The Meaning of the Russian IMF Bailout


The Meaning of the Russian IMF Bailout

October 27, 1998 37 min read
Governor George Allen

This lecture was held at The Heritage Foundation on July 23,1998

On July 12, 1998, the International Monetary Fund (IMF) and the Russian government agreed "in principle" on $22.6 billion in new loans to Russia. The loans--Russia's second IMF bailout since 1996--will be funded by the IMF ($15.1 billion), the World Bank ($6 billion), and the government of Japan ($1.5 billion). The IMF Board approved the agreement on July 20, and total Russian indebtedness now stands at a towering $200 billion.

The issue of financial instability in Russia is of great concern to many policymakers and investors in America. To shed light on Russia's internal problems and the appropriateness or potential effectiveness of the new bailout, The Heritage Foundation had scheduled a conference bringing together a distinguished panel of experts on July 23. As it turned out, the conference took place only days after the IMF Board had approved the loans to Russia. Thus, the remarks presented on July 23 were based on expectations about the impact that the new IMF loans would have.

Much has happened since this panel came together that makes hindsight a better interpreter of that impact.

On August 14, Russian President Boris Yeltsin stated unequivocally that the ruble would not be devalued. On August 17, then-Prime Minister Sergei Kirienko announced that the government would allow the ruble to devalue 34 percent by the end of the year. He declared a 90-day foreign debt moratorium and announced a de facto default on the government's domestic bond obligations. On August 23, Kirienko was fired and Viktor Chernomyrdin was brought back to serve as Prime Minister upon approval by the Duma.

On August 26, the Russian Central Bank announced that it would not be able to support the ruble any longer. In less than a month, the ruble collapsed by 300 percent, falling from 6.2 rubles to the dollar to over 20 to the dollar. Inflation had shot up 15 percent in August, compared with 0.2 percent in July, and continued to climb.

On September 6, Yeltsin, facing intransigent Duma opposition to the renomination of Chernomyrdin, appointed veteran intelligence official and diplomat Evgeny Primakov as Prime Minister. The communist-era head of Central Planning (GosPlan), Yuri Maslyukov, was appointed as First Deputy Prime Minister in charge of economic policy. On September 7, Professor Sergei Dubinin, Chairman of the Russian Central Bank and the architect (with Chernomyrdin) of the recent economic policy, resigned. Communist Viktor Gerashchenko, who was responsible for the Central Bank's hyperinflation of over 2,000 percent a year, was nominated as the next Central Bank Chairman. This signaled the end of free-market reforms in Russia--at least for now.

Looking back, several statements made by IMF officials indicate that they may have had little, if any, advance knowledge of what would soon happen in Russia:

  • During a Moscow press conference on May 29, John Odling-Smee, Director of the IMF's European II Department and the top IMF official with line responsibility for Russia, stated, "The IMF management and staff believe that...a devaluation of the ruble can and should be avoided. With the reestablishment of confidence in the currency, we hope to see stability return to the financial markets...."1

  • When asked at a July 13 press conference why the IMF intervened to prevent the devaluation of the ruble, IMF First Deputy Managing Director Stanley Fischer responded, "[T]he problem with the devaluation is more than anything else that it doesn't solve the underlying problem. The underlying problem is the budget and the financing needs. So if you devalue, you sort of relieve the pressure on the markets for a while, causing difficulties, but unless you get the budget in shape--and the devaluation wasn't going to do anything for the budget--you would be back in this situation."2

  • In a July 20 press release, Professor Fischer stated, "The enhanced policy package represents a strong and appropriate response to overcome Russia's current difficulties."3

  • Speaking at Heritage on July 23, Stanley Fischer explained the causes of the crisis leading to the bailout:

Another cause was that the confidence of investors was set back by Russia's failure to implement agreed programs with the IMF and with others. The fact that the tranches under the existing extended fund facility, the EFF, had been so slow in coming is because various elements in those loans were not being implemented--including elements closely related to the attempt to get major tax delinquents to pay taxes. It was to be an extraordinary and unfortunate fact that, at a time when the negotiations on the anti-crisis program package could have started, we were in fact tied up for about a week trying to straighten out the failure of the government to meet the requirements for the $600 [million] and $700 million tranche under the pre-existing EFF which related to getting the oil companies to pay taxes. That surely was a factor that contributed to the crisis.

  • Commenting on the Russian devaluation and debt moratorium on August 17, Michel Camdessus, the Fund's Managing Director, stated, "Implementation of [Russia's economic] program has been satisfactory. Despite this, confidence in financial markets has not been re-established and as a result Russia has continued to lose reserves, and asset prices have fallen sharply."4

It is now painfully clear that the IMF and its $22.5 billion bailout were unable to rescue Russia's imploding economy or bolster investor confidence. The stock market continued its free-fall, and interest rates on government bonds again climbed above 200 percent. The roots of this economic crisis are much deeper than this recent bailout package could possibly address, and the economic breakdown portends dire political consequences for the future of democracy in Russia and for Moscow's relations with the United States.

The Russian financial crisis demonstrates the failings of the IMF on several fronts:

First, the IMF conducted an inadequate risk assessment concerning its loan beneficiary. Risk assessment is standard operating procedure for bankers, even when disbursing smaller loans. The IMF's assessment overestimated the growth rate of Russia's GDP each year since 1994.

Second, the IMF based its commitment to the lending package on a wager that the Russian government would put the appropriate policies in place--yet these were policies that Russia either could not or would not implement. This is similar to a banker's misreading the business viability of loan applicants.

Finally, the IMF made deals with individuals, such as former Prime Minister Sergei Kirienko and debt negotiator Anatoly Chubais, who then disappeared from the political scene. This is as troubling for investors as it would be in the case of any large company that lost its top management immediately after securing a bank loan.

Thus, the IMF failed to implement due diligence procedures and violated its fiduciary duty to its shareholders--the member governments that fund and support its lending policies--and the taxpayers who finance them.

Before the August 17 devaluation, Russia had asked whether the international community was prepared to provide some additional financial support beyond the $22.5 billion promised on July 13. The G-7 countries thus far have refused to provide additional assistance, but there is increasing talk of new bailouts. Russia is in an economic morass. The only achievements of the Yeltsin administration--stable currency and a low inflation rate--have evaporated. Now, because millions of Russian workers and pensioners have not been paid for months, the political price to secure the future of Russia's democracy and open markets will be tremendous.

IMF officials and financial experts agree that a competitive business culture needs to be established before Russia can increase economic efficiency and capital accumulation. In light of this, the IMF's reasoning behind its key decisions at critical points in the development of the current crisis needs further examination. For example, when asked at a July 13 press conference whether the relatively low liquidity of the IMF would prevent the organization from engaging in new lending, IMF Treasurer David Williams responded, "[A]s Mr. Fischer said, we never say no." Within two weeks of the IMF credit package approval, the lull in the Russian market decline collapsed. The policy expressed by Mr. Williams lies precisely at the heart of the problem.

Much has happened since Stanley Fischer, the architect of the bailout, defended the IMF's credit package at The Heritage Foundation on July 23, 5stating that, "On the macroeconomics side, inflation [in Russia] has been brought under control and the ruble has been stabilized." Further lauding the package, he asked:

What are the gains? The gains are that we have got a very concrete plan, a very concrete set of actions beginning to deal with the fiscal problem. We have seen signs of improved investor confidence. We are seeing a central bank that is demonstrating once again, as it did in 1996 repeatedly, that it is willing to defend the currency when it comes under attack, and which now in the context of this loan and in any case is beginning to deal with the banking system difficulties and to take measures that will strengthen it.

The remarks made by Mr. Fischer and IMF Executive Director for Russia Aleksei Mozhin (both of whom subsequently elected to withhold their remarks from publication), like those of the other panelists, demonstrate well the difficulty encountered in trying to predict with certainty the reliability of markets and governments and the success of international financial bailout programs in the global economy.

--Dr. Ariel Cohen, is Senior Policy Analyst in Russian and Eurasian Studies in The Kathryn and Shelby Cullom Davis International Studies Center at The Heritage Foundation.

By Marshall I. Goldman

Just as in The Perils of Pauline, the International Monetary Fund has once more come to the rescue of the Russian economy. By putting together a package of almost $23 billion in loans, the IMF has managed to immunize Russia from the Asian financial flu, at least temporarily, and more important, provide some breathing space for the new government of Sergei Kiriyenko.

Prime Minister Kiriyenko, who has been in charge only three months, is probably the best prime minister Russia has had since the 1890s. It is unfortunate that he and his team find themselves besieged by the legacy of the misbegotten reform efforts of his predecessors.

If that were not enough, the drop in commodity prices due to the crisis in Asia has hit Russia's most important export earners--its oil and gas. Even if Russia's domestic economy were not in such disarray, the drop in export earnings would have complicated Mr. Kiriyenko's task. As it is, it is unclear whether Mr. Kiriyenko, even with the IMF's help, will be able to cure his country's maladies or, for that matter, even satisfy the conditions the IMF attached to the loan.

Russia's difficulties today have been centuries in the making. Even in Czarist times, the Russians felt a certain mixed pride in their ability to mislead their governments. From the false fa├žades and the waving peasants in the Potemkin Villages to the use of Dead Souls and fraudulent Inspectors General, the sense of civic responsibility and rule of law has never taken deep root. Seventy years of the Leninist party-state--with all power emanating from the top down--has enhanced a culture where thwarting the state is a major indoor sport.

Given this background, international financial institutions should not have been surprised to find that only about four million out of the 60 million or so in the Russian work force submit tax returns. The new chief collector of taxes, Boris Fedorov, has mounted an impressive effort to round up some of the most flagrant tax evaders. The richest 1,000 individuals and the oil and gas companies have become his special targets. But almost all of the oil companies as well as Gazprom have already found one loophole or another that allows them to avoid most of their taxes as before.

Moreover, Mr. Fedorov is just the latest in a series of tax collectors determined to uproot such a deeply held culture. After all, it was just this past December that a Fedorov predecessor, Anatoly Chubais, declared his intention to rein in the same tax delinquents. To demonstrate his seriousness, he decided to create a new tax collection agency, the Extraordinary Tax Commission, which in Russian has the same initials as the predecessor of the KGB.

Consequently, there can be no assurance that, unlike the existing situation, this new government will be able to generate an increase in tax revenue, a key condition of the IMF loan.

Nor should we expect a significant drop in government expenditures, another IMF condition. Not only must Mr. Kiriyenko find the funds to pay the back wages of workers and the bills of unpaid contractors, he must also find new money to cover the debt service on Russia's new loans. If debt service now amounts to 36 percent of the national government's budget expenditures, the $23 billion increase in new loans (equal to 5 percent of the GDP) will push up debt service to as much as 45 to 50 percent.

Ideally, the conditions imposed by the IMF will facilitate the Russian government's efforts to hammer home the structural reforms that, so far, the Duma and the country as a whole have resisted. However, as dire as the underlying situation may be, even if the Duma gives its assent to these changes, assent is not the same thing as implementation. In fact, a review of past IMF loans and accompanying conditions reveals that even when the IMF insisted on parceling out loans step-by-step in tandem with performance, more often than not it was the IMF that blinked as a succession of Russian leaders begged for just one more chance.

Because they are so intractable, few if any of the country's fundamental problems are likely to be resolved; and we can expect that it will not be too long before the Russians again find themselves in financial difficulty, and Boris Yeltsin finds himself pleading with Bill Clinton, Helmut Kohl, Tony Blair, and Jacques Chirac to lean on the IMF just this last time. But if we are honest, we should recognize that as long as the alternative to Mr. Kiriyenko seems to be either a far right or a far left government, we will back off just as we did several times when Viktor Chernomyrdin was prime minister, a much less deserving and committed reformer.

At some point we have to ask whether we will ever insist on reform first and loans later. The longer we avoid facing up to this challenge, the more serious the next crisis is likely to be, and the more painful the ultimate climax.

--Marshall I. Goldman is Kathryn J. Davis Professor of Russian Economics at Wellesley College and Associate Director of the Davis Russian Research Center at Harvard University.

By John P. Hardt

The new assistance program is designed to strengthen reform in the Russian economic system sufficient to assure transition to a functioning market economy as well as to provide relief from the immediate financial crisis. A central feature of this program is its emphasis on macro-stabilization, to be followed by restructuring of institutions and enterprises.

Conditionality supporting macro-stabilization is keyed to full implementation of a new tax code and budgetary policies featuring increased tax collection and reduced expenditures as measures designed to reduce the debt burden and balance the budget. Part of the disbursement of the assistance has been held back so that the parliament meeting in special session in August may be persuaded to pass the tax and expenditure measures they left out of their earlier legislative action. Government actions to increase revenue collections and reduce subsidies to industrial enterprises and regional governments are also vigorously encouraged.

The IMF representative, Dr. Stanley Fischer, not only stressed the priority of macro-stabilization but also noted that "We view this very much as the last chance for Russia.... [T]he country is running out of time."6

Two sets of questions were raised in the commentary on the presentations at The Heritage Foundation of Dr. Stanley Fischer and Dr. Aleksei Mozhin of the IMF on the IMF-led Russian reform assistance program:

  1. Would a new emphasis on restructuring over macro-stabilization accelerate progress in reform that would generate growth and improve the economic security of Russian citizens? Would a new emphasis on both restructuring and stabilization call for broader monitoring and conditionality of programs supported by both the IMF and the World Bank? Moreover, were there a new emphasis on restructuring, would that restructuring priority include programs for reform in the military establishment and its loss-making military-industrial base?

  2. Is meeting the reform requirements of Russian leadership and commitments to IMF-led assistance likely to be frustrated continually by lack of legal and policy support from their parliament, the financial-industrial groups--the oligarchs--and local governors? Would their policy and legal support be more likely if growth-generating restructuring were upgraded in importance and timing?

The first set of questions is supported by general criticisms of the IMF macro-stabilization priority strategy in the donor community for assisting economies in transition, with specific reference to Russian reform. The need for considering broader goals, timing, and priorities for economies in transition has been articulated most frequently by the chief economist at the World Bank.

Dr. Joseph Stiglitz has drawn attention to the importance and timing of restructuring, regulation, and transparency in economies in transition toward a functioning market economy. Making markets work, he argues, requires more than just low inflation. Attention should be given to sound financial regulation, competition policy, and measures to facilitate technology transfer and encourage transparency. Specifically, he notes, "The agenda for creating sound financial markets should not confuse means with ends; designing a regulatory system, not financial liberalization, should be the issue."7

The prescriptions of the World Bank are not to slow stabilization but to speed up restructuring that would, in turn, support stabilization efforts. Nicholas Stern, chief economist of the European Bank for Reconstruction and Development (EBRD), adds that when an economy has made material progress in controlling inflation and positive growth is returning, economies in transition enter a new stage when restructuring of institutions and enterprises takes on more priority. Russia may be entering this new stage.

Although all the major donor institutions coordinate their programs and have periodic assessments of the countries' progress related to their own assistance programs, there does not appear to be comprehensive monitoring and conditionality. Specifically, the IMF may closely monitor its own programs for supporting stabilization, but it does not condition its own sequential allocation of funds based on effective use of World Bank funds. If restructuring is critical to overall success in reform and a means for strengthening stabilization, then broader, cross-institution conditionality would appear to be logical.

While not explicit in Dr. Stiglitz's critique, the requirement to change the institutional structure and composition of Russian military forces and their companion industrial-military complexes would seem to be important ingredients of successful restructuring. The impact of successful military restructuring is likely to have substantial budgetary implications, with the prospect of significant savings from more effective administration of the military establishment on the one hand and increased expenditures for down-scaling and restructuring military forces and their military-industrial base in transition on the other hand. Moreover, successful military reform might be considered an important step toward reaching the broader goals of a functioning democratic market system.

The second set of questions has to do with the prospects that a broader restructuring-led strategy has for acceptance and support of reform measures in policy and law by the parliament, the large financial industrial groups or oligarchs, and regional governors. The financial-industrial groups led by seven strong bankers or oligarchs also wield considerable power either to obstruct or to support reform. The regional governors, also represented in the upper chamber of the parliament, not only have considerable power to control resources and budgets, but are partially responsible for the persistence of subsidization of loss-making enterprises and toleration of corruption that plagues reform efforts.

As Yeltsin and his central government cannot effectively rule by decree or diktat, getting these three groups to support reform is crucial. If implementation of restructuring programs serves to generate increased stabilization, economic growth, and enhanced economic security, these opposition groups may be inclined to join a government-led consensus. There are serious shortfalls in passage of key legislation and support needed for implementing reform measures by the parliament, oligarchs, and local leadership that erode prospects of success in economic reform and ability to fulfill donor commitments.

A comprehensive restructuring-led reform strategy may be more supportable if it attracts growth-generating investment and non-debt-creating revenue with more attention to economic security involving the social safety nets. The following illustrate central features of the projected strategy with an indication of shortfalls that may be filled by more emphasis on supportable restructuring measures:8

  • A consolidated budget process and new tax code suited to fulfilling the needs of a functioning market economy proposed by Yeltsin's government is necessary but not sufficient for effective stabilization or restructuring. The Duma has supported only part of the necessary tax changes, and the full requirements for effective budgeting have not been approved. Presidential decrees have been used to pass a land code and new land, income, and value-added taxes. But laws adopted by the parliament will probably be necessary to support decrees effectively.9 Restructuring priority would strengthen stabilization programs. More revenue may be squeezed out of the small taxpaying economy by primary reliance on austerity measures keyed to reduction in subsidies to loss-making enterprises, cutting out housing subsidies and vigorous tax collection from enterprises, and resort to increased tax burdens on consumers. Restructuring could generate new revenue from other than tax sources and cushion the impact of reduced subsidies on consumer income.

  • Competitive privatization with substantial foreign participation and vigorous bankruptcy procedures would provide both short-term sources of new revenue and more efficiency. Sale of the major Russian oil company Rosneft is a test case for proceeding on this course. Open auctions and foreign participation are needed for a series of privatization sales for generating non-debt-creating revenue and encouraging technology transfer and more efficiency in enterprise governance. While sale of assets provides a one-time source of revenue, the importance of the addition of over ten billion to the 1999 budget in balancing and reducing the debt burden in the budget would be significant. Without this increment, a greater burden would be put on consumers, and tax collection efforts may become counterproductive. The longer-term advantage of foreign participation in ownership would be in technology transfer, corporate governance, and portfolio investment that might increase the efficiency and profitability of Russian enterprises. Can and will the oligarchs, such as Boris Berezovsky, still block this process and weaken reform? Perhaps, but the self-interest of some oligarchs and the Russian consumer might be better served through an upgraded restructuring and stabilization strategy.

  • Anti-monopoly actions are necessary for development of a regulated, competitive environment for state-owned natural monopolies and more revenue from taxes paid and assets sold. Restructuring and regulation of Gazprom and United Energy Systems are critical test cases. Does the Russian government have the capability to make the largest gas company in the world, Gazprom, and the United Energy Systems competitive, profitable, transparent, and taxpaying? Would the parliament, oligarchs, and governors prefer revenue-generating restructuring to budgetary discipline or a combination of both? There is clearly opposition to the current stabilization-first strategy. Whether a revised strategy would gain support has not been demonstrated, but a case can be made for its support in the self-interest of the opposition groups.

  • Administrative down-scaling of bureaucracy at the center and in the localities to create a leaner, less corrupt, market-friendly system is projected. A 25 percent reduction in central bureaucracy might serve to make the government smaller, cheaper, and more market friendly and honest. The arbitrary and discriminatory tax system, licensing, inspections, and certification procedures of these carryover bureaucrats deter growth, especially limiting freedom of entry for small- and medium-scale enterprises.10 Such a purge of local government would appear to perform the same purpose in localities if it were possible to implement. Support of central and local purges in a restructuring-first strategy might be preferred by the opposition groups to sole reliance on budgetary discipline if it were growth-generating.

  • Military reform to down-scale security forces with new roles and missions for military employees seems appropriate and more efficient for a democratic market state. A commitment to a definitive program for re-orientation and down-scaling of the military forces and the military-industrial complex would reduce many of the expenditures in the current budget. While re-orientation and restructuring of the military complex would require substantial new appropriations to be effective, it may be supported by governors such as General Lebed in Krasnoyarsk. While many vested interests appear to constrain reform, the perilous state of the Russian military and its economic support base is viewed as a reform imperative by Governor Lebed and some other opposition forces.

  • Institutionalization of relationships between the center and local governments to assure more workable resource sharing, restructuring of enterprises and institutions, and budgetary arrangements might advance growth-generating reform. Agreements between the central government and provinces now being negotiated are a step in that direction. However, implementation of effective resource and budget sharing by the central government and the provinces will require substantial involvement and effective bargaining power by the President and his current government with regional governors, the parliament, and the oligarchs. Economic growth prospects resulting from sharing incremental revenue and increased foreign investment might facilitate central-local agreements.

  • Integration of Russia into the global marketplace and institutions would spur restructuring and growth. A workable integration of Caspian Sea oil and gas production and distribution with new legal instruments such as production-sharing arrangements could be growth-generating. Parliament, the oligarchs, and some governors have slowed progress on important legislation such as production-sharing agreements. Globalization on economic criteria of the Caspian Sea development would set a pattern for further economic integration into the world marketplace. Agreements stimulating economic self-interest by some oligarchs might compel interest by others and foster wider support.

All of the above are interrelated or synergistic. To be more effective, programs insuring macro-stabilization may accompany, not dominate, those involving restructuring of the enterprises and institution-building. Adoption of a more comprehensive restructuring-led Russian strategy might call for more coordinated conditionality between the IMF and the World Bank. If the parliament, oligarchs, and governors are convinced that a restructuring strategy would lead to growth-generating programs, encourage domestic and foreign investment, and increase incomes and economic security, a workable consensus and acceptance of a new legal framework may be possible.

In sum, if a restructuring-led strategy were to prove more growth-stimulating and supportive of stabilization, would the IMF revise its priorities to support both restructuring and stabilization reforms and broaden its conditionality to include all international donor programs? Would a broader restructuring-led reform then include restructuring Russia's military forces and its military-industrial complex? With this changed reform strategy and conditionality, would the Russian government be better able to fulfill its commitments to international donors, with support of a functioning consensus among its parliament, oligarchs, and regional governors?

Considerable progress has been made in setting in motion restructuring programs, including changes in institutions, enterprises, and adoption of key elements of the rule of law favorable to the development of a market economy. The Kiriyenko team is giving more priority to restructuring and to consultation and negotiation with the parliament, oligarchs, and regional governors.11 If these restructuring changes are key to successful reform, as argued by Dr. Stiglitz, and if the current reform efforts and present government team are Russia's "last chance," as indicated by Dr. Fischer, the issue may be joined.

A restructuring strategy priority with continued emphasis on stabilization may be the best approach for the Russian government and its assistance providers to follow. If so, then the restructuring aspects of the current strategy involving institutional, legal, and enterprise restructuring would be upgraded. The result might then be an improved prospect for growth, improvement in the economic security resulting from a repaired social safety net, and reinforcement of the stabilization program.12

-- John P. Hardt is Senior Specialist in Public Policy at the Congressional Research Service.

By Roger W. Robinson, Jr.

My earlier experience as an East-West banker with responsibilities for Chase Manhattan's portfolio in the former Soviet Union and the region was particularly helpful when I went to work at the National Security Council. Indeed, it is the nexus between global finance and national security which I would like to focus on during these brief remarks.


First, it is worth underscoring the predictability of the $22.6 billion emergency rescue package for Russia forged by the United States and the International Monetary Fund (IMF) just a few days ago. When a country has some $1.3 billion in short-term debt obligations coming due per week on total hard currency reserves of some $12 billion to $15 billion, it does not take a banker to recognize the sharp escalation in the bailout amount which will ultimately be required.

Initially, the IMF appeared to understand that its past disbursements of the existing $9.2 billion facility for Russia had been largely politicized by Washington and other G-7 capitals. To its credit, the Fund at least tried to hang tough against Russia's rhetorical pledges of reform in the interest of preserving its already damaged institutional integrity. Instead, it demanded that Moscow implement meaningful systemic change before it would commit to new multibillion-dollar outlays. Regrettably, it was again not to be.

As the debt service pressures rose to intolerable levels in June and the first weeks of July--with soaring interest rates on newly issued GKO bonds, some of which had maturities of only seven days--President Yeltsin re-politicized the IMF via urgent phone calls to key G-7 leaders, including President Clinton, telling them in blunt terms to produce the money immediately. During this relatively brief six-week period, the cost of the IMF portion of the bailout doubled from $5.6 billion to $11.2 billion.

This sad state of affairs--particularly for United States and other Western taxpayers--was eerily reminiscent of the countless warnings concerning the unsustainability of the Soviet debt structure which went unheeded in the late 1980s. In fact, my first Heritage lecture in February 1986 was on the subject of why Moscow would ultimately be unable to service its hard currency debt owed Western governments and commercial banks, due primarily to a lack of systemic transformation, capital flight, the outflow of hard currency to support an aggressive foreign policy and strategic modernization efforts, and the undisciplined, unconditioned, and largely non-transparent lending practices of Western creditors.


In the current circumstances, however, there exists an important additional complication, fortunately not as evident in the Soviet era--namely, the use of bond offerings as a principal means of offsetting revenue shortfalls and advancing Moscow's economic and political agenda. Unlike loans from Western governments and commercial banks--nearly the only forms of Soviet borrowing--bonds cannot be rescheduled. It also permits Moscow to tap into a large number of new lending sources, including Western securities firms, pension funds, insurance companies, corporations, and even individuals.

Make no mistake: Russian leadership is keenly alert to the political windfall of this new borrowing method--the creation of politically powerful new constituencies throughout the U.S. and the West which would henceforth have a vested financial interest in opposing the imposition of economic sanctions or other penalties against Russia for its proliferation and other global misdeeds and supporting future bailouts.

The funding Russia attracts via bond offerings also is so-called general purpose or balance-of-payments financing, with no specific underlying trade transactions or projects which would potentially advance the country's economic vitality. In short, it is simply cash disbursed with few, if any, questions asked concerning where the money is going or how it is being used--a proven formula for a financial train wreck.

Accordingly, I concur with Marshall Goldman's assessment that we have not seen--nor will we see in the next few critical months--the kind of systemic transformation necessary for the $22.6 billion package to gain sufficient traction to turn around Russia's structural crisis.

A new domestic consensus on the payment of taxes--even with strengthened enforcement measures--remains elusive. Indeed, it is a centuries-old national sport to evade paying taxes, even though it perpetuates widespread barter arrangements and other value-subtracting distortions of the market. The so-called oligarchs of Russian banking and business, as well as energy resource monopolies such as Gazprom, have likewise not yet signed on to the IMF compliance package. Property rights and agricultural reform continue to be pushed into the indefinite future. Traumatized investors are still reeling from the Japanese and Asian economic declines (as well as a roughly 75 percent slide in Russia's market value in the past year) and massive non-performing loan portfolios, and have little appetite to reenter the highly volatile Russian market. Finally, Russian foreign policy adventurism and strategic force modernization continue apace, in some cases with more than adequate budget allocations.

For these and other reasons, my guess is that Moscow will return to the West for a bailout "supplement" or an official request for the acceleration of disbursements before the end of the year--well short of the minimum two-year period the $22.6 billion package is advertised to cover.

Not surprisingly, amid the flurry of discussions about Russian debt restructuring, tax collection, budget deficit reduction, privatizing energy and other monopolies, property rights, and the construction of genuine commercial and legal codes, virtually no G-7 or IMF attention has been directed to the funding of sophisticated Russian military programs and associated expenditures. Similarly, no Western cash flow calculations appear to have been made with respect to the hard currency costs of the robust and belligerent "Primakov Doctrine" which governs Russian foreign policy.


With regard to costly Russian military modernization programs, consider the following:

  • Continued construction of a massive, multibillion-dollar underground command-and- control bunker network;

  • Deployment of the new mobile SS-27 ICBM (the so-called Topol-M2);

  • The commissioning of a new aircraft carrier (the Admiral Kuznetsov);

  • A new stealth fighter program modeled after the F-22;

  • Recent completion of a new nuclear cruiser (the Peter the Great);

  • Construction of a fifth-generation ballistic missile submarine (the Borei class);

  • Continued payment of roughly $200 million annually to lease the massive Lourdes signals-intelligence facility in Cuba; and

  • The refitting of all Typhoon-class submarines to accommodate the SS-N-24/26 missiles.

This partial list alone involves expenditures of probably as much as $10 billion or more--an amount representing roughly half of the $22.6 billion bailout package. Perhaps the Congress is operating under the assumption that these questionable military expenditures were a significant agenda item in the configuring of IMF conditionality or, at minimum, the "quiet diplomacy" of G-7 capitals with Moscow. If so, they should ask some tough questions of the Clinton Administration and be prepared for some disappointing answers.


Regrettably, there is an equally ominous list associated with Russian foreign policy priorities and attendant financial outlays. Among these priorities are:

  • The political sheltering of Iraq's weapons of mass destruction programs and a reported commitment to provide a multibillion-dollar credit line to bolster Baghdad's oil production as soon as U.N. sanctions are lifted;

  • The transfer of sensitive ballistic missile technology and components to Iran, as well as providing at least two nuclear reactors to Tehran;

  • A concerted effort to destabilize the Western-oriented, secular Muslim states in the oil-rich Caspian Sea region (i.e., Azerbaijan and Turkey) and monopolize regional pipeline routes (notably, through Georgia);

  • The fostering of a crisis on Cyprus, with the scheduled November delivery of S-300 missiles to the Greek Cypriots and efforts to disrupt the deployment of U.S. and NATO forces to war-ravaged Kosovo in the Balkans; and

  • In recent months, the Kremlin's renewal of its commitment to complete an irretrievably flawed nuclear reactor complex in Juragua, Cuba, as well as continue its large-scale sharing of military technology and intelligence with China.

Unfortunately, these and other malevolent Russian actions (for example, supplying military equipment to North Korea and fueling tensions on the Indian subcontinent and the Middle East) are threatening American interests as well as geopolitical stability throughout the world. How is it that the insidious portfolio of Yevgenii Primakov goes almost completely unchallenged at a moment of unique Western financial leverage? Clearly, this must change when Congress reconvenes.


For those who doubt that national security issues are affecting global capital markets as never before, consider what befell the huge Russian natural gas monopoly, Gazprom, in the United States in October and November of last year.

Put simply, in the summer of 1997, Gazprom decided under withering pressure to pay as much as $4 billion in tax arrearages to the Russian government in order that it might, in turn, pay back wages to miners, pensioners, and other workers. This action left Gazprom in a liquidity bind that they sought to remedy by concluding two major financings in the November time frame. The first was a syndicated loan collateralized by natural gas receivables (primarily those of Gaz de France and Germany's Rhurgas), and the second was a $3 billion bond offering in the U.S. market.

In the immediate window of the bond offering, Gazprom signed on as 30 percent shareholder in a consortium configured by the French oil company Total to develop Iran's South Pars offshore gas fields. This was judged in violation of U.S. law under the Iran-Libya Sanctions Act (ILSA). The Senate Banking Committee subsequently convened hearings on this subject on October 30, 1997, and a Senate Banking subcommittee held companion hearings on November 5. Gazprom was confronted with the withdrawal of a roughly $750 million U.S. Ex-Im Bank credit line to facilitate U.S. equipment supplies, among other penalties.

What the company did not count on, however, was a blistering critique of its intention to go forward in the U.S. bond market with a $3 billion-plus offering. The level of security-related concerns expressed by members of the Senate Banking, Foreign Affairs, and Intelligence Committees--combined with some deterioration in market conditions--was sufficient to cause the withdrawal of the Gazprom bond, even though its activities in the private U.S. capital markets were not covered by the statute.

While there are many who argue that Gazprom and its lead U.S. investment bank were reacting solely to adverse market conditions catalyzed by the Asian financial crisis, the facts prove otherwise. In short, Gazprom desperately needed those funds and was not stepping back to await more favorable borrowing terms and conditions. Indeed, when it became apparent that U.S. congressional opposition to the bond offering was serious, Gazprom abandoned the bond issue and increased significantly the amount of its more expensive collateralized syndicate loan in Europe, which was being readied for market at the same time as the U.S. bond offering.

Coincidentally, the ultimate amount of this eight-year syndicated loan brought to market on November 4, 1997, was $3 billion. A managing director of a major commercial bank who followed these transactions closely termed the congressional hearings of October 30, 1997, on the ILSA legislation "the coup de grace" for the Gazprom bond.

To my knowledge, this was the first major foreign bond offering in the private U.S. capital markets ever derailed primarily by U.S. national security considerations. As such, it is an immensely important precedent in demonstrating that foreign governments and enterprises cannot expect to enjoy completely unfettered access to the U.S. capital markets when engaged in activities harmful to U.S. security interests.


It is highly unlikely that the two-year $22.6 billion Russian rescue package will be sufficient to restore investor confidence, allow the implementation of requisite radical reform measures, or restructure the maturities of the country's large remaining short-term debt (roughly $28.5 billion of which is coming due by the end of this year). In part, this pessimistic prediction is predicated on the continued unwillingness of the IMF and G-7 leaders to press Moscow to reallocate the multibillion-dollar sums currently earmarked for strategic modernization programs and Mr. Primakov's aggressive, global foreign policy initiatives.

Accordingly, the Congress must begin immediately to scrutinize Russia's hard currency cash flow--that is, all sources and uses of cash as well as its activities on the U.S. debt and equity markets--on a routine basis.

It should be recalled that U.S. taxpayers are still being penalized for undisciplined, imprudent Western lending practices with regard to the former Soviet Union, which resulted in roughly $100 billion disappearing into long-term debt reschedulings concluded over the past five years in the London and Paris Clubs. Under these circumstances, continuing to neglect to integrate relevant national security considerations into provisions of future funding measures for Russia and the IMF would be unwise and counterproductive.

Finally, U.S. and other Western financial policymakers, as well as private investors and lenders, should include existing and emerging national security issues in their future due diligence and creditworthiness evaluations, despite their seeming antipathy for this potentially "disruptive" portfolio of concerns. Past efforts to construct a firewall between global finance and national security are no longer sustainable or desirable.

For example, the current push by the U.S. business community on Capitol Hill to eviscerate economic sanctions as a policy response to dangerous geopolitical behavior on the part of foreign governments (or their surrogates) in the name of market stability and "engagement" is misguided and irresponsible. Borrowers like Russia and China will continue to take actions that periodically endanger American interests and those of our allies. When they do, the American people, the Congress, and the media will demand a swift and credible U.S. reaction which will, more often than not, disrupt trade flows and the markets more than would have been the case if national security concerns had been taken into account at the outset.

In short, no firewall can hold up against the advent of the proliferation of weapons of mass destruction and ballistic missile delivery systems, not to mention other security-related challenges of the 21st century. Regrettably, the costs of denying this reality have been high and are rising.

--Roger W. Robinson, Jr., is former Senior Director for International Economic Affairs at the National Security Council.

By Dr. Ariel Cohen

The International Monetary Fund (IMF), pressured by the Clinton Administration, is considering granting Russia a new package of loans totaling $22.5 billion to support the weakening ruble and jittery financial markets in Moscow.13 If the goal is to support economic reform in Russia, nothing could be further off target than a new infusion of funds.

Additional IMF loans will only prolong the systemic disorder afflicting the Russian economy. Despite being one of the IMF's largest borrowers, Russia remains economically weak because it refuses to implement fundamental budgetary, fiscal, and structural reforms, which are the only cures for its financial woes. The IMF and the G-7 governments should demand that Russia institute economic reforms rather than provide even more lending, which has proven ineffective in the past.


The Russian economy almost collapsed on May 27, when foreign and domestic investors went on a panicky spree of selling government bonds, corporate stocks, and rubles. In a desperate attempt to defend the ruble and offset the mass exodus from the Russian capital markets, the Central Bank hiked interest rates on government bonds to an astronomical 200 percent a year and expended large amounts of Russia's foreign exchange reserves purchasing rubles. Although these measures were successful, they cannot continue indefinitely.

There were several causes for the downfall. Specifically, the Duma (the lower house of the Russian parliament) passed legislation prohibiting foreign ownership of stock in the national electrical monopoly, the Unified Energy Systems (UES), beyond 25 percent. Foreign investors also became jittery when Rosneft, a huge government-owned oil company with oil reserves worth tens of billions of dollars, failed to attract buyers for the asking price of $2.1 billion.

Oil prices have remained soft, severely decreasing both the earnings of Russian companies and the Russian government's receipts (oil and gas are responsible for up to 75 percent of Russia's foreign currency earnings). Investors finally noticed that corruption and nepotism are not only endemic to Asia, but in full potency in Russia as well.

To support the ruble, the Central Bank sold $1 billion in one day, causing its hard currency reserves to dwindle to $14 billion. It is obvious that the Central Bank will not be able to support the currency forever without a return of investor confidence.

There are deeper causes for pessimism. As the IMF's First Deputy Managing Director, Stanley Fischer, a renowned economist, wrote in January 1998, "a major constraint to Russia attaining satisfactory rates of growth is that the process of structural reform has not gone far enough."14

The first problem Russia is facing is fiscal and budgetary. It is running large budget deficits (7.5 percent of GDP); and it has a complex, punitive, and arbitrary tax system and failing tax collections. The tax system itself is mismanaged, corruption is rampant, and the tax base is extremely narrow. As The Heritage Foundation warned more than a year ago in its publications and at numerous conferences, the Russian government's borrowing spree was like a pyramid scheme that, sooner or later, would come crashing down.15

The second major problem is structural: Russia has yet to experience meaningful economic growth in the post-communist era. IMF officials and financial experts agree that a competitive business culture needs to be established before Russia can increase economic efficiency and capital accumulation. In addition, drastic reform of the legal and institutional frameworks is necessary, including the following elements:

  • Faster, more transparent privatization. Privatization should be open for all investors, whether foreign or domestic.

  • A restructuring and breaking up of the natural monopolies (gas, electric power, district heating, and railways) and an introduction of competition in those sectors. Only through competition will these industries become efficient and competitive.

  • Urban land and real estate reform, housing market liberalization, and agricultural privatization. The Duma currently is blocking a market-oriented land code. Russian agriculture, which could have been among the most thriving in the world, is a drain on the budget. Fully functioning land and mortgage markets should be created.

  • A reduction in military expenditures. Almost a decade after the end of the Cold War, Russia is still attempting to maintain the apparatus of a superpower, and on occasion tries to behave like one. In its current economic condition, these efforts may be self-defeating. Russia's military, estimated at 1.5 million persons, is much too large for a country that has a GDP equivalent to that of Spain or Mexico.

  • Abandoning of nuclear modernization. The Russian government is implementing an expensive nuclear modernization program that includes construction and deployment of the next generation of SS-27 intercontinental ballistic missiles (the so-called Topol-M2), nuclear subs, and the nuclear powered missile cruiser Peter the Great (formerly Yurii Andropov). Roger Robinson has addressed this problem eloquently.

These and other urgently needed policy reforms--such as capital market development, improvements in the banking system, opening the economy to foreign investment, and eradication of crime and corruption--must be implemented before the Russian economy can recover.16 Without these reforms, the economy will not be capable of generating growth and the fiscal basis for maintaining a modern state.

Indeed, many of these reforms have been included as requirements with each of the four previous IMF loans and Stand-By Arrangements--totaling $18.83 billion--that Russia has received since becoming a member of the IMF in 1992. The problem is that the IMF has continued to dis


Governor George Allen