Russia Economic and Financial Policy in the Early 1990’s

By | February 28, 2022

Russia faces the new millennium in an extremely difficult economic situation. Contrary to what proponents of shock therapies had prophesied about the transition to the market economy, the goal of stabilizing the economy is far from being achieved, and the start of a new development appears all the more problematic. The main ingredients of the negative economic reality are the dismantling of the industrial apparatus, galloping inflation, the accumulation of arrears in payments, the serious crisis in the banking sector, the absence of a tax system capable of financing state expenditure, the uncontrollable devaluation of the ruble, the insolvency of internal and external debt, the flight of capital, the growing poverty of large masses of the population. After the initial intoxication, the perverse cocktail of these ingredients has brought down the ‘young reformers’, and risks jeopardizing the very irreversibility of the process of transformation of the mechanisms of the national economy and the full insertion of the Russia in trade and finance world. In summary, the Russian experience constitutes, at least currently, the most glaring defeat among the attempts of rapid transition from centralized planning to the market.

Regardless of the debate on the mechanisms of transition, the main problem remains that of restarting the growth of the production system. The fall in economic activity is of dramatic size: GDP has halved compared to 1990, and in particular there has been no recovery in fixed investments (in 1998 less than a fifth of that of 1990); the index of industrial production did not reach in 1998 the 40 % of the level in 1990.

After reaching a four-digit rate (over 1300 %) in 1992, inflation seemed to have returned to normal (47, 8 % in 1996 and 14, 7 % in 1997) as a result of credit crunches and in the presence of long delays in payments of wages and salaries; but price growth resumed in 1998 (27.7 %), and in the first two quarters of 1999 much higher rates were recorded than in the corresponding quarters of 1998. Payment arrears have reached such a size that they alone are sufficient to paralyze any economy. Those in the state sector amount to about $ 4 billion, mostly wages and pensions, but also debts to state-owned enterprises; the latter, in turn, do not pay other companies, and so on, and in this way a chain of non-payments is set in motion, partly replaced by barter, which exceeds the unlikely figure of 90 billion dollars (corresponding to over half of all internal transactions).

The abnormal privatization process followed a path of savage hoarding, allowing a small group of people (former executives of state-owned enterprises, neo-bankers and financiers allied to the political leadership) to concentrate in their hands, at low or no cost, the part more profitable than large state monopolies; but at the same time it has not succeeded in giving a new impulse to investments and production, maintaining the pre-existing inefficiency, or giving rise to definitive closures rather than restructuring.

The credit system, which had had an impetuous development driven by speculative operations, has come to ruin. Almost half of the more than 1500existing banks is practically bankrupt, but many of the others, even not involved in speculation in government bonds and more attentive to risk analysis, have been overwhelmed by the liquidity crisis of the system, from which not even the major banks are saved. Credit: Inkombank, the second largest commercial bank, has also suspended its operations with clients and asked to be placed under temporary administration by the Central Bank. The new tax system, made necessary by the transformation of the very nature of the revenue and expenditure of the state budget, does not work: the taxation mechanisms are cumbersome (too many rates and too high), there is no real tax administration, evasion is huge. This frustrates attempts to contain the state deficit.

Thus, a fictitious financing of the state budget, discarding the hypothesis of printing money and not being able to cancel the spending commitments, took place simply by postponing payments: first by not paying salaries and supplies, then by not repaying the short-term internal public debt issued to interests even higher than 200 % and has grown dramatically in recent years. To the insolvency of the internal debt, officially declared in August 1998 (about 40 billion dollars, of which over a third in the hands of foreign banks), was added more recently the declaration of default of foreign currency debt. It is a total of 180billions of dollars, for which payments due (interest and principal repayment) amounted to 3 billion in 1998 and 19 billion in 1999. About twenty billion is made up of debts, already in moratorium, of Russian banks towards the international banking system (ruble / dollar forward contracts and credits for import-export operations); the largest part is made up of debts of the Russian state towards other states (sovereign debt), only partially inherited from the Soviet period (about 40 billion). In the three months following the financial crisis of August 1998, the ruble lost 60% of its value against the dollar, after a reckless policy of supporting an overestimated parity had drained the central bank’s foreign exchange reserves. Considering the entire period 1991 – 98, the ruble has devalued by more than 5,000 %. With funding from the International Monetary Fund (IMF) and other international public creditors frozen, foreign investments, already insufficient, are also taking safer directions, while the flight of national capital abroad continues.

A Russia, therefore, with a devastated economy, in which social problems of gravity never experienced since the First World War are nurtured, summarized in the data concerning the growing share of the population below the poverty line, and traceable even in the relative epochal data to the demographic decline. Faced with this situation, everyone in Russia is committed to accusing the others of the mistakes made, rather than indicating prospects for intervention in the economic field. It is therefore difficult to predict what action will be taken. Uncertainty about the political situation increases this difficulty: even today, after seven years of post-Soviet Russia, a political line – on which any plan for the transformation of the economy depends – that presents clarity, coherence and continuity has not succeeded in affirming itself.

In the second half of 1999, the crisis generated by the scandal connected with the misappropriation of IMF loans during the ruble crisis of August 1998 took place in this already dramatic picture. During the first half of 1999, after the most acute phase of the 1998 currency crisis, economic policies were reoriented in a restrictive direction, causing a slowdown in inflation compared to the last months of 1998. The devaluation of the ruble favored a reduction in imports, without however promoting a significant recovery in exports. Consequently, in the first half of 1999, GDP in real terms was around 1 % lower than in the corresponding period of the previous year. The fundamental problems, of a structural nature, of the Russia however all remain substantially unsolved. The room for maneuver to restore conditions of economic normality, without fueling dangerous social tensions and at the same time maintaining the structural changes that have taken place, are objectively very limited. The possible directions of intervention in the economic field – concerning both the initial objectives of the transition and the new problems that occurred in the first phase of it – can be traced back to four main obligatory paths.

Industrial policy has absolute priority: having abandoned the hope of recovering at least one third of the production system, considered to be outdated, it is a question of avoiding the collapse of the rest of the companies which, even when they are relatively efficient, risk closure due to lack of financial means.. While the rumors regarding hypothetical renationalisations appear not very credible, the government and Parliament seem to be moving towards a verification of the functioning capacity of privatized companies, the reconversion of the oboronka (military industrial apparatus) and the boycott of joint ventures for the exploitation of natural resources. On the other hand, an orientation with less uncertain outcomes is the intention to launch a policy of public funding no longer destined for financial intermediaries, but directly to businesses and aimed at making new investments.

The second problem to be solved is that of building a less expensive and more efficient tax system. The measures taken so far have produced an increase in revenues and a reduction in expenditure, but they remain uncertain and insufficient to restore order in public finances.

Another fundamental issue to be addressed is the reorganization of the banking and financial system. On the first front, the government granted stabilization credits for 35 billion rubles in 1998 (2billions of dollars) to the main commercial banks in difficulty, but it was only a buffer intervention, moreover accompanied by strong suspicions of misuse of funds. On monetary policy, government intentions oscillate between an expansion of liquidity anchored to gold reserves and the creation of a monetary base sufficient to pay all the arrears and restore liquidity to the system; between the prevalent use of market instruments (interest rates) and the strengthening of quantitative controls and administrative tools; between free floating and exchange rate control (parity of reference and restoration of currency constraints, such as the obligation imposed on companies to convert 75 % of collections in foreign currencies into rubles).

Finally, the renegotiation of foreign debt is an obligatory path: no country can afford to be insolvent without being placed on the sidelines of the international economic community. The rescheduling and redenomination into rubles of the dollar debt of Russian banks is a first step, already carried out within the Paris Club, in this direction, but certainly not towards the rebuilding of a climate of confidence. The renegotiation of the sovereign debt is proceeding more slowly and cannot ignore the orientations of the more industrialized countries and the IMF regarding the stabilization of the world financial system: it is up to Russia to prepare the conditions that make a financial plan similar to the one recently adopted for the restructuring of Brazil’s foreign debt.

It is reasonable to believe that these directions of economic policy will have to be followed by any possible governmental structure in the uncertain political framework of Russia. In any case, the country will have to face, without relying too much on external aid, a period of adjustment of its economy, which promises to be long and difficult; and it will also have to adapt to a certain downsizing of its economic and political role in the international arena.

Russia Economic and Financial Policy in the Early 1990's