House of Lords - European Union

Select Committee on European Union Fourteenth Report

APPENDIX 4: NOTES OF MEETINGS IN MOSCOW

The following are informal notes of Meetings held in Moscow. Present at all meetings were the following members of Sub-Committee C:

Meeting with Mr François Bellon, Head of Delegation of the International Committee of the Red Cross (ICRC) in Russia

11 DECEMBER 2008

Mr Bellon:

There have been no general hostilities in Chechnya for two years, and no humanitarian crisis since 2004. [Humanitarian crisis means, for example, starvation, serious death toll, etc]. Eight hundred members of the armed and security services have disappeared, so have thousands of civilians. But there has been a sharp decrease in the number of arrests which now runs at one a day, and there is now a more orderly process of trial and conviction or release. But the basic problem in Chechnya remains: the desire for independence will resurface at some point in the future.

Meanwhile a significant number of the Russian civilians have effectively left the whole of Northern Caucasus. There are few international fighters reported left there now. The rebels in the Northern Caucasus are now looking for a more Islamic agenda in the region, beyond Chechnya. Armed opposition groups are however attempting, since Beslan, to limit collateral damage and civilian casualties. Their capacity for conducting large-scale sustained operations is now limited.

In contrast to the 99% turnout in Chechnya for the election, the turnout in North Ossetia was only 58%.

More generally the declaration by the Clinton administration in the late 1990s that the Southern Caucasus was an area of US national interest means that the conflict of interests in the region has been further complicated. The Russian attitude to this and other encroachments has been and is that they do not like it, and the West will pay for it. The Russians' signals are always clear for those who wish to read them, but some do not want to listen to what they say.

No foreign NGOs have been closed down as a result of the new law.

Meeting with Mr MARC FRANCO, Head of Delegation of the EU Commission in Russia and members of the Commission Office:
PAUL VANDOREN, Deputy Head of Delegation; HANS SCHOOF, Head of Operations; TANELI LAHTI, Head of Political Section; TIMO HAMMEREN, Head of Economic, Trade and Agricultural Section; ULRICH WEINS, Head of Science, Technology, Transport, Energy and Environment Section.

11 DECEMBER 2008

Mr Franco:

The activities of the Commission office are directed at two main subjects:

i) Systemic issues, such as the approximation of legislation, accounting standards, the training of judges, economic legislation, citizens' awareness of rights and duties. On the latter the EU Commission has produced a Russian language handbook for schools.

ii) An active human rights programme.

The Russians prefer to conduct most of their contacts with the EU through Brussels. Consequently on many issues it is Ambassador Chizhov not Mr Franco who takes the lead. This makes life harder for Mr Franco, because it impoverishes the range of his contacts in Moscow. Moreover the Foreign Ministry, to which Ambassador Chizhov reports, is a factor for rigidity in Russia EU relations. The technical ministries such as the Ministry of Culture, or the Ministry of Economics, are more likely than the Foreign Ministry to go for mutually satisfactory deals.

[In answer to a question]. The Commission office in Moscow would not need to change very much when the Lisbon Treaty comes into force, since it was already very effective and well staffed: at most a couple of extra officials would be needed, including a military representative. It was probably amongst the three most effective European missions in Moscow.

The international co-ordination machinery in Moscow is chaired by Mr Naryshkin, a former Kremlin official. The Kremlin is of course the last resort: if there is an interdepartmental logjam, it can only be unblocked by the Kremlin. But the Kremlin machinery for dealing with European matters is inadequate.

The sectoral dialogues are going well, for example on the alignment of legislation. But the administration and the courts are not good at applying the legislation: hence the new Commission programmes to assist in improving the legal machinery.

There is no pressing need for a new PCA, but eventually one will be needed to define the ultimate objective of EU-Russia collaboration, e.g. the creation of a deep free-trade area.

Research and technology. There is plenty of potential for cooperation in areas such as renewable energy. Progress has accelerated in the past two to three years.

Education: the Bologna project and Erasmus scholarships are important. The Commission has produced a brochure in Russian setting out the possibilities for getting scholarships in the EU.

Progress was also being made in justice and home affairs.

[In answer to a question about support for the British Council] The EU is building up a cultural programme based on the activities of national bodies such as the British Council, the Goethe Institute, the Alliance Française. The first EU cultural cooperation projects should start up next February. The British Council do not want the Commission to take up their problems for the time being, because a negotiation is still in process.

The Commission's projects are now based on the principle that we should not lecture the Russians. Consultants from the West are barely used, and the exchanges are much more like consultations between professionals on both sides. The Commission is now more willing than before to discontinue projects which the Russians are not interested in, and does not attempt to seek credit where this seemed likely to be counter-productive.

Investment flows are now going in both directions. The Russians are wrong to believe that they have been discriminated against. On the aluminium takeover, Mordashev [owner of Severstal] has admitted that his bid for Acelor had been poorly put together; and the Russians claim that they never actually put in a bid for Centrica [formerly part of British Gas]. Europe's long term interest is to get Russian inward investment. The Russians already have the right under the existing PCA to go to court if they think they were being discriminated against.

A number of new issues have arisen since the EU had agreed that the Russians should join the WTO: these included discrimination on railway tariffs; export taxes on timber; and Siberian overflights. Compromises are in sight on all of these. But the Russians are now less keen to enter the WTO than the EU is to get them in. They object to new conditionality being imposed. Their line is: 'First let us in, then we will make suggestions and the compromises for which you were asking.'

On energy the main weakness is that there is no EU policy. The only part of the Commission that the Russians take really seriously is the Competition Directorate, since they know that they can be taken to court.

The Russians exaggerate the extent of EU protectionism. GazProm has 20 joint companies in Europe. An undue fuss is being made about the whole unbundling issue. The basis for reciprocity is simple: 'We will let you into our pipelines and power lines, provided you let us into yours'.

Russian attitudes to Europe. Opinion polls show that the views of ordinary Russians are now far more pro-European than they were in 1998-9 [at the time of the economic collapse and the Kosovo war]. The EU has some 40 information centres throughout Russia.

The EU co-founded the European Studies Institute which is situated inside the Moscow State Institute for International Affairs (MGIMO). The Institute has a joint board of eight Russians and eight Europeans, and at any one moment about 200 students are doing evening courses there, mostly bureaucrats from the ministries in Moscow.

Mr Franco agreed with the Chairman's suggestion that more effort should be put into providing distance learning. He would put this to the head of the Institute, Professor Mark Entin.

The EU's co-ordination machinery in Moscow works particularly well.

Mr Lahti: reported on a presentation by the Russian ambassador at large on the South Caucasus: the Russians are playing hard ball, but they do not want trouble and would observe the rules. On the nomination of Medvedev he said that it was too early to judge.

Political Counsellors at EU Missions in Moscow, who had just been meeting, did arrive at common analyses.
Meeting with Mr YEGOR GAIDAR, Director, Institute for the Study of the Economy in Transition

11 DECEMBER 2007

Mr Gaidar:

The Russian economy is diversifying. The oil and gas sector is growing at 1% a year, but GDP is rising at 7% a year. The economy is diversifying into agriculture and manufacturing. Nevertheless the economy will be dependent on oil for the next 10 years. The prognosis of Mr Gaidar's Institute is that there will be no serious problems in the next 10 years. They tested their analysis, but could find no signs of a possible catastrophe. The main point is that macro economic policy in Russia is in safe hands and is sensible.

The most serious problem is that for the next 10 years the budget and current account will be dependent on the oil price. Many countries which enjoyed a high oil price in the 1970s and 80s, including the Soviet Union, made bad mistakes. The Russian government has learned the lessons, and has created a reserve fund. It is not always easy, politically, to explain to the public why this money is not being spent on the country's social needs.

'Running Russia at $80 per barrel and at $20 per barrel are different jobs.' An oil price of less than $40 a barrel would cause problems. If there were a 15 year low things would become difficult, but still easier than in the Soviet period. The economy started growing after the crash of 1998, even though oil prices then were low and remained low until 2004. Predictions of oil prices are in any case always wrong, so the task is to create a Norwegian size reserve.

The other main problem is the need to stabilise the pension fund. Mr Gaidar's Institute made proposals last year, but they have not yet been fully developed. A pensions strategy will be approved after the presidential elections. Again Mr Gaidar is looking at the experience of Norway.

Foreign investment and shares in the oil sector have gone up with the announcement of Medvedev's candidature for presidency. Those in authority would always be wary of foreign investment in the energy sector. But foreign companies are investing nevertheless. As one of their representatives recently said: 'You are doing everything to push us out, but you are not doing enough.'

Rising inflation is also a problem, and indeed the government is not doing enough to sterilise it. Growth is therefore likely to be considerably lower. But the high value of the rouble allows a substantial increase in the purchase of machine tools for the productive sector.

Demography is also a major problem.

Europe is Russia's major partner. It is a mistake for the Russians to think that they can dictate Europe's energy policy. The Commission's proposal for unbundling is important, promising, but dangerous: the EU needs to consider its policies carefully. The liberalisation of the electricity generating sector in Russia has been successful so far: something real is now happening. Russia's energy requirements increased by 6.7% last year. As for the Energy Charter, the right way forward was to start a practical negotiation from scratch.

It will be easier to predict the course of future economic reform after the presidential election on 2 March. Reforms were successful in Putin's first term, and a total failure in his second term. The socio-economic priorities should be pension reform, health care, education, military recruitment and procurement, budgetary process reform (expenditure side—the revenue side is working effectively) and the energy sector. Russia is not at present a democracy.

On the WTO the Russians are strongly divided. A number of senior people think that membership of the WTO would not be to Russia's advantage. The issue cannot therefore be used by the EU as a negotiating lever.

On the prospects for a new PCA, things should be much easier now the Polish election is out of the way.

Meeting on EU-Russia Relations with Professor MARK ENTIN, Director, European Studies Institute at MGIMO University; OLGA BUTORINA, Institute for Europe; DMITRI SUSLOV, Higher School of Economics; ANDREI BELY, Higher School of Economics; LAURIE BRISTOW, Deputy Head of Mission, British Embassy.

11 DECEMBER 2007

Ms Butorina: It was clear five years ago that there would be a cooling off in relations between the EU and Russia, partly because both are stronger than they were. There would be no breakthrough in the next two to three years. But longer term prospects were good: the two sides were doomed to cooperate closely. There are two main issues:

(i) The question of values;

(ii) Relations between the EU and the CIS countries: neither Russia nor of the EU have good strategies. A framework agreement is needed between the EU and the CIS which would make it possible to introduce elements of the EU acquis into the CIS countries.

Mr Suslov: Russia EU relations are in a state of stalemate, but not crisis. There will be a technical move forward during the French Presidency, and negotiations on a new PCA will then begin—but they will go on for ever. This is because of disagreements over energy, and because of the logic of the relationship.

An EU-CIS neighbourhood policy would ruin the Russian competitiveness and is therefore not attractive to Russia. The Russians are expected to adopt the EU acquis in areas which are of interest to European businessmen, but not necessarily for the Russians.

The proposal made by Prodi when he was President of the Commission that there should be 'Everything except institutions' is not understood by the people in the Kremlin who wrote Putin's speeches. There is a disagreement within the Kremlin: do the Russians accept European norms? or do they insist on equality? The second tendency is beginning to prevail: that is evident from the marginalisation of Gref and Kudrin. The 'Europeanisation' of Russia goes against the revisionist logic of Russia, which was challenging the results of the Cold War. It is therefore very unlikely that the stalemate will be overcome unless EU policies are changed and there is an identification of genuine common aims in the areas of energy, democracy, and the CIS. EU enlargement has weakened the EU, because it goes against the logic of integration. The EU will have to conduct its relations with Russia as an independent player, with its own domestic system

Mr Bely: The energy sector is the most problematic. There were no difficulties over energy supplies in Soviet times. But with the liberalisation of western economies there were big changes in the energy market. The UK's liberalisation in the 1980s was a consequence of the fact that the UK was self-sufficient in energy. Perceptions between Russia and the EU have changed and the romanticism of the earlier period has disappeared. The Russians do not see how the Europeans expect to be able to get a long-term supply of gas unless there are long-term contracts. Russia is in a period of deep transition: the Russian state has increased its share of the energy sector, but there are also measures of liberalisation. Europe only sees the former. Meanwhile the Commission is proposing to restrain foreign investment: but the only way forward is long-term planning of investment combined with the elimination of mutual restrictions.

Mr Suslov: It is a mistake to interpret the nomination of Medvedev as a sign that Russian liberalism is gaining the upper hand. Medvedev was and is the architect of Russian energy policy. The situation is still flexible but the West should not make false deductions.

The way forward is to transform the issue of reciprocity: each side should be given an equal share in the pipeline arrangements of the other. There should not be an attempt to introduce 'European standards' for the energy market.

Lord Hannay: The idea of a multilateral EU-CIS framework agreement makes no sense: the Russians would surely not accept to be put in the same box as Ukraine and Georgia. The most sensible way forward is to base ourselves on the existing arrangements under the present PCA. Contrary to what some seem to think, the EU is not going to become a federation. But it is not moving rapidly in an opposite direction either. Attempts by the Russians to divide and rule would simply consolidate the EU's solidarity.

The energy problem is misrepresented. There is no problem about oil, coal, or LNG. The issue is solely one of gas supplies. Although we need to have a contractual framework, it should be negotiated from scratch: the Energy Charter is inappropriate as it stands.

Lord Truscott: The issues of climate change and energy efficiency need to be brought into any energy policy the EU devises.

Mr Suslov: Russia will deal bilaterally with the European countries when it can, and with the EU when it must. It would be a mistake for the EU to get obsessed with energy, since this will get in the way of other agreements with Russia. The best thing is to forget about the idea of an all embracing treaty, and concentrate on agreements on sectoral matters, with a political declaration to cover the whole.

Professor Entin: is optimistic. Developments in Poland are now more favourable. There has been a huge annual increase (20%) in the number of Russian travellers to Europe. Russian anti-monopoly policy is working well, although the Europeans never notice that. His institution is organising courses for officials from the Russian provinces to teach them about the EU.

Mr Suslov: It is crucial to create a new generation of specialists. Russia is unwilling to accept the EU agenda as the precondition for a better Russia-EU relationship.

Professor Entin: twenty-five million people are now connected to the Internet in Russia: they have access to all the information they want, whatever restraints are put on Russian television.

A technical problem is that the judgements of the European Court of Human Rights are not admissible in Russian courts because they are not in the Russian language. A special commission of European and Russian MPs should be set up to consider legislative proposals while they are still in draft to try and ensure that they are acceptable to the two sides.

Lord Hannay: We seem to have forgotten that foreign policy issues such as Kosovo, Iran, and the Middle East are bound to affect the EU-Russia relationship.

Meeting with Mr VLADIMIR MAU, Director, Working Centre for Economic Reform of the Government of the Russian Federation

12 DECEMBER 2007

Mr Mau:

The Academy of the National Economy is directly subordinated to the government. It has just celebrated its 30th anniversary. The emphasis is on business. There are 3,000 MBA students, 5,000 undergraduates, and a thousand civil servants on short training courses. The Institute also does consultancy work for the government. It publishes studies in conjunction with the World Bank and the Gaidar Institute and is currently making a comparative study of corruption in state investment projects in a variety of countries.

The scope for further reform: are people willing to accept reform? The trouble with cheap money, such as Russia now enjoyed, is that people see no reason for reform. High oil prices are an impediment to economic development, and prevent structural and institutional reform. This is true even though Russia has managed so far to avoid the Dutch disease.

Eight years ago Mr Mau was optimistic about the future of the relationship between Russia and the EU: there seemed to be good prospects for a common market, even if Russia was not a full member of the EU. There is no reason why Russia should not accept the community acquis (though not the common agricultural policy and the social legislation), and enter into a relationship with the EU similar to that of Norway. Sooner or later this is inevitable. The prospect has however been pushed into the future because of the results of the last enlargement: it is natural and obvious that the policy of the EU will be dominated for a while by the new east European members, with their difficult historical experience of Russia. But in the long run there is no alternative for Russia to a closer association with the rest of Europe: 55% of its trade went to the EU. Talk of an 'eastern dimension' is senseless.

On the trickle down effect of high oil prices, Mr May thinks that oil riches stimulate imports rather than domestic production. The stabilisation fund is something to be proud of. At least it means that that sum of money has not been stolen. But most successful countries do not need the stabilisation fund. The problem is not that Russia needs to diversify its exports: it needs to diversify its domestic production. It is not clear whether the process of creating new state corporations is merely a transitional measure, as Putin has implied. Transitional measures can go on for a very long time. Though many disagree, the privatisation of the 1990s was successful. Privatisation in Britain in the 1980s had had three objectives: political, fiscal, and economic. It was possible to achieve all three in a stable society like Britain, but it was not possible in the turbulent Russia of the 1990s. At that time the most important objective was political: to make any comeback by the Communists impossible. Putin's policy of buying up the oligarchs and eventually selling the new state corporations on the open market, could help to legitimise property ownership.

Russian energy policy is mostly driven by political considerations: it is not about investment or efficiency, but about the power of the elite. Foreign policy objectives are certainly not the primary aim. Higher oil prices had enabled the Soviet Union, towards the end of its existence, to import 42 million tons of grain a year.

A relationship between Russia and the EU similar to that enjoyed by the members of the EEA is a feasible objective. Mr Mau is currently engaged in discussions inside the government about the long-term development prospects for the Russian economy. All the participants implicitly assume that the benchmark for Russian development should be the European Union. The process is being slowed up by opposition from the Poles: their historical Russophobia would probably take up to 40 years to be overcome.

The depopulation of Russia is a serious problem. Government attempts to stimulate the birth rate will probably not succeed: there are no successful historical precedents. The high level of mortality could be overcome, however, with some basic social policies. There are problems with getting the right mix of migration, but it is clear that migration was necessary. The law has recently been liberalised. However what the Russians dream of is an "Australian" immigration policy: the planned attraction of skilled labour. Incidentally, historical evidence shows that economic growth is always associated with population growth.

Many Russian economists thought in the early post-Soviet years (2000 to 2003) that Russia should adopt the EU acquis. Probably only a third of those people think the same today. But even so, Russian legislation is still in practice being approximated to European legislation. But there are two important limitations on the process. The law enforcement mechanisms in Russia are not capable of ensuring the practical application of good laws; and the human capital available is inadequate. Cooperation in the four spaces of the PCA is helpful in this context.

On WTO membership, the situation is now thoroughly confused. The opposition to Russian membership from other countries is political not economic.

The first obstacle to improvements in Russia's relationship with the EU is political, and stems from the last enlargement; the second obstacle is the attitude of European business, which is afraid of competition, especially in the agricultural field.

Meeting with MIKHAIL MARGELOV, Chairman; Ambassador VASILY LIKHACHEV; Ambassador IGOR ROGACHEV, Foreign Affairs Committee of the Federation Council

12 DECEMBER 2007

Ambassador Likhachev: Ambassador Likhachev, who had just returned from Switzerland and Luxembourg, had once again noted increased Russophobia in the European institutions. This makes it hard to reach sensible agreements. The matter is very subjective: emotions in Russia are much stirred by the American proposal to put missiles in Poland and the Czech Republic; by the American position on Kyoto; and by Kosovo. It is necessary first to talk in a very frank way to sort these things out.

The relationship between Russia and Britain is of strategic importance: parliamentarians had a responsibility to carry things forward.

Mr Margelov: European Union matters are dealt with in Moscow in a number of different places. One is through the Parliamentary relationship between the EU Parliament and the Russian parliament. The second is inside the Kremlin, where Yastrzhembski is in charge. Before 2004 there was a special committee inside the Russian cabinet dealing with EU affairs, headed by a Deputy Prime Minister. When he was ambassador to the EU, Fradkov thought that the coordinating task could best be performed by the Russian mission in Brussels. But when he became Prime Minister, that arrangement broke down. There is a shortage of knowledgeable people in Moscow: only 20 to 30 people deal with EU affairs in the Russian ministries, compared with 300 odd people dealing with Russia inside the EU Commission.

The Russian economy is 55% dependent on foreign trade, and 70% of its energy goes to the EU. Therefore Russia is firmly on the hook. So we are interested in a positive agenda for Russia-EU relations. Work on the PCA needs to be revised. Polish meat (which actually comes from India) should not be an obstacle. Russia and the EU need to be more creative in working out a new agenda. The Russian economy is already firmly involved in the world economy: it can never close its doors again.

Mr Margelov had recently talked with the Estonian Commissioner, Simkalas, who had come up with a new idea. The Council of Europe parliamentarians and those in the European Union should get together to discuss all the relevant issues: it is a matter for politicians and bureaucrats.

The visa issue is also important. If a regime for free movement could be set up, it would be a death blow to the Russian isolationists.

Lord Roper: The negotiations over Kaliningrad could be a good precedent for negotiations on a visa regime. In Brussels the Sub-Committee had been much impressed by the progress being made in the Four Spaces. Is there a role for parliaments in developing the Northern Dimension?

Mr Margelov: The Russians are moving from the complex of superiority from which they suffered during the Soviet period through the humiliation which followed 1991 towards the building of a self-confident modern non-empire.

In Russia the WTO is a purely economic matter. But elsewhere politics have got involved and the Russians are being kept waiting outside Brussels. We need to move forward on the Energy Charter. The Russians will not ratify the Transit Protocol: the political elite is concerned at the prospect of losing control. What we need is more cooperation on things like research and development, refining, exploration, extraction.

Ambassador Likhachev: We are living in a period of contradictions in the EU-Russia relationship. In the political sphere there are 'small volcanoes'. But when we talk of trade, although it might be inaccurate to talk of 'integration' with Europe, we can talk of a process of 'integrative cooperation'. 52% of Russia's trade is with Europe. 70% of its foreign investment comes from Europe. Russia is the third largest importer from Europe and the fourth largest exporter. Europe provides 27% of the demand for its gas and 24% of the demand for its petrol. Politics cannot limit these facts. Poland is a very good example. Despite the bad political relationship, and the problem over meat, Poland holds the fifth position in trade with Russia.

A roundtable should be organised to discuss issues of harmonising legislation. 'Juridical security' is as important as military and other forms of security.

Mr Margelov: Russia wants to be inside the WTO and involved in working out the rules. The arrangements for Norway and Switzerland could provide models for Russia's relationship with the EU. National security and sovereignty are very important to Russia—in the old Soviet Union, Russia had no separate identity. The closer we are the better it is for us.

Lord Hannay: There is no precise model for Russia's relationship with the EU. Norway for example pays a large sum into the EU budget. Russia needs to have a specific arrangement of its own. But there are practical difficulties. The PCA with its four spaces are functioning reasonably well and producing results. But it is not a good long term basis for the relationship and a new agreement will be needed eventually. However there is no immediate pressure to negotiate one. A free-trade area could be the ultimate aim.

On energy we need a joint regulatory framework. One way forward would be to take elements from the existing Charter and negotiate them into a form that was satisfactory to both sides.

Ambassador Likhachev: Ambassador Likhachev wishes the British government would emulate the optimism of the British delegation. The MFA and the Kremlin have been working on the shape of a future EU-Russia agreement for more than a year. The PCA is not such a bad document: of the ten targets listed in article 3 of the PCA, the only one not yet attained relates to a free trade zone between Russia and the EU. WTO entry will solve that. On the whole Russian opinion is in favour of WTO membership, though some sectoral interests, such as agriculture, have their doubts. The Russians had hoped that there would be an appropriate declaration at the last EU-Russia summit, but none emerged, because of Poland. However the new Polish Prime Minister would come to Russia in February [2008], and the issue should then be resolved.

The new agreement should contain a small nucleus of norms, and then a series of agreements on particular sectors. It should be possible to negotiate in a couple of years. That is the Russian objective, and we are very interested in achieving it.

Russia is also a part of Europe.

The problem with Kyoto is the US position. The agreement that will succeed Kyoto in 2012 will depend on for its success on whether everybody signs up to it.

Mr Margelov: What we need now is confidence-building measures, like those we had at the time of détente. Confidence on both sides is much diminished. This is partly because of the election campaign rhetoric which had been heard in Russia in recent months and which is now hotting up as the presidential election approaches in the United States.

Meeting with YEVGENI PRIMAKOV, President; GEORGY PETROV, Vice-President, Russian Chamber of Commerce and Industry

12 DECEMBER 2007

Mr Primakov: The Russian attitude to the European Union is very positive. EU enlargement had a less negative effect in Russia than NATO enlargement. We have to live together until Russia joins the EU. Russia does want a new agreement to follow the PCA. The chances for a successful negotiation are now greater as a result of the Polish election. The limitations will be lifted.

The Energy Charter is a complicated business. The Russians want to be treated as equals. If there is to be equal access it has to be equal at both ends. The Commission proposals on unbundling seem to be one-sided, since they prohibit foreign control. The Russian experts think the Commission proposals would damage Russian interests, and would be in breach of the PCA and the Energy Charter which provide for national treatment.

On the CFE the movement of Russian forces inside Russia is still restricted, but the Balts have not ratified the Treaty and NATO feels free to move forces into the Baltic states.

If Kosovo becomes independent there will be trouble between Abkhazia and Georgia. The European position is amazing. There will obviously be a knock-on effect in Bosnia. The Bosnian Serbs and the Croats will take advantage of the precedent, and there will be trouble in Macedonia.

Russia is now stable. So is the North Caucasus, despite occasional outbreaks. Chechnya is now run by Chechens. Mr Primakov does not like their methods in all things, but the war is now over.

The economic policy of recent years will continue. The aims are:

(i) To increase the share of Russian gross domestic product (GDP) in the world: this is already happening. Russia is consolidating its position in the world economy. Foreign direct investment into Russia is growing rapidly. Russia invests more in the United States than the United States invests in Russia. This shows that the Russian economic policy is on the right lines.

(ii) There was a dilemma in the 1990s: Russia had to choose between macroeconomic rectitude and a free market, or state involvement in the real economy. Now the dilemma is over. The macro economy is working, but the state is now involved. That is necessary for Russia, where the market still works inadequately, and we need to move away from a commodity-based economy. This is beginning to happen: two thirds of GDP is created on the basis of the domestic market, not on the basis of commodity exports.

(iii) Tax policy needs to be exploited as a tool of industrial policy, e.g. to build up Siberia and the Far East. Only 18 million people live beyond the Urals, right next to overpopulated China.

(iv) Government intervention is needed to bring about a dynamic innovation policy. Some people in the West argued that the problem would be solved by the market. But it was not, because there was not enough competition inside Russia. Now the state is doing it. The problem in the Soviet period was that fundamental science was very good, but it took a long time to implement.

There is an issue over the use of oil and gas money. The Ministry of Finance will not allow it be spent on social objectives and infrastructure, because they fear inflation. They are therefore spending their money on US Treasury bonds. Yet, although we have shown virtue by paying off state debt, corporate debt to overseas providers is now $300 billion.

Putin has suggested that the stabilisation fund be split in two. Half should be used as a reserve, and the remainder spent on social and economic projects. The original reformers [Gaidar and Burbulis] were unaware of the needs of ordinary people. The priority sectors for government expenditure are now education, health, housing, agricultural sector development, and also science absorbing industries.

There is no danger of a return to the Soviet Union: you should not be misled by the widespread and nostalgia for past Soviet greatness.

There are two main dangers:

(i) the tendency, enjoying backing in the West, of the so-called liberals and those with connections to émigré oligarchs, who want to return to the 1990s. These people are not supported by the Russian voter.

(ii) part of the state apparatus is getting too close to business. This leads to corruption.

The West should welcome the Medvedev nomination: he is a democrat.

On energy, Russia and the EU should start a negotiation which should be practical and not based on abstractions.

On the WTO, new obstacles are constantly raised to Russian membership. For example the Saudis were demanding free access to the Russian aircraft market even though they produce no aircraft. No doubt there were other forces behind them. The Georgians were also making difficulties.

As for the overall relationship with the EU, economic links are growing despite political difficulties. The future may be cloudy, but in the long run the horizons are clear.

Russia is irresistibly irreversibly committed to join the international community: but you do need to take account of us. We will not slavishly follow the US lead, as we did in the early 1990s.

Primakov agrees that there is a substantial measure of agreement between the EU and Russia over Iran, since both have the same long-term objectives. There is no agreement over Kosovo.

Meeting with ALEXANDER GRUSHKO, Deputy Minister of Foreign Affairs responsible for EU-Russia Relations.

12 DECEMBER 2007

Minister Grushko:

Europe is our house and Russia is part of Europe, historically, culturally, socially. Europe is more than the EU. Russia is not planning to join the EU or NATO: Russia is too big and has to consider its relations with other neighbours, for example China. It is preparing to build a general strategic partnership with Europe everything but membership. This is Russia's policy towards the EU.

There is a huge potential for healthy economic relations and trade. Fifty to 60% of Russia's external trade is with the EU. EU capital is bringing investment to the tune of 70% of investment in Russia. Cooperation is also extensive, especially from France, Italy and Germany, in areas such as space, airplane construction and science.

In international affairs and external security, the EU's strategic concept is very close to what Russia wants. Russia's position is very close to the EU's on organised crime, mafias, Iran, Afghanistan and the Middle East. Other areas are international law, the non-use of military methods and eschewing unilateral actions. There is huge potential for combining efforts and synergy in specific cases.

As far as the 4th Space is concerned, culture and technology are close to the heart of Russia's people. They are happy to have as many visitors as possible for exchanges. Russians are educated as European people, for example in British and French literature. They would like to reinforce the feeling of being in a common European civilisation. Russia wanted to make its education more Western. Russia had joined the Bologna process. There was much internal discussion which had been painful. The British Council, a subject for bilateral relations, had lacked a real basis. Some years ago it had been possible to open everything in the Russian Federation. There had been some problems about cooperation in this area, not just with the UK, which related to taxes and whether operations were profitable or non-profitable. The problems with the Germans and Spanish had been solved but there had been a lack of progress with the UK which had caused systemic damage to the Russian/UK relationship which was not in good shape due to many problems. To solve the British Council problem it would be necessary to re-open negotiations. Russia had been the first to ask the EU for no visas for diplomats. It had been criticised by the media but still considers that a modest example of visa free regime.

There are difficulties in the Russia/EU relationship. Russia managed to build capitalism with the help of the West. The Russians have the impression however that partners are still looking at Russia as in a transit phase. The results are quite impressive: 6-7% growth for 2 years, 10-12% growth in construction, 10-15 % growth in the processing industry. Russia is not therefore becoming just an energy producing state. Russia is trying to diversify and become more modern. Inevitably there will be competitiveness between the EU and Russia, as there is between the EU and the US. President Putin had said that Russia was not afraid of inward investment but Russia would expect to get the same treatment with the penetration of its investment in the West. Russia felt that there was a lack of trust: when a Russian firm bought 5% of EADC it was presented as a Kremlin plan, but it had been a commercial deal. This attitude should be overcome. Unbundling would lead to price rises as each part of the operation took a profit. Gazprom is therefore important as it can combine non-profitable and profitable operations. The EU should digest the new Russia which has our own vision which it will protect, on Kosovo, CFE, the Middle East, international law. But there are more things that unite Russia and the EU than divide them.

Policy in the EU is a kind of lowest possible denominator. Sometimes countries with problems with Russia are pushing the EU, for example, the Poles with the meat issue. This was near solution but a year had been lost. EU solidarity was becoming a 'brake' on building situations. There was a tense situation over Russia/EU relations. Russia was prepared to be very flexible. The MFA wanted to replace the PCA, but until it could be replaced, annual prolongation was possible. Russia was following developments in the EU closely. The phenomenon of non-citizenship in Latvia and Estonia should be tackled by the EU in accordance with European Conventions on protection of the National Minorities. New Member States were still fighting on historical grounds: there were attempts to equate Nazism with Stalinism and to use history as a political instrument. This was not based on a desire to unite peoples. Russia would be patient but could see serious consequences. There were more possibilities than difficulties. Russia realised that the good relations between the EU countries would impact on EU policies but it did not like countries using the EU to solve specific problems. The Netherlands meat problem had been solved bilaterally. In the Polish case, Polish meat was acceptable, but there was a mafia in Poland which was exporting prohibited meat. The Commission tended to consider Russia's policy as designed to divide Europe but Russia prefers strong partners.

In the regulatory sphere it was not good that the EU (the Commission) was inventing something for itself then trying to project it outside when is was not applicable to Russia. Sometimes the EU pushes, for example, with commercial directives. In the field of energy and electricity Russia is selling many power stations to international companies: ENEL has more than 50% in part of Russia. In the field of gas, predictability, transparency and long-term contracts were needed with guarantees which would make investment in gas pipelines worthwhile. The Commission wants to engage in nuclear fuels negotiations with Russia which breaches EU regulations. Negotiations should be on an equal footing. Russia was prepared to engage in a direct dialogue with individual partners. Russia will formulate regulations with or without the EU, using some of the acquis. Understanding where Russia stands is important.

There are two summits a year and 13 sectoral dialogues. But there is no body for conducting external political analysis, unlike the NATO/Russia Council (Russia was training Afghans in counter-narcotics with NATO). Where can subjects such as Transdniestria and Moldova be managed? Russia had been asked by the EU for help in Chad/Sudan. Russia will co-operate but we have to think over different types of such operations: led by the EU, led by Russia, common operations. On Kosovo the message from the EU was that they did not yet have a position, but Kosovo was becoming an EU problem. Russia wants the EU to refrain from any unilateral steps; to support the elements in the Security Council based on the work by the troika; and to support the idea of prolonging negotiations. It should not start with an EU position which cannot be changed. It was important to find a way of cooperating; the Contact Group had done good work. Russia did not exclude Joint Actions. Maybe Russia could cooperate with the EU, or some of the EU, on Nagorny Karabakh, but there was no structure. Russia was present in the police mission in Bosnia-Herzegovina though from the political point of view this was negative for Russia which did not participate in the decision-making process as it would wish.

Meeting on Russian Foreign and Security Policy with VLADIMIR BARANOVSKY, Deputy Director, Institute of World Economy and International Relations (IMEMO), Moscow; FEDOR LUKYANOV, Chief Editor, Russia in Global Affairs journal; SERGEI KARAGANOV, Deputy Director, Institute of Europe Academy of Sciences; SIR ANTHONY BRENTON, British Ambassador to Russia

12 DECEMBER 2007

Mr Lukyanov: On the Balkans/Kosovo: Europe is destroying principles of international law. Why was Milosevic not stopped earlier? Russia has no interest in the Balkans. The EU is taking responsibility. Let them go ahead and let us see what happens. Negotiations should go on as long as possible. Kosovo's status is absolutely unimportant for us. The Slavic brotherhood is no longer relevant. But no territory should be separated without agreement (in the case of Kosovo, the agreement of the Serbs). The position of Georgia will be much worse after Kosovo but Russia will not make use of the situation.

Mr Baranovsky: Chechnya is settled. Russia's position on these issues has been consistent. Matters should be settled in accordance with international law. Russia is very emotional about Georgia; its view is that Abkhazia is a separatist issue. People are sympathetic to the West over Kosovo but think the West is being cynical. Their approach was not necessarily a fair one.

Issues of Russian trade tend to become political. It is not fair on the EU's part to try to undermine Russia's natural strengths. As far as possible Ukrainian membership of the EU is concerned, whatever the EU does in Ukraine is against Russia. Is NATO still the traditional adversary—maybe the EU now is.

Dr Markov: On the positive side, Russia, the EU and the UK have common interests in stability. On the negative side, the West has lost moral credibility. The 1990s were a catastrophe for Russia, but which the West considered as good. Cheney had criticised Putin but praised Kazakhstan because of the oil. Russia was trying to attain the ideal of democracy. Kosovo is important because if Kosovo declares independence, why not Abkhazia or South Ossetia. If Russia recognised the latters' independence it would be in conflict with Georgia. Iran as an issue is more important than Kosovo. The Ukraine for us is not another country.

President Putin will be the number one at least for a period. Medvedev might stand down (after being elected President). At Davos some saw Medvedev as quite a poor performer. The Prime Minister's powers can be increased without changing the Constitution—it could be done in the Duma. Putin would delegate the difficult problems. If Putin were to be appointed party leader, that would send a very bad message to the public in Russia and outside. Putin likes Russia to be a big country which is respected.

Dr Karaganov: The Russian and EU positions on Iran are not so far apart. The less the EU and Russia interfere in Ukraine the better.

Meeting on EU-Russia Energy Relations with VLADIMIR KONOVALOV, President, Petroleum Advisory Board; SERGEI DUBININ, CFO, RAO United Energy Systems (UES), formerly Board of Gazprom; REINER HARTMANN, Chairman, Energy Committee, Association of European Business (AEB), E.ON (Germany); SHAWN McCORMICK, TNK-BP; VLADIMIR MILOV, President, Institute of Energy Policy; LAURIE BRISTOW, Minister, British Embassy, Moscow

13 DECEMBER 2007

Mr Konovalov: The Petroleum Advisory Forum is an association of Western oil and gas producers in Russia. Investors are looking at Russian law, especially the subsoil law, which has been under revision for the past two years. The Forum has advised the government to move in a market direction. This has not been altogether successful. The Government was now moving towards a law to restrict foreign investment in which foreigners would not be allowed more than 50% investment. Laws are getting bogged down and therefore clarity is lacking. For oil production over 90 cents in the dollar are taxed which is onerous. Taxes are based on price and quantity, not profit. Western businessmen argue that this was regressive but the Government does not believe the oil industry. However, the Government is beginning to see that investment might not be forthcoming for developing new Greenfield sites in Siberia. There would be a geo-political dimension to big projects. The government was meant to be business-oriented and internationalist. Difficult times lie ahead but foreigners would be there.

Mr Dubinin: In the gas industry long-term contracts are vital to secure long term investment. Profitability for the producer and consumer should be equal. Russia was in the long-term Russian and European markets. In the longer term it could cooperate with other gas producers such as Iran. There is a good spot contract market. Nuclear energy is a possibility for the future particularly for its efficiency and the environment.

Mr McCormick: In September 2003 TNK-BP was created through the merger of TNK, Sidanco and most of BP's assets in Russia; BP's investment represented the single largest by a foreign company in the history of Russia. TNK-BP is primarily an oil company with some gas interests. The company currently produces 1.8 million barrels of oil equivalent per day—of which BP books half, representing 25% of its daily production. But TNK-BP only accounts for 10% of BP's profits because of high costs pressures and tax take in Russia. After several year of double-digit growth, TNK-BP's oil output is currently flat because most of it comes from older oil fields initially discovered/developed in the 1970s and 1980s which the company is working hard simply to maintain production. TNK-BP's future lies in new "Greenfield" projects in which it is investing heavily and it expects to see overall production increase again next year. These are very complex, remote and expensive oil fields to bring on-line—they are ice covered for six months, and in swampy areas for the remainder of the year. For Russia, the largest and most important market is the domestic one, and for exports it is Europe where over 4 million barrels per day are shipped. TNK-BP is the largest exporter of Russian crude, with one out of every 20 barrels consumed in Europe being produced by the company.

In the Russian oil sector overall, nearly 75% of output is produced by "non-state" companies like TNK-BP, which in the gas sector an estimated 85% of production is from state companies. The largest consumer of Russian gas is, again, the domestic market and for exports it is Europe, not Asia, due to infrastructure and location of deposits. In the future, LNG could change that dynamic—and certainly China, Japan, South Korea and the United States are large potential markets.

As a normal course of business, TNK-BP regularly competes with other companies for new oil fields via auctions. The company has won around 35 such new permits in the last two years through this open and competitive process. In addition, TNK-BP has several large and new projects in its development "pipeline" which all require significant levels of capital, technology and trained staff. TNK-BP is fortunate to work in a country where the same amount of engineers graduate from universities annually as they did 20 years ago (this is not true in Europe or the United States). There is fierce competition between companies—and indeed other industries in Russia—for the best candidates, so the company must remain highly competitive.

It is right to say that large amounts of gas are not utilised effectively: estimates of gas flared range between 35-50 bcm annually—the equivalent of nearly half of UK annual demand. TNK-BP is investing $2 billion over coming years to reduce its share of that total.

Mr Milov: EU energy policies are based on markets. Russia talks of the unfairness of the 1990s when the oligarchs obtained their money in a controversial manner. Russia is the third largest exporter of coal in the world whereas previously it had been a net importer. State owned enterprises were the least efficient, and it was this part of the energy industry that has been expanded. The price of oil has risen from $3.5 per barrel to $11 per barrel in 5 years. Russia has the potential to expand its energy sector, but redistribution in favour of the state prevents expansion and production has stagnated.

There are far fewer problems and challenges in the private sector than in the area covered by state control. As far as upstream is concerned, the Russians do not have off-shore experience. Sakhalin 1 and 2, in the hands of international oil companies (IOCs), were producing oil and would soon have gas. Sakhalin 3, 4 and 5, under state control, had nothing and the situation was no different from the mid 1990s. Unfortunately the Russian government was attempting to maximise profits for Russian-run companies and it sees the IOCs as competitors. The model of cooperation with the IOCs as minor partner will not work; the Government only wants IOC resources.

The policy thinking mentality gap between Russia and the EU is fuelling energy security concerns in Europe which is serious. The situation would not change soon. The EU has never been in favour of applying the Energy Charter Treaty (ECT) in their own countries. Article 20 in the Transit Protocol does not apply on the territory of EU Member States, and this destroyed attempts to apply it in Russia. A new agreement is a good idea.

Mr Hartmann: E.ON produces 37 billion cubic metres of gas per annum. It is involved in long-term contracts with Gazprom. It has significant investment in the power sector and recently acquired 5 power plants (in the privatisation of OGK4) at a cost of Euros 4.1 billion. The company found the auction to be well organised, highly professional and transparent, with the participation of several European companies. They now need to consolidate 5,500 people. This privatisation was driven by Chubais who announced a disastrous situation in the power industry. President Putin approved the action. The Russians are not too happy about the approach of Brussels to reciprocity.

The Russians will not ratify the Energy Charter Treaty, part of which—the gas transit elements—should be incorporated into the PCA. The oil and gas industries are indeed separate and different, with gas needing long-term commitment and projects. There had been very positive developments in coal, but merger of Russia's largest coal producer, SUEK with Gazprom, could undermine competition in primary energy production.

Meeting with Association of European Businesses in the Russian Federation (AEB)
FRANK SCHAUFF, CEO, AEB; ROGER MUNNINGS, Member of the Executive Board, KPMG; JOERG BONGARTZ, Chairman of the Banking Committee, Deutsche Bank; DMITRY CHELTSOV, Chairman of the Transport and Customs Committee, Finland Post Corporation; MARIE RONDELEZ, AEB, Adviser on EU Affairs; Discussion moderator: Chris Bowers, Director, Trade and Investment, British Embassy, Moscow

13 DECEMBER 2007

Mr Bowers: Many in the UK business community in Russia have a horror story or two about dealing with Russian bureaucracy, but most if not all are smiling about their profits and future growth potential. Russian Government figures put the UK as the biggest investor in Russia. The UK has particular success in oil/gas and financial services. There are many areas of potential growth and large potential opportunities for UK companies pretty much across the board. But UK medium size industrialists tend to be more convinced of the need to explore or invest in India or China than in Russia, of which some still seem wary. A lot of this is to do with outdated perceptions of Russia. Of major UK companies, HSBC is doing well. Pilkington had trouble setting up but in one year has captured 17% of the Russian market. Boots is in 250 stores. As far as the rule of law is concerned, the Russians are making decent progress but implementation, as ever, remains a problem. The commercial law system is gradually improving and foreign companies are getting a better chance of a fair hearing and ruling. Many in the business community have been encouraged by Medvedev's nomination. Medvedev is seen as "liberal" in the Russian context.

Dr Schauff: The Association of European Businesses (AEB) has nearly 600 members of which the largest groups are Germans, British and French. Most EU Member States are represented (except Malta, Slovakia and Slovenia). The AEB is growing fast with double digit growth of trade in Russia and three quarters of investment from the EU and several thousand companies. The mood is positive about Russia though some companies are facing problems on visas, work permits/immigration issues. Companies also face bureaucratic obstacles: more than 100 stamps are needed to open a chemical plant. Corruption plays a role, thought not a major one. It tends to consist of petty problems with militia on the street. Major companies do not encounter these problems as they can re-locate. There can also be problems with authoritarian structures. Trade Unions are in bad shape though there had been strikes at Ford in St Petersburg and trouble in the automotive industry. Growth rates are impressive. From the business point of view it was valuable that the Russians seem to be adopting some of the acquis. The proposal of Medvedev as a candidate for the Presidency is welcome as he is constructive and knows the Kremlin structure and Gazprom.

The AEB had visited Brussels and discussed the WTO issue with Frattini, Piebalgs, Alumunia and Mandelson. The Russians say that others are more interested in Russia getting into the organisation than Russia is. Russia's leaders are not so keen on membership; the problems concern Siberia overflights and timber. The issue of Polish meat had been resolved and it was hoped that the EU could now move on its relations with Russia.

Mr Munnings: President Putin was initially keen on WTO membership as legitimising, but he had drifted away as Russia became more powerful. He would probably like WTO membership during his Presidency but the EU would probably not be able to achieve it in time. Membership would however be an important part of the future framework where, together with Russia's interaction with others, a change has been seen in the last 10 years. KPMG in Russia is the fastest growing business anywhere in the world. 90% of clients and 95% of employees are Russian.

The candidature of Medvedev for the Presidency is seen by "internationals" as a liberal and as a very positive sign. Russians at the liberal end of the spectrum are also happy. The Medvedev/Putin pairing would be popular. President Putin had originally been an internationalist, is now less so and there is uncertainty about his present position. From outside we need to help Russia to engage. This message was conveyed to Brussels during a visit and they had been shocked at the amount of detailed work which was being undertaken. In international affairs, Putin has been interested in separate poles. The Russians feel European and want a strong Europe. They will pick the best practice from around the world, for example on corporate governance, though they tend to complain if something was not "Russian". The AEB would produce written evidence for the Sub-Committee on what should be in the new PCA with Russia.

There has been a turn-around in Russia from the beginning of the century which extends to the regions where, for example, modern milking parlours could be seen. The Russians would try to regenerate the economy to produce wealth for the people and would put the home market first, creating national champions for this market. This could lead to international competitiveness. The Russian CBI had drafted a strategic industries paper for the government. Russia had traditionally had a strong scientific community and was keen on the security sector. On energy supplies the Russians could not decide where to go in addition to the Europeans: China or US. Gazprom was a company with strategic assets to the tune of 28% of the world's supply. The top of the administration know Gazprom well. It was to be hoped that Chubais would sell off the electricity organisation and take over Gazprom.

There were problems caused by unbalanced media representation. When working in Russia one had to understand that what felt like confrontation is just the way the Russians worked. It is necessary to get past this, go straight to the subject and deal with it. Implementation of commercial law takes time but the Russians are pushing it forward. In the courts 70% of cases were won by the taxpayer/company in 2006. Russia just has the edge on China and India in terms of market development. Russian would be a hypercompetitive nation before people thought, and they wanted to be part of the world. What the EU had to offer was the financial sector. The EU is keen to develop the capital market. London could help without damaging itself. Within the EU the Germans and Italians do well, the Irish have some flexibility. Foreign firms are getting good quality MBA employees, though less so in Moscow because of the competition. Labour is not strongly represented but there is legislation on obligations to workers. Oil industry skills are in short supply worldwide and Russia is lacking in offshore skills and experience.

Mr Cheltsov: The issue of timber with Finland is not crucial though important. Finland constituted 6% of Russian trade with the EU countries. Russia was 12% of the Finnish trade (second to Germany which was 12.5%). The Northern Dimension is working. Customs problems have been a serious barrier to trade but a new customs code introduced in 2004 has made a dramatic change and relations with the customs authorities are improving. But major issues are being resolved and cooperation is working well.

Mr Bongartz: Foreign banks are not discriminated against though there is much to do on regulation. Banks, such as Société Générale and Deutsche Bank are doing well. Foreign banks are not allowed to set up branches but need subsidiaries. The Russians have lifted banking capital limitations to 50% and there is room for manoeuvre. Dialogue is good with the regulators and representatives of the Central Bank come to meetings. Discussions are underway about a better settlement system, for example on derivatives regulations. Pension reform is also under discussion. Sometimes people think the Russians are moving too slowly but the financial sector is booming, with over 40% growth recently. It would not slow down. Substantial funding comes from outside Russia.

Ms Rondelez: Discussions are underway on the acquis in the investment, banking and energy sectors. The Russians seem to be taking them on board as the EU spread the acquis around itself. However, the Russians could react against this.