The pressure mounts in Putin's powerhouse

The President has tightened his grip on Russian business, writes Raymond Whitaker in Moscow. But as the cash flows in, does he know how to handle the boom?

Ask businessmen in Moscow or St Petersburg what they think of Vladimir Putin, and you get only one reaction on the record: "I am in business, not politics."

It is not surprising that they should react that way. Last Monday Russia's richest man, Mikhail Khodorkovsky, began his second year in jail. His Yukos oil empire is staggering under the weight of tax demands that could total $10bn (£5.5bn), and the government seems intent on renationalising a hefty chunk of the country's oil and gas industry, which accounts for 70 per cent of growth.

Gazprom, Mr Putin's favoured vehicle, is already the world's biggest gas producer. It is about to absorb state-owned Rosneft, Russia's seventh-biggest oil producer, but second only in gas reserves to Gazprom itself. Mr Khodorkovsky's real crime is seen as political - funding liberal, anti-Kremlin political parties, and possibly entertaining ambitions to run for president himself. But the result of the upheaval touched off by his arrest is that the state will end up with 51 per cent of Gazprom, which may already be the world's biggest company, even before it eyes parts of Yukos.

Another development that makes the business community reluctant to be seen to dabble in politics is the drastic move towards centralisation of power in the Kremlin. If Mr Putin gets his way, provincial governors will be appointed by Moscow, and not locally elected. Constituency MPs will disappear, to be replaced by party lists, another move seen as eliminating grass-roots opposition. Not that critics of the President can get on television to air their views, because every channel is now subservient to him.

All these initiatives are for political reasons - most recently in reaction to the impact of the bloody school siege in Beslan - but there are economic consequences that may or may not be intended.

"The mistake the West makes is to see the state as overwhelmingly powerful," said a foreign banker. "In fact, it is pathetically weak." This weakness has contributed to the atmosphere of crisis in which Mr Putin, an ex-KGB man, has surrounded himself with people from a similar background: nationalistic figures who rose through the security services and the Soviet bureaucracy, and who are happier with state-controlled industry than private enterprise. Many of these attitudes are shared by ordinary Russians. The effect has been to bolster the President's popularity with the public but keep businessmen off balance.

"I don't think there will be another Yukos," said the banker, "but the threat is there. The difficulty today is knowing when you need a permission slip and when you don't. There is excessive blessing-seeking going on."

One of Russia's richest men, who insisted on staying off the record, said it had been natural to seek government approval for the huge Siberian joint venture that brought BP together with Russia's TNK. "It was the biggest deal in Russian history, bigger than the sale of Alaska in the 19th century," he pointed out. But other foreign companies who had felt it necessary to approach the authorities had been greeted with suspicion, and official condemnation of Mr Khodorkovsky for "lobbying" had heightened confusion over what was expected.

The Kremlin's remote and autocratic image does not help. "The only standard of government now is personal loyalty to the President," said an entrepreneur in St Petersburg. "The aim is to concentrate political power, but with it has come power over the economy, and they don't know what to do with it."

According to Alexei Moisseev, chief economist at independent investment bank Renaissance Capital, transparency has decreased in all areas of Russian government. "The Putin government was much more open in its first term, but since he was re-elected it has become worse," he said. "The government statistics compare badly to somewhere like Turkey. Even somewhere like Romania has improved."

While Russian businessmen insist that Yukos was a one-off, they have little access to the top and less insight into how decisions are made. There is disquiet over some actions that have been taken, such as a tenfold pay rise for apparatchiks, and over many examples of inaction, including delays in promised reforms of national monopolies, notably telecoms.

Some console themselves that despite the prominence of numerous bureaucrats of questionable competence, Mr Putin has liberal economists like Andrei Illarionov on his team. On Friday, however, Igor Shuvalov, another of the President's top economic advisers, warned other oil companies that they too could face demands for back tax. How much authority should be placed on his words? Nobody is sure.

The irony is that, partly due to the Yukos affair, world oil prices have soared, and Russia's energy-heavy economy is awash with money. The government is running huge surpluses, but all it has done with the influx of funds is to boost military spending - up 35 per cent since Beslan - and pay off foreign debt. It has yet to revise its economic targets, which envisage inflation falling to around 11 per cent this year and 7 per cent in 2005, as well as a decline in the rouble. These would look unrealistic even at much lower oil prices than most analysts expect. The "Yukos effect" is expected to result in capital flight of $12bn this year, and the banking sector is still feeling the effects of a mini-crisis in May.

All the same, there is a boom-town atmosphere about Moscow which has foreigners desperate to invest. One manifestation of this, appropriately enough, is an explosion of casinos. "Competition is still quite low, and foreigners can succeed here even when they have failed elsewhere," says Oleg Tinkov. "That will end in time, but we are in a phase when anyone who wants to make money can do it. This is the last frontier." Once a "suitcase trader" who shuttled between Warsaw and Moscow, Mr Tinkov has a chain of fashionable restaurants with their own micro-breweries, and exports his beer to the US and Switzerland.

Andrei Korkunov, whose brand of chocolates is marketed under his own name, like Mr Tinkov's restaurants and beer, agrees. "Every dollar invested in 1999 is now worth $10," he says.

In this climate of "managed democracy" and economic fever, the world is being scoured for countries which might serve as models for Russia's future. Two of the favourites are Chile under General Pinochet - for its daring economic reforms, one hopes, rather than its human rights abuses - and Mahathir Mohamad's Malaysia, an example of a commodity-led economy that turned to manufacturing. Turkey and Brazil are frequently cited, but China, an apparently more obvious example, is rejected, not least because of the disparity in population.

Pessimists fear, however, that the closest parallel could be with Indonesia under Suharto. It, too, enjoyed an oil bonanza, and drew up sensible plans to invest the proceeds, only to end up with a hugely corrupt dictatorship that squandered billions on inefficient state-sponsored industries. Could Russia go the same way? The roulette wheel is spinning, but the ball has not yet dropped.

$20BN TO SPEND: BUT WHERE WILL THE WINDFALL GO?

In every debate about Russia's runaway economy, one question dominates all others: what to do with the country's booming "stability fund". Set up at the end of last year to mop up windfall profits from energy exports, it already contains close to $20bn, and could reach $30bn well before next summer if oil prices remain above $50 a barrel into 2005.

Under finance ministry rules, no money from the fund can be used until it reaches $17.4bn, but that level is being passed and there is no shortage of ideas as to how the cash should be spent. The government's instincts are cautious: although its own budget surplus has soared from $2.9bn to $17.6bn, it has announced few plans beyond a rise in military spending and a push to pay official salaries and pensions on time.

What some businessmen call indecision, others consider prudence, arguing that the Kremlin should wait and see what happens to oil prices. They tend to agree with the finance minister, Aleksei Kudrin, that to loosen the purse strings would be inflationary. Still others believe that with state monopolies such as Transneft, the pipeline operator, and the national power utility openly discussing projects they would like funded, the result would be waste and corruption. "The Kremlin knows that the money could disappear into a black hole if the state sector gets its hands on it," said one businessman.

There is no shortage of infrastructure work to be done. Igor Shuvalov, a Kremlin adviser, has suggested spending on railways, highways, airports, powerlines and pipelines, but liberal politicians go much further. They argue that the world's second-largest oil exporter should be using its earnings to close the widening wealth gap in a country where life expectancy is actually falling, and where millions must get by on $20 a week.

Alexander Lebedev, a billionaire banker formerly in Boris Yeltsin's government, calls for a Roosevelt-style "New Deal", aimed at bringing the mass of the population out of poverty and giving them a stake in Russia's unbalanced economy. He points out that development is hugely concentrated in the capital.

Mr Lebedev, however, has no influence in the Kremlin these days, and the instinct of Mr Putin and his circle will be to hold back. What they almost certainly will not do is follow the suggestion of some economists that they could stop taxing as much as 90 per cent of oil companies' profits above $25 a barrel and release some liquidity back into the economy.