kagarlitsky testimony

[Robert Weissman <rob@essential.org>]

September 10, 1998, Banking subcommittee

Dr. Boris Kagarlitsky, advisor to the Russian Duma and Senior Research
Fellow, Institute for Comparative Political Studies, Russian Academy of
Sciences

First of all I want to stress that it would be highly inappropriate to
characterize IMF credits to Russia as "aid".  These are credits for which
Russia has to pay. Though these credits seem cheaper than those taken on
the financial markets Russian government has to accept the conditions
formulated by IMF ideologues and policy makers. 

So far Russia has in general followed the instructions of the IMF and
other international financial institutions.  There have been minor
disagreements, but basically the IMF has accepted and supported economic
policies of the Russian government, while the Russian government has
accepted the basic principles and advice of the IMF decision-makers. These
decisions resulted in the current chaos which has not only led to the
total collapse of the Russian economy, something unprecedented in peace
time, but also is bringing the whole world economy closer to recession. 

The collapse of the debt market in the first half of August came even
though the International Monetary Fund had just begun payments to Russia
from one of the largest economic ``rescue'' packages in history. Along
with the devaluation that followed, the crash marked the definitive
failure of the key strategies that the IMF and major world governments had
urged on Moscow throughout much of the 1990s. 

The Russian government never discussed its economic programs with its own
people or parliament. It was always the IMF to which all the basic
documents were addressed. It was the IMF that systematically worked with
the Russian elites, advised them and publicly supported them. The leaders
of the Russian Central Bank who are personally responsible for the
financial catastrophe in today's Russia have always enjoyed political
support from the IMF experts who have stressed "professionalism" of their
Russian colleagues. 

The policies of the IMF were based on the assumption that a stronger
currency automatically leads to a stronger economy. The currency should be
strengthened at whatever price including the decline of production, the
impoverishment of the population and even the disappearance of most basic
services in the spheres of healthcare, education and social security.

The IMF ideologues were sure that the emission of paper money by the
national government was the only source of inflation. At the same time
they did not see government borrowing as a potential source of inflation.
The Russian government even registered borrowed money in 1997 as "budget
revenues".  The IMF theorists also insisted that privatization would lead
automatically to better management of industries and lower government
spending. 

As early as 1992-93 these measures had disastrous consequences. As was
recognized in a report issued in 1994 by former privatization agency head
Viktor Polivanov, the quality of management in practice either remained
the same or declined. No big company had shown any visible improvement in
performance. At the same time the government lost the revenues from
profitable public companies, which had earlier been the main source of its
income. The new owners were incompetent, often lacked capital for
necessary investment, and turned the companies into semi-feudal personal
domains. In many cases the old Soviet bureaucracy remained in charge, but
the old Soviet system of external control disappeared. Of course there
were also success stories, but mainly in small companies that were not
capital-intensive.

While the performance of privatized companies generally deteriorated, the
state faced a permanent budget crisis.  Totally in agreement with IMF
instructions, the government saw taxes as the only legitimate source of
income, but the taxes never came. In order to cover the budget deficit,
the government had to cut services and increase taxes.  That inevitably
led to an even greater decline of business activity. The purchasing power
of the population remained low, private investment was almost
non-existent, and public investment constantly declined. The paradox
however is that given the lack of private investment, the state, no matter
how it reduced its spending, remained the main investor in the economy. 

In the years between 1994 and 1998, however, the government managed to
stabilize the ruble. The methods used were government borrowing on the
international and domestic financial markets, and non-payment of wages. By
August 1, 1998 there were 75.84 billion rubles unpaid wages in the country
(that is approximately $12.5 billion).  Today the administration in Russia
pretends that enterprise managers are the only ones to blame for the wage
arrears. While it is clear that the non-payment of wages played a decisive
role in the supposedly successful fight against inflation, it is simply
not true that the blame for non-payments lies exclusively with the
managers of private companies; 19,6% of this money should have come from
the budget. 

The non-payment of wages lowered the purchasing power of the population
and reduced the quantity of money in circulation. That helped to stabilize
prices. Even if we abstain from discussing the moral side of these
practices it is clear that they also led to the gradual disintegration of
the internal market and to a further decline in production (the data
concerning wage arrears in Russia are provided as a supplement to this
text). Though the Russian government and international financial
institutions proclaimed the beginning of economic growth in 1997, the
reality was quite different. The growth last year was supposed to have
been 0.5%, but the government statisticians themselves admitted that their
figures were only accurate to within plus or minus 2%!  The best
interpretation you could put on things was that during 1997 decline was
replaced by stagnation. Then in the spring of 1998 the economy again
started to contract. According to information

provided by the trade unions, the real incomes of working people declined
by 9% in the first half of 1998 alone.  Wage arrears increased as well,
with the state's wage debt growing at more than twice the rate of arrears
as a whole (the state's wage debt in August was up by 14.6% over the July
figure, compared with an overall rise of 6.5%). 

Worst hit were services such as health care (a 33% increase in
nonpayments), culture and arts (28%), education (17%), housing (10%),
science and research programs (7%) and communal services (3,8%). The
living conditions of the people deteriorated, and at the same time public
services were cut.  That meant that where the state stopped providing
services no private investor moved in, because people simply had no money
with which to pay. The schools do not have enough textbooks, school
buildings are falling apart, and in many villages local schools are simply
closing down. The number of high school students has also declined. 

Government borrowing became a sort of drug to which the ruling elites
became addicted. At the urging of its foreign advisers, the government
created a market in short-term state bonds. Sales of these bonds would
allow the government to lower its deficits and dampen price rises. Lower
inflation, the economic ministers gambled, would encourage investment and
lead to economic growth, and as the tax system improved, to steadily
increasing state revenues. These, it was hoped, would allow the government
to service the additional debt. 

In fact, this diagram turned out to be full of short circuits. 

The lenders - at first exclusively Russian financial institutions, but
later including many foreigners - understood from the first that lending
to the Russian government was a risky proposition. If they were to play an
increasingly hazardous game of financial roulette, they demanded big
returns. Real annual rates of interest in the Russian bond market at times
exceeded 100 per cent.

If the state was prepared to give lenders high returns on loans for three
or six months, why would they invest in long-term projects, where they
would have to leave their money for years, endure risks that were just as
hair-raising, and have much lower returns at the end of it? So private
investment in the real economy was virtually wiped out. Economic decline
continued, halting only for a period from mid-1997. The government was
hooked on short-term debt. The only way it could meet the payments on its
bonds was to borrow ever more money. Like every drug addict, the
administration was not only incapable of imagining life without borrowing,
but also needed ever-greater doses of loan funds. The state's financial
operations came to resemble the notorious "pyramid scheme"  investment
funds of the early 1990s, through which Russia's gullible and reckless
were stripped of their cash.  Inevitably, the point finally came where
there was simply no money in the budget to continue servicing the debt. In
mid 1998 it was announced that no less than 30% of the budget was being
used for that purpose. Economists calculated that if this trend continued,
by the year 2000 more than 60% of the budget would go there. 

Now, the Russian government's economic ministers in the early 1990s had
watched the growth and collapse of the pyramid schemes with as much horror
as anyone else. Why did they then go and blunder their way into the same
kind of mess? A great deal of the blame lies with the IMF. Not only did
the IMF encourage the Russian leaders in the illusion that squashing
inflation would automatically lead to growth, but IMF spokespeople also
fed the misconception that if things went wrong, there'd be plenty of
money in the world financial system to bail the Russians out.

The Russian government, of course, didn't rely only on borrowed money to
lower its deficits. The screws went on government spending, including
public investment. But meanwhile, the spending of financial institutions
both private and public was a bacchanalia of waste. Huge skyscrapers were
build by the Russian Central Bank and the publicly-owned State Savings
Bank. Staff numbers mushroomed, and salaries increased. The Russian press
now tells us that money borrowed from the IMF was used to pay for all
these luxuries. However the IMF and its experts in Russia never questioned
the expenses of the banking institutions. They only stressed the need to
spend less on education, social welfare, healthcare etc. 

It is important to note that the finance ministry was one of the most
corrupt institutions of the Russian regime, which is anyway famous for
corruption. Officials of the ministry are now being investigated, and some
arrests have already been made (for example deputy minister of finance
Vladimir Petrov). No doubt more will follow.

Misuse of the funds provided by international financial institutions is
well known; it has been reported in the Russian press and discussed in the
parliament. Perhaps the most impressive example was when $5 billion
provided by the World Bank for the restructuring of the coal industry
simply disappeared. The Chechen war didn't stop IMF and other
international lenders either. It is very clear that credits given to the
Yeltsin regime were used to guarantee the government's political survival
in a context of growing resistance. 

The conditions that the IMF, the World Bank or other Western financial
institutions have placed on their Russian counterparts have never meant
very much. How can you talk about due safeguards when it is a notorious
fact that capital flight from Russia has far exceeded the sums provided as
credits by international financial institutions and world financial
markets? To a large extent this is the same money which immediately leaves
the country through private banks working with government agencies. It is
impossible to imagine that IMF experts are not aware of these facts, which
every shopkeeper in Moscow knows about. On th contrary western experts
always insisted on open markets and liberal regulations of international
financial transactions. In Russian conditions, open markets and liberal
regulations on international financial transactions mean not only a green
light for capital flight, but also excellent prospects for the mafia. It
is no accident that Russian financial markets have become one of the main
centers of money-laundering for international drug dealers. But none of
this has stopped the IMF and similar institutions from insisting that
controls be kept loose. 

Foreign credits did not save Russia. They did not prevent the current
crisis. On the contrary they provoked it. At the same time, the conditions
imposed on Russia by the IMF and other international financial
institutions prevented Russian decision-makers from seeking realistic
solutions to the country's problems using domestic resources, which even
now are impressive. The IMF created the situation in which banks and trade
grew at the expense of industry, in which the enormous possibilities of
the public sector were wasted, and in which Russian developed an
entrepreneurial community totally uninterested in long-term domestic
economic projects. 

It is quite possible that the chief concern of the IMF decision-makers was
not the success of Russia but the prosperity of the Western financial
community which made a lot of money out of our crisis. But if the IMF
chiefs take this attitude, they are extremely shortsighted. Today's
collapse of the ruble shows that the compradora economy which emerged in
our country is a problem not only for us, but for others as well. American
companies are not making money in Russia any more, but are losing it. 

In 1994-97 the ruble was strengthened against Western currencies. 
Inflation fell, to about 14 per cent in 1997.  Commentators wrote
glowingly of ``stabilization''. But the crunch was approaching. In May
this year, as investment analysts weighed the Russian government's real
chances, the stock market collapsed.

Foreign investors began a stampede to get their money out of the country. 
The government's financial position was now dire. ``Each week we were
paying 6 to 7 billion rubles [a little over US$1 billion] in state
short-term bonds, or 35 billion a month,'' former prime minister Sergey
Kiriyenko recalled after his ouster. ``But our entire budget receipts in
May were only 20-21 billion.'' Wage arrears spiraled upward, as funds
needed 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 ruble, the state
authorities began massive sales of foreign currency. This, however, was a
desperate resort that could not be sustained for more than a few months.
To restore confidence and allow bond sales to resume, 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
International Monetary Fund, in mid-July. 

Towards the end of July the IMF delivered the first tranche of its money. 
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 decide the timing. The one cited most often was a sharp dip, in
early August, in already weak world prices for the crude oil that is
Russia's largest export earner. But even before this, the broader Russian
economy had begun to sag. According to official figures, Russian GDP in
July slumped to a level 4.5 per cent below that of the same month a year
earlier. Industrial output was down by 9.4 per cent on July 1997, and
agricultural production by a catastrophic 16.7 per cent. The steepening
decline in the real economy 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 had felt reasonably certain that
the state would pay out on 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,
their jitters turned to panic. Suddenly, many Russian banks were in acute
financial trouble. 

Further efforts to prop up the ruble were now doomed. The government could
devalue the currency immediately, and keep its remaining reserves of gold
and foreign currency intact, or put the devaluation off for perhaps four
or five months, by which time the country would have lost its reserves for
good. 

The pyramid of Russian state debt, built up on the same principles as the
private pyramids in Russia and Albania, finally crumbled.

Dumbfounded bankers learned that the government would not pay out on its
bonds. Instead of money, it would give the banks new state securities that
were supposed to be even more valuable. Payments on the private foreign
debts of Russian firms were frozen for 90 days.

Today a crisis of the elites is unfolding in Russia. Neither the collapse
of the economy, nor the impoverishment of the population, nor the
drawn-out slide in production have posed serious problems for this layer
of Russians. They have been preoccupied with other matters.

However bad things have become in the country, their aims have been
fulfilled. The richest resources have been seized and divided up, and the
demands of Western financial institutions have been satisfied. But it has
finally proven impossible to continue along this path. The banking system
is quickly becoming ungovernable, demonstrating the truth of the
well-known Marxist thesis that the state of production determines the
state of finances, and not the other way round. Seized with foreboding,
Western investors are rushing to scoop up their money and quit the
country. Yeltsin is hastily reorganizing the security forces, which are
bearing more and more of a resemblance to the Soviet KGB.

Market mechanisms are paralyzed, and the Russian capitalist class (if
there ever was such a thing) is bankrupt both politically and
economically. The dominant mood is anger. No one has any trust in the
official institutions. Most of support for Yeltsin is now external. This
means that the International Monetary Fund and G7, which supported him,
gave him money, and dictated his economic policies, are in crisis as well. 

The IMF gave its money in the form of loans, and these still have to be
paid back. But the way things are turning out, the repayment of the loans
could be in question. It is worth reminding the Western bankers that after
the fall of the Romanov dynasty, there was no-one to pay back the debts of
the tsar. 

The IMF, however, only recently gave Russia a new credit, in order to
stave off devaluation. And even after the crash of the ruble, it seems,
the IMF will continue to hand over money.  The fund simply has no other
choice. But in order to lend money, it first of all has to get it from
somewhere else.  The directors of the fund have already passed the hat
around, seeking additional contributions from donor countries, above all
the US. The directors of the IMF are in the same trap as the Russian
government. They are the hostages of earlier decisions, and above all, the
hostages of neo-liberalism. The US government is in the trap as well.  The
cost of maintaining "stability" in Russia is rising all the time. The
"taxi principle" that operates here was familiar to Soviet citizens as far
back as the time of Brezhnev - the longer the ride, the higher the fare.
And the financial resources of the US are not limitless.

During the 1990s the neo-liberal economic model has been implemented on a
global scale. As a result, the IMF and the World Bank have begun to play
approximately the same role on a global scale as the Central Committee of
the Communist Party of the Soviet Union once played for the "communist
bloc".  IMF and World Bank experts decide what to do with the coal
industry in Russia, how to reorganize companies in South Korea, and how to
manage enterprises in Mexico. Despite all that is said about the "free
market", world practice has never before known such centralization. Even
Western governments are forced to reckon with this parallel authority. But
this spectacular success has given birth to no less spectacular problems
of the type that are inherent to any hyper-centralized system. The point
is not that the neo-liberal model of capitalism dooms most of humanity to
hopeless poverty, and the countries of the "periphery" to dependency on
those of the "centre".  Such "moral" and "ideological" issues cannot
disturb "serious people". The trouble is that the price of mistakes is
becoming unbelievably high. The huge resources at the disposal of the IMF
make it possible to "stabilize" the situaton and the Soviet Union
collapsed. 

In Russia, the international financial institutions are not passive
onlookers. They bear full responsibility for what is done in our country.
All the major decisions that led to the present crisis were cleared with
them. The policies of the present day are being agreed with them too. This
is why they will do their utmost to maintain the present state of play. It
may be a comfort to our national pride to know that the IMF is more
interested in Russia than in some African country impoverished under the
fund's wise guidance. Russian patriots sincerely think that the West sets
out deliberately to play foul tricks on us. "Westernizers", who think that
the countries of the West want to help us, scarcely exist any more.
Meanwhile Russia, as in the early years of the century, has again become
"the weak link of world capitalism." The Russian soul, mystical
"collectivism" and other national peculiarities count for nothing here.
Our country has come to occupy a particular place in the world system, and
the economic collapse here could serve as the prelude to global shocks.

This is also the result of the policies implemented under the guidance of
the IMF. The fund set out to incorporate Russia, with its corrupt
authorities and debauched lumpen bourgeoisie, into the world system - at
any price. The international banks got what they were looking for. 

In the late spring and early summer, when the inevitability of devaluation
was already obvious to any street trader in Moscow, official spokespeople
and international financial bureaucrats spoke of a victory over the
crisis. In a country on the verge of hunger, millions of dollars were
thrown into "supporting the national currency". The outcome was a
humiliating failure. The ruble fell. 

The stable ruble was proof that the course that had been followed was
correct no matter what. About a year ago the Western press was full of
prophesies of future success for Russia. One economist even published a
book entitled The Coming Russian Boom. In fact, not even the authors of
these predictions believed them. Such forecasts are like aspirins: they
are not good for any long-term effect, but are meant for immediate pain
relief. When used persistently, pain-relieving drugs often become less and
less effective.  With the devaluation of the ruble, such methods of
collective psychotherapy will have to be taken out of use for a time.

The available financial resources will become less, and the demand by the
fund's clients for rescue credits will increase. The resources of
international financial institutions are not unlimited. It may be that
defending "weak positions" on the periphery results in the loss of
something important in the "center". Europe has its own potential for
social explosion; it is enough to look at the eastern laender of Germany.
How things will proceed with the unified European currency is not clear
either. 

The growing difficulties of the IMF inevitably arouse a certain malicious
joy among Russians. But the situation will not make things easier for us.
In order to escape from the present dead-end, we have to recognize our
position in the modern world, our possibilities and our global
responsibility. And we have to learn finally to take decisions
independently. Even if these decisions are very painful. 

There is one thing we need from the West now - for it to leave us in
peace. We need it to stop imposing economic policies that are ruinous for
us, while using the pretext of giving us aid. The money that has been sent
to support Yeltsin could have been used far better - for creating jobs in
Europe and America, for helping the poorest countries, and for solving
environmental problems. But you will never get money from the
international bankers for these purposes.