Money Is Fleeing Abroad Again

Capital flight, which has drained the economy since the Soviet collapse, is back as fears over Yukos and property rights push Russians to funnel billions of dollars out of the country instead of investing at home.

The authorities are actually encouraging capital flight and discouraging domestic investment through their contradictory actions, foreign investors and economists said.

In doing so, officials risk undermining some of President Vladimir Putin's greatest achievements: economic growth and the perception of stability -- two things Putin says the country needs to be strong after the chaotic 1990s.

"The Yukos affair, random statements by top government officials and clashing policy priorities are not helping the doubling of Russia's GDP and the necessary diversification of the economy from oil-related industries," said Pavel Erochkine, head of research at the London-based Center for Global Studies and a researcher at the House of Lords.

"The government and the Kremlin seem to be encouraging capital flight," he said.

The attack on Mikhail Khodorkovsky and Yukos, the country's largest oil exporter, spooked people with money to spend, while the plethora of conflicting decisions about Yukos shows, some say, a disregard for property rights and a lack of authority on the part of Putin.


Not helping matters is government infighting, as illustrated by a heated exchange at a Cabinet meeting Thursday in which Finance Minister Alexei Kudrin and Economic Development Minister German Gref criticized Prime Minister Mikhail Fradkov for delaying key economic reforms.

Dealing another blow to confidence, the Central Bank sat idly by in May and June as rumors swirled about a looming banking crisis and clients made a run on banks.

Yukos, however, is the single driving force behind capital flight, said Yevgeny Yasin, head of the Higher School of Economics and a former economy minister.

"It is a symbol that the state wants to control the economy, and that has scared business," Yasin said Tuesday. "Capital flight is terrible because we could have used that money to modernize the country."

Capital flight bled Russia white in the chaos following the Soviet collapse. About $25 billion per year -- and perhaps much more -- was sent abroad in the 1990s, and the government attempted to stem the outflow. Last year, capital flight fell to $2.3 billion, and Kudrin told reporters in March that he hoped to record the first inflow ever this year.

But that won't happen. The actual amount of money being spirited abroad is impossible to count, but the Economic Development and Trade Ministry said it will grow to as much as $12 billion this year. Recent data from the Central Bank show money is leaving: Russia had a capital outflow of $5.5 billion in the first half of the year compared with a capital inflow of $3.9 billion over the same period last year.

Fitch Ratings estimates capital flight rose to $31 billion in the 12 months to July, from $20 billion over the previous 12 months. Standard & Poor's and Fitch cite concerns over Yukos and property rights as reasons for Russia's credit rating remaining one notch short of investment grade, known as a junk rating by bond traders.

While oil prices reached record highs this month, the growth of foreign currency and gold reserves has slowed, indicating that more money is leaving the country. The ruble has fallen while bond yields have risen, despite the billions of dollars of export revenue that are swelling the state's coffers. Industrial production growth has slowed.

"The data on the outflow of capital are negative, indicating a reduction in the investment capital that the country needs to develop the economy," said Garegin Tosunyan, president of the Association of Russian Banks, whose members own 90 percent of all banking capital.

Tosunyan said he has seen cases where foreign investors as well have put off investment.

"It seems that the government is trying very hard to discourage even the investors who are most favorably inclined toward Russia," said Hans-Jorg Rudloff, deputy chairman of Barclays Capital, the securities unit of Barclays Bank.

Two major investment banks -- ING Groep, the biggest Dutch financial services company, and Societe Generale, France's third-biggest bank -- pulled out of a loan agreement with TNK-BP recently because of the greater risks in Russia, Reuters reported.

Many potential foreign investors may find it hard to justify the perception of current risks to directors in London, New York or Tokyo.

"Foreign investors have been unsettled by the uncertainty from the banking crisis and the Yukos affair," said Sergei Rusin, a fund manager at Region Asset Management, which has 2.5 billion rubles ($85.6 million) of assets under management.

Nevertheless, some big foreign names, such as BP, Heineken, IKEA and Siemens, have boosted investment, attracted by Russia's unrivaled bazaar of commodities and a six-year economic boom.

The country's wealthiest, however, are less optimistic and leading the pack in sending their money abroad, economists said.

"Pressure on Yukos has undermined the level of confidence among so-called oligarchs, and they have resumed taking large amounts of capital out of Russia," Alexei Moisseyev, an economist at Renaissance Capital, wrote in a recent note to clients. He estimated that capital flight totaled $10 billion in the first six months of 2004.

This bodes badly for the economy, since the wealthiest Russians are the most business-savvy and, according to a World Bank report, already control about one-third of the country's industry.

"Russia needs Russian investment to build her economy, Russian small businessmen to invest and create jobs, but this is the very money that is going abroad," said Bruce Bean, chairman of the Russia/Eurasia Committee of the American Bar Association.

"This is going to hurt the economy. The scary thing is that big investors are not going to say they are putting off investment, they just won't invest. It will be very subtle."

But it is clear that some bureaucrats do not care: With billions of dollars flowing into the country from high oil and commodity prices, the economy is for now insulated from fallout from the Yukos affair.

Too much money sloshing around strengthens the ruble and leads to a rise in inflation, two indicators to which Putin pays a lot of attention in his televised meetings with Central Bank Chairman Sergei Ignatyev.

"Provoking capital flight in an environment of high oil prices is perhaps the only way to simultaneously achieve a weak ruble and reduce inflation," Moisseyev said.

Yasin agreed that some in government circles view capital flight as a tool to reduce inflation and reduce excess liquidity.

"There are some people -- and I won't name names -- who think capital flight is good as excess money leaves the country and that helps reduce inflation," Yasin said.

But producing varying degrees of chaos in some of the best economic conditions Russia has seen in more than 20 years cannot be considered success, and Gref warned at the Cabinet meeting Thursday that capital flight is threatening to put a dent in economic growth.

"The increase in capital outflows that is beginning to show in the second half -- and also the consequences of the crisis of confidence toward banks -- may exert a negative influence on growth," Gref said.

Gref also predicted, however, that capital flight will fall to $4.8 billion next year from $9.1 billion this year.

But provoking capital flight is dangerous because it is difficult to stop and the money is hard to attract back, Bean said. "A large part of capital flight is money that never comes back again -- it goes somewhere else and works for that country's economy," he said.

With dollars flowing into the country from commodity sales, there is too much cash following too few investments, whipping up bubbles in Moscow real estate and dacha country.

Yet the money is not going where it is needed because many sectors remain under the control of the oligarchs and corrupt officials discourage investment, making it simpler to go in search of profits abroad, often to countries in the former Soviet Union.

"Investor confidence has been hit and I don't think Russia has played it very well, but what we are seeing is an export of capital to invest in other places, like Ukraine, Belarus and Georgia," said David Mapley, chairman of Shimoda Group, which has $50 million invested in the former Soviet Union.

"With commodity prices so high, I am constantly racing against Russians who just come in and put the money on the table," Mapley said. "They are buying up everything in places like Ukraine and Georgia."

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