FORTNIGHT IN REVIEW

Russia’s prolonged and agonizing economic turmoil turned into a full-scale political crisis when, on August 31, the opposition-dominated State Duma voted down President Boris Yeltsin’s nomination of Viktor Chernomyrdin as prime minister. Yeltsin immediately reconfirmed his support for Chernomyrdin’s candidacy. If the Duma rejects his nomination three times, the president will have the constitutional right to dissolve parliament and call fresh elections.

Confidence in the Russian currency had been shrinking ever since the first panic over emerging markets began in Thailand in the fall of 1997. The resultant spotlight on emerging markets worldwide revealed deep structural flaws in Russia’s political and economic systems–which are exemplified by cronyism, corruption, weak public finances and disregard for the rule of law. International confidence was further undermined by this year’s fall in the world price for oil–Russia’s main foreign currency-earner. Awareness grew that President Yeltsin’s imperious rule, based on a constitution that emasculates parliament and concentrates huge powers in the hands of a physically and mentally enfeebled president, was a major part of the problem. There was growing disquiet, too, about the self-assertion of Russia’s new class of bankers and oil magnates, commonly known as the “oligarchs.”

The country’s inability to shore up its public finances by collecting taxes and its dangerous dependence on high-yielding, short-term debt sparked fears that Russia would be unable to honor its commitments. The government’s efforts to crack down on tax defaulters, which include many of the country’s largest oil companies, earned it the animosity of the “oligarchs.” Meanwhile, attempts to reform the tax system by shifting the burden from the corporate sector to the individual were frustrated by the opposition-dominated Duma.

Emergency funding of US$11.2 billion negotiated in July with the IMF and World Bank failed to restore confidence because it failed to address these structural problems. In fairness to the international lending organizations, they came under heavy pressure from G-7 governments to support Russia. They lent money against repeated promises from the Russian government that structural problems would be addressed and austerity policies implemented. Virtually none of these promises was met. Given that IMF Managing Director Michel Camdessus could not go personally and switch off the electricity to the thousands of Russian enterprises now in a persistent vegetative state, the IMF’s best efforts were doomed to failure. Markets continued to slide and the ruble came under increasing pressure. The government found itself spending a third of its monthly budget revenues on interest payments.

Fears that the government would be forced either to default or devalue were realized on August 17 when the government and Central Bank decided to effectively devalue the currency, default on government bonds and impose a ninety-day moratorium on most foreign commercial debts. These decisions sent shock waves around the world. Until then the conventional wisdom had been that Russia was too big to be allowed to fail. The threat of economic meltdown and fears of resultant political instability sowed panic among investors and provoked a further exodus from emerging markets worldwide.

Devaluation made it impossible for many of Russia’s 1,500 banks to continue to service their substantial foreign currency debts. To stave off complete collapse of the banking sector, the government came up with a plan to both protect twelve of the country’s major commercial banks and encourage smaller ones to merge. These moves confirmed what many suspected all along: that devaluation had been delayed because banking sector officials had put pressure on the government to save their skins. Analysts pointed the finger at Russia’s new ruling class–those heirs of the Soviet nomenklatura who amassed their fortunes in the USSR’s sunset years by privatizing the old Soviet ministries and state-owned enterprises. It is this group that has most fiercely resisted efforts by reformist wings of successive governments to force them to pay their taxes and introduce greater transparency to their business dealings. Typified by oil and media tycoon Boris Berezovsky, the “oligarchs” put Yeltsin in power for a second term in 1996 and did not intend to let him or his government forget it.

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