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. Last Updated: 07/27/2016

Kremlin Politics Stall GAZ-Fiat Deal

Problems are a lack of decisiveness and political instability.

Russia's stormy political life is proving as big a headache for Western investors as for the country's fragile economy, and left the European Bank for Reconstruction and Development's flagship multimillion-dollar GAZ-Fiat deal stalled on the starting block.

The $854 million project between the Italian car giant and Russia's second largest automaker has been struggling to get out of first gear ever since the landmark accord was signed this February in Rome under the watchful gaze of President Boris Yeltsin.

Under the deal, Fiat and GAZ, the ambitious Nizhny Novgorod carmaker, will each own 40 percent of the joint venture while the EBRD takes a 20 percent equity stake.

But officials close to the project, the first joint venture agreement in Russia to mass produce Western-standard vehicles, concede the deal has become an unexpected victim of Kremlin politics.

"The major problem we have encountered so far has been political uncertainty, this kind of lack of decisiveness, coupled with political instability," said a well-placed source ahead of the EBRD's annual general meeting in Kiev, which starts Saturday.

After the deal was first announced in September, Yeltsin signed a vaguely worded decree granting the auto industry a series of tax breaks and financial incentives. But breaks fell foul of existing legislation and the International Monetary Fund.

European diplomats in Moscow said the IMF, which has tied billions of dollars in loans to improve tax receipts in Russia, took a dim view of such largess from a government with a history of woeful revenue collection. The fund's opposition forced authorities to scale back the sweeteners.

When a government decree setting out the incentives package was finally ready for signature in March, Yeltsin sacked his prime minister, Viktor Chernomyrdin, provoking a monthlong government crisis which again put the brakes on the deal.

Although Prime Minister Sergei Kiriyenko signed a decree last week, "the text was so vague as well, against all expectations, the government will have to enter into bilateral arrangements with the joint venture so that all these incentives can be specified," said one official close to the project.

That has stymied EBRD attempts to raise a $300 million to $330 million syndicated loan to finance construction of a greenfield site factory capable of producing annually 150,000 cars of the Palio, Palio Weekend and Marea models.

The incentives package "has a great impact on the cash flow and the earnings of the joint venture," said a Western banker who asked not to be identified.

EBRD Moscow chief Neil Parison was keen to play down the problem. "I think it's a processing problem rather than a substantive problem. We're reasonably realistic," he said.

"We've done about 110 projects in Russia, and there will be delays of a few months now and again," he added. "At a time when the new government is still not completely formed it's not surprising that things slow down a bit. It's a bit frustrating but its not viewed as a major problem."

The Fiat-GAZ partnership is a high-profile project for the bank, the single largest direct investor in Russia with projects totalling 3.6 billion ecus ($3.2 billion). But only 10 percent of the projects involve federal or regional authorities, said Parison.

"The political risk factor in Russia as perceived and experienced by Western investors coming in, given the overall legal framework is still developing, means we are sometimes called upon to, in effect, provide political risk insurance" to attract foreign firms into schemes their boards would otherwise have vetoed, Parison said.

The EBRD is keen for Russian banks to take up some of the investment slack in the future, allowing it to use its funds to meet the clamor for new project finance, Parison said. The EBRD is working with some 40 Russian commercial banks it hopes will play a key role in restructuring the Russian economy.