MINFIN OFFICIAL ON KUDRIN RUMORS, INVESTMENT

C O N F I D E N T I A L MOSCOW 002316

SIPDIS

STATE FOR EUR/RUS; NSC FOR MWARLICK

E.O. 12958: DECL: 08/08/2018
TAGS: ECON EINV ETRD PREL PGOV RS
SUBJECT: MINFIN OFFICIAL ON KUDRIN RUMORS, INVESTMENT
CLIMATE, WTO ACCESSION

Classified By: Minister Counselor for Economic Affairs Eric Schultz for
Reasons 1.5 (b) and (d).

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Summary
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1. (C) In an August 6 meeting with ECMIN, Finance Minister's
Kudrin,s Assistant, Vadim Grishin, dismissed rumors of
Kudrin's impending departure, which he said were the result
of sharp internal GOR budget negotiations. He said Kudrin
had arranged a delay in the BONY case, providing time for a
compromise to be negotiated, but added that the Finance
Ministry had no authority to intervene in the TNK-BP dispute,
which he acknowledged had affected investor confidence.
Grishin said the GOR had also mishandled the Mechel case,
further depressing the markets and weakening the economy.
However, the Finance Ministry saw a silver lining in the form
of slower growth, which could help cool the economy and
reduce inflation. Grishin said he was increasingly
pessimistic about the chances of WTO accession for Russia
this year and said failure could have global consequences.
End Summary.

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Tough Internal GOR Negotiations
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2. (C) Grishin acknowledged that rumors Kudrin might be on
his way out were gathering steam. However, Grishin said
there was no substance to the rumors. They were being spread
by Kudrin's opponents within the GOR. Grishin noted that
these rumors peaked at about this time very year, when the
GOR was negotiating the annual budget. Kudrin's job was to
try to hold the line on public spending and his efforts to
impose fiscal discipline put him at odds with many of the
other ministries. Grishin added that while there might be
some small changes to the cabinet in the fall, he did not
expect any major changes, especially to the economic
ministries given the current uncertain global financial
environment.


3. (C) Grishin said one of the most contentious disputes on
going within the GOR was over a reduction in the VAT. Kudrin
strongly opposed a cut, arguing that that it would make the
government budget more dependent on oil and gas taxes and
therefore subject to the tremendous price volatility in that
sector. Kudrin also believed that the problem with VAT was
not the rate but the government's administration of the tax.
There were too many loopholes, which allowed excessive
rebates to companies and individuals and reduced government
revenue. The Presidential Administration favored a
substantial cut, especially Presidential Assistant
Dvorkovich, in order to stimulate faster and better economic
growth. Dvorkovich's former assistant, now Deputy Economic
Minister, Voskresensky also strongly favored a cut in the VAT
but his Minister, Nabiullina, was more cautious and was
trying to broker a compromise proposal.

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BONY/TNK-BP
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4. (C) Grishin said Kudrin had personally intervened in the
Federal Customs Service (FCS) case against the Bank of New
York (BONY) to secure a postponement until October 6. Kudrin
hoped, according to Grishin, that the two sides would use the
hiatus to negotiate a resolution of the case. BONY Officials
had undoubtedly been involved in some shady dealings in the
1990s in Russia and had admitted as much in the U.S. case
against them. However, the Finance Ministry did not believe
it was in Russia,s best interests for this case to be
decided in a Russian court, especially if the court relies on
the U.S. RICO statute to make a decision.


5. (C) ECMIN asked whether the same logic did not apply to
the TNK-BP dispute. Grishin responded that the Finance
Ministry had made its views on the case known; that the
dispute was hurting Russia economically. However, it was not
his Minister's area of responsibility. Deputy Prime Minister
Sechin was overseeing the case.

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Mechel
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6. (C) Grishin explained that the GOR had also erred on
Mechel. Again, there was no question that there was a case

to be answered by Mechel's management over their use of
transfer pricing to evade taxes. However, the GOR was still
learning how to manage an economy in which the stock market
was a major player. The public attacks had been a mistake,
causing an unexpected downturn in the stock market, which in
turn was hurting the overall economy. Grishin stressed that
it was not a "political process" but a legal one. Still, he
expressed hope that the GOR would learn from this incident
and be more careful in the future over market reactions.

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Inflation
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7. (C) Grishin added that, perhaps counter-intuitively, the
Finance Ministry saw an upside in the market's reaction to
Mechel since it was anti-cyclical and was helping to cool the
overheating economy. In that regard, Grishin acknowledged
that Russia might be nearing the end of the current business
cycle. Slowing economic growth was likely, and that might be
the best way to reduce inflation. While inflation had
softened from June to July, this reflected a seasonal
weakening of demand rather than any lasting downturn driven
by policy shifts. In fact, Grishin noted, the GOR had weak
tools to fight inflation and if the VAT was cut the resulting
stimulus was likely to exacerbate inflation even further,
another reason Kudrin opposed the cut.

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WTO Accession
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8. (C) Grishin said he would rate the chances of Russia
acceding to the WTO this year at less than 50 percent.
September and October would be the last chance to make it
this happens this year. However, momentum was slowing and we
appeared to have hit a spot where countries were adding more
new items to the agenda than were being struck off by the
negotiators. In that regard, he pointed to the absence of an
agreement with the U.S. on state-owned enterprises (SOEs),
which had opened the door for Saudi Arabia and others to
raise this issue in Geneva.


9. (C) Grishin said failure this year would greatly
strengthen the hand of the domestic opponents of WTO
accession. Emboldened critics in the Agriculture Ministry
and elsewhere would press for more protectionist measures.
Grishin added that the Finance Ministry's view was that
Russia's failure to accede, the last large economy outside
the WTO, coming on the heels of the failure of the Doha
round, would also undermine the WTO internationally.

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Comment
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10. (C) The Russian economy has hit a rough patch, the most
visible symbols of which are high inflation and the
precipitous drop in the stock market. Growth remains strong
but investor confidence is down and risk premiums are rising.
Most analysts, economists and businessmen with whom we talk
believe that the GOR is capable of managing a downturn in the
business cycle, provided Kudrin remains at the Finance
Ministry. However, if his opponents succeed in dragging him
down, the resulting reduction in economic confidence is
likely to be substantial.
RUBIN