SCENESETTER FOR VISIT OF UNDER SECRETARY ROBERT

C O N F I D E N T I A L MOSCOW 002903 SIPDIS DEPARTMENT FOR UNDER SECRETARY HORMATS E.O. 12958: DECL: 11/27/2019 TAGS: ECON ETRD EAGR PREL PGOV RS SUBJECT: SCENESETTER FOR VISIT OF UNDER SECRETARY ROBERT HORMATS Classified By: Ambassador John Beyrle, Reason 1.4 (b) and (d) Summary -------------- ¶1. (C) Your visit to Moscow provides an opportunity to strengthen bilateral economic relations at a time when both our economies are beginning to show signs of recovery following an extremely difficult year. Because our economic relations with Russia were relatively stable even prior to the political "reset" we've seen this year, we are well-positioned to press for progress on a few key issues, including Russia's WTO accession, agricultural trade and intellectual property rights, where more work is needed. End Summary. U.S.-Russian Relations -------------- ¶2. (C) Four meetings this year between Presidents Obama and Medvedev, including the President's July visit to Moscow, and Secretary Clinton's numerous discussions with Foreign Minister Lavrov have given impetus to real change in our bilateral relations. Addressing the ruling United Russia party congress November 21, President Medvedev even used the phrase "reset" - heretofore reserved for issues involving the U.S. and Russia - and called for an "economic reset" as well. We want to see this will applied not just to the modernization that Medvedev is advocating for Russia itself, but to its interaction with foreign investors and integration into global financial institutions, all of which force reforms deeper into the system. The challenge, as always, is to translate rhetoric into specific decisions and joint actions. ¶3. (C) For the first time in years, we have structure in the relationship to do this. The Obama-Medvedev Commission has four working groups--business development and economic relations, energy, nuclear energy, and agriculture--with a remit to broaden the economic base of interaction between us. The Commission will give us regular, focused interaction with influential centers of Russia's business and economic decision-making. In early contacts, some Russian participants in the working groups have shown a preference fro form over substance, though. We need to continue to set a higher standard. The Commission needs to produce results, not reports, and decisions, not dialogue. Global Economic Crisis And Russia's Response -------------- ¶4. (C) The global economic crisis hit Russia particularly hard, as the economy remains heavily dependent on commodities exports (primarily oil and gas) for growth, and on foreign capital for investment. The abrupt drop in the price of oil combined with a decline in foreign investment strained the Russian economy, beginning in mid-2008. Throughout the following twelve-month period, Russian industrial production plummeted, with double-digit declines in month-on-month production occurring on a regular basis. Key sectors such as steel and automobiles were hit particularly hard, with Russian domestic automobile production declining by over 50% in the first half of 2009. The industrial sector, particularly the single-company towns, was hard hit, with unemployment remaining at an unprecedented high. Predictions for 2009 GDP decline grew from 3% early in the year, to the current estimates of 7.5%. ¶5. (C) At the beginning of the crisis, the Russian government held the third largest quantity of reserves internationally and relatively little sovereign debt. Thus, the GOR was much better positioned to react than many other countries. The GOR burned through a third of these reserves (an estimated $200 billion) to slow the decline of the ruble. The GOR also provided large infusions of capital into the domestic financial sector in an effort to keep stressed banks afloat. In addition, the Russian government instituted a series of "temporary crisis measures," including tariff increases and other import restrictions, in an effort to protect domestic production in key sectors and increase demand. ¶6. (C) While these measures were successful in staving off a complete collapse of the financial sector a la 1998, they have come at a price. Official Russian reserves are significantly lower than at the start of the crisis and we expect the GOR will be required to borrow, including on international markets, in order to cover its expected federal budget deficit in 2010. Also, while the infusions of cash into the financial system prevented a total meltdown, banks used much of the funding to make provisions for non-performing loans and other distressed assets. The infusions of cash did not result in a resumption of lending, and domestic financing remains hard to come by, constraining efforts to stimulate the real economy. ¶7. (C) The tariff and other trade barriers did slow imports during the first half of 2009, but the reduced competition did not appear to do much to help domestic producers. Domestic demand, particularly in the automotive and real estate sectors, remains extremely weak. The GOR has pushed companies to retain workers during the economic downturn, in an effort to slow unemployment growth and avoid potential social difficulties. As a result, many companies have used their limited reserves to continue paying workers and are not well placed to take advantage of an economic up-turn when it arrives. That said, Russia appears to have muddled through the worst of the crisis and, aided by higher oil prices and a strengthening ruble, GOR officials are now considering how to encourage a return to strong economic growth. Key Challenges To Russian Economic Growth -------------- ¶8. (C) Dmitriy Medvedev has made a central theme of his presidency Russia's need to diversify its economy, develop an innovation economy based on its strong intellectual resources, integrate itself into the global economy and deal with the problems created by corruption. While we support these objectives, we are concerned that progress has been limited, at best. The recent economic crisis dealt yet another blow to Russia's limited industrial base. The lack of domestic financing limits entrepreneurs' efforts to move into new sectors. Weak enforcement of intellectual property laws and gaps in key areas, such as protections on encryption technologies, restrict growth in IT and other innovative sectors. Russia's on-again, off-again approach to WTO accession has not only slowed down Russia's own accession process, but has also made it difficult for others, such as the U.S. and EU, who are interested in supporting Russia's accession. Russia's continued tariff and non-tariff restrictions on agricultural trade also present challenges to increasing bilateral U.S.-Russia trade, as many U.S. producers are simply not able to export their products to Russia. Finally, corruption and "legal nihilism" continue to plague the Russian governance system; the death in custody of Russian lawyer Sergey Magnitskiy is only the latest example. Domestic Political Context -------------- ¶9. (C) After a year and a half of tandem leadership of Russia, Medvedev and Putin continue to function based on a division of labor. The President plays to his strengths of clear public presentation and a long-range focus on a modern economy, and underscores his constitutional responsibilities for foreign policy. His November 12 annual address to the nation again highlighted and expanded on the theme of economic modernization, and to a lesser extent political reform as well. Putin, meanwhile, has built on his image of a domestic problem solver, employing his trademark street-wise rhetoric in dressing down oligarchs or critics. His November 21 address to the annual congress of the United Russia party (which he heads) reaffirmed public perceptions of him as the man who is making sure government pays pensions and salaries. A just-published poll supports this: though their ratings had been declining, they shot up to 74 and 79 percent, respectively, after their strong performances. ¶10. (C) Although there is evidence that their closest advisors spar over specific policies and personnel matters, the two leaders themselves share state-run national media coverage (to the near-exclusion of other political figures) and project an aura of ease with one another in public. Medvedev has yet to make major changes to the senior staff he inherited from Putin. Putin's prominence in tackling crises - whether conflict with Georgia, gas supply negotiations with Ukraine, or localized unrest or frustration due to the economic crisis - earns him higher public opinion ratings and elite group allegiance than Medvedev. This, combined with his suggestions that he might stand for a third presidential term, all ensure that major decisions are not made without Putin's approval. The complete national dominance of the ruling United Russia party under the leadership of Putin, reinforced through the party's overwhelming, yet tainted victory in October 11 regional elections, has made it difficult for opposition parties to function, let alone capitalize on economic discontent. Conclusion -------------- ¶11. (C) In sum, your visit comes at a promising moment--both our bilateral relations and our economies are beginning to move in a more positive direction, but challenges remain. We encourage you to use your meetings with key Russian governmental and private interlocutors, as well as with the American business community, to push for continued dialogue leading to concrete positive action. We want Russia to integrate into the global economy, to join the WTO, to diversify its productive base and to move forward in the fight against corruption and we stand ready to work with Russia on these issues. Your meetings with Medvedev's top economic adviser Dvorkovich and First Deputy Foreign Minister Denisov, in particular, are a chance to move beyond improved atmospherics and examine in greater depth how we can support the best of Medvedev's modernization goals--e.g., greater energy efficiency--in ways that pay dividends to both economies and broaden the economic base of the relationship. Beyrle