The Heritage Foundation

Executive Summary #1296es on Russia

June 18, 1999

June 18, 1999 | Executive Summary on Russia

Executive Summary: What Russia Must Do to Recover from its Economic Crisis

When President Bill Clinton meets Russian President Boris Yeltsin on June 20 at the summit of the world's seven leading industrialized countries (the G-7) in Cologne, Germany, the discussion likely will focus on the current economic crisis in Russia. The reforms attempted by Moscow between 1992 and 1998 were poorly planned and executed, and riddled with corruption. They were unable to stop Russia's economic decline. A recent agreement with the International Monetary Fund (IMF) for $4.5 billion in new credits is not likely to reverse this trend. What Russia must do to recover from its economic implosion is to put in place a new economic team with leaders who understand the principles and policies of market economics and will undertake a new round of comprehensive reforms.  

Unfortunately, the war in Kosovo and a protracted political crisis in Moscow have distracted Russia's power elite from attending to the deteriorating economy. The communist-dominated Duma tried but was unable to impeach President Yeltsin, who then fired Prime Minister Evgeny Primakov (thought by many to be Yeltsin's successor) and installed a relatively centrist government under new Prime Minister Sergei Stepashin, a senior security official. The new economic team under Stepashin should be an improvement over the Primakov cabinet, which was dominated by Soviet-era stalwarts who tried to implement policies favoring rust-belt industries and the state sector. Unless the new economic team undertakes a significant new reform plan, however, it is doubtful that these officials will be any more able to pull Russia out of its economic morass than their predecessors were. 

Russia is suffering from the effects of an unprecedented ten-year slump. According to Moscow's Institute of Economy in Transition, the 1999 inflation rate may reach 50 percent. Unemployment is approaching 18 percent. In the six months between July 1998 and January 1999, the consumer price index rose over 90 percent and average monthly wages dropped from $177 to $57. Domestic and foreign investment dropped to 20 percent of 1990 levels. Overall, Russia's economic prospects appear to be worse than they were 100 years ago, when the market-based economy was growing at 5 percent to 7 percent a year. 

This systemic economic crisis is the result of many distinct problems: 

  1. An obsolete industrial base that manufactures non-competitive goods--a byproduct of the economy that formed around the gigantic Soviet-era military-industrial complex;
     

  2. A barter-based domestic economy, subsidized by the state through artificially cheap raw materials and energy;
     

  3. A large budget deficit, which accrued as the result of the punitive and poorly administered tax system; 

  4. Sharply declining oil and commodity prices in 1997 and 1998, which caused foreign currency revenues to decline;
     

  5. The devaluation of the ruble in August 1998;
     

  6. A shrinking federal budget; and 

  7. An inability to service foreign debt, a decline in domestic and foreign investment, and capital flight since 1987 amounting to more than $150 billion. 

Clearly, misdirected economic policies and adverse market conditions have combined to create the most prolonged economic depression in Russian history. Instead of working to resolve these problems, however, the Russian government chose to deal with the crisis by replacing market reforms with foreign borrowing. Today, Russia owes more than $150 billion to the West, including over $90 billion from its Soviet-era debt to Western governments (the "Paris Club"), and $51 billion of post-1992 Russian Federation debt. This "new" debt involves $19 billion to the IMF; $18 billion to Western commercial banks (the "London Club"), Eurobonds, and bilateral foreign government loans; and $14 billion in ruble-denominated short-term treasury bills (GKOs) and short-term bonds (OFZs) held by foreigners. 

To reverse Russia's economic free-fall, the new Russian government under Stepashin must undertake a comprehensive program of reforms as quickly as possible. Specifically, it should: 

  • Reduce crime and corruption; 

  • Strengthen the rule of law by reforming the judicial system; 

  • Secure current and future foreign loans with collateral, such as oil fields and gold mines; 

  • Improve debt management and concentrate it within a high-level government agency; 

  • Reform the tax system; 

  • Eliminate the barter system in non-competitive goods and services, and abolish the use of barter to pay local and federal tax arrears; 

  • Stop the disruption of interstate commerce by regional governors; 

  • Pass a land code to encourage the development of construction, private farming, and agribusiness; and 

  • Consider the benefits of a currency board.

President Clinton will soon have an opportunity to convey to President Yeltsin the importance America places on Russia's economic recovery. Jump starting the economy, facilitating entrepreneurship, and attracting domestic and foreign investment, however, will require a new economic reform package that goes beyond the failed quasi-socialist policies of the former Primakov cabinet. Moscow needs modern market institutions to develop quickly, but this effort will not succeed unless the rule of law is firmly in place.

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.

About the Author

Ariel Cohen, Ph.D. Visiting Fellow in Russian and Eurasian Studies and International Energy Policy in the Douglas and Sarah Allison Center for Foreign and National Security Policy, a division of the Kathryn and Shelby Cullom Davis Institute for International Studies, at The Heritage Foundation
Douglas and Sarah Allison Center for Foreign and National Security Policy