July 14, 2010

Yanukovich Between a Rock and a Hard Place

Russia Profile - Between a Rock and a Hard Place

Yanukovich Wants Close Ties With Russia and Backing From Local Oligarchs, but Can He Have Both?

June 30, 2010
Between a Rock and a Hard Place
By Dan Peleschuk
Special to Russia Profile

Since taking office in February, Ukrainian President Viktor Yanukovich has made it clear that he is shifting Ukraine’s focus back to Moscow. But the telling measure of just how far he’ll tilt may not be the deals struck with the Kremlin, but the creeping incursion of Russian business into Ukrainian industry, which now threatens one of his biggest financial backers.

Yanukovich’s first four months in office have brought rapprochement with Russia at lightning speed. On the heels of his seemingly Russophobic predecessor, Yanukovich was left with many fences to mend. But after allowing the Russian Black Sea Fleet to remain in Crimea another 25 years and signing bilateral agreements with Russian President Dmitry Medvedev in several sectors, relations seemed to be back on track.

But there’s a battle raging in southeastern Ukraine that could threaten Yanukovich's blossoming relations with Russia. One by one, metallurgical enterprises there are falling victim to an influx of mysterious Russian businesses. In the process, Ukrainian steel tycoon Rinat Akhmetov has seen his interests muscled out of the picture. And because Akhmetov, Ukraine’s richest man, is among the president’s biggest backers, his problems are Yanukovich’s problems.

The saga began when an undisclosed Russian investor inked a deal last month for Zaporozhye-based Zaporozhstal, among Ukraine’s top steel mills, which Akhmetov was purportedly eyeing in a joint deal through his System Capital Management (SCM) conglomerate and South Korean steel giant POSCO. Analysts said the owners of the plant tossed Akhmetov’s winning bid, ostensibly secured by a $50 million deposit, to make way for the Russian investors. Akhmetov was returned his deposit, and the investors even paid the $50 million fine for their late bid.

The sale, which went for about $1.7 billion, according to the Ukrainian Internet news source Ukrayinska Pravda, is currently under review in a London court. What’s more, however, Ukrainian officials allege the mysterious Zaporozhstal investor is in fact linked to Vnesheconombank, chaired by Russian Prime Minister Vladimir Putin. In January, the bank financed a deal for the Industrial Union of Donbass, a major player in Ukraine’s metallurgical sector alongside Akhmetov’s SCM, in a deal critics denounced as nontransparent.

In a second event, a spokesman for Mariupol-based Ilyich Iron & Steel Works, one of Ukraine’s top three steel mills in which Akhmetov owns a minority share, cried foul late May when two representatives claimed that their client, another undisclosed Russian investor, had taken control of the plant through a Cypriot holding company. There were no banks involved, and Ilyich’s management has firmly denied any talk of a sale.

Sensing an opportunity, Akhmetov rushed to Ilyich’s rescue – if only to cover his own interests. The plant’s chief executive officer, Volodymyr Boiko, promised to merge Ilyich with Akhmetov’s lucrative metallurgical holding group, Metinvest, in exchange for helping to stave off the attack. The merger, analysts say, would create a metallurgical powerhouse and provide Akhmetov with a major asset, but the problem may be rooted far deeper.

Experts say Yanukovich’s Moscow-friendly tone has sent clear messages throughout Russian business circles that lucrative Ukrainian industries are now fair game for their interests. “It’s a psychological phenomenon,” said Ivan Lozowy of the Kiev-based Institute of Statehood and Democracy. “The environment in which the new Ukrainian government has wished to reset relations with Russia has created a psychologically positive context for Russian business to become more active.”

If there’s credence in officials' allegations that these incursions are tied to the Kremlin, then Yanukovich is stuck between a rock and a hard place. The events arrive in the midst of a leaked foreign policy report by Russian Foreign Minister Sergei Lavrov, which spelled out Russia's interest in pulling Ukraine deep into its economic orbit. But while Yanukovich has pushed for warmer relations with Moscow, there’s evidently a price to pay.

Nikolai Petrov of the Carnegie Moscow Center suggested that Yanukovych may be “playing the Russian card” in an effort to lessen his monolithic reliance on Akhmetov, using Russian business as an excuse to diversify. “What’s going on here is the weakening of Akhmetov’s group,” he said. “Yanukovych, who was dependent on Akhmetov, is trying to become more autonomous, which means not being completely dependent on one big guy, but keeping a balance between several big guys.”

But while Petrov believes that this “natural expansion of effective and profitable Russian metallurgical companies” is not necessarily a detriment, it still presents a danger for Yanukovych’s oligarch backing, if it goes too far. “Being so closely connected with big business groups, they [the Ukrainian government] will never let Russian businesses act against the interests of big Ukrainian players,” Petrov said.

For its part, the government is defending its turf as best as it can. While Yanukovich promised to launch an investigation into the Ilyich affair, Prime Minister Mykola Azarov denounced it as “typical raider business.” “The government is on the side of the working collective and will not allow a raider takeover of one of Ukraine’s flagship metallurgical enterprises,” he told reporters two weeks ago.

On Zaporozhstal however, which hangs in the balance between the Russian investors and Akhmetov, the government has remained relatively tight-lipped. Yanukovich’s only comment on the matter was that the courts have frozen the deal, and that the plant’s fate would be left to them. Now, POSCO – Akhemtov’s would-be partner in the deal – has bowed out of the attempt to win back Zaporozhstal, saying they're no longer interested because of the "unclear sales process." Even if the Zaporozhstal sale is annulled, observers have speculated that Akhmetov may lack the financial capital to buy it on his own.

There’s no telling yet how far this trend will go. But what can Yanukovich expect if Russian business knocks Akhmetov from the top spot in Ukrainian metallurgy? A tough challenge at maintaining his consolidated control over Parliament, experts say. “It would be a massive strategic mistake for Yanukovich,” said Andrew Wilson, a Ukraine expert at the European Council on Foreign Relations. “Oligarchs who lose out can fight back.”

Wilson believes that Akhmetov could muster the influence – and cash – to threaten Yanukovich’s fragile coalition, which was scraped together in March with parliamentarians poached from other factions. By luring deputies away through financial means, Akhmetov could potentially split up the very parliamentary majority on which Yanukovich relies to keep his power consolidated.

Whatever happens in the coming months, Yanukovich may have to juggle his allies more than he first thought. This time, however, it’s not between Washington DC, Brussels and Moscow, but between Moscow and his backers at home. “It’s about a point of balance – but where does he want it?” said Wilson. “The interesting question here is whether this is part of a consequence of his deal with Russia that Yanukovich wasn’t prepared for.”

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