---

By Sergei Blagov

MOSCOW (KWR) Despite the massive revenues Russia is enjoying from record oil prices, foreign investors have become increasingly put off by the yearlong legal campaign against Yukos and a summer-long crisis of confidence in the banking system. Taken together, an attack on Yukos, the banking crisis and a spate of terrorist attacks are taking their toll on business confidence in Russia.

Yukos, Russia's largest oil-exporting company, faces crippling demands to pay back taxes, and the authorities plan to sell its largest Siberian production unit to recover the multibillion dollar debt. In mid-September, the International Monetary Fund expressed concern about the impact of the troubles besetting oil major Yukos on Russia's standing as a place to invest.

IMF First Deputy Managing Director Anne Krueger, visiting Moscow, called Russia's investment climate "mixed" and noted that, on a net basis, capital had started flowing out of the country of late. "There is evidence around of foreign investment and people taking advantage of some of the opportunities created by ongoing structural reforms," Krueger told a news conference after meeting senior Russian officials. "[But] there does seem to be some hesitation," she said, expressing "some concern" about Yukos.

Krueger singled out overhauling Russia's fragmented banking sector, shaken by a recent crisis of confidence, as a key step. "Postponing reforms of the banking sector will only complicate matters in the future," she said.

Meanwhile, on Sep.14, President Vladimir Putin allowed Gazprom the go-ahead to acquire the government's last major oil company while simultaneously lifting an eight-year ban on foreign ownership of the gas monopoly's local shares.

Uniting Gazprom and Rosneft, two of the three companies considered best positioned to acquire the assets of besieged oil giant Yukos, dramatically strengthens the government's hold on the energy sector while paving the way for billions of dollars of foreign fund money to flow into the stock market.

Prime Minister Mikhail Fradkov told Putin he had come up with a way to increase the state's stake in Gazprom, the nation's biggest taxpayer, from 38 percent to a controlling one, a condition the Kremlin said had to be met before it would agree to the elimination of restrictions on foreign ownership in the company. Gazprom's subsidiaries own 16.6 percent of their parent company's stock, and Fradkov told Putin that they would exchange most of it to acquire Rosneft.

Currently foreigners are only allowed to buy Gazprom proxy shares bundled into groups of 10 and sold at a premium in the West as American Depository Receipts.

Gazprom CEO Alexei Miller later said the company would trade 10.7 percent of its own shares for Rosneft, valuing the deal at about $5.6 billion. "This is a deal the market has been waiting for a long time," Miller told journalists in televised remarks. "It will be a real locomotive for the whole Russian stock market."

The government believes it is creating what could be a global energy force along the lines of Saudi Arabia's Aramco, breathing new life into a depressed stock market. Some investors are less enthusiastic. "The Ministry of Oil and Gas Is Back," privately owned MDM Bank wrote in a note to clients, referring to the Soviet-era institution.

Putin's announcement on Sep.13 that he was rolling back more than a decade of democratic reforms by doing away with directly elected governors and parliamentarians, also sounded somewhat discouraging for investors. The merger of Gazprom with Rosneft is seen in line with Putin's drive to consolidate power, which started in politics and has spread into the energy sector, which is the lifeblood of the Russian economy.

Moreover, the head of the Federal Energy Agency,Sergei Oganesyan, recently told journalists that the state should ideally control about 20 percent of Russia's oil production. If the newly merged Gazprom-Rosneft were to take over key Yukos subsidiary Yuganskneftegaz, the state would gain control of 20 percent of national oil output. The new company will be well-poised to win any auctions the government might conduct for assets taken from Yukos.

Yet despite all this, the World Bank sounds positive about Russia. Russia ranks in the top third of countries in terms of doing business, according to a report published by the World Bank.

Despite acknowledging the country's need to improve corporate governance and transparency, the World Bank put Russia in 42nd place in its survey of legal parameters for businesses in 145 countries. The World Bank made no comparison to last year because its set of criteria has since changed. "Russia's business climate is one of the best in the region," the World Bank said in a statement earlier in September.

The report analyzes governments' regulations on such things as starting a business, hiring and firing workers, registering property, enforcing a contract and filing for bankruptcy. The World Bank positively appraised Russia's business climate because of the country's flexible employment regulations and improvements in business administration procedures.

It takes 36 days to register a new business in Russia, compared to 123 days in Azerbaijan. Registering a property takes 37 days in Russia, while in Croatia it takes more than 2 1/2 years.

The country's ranking was hurt by such considerations as the fact that it is the only economy among the countries with 40 largest stock markets without credit bureaus. Overall, Russia was placed in the second best of five categories, along with Armenia, Bulgaria, Georgia and Estonia.

Despite the World Bank’s optimistic pronouncements, big Western lenders have become concerned about Russia. In August, Societe Generale and ING Bank backed out of a megaloan to TNK-BP. Soon afterwards, a $500 million loan to Norilsk Nickel was scaled down to $300 million after HSBC abruptly left the lending syndicate.

The capacity of Russian companies to raise debt abroad has also been on the decline in 2004. While borrowed funds in the first quarter hit $1.2 billion in international placements -- including eurobonds, medium-term notes and commercial papers -- that figure dropped to $450 million in the second quarter, according to Standard & Poor's. In the long-term, Western lenders' reluctance could have a knock-on effect throughout the economy.

Less funds available to domestic banks will mean a decrease in loans to second and third-tier real sector companies, which do not raise debt abroad.