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September 28 - October 2, 1998

Wednesday, September 30, 1998

Russia and the IMF, Part 1

by Boris Kagarlitsky

Journalist and historian Boris Kagarlitsky is an adviser to the Russian Duma and Senior Research Fellow, Institute for Comparative Political Studies, Russian Academy of Sciences. He is a prominent figure in the Russian New Left, and his works include The Dialectic of Change and The Thinking Reed. He traveled to Washington and addressed  the House Banking Subcommittee on September 10, 1998. His remarks went unreported in the U.S. press, and will be reprinted here in two parts, in today's and Friday's editions.
First of all I want to stress that it would be highly inappropriate to characterize IMF credits to Russia as "aid." These are credits for which Russia has to pay. Though these credits seem cheaper than those taken on the financial markets, the Russian government has to accept the conditions formulated by IMF ideologues and policy-makers.

So far Russia has in general followed the instructions of the IMF and other international financial institutions. There have been minor disagreements, but basically the IMF has accepted and supported the economic policies of the Russian government, while the Russian government has accepted the basic principles and advice of the IMF decision-makers. These decisions resulted in the current chaos, which has not only led to the total collapse of the Russian economy, something unprecedented in peacetime, but also is bringing the whole world economy closer to recession.
The collapse of the debt market in the first half of August came even though the International Monetary Fund had just begun payments to Russia from one of the largest economic "rescue" packages in history. Along with the devaluation that followed, the crash marked the definitive failure of the key strategies that the IMF and major world governments had urged on Moscow throughout much of the 1990s.

The Russian government never discussed its economic programs with its own people or parliament. It was always the IMF to which all the basic documents were addressed. It was the IMF that systematically worked with the Russian elites, advised them and publicly supported them. The leaders of the Russian Central Bank who are personally responsible for the financial catastrophe in today's Russia have always enjoyed political support from the IMF experts, who have stressed the "professionalism" of their Russian colleagues.

The policies of the IMF were based on the assumption that a stronger currency automatically leads to a stronger economy. The currency should be strengthened at whatever price, including the decline of production, the impoverishment of the population and even the disappearance of most basic services in the spheres of healthcare, education and social security.
The IMF ideologues were sure that the emission of paper money by the national government was the only source of inflation. At the same time they did not see government borrowing as a potential source of inflation. The Russian government even registered borrowed money in 1997 as "budget revenues." The IMF theorists also insisted that privatization would lead automatically to better management of industries and lower government spending.
As early as 1992--93 these measures had disastrous consequences. As was recognised in a report issued in 1994 by former privatization agency head Viktor Polivanov, the quality of management in practice either remained the same or declined. No big company had shown any visible improvement in performance. At the same time the government lost the revenues from profitable public companies, which had earlier been the main source of its income. The new owners were incompetent, often lacked capital for necessary investment, and turned the companies into semifeudal personal domains. In many cases the old Soviet bureaucracy remained in charge, but the old Soviet system of external control disappeared. Of course there were also success stories, but mainly in small companies that were not capital-intensive.
While the performance of privatized companies generally deteriorated, the state faced a permanent budget crisis. Totally in agreement with IMF instructions, the government saw taxes as the only legitimate source of income, but the taxes never came. In order to cover the budget deficit, the government had to cut services and increase taxes. That inevitably led to an even greater decline of business activity. The purchasing power of the population remained low, private investment was almost non-existent, and public investment constantly declined. The paradox, however, is that given the lack of private investment, the state, no matter how it reduced its spending, remained the main investor in the economy.
In the years between 1994 and 1998, however, the government managed to stabilize the ruble. The methods used were government borrowing on the international and domestic financial markets, and non-payment of wages. By August 1, 1998, there were 75.84 billion rubles of unpaid wages in the country (that is approximately $12.5 billion). Today the administration in Russia pretends that enterprise managers are the only ones to blame for the wage arrears. While it is clear that the non-payment of wages played a decisive role in the supposedly successful fight against inflation, it is simply not true that the blame for non-payments lies exclusively with the managers of private companies; 19.6 percent of this money should have come from the budget.

The non-payment of wages lowered the purchasing power of the population and reduced the quantity of money in circulation. That helped to stabilize prices. Even if we abstain from discussing the moral side of these practices, it is clear that they also led to the gradual disintegration of the internal market and to a further decline in production (the data concerning wage arrears in Russia are provided as a supplement to this text). Though the Russian government and international financial institutions proclaimed the beginning of economic growth in 1997, the reality was quite different. The growth last year was supposed to have been 0.5 percent, but the government statisticians themselves admitted that their figures were only accurate to within plus or minus 2 percent! The best interpretation you could put on things was that during 1997 decline was replaced by stagnation. Then in the spring of 1998 the economy again started to contract. According to information provided by the trade unions, the real incomes of working people declined by 9 percent in the first half of 1998 alone. Wage arrears increased as well, with the state's wage debt growing at more than twice the rate of arrears as a whole (the state's wage debt in August was up by 14.6 percent over the July figure, compared with an overall rise of 6.5 percent).

Worst hit were services such as health care (a 33 percent increase in non-payments), culture and arts (28 percent), education (17 percent), housing (10 percent), science and research programs (7 percent) and communal services (3.8 percent). The living conditions of the people deteriorated, and at the same time public services were cut. That meant that where the state stopped providing services no private investor moved in, because people simply had no money with which to pay. The schools do not have enough textbooks, school buildings are falling apart, and in many villages local schools are simply closing down. The number of high school students has also declined.
Government borrowing became a sort of drug to which the ruling elites became addicted. At the urging of its foreign advisers, the government created a market in short-term state bonds. Sales of these bonds would allow the government to lower its deficits and dampen price rises. Lower inflation, the economic ministers gambled, would encourage investment and lead to economic growth, and as the tax system improved, to steadily increasing state revenues. These, it was hoped, would allow the government to service the additional debt.

In fact, this diagram turned out to be full of short circuits.
The lenders --- at first exclusively Russian financial institutions, but later including many foreigners --- understood from the first that lending to the Russian government was a risky proposition. If they were to play an increasingly hazardous game of financial roulette, they demanded big returns. Real annual rates of interest in the Russian bond market at times exceeded 100 percent.
If the state was prepared to give lenders high returns on loans for three or six months, why would they invest in long-term projects, where they would have to leave their money for years, endure risks that were just as hair-raising, and have much lower returns at the end of it? So private investment in the real economy was virtually wiped out. Economic decline continued, halting only for a period from mid-1997. The government was hooked on short-term debt. The only way it could meet the payments on its bonds was to borrow ever more money. Like every drug addict, the administration was not only incapable of imagining life without borrowing, but also needed ever-greater doses of loan funds. The state's financial operations came to resemble the notorious "pyramid scheme" investment funds of the early 1990s, through which Russia's gullible and reckless were stripped of their cash. Inevitably, the point finally came where there was simply no money in the budget to continue servicing the debt. In mid-1998 it was announced that no less than 30 percent of the budget was being used for that purpose. Economists calculated that if this trend continued, by the year 2000 more than 60 percent of the budget would go there.

Now, the Russian government's economic ministers in the early 1990s had watched the growth and collapse of the pyramid schemes with as much horror as anyone else. Why did they then go and blunder their way into the same kind of mess? A great deal of the blame lies with the IMF. Not only did the IMF encourage the Russian leaders in the illusion that squashing inflation would automatically lead to growth, but IMF spokespeople also fed the misconception that if things went wrong, there'd be plenty of money in the world financial system to bail the Russians out.
The Russian government, of course, didn't rely only on borrowed money to lower its deficits. The screws went on government spending, including public investment. But meanwhile, the spending of financial institutions both private and public was a bacchanalia of waste. Huge skyscrapers were built by the Russian Central Bank and the publicly owned State Savings Bank. Staff numbers mushroomed, and salaries increased. The Russian press now tells us that money borrowed from the IMF was used to pay for all these luxuries. However the IMF and its experts in Russia never questioned the expenses of the banking institutions. They only stressed the need to spend less on education, social welfare, healthcare etc.

It is important to note that the finance ministry was one of the most corrupt institutions of the Russian regime, which is anyway famous for corruption. Officials of the ministry are now being investigated, and some arrests have already been made (for example, Deputy Minister of Finance Vladimir Petrov). No doubt more will follow.
Misuse of the funds provided by international financial institutions is well known; it has been reported in the Russian press and discussed in the parliament. Perhaps the most impressive example was when $5 billion provided by the World Bank for the restructuring of the coal industry simply disappeared. The Chechen war didn't stop IMF and other international lenders either. It is very clear that credits given to the Yeltsin regime were used to guarantee the government's political survival in a context of growing resistance.

Originally distributed by Focus on the Global South (FOCUS). Contact information: c/o CUSRI, Wisit Prachuabmoh Building, Chulalongkorn University, Bangkok 10330 Thailand. Tel: (66 2) 218 7363/7364/7365, Fax: (66 2) 255 9976, E-Mail:, Website:

Friday, October 2, 1998

Russia and the IMF, Part 2

by Boris Kagarlitsky

The following selection concludes the testimony given by Russian journalist and historian Boris Kagarlitsky to the House Banking Subcommittee on September 10, 1998.

The conditions that the IMF, the World Bank or other Western financial institutions have placed on their Russian counterparts have never meant very much. How can you talk about due safeguards when it is a notorious fact that capital flight from Russia has far exceeded the sums provided as credits by international financial institutions and world financial markets? To a large extent, this is the same money which immediately leaves the country through private banks working with government agencies. It is impossible to imagine that IMF experts are not aware of these facts, which every shopkeeper in Moscow knows about. On the contrary, Western experts always insisted on open markets and liberal regulations of international financial transactions. In Russian conditions, open markets and liberal regulations on international financial transactions mean not only a green light for capital flight, but also excellent prospects for the Mafia. It is no accident that Russian financial markets have become one of the main centers of money laundering for international drug dealers. But none of this has stopped the IMF and similar institutions from insisting that controls be kept loose.

Foreign credits did not save Russia. They did not prevent the current crisis. On the contrary they provoked it. At the same time, the conditions imposed on Russia by the IMF and other international financial institutions prevented Russian decision-makers from seeking realistic solutions to the country's problems using domestic resources, which even now are impressive. The IMF created the situation in which banks and trade grew at the expense of industry, in which the enormous possibilities of the public sector were wasted, and in which Russia developed an entrepreneurial community totally uninterested in long-term domestic economic projects.

It is quite possible that the chief concern of the IMF decision-makers was not the success of Russia but the prosperity of the Western financial community, which made a lot of money out of our crisis. But if the IMF chiefs take this attitude, they are extremely shortsighted. Today's collapse of the ruble shows that the compradora economy which emerged in our country is a problem not only for us, but for others as well. American companies are not making money in Russia any more, but are losing it.
In 1994--97 the ruble was strengthened against Western currencies. Inflation fell, to about 14 percent in 1997. Commentators wrote glowingly of "stabilization." But the crunch was approaching. In May of this year, as investment analysts weighed the Russian government's real chances, the stock market collapsed.

Foreign investors began a stampede to get their money out of the country. The government's financial position was now dire. "Each week we were paying 6 to 7 billion rubles [a little over US$1 billion] in state short-term bonds, or 35 billion a month," former prime minister Sergey Kiriyenko recalled after his ouster. "But our entire budget receipts in May were only 20--21 billion." Wage arrears spiraled upward, as funds needed for state payrolls were diverted to debt servicing; workers' protests multiplied as a result.

Efforts to improve tax collection yielded only mediocre results.
Meanwhile, potential lenders were losing their nerve. Even at astronomical interest rates, offerings of state bonds began to be ignored.

To pay off maturing bonds and prevent a collapse of the ruble, the state authorities began massive sales of foreign currency. This, however, was a desperate resort that could not be sustained for more than a few months. To restore confidence and allow bond sales to resume, the government began seeking a huge loan from international financial agencies. Lengthy petitioning resulted in a pledge of US$22.6 billion, mostly from the International Monetary Fund, in mid-July.

Towards the end of July the IMF delivered the first tranche of its money. In the weeks that followed a reported US$3.8 billion in IMF loan funds was handed over to the bondholders. Then the debt pyramid shattered.

Although this collapse was a mathematical certainty, various factors helped decide the timing. The one cited most often was a sharp dip, in early August, in already weak world prices for the crude oil that is Russia's largest export earner. But even before this, the broader Russian economy had begun to sag. According to official figures, Russian GDP in July slumped to a level 4.5 percent below that of the same month a year earlier. Industrial output was down by 9.4 percent on July 1997, and agricultural production by a catastrophic 16.7 percent. The steepening decline in the real economy increased pressures on the banking sector at the same time that state short-term bonds were becoming near-worthless as a source of liquidity. So long as bankers had felt reasonably certain that the state would pay out on the bonds, a standard way for banks to raise cash had been to sell bonds or to use them as collateral for loans. But as the bankers analyzed the government's financial position early in August, their jitters turned to panic. Suddenly, many Russian banks were in acute financial trouble.

Further efforts to prop up the ruble were now doomed. The government could devalue the currency immediately, and keep its remaining reserves of gold and foreign currency intact, or put the devaluation off for perhaps four or five months, by which time the country would have lost its reserves for good.

The pyramid of Russian state debt, built up on the same principles as the private pyramids in Russia and Albania, finally crumbled.

Dumbfounded bankers learned that the government would not pay out on its bonds. Instead of money, it would give the banks new state securities that were supposed to be even more valuable. Payments on the private foreign debts of Russian firms were frozen for 90 days.

Today a crisis of the elites is unfolding in Russia. Neither the collapse of the economy, nor the impoverishment of the population, nor the drawn-out slide in production has posed serious problems for this layer of Russians. They have been preoccupied with other matters.

However bad things have become in the country, their aims have been fulfilled. The richest resources have been seized and divided up, and the demands of Western financial institutions have been satisfied. But it has finally proven impossible to continue along this path. The banking system is quickly becoming ungovernable, demonstrating the truth of the well-known Marxist thesis that the state of production determines the state of finances, and not the other way round. Seized with foreboding, Western investors are rushing to scoop up their money and quit the country. Yeltsin is hastily reorganizing the security forces, which are bearing more and more of a resemblance to the Soviet KGB.

Market mechanisms are paralyzed, and the Russian capitalist class (if there ever was such a thing) is bankrupt both politically and economically. The dominant mood is anger. No one has any trust in the official institutions. Most of support for Yeltsin is now external. This means that the International Monetary Fund and G7, which supported him, gave him money, and dictated his economic policies, are in crisis as well.

The IMF gave its money in the form of loans, and these still have to be paid back. But the way things are turning out, the repayment of the loans could be in question. It is worth reminding the Western bankers that after the fall of the Romanov dynasty, there was no  one to pay back the debts of the tsar.

The IMF, however, only recently gave Russia a new credit, in order to stave off devaluation. And even after the crash of the ruble, it seems, the IMF will continue to hand over money. The fund simply has no other choice. But in order to lend money, it first of all has to get it from somewhere else. The directors of the fund have already passed the hat around, seeking additional contributions from donor countries, above all the US. The directors of the IMF are in the same trap as the Russian government. They are the hostages of earlier decisions, and above all, the hostages of neoliberalism. The US government is in the trap as well. The cost of maintaining "stability" in Russia is rising all the time. The "taxi principle" that operates here was familiar to Soviet citizens as far back as the time of Brezhnev --- the longer the ride, the higher the fare. And the financial resources of the US are not limitless.

During the 1990s the neoliberal economic model has been implemented on a global scale. As a result, the IMF and the World Bank have begun to play approximately the same role on a global scale that the Central Committee of the Communist Party of the Soviet Union once played for the "communist bloc." IMF and World Bank experts decide what to do with the coal industry in Russia, how to reorganize companies in South Korea, and how to manage enterprises in Mexico. Despite all that is said about the "free market," world practice has never before known such centralization. Even Western governments are forced to reckon with this parallel authority. But this spectacular success has given birth to no less spectacular problems of the type that are inherent to any hyper-centralized system. The point is not that the neoliberal model of capitalism dooms most of humanity to hopeless poverty, and the countries of the "periphery" to dependency on those of the "center." Such "moral" and "ideological" issues cannot disturb "serious people." The trouble is that the price of mistakes is becoming unbelievably high. The huge resources at the disposal of the IMF make it possible to "stabilize" the situation and the Soviet Union collapsed.

In Russia, the international financial institutions are not passive onlookers. They bear full responsibility for what is done in our country. All the major decisions that led to the present crisis were cleared with them. The policies of the present day are being agreed with them, too. This is why they will do their utmost to maintain the present state of play. It may be a comfort to our national pride to know that the IMF is more interested in Russia than in some African country impoverished under the fund's wise guidance. Russian patriots sincerely think that the West sets out deliberately to play foul tricks on us. "Westernizers," who think that the countries of the West want to help us, scarcely exist any more. Meanwhile Russia, as in the early years of the century, has again become "the weak link of world capitalism." The Russian soul, mystical "collectivism" and other national peculiarities count for nothing here. Our country has come to occupy a particular place in the world system, and the economic collapse here could serve as the prelude to global shocks.

This is also the result of the policies implemented under the guidance of the IMF. The fund set out to incorporate Russia, with its corrupt authorities and debauched lumpen bourgeoisie, into the world system --- at any price. The international banks got what they were looking for.

In the late spring and early summer, when the inevitability of devaluation was already obvious to any street trader in Moscow, official spokespeople and international financial bureaucrats spoke of a victory over the crisis. In a country on the verge of hunger, millions of dollars were thrown into "supporting the national currency." The outcome was a humiliating failure. The ruble fell.

The stable ruble was proof that the course that had been followed was correct no matter what. About a year ago the Western press was full of prophesies of future success for Russia. One economist even published a book entitled The Coming Russian Boom. In fact, not even the authors of these predictions believed them. Such forecasts are like aspirins: they are not good for any long-term effect, but are meant for immediate pain relief. When used persistently, pain-relieving drugs often become less and less effective. With the devaluation of the ruble, such methods of collective psychotherapy will have to be taken out of use for a time.

The available financial resources will become less, and the demand by the fund's clients for rescue credits will increase. The resources of international financial institutions are not unlimited. It may be that defending "weak positions" on the periphery results in the loss of something important in the "center." Europe has its own potential for social explosion; it is enough to look at the eastern border of Germany. How things will proceed with the unified European currency is not clear either.

The growing difficulties of the IMF inevitably arouse a certain malicious joy among Russians. But the situation will not make things easier for us. In order to escape from the present dead-end, we have to recognise our position in the modern world, our possibilities and our global responsibility. And we have to learn finally to take decisions independently. Even if these decisions are very painful.

There is one thing we need from the West now --- for it to leave us in peace. We need it to stop imposing economic policies that are ruinous for us, while using the pretext of giving us aid. The money that has been sent to support Yeltsin could have been used far better --- for creating jobs in Europe and America, for helping the poorest countries, and for solving environmental problems. But you will never get money from the international bankers for these purposes.

Originally distributed by Focus on the Global South (FOCUS). Contact information: c/o CUSRI, Wisit Prachuabmoh Building, Chulalongkorn University, Bangkok 10330 Thailand. Tel: (66 2) 218 7363/7364/7365, Fax: (66 2) 255 9976, E-Mail:, Website:

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