By Renfrey Clarke
MOSCOW — President Boris Yeltsin on August 23 sacked Prime Minister Sergei Kiriyenko and the entire government in the midst of a shattering financial crisis.
From the second week of August, the country's newly restored capitalist state machine had been bankrupt not just in the political sense, but also literally.
Potential lenders had concluded that any hope of the government meeting repayments on existing loans, let alone new borrowings, had vanished. On August 17, Kiriyenko had responded with a shock decision to devalue the rouble and to default on many debt servicing obligations.
To replace Kiriyenko, Yeltsin named Viktor Chernomyrdin. Chernomyrdin, as prime minister from late 1992 until March this year, set in place many of the policies that led directly to the crash.
Ordinary Russians were not reassured by the appointment, flocking to the banks to try to withdraw their rouble savings and turn them into dollars. On August 25 alone, the rouble fell by 9%.
Sellers in Moscow's shops and pavement kiosks wielded their pens, adding 20% or even 30% to the price labels on imported goods.
Failed strategies
The collapse of the debt market came even though the International Monetary Fund had just begun payments from one of the largest economic "rescue" packages in history. Along with the devaluation that followed, the crash marked the definitive failure of key strategies that the IMF and major world governments had urged on Moscow throughout much of the 1990s.
In the initial, "shock therapy" phase of capitalist restoration beginning in 1992, price controls were dropped, and hyperinflation was allowed to destroy much of wages and savings.
A problem of excess purchasing power was dealt with, but inflation remained. Short of revenues because of its lack of an effective tax system, the government needed to find some means of paying for its operations without constantly expanding the money supply.
The mechanism that foreign advisers urged, and which Chernomyrdin accepted, was a market in short-term state bonds.
Sales of these bonds would allow the government to reduce its deficits and dampen price rises. Lower inflation, the economic ministers gambled, would lead to growth, and as the tax system was improved, to increasing revenues. These, it was hoped, would allow the government to service the added debt.
Predictably, the government's bet was a loser. Economic decline continued, halting only for a period from mid-1997. The only way the government could meet payments on maturing bonds was to borrow ever more money.
The state's financial operations thus came to resemble the "pyramid" investment funds of the early 1990s which stripped Russia's gullible of their cash.
The lenders — at first exclusively Russian institutions, but later including foreigners — had few illusions. If they were to play an increasingly hazardous game of financial roulette, they demanded big returns. Real rates of interest at times exceeded 100%.
Meanwhile, budget deficits were reduced, and the rouble was strengthened. Inflation fell to about 14% in 1997. Commentators wrote glowingly of "stabilisation". But the crunch was approaching.
Investors panic
In May, as investment analysts weighed the government's real chances, the stock market collapsed. Foreign investors began a stampede to get their money out.
The government's position was now dire. "Each week we were paying 6 to 7 billion roubles [a little over US$1 billion] in state short-term bonds, or 35 billion a month", Kiriyenko recalled after his ouster. "But our entire budget receipts in May were only 20-21 billion."
Wage arrears spiralled upward, as funds 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 rouble, the authorities began massive sales of foreign currency.
This was a desperate resort that could not be sustained for more than a few months. 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 IMF, in mid-July.
Towards the end of July, the IMF delivered the first tranche. 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 to decide the timing. One was a sharp dip, in early August, in already weak world prices for crude oil, Russia's largest export earner. But even before this, the broader economy had begun to sag.
GDP in July slumped 4.5% below that of the same month a year earlier. Industrial output was down by 9.4% on July 1997, and agricultural production by a catastrophic 16.7%.
Pressure on banks
The steepening decline increased pressures on the banking sector at the same time as state short-term bonds were becoming near worthless as a source of liquidity.
So long as bankers felt reasonably certain that the state would pay 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 analysed the government's financial position early in August, suddenly, many banks were in acute financial trouble.
Further efforts to prop up the rouble were doomed. The government could devalue immediately, and keep its remaining reserves of gold and foreign currency intact, or put off the devaluation for four or five months, by which time the country would have lost its reserves.
Under Kiriyenko's August 17 announcement, the rouble was to be allowed to fall from a previous limit of 7.15 to the US dollar to 9.5 before the Central Bank would defend it.
Trading in government short-term bonds was suspended; they would be converted into longer term securities, on terms to be negotiated.
Tempted by high profits on the state bond market, many of Russia's 1500 commercial banks had taken out hard-currency loans abroad in order to buy the Russian government's rouble-denominated debt.
Eventually, the foreign loans would have to be repaid. Now, the return on the state bonds would be much slower, and the rouble cost of the foreign currency needed in order to repay western lenders would be dramatically greater.
The government went some way toward letting the bankers off the hook. Kiriyenko included a provision that Russian financial institutions would be banned from paying out on various types of foreign debts for 90 days.
The downside was that this placed the country in credit quarantine. Financial specialists predict that it will be years before western lenders again give money to Russia.
Even when excused from servicing their international borrowings, hundreds of Russian banks, including some of the largest, are unable to meet their commitments. They now face collapse unless the government steps in.
Except perhaps in the case of a few banks that have large numbers of small depositors — or well-placed friends — the state is thought unlikely to mount a rescue effort. The move would be inflationary, and the cost would exhaust the government's now minuscule resources.
The banking sector appears doomed to a massive shake-out. "I expect the banking industry to collapse in the next two weeks", a Moscow-based economic consultant, who asked not to be identified, told Green Left Weekly on August 21.
Except for the thousands who will lose their jobs, relatively few Russians will lament the crash of the banking industry. Banks here do not have a good reputation; most are little more than fronts for financial speculation and, often, for the laundering of mafia cash.
But the impact of devaluation and default will not be limited to a purge of fly-by-night banks. The effect on the economy will be marked.
Prices to leap
To some extent, this impact will be positive; devaluation is expected to mean that the cash flow from oil, gas and metals exports will rise significantly. For most Russians, however, the effect will be reduced living standards as prices leap upwards.
The areas of production hit hardest by the economic policies of the 1990s include agriculture and consumer manufacturing; more than 60% of the food consumed in Moscow is now imported. Rebuilding the capacity of these sectors would take years even in a favourable business climate. Failing this, imports must be paid for with hard currency — and the dollars and deutschmarks now cost a good deal more.
The state machine faces life as a notorious problem debtor, unable to bite any of its friends for money. If Chernomyrdin's new government does not want to live on its income, it will have to "crank up the printing press".
A serious effort to cut budget outlays to match revenues seems unlikely, since it would bring many essential operations to a halt. The alternative of increased emission would restart many economic functions, and in modest amounts would not necessarily be inflationary. But it is hard to see growth in the money supply being kept within these limits.
Himself rumoured to be among Russia's richest citizens, Chernomyrdin has a history of accommodating the demands of business oligarchs. The most likely picture of coming months therefore includes steeply rising inflation as the government deals generously with well-heeled thieves in plush boardrooms.