Vladimir Radyuhin

The rise of mega companies is part of a concerted Kremlin effort to lend a competitive edge to Russian industry and extend its reach into global markets.

ON NOVEMBER 2, the Russian Government approved the merger of the country's main aircraft design and production assets, including MiG, Sukhoi, Ilyushin, Tupolev and Yakovlev, in a state-controlled United Aircraft Corporation (UAC). On the same day, the Government sent a bill to Parliament to clear the way for rebuilding the vertically integrated Soviet-era nuclear industry complex from what is today a fragmented assortment of commercial and state-owned enterprises.

The moves reflected Russia's new strategy of forming giant national champions capable of becoming global players.

A month ago two private Russian companies and a Swiss commodity trader announced a merger that would form the world's largest maker of aluminium. Russia's natural gas monopoly Gazprom earlier this year emerged as the world's third biggest company in terms of capitalisation after buying some oil assets.

Unfolding consolidation stands in sharp contrast with the policy of breaking up, bankrupting, and selling off giant state companies the government of President Boris Yeltsin pursued in the 1990s. The policy aggravated the economic crisis triggered by the collapse of the Soviet Union. By 1999 industrial production in Russia fell by more than 60 per cent. Russia joined globalisation as a raw commodity appendage to the world economy.

After taking over as President from Mr. Yeltsin in 2000, Vladimir Putin sought to reverse asset fragmentation. He began by consolidating the natural resources industry, the most viable sector of the Russian economy at the time. Gazprom led the way. The company, which claims to control a third of the world's natural gas resources, has diversified into oil production aiming to become the world's biggest energy company in a few years.

From the energy sector consolidation moved on to other Russian industries. The United Company RusAl, to be formed in the next few months through the merger of Russia's No.1 aluminium producer, Russian Aluminium, with a smaller domestic competitor, SUAL, and Switzerland-based Glencore, a commodity trader, would pour more aluminium than the current world leader, Aluminium Co. of America roughly four million tonnes a year, compared with Alcoa's 3.55 million tonnes.

Captains of Russian industry admit their own country has simply become too small a playing field for them. "RusAl is buying up companies abroad because we are running short of bauxites," the company's director for international projects, Alexander Lifshits, said.

The rise of mega companies is also part of a concerted Kremlin effort to lend a competitive edge to Russian industry and extend its reach into global markets.

Back in the 1990s, way before he became Russia's leader, Mr. Putin wrote a paper for his Candidate of Science degree where he argued that globalisation "demands all possible state support for creating strong financial-industrial corporations with an inter-sector profile on the basis of resource extraction enterprises." These entities should be "capable of competing on equal terms with Western multinational corporations." It is this programme that Mr. Putin is implementing today. He has consistently pushed for consolidation in "strategic sectors" under state control.

"Resource extraction" was the first target of Mr. Putin's policy. Last year the Russian government raised the state's stake in Gazprom to a controlling 51 per cent. The Kremlin also promoted a medium-sized state-owned company Rosneft to become Russia's biggest oil company. Rosneft snapped up the main production assets of the private Yukos company crushed with back-tax claims last year and is planning more acquisitions. Thanks to Gazprom and Rosneft, the share of the Russian state in oil production rose from 10 to 30 per cent over the past three years, and may go up to 50 per cent next year.

The idea is to create 30 to 40 large holding companies in a range of fields in which the state will control at least 50 per cent of the shares. Following the pooling of aircraft-building assets, plans have been drawn up to consolidate nuclear energy, aircraft engine building, tank building, electrical machine engineering, and some other industries.

Economists say it is only through consolidation of assets that Russia can win a place in the sun in the increasingly globalised world. "World economy is heading towards oligopoly, and the only way to compete with foreign multinational corporations is to create national champions," says Dr. Ruslan Grinberg, head of the Russian Academy of Sciences' Institute of Economy.

The mammoth nuclear energy holding, which will embrace a full production cycle, from uranium mining to nuclear machinery manufacture and fuel reprocessing, for example, hopes to win contracts for the construction of 40 to 60 nuclear reactors abroad over the next 25 years.

Mr. Putin's plan also provides for consolidated Russian companies to aggressively expand globally through mergers and acquisitions. This will help Russia to get access to Western markets and advanced technologies, which the West is still reluctant to share with Russia, even though the Cold War is long over and the COCOM lists of Western technologies banned for export to the Soviet Union have been abolished.

"We are still meeting rigid curbs on transfers of high technologies to Russia," Mr. Putin said.

With roughly half a billion dollars flowing into the country every day from oil and gas exports, Russian companies have gone on an asset-buying spree in Europe and beyond. Earlier this year Russia's Severstal steel maker tried to snatch up Arcelor, the world's second-biggest steel company, but lost to Mittal Steel. The bid showed a trend, not only in the steel, but also other major Russian industries.

Mr. Putin is encouraging Russian corporations to buy their way into European industry on a grand scale to form a giant highly competitive market encompassing the Russian and European Union economies.

According to The Economist Intelligence Unit (EIU), Russia has invested $120 billion abroad over the past five years, more than any other emerging economy except Hong Kong. In the first half of 2006, Russian direct investments worldwide climbed to a new record level of just under $13 billion.

Two months ago, the Russian state bank for foreign trade, Vneshtorgbank, bought a five per cent stake in the European Aeronautic, Defence and Space (EADS), the parent company of Airbus. The bank said it wanted to increase the EADS stake to 10 per cent and could eventually hand over the shares to the UAC. For his part, Mr. Putin said his goal was to "pull the efforts" of the European and Russian aircraft industries in order to make them more competitive.

Russian business expansion came as a rude shock to the West, which had all but written off Russia as a competitor. The U.S. has been blocking Russia's bid to join the World Trade Organisation, while European governments are willing to foreswear the sacred principle of free market competition to stop the Russian onslaught. EADS, controlled by the governments of Germany and France, made it clear the investment by Vneshtorgbank would not give Russia a role within the company. Earlier this year Russia's Gazprom faced opposition from the British government to its plan to buy into Centrica, Britain's biggest gas supplier.

However, the Kremlin has a powerful instrument to help advance Russian corporate interests abroad the country's vast energy resources. Mr. Putin made it clear Western companies would not get access to Russian oil and gas unless Russian industry both commodity and manufacturing was allowed to expand into Europe. A month ago Gazprom reversed its earlier plans to invite foreign partners for the development of the world's biggest gas field, Shtokman. Explaining the surprise decision, which dealt a blow to Western multinationals, such as ConocoPhilips and Chevron, Mr. Putin said Western companies had failed to offer comparable assets in exchange for a stake in Shtokman.

Moscow has demonstrated readiness to play it rough if its commercial interests are not taken into account by other nations. When the former Soviet state of Lithuania unwisely decided to sell its only refinery, which runs on Russian oil, to a Polish company rather than a Russian bidder, the Russian state oil transport monopoly, Transneft, just cut oil shipments to the disputed refinery citing pipe safety fears.

Russia's hard-nosed strategy is paying off. Earlier this year, Gazprom won a 50 per cent minus one share in Germany's BASF gas distribution network in exchange for a stake in the vast Yuzhno-Russkoye gas field in Siberia.

The Guardian last month quoted a former British government adviser as warning that it was "only a matter of time" before BP or Shell faced a bid from a Russian state-owned group such as Gazprom.

Internationalisation of the Russian corporate sector deserves closer attention from the Indian business community if it does not want to miss new opportunities on the Russian market. Aircraft building is one example. At the Airshow China-2006 earlier this month, Russia invited China to join forces with Russia's UAC to create an aircraft building centre on a par with Airbus and Boeing. Meanwhile, India is in a far better position to form such an alliance with Russia given their long successful record of cooperation in combat aviation. In fact, the head of Russia's Irkut aircraft corporation, Alexei Fyodorov, who has been appointed to lead the UAC, has consistently favoured India over China for strategic partnership in the aircraft industry.