GOR CONTINUES STOP-GAP BUSINESS MODEL

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 002735

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STATE FOR EUR/RUS, DRL
DOL FOR BRUMFIELD

E.O. 12958: DECL: 11/05/2019
TAGS: ECON EIND ELAB PGOV RS SOCI
SUBJECT: GOR CONTINUES STOP-GAP BUSINESS MODEL

REF: A. ST.PETERSBURG 68

B. ST.PETERSBURG 116

Classified By: EconMinCouns Matthias J. Mitman, Reasons 1.4 (b,d)

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SUMMARY
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1. (C) Recent interventions in Pikalevo and Tolyatti
demonstrated the GOR's commitment to preventing social unrest
but also highlighted its failure to address the underlying
problems facing Russian industry. After the enterprises of
the Pikalevo production chain were unable to reach a new
production agreement by the end of October, Deputy Prime
Minister Sechin set a deadline of November 16 for them to
solve their differences. Separately, Prime Minister Putin
announced this week that the GOR would provide 38 billion
rubles (USD 1.3 billion) in debt restructuring to nearly
bankrupt auto manufacturer AvtoVaz. However, experts assert
that the GOR lacks the initiative to complete fundamental
reforms necessary to strengthen its domestic economy. Recent
measures taken to shore up the Pikalevo production chain and
AvtoVaz reflect a GOR strategy of spending whatever is
necessary to maintain order while waiting for the overall
economy to turn around. The GOR's ability to postpone
dealing with deeper structural problems will depend on how
quickly the economy rebounds in the months ahead. End
Summary.

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SHORT-TERM AGREEMENTS WITHOUT LONG-TERM SOLUTIONS
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2. (SBU) Whether by providing debt restructuring assistance
to AvtoVaz in Tolyatti or intervening in pricing and
production disputes among enterprises in Pikalevo, the GOR
continues its pattern of interjecting itself into situations
in which corporations' financial problems threaten to
aggravate social tensions. The collapse of the construction
sector last fall brought to light issues concerning the
long-term viability of cement and mineral production
enterprises in the town of Pikalevo. Prime Minister Putin
berated Oleg Deripaska and the other owners of the production
chain on national television before forcing them to sign a
three-month agreement that would restart production (see
reftel A). The companies were unable to reach an agreement
on the price of materials, and the Federal Anti-Monopoly
Service intervened to determined price levels acceptable for
all players involved, which facilitated the conclusion of an
additional agreement regulating production and prices through
the end of October (see reftel B). Disputes over prices,
payment, and production methods continued among the members
of the chain. On October 28, Deputy Prime Minister Igor
Sechin met with the parties involved with the goal of
reaching a new joint production agreement, without which
production could again halt in November. Sechin laid down a
deadline of November 16, by which time he expects the
companies to conclude an agreement.


3. (C) Similarly, Prime Minister Putin announced in November
that the GOR would interpose itself between AvtoVaz and its
creditors to help the company stave off bankruptcy. While
the relief package will include cash injections to revive
AvtoVaz' model line-up and create new jobs, the vast majority
of assistance will take the form of 38 billion (USD 1.3
billion) rubles in government issued bonds. AvtoVaz'
creditors, primarily state-owned Sberbank and VTB, will be
able to exchange AvtoVaz debts for lower risk government
bonds. According to press reports, AvtoVaz' debts will
exceed 76 billion rubles (USD 2.6 billion) by the end of the
year, not counting 9.7 billion rubles (USD 330 million) owed
to its suppliers. Last month, Deputy Prime Minister Shuvalov
also announced that regional and municipal authorities in
Samarskaya oblast would assume responsibility for the
financing of AvtoVaz' social infrastructure, which would
total approximately 1.8 billion rubles (USD 61 million) per
year. Company and government officials have not yet made
clear how this new round of state assistance will affect
AvtoVaz' previously announced plans to reduce the size of its
workforce by more than 27,000 workers. Shuvalov was quoted
as stating that AvtoVaz would inevitably have to shed 21,000
jobs to operate efficiently. The real problem the GOR is
beginning to realize is that it has assumed the burden of
paying AvtoVaz' debts to state-owned banks without imposing
conditions on company management or insisting on operational
reforms. Only recently - and late in the game - was there

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discussion of attracting "strategic investors" to implement a
broader development plan to revive AvtoVaz.


4. (C) Despite its obvious commitment to preventing social
unrest in economically depressed regions, the GOR has not
demonstrated the willingness to undertake on its own the
reforms necessary to facilitate the long-term growth and
sustainability of the Russian economy. During our last
meeting, All-Russian Confederation of Labor President Boris
Kravchenko complained that the GOR had wasted eight years of
economic growth by failing to address the country's economic
problems, paving the way for the precarious situation in
which many workers in the ailing industrial sector NOW find
themselves. In the case of Pikalevo, Alexander Shitov,
Chamber of Trade and Industry Deputy Chairman, told us this
week he was certain Sechin would succeed in mediating a new
production agreement among companies, and that the GOR would
facilitate whatever financing the companies needed to save
workers' jobs. On the other hand, Shitov confidently stated
that the GOR and Russian businesses would not voluntarily
take the steps necessary, either in terms of an improved
investment climate and stronger rule of law or in terms of
industrial innovation and diversification, to ensure their
profitability and competitiveness. According to Shitov,
Russia needs WTO membership and the associated institutional
regulations and pressure of trade liberalization to provide
the impetus to develop and diversify its economy.

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COMMENT
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5. (C) Russian efforts to resolve production disputes or
prevent downsizing in major corporations consistently
emphasize short-term measures to save jobs over the
fundamental reforms needed to transform aging industrial
giants into viable enterprises. Falling domestic demand and
declining industrial output and construction brought on by
the financial crisis have highlighted the weakness and
inefficiency of many major corporations. While the GOR is
committed to doing whatever it takes to prevent the crisis
from fomenting social unrest, it is unwilling to undertake
the deeper legal and institutional reforms needed to attract
investment, modernize Russian industry, and diversify the
economy. Recent GOR decisions reflect a belief that the
government and Russian businesses can avoid these reforms by
holding out until the economy turns around. This strategy is
not without risks, especially if Russia's economic recovery -
dependent as it is on world commodity prices and global
economic growth - does not accelerate quickly next year. End
Comment.
Beyrle