Transnational Holdings Have a Stranglehold on Russian Local Governments

04.06.2010 — Analysis

Uralsevergaz CJSC, a monopoly supplier of gas to the Sverdlovsk Oblast, claimed that consumers owed it 4.7 billion rubles. The "leader's" list is headed by Nizhny Tagil (364 million rubles), which is the home-city of enterprises belonging to Evraz Group, a mining and smelting holding that also owns production businesses in the USA, Canada, Italy, Czechia, South Africa and Ukraine. Several months ago, the Nizhny Tagil Iron and Steel Works, which is a member of the holding, brought a suit against the city council, claiming 165 million rubles for heat and hot water provided to the citizens. The Nizhny Tagil authorities gave in without a struggle. Probably, because the city Mayor Valentina Isayeva took up her post with the support from the holding.

Gennady Uporov, Chairman of the City Duma, says that the municipal government is desperately short of money. The budget deficit, together with the population's insolvency, generated utility debts. The local budget is formed mainly by tax revenues received from the citizens; as their incomes changed significantly during the crisis, the Duma head forwarded the proposal to revise the National Budget Code that should regulate tax distribution in favor of local governments.

Oksana Dmitrieva, a member of the RF State Duma Committee on Budget and Taxes, thinks that federal authorities will be able to help local governments in two ways: firstly, taxes must be distributed equally between federal and regional budgets (today, entities of the Russian Federation receive not more than 34% of tax revenues); secondly, tariffs of natural monopolies should be limited. The deputy reckons that municipal governments will inevitably encounter arrears in payment when gas and electricity prices show an annual increase of 24-27%.

Experts think that supervisory authorities must also focus their attention on industrial companies that fill local budgets with taxes and, generally, provide single-industry cities and towns with energy. Business owners do not always demonstrate good conduct. According to the Russian Mining and Metallurgical Trade Union, in 2009 Evraz Group slimmed down its workforce by 14.5%, having cut the personnel costs by 203 million rubles. At the same time, the wages were trimmed. G.Uporov states that at the Nizhny Tagil Iron and Steel Works the wages decreased on average by 3 thousand rubles. Consequently, payments to the local government took a nosedive, as the lion's share of the fiscal revenues comes from the income tax paid by Evraz Group employees. The improper behavior on the part of the owners of the backbone enterprise lies in the fact that expenses on personnel could have remained intact.

According to experts, these expenses account for 6-9% at Russian metallurgical enterprises. The world blue-chip companies have a much higher "salary" index: for example, US Steel's personnel expenses amount to 24.1% of the product cost; and the similar expenses of ArcelorMittal are about 14%. It is clear that within the cost structure existing in Russia, Evraz Group saved just nickels and dimes, having leveled down the wage pool. Ore and coal costs are much heavier in weight; however, the holding decided to retain the existing cost structure: probably, due to the fact that coking coal is a separate business area of Evraz Group, and Roman Abramovich and his copartners are not interested in shaving its prices.

The plan of the owners was simple: the production output will come back to the rising track; the laid-off employees will be taken back, but at lower wages. The single-industry city residents are backed into a corner, since other job opportunities are not available. The fact that such a position of the employer brings no relief to the Nizhny Tagil citizens in their utility payments seems of no concern to Evraz Group. Moreover, debts for the energy supplied to the city are set off, over and above, through the budget that is formed primarily by tax revenues received from the above metallurgists.

Meanwhile, the situation with Evraz Group's tax payments is not hitch free. At the beginning of 2010, the holding announced that in 2009 the revenue decreased five times at the Nizhny Tagil Iron and Steel Works, and ten times at the Kachkanar Mining and Processing Integrated Works. Curiously enough, but in October 2009, Giacomo Baizini, Finance Vice President of the Group, in his interview with the RBK Daily stated that "our Russian and Ukrainian enterprises are operating at full stretch; the Italian factories are operating at 100% capacity; the similar situation can be observed in Canada and the RSA". His optimism extended further to the prices for metallurgical products: as of the end of 2009, the estimated contract prices for slabs ranged from 450 to 470 dollars per ton at the ports of Taiwan, Korea and Vietnam, taking into account the average cost price equal to 220 dollars.

The Sverdlovsk regional government did not believe the statements that the Evraz Group executives made concerning the tenfold drop in the Kachkanar GOK's revenue and commissioned the revenue service to audit the financial operations of the enterprise. Evgeny Kharlamov, the government press-secretary, informed "RusBusinessNews" that soon after that, Evraz Group transferred sizeable amounts to the regional and municipal budgets. According to Alexei Agureyev, Evraz Group's Vice President for Public Relations, in 2009 Evraz transferred more than 100 million dollars to the Sverdlovsk regional budget alone. However, just a few months before, the executives claimed that the revenue of the transnational holding amounted to 7 billion dollars over nine months in 2009.

Analysts point out that Evraz Group uses to the maximum the holding structure to skimp on tax payments. The subsidiaries do not pay dividends to the shareholders, but provide the owners with loans issued on non-commercial terms, thus, reaching tax savings that may equal 30%. Vysokogorsky GOK is a prime example in the Sverdlovsk Oblast. The enterprise lent 2.5 billion rubles to Sibmetinvest (is also a member of Evraz), and then began to ease the terms of the loan to its own disadvantage.

Today, the Evraz Group strategy for development has become very clear. By using low-cost production capacities of Russia, the company exports semi-finished products to other countries, where it uses the received profit to purchase good assets. The latter, according to Giacomo Baizini, constitute enterprises in the USA, Europe and the Republic of South Africa. The Russian production base aids the holding's competitiveness on the world markets. As the top manager says, it is a Group's strong stand; therefore, the conclusion is that the cost structure in terms of the Russian workforce will remain at the moderate level of 6-9%. The regional authorities confine their efforts to requests, asking the business owners to increase metallurgists' wages.

Vladimir Terletsky