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Reference ID Created Released Classification Origin
07MOSCOW2206 2007-05-14 03:19 2011-08-30 01:44 CONFIDENTIAL Embassy Moscow

DE RUEHMO #2206/01 1340319
P 140319Z MAY 07

C O N F I D E N T I A L SECTION 01 OF 05 MOSCOW 002206 
E.O. 12958: DECL: 05/11/2017 
REF: A. MOSCOW 01904 
     B. 06 MOSCOW 12191 
     C. 06 MOSCOW 11387 
     D. 06 MOSCOW 09942 
     E. 06 MOSCOW 05355 
     F. 06 MOSCOW 04091 
Classified By: EST Counselor Daniel O'Grady. Reasons: 1.4 (b,d) 
1.  (C) SUMMARY: The information and communications 
technology sector is the most vibrant in the Russian economy, 
demonstrating double digit growth year to year since 2000 and 
contributing more than five percent to total GDP in 2006. 
Despite the prospect of surging expansion of the IT sector 
based on outsourcing and product development, the mobile 
phone segment has reached saturation of the market, 
threatening to slow future growth.  The Ministry of 
Communications has become part of the problem due to 
regulatory constraints and the legal travails of its head 
Leonid Reyman.  At this juncture, First Deputy Prime Minister 
Sergey Ivanov has taken control of the ICT sector and 
promises to continue the positive trends, but to crack the 
whip on negative aspects.  This shifting situation poses a 
strategic question for the prospect of cooperation. END 
2.  (SBU) The Russian information and communications 
technology (ICT) industry contributed $28 billion, or more 
than 5 percent, to 2006 GDP, according to figures released by 
the Ministry for Information Technologies and Communications 
(MinInformSvyazi).  The latest economic reports for 2007 show 
that the ICT industry continues to grow by more than 20 
percent per year, as it has every year since 2000, while the 
overall GDP is growing by 6.7 percent.  In March, Minister of 
Communications Leonid Reyman predicted the ICT market would 
reach $40 billion by 2010 and exports of software would total 
$10 billion, up from $1.5 billion in 2006.  Steve Chase, 
president of Intel Russia, said on April 14 that Russia would 
have an outsourcing market for software design of $1 billion 
by the end of 2007.  Russia currently ranks third in 
outsourcing behind India and China (albeit having less than 
10 percent of the market) and is valued for its strong design 
capability and highly-educated workforce.  There are 300,000 
IT professionals in Russia, and Russia is second to the 
United States in producing science and engineering graduates 
every year. 
3.  (SBU) Despite the impressive growth of the ICT sector in 
recent years, it reached a crucial stage in its development 
in the past year.  The mobile telephone industry -- the 
largest component of the C in ICT -- moved from the era of 
explosive growth that characterized the period from 2000 to 
2005, when it grew by over 20 percent per year, to more 
gradual expansion in 2006-07 with the growth rate dropping 
below 15 percent.  The telecommunications industry faces 
potential stasis in 2008 and thereafter.  While mobile phone 
operating companies are looking for new customers and new 
markets to increase stagnating revenues, the information 
segment (IT) of ICT has continued to climb rapidly from 33 
percent of total ICT output in 2005.  In 2006 the IT market 
grew 17 percent to $13.6 billion and shows signs of becoming 
the more dynamic element as a result of increased consumption 
by government, the corporate sector and increasingly affluent 
households.  The IT export market -- primarily software, but 
increasingly turning to outsourcing -- reached $1.8 billion 
in 2006, according to the MinInformSvyazi. 
3G . . .and beyond! 
4.  (SBU) On April 20 the Ministry of Communications awarded 
the eagerly-anticipated licenses for the third generation 
mobile services.  The 3G mobile technology will allow mobile 
telephones to become an extension of the Internet.  Services 
such as e-mail, instant messaging (IM) and video-telephony 
will be available.  Although 3G is hailed by the Russian 
media as signaling the arrival of the Russian ICT industry on 
the global market, this step is fraught with painful choices 
MOSCOW 00002206  002 OF 005 
and potential pitfalls for the major mobile phone operators. 
Minister Reyman said in December: "We were not in a hurry to 
issue 3G licenses...because from our point of view there is 
not a big demand for some services that 3G can offer." 
Losers in the 3G license competition claim the winners only
intend to roll out their service in the largest cities and 
will ignore the regions in contravention of the license 
requirements.  They have asked that a fourth 3G license be 
awarded to a regional alliance of mobile operators using the 
networks of the companies that obtained the licenses. 
5.  (SBU)  MobileTeleSystems (MTS), the largest mobile phone 
operator, has 72 million subscribers in Russia and the CIS, 
with 2006 fourth quarter revenue of $1.81 billion.  MTS 
President Leonid Melamed said on April 23 the company would 
spend $1 billion through 2010 in the creation of the 3G 
network.  According to Melamed, MTS plans to start operations 
in the second half of 2007 in Russia's 15 largest cities and 
expand to the rest of the country in 2008.  However, Melamed 
said there was an "uneasy state with frequencies" that must 
be approved in some of the local markets to begin operations. 
 But he predicted that in three years 30 percent of all 
companies in the customer base would be using the 3G network. 
6.  (C) VimpelCom,the second largest mobile phone operator, 
declared on April 13, even before it received the 3G license, 
that it would spend up to $350 million by the end of 2008 to 
create the infrastructure necessary to carry service to all 
regions as required by the license.  VimpelCom plans to build 
up to 2,000 base stations in three years to cross Russia. 
VimpelCom's CEO Alexander Izosimov said that 3G would 
"contribute to healthy competition in the Russian 
telecommunications sector."  However, a month earlier the 
senior vice president for Central and Eastern European 
operations of Telenor (protect), one of VimpelCom's two 
controlling shareholders, told us that 3G operations were at 
best likely to contribute little to the bottom line.  He said 
that the enormous initial investment in infrastructure would 
offset the expected growth in revenues for the foreseeable 
7.  (SBU) Going beyond 3G, in the past year 
telecommunications provider Comstar initiated wireless 
Internet access services (Wi-Fi), starting in central Moscow 
and expanding to Metro stations in Moscow and St. Petersburg. 
 Other companies offer a national broadband wireless access 
network (WiMAX) in Voronezh, Lipetsk, Penza, Samara, Tula and 
Yaroslavl.  By the second half of 2007 WiMAX will be 
operating in 32 cities outside Moscow and St. Petersburg. 
This development capitalizes on the spread of personal 
computers (up 33 percent to 23 million units) and the 
increase of Internet users (up 15 percent to 25.1 million 
people) in 2006.  Although trailing the United States by a 
wide margin, Russia is outstripping India and China in the 
expansion of the telecommunication society.  However, the 
unpredictable regulatory environment and growing conflict 
among the major players in the mobile phone market cloud 
prospects for the future. 
Regulatory Hurdles and Hidden Interests 
8.  (SBU) VimpelCom stock has been listed on the New York 
Stock Exchange for over 10 years.  Corporate rating agencies 
rank it as one of the most transparent Russian businesses. 
However, VimpelCom has had difficulty obtaining favorable 
regulatory decisions.  VimpelCom applied 20 times for a 
license for radio frequencies in 11 regions in the Russian 
Far East, but was denied by the Federal Service for 
Supervision of Communications (Rossvyaznadzor), the agency 
responsible for assigning radio frequencies.  Finally, 
VimpelCom filed a complaint with the Federal Anti-Monopoly 
Service and won a ruling in 2006 ordering Rossvyaznadzor to 
issue the license.  Nevertheless, the Ministry and 
Rossvyaznadzor now claim that no frequencies are available. 
9.  (C) Dmitriy Zimin, founder of VimpelCom, told us with a 
shrug that this is the reality of doing business in Russia. 
MOSCOW 00002206  003 OF 005 
He acknowledged the common belief that Minister Reyman has a 
concealed stake in MegaFon, the only mobile operator with 
licenses in all regions.  He strongly voiced his opinion that 
this interest dictated decisions favoring MegaFon and 
disadvantaging its competitors. 
10.  (C) On March 19 President Putin ordered Rossvyaznadzor 
to be incorporated into the new Federal Agency for Mass 
Communications, Telecommunications and Cultural Heritage. 
(NOTE: The head of the new agency, Boris Boyarskov, has 
written to us that he intends to continue to work with the 
USG on IPR issues such as the licensing of optical disk 
production plants. END NOTE)  The new agency will also 
inherit Rossvyaznadzor's oversight of protection of personal 
privacy pursuant to the new laws "On Personal Data" and "On 
Information, Information Technologies and Information 
Protection." (REF D)  According to the Presidential decree, 
regulations for the new agency will be drafted by early 
summer to reassign functions among the various agencies. 
Minister vs.Oligarch vs. Shareholders 
11.  (C) Reyman's concealed interest in MegaFon allegedly 
arose in the 1990s when he oversaw the privatization of the 
local communications sector.(REF E)  In May 2006, the Swiss 
Arbitration Court identified (but did not name) a Russian 
minister as the secret beneficiary of a Bermuda trust, IPOC 
Holdings, that owned a controlling interest in MegaFon as a 
result of a web of money laundering and fraudulent transfers 
that took place in St. Petersburg.  The description clearly 
applied to Reyman, but he was not a party to the legal 
proceedings and was not bound by the decision.  He has 
repeatedly denied the accusations over the years, claiming he 
has no interest in MegaFon.  However, his explanations have 
been unraveling, and in March, Bermuda initiated steps to 
dissolve IPOC for fraudulent concealment of the secret 
interest.  German prosecutors are currently investigating 
transactions from the 1990s in which Reyman may have received 
12.  (SBU) The charges against Reyman came to light as part 
of a struggle for control of MegaFon by Mikhail Fridman, the 
billionaire oligarch controlling the Alfa Bank empire. 
Fridman claimed to have purchased stock representing 25 
percent of MegaFon from LV Finance, to whom IPOC had 
previously paid $50 million for an option to purchase the 
same stock.  In June, 2006, IPOC brought a $150 million RICO 
(Racketeer Influenced and Corrupt Organizations) action 
against Fridman, Alfa Bank and LV Finance in New York Federal 
court based on allegations that the defendants conspired to 
seize IPOC's right to the stock.  On April 16 Leonid 
Rezhetskin, former owner of LV Finance, sued Reyman in the 
same court, claiming Reyman threatened his business in order 
to force him to sell to IPOC.  The legal wrangling is 
expected to continue long into the future. 
13.  (C) While charges swirl around Reyman and Fridman over 
MegaFon, the Norwegian communications giant Telenor is locked 
in a struggle with Fridman for control of VimpelCom.  Fridman 
owns approximately 36 percent of VimpelCom while Telenor has 
29 percent.  According to sources at Telenor, Fridman has 
been trying to oust Telenor by circumscribing its minority 
rights.  They also claim Fridman directed VimpelCom to expand 
into Ukraine, where Telenor has the majority interest in the 
largest Ukrainian mobile operator, without business 
justification and solely in order to dilute Telenor's 
interest in VimpelCom. (COMMENT: The competitiveness of the 
telecommunications industry is at stake in the conflict among 
Reyman, Fridman and Telenor.  Fridman threatens to seize 
control over two of the three largest mobile companies while 
Reyman manipulates the industry despite a glaring conflict of 
interest.  Ominously for Russia, the ICT industry is the 
fastest growing sector in the economy and represents the 
breakthrough to future innovation technology. END COMMENT) 
The Minister's Conundrum 
MOSCOW 00002206  004 OF 005 
14.  (C) Reyman is at once one of the most forward-looking 
members of the cabinet and arguably one of the largest 
gluttons at the privatization trough.  In public disclosure 
for cabinet members, he ranks as the third richest minister, 
but his acknowledged income is only $44,000 with assets 
(primarily his apartments) valued at about $400,000.  His 
reputed interest in MegaFon may be worth several billion 
dollars, but his accusers allege he acquired the interest 
through fraudulent conversion of state assets to personal 
benefit and the use of laundered money. 
15.  (C) In contrast to his alleged private behavior, Reyman 
is leading his ministry, in cooperation with the Ministry of 
Education and Science, in a new national project to provide 
licensed software for all Russian schools by the opening of 
the coming school year, and he offered a plan for federal 
funding of the program.  He has championed the freedom of the 
Internet from state control over content despite calls in the 
State Duma to regulate electronic speech.  (NOTE: A case is 
wending its way through the judicial system where a chat room 
user was charged with defaming President Putin. END NOTE)  As 
minister, Reyman has promoted development of public-private 
partnerships to foster innovative technology.  He was one of 
the primary sponsors of the Investment Fund for Information 
and Communication Technologies and will oversee 1.5 billion 
rubles ($60 million) in investment in technology development. 
 And yet the price for his public service seems to be 
tolerance of his shady dealings with one of the major 
companies his ministry regulates. 
--------------------------------------------- - 
A Very Long Engagement...and Ivanov Takes Over 
--------------------------------------------- - 
16.  (C) For over a year, Reyman has been trying to engage 
the USG in a variety of cooperative efforts.  In May 2006, he 
visited Commerce Secretary Gutierrez in Washington and 
invited him to attend an October roundtable of 
telecommunications companies and government officials in 
Moscow.  Although the Secretary declined, Reyman renewed the 
offer in August and coupled it with an invitation to the 
Communications Ministers meeting of the Black Sea Economic 
Cooperation Organization (REF B).  After Reyman met the 
Secretary on his recent trip to Moscow, he renewed his 
pursuit on April 24 by proposing the Secretary attend a 
business-government roundtable at the Ministry-sponsored 
InfoCom gathering this coming October (REF A).  At the same 
time, the Ministry requested the creation of a government to 
government working group on communications, which would meet 
17.  (C) Reyman is a savvy member of the St. Petersburg 
circle that is close to Putin.  As such, he has been a nimble 
player of the Kremlin power game, even when confronted by 
such powerful adversaries as VimpelCom and Mikhail Fridman. 
Reyman will now have to deal with First Deputy Prime Minister 
Sergey Ivanov, who was given responsibility for 
communications and innovation technology as part of his 
elevation in status from Defense Minister.  In his first 
speech on ICT issues, Ivanov addressed the MinInformSvyazi at 
the annual departmental convocation on March 27 about the 
value of innovation, but he also criticized "a whole industry 
of corrupted officials."  He told Reyman and the assembled 
bureaucrats that the future of Russia was intimately 
connected to the new technology they supervised, but that 
"the current situation still leaves a lot to be desired." 
While praising the industry's accomplishments, he took a 
swipe at its shortcomings by noting that too many components 
were imported.  He held out hope that Russia would rise from 
its current low position to become a major player in the 
international ICT market and said "all regions of the Russian 
Federation should have the technical infrastructure in place 
for land-line connection, mobile communications and access to 
the Internet by 2015." 
18.  (C) Ivanov's influence is already being felt.  On April 
19, Deputy Information Minister Boris Antonyuk, Federal 
MOSCOW 00002206  005 OF 005 
Communications Agency Head Anatoliy Beskorovainy and Deputy 
Chief of the General Staff Evgeniy Karpov announced the 
future coordination of regulation of civil and military radio 
frequencies.  Antonyuk said this represented "a one-stop 
principle" for regulation whereby one agency will be 
responsible for processing applications and obtaining civil 
and military clearance.  This holds promise that the Kremlin 
may finally proceed with the long-delayed privatization of 
Svyazinvest, the government-owned communications holding 
company that controls the fixed-line telephone services. 
This sale would raise up to four billion dollars, but the 
Defense Ministry reputedly has stalled the sale over concerns 
within the armed forces that their lines of communications 
would be compromised. 
Comment: Encourage Progressive Trends 
19.  (C) The ICT industry is poised for significant growth if 
it can overcome both the natural flattening of demand in the 
mobile phone sector and complications related to the 
precarious legal position of the Communications Minister. 
The former conditions are within the control of the major 
industry players based on innovation, competition and the 
growth of the IT sector and outsourcing.  There is a 
significant chance that Reyman's schemes will be exposed in 
coming months, and it is even possible that he may be accused 
of criminal acts in several jurisdictions.  Ivanov evidences 
support for Reyman's vision of the telecommunicatio
industry's future, but he promises a strict standard of 
accountability.  In these circumstances, the USG should 
support the opening of Russia to competition and innovation, 
acknowledging the Communications Ministry's overtures by 
responding to invitations to greater cooperation, such as the 
establishment of industry working groups, the creation of 
experts' panels and the exchange of regulatory experience. 
However, we should keep an arm's length relation with the 
Minister himself, who may not survive the transition after 
Putin or even before as Ivanov takes control of ICT. 


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