Date: Sat, 25 May 1996 16:23:46 CDT
Russia faces financial meltdown
By Renfrey Clarke, Green Left Weekly, #232, 22 May 1996
MOSCOW - Partly as a result of President Boris Yeltsin's efforts to buy himself victory in the June 16 elections, Russia in coming months is due to experience its most severe financial shocks since the policies of "reform" began to be implemented in January 1992.
The government has borrowed money in such quantities and at such high interest rates that a straightforward servicing of the public debt is now impossible. When the time comes in the late summer and autumn to repay the heaviest of these borrowings, the government can be expected to mount a savage offensive against the living standards of the mass of the population. Only in this way, government spokespeople will argue, can a total collapse of state finances be avoided.
The looming financial cataclysm is no mystery to western economic pundits. Russian bankers as well are in gloomy agreement that some such "meltdown" is inevitable.
But with one exception - an article on April 19 in Nezavisimaya Gazeta, the favourite newspaper of the Moscow intelligentsia - the Russian media have refused to take up the issue of how Yeltsin's pre-election largesse is to be paid for. Debate on this topic has been tacitly suppressed, as news editors have recognised that the president would have little chance of re-election if the true prospects after the polls were widely known.
The "reform" policies followed by Russia's new capitalist elite have never been distinguished by their theoretical coherence or practical success. Instead of pursuing the strategy - implemented with remarkable success by the Chinese in the 1980s - of retaining a planned state sector of large-scale industry and complementing it with the development of small and medium cooperative and private businesses, Russia's "reformers" have insisted on near-blanket privatisation and the imposing of monetarist "shock therapy".
The result has been a crash of industrial production to little more than half 1990 levels, and inflation since 1991 of thousands of per cent.
The crisis of "reform," clearly evident by 1993, was followed by desperate and often haphazard attempts at "stabilisation".
As part of this effort, the government swore off funding its deficits with credits from the State Bank - an inflationary practice which had amounted to the state borrowing from itself. Instead, loans were to be contracted abroad, and funds sought from Russian banks and other enterprises through the creation of a securities market.
To make lending to the government an attractive proposition, short-term securities were offered to Russian businesses at extraordinary rates of interest, sometimes above 100% per year in real terms.
The government's program of borrowing was praised in the west as an antidote to inflation. However, it had the effect of making lending to the government a far more secure and profitable option than investing in production. Investment rates continued to shrink, and output in the economy to slide.
Meanwhile, serious economists were comparing the super-profitable securities market to the "pyramid schemes" which had appeared in Russia in the early 1990s, flourished briefly and spectacularly and then collapsed, taking with them the savings of millions of small investors. With production in the economy declining, and the tax base shrinking, the only way the government could redeem its securities was by selling still more of them. Eventually, potential lenders would run out of money, or their confidence would crack.
In the spring of 1995, responding to demands from international lenders that inflation be curbed at all costs, the authorities began another ill-conceived manoeuvre. This was to use foreign loan funds to intervene in the currency market, bringing about a dramatic strengthening of the rouble.
While this helped reduce inflation - in recent times, to less than 3% per month - Russian products lost their competitiveness on foreign markets. Imported consumer goods, which many Russians found affordable for the first time, drove many local products from the market.
The result, from the final months of 1995, was a marked acceleration of the decline in output. Enterprises ceased paying wages, then taxes. State finances deteriorated alarmingly. Monthly budget revenue fell from an average of 15.4% of gross domestic product in August-October 1995 to 8.3% in January-February 1996. The budget deficit swelled; in the first quarter of 1996 it amounted to 28 trillion roubles (about US$5.6 billion) instead of a planned 19 trillion.
By increasing the budget deficit, the government's strong-rouble policies were creating an inflationary dynamic at least as powerful as the one they were designed to suppress.
In major cities, the presence of affordable imported goods created the illusion of prosperity in the period before the December 1995 parliamentary elections. The widespread failure to pay wages, however, helped doom the pro-government "Our Home is Russia" electoral bloc to a humiliating defeat.
In the aftermath of the parliamentary elections, opinion surveys were showing Yeltsin's confidence rating at less than 10%. Early in 1996, government leaders were faced with survey findings which suggested that Communist Party leader Gennady Zyuganov would easily out-poll Yeltsin in the June presidential vote. The result was the abandonment by the government of any attempt at coherent financial policy-making, and the complete subordination of economic strategy to the goal of getting Yeltsin re-elected.
Recognising the non-payment of wages and pensions as the core of his electoral problems, Yeltsin pledged that all state wage and pension debts would be paid by the end of March. As one of the means of achieving this, other areas of state spending were plundered. The journal Expert observed on April 29:
"In practice, the government has been living since February under an emergency budget with a single protected item - expenditure on wages. All other programs have been severely cut. Thus in January-March expenditure in the social-cultural sphere was two-thirds of the sum designated for the first quarter, spending on science was barely more than half, and financing of the federal investment program had effectively not started."
Maintaining these cuts in the longer term will be impossible. After the June elections, some balance will have to be restored - and wages and pensions will again cease to be paid. Meanwhile, the underlying problems have been greatly exacerbated by the other method that the government has used to boost real incomes in the pre-election months: a huge increase in its borrowing on the securities market, to more than US$4 billion per month.
By the first months of 1996, the ability of the securities market to supply the quantities of money the government was demanding was already near its limit. Interest rates had to be raised accordingly. From an annualised figure of 79% on January 31, the rate paid by the government on six-month securities rose to 126% on March 27.
On that date, the government's financial pyramid suffered its first collapse. Despite the fantastic interest rates, the government failed to sell almost a quarter of the securities it attempted to place. The market had been exhausted.
Facing catastrophe, the government desperately sought emergency loans from Germany and France, in addition to US$10 billion already promised by the International Monetary Fund. Germany quickly supplied US$2 billion, and France US$700 million. But even this extra money could calm the Russian financial scene only for a few weeks.
The government continued desperately trying to borrow. On April 17, with annualised interest rates at 166%, the market for short-term state securities suffered another failure. The government could persuade lenders to take up only about 60% of US$1.2 billion in six-month securities on offer. In financial terms, this was the equivalent of slamming into a brick wall.
The catastrophe on the financial markets made headlines around the world, receiving extensive coverage in newspapers like the Wall Street Journal. In Russia, however, the news passed with scarcely a whisper.
Even without paying most budget-sector wages after June, the government will still face an acute financial dilemma in the mid-summer. A recent estimate puts the monthly repayments on short-term securities after July at 25-30 trillion roubles, currently equivalent to US$5-6 billion.
By comparison, the average monthly repayment in the second half of 1995 was 9.4 trillion. Current tax revenues in real terms are barely half what they were in the autumn of 1995, and there is no possibility of raising the necessary sums on the now profoundly shaken securities market. The conclusion is inescapable: the government will not be able to pay off the full value of its debts, and will meet its formal obligations only through some fiscal sleight of hand.
Who will pay
When governments are insolvent, they have a variety of escape routes not available to individuals. The chief of these is to allow the currency to inflate, and to pay off creditors in devalued monetary units. The only eventuality which might save the Russian government from having to use this tactic would be if international lending agencies were to pledge tens of billions of dollars in new loan funds - something which is clearly impossible.
The main burden of accelerated inflation will be borne by Russia's workers, whose wages - if paid at all - will be worth less. Higher inflation, meanwhile, will be accompanied by devaluation of the rouble against other currencies. This will also slash living standards, by raising the prices of the imported consumer goods on which Russia's big cities now mainly subsist.
The situation which is now shaping up comes as no surprise to the government or to the country's financial elite. What Russia's rulers evidently failed to anticipate was that the debt pyramid would splinter in March and April, instead of after the presidential elections, as had been planned. Whether a major assault on living standards can now be put off until after mid-June, and Yeltsin's electoral prospects saved, remains to be seen.
No matter who wins the election, Russia is doomed to enter a new maelstrom of economic chaos that will include rapid price rises, a renewed fall in mass purchasing power and hence in demand on the internal market, and fresh declines in investment and output.
There is nothing conjectural about these prospects; they are the ineluctable result of decisions taken long ago. It must be stressed that while Yeltsin's pre-election handouts have brought forward the day of reckoning, the limits of the securities market were bound to be reached soon in any case.
It is time, therefore, to bluntly refute the lie that the policies which the international credit agencies have dictated, and which the Russian rulers have put in place, are correct and necessary. The evidence is now conclusive that the Yeltsin regime implemented the wrong "reforms", in the interests of the wrong people. Amid a new spiral of collapse, the workers and poor in Russia face the task of outlining a fundamentally different political and economic course, and of developing the forces that can put it into practice.
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