AMBASSADOR'S SEPTEMBER 27 MEETING WITH RUSSIAN

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 010985

SIPDIS

SIPDIS

STATE FOR P, E
STATE EB/IFD/OMA
STATE FOR EUR/RUS, NEA/FO, NEA/I, SA/FO, SA/A
STATE PASS USTR FOR DWOSKIN, MOLNAR, KLEIN
TREASURY FOR D/S KIMMITT, A/S LOWERY, COX/ALIKONIS/BAKER
USDOC FOR 431/ITA/MAC/EUR/RISA EDWARDS AND BEADLE
NSC FOR GRAHAM AND MCKIBBEN

E.O. 12958: DECL: 09/27/2016
TAGS: ECON EFIN ETRD PREL PGOV RS
SUBJECT: AMBASSADOR'S SEPTEMBER 27 MEETING WITH RUSSIAN
FINACE MINISTER KUDRIN

REF: MOSCOW 5629

Classified By: Amb. William J. Burns, Reasons 1.4 (b/d).

Summary
--------------


1. (C) In a September 27 meeting with the Ambassador,
Russian Finance Minister Aleksey Kudrin gave few details on
debt relief for Afghanistan, but noted he hoped to conclude a
bilateral agreement by February 2007. On Iraq, Kudrin said
resolving the Qurna-2 license issue was important but not a
pre-condition for debt relief. He reiterated the GOR's
commitment to continuing banking sector reforms that slain
Central Bank (CBR) First Deputy Chairman Andrey Kozlov had
championed. He said proposed 2007 budget spending increases
would support GOR priorities during the last 18 months of
Putin's term. Kudrin strongly emphasized his personal hope
that a bilateral agreement on Russia's WTO accession will be
concluded this fall. End Summary.


2. (U) In addition to Kudrin, Deputy Finance Minister Andrey
Storchak and Tax Affairs Department Director Mikhail Motorin
attended the September 27 meeting with Ambassador.

Afghan, Iraqi Debt
--------------


3. (C) Kudrin said that bilateral negotiations with Afghan
authorities were underway and that he expected to conclude an
agreement by February 2007. On Iraq, he noted that a
bilateral agreement has already been negotiated; signing of
the accord is all that remains. (Note: This differs from
media accounts of Kudrin's statements on the margins of G7/G8
meetings in Singapore that "technical work was underway" on
Iraqi debt forgiveness. End Note.) He said that Russia's
position on debt relief was connected, "but not directly
connected," to the restoration of Lukoil's license to operate
the Qurna-2 oilfield.


4. (C) Kudrin recounted that Lukoil had hired a U.S. legal
consultant to review the legitimacy of the firm's claim to
Qurna-2 and lamented that the Iraqi government had not made a
decision on the issue since it was raised 18 months ago. He
commented that the GOR was obliged to fly the flag so that
Russian firms would know that the government was promoting
their interests in Iraq. Both Kudrin and Deputy Minister
Storchak maintained that the license issue had not delayed
assistance to Iraq and would not lead to any negative
financial consequences for Iraq.


5. (C) Kudrin added that there have been many positive
developments in Russia's relationship with Iraq. He
highlighted that the Iraqi government was prepared to sign an
MOU on oil-related technical assistance and that Lukoil has
pledged USD 4.5 million to redevelop neglected oilfields.

Expressions of Concern, Hope for WTO
--------------


6. (C) Kudrin expressed concern that during the recent G7/G8
meetings in Singapore, Treasury Secretary Paulson had
"hinted" a review of the financial services section of our
bilateral WTO accession agreement might be forthcoming.
Although he did not specify what issues Secretary Paulson
mentioned, Kudrin told the Ambassador that a more appropriate
time for discussion of Russia's financial sector market
access commitments - further to what had already been agreed
in our bilateral WTO accession negotiations - would be during
Russia's negotiations on OECD accession. The Ambassador
expressed hope that both countries' negotiators would be able
to resolve pending issues in our bilateral WTO negotiations
before Presidents Bush and Putin meet at the November APEC
Summit.

Banking Sector Reforms
--------------


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7. (C) Regarding the murder of Central Bank (CBR) First
Deputy Chairman Andrey Kozlov, Kudrin said that Kozlov was a
man of conviction who, regrettably, irritated many "shadow
economy groups." He noted that Gennady Melikyan's
appointment as head of the CBR's Banking Supervision
Committee was temporary and that officials were looking for
"a stronger candidate" to succeed Kozlov. He stated
matter-of-factly that banking reforms will continue and that
"norms will be tougher."


8. (U) Kudrin explained that the Central Bank recently began
the process of implementing Basel II capital adequacy
standards to consolidate the banking sector, and speculated
that banks unable to comply might be attractive acquisitions.
He said that CBR controls in place following the mini-crisis
of 2004 included close cooperation with the Interior
Ministry, which has improved the pace of some investigations.
Regulatory tools have helped bring some banks into
compliance and have facilitated shutting down others. (Note:
The CBR has revoked 110 licenses since 2004. End Note.)

2007 Budget Overview
--------------


9. (U) Kudrin defended the spending increases envisioned in
the 2007 budget as nominal and in support of President
Putin's goals. He maintained that the budget served the
GOR's goals of reining in inflation, promoting economic
growth, and adding to the Stabilization Fund, which will
continue to grow as long as the per-barrel price of Ural oil
is USD 27 or more. Kudrin clarified that the budget is
balanced when oil is USD 37 per barrel. The GOR is also
developing a proposed legislative amendment that will allow
the government to submit a 3-year budget. He expected work
on the first 3-year budget would begin by June of next year.


10. (U) Kudrin also described the GOR's tentative plans to
institute a so-called Future Generations Fund that would
begin accumulating revenue when the Stabilization fund
reached 7 percent of GDP. (Note: The Stabilization Fund is
currently around 6.5 percent of GDP. End Note.) He
pronounced the proposal as more political than economic or
financial in nature, adding that Norway had developed such a
fund, which now exceeds 100 percent of GDP, to pay for
pension programs. Kudrin said that revenue from the natural
resource sector would finance the Future Generations Fund,
which would invest in as-yet unspecified instruments. The
proceeds from these investments would eventually supplement
the budget. He noted the GOR would elaborate on program
details and goals again in November.

Specific Tax Issues
--------------


11. (C) The Ambassador sought Kudrin's assistance in
reviewing two tax issues that concern U.S. business
interests. Tax authorities have assessed the Caspian
Pipeline Consortium (CPC) USD 170 million in back taxes for
purportedly wrongfully claiming certain 2002 interest
payments as deductible expenses. The case has gone to trial
and the September 15 decision was in favor of the tax
authorities. Senior CPC managers are anxious that
authorities could levy assessments of back taxes of
reportedly up to USD 800 million. They are also troubled by
the prospect of facing criminal charges. In another case,
Pricewaterhouse Coopers (PwC) was alleged to have
fraudulently deducted salary expenses for expatriate
employees. Although the Finance Ministry has issued a letter
explaining that PwC's deductions were consistent with
standard Russian business practices, tax authorities are
continuing with the case and have introduced what PWC
considers immaterial evidence about its work with YUKOS, a
former client.


12. (C) Tax Affairs Department Director Mikhail Motorin
responded that regarding CPC there was nothing to suggest
that criminal charges would be brought or would even be
appropriate. However, he said that the tax rate in question

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was not onerous (Note: implying that the deductions for
interest payments were unnecessary. End Note.) and
maintained that tax inspectors had made a proper assessment.
As for PwC, Motorin stated that the ministry's letter
regarding PwC would be the determining factor. He expressed
confidence that the case,s outcome would correspond with the
message contained in the ministry's letter.

Comment
--------------


13. (C) Kudrin's attempt to play down the connection between
Russia's bilateral agreement on Iraqi debt and Lukoil's claim
to Qurna-2 was unconvincing, but he was eager to emphasize
positive engagement with Iraq on the assistance and
commercial fronts. We will continue to press the GOR on debt
agreements with both Iraq and Afghanistan. We will also
continue to urge the GOR to handle the CPC and PwC tax
disputes in compliance with GOR law and prior understandings
with both entities.
BURNS