Medvedev’s Russian offshore zone plan ‘won’t work’
The economic turmoil in Cyprus, a popular offshore haven, has led to some high-level talks in Russia, with Prime Minister Medvedev even suggesting an offshore zone in the Russian Far East could be created.
Although Russia is stepping in line with the European
anti-corruption clampdown on offshore havens, trying to create an
offshore on its own soil may lead to another “black hole” in the
country’s economy, says Ben Aris, editor in chief for Business New
RT:Looks like the big story is happening. Will it really shape and change the way the Russian financial system and Russian business is working? Are they really in trouble as Cyprus lost its tax haven status?
BA: I think in the short term it is going to have relatively little impact. The amount of money we’re talking about, $20 billion, is a fraction, a tiny fraction – less than a percent of total Russian deposits. And so if this money is all lost, and the estimates now are… between 60 and 80 percent of it is going to be lost, although that’s painful, it’s not actually in the grand scheme of things very much money at all.
In the longer term it is going to have fairly profound implications on the way Russian business is done. I mean, Cyprus is not so much of an offshore haven, I think that’s a misunderstand of what’s going on there, because of a double taxation treaty it was far more tax efficient for Russian companies to domicile themselves in Cyprus. It’s better to think Cyprus is a sort of an offshore treasury operation for Russia, and so companies that were trying… to send money abroad and get it back again, it was much simpler for them to center the money in the financial operations in Cyprus, and send it all out from Cyprus, which was an EU country, which was connected to the European banking system, rather than send it from Moscow. It’s really a practical question, I mean, sending the money from here is actually quite difficult, because you have to have double language treaties, you have to have registered stamp, the bureaucracy in all of this is quite horrific, whereas if you do it in Cyprus you just go online, you go onto your bank’s website, you fill in your account details, press the button – and the money is gone, that’s all.
All in all… about 30 percent of Russia’s foreign direct investment comes from Cyprus, but clearly that’s Russian money. So is it going to have an impact there? But then again you can see this sort of treasury operation function again in the foreign direct investment numbers. For example, last year Cyprus made about $17 billion of direct investment into Russia. However, there was exactly the same amount sent as a direct investment to Cyprus. So what Russian companies were doing is ‘investing’ their own money in Cyprus and then bringing it back, so that money is now Cypriote money and it benefits from all these tax advantages. So now Cyprus is clearly closed down. I talked to a businessman the other day and he said no one in their right mind is going to send money into Cyprus at the moment, because you can’t get it out. And as long as the capital controls stay in place, which they probably will do for the foreseeable future, everybody is forced to open new bank accounts so that they can carry on doing business and imports, exports. The bulk of this money is not ‘illegal’ or ‘dirty money,’ ‘mafia money’ – there’re simple small or medium-size enterprises who set up bank accounts there in order to pay for their import business, trade business, whatever it is. And so everyone is going to go and look for a new place to do business, to have your offshore money to deal with the rest of the world. And the list of candidates is relatively short.
RT:But why is it so short?
BA: Well, there’re several issues involved. And first of
all, it’s the tax issue, I mean, they’re going to look for
advantageous tax domiciles. And the thing with Cyprus was that you
only paid 10 percent profit tax on your business, which is the
lowest in the whole EU. That’s even lower than the Russian
corporate tax, which is 20 percent, and the personal income tax
[which] is 13 percent. So you have lots of individuals keeping
their money in Cyprus because the tax rate is lower. And if you go
somewhere else, like to the BVI, or Caymans or to even the UK, the
tax rate is much, much higher, and of course the transaction’s much
higher. So some of the places I’ve been suggested – Latvia is an
obvious candidate, they have relatively low taxes, they have lots
of boutique banks that specialize in dealing with Russian business,
they speak Russian, and it’s not really far away – being close to
your money is now more important than ever as you can go and get it
if you have to in a crisis. Luxembourg is also being named.
But there’s an issue on the other side: the countries like
Latvia are very nervous, because they have the same problem as
Cyprus in that their banking sector is already bigger that their
economies. And that means that the government, should something go
wrong, is incapable of rescuing its bank sector and it has to go to
the European Union for the bailout. The same with Luxembourg, the
banking sector there is 25 times larger than the entire economy.
And although the Luxembourgian say that they only invest into
Triple-A assets, if there’s devaluation in the West, if the Euro
collapses, then suddenly someone like Luxembourg is in deep, deep
trouble. And will the EU come to their rescue – probably not, it’s
going to be very expensive.
So the size of the country is an issue, you know, when one is looking for a sort of stability. And Latvia this year already has had two banks collapse, which were connected to dodgy Russian money, and Magnitsky money, that case was also implicated in one of the collapses of the Latvian bank. So looking around there’s not that many candidates. But as I say, this is driven largely by pragmatic business interest: where can I get a good tax rate, where can I deal with people who speak my language, and who’re willing to accept a large amount of Russian money, because the amount of money coming is going to swamp the country like Latvia.
RT:So maybe it’s good for Russia, what do you think, or you think that’s impossible that all this money come back?
BA: Oh, I think some of it will come back. The returns on ruble deposits are actually pretty good, and they’re real positive interest rates in Russia for the first time. But there’s the bureaucracy aspect of it, people don’t like that it’s hard work, particularly if you’re trading. But against that the government is working hard with its capital market reforms. So I think some of it will come back.
RT:But do you think the situation will lead to even higher capital outflow from Russia, or it will bring some money back?
BA: I think it will bring a bit back. Having said that, though, the capital outflow this year and the first two months was already 25, and the government was predicting 10 for the whole year. And now they’re saying on something on around 40 (billion euro), which is still less than the last year. Nevertheless, it’s still pretty high. And I think, because the issue here is not fleeing capital protected from the Russian government, it’s an operational issue, that the needs of those operations require foreign bank. And until the reforms here are finished, until the Russian banking sector works as efficiently as the EU one, then we’ll always have this situation when people would want to have foreign banks. And we’re still a long way away from getting to that point.
RT:What do you think, will the alternative offshore area be Asia?
BA: Well, it’s slightly inconvenient in dealing with Hong-Kong, you know, if they’re asleep while we’re awake. Nevertheless, banking services are good there, and they’ve very, very light regulation in terms of getting money in and out, it’s very simple to work there. Again, I think people look at it in terms of geography and convenience. If they have business in Asia – and Russia increasingly does have business in Asia, the turnover of trade there tops $100 billion a year – certainly they’re going to open banks in Singapore and Hong-Kong. But then, again, half of Russia’s trade remains with Europe, and therefore if you’re doing that kind of business, you want the European banks, so you can actually pick up the phone and talk to your banker in the daytime, when you’re at work. So I think the need will remain for European bank of some sort.
RT:Coming back to Cyprus, don’t you think that the whole tax thing that they did can actually help Russia in its fight with corruption, illegal money flow? Maybe it’s all part of that anti-corruption campaign?
BA: Certainly quite timely, wasn’t it? Ignatyev, the head
of the Central Bank, came out on a speech a couple of months ago,
saying that he thinks half of the flying capital belongs to one
group, you know, without naming them, he was talking about
officials. And at the same time Putin’s introduced first the Duma
deputies had to declare their income, and that was broadened to
state civil servant functionaries. Most recently last week it’s now
including all the state executive, and they’ve all been given three
months to close down their foreign bank accounts, or else. And it’s
certainly getting serious, they’ve also brought the tax authorities
and got the bank involved as well, so not only are they turning
people to do this, but they start looking at people’s accounts and
see where the money is going. And then you have Cyprus on top of
that. And then just this morning the Guardian and the international
journalist association released this 2 million emails, that’s
bigger than WikiLeaks they’re saying, about offshore banking and
haven in British Virgin Islands, where lots of people have money,
and [First Deputy Prime Minister] Shuvalov’s wife has been
implicated, the president of Azerbaijan – his daughters have some
$4 billion there.
And so this whole thing about the offshore havens is certainly in the air, and Cyprus will only add to… clampdown on this and make everyone be a bit more transparent about where they keep their money. Which is a good thing, I mean, Russian officials who have secret offshore accounts is no good for business, it’s going to just engender the corruption. And now there’s a risk to doing it for the people – in France too, I mean, Hollande’s aide was just caught having a Swiss bank account, which he had for 20 years and didn’t declare, and it’s caused a huge scandal. So it’s becoming more and more unacceptable. And in that sense Russia is keeping pace with the rest of Europe against these offshore havens – if you’re going to be corrupt you have to park your money in some place, and it used to be Switzerland, but Switzerland now is becoming increasingly more transparent, so everyone went to the BVI, to the Caymans, to Latvia, to Cyprus, to Macedonia – and one by one these havens are being closed or made to be more transparent. For a country it’s dangerous to grow your banking sectors so large and be dependent on just one industry for your welfare – the Cypriote economy is being destroyed now, they’re going to be in a depression for a long time, because they’ve got nothing left, banking was the island’s entire economy.
RT:People are being skeptical about Medvedev’s initiatives to set up offshore zones here in Russia, like in the Far East. Do you take it seriously?
BA: No, not at all. They’re talking about special economic zones with tax advantages, but if you’re talking about an offshore banking sector within Russia, say, in Siberia, it won’t work, you’d have to set up a second Central Bank and you’d need to have second set of legislation that are more attractive. And it was tried in Yeltsin’s era when they set up these special tax zones to attract money for local investment, and it just turned into a huge black hole for tax avoidance, and it just engendered corruption. I mean, they’ve experience of it, and it’s not a good idea, and it doesn’t work.
RT:What is happening now, do you think it will decrease the level of corruption, or will it just make the people more ‘inventive’, and new schemes will appear?
BA: I think it’s probably a good thing. The first result
will be, countries like Luxembourg, which have these massive
banking sectors in proportion to their economies, will have to go
back and review everything. Clearly it’s unstable, and should there
be an event like the collapse in the Eurozone, then they’ll go to
the wall. And so they need to think about how they’re going to deal
with that and reduce that size. And you have countries of Latvia
who’re expected to receive a lot of Russian money – I think the due
diligence is to who this money belongs to, where it comes from,
what’s the source of the money. It’s going to be scrutinized a lot
more closely, which is a good thing, because part of this money is
illegal money from drugs, prostitution, arms trade – all those
things, and black money. And that money is going to take a lot
harder to find a home now.
And so that’s a step forward. And I think it’s also going to
continue the process of Russian integration, it’s going to go the
government in having its own banking sector. The people will want
to bring money home, make it easier to bank here, if you’re doing
international business. And it also fits into a general drive
against corruption, with state officials who’ll find it hard to
hide money abroad, if they do take bribes. You know, the risk of
taking that money has gone up and the chances of being caught are
higher. And eventually it will stop, bringing corruption down – it
hasn’t [been] done yet.