The dark night ahead

The only certainty about the direction that Russia's development strategy will take is that a retreat from reform is inevitable. What that retreat would mean for Russia's poor and middle classes is not known.

C.P.CHANDRASEKHAR

RUSSIA'S reformers have little to offer a nation in crisis. Prime ministerial nominee Viktor Chernomyrdin travelled to Ukraine's Black Sea coast to meet International Monetary Fund Managing Director Michel Camdessus and returned with little other than a disconcerting silence on the outcome of the talks. And U.S. President Bill Clinton completed his much-touted summit with Boris Yeltsin, but reneged on his promise to lend Russia a helping hand through "the dark night ahead". The West, it appears, has decided to wash its hands of Russia. This decision is doubly significant.

It is significant because this would be the first time since the debt crisis of the 1980s that the IMF has chosen not to broker one more deal with the government of an "emerging market" in crisis in order to prevent or reduce the losses of foreign financial investors. Foreign and non-resident investors are estimated to hold about $17 billion worth of the $40 billion of short-term treasury bills (called GKOs) that are outstanding. As part of a strategy to reduce the interest and repayment burden associated with that debt, the Russian Government has chosen forcibly to convert that debt into long term debt. Investors have been given the choice of converting up to 20 per cent of their GKO holdings into long-term dollar-denominated debt at the exchange rate prevailing on August 14 so that they are at least partially protected against the depreciation of the rouble that has already occurred and seems likely to recur. But the market estimates that even if investors choose this option they would stand to lose up to 95 per cent of the original value of their investment, making the Russian Government's decision a case of virtual default.

The withdrawal of the West is also significant because it now appears that Russia's crisis could be the final push that transforms slow growth in the world economy into a global recession. World economic growth was expected to fall below 2 per cent this year, even before the contagion from Russia had begun to affect Wall Street. But with the decline in the Dow Jones index having wiped out all the gains of the first six months of this year, consumers who went out and spent because of the income and wealth gains delivered by the stock market boom are expected to withdraw from the market, resulting in a sharp slowdown in growth in the U.S. as well. The extent of that slowdown would depend on the extent of decline in the financial markets.

Unfortunately, for the marketists, since the decline is being driven by the collapse of investor confidence and such confidence in turn is being undermined by the new spectre of default and the breakdown of the faith in IMF-inspired market-friendly regimes, there is no informed guess possible as to when the markets would bottom out. Talk about the parallels between the current situation and the 1930s has, therefore, surfaced again.

If despite these far-reaching consequences the IMF has chosen to cut its losses and run from Russia, it could only be because it has been forced to accept the failure of its recipe for dealing with the financial crisis that afflicts any country that opts for a liberalised financial sector in a world of volatile capital flows. Having bank-rolled huge restructuring packages in Thailand, Indonesia, South Korea and Russia, aimed at stabilising currencies and prices, the IMF's experience points in three directions. First, that such stability even if achieved is only temporary. Second, that the costs of even such temporary stability in the form of low growth and social deprivation are of a magnitude that spawns discontent and undermines the very investor confidence that the IMF's package is ostensibly geared to win. And, finally, the process of financing periodic rescue packages in one country after another involves capital of a kind that even the IMF, with its immense resources and backing, cannot garner.

These lessons from experience notwithstanding, the IMF had stuck by its resolve to support countries in transition. Such support was, in fact, almost unrelenting in countries which were moving not just from less to more market-friendly regimes as in East Asia but from centrally planned to completely market-governed systems as in Russia. Thus, after years of reform and a series of special financial packages, when Russia was faced with difficulties barely two months back, the IMF came in with a new $22.6 billion package to stabilise the rouble and revive the economy. It was when even that did not work that the IMF, unable to badger its financiers to pour more money into its programmes, was forced to withdraw.

The IMF and its Western backers have now launched a damage control exercise aimed at convincing governments and markets that liberalisation and reform can in fact work. To that end they are in search of scapegoats for the plight of countries like Russia. Immediately after Russia declared that it would default on its debt payments, the IMF's Deputy Managing Director, Stanley Fischer, ironically echoed Malaysian Prime Minister Mahathir Mohammed when he said: "I am convinced that we could have pulled it off this time if it had not been for George Soros and his call for devaluation." But realising that focussing on speculators is bad strategy for protagonists of the market, the IMF has changed tack, blaming the rapacity of Russia's new capitalists and the influence they wield vis-a-vis the state. According to the IMF, it is the attitude of these oligarchs, rather than the system the reforms created, that explains capital flight.

According to Credit Suisse First Boston, the capital taken out of Russia between 1994 and 1997, estimated at $66 billion, exceeded the $58 billion that was brought into the country either directly or indirectly by the IMF.

Thus, the IMF's defence of the policies it recommends rests on dissociating the phantoms that its marketist reforms create from the reforms themselves. Any new government, the IMF argues, must not just continue with market-friendly reforms but also come down heavily on those whom the IMF till recently considered the harbingers of a capitalist Russia, who have subverted the reforms.

President Yeltsin used the opportunity of Clinton's visit to declare his adherence to this view and state that Russia would stick by the reform agenda, if he can help it. Unfortunately, with the IMF unable to put its money where its mouth is, Yeltsin has lost the only source of credibility he has had in recent times. Not surprisingly, the Russian Duma, by voting against Chernomyrdin's prime ministership in the first round on August 31, declared that both Yeltsin and the reforms must go.

CZAREK SOKOLOWSKI/ AP
As the rouble tumbles, moneychangers in Moscow announce the latest exchange rate, on September 4.

IT is not, however, clear what would come in place of the reform. There are few people left in Russia now who disagree with the idea that there must be a return to a more insular policy with currency controls, controls on trade and some relaxation of monetary controls. However, there are bound to be differences on the form and substance of such controls.

Russia's so-called "oligarchs" are interested in protecting and enhancing the huge wealth they accumulated during the years of privatisation and reform. They are therefore in search of means to freeze the rouble-dollar parity, so as to protect the dollar value of their assets without having to give up the benefits of convertibility. According to reports, they are canvassing to bring in as a consultant Domingo Cavallo, who was the architect of Argentina's hybrid currency board system, "convertibility". However, these oligarchs also want the Central Bank to print money to bail out banks which had, among other things, borrowed dollar funds to finance speculative investments in high-yielding short-term government bonds. The decision to restructure the Government's debt by replacing short-term paper with long-dated securities, coupled with the collapse of the rouble, has rendered these banks bankrupt, necessitating a fresh infusion of funds. Lax money supply to finance such infusion and a currency board system that ties money emission to foreign exchange availability in order to stabilise the exchange rate are obviously contradictory.

But the oligarchs believe that they can have all they want. According to one source, there is a report circulating among the "oligarchs" which makes the case for a New Mobilisation Economy. Under such a regime the burden of adjusting the government's budgetary position would be borne by second-tier businesses while the super-profits of the big industrial groups will be protected as a spur to private sector-led growth.

AS compared with the intentions of the oligarchs, the Communist Opposition is more concerned about clearing wage arrears, expanding social spending and increasing the access of public enterprises to credit. For these purposes they have demanded controlled money emission totalling 30 million roubles to 50 billion roubles. This is to be combined with trade and exchange controls and controls on the workings of the financial sector. As yet they are not too vocal about dealing with the phantoms created by the reform, triggering speculation that the reach of the likes of Boris Berezovsky stretched to the Communists in Parliament.

Only when a new government and its policies are in place can such rumours be checked and the true direction of Russia's development strategy assessed. The only certainty, as of now, is that a retreat from reform is inevitable. What that retreat would mean for Russia's poor and middle classes is yet to be seen.

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