06MOSCOW11765, OCT 18 MEETING WITH KREMLIN ECONOMIST DVORKOVICH

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Reference ID Created Released Classification Origin
06MOSCOW11765 2006-10-19 13:00 2011-08-30 01:44 CONFIDENTIAL Embassy Moscow

VZCZCXRO4430
OO RUEHDBU RUEHFL RUEHKW RUEHLA RUEHROV RUEHSR
DE RUEHMO #1765/01 2921300
ZNY CCCCC ZZH
O 191300Z OCT 06
FM AMEMBASSY MOSCOW
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4225
INFO RUEHRC/DEPT OF AGRICULTURE WASHDC IMMEDIATE
RUCPDOC/DEPT OF COMMERCE WASHDC IMMEDIATE
RHEBAAA/DEPT OF ENERGY WASHDC IMMEDIATE
RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RHEHNSC/NSC WASHDC IMMEDIATE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCNCIS/CIS COLLECTIVE

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 011765 
 
SIPDIS 
 
SIPDIS 
 
 
LONDON FOR VISITING USTR DEL FOR DWOSKIN 
STATE PASS USTR FOR DONNELLY 
STATE FOR EUR/RUS WARLICK AND HOLMAN 
STATE FOR FOR EB/ESC/IEC GALLOGLY AND GARVERICK 
DOE FOR HARBERT/EKIMOFF/PISCITELLI 
DOC FOR 4231/IEP/EUR/JBROUGHER 
NSC FOR GRAHAM AND MCKIBBEN 
USDA FOR OSEC/TERPSTRA 
USDA FAS FOR ITP/MACKE, FLEMINGS, THOMAS; DLP/WETZEL 
 
E.O. 12958: DECL: 10/20/2016 
TAGS: ECON ENRG ETRD KIPR
SUBJECT: OCT 18 MEETING WITH KREMLIN ECONOMIST DVORKOVICH 
 
 
Classified By: Ambassador William J. Burns by reasons 1.4 (b) and (d). 
 
1. (C) SUMMARY.  In a wide ranging discussion with Economic 
Minister-Counselor October 18, Arkadiy Dvorkovich, Head of 
the Experts Group of the Russian Presidential Administration 
exuded quiet confidence about the difficult path of economic 
reform in Russia.  He cited recent positive movement across a 
diverse array of issues, including electricity, gas, 
municipal government and tax reform, predicting as well that 
long-stalled legislation on foreign investment in strategic 
sectors (including energy) could move into the Duma before 
the end of the year.  Expressing concern about the killing of 
Central Bank Deputy Andrey Kozlov, Dvorkovich predicted 
Kozlov's reforms would continue.  On WTO, Economic 
Minister-Counselor raised USG dismay over indefensible 
Russian Veterinary Service claims of substandard U.S. meat 
handling and the deeply flawed Part IV of the Civil Code on 
IPR.  Dvorkovich expressed understanding for the situation 
Russian Veterinary inspectors were creating regarding USG 
sanitary and phytosanitary norms for beef and pork, and 
promised to raise our concerns about the flawed approach to 
IPR protection contained Part IV of the Civil Code in Kremlin 
circles. Responding to questions about contract sanctity for 
U.S. oil companies, Dvorkovich claimed no broad attack on 
Production Sharing Agreements was in play, but that Sakhalin 
II operators were seen as badly abusing their privileged 
position and would need to come to a reasonable negotiated 
outcome with the GOR on the cost overrun issue.  He said 
there were no plans to replace former Presidential Economic 
Advisor Andrey Illarionov and that Illarionov,s staff had 
been disbanded.  END SUMMARY. 
 
2. (C) Atmospherics.  Unlike previous encounters over the 
past two years, Dvorkovich was visibly less haggard and 
displayed much of his hallmark enthusiasm.  In contrast to 
his downbeat assessment of the outlook for reform a year ago 
(in the wake of the problems which plagued the monetization 
of benefits in early 2005) he noted a wide range of positive 
developments in motion on everything from taxes to 
electricity to federal-municipal relations.  He was upbeat 
about overall growth prospects and did not see any serious 
risks to the economy in the medium-term, including from a 
softening in oil prices.  The economy is developing on two 
separate and independent tracks, with the non-extractive 
sectors demonstrating significant sustainability, again 
independent of the energy sector. 
 
3. (C) Energy Reform.  Dvorkovich conveyed a sense of steady 
confidence that reforms currently in play would bear fruit 
over the next 2-4 years.  He said independent producer access 
to Gazprom,s pipeline monopoly was still insufficient, but 
that the drive to close the 2010 gap in gas supplies was 
sharply changing that dynamic in favor of the independents. 
Talk of freeing prices for Gazprom,s industrial users was 
serious, but success was not a foregone conclusion. 
Regardless, by 2010, the gas sector would have undergone 
"seminal change."  On electricity reform, he complained that 
UES Chairman Chubays often strained the system with his 
 
SIPDIS 
maximalist approach to liberalization, but that the effect of 
his efforts had been to drive reform much faster than might 
have been expected. 
 
4. (C) Tax Reform. For the past year, Dvorkovich has 
struggled against Finance Ministry objections to advance a 
plan to replace Russia,s value added tax (VAT) with a sales 
tax.  His position is gaining momentum, as many were coming 
to realize just how open to abuse the VAT system had become 
(despite the enthusiasm of the early 90,s which held that a 
VAT approach was virtually corruption-proof). They had 
carefully studied the U.S. model of state sales tax and had 
drawn lessons, both positive and negative from our experience. 
 
5. (C) Banking Reform.  Dvorkovich, like many of his 
colleagues who have risen steadily through the system since 
the mid- 1990,s, shared his dismay at the death of Central 
Bank Deputy Chairman Andrey Kozlov.  He said the search was 
 
MOSCOW 00011765  002 OF 003 
 
 
on to find a suitable replacement, with number of candidates 
under consideration -- most prominently former Finance 
Minister Mikhail Zadornov (who Dvorkovich considered the best 
qualified of the group).  Evidence was emerging to support 
the theory that Kozlov,s work on cross borders bank 
trans
fers had triggered his assassination -- which made sense 
-- he doubted that Russian banks were still so heavily 
criminalized as to go after a senior official in this manner. 
 The banking sector overall is in the midst of an intense 
recapitalization, fueled by both domestic and foreign 
investment, and that this will bring significant competition 
to bear in the sector over the next few years to the benefit 
of the economy as a whole. 
 
6. (C) The Law on Strategic Sectors.  Dvorkovich himself has 
led the debate on the need to develop a CFIUS-like (i.e., 
Committee on Foreign Investment in the U.S.) approach in 
Russia, and he confirmed that the draft law is now in motion 
again, having been submitted last week to the Government.  It 
will likely reach the Duma during the current session. 
Outstanding issues remain 1) the trigger threshold for 
government review of an investment in a strategic sector (the 
FSB is pressing for a 30% stake trigger, vs. the 50% stake 
advocated by the rest of the interagency) and 2) the size of 
oil and gas fields that would be automatically subject to 
review (on which opinions still differ widely). 
 
7. (C) Production Sharing Agreements (PSAs).  Economic 
Minister-Counselor raised USG concerns about contract 
sanctity and apparent efforts to reopen PSAs.  Dvorkovich 
complained that the operators of Sakhalin II had abused the 
terms of their generous ("the most generous") PSA through 
inexplicable cost overruns.  The overruns significantly 
reduced the overall profitability of the project, and caused 
a 2-3 year delay in the start of payments to the GOR. 
Echoing an October 17 conversation with Deputy Economic 
Minister Kiril Androsov, Dvorkovich said the government 
expected the consortium to enter into good faith negotiations 
on the cost overrun issue, a process which was now underway. 
Dvorkovich confirmed the positive assessment we have heard 
from others in the GOR about ExxonMobil,s Sakhalin I 
project, which is seen as delivering on-time and on-budget. 
 
8. (C) WTO.  Economic Minister-Counselor impressed upon 
Dvorkovich the seriousness of the emerging situation created 
by the Russian Veterinary Service (VPSS) in the context of 
our WTO negotiations.  She complained that it simply flies in 
the face of common sense for the Vets to assert that U.S. 
meat exports were of substandard quality.  Economic 
Minister-Counselor urged that the Russian side not allow 
itself to be caught up in VPSS hyperbole.  Dvorkovich agreed 
to try and keep the discussion balanced.  He also sought 
assurances that other open issues in the negotiations were 
progressing, and Economic Minister-Counselor suggested that 
it appeared so, given the concentrated efforts of both USTR 
and MEDT since July. 
 
9. (C) IPR.  Economic Minister-Counselor expressed deep 
concern about Part IV of the Civil Code on IPR.  All 
indications were that a deeply-flawed text was moving towards 
precipitous passage in the Duma, all driven by some perceived 
Presidential imperative.  Better to get it right than have to 
amend the text extensively after passage.  Dvorkovich 
expressed a clear understanding of the issue, noting that the 
outcry against this legislation had been very vocal.  He 
agreed to raise it with Deputy Prime Minister Dmitriy 
Medvedev, and would see if the Kremlin might be able to make 
clear to the Duma the need for accuracy over speed.  Economic 
Minister-Counselor repeated USG willingness to engage on the 
text, noting our July and early October USTR-led delegations 
to Moscow. 
 
10. (C) Boeing.  In an aside, Dvorkovich commented that the 
Boeing sale of 22 787,s to Aeroflot was explicitly tied to 
the outcome of our WTO negotiations.  This was true even 
though depriving Aeroflot of the sale made little sense since 
 
MOSCOW 00011765  003 OF 003 
 
 
Airbus simply had no competing plane to sell.  Economic 
Minister-Counselor drew his attention to the upcoming October 
24 Aeroflot board meeting and asked if a way forward could be 
found to keep this sale from an unnecessary demise after 
November 1, after which Aeroflot might still be able to buy 
the planes, but not at the price or delivery date in the 
current package. 
 
11. (C) Federal-Municipal Relations.  Dvorkovich confirmed 
that a significant effort was underway to get Municipal 
reform on track.  The basic idea calls for Municipal-level 
(County-equivalent) units of government to become fully 
operational by January 1, 2009.  This entails the development 
of a property tax system, which is being coupled with an ever 
increasing devolution of responsibilities to town councils -- 
making them accountable to the populace for basic services 
and maintenance.  Legislation refining those responsibilities 
is before the Duma even now.  Unfortunately, Municipalities 
have been far from uniformly successful to date at the 
mechanics of establishing an independent revenue stream, 
which has necessitated suboptimal Federal transfers straight 
from the top to the bottom of the fiscal federalism ladder. 
In select instances, federal authorities are working these 
transfers through regional governments, but this was 
dependent on the quality of regional officials. 
 
12. (C) Comment.  Dvorkovich clearly understands our concerns 
about the meat safety, IPR protection, and the WTO 
negotiations, as well as PSA contract sanctity.  Looking at 
the broad sweep of reform over the past two years, it was 
clear that in the wake of the fiasco surrounding the 
implementation of the monetization program in January 2005, 
reformist elements in the GOR had scaled back their 
ambitions.  Yet this conversation suggests that reformers 
have been quietly advancing their agenda -- although not 
under the reform banner.  This is all the more interesting in 
light of Kozlov's murder and well-publicized actions that 
seem antithetical to the trend described here.  Dvorkovich 
may be overly optimistic about the results, but progress is 
possible over the next year on tax and electricity reform, 
independent access to the gas pipeline monopoly, and perhaps 
even passage of the Strategic Sectors and Subsoil laws. 
 
 
 
 
 
BURNS

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