U.S. officials, who once shied away from criticizing Putin, now launch regular attacks on everything from his democratic record to the war in Chechnya. In a meeting with Russian Foreign Minister Sergei Lavrov earlier this month, Secretary of State Condoleeza Rice raised concerns over attacks on private enterprise, a clampdown on the media and the increasing concentration of power in the Kremlin.
Ukraine seems to have been the final straw. The feeling in the Kremlin is that Russia has "lost" traditional ally Ukraine with the election of Viktor Yushchenko. The pro-western reformer won a run-off vote late last year after hundreds of thousands of Ukrainians took to the streets to protest the allegedly fraudulent election of the Moscow-backed prime minister, Viktor Yanukovich. Putin has himself described Ukraine's "Orange Revolution" as a western attempt to isolate Russia and strip it of regional influence. "The sense in the Russian elite is that the West has rejected Russia, that the United States and the European Union feel that they don't need Russia," says Yevgeny Volk, a political analyst with the conservative Heritage Foundation. "So Russia is looking for new partners, and it sees in China and India countries that are closer to Russia, both politically and economically."
In December, Russian defence officials announced the country would be holding its first-ever joint military exercises with China this fall, involving, among other things, the deployment of Russian troops on Chinese soil. In early February, Putin and a visiting Chinese official announced the two nations would start holding regular security consultations--the first time China will do so with another country. Russia has also been pushing for closer economic ties with both China and India. During Team Canada-style visits to China in October and to India in December, Putin signed agreements with both countries aimed at boosting trade.
The dismantling of Russian oil giant Yukos, which has been a lightning rod for western criticism, offers a prime example of the new course the Kremlin appears to be steering. Critics have accused Putin of going after Yukos because its CEO, billionaire Mikhail Khodorkovsky, was backing opposition parties. Khodorkovsky was arrested in October 2003 on charges of tax evasion and fraud, and remains in detention while his trial creeps forward. At the same time, authorities hit Yukos with a multibillion-dollar back-tax bill and rebuffed all efforts at negotiating a solution. In December, Yukos was essentially renationalized when an unknown company, Baikal Finance Group, picked up its main asset, Yuganskneftegaz, at a government auction for US$9.3 billion. Shortly before the new year, state-owned oil firm Rosneft announced it had bought Baikal and was in control of Yugansk.
The government promptly turned around and offered stakes in Yugansk to China and India, both starving for energy. (Car ownership in China alone is growing at a rate of 20% a year.) In late December, Russian Energy Minister Viktor Khristenko said Russia may offer 20% of Yugansk to the China National Petroleum Corp. A few weeks later, officials in New Delhi said India's Oil & Natural Gas Corp. was itself negotiating a deal to acquire at least 15% equity in Yugansk.
In fact, China may even have been involved in financing Rosneft's purchase of Yugansk. Russian finance minister Alexei Kudrin recently let slip that state-owned Vneshekonombank "borrowed $6 billion from Chinese banks to credit Rosneft" for the purchase. Rosneft and Chinese officials moved quickly to deny any link, saying that the money was payment for oil sales through 2010 and wasn't a loan for the Yukos purchase. Kudrin said he had been misunderstood.
Analysts here remain convinced China played a key role in securing the Kremlin's takeover of Yugansk. Alfa Bank's Weafer says the opaqueness of the deal helps explain why Russia is keen on eastern business partners. "How can I put this diplomatically? Indian and Chinese partners are more flexible than highly regulated and transparent western companies," he says, adding that the Yukos deal "featured a collusion of intransparency that would have been impossible if a western company were involved."
More worrying for western investors, however, is the sense that Putin is increasingly drawing inspiration from the Chinese way of doing business. "Instead of having foreign companies buying assets in Russia, he is looking to have Russian companies buy them and invite foreign investment," Weafer says. "Putin has several times identified that aspect of the Chinese model as one Russia should follow."
Analysts say that with the purchase of Yukos, the Kremlin is setting itself up as the dominant force in Russia's energy sector, which accounts for nearly 30% of gross domestic product. State-controlled Gazprom, which already has a stranglehold on Russian gas supplies, is expected to merge with Rosneft this year, making it a global energy giant second only to Saudi Aramco in terms of output and exports.
After consolidating its control of energy flows, the Kremlin is expected to move on to other strategic sectors, in particular mining and metals. With 55% of total Canadian investment in Russia (estimated at about US$1 billion in 2003) in the mining industry, that could prove especially troublesome for Canadian companies. Signs are already emerging of a clampdown on foreign purchases of mineral assets. At a gold conference in Moscow earlier this month, the deputy head of Russia's Natural Resources Service, Vladimir Bavlov, said the government is likely to bar foreign firms from upcoming tenders for the right to tap two coveted deposits: the Sukhoi Log goldfield and the Udokan copper deposit. Toronto-based Barrick Gold Corp. (TSX: ABX) was among western firms expressing an interest in developing the Sukhoi Log field, which accounts for about one-third of Russian gold reserves.
Another Canadian gold miner, Toronto-based Kinross Gold Corp. (TSX: K), has recently run into problems at its Kubaka mine near the Far Eastern city of Magadan. Christopher Hill, Kinross's vice-president of investor relations, says local officials are claiming the company has been deducting a 4% management fee from its tax bill and owes US$8 million in back taxes and penalties. "They've challenged us on this item in the past, but the courts have always ruled in our favour before," Hill says. "Now we're meeting some reluctance from the courts." Kinross recently cited "an unpredictable tax climate" as one of the reasons it has decided not to develop a second gold vein near its existing operations.
It's unclear whether Russia, through such moves, is trying to pave the way for increased co-operation with Asian partners in the mining sector. With recent acquisitions in Latin America and the bid by China's Minmetals Corp. to acquire Canada's Noranda Inc., the Chinese have certainly shown an interest in becoming a major player in global mining. Still, some analysts are warning against reading too much into recent events. "It simply makes commercial common sense for Russia to be looking at Asian energy markets right now," says Christopher Granville, chief strategist at Moscow's United Financial Group, a leading investment bank. "Putin is a pragmatic leader and that is what's guiding this, not some grand new strategic shift. I don't see some zero-sum game of western or eastern markets."
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