Arresting foreigners and the Kremlin’s search for leverage

Hello! This is Alexandra Prokopenko with your weekly guide to the Russian economy — brought to you by The Bell. Although it doesn’t fit our economics-focus, given recent developments, I believe it is most appropriate to start this week’s newsletter with the arrest of our friend and colleague, WSJ reporter Evan Gershkovich. This is the first time a foreign journalist has been arrested on spying charges since the collapse of the Soviet Union and it sends a worrying signal to reporters and analysts alike. Journalism is not a crime!

We also look at the rules for foreign companies seeking to exit Russia, how wartime bank runs affected Russia in 2022 and Austrian lender Raiffeisen Bank International’s plans to wind down parts of its Russian business.

The Kremlin adds to its ‘exchange fund’: WSJ journalist arrested in Russia

The Federal Security Service (FSB) arrested The Wall Street Journal reporter Evan Gershkovich in Russia on suspicion of gathering information about a defense company. On Thursday, Gerhskovich was taken from Yekaterinburg (where he was detained) to Moscow. He is currently in the Russian capital’s infamous Lefortovo prison.

Gershkovich is a reporter with long experience covering events in Russia, Ukraine and the former Soviet Union. Previously, he worked with AFP, The Moscow Times and The New York Times. Gershkovich has lived in Moscow for six years and holds media accreditation from the Russian Foreign Ministry.

Not only is Gershkovich the first foreign journalist to be arrested in Russia since the start of the war in Ukraine, it is the first such case in modern Russian history. The last comparable incident was back in 1986.

Russia’s Foreign Ministry claimed that Gershkovich’s activities in Yekaterinburg “had nothing to do with journalism,” while Putin’s press-secretary Dmitry Peskov said that “the journalist was caught red-handed.” Gershkovich’s last article, which was published on March 28, looked at the impact of the war on Russia’s economy.

Many Western countries have warned their citizens not to go to Russia and encouraged those already there to leave. Journalists and analysts have repeatedly discussed the possibility that the Kremlin would seek to build up an “exchange fund” of prisoners to put pressure on the White House.

Currently, Russia’s “exchange fund” includes two U.S. citizens whose arrests were widely reported in the media: Paul Whelan, serving a 16-year sentence for espionage; and Mark Vogel, who got 14 years for “smuggling marijuana.”

And Russia has many potential targets for an exchange. In 2022 and 2023, Western intelligence agencies identified and arrested about a dozen Russian “illegals.” Political analyst Tatiana Stanovaya suggested hacker and likely intelligence agent Vladislav Klyushin as one possible target, along with Vadim Krasikov, who murdered Chechen warlord Zelimkhan Khangoshvili in Berlin in 2019. However, to do an exchange involving Krasikov, the U.S. would have to negotiate with Germany where he is serving a life sentence.

It’s not difficult for the FSB to fabricate espionage cases. In July, it took the Russian parliament just one minute and 20 seconds to approve legislative amendments that expand the definitions of “treason” and “espionage.” Now anyone collecting information that could be used against the Russian military or the Russian authorities, as well as information containing state secrets, can be accused of spying (which carries a 20-year jail term). Almost any data could form the basis of a criminal case: Russian legislation is notoriously opaque when it comes to defining classified information.

Why the world should care

The simple fact that an accredited foreign journalist has been arrested while pursuing his professional duties is new. Previously, the authorities shied away from accusing journalists of espionage. If they wanted to get rid of a foreign journalist, they would have their accreditation withdrawn or stop them entering the country. Now, though, the Kremlin has little meaningful leverage with the West, and arresting foreigners — including arrests with a view to a future exchange — is one of their few remaining options.

For observers, journalists and analysts, the Russian authorities have a simple message: if you have a foreign passport and you peddle a narrative that contradicts the official Russian line, you are an enemy. If you have a Russian passport and do this, you are a traitor.

‘Exit tax’ for foreign companies seeking to leave Russia

Foreign companies face ever more obstacles if they want to leave Russia. Now, any firm from a so-called “unfriendly nation” (defined according to a list published by the government) that wishes to leave is not only obliged to sell its assets at a discount of 50% — but also to make a “donation” to the Russian state of 10% of the proceeds.

A foreign exodus

The mass departure of Western companies from Russia following the invasion of Ukraine came as a nasty shock to the Kremlin. Russian officials had always assumed that commercial interests would continue to outweigh ethical concerns (ignoring the international trend towards politicized brands). Fearing the possibility of mass lay-offs, in March 2022 the government introduced a range of measures regulating transactions with foreigners from “unfriendly” countries. For any transaction to be approved, the foreign company had to submit an application with information about all participants. A specially-convened commission can refuse permission or impose additional conditions.

In late December, this commission ruled companies from unfriendly nations (ie, all those that support sanctions against Russia) can only sell their Russian assets at a discount of at least 50% of their market value — and must offer the buyer the opportunity to pay in installments over two years. This rule effectively formalized existing practice: in June, the Russian Union of Industrialists and Entrepreneurs (RSPP) president Alexander Shokhin said that foreign firms were selling assets at a 50% discount to independent valuations.

Now the commission has adopted a further restrictive rule. Sellers from unfriendly nations must make a “voluntary contribution” to the Russian budget in order to secure the necessary permit. That donation must be at least 10% of half the market value of the assets sold, or 10% of the full market value if those assets are sold at a discount of 90% or more. The point is to prevent “assets being sold to the management for a ruble, or other ways of not paying the market value,” a federal official told The Bell.

It's true that many of the transactions in which Western companies departed Russia took place ahead for nominal sums. For example, Renault-Nissan sold to its management for one ruble. AvtoVAZ and DIY chain OBI sold for one euro. The “Vkusno – I Tochno" fast food chain cost Alexander Govor 1 million rubles when he acquired it from McDonalds. Most of these deals are being concluded far below market rates and several may never be completed due to legal restrictions, according to a recent report by AK&M.

Who is leaving, and how?

The Bell has looked at how foreign companies are quitting Russia. The first to go were companies with no production facilities in the country. Next came those who ran into difficulties because of sanctions — perhaps due to supply chain issues. At the same time, some big players left due to criticism in their home countries.

A common model for any sale was to transfer the business to the current management with a buy-back option. About 32% of publicly-reported transactions were set up in this way.

Regional authorities are very concerned about the departure of foreign companies, one former official told The Bell. This was confirmed by the deputy governor of another Russian region. Typically, foreign companies are the largest employers in the regions, and make the biggest contributions to local government budgets. Halting production, laying off staff and freezing future plans become big problems for regional governors.

When foreign companies arrived, they lavished a lot of attention on the local authorities. Now, though, they are arranging their departures directly with the new owners and regional officials are concerned they are being sidelined, the former official explained.

In 2023, there were about 2,000 foreign companies lining up to leave Russia, according to The Financial Times. However, if the commission reviews their applications at its current rate (no more than seven applications at a time) then it will take eight years to approve them all.

This data contradicts Russian claims that the war has not discouraged foreign companies from operating in the country. “75.9% of foreign companies remain in Russia. Their decision says a lot: they believe in the prospects for our economic development, they are content with the business climate,” wrote State Duma speaker Vyacheslav Volodin in January.

Problems getting out

There are some foreign companies that chose to stay – for example French retailer Auchan or Germany’s Globus. Britain’s Unilever continues to operate in Omsk, Yekaterinburg, Petersburg and Tula. However, many cannot sell because of the sluggish work of the commission, and others are hamstrung by the absence of a buyer. “You can’t sell your assets to a company under sanctions. If there is anything that falls under “dual-purpose” production or export control, getting rid of the asset is doubly difficult – it requires the express permission of foreign regulators,” said a consultant working on these transactions.

The new rule will make it even more difficult to sell Russian assets. The United States’ Office of Foreign Assets Control (OFAC) indicated that American companies would need to apply to it for permission to pay an “exit fee” to the Russian budget.

In total, foreign companies in Russia sold assets worth $16.31 billion last year, AK&M calculated: in monetary terms that represented 38% of the total M&A market, or 20.9% in quantitative terms. Companies from the United States, Finland, the Czech Republic, France, Germany, Cyprus and Sweden were the most eager to leave.

“It’s crucially important to distinguish political attitudes to the foreign companies and practical approaches at the lower levels,” explained political analyst Tatyana Stanovaya in her bi-monthly bulletin (you can subscribe to it here — it’s expensive but good value).

“The Kremlin's general political attitude, meaning Putin’s attitude, towards foreign companies in Russia has not changed... Putin welcomes those who have decided to stay. He frequently mentions that he sees Western companies as victims of their own governments’ irresponsible geopolitical choices rather than villains in their own right.”

At the recent RSPP congress (which we wrote about in a recent newsletter) Putin promised foreign businessmen he would think of a way to make it easier to withdraw dividends (at present this is only possible in rubles and via a special C account). However, this change may be accompanied by a tightening of other regulations.

At the moment, the Russian authorities are trying to avoid nationalization of foreign assets. However, discussions are ongoing about the fate of shares in companies that are difficult to find a buyer for, or which are courted by major Russian companies under sanctions. One idea is to give the Federal Property Management Agency the right to buy up these assets.

Why the world should care

In the 2000s, the Russian authorities invested great efforts in attracting foreign companies to Russia. Typically, these foreign companies are significant employers and contributors to regional budgets. Now, hundreds of foreign companies are leaving, selling off their assets at bargain prices and even making payments to the state. The slow pace of the work of the government commission and the possibility of the Federal Property Management Agency acquiring these assets suggests that, in future, it could be even harder to leave. Meanwhile, business as usual is hardly an option — the war in Ukraine is evolving into a protracted conflict.

Wartime bank runs cost Russian banks 2 trillion rubles

Russian banks borrowed 4.5 trillion rubles ($60 billion) from the Central Bank last year. The financial regulator noted that peaks in demand for additional liquidity came in February and September. Both of these peaks were connected with the war in Ukraine:

• In February, Russians withdrew 1.2 trillion rubles ($16 billion, or 3.5% of total deposits) from their accounts
• In late September, partial mobilization led to more demand for cash and outflows from ordinary savings accounts. As a result, according to Frank RG, the volume of cash in circulation outside the Central Bank, increased by almost 1 trillion rubles.

At its peak in early March, the volume of liquidity the regulator was providing to the banks reached 10 trillion rubles. However, that had little impact on overall banking results for the year. According to last year’s results, funds held by Russians increased 6.9% (up 2.3 trillion rubles to 36.6 trillion) and the growth rate was greater than in the previous year (+5.7%). The Central Bank attributed this increase to December’s “significant volume of welfare payments, plus advances on pensions for Jan. 2023.”

Raiffeisen Bank International to reduce its operations in Russia

Austrian lender Raiffeisen Bank International said this week that it will continue to reduce its customer lending and foreign currency operations in Russia. At the same time, the group added that this will lead to a reduction in its payments business.

At the moment, Raiffeisen Bank remains one of the few ways that Russian companies and individuals can make transactions with the west. The bank has faced pressure from Ukraine and Western countries to halt its work in Russia amid the ongoing war.

Figures of the week

• As of Jan. 1, 2023, Russia’s external debt was $380.5 billion. This figure fell by $101.8 billion over the previous year, according to Russia’s Central Bank.
• Weekly inflation from March 21-27 slowed from 0.1% to 0.05%, according to Economic Development Ministry data. For the first time since Oct. 2020, the annual inflation rate was 4.3%, approaching the Central Bank’s target of 4%.
• Unemployment dropped to a new all-time low of 3.5% in February (compared with 3.6% in January), the Economic Development Ministry reported. The ministry describes the situation as “favorable”. In our last newsletter, we explained why this is far from the whole story.  Retail trade turnover in February was down 7.8% year on year (compared with -6.6% in the previous month) following a surge in demand in February. Total turnover for retail trade, catering and paid services was down 4.4% year-on-year, compared with -3.6% in January, according to the Economic Development Ministry.

What to watch for next week

• Weekly CPI from 28 of March till 3 of April (05 april)
• GDP in 2022 (07 апреля)

Further reading

• Hosting Russian Nuclear Weapons Will Have Far-Reaching Consequences for Belarus argues Artyom Schraibman
• Turbulent Times: How Russian Airlines Are Weathering the Storm explains Anastasia Dagaeva
• The Rise of the Russian Spetsnaz University Harold Chambers looks into how Chechnya’s main training base has taken on a symbolic and strategic role for Ramzan Kadyrov

The author of this newsletter is one of Russia’s leading writers on this topic: independent economic analyst Alexandra Prokopenko. Alexandra worked as an advisor at Russia’s Central Bank and Moscow’s Higher School of Economics from 2017 to 2022 — and before that she was an economic journalist for Vedomosti, then Russia’s leading business newspaper. Today, Alexandra is a columnist at the Carnegie Endowment for International Peace and a visiting fellow a the Center for Order and Governance in Eastern Europe, Russia, and Central Asia at the German Council on Foreign Relations. She holds an MA in Sociology from the University of Manchester.