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Changes in Putin's Russia

Changes in Putin's Russia

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Published by: CasualFriday on Dec 29, 2011
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The crisis that swept the Russian money markets in 1998 was an
extension of the East Asian crisis in 1997. And all these events were
tremors that preceded the international financial earthquake of
2007–08. The way for these events was paved by low interest rates
in the world’s largest economies, which had encouraged investors to
move billions to emerging markets – at first to Latin America, but
after the Mexican crash of 1994, increasingly to East Asia. Share
prices, levels of debt and exchange rates became unsustainably
high. In August 1997, the financial system in Thailand collapsed
and triggered a run of crashes across East Asian markets. Volatile
capital flowed out much more quickly than it had flowed in. What
the US economist Paul Krugman wrote about the Asian countries
also applied to Russia:

They had become more vulnerable partly because they had
opened up their financial markets – because they had, in fact,
become better free-market economies, not worse, [and also]
because they had taken advantage of their new popularity
with international lenders to run up substantial debts with the
outside world.19

In Russia, that indebtedness was driven primarily by the weakened
state. After the 1996 election, key government and administrative
posts were handed to oligarchs (Berezovsky, who joined the national
security council, and in 1998 served briefly as executive secretary
of the CIS, and Potanin, who was deputy prime minister for a
year), and to extreme free-market reformers (Chubais, from July
1996 head of the presidential administration and from March 1997
first deputy prime minister in charge of economic policy, and Boris
Nemtsov, who was put in charge of social policy and the energy
complex). Chernomyrdin remained prime minister. They presided
over three aspects of a deepening crisis:

• The nonpayments epidemic. The government and Central Bank
– strongly supported by the IMF, in line with its dogma of
‘fighting inflation’ – had starved the economy of money, causing
basic economic relationships to seize up. Government subsidies
to or invoices from enterprises, enterprises’ bills to each other,
and millions of people’s wages, were left unpaid for months and



years. Noncash forms of payment – the barter of goods, offset
arrangements, promissory notes or local government securities
– rose from less than 10 per cent of all transactions in 1992
to 54–70 per cent in 1998, according to government statistics.
Stories of workers being paid with boxes of shoes, or firms
settling bills with stocks of machine components, filled news-
papers. Nikolai Shmelev, one of the moderate reform econo-
mists, calculated that in 1992–95 prices had risen about 8,500
times, but the total money flow had risen only 230 times. Even
accounting for the collapse of industry, the volume of money
in circulation in 1996 was 15–20 times lower than required, he
• The state’s inability to balance its books. The state was strug-
gling to collect taxes, and things were made worse both by the
nonpayments crisis and by the chaotic condition of the tax code.
Nominal tax rates remained absurdly high, while special interest
groups were handed out tax breaks which together exceeded the
size of the budget deficit. A new code had been drafted in 1993,
but got bogged down in parliament and was not made law until
1999. The government, having agreed with the IMF not under
any circumstances to print more money, now depended more
heavily than ever on the Fund’s loans, and on money raised by
issuing short-term treasury bills, known by their abbreviation,
GKOs (see Glossary). The total volume of GKOs outstand-
ing soared from $3 billion at the end of 1994 to more than
$70 billion in mid-1998, just before the crash.21
• A speculative bubble was inflated by Russian and foreign banks
at the state’s expense. As interest rates rose, the yields (regular
interest payments to investors) on GKOs rose, and new GKOs
were issued to redeem previous ones. Foreign banks joined in.
They bought up about one-third of all the GKOs in circulation,
and arranged currency forward contracts with Russian banks to
protect themselves against possible devaluation. In line with the
IMF’s anti-inflation dogma, the Central Bank repeatedly insisted
that it would not allow the ruble to devalue, and in 1997–98
spent a large proportion of its reserves defending the ruble’s
high level in the international currency markets. The Russian
banks were betting that this policy would not change.

In November 1997 the shudders emanating from East Asia
combined with these domestic factors to produce disaster. Foreign
banks sold $5 billion of their GKO holdings. They pulled money



out of Moscow’s still embryonic stock market, mostly composed of
minority holdings in oligarch-owned companies, sending it into a
year-long downward spiral. Oil and other commodity prices were
falling, cutting into Russia’s already meagre tax revenues. Govern-
ment floundered: in March 1998, Yeltsin sacked Chernomyrdin
from the premiership and replaced him with the inexperienced free
marketeer Sergei Kirienko. In April–June 1998, after a temporary
improvement, tax collection fell steeply. The GKO market had
become a crippling burden on the state’s finances, with debt repay-
ment now accounting for 40 per cent of federal government expen-
ditures. The government scrambled to raise money abroad, and in
July the IMF announced a $22.7 billion rescue package supported
by the World Bank and by Japan.
But by keeping the ruble artificially high and pouring ever-larger
sums of money into the banking system via GKOs, the state was
running a serious risk of bankruptcy. Something had to give way.
On 17 August, the government announced a default:

• The ruble would be allowed to depreciate against the dollar.
• It froze its own ruble-denominated debt repayments and would
restructure (that is, reduce and postpone payment on) GKOs.
• It froze certain private-sector foreign debts – including, crucially,
those on currency forward contracts designed to protect foreign
investors from the effects of a devaluation.

The process of integration into world markets was seriously
disrupted. The Russian economy, which had just begun to grow,
was pushed back into recession for another year. Many Russian
banks – which had bet against the state defaulting, and lost – were
effectively bankrupted. In most cases, their owners cut deals with
the Central Bank to allow sustainable parts of their businesses to
be transferred to new ‘bridge’ banks. Foreign banks bet, and lost
too. They were left holding drastically devalued GKOs and losing
billions on unfulfilled currency forward contracts. The biggest
known single loss was Credit Suisse First Boston’s $980 million.22
The crisis led to renewed criticism of the IMF’s politically driven
lending programme. Economists at the UN Conference on Trade
and Development blamed the IMF for leading the Russian govern-
ment into a blind alley with monetary and exchange rate targets.
The anti-inflation policy had ‘sowed the seeds of its own destruc-
tion’ by creating a ‘culture of non-payment and an intricate web
of arrears’. The ‘herd behaviour of international investors’ had



done much of the rest. The Financial Times commented that the
IMF should not have lent money to Russia to support the ruble
at an ‘unsustainable’ level – to which the economist Harry Shutt
responded that this lending, combined with the absence of exchange
controls on which the IMF also insisted, had:

ensured that domestic interest rates [were] kept at astronomic
levels. This in turn ensures that, as long as the exchange rate
is kept more or less stable, … holders of government treas-
ury bills at interest rates ranging from 40% to 100% make
super-profits, while local enterprise is strangled, government
debt is pushed to ever more unfundable levels, public servants
and pensioners go unpaid and millions more are subjected to
destitution and premature death.23

As a result of the crisis, Yeltsin was forced into something of a
retreat from ‘shock therapy’. He sacked Kirienko as premier, and
tried to bring back Chernomyrdin. Parliament rejected the candi-
dacy. Foreign minister Yevgeny Primakov, more a friend of the state
bureaucracy and the moderate reform economists than the free
market extremists, became premier. His arrival coincided with a
surge of anger among ordinary people about the loss of savings and
consumer price inflation that resulted from the crisis. This climaxed
in October 1998 with a brief revival of trade union protest. Millions
of workers downed tools for a day of action and at least 1 million of
them took part in demonstrations. Primakov sanctioned increased
state spending, and in particular attempted to address the problem
of unpaid wages and benefits. In a nine-month period the govern-
ment coughed up about $2.4 billion in overdue wages, pensions and
social benefits, about 12 per cent of its total budgetary spending.24
This naturally made Primakov popular, and the Yeltsin clique – by
1999 casting around desperately for a successor to stand in the
2000 presidential election – conspired to sack him in May 1999.
He was followed by Sergei Stepashin, who lasted three months, and
then by Putin.


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