Piling up yet more economic woes for Russia

Piling up yet more economic woes for Russia

The Permanent Court of Arbitration in The Hague announced on July 28, 2014, that Russia would have to pay just over US$50 billion in damages to the former shareholders of Yukos Oil, which was pushed into bankruptcy in 2006. The ruling was a real bombshell, compounding damage already inflicted on the Russian economy by economic sanctions over Ukraine, writes Professor Stefan Hedlund.

The ruling came after years of deliberation. The former shareholders in Yukos Oil, a Russian petroleum company owned by Russian oligarch Mikhail Khodorkovsky, have been awarded less than half of their original claim of US$114 billion, but this is a huge award. By way of comparison, Russia’s Reserve Fund, set up as a buffer against fluctuations in export revenue, held US$87 billion on July 1, 2014. And Russia’s government will soon have to start drawing on that money to plug other holes.

The immediate reaction from Moscow was dismissive. Russia’s finance ministry called the ruling ‘politically biased’ and claimed it has ‘serious flaws’. Foreign Minister Sergei Lavrov added that Russia would use ‘all available legal possibilities to defend its position’. That sounds defiant but may in practice not be so easy. The rules of the court say that its decisions on awards are ‘final and binding’.

But enforcing the decision will not be easy. If Russia refuses to pay - which is highly likely - the winners will have to track down Russian assets abroad which can be expropriated. These assets will have to be purely commercial and exclude Russian state property.

The main impact of the ruling is political. The court agrees with long-standing accusations that Russian authorities abused its legal system not to recoup taxes in order to bankrupt Yukos. This is damaging for state-owned oil giant Rosneft, which was the main beneficiary of what some have referred to as the ‘lynching’ of Yukos. It is also damaging to Russia’s President Vladimir Putin, who has long been viewed as the main driver in the ‘Yukos Affair’.

The ruling comes as German intelligence sources are telling German media, and Chancellor Angela Merkel, that there is evidence of a power struggle in the Kremlin. Business oligarchs, fearful of what the West’s economic sanctions will do to their personal fortunes, are reported to be at loggerheads with people from the security apparatus who welcome sanctions as a further step away from the West.

There is little reason to believe that such rifts, even if they do exist, will have any serious impact on Mr Putin’s personal position. But it will impact severely on Russia’s already deplorable business climate.

The Hague ruling comes as the Russian economy is about to go into recession, when capital flight is soaring, fixed capital investment is way too low, and restrictions on Russian access to Western capital markets will cause the costs of financing to increase further.

Russia’s former Minister of Finance, Alexei Kudrin, once dubbed ‘Putin’s brain’ warns in an interview with German news magazine Der Spiegel, that ‘If sanctions are imposed against the entire Russian finance sector then our economy would collapse within six weeks’.

The full cost of the legacy of Yukos has still not been added up. The European Court of Human Rights will issue its ruling on Thursday, July 31, in a parallel multi-billion case filed by Yukos shareholders who claim the company was unlawfully expropriated.

History is about to catch up with Mr Putin. His reaction is likely to be defiance, compounding the damage being inflicted on Russia even further. It is eerie to note that while this is all happening, his popularity at home is higher than ever.

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