Crime Keeps Out Smolensk Investors

For MTMaslov being blessed by Metropolitan Kirill of Smolensk and Kaliningrad at a ceremony after his election as Smolensk governor.
SMOLENSK, Western Russia -- When Viktor Maslov took the oath as Smolensk governor this month, he closed the book on one of the nastiest elections in modern Russian history.

Maslov, the former Federal Security Service chief for the city of Smolensk, also found himself in charge of a region that vies for the title of criminal capital of Russia and has become a byword for corruption in the national media.

Many of the region's woes have been blamed on former Governor Alexander Prokhorov, who ran for re-election on a Communist ticket and lost to Maslov by a narrow margin last month.

The Smolensk election campaign made headlines in Moscow when 20 automatic rounds narrowly missed Prokhorov's first deputy, killing a driver, just before the mid-May vote. The deputy, Anatoly Makarenko, whose 5-year-old daughter was also in the line of fire, immediately pointed the finger at Maslov and the FSB.

Maslov responded by calling Makarenko a "semi-criminal businessman with no place in politics" and suggested that backers of the former governor may have tried to execute Makarenko for the sake of a sympathy vote.

"For the team playing against me, the death of a man is a trifle compared with the prospects that beckon following victory at the elections," Maslov said in an interview just before the poll.

Smolensk in early summer seems an unlikely venue for such deadly games, with its beautiful mixture of green squares, pavement cafes, attractive shops, ancient churches and town walls running down to the Dnieper River.

A little larger than Switzerland and with a population comparable to Estonia, Smolensk has drawn less than $50 million of direct foreign investment since 1991, and only about $6 million in 2001, despite its prime location astride Moscow-Europe transport arteries on the western border.

But the region has drawn organized crime like bees to a honey pot. Annual cargoes worth over $8 billion on the main Moscow-Europe highway provide scope for hijacking and protection rackets. The transit business includes drug smuggling, making Smolensk one of the worst regions for drug addiction.

Criminal groups have flocked to share cash flows at numerous vodka distilleries, and a leaky budget under the old administration offered rich pickings for crooked businessmen and corrupt bureaucrats.

"The former administration seemed more interested in sharing money than earning it, and we have got to put that right," said Maslov, a native of Smolensk.

The new governor receives journalists under a portrait of his former FSB boss, President Vladimir Putin, in an enormous office overlooking an equally enormous statue of Lenin on Lenin Square. Short and soft-spoken, Maslov exudes thoughtful intensity, chooses his words carefully and seems nervous of the press, though he insists that he is in favor of open government.

"I sincerely want to achieve greater social control over executive power in order to make that power more accountable and transparent," he said.

Maslov makes no apology for his FSB-KGB past, but takes care to point out that he worked on economic security and not suppression of dissent in the years before 1991. He said that the decision to run for governor was not dictated by superiors in Moscow but was a personal decision based on what he had learned about the former regional administration.

He does not reveal what he learned and how, but Dmitry Pavlov, who ran as a gubernatorial candidate for Smolensk from the Union of Right Forces, fills in some of the gaps.

"In 2000, the FSB arrested Yury Balbyshkin, who had a reputation as an official representative of the mafia in the Smolensk administration. The FSB kept him in their own pen, because in an ordinary pen he would have been killed in an attempt to silence him. The deal was that he would tell them everything he knew and go free," Pavlov said.

Balbyshkin, who preceded Makarenko, the apparent object of the contact hit, as deputy governor responsible for trade, property and investment, was accused of selling state assets for personal gain. He was held for a year and released last fall after a court ruled, surprisingly, that he was only guilty of accepting a mobile phone from a private firm. The court then freed him under an amnesty.

Smolensk has seen a spate of contract killings over the past four years. Among those killed was the owner of independent local radio station Vesna -- who was shot dead after promising to expose the Prokhorov administration's links with organized crime -- and the heads of some of the region's biggest enterprises, the state-owned distillery Bacchus and the diamond-polishing conglomerate Kristall.

Suspected bandits on the losing side in Smolensk turf wars have suffered messier fates. One was dredged from the Dnieper River with his stomach cut open, another was found strangled in a shallow grave with signs of torture by sulfuric acid, and a third was clubbed to imbecility. Nobody has been tried for these and dozens of other killings and maimings.

Much of the mayhem is attributed to alleged gang leader Tigran Petrosyan, who cut through the Smolensk underworld and business community like a knife through butter -- before being gunned down 18 months ago, aged just 25. The start of Petrosyan's criminal career has been traced to a Smolensk sports club, where he was sponsored back in 1990 by a trading firm set up by former Deputy Governor Balbyshkin. Balbyshkin was then a businessman and Prokhorov was the head of the local branch of the Soviet Communist Party, providing breaks to Balbyshkin's firm.

After Prokhorov won the governor's seat in 1998, Petrosyan became almost untouchable, assuming control of rackets and hijackings on the Moscow-Europe highway near Smolensk, according to local and national media investigations. On one occasion the local prosecutor's office ordered his release after police caught him in possession of weapons.

In the year after Balbyshkin's arrest and the breakup of Petrosyan's gang, Smolensk became the fastest climber in Expert RA's authoritative annual rating of Russian regions by investment risk, rebounding from 70th to 19th place in 2000-01.

Nikolai Goshko, head of news at the Vesna radio station, burns with a bitter hatred for the old administration and predicts at least one more prominent death in Smolensk. "This has been the worst year of Prokhorov's life -- I think it will also be his last," Goshko said.

"The Prokhorov campaign cost about $15 million, which is money paid by very serious people for control of the Smolensk region. His guarantee was the Communist bulldozer," he said.

"Now the guarantee has flopped and those people need an example more than they need their money back, so that candidates in other regions do not dare take money on shaky guarantees."

Goshko, who has an encyclopedic knowledge of the local underworld and does not hesitate to use its jargon, confirms Maslov's reading of the Makarenko hit.

"It was ordered by Prokhorov's backers, who needed two coffins -- one small -- to parade through town right before the election," he said. "But most of the money was pilfered by intermediaries, so they got an amateur job."

Since Maslov's election victory, Makarenko has backed away from allegations that the new governor was behind the attack on him and offered, at a news conference, to give evidence against his former colleagues.

He and other members of the former Smolensk administration refused to comment for this report.

Oleg Khmelyov, who worked as manager for a $12 million direct-investment fund set up in Smolensk by the European Bank for Reconstruction and Development, recalled another episode in which Makarenko played a key role. The incident was also the EBRD's worst experience in the Smolensk region.

The EBRD fund, set up in 1994, spent $800,000 to construct and take a 42 percent stake in the Oasis services complex on the Moscow-Europe highway. In 1998, when the value of the complex had grown to about $5 million, inspectors controlled by the Smolensk administration suddenly ordered that $5 million be confiscated from Oasis for alleged currency irregularities.

A Moscow court overturned the order.

But the EBRD then found out that a major slice of the complex had been effectively signed away to house a vodka distillery managed by Makarenko.

"We called a general meeting to sack the Oasis managing director, who signed that deal, but the meeting was adjourned after men in Jeeps with guns showed up outside. It was Tigran's boys, and Makarenko was with them," Khmelyov said.

That fiasco aside, the fund has also had some successes. A $1.2 million investment helped bottle maker Sitall, located in the town of Roslavl, boost output by five times and become the only plant in Russia making Coca-Cola bottles. An investment in Fayans, a Smolensk manufacturer of toilet china, also came up trumps, and a stake taken by the Smolensk fund in household goods manufacturer Korall, located in the neighboring Kaluga region, provided the best markup of all Russian direct investment projects by the EBRD.

Khmelyov is now setting up a new independent fund management company called Espero Ventures to channel private capital and is confident of finding worthy investment targets.

Foreign companies investing in Smolensk can be counted on one hand -- much of last year's foreign investment appears to be money held in Cyprus companies by diamond polisher Kristall. One notable exception is UCAR-Graphit in the town of Vyazma, which is fully owned by Nashville, Tennessee-based UCAR and has 30 percent of the market for graphite supplies to Russian steelmakers.

UCAR bought a stake of more than 90 percent in the company, then called Vyazma Graphit, in 1996. The company makes electrodes and other graphite products and its main customers are Russian ferrous metallurgy plants.

Maslov promised to resume dialogue with the EBRD and to work to attract other foreign investors in a bid to kick-start the region's ailing economy.

"One of the advantages of a change of power is the creation of new possibilities for cooperation," he said. "We are looking for much more than $6 million of foreign investment, and we already have some interesting proposals."

Maslov also needs the resolution of a long-standing dispute between Smolenergo, the regional power utility owned by national power monopoly Unified Energy Systems, and sales intermediary Smoloblkommunenergo, which is owned by the regional administration and has allegedly "lost" the payments by power and heat consumers that it collects for UES. The result has been power cuts and cold water.

Maslov promised to dismantle the sales intermediary, in line with UES' ambitious plan to revamp the electricity sector.

Semyon Levenkov, head of Smoloblkommunenergo, sits in his office beneath a framed motto -- "Don't tell me what to do, and I won't tell you where to go" -- and resolutely dodges the question of misspent funds. Hopes for a new job organizing distribution for the non-UES nuclear power station near Smolensk make him casual about Maslov's threat of dismissal.

"Administrations come and go, but people always need electricity and heat," he said.

Regional agriculture is another economic black spot. The cultivation and processing of flax, for which Smolensk was famous in Soviet times, is severely depressed, as is dairy farming. Pavlov of the Union of Right Forces pins the blame on the collapsing system of collective farms, whose directors have poor management skills and hold private farmers ransom with harsh contracts for lease of collective land and machinery.

Maslov said that he supports legislation in the State Duma allowing the private ownership of farmland and plans to encourage the creation of small plants to turn Smolensk milk into processed goods for the Moscow market.

Entrepreneurship in the region seems to have an Italian aptitude to survive and prosper in an adverse political and economic climate. Marat Ovchiyan, director of local credit union Sodeistviye, has seen an explosion of borrowing and depositing by its members, small businesses and sole traders over the past three years. Total union funds grew six times in 1999-2001 to nearly $2 million, and the growth rate is quickening this year. Sodeistviye has extended its services to leasing (often Gazel light trucks) and business incubators, and boasts a bad-debt ratio of just 0.27 percent.

"We take great care to vet borrowers, but we are ready to lend tiny sums as small as 1,500 rubles [$50] because it is in our interest to work with small clients and help them grow," Ovchiyan said.

Ovchiyan worked as head of the region's economics committee at the start of the 1990s and readily acknowledges that his old contacts are essential for helping credit union members cross bureaucratic hurdles.

Pavlov says that the regional bureaucracy has swollen by 150 percent since the 1980s to 9,500 desk officials.

A computer dealer, who asked not to be named, said that no regional budget orders are placed without major kickbacks for officials.

Virtual Smolensk, a small Internet project supported by Sodeistviye and the Moscow-based Eurasia Fund, is aiming to root out such corruption by putting regional government procurement tenders online, with full details of the winners and pricing.

"We are working with the administration and expect to launch in a few weeks' time -- the aim is to overcome lobbying and lack of transparency, which cost a lot for the regional budget," said Olga Slesareva, art director of Virtual Smolensk.

However, the key challenge is to prune the bureaucracy, and Khmelyov, whose wife works in the administration's committee for foreign economic relations, said that the new governor had already moved from words to actions in the first half of June.

"All committee heads have been replaced, and committees are being merged," he said. "For instance, three committees related to education have shed 52 percent of their staff via a merger."

The process is painful, not least because Russian law compels the administration to find new jobs for the axed officials.