Publication: Prism Volume: 2 Issue: 5

An Economy Under Pressure

The Kremlin Explains Russia’s Economic Problems

by Aleksandr Zhilin

Recently, the Presidential Analytical Department has devoted increasing attention to studying the economic situation in the country. Experts believe this is connected with the approaching presidential elections and the attempts of Boris Yeltsin to find ways to improve the social situation in the country to boost his standing with the public. The following is a summary of the materials on the state of the Russian economy prepared by members of the President’s economic analytical group which is headed by Mikhail Delyagin.

Russia’s Financial System: A Complex Crisis

The end of the practice of borrowing money from the Central Bank to cover the budget deficit (April 1, 1995) was the point at which Russia’s society entered a new stage in her development.

Back in mid March an agreement was signed between the CBR and the government according to which the volume of CBR credits to be allocated for covering the budget deficit was cut by more than 30 percent (i.e. from initial 5 trillion rubles to 3.475 trillion rubles).

The rejection of the mechanism of financing the budget deficit with CBR credits was an important step on the way towards "emancipating" Russia’s national economy; in other words helping the economy, specifically its financial system, break free from the federal budget. However, it has to be admitted that the pressure of the rigid financial policy turned out to be too much for the economy to bear. A complex (all-embracing) crisis developed. The first to suffer was the private sector. The lack of cash resulted in a massive sale of hard currency (April through June 1995), the fall of the dollar against the ruble, and the introduction of a semi-fixed ruble/dollar rate which saved the export-oriented segment of the Russian economy.

A second stage of this complex crisis was a crisis of the budget system. The latter crisis began in July 1995 when the budget deficit was almost entirely financed at the expense of external sources. The depletion of internal sources of financing and the huge expense of servicing the external debt had the result that as of August 1995 the cost of servicing and repayment of the old debts exceeded the income obtained from taking new foreign and domestic credits (by 0.7 trillion rubles and by 2.1 trillion rubles respectively). The country was experiencing an extremely acute shortage of cash, the government was failing to fulfill its obligations, a political crisis was brewing while on the other hand the federal budget deficit diminished by 13.4 percent, i.e., by 2.75 trillion rubles.

This "suck-out" of money from the national economy could not but affect the domestic banking system. A massive withdrawal of cash by the commercial banks from their correspondent accounts in the CBR began in July. It was at this time that the banks exhausted their reserves. "Black Thursday" came. On this day the banking crisis in Russia went from "covert" to "overt." According to expert estimates, some 300 Russian banks are insolvent (some 100 of them were deprived of their licenses in October and November of 1995).

The shortage of cash in the country naturally resulted in wages being delayed. In August and September of 1995 the sum owed for unpaid wages grew at a rate of 25 percent a month: as of October 1, 1995 the combined total of debts for unpaid wages (in industry, agriculture, civil engineering and transport) equaled 10 trillion rubles. And since allocations to the pension fund come from wages actually paid, delays in paying salaries mean that the pension fund does not receive these allocations; to compensate for this shortfall, these funds must be replaced by allocations from the federal budget or from other off-budget funds–which, in turn, deepens the country’s financial crisis.

As a result the government’s debt for unpaid pensions totaled 5 trillion rubles as of early October (approximately two thirds of the monthly volume of pension payments). Social services were underfinanced by more than 20 percent (the budget plan for these allocation had been very tight already). The government’s debt to the military (excluding only Defense Ministry units and benefits, increments, food and uniform provisions) climbed to 1.4 trillion rubles.

The Chechen war, which was waged by means of "saved funds," turned the Defense Ministry into a major debtor. The Defense Ministry’s debts hit 15.2 trillion rubles as of early October 1995. If an attempt is made to settle them the federal budget deficit will increase by more than 1.5 times (50 percent).

As of october 23, 1995, Russian farms of all types harvested 69.0 milllion tons of grain. The state grain purchasing agencies bought up 8.0 million tons (11.6 percent) for government needs, and 0.7 million tons (1.0 percent) went into the federal grain fund, which is 8.2 percent of the planned amount. In addition, agricultural producers have sold another 10 million tons of grain through other channels (on the market, in the commodity exchanges, auctions, barter, as payment for services, etc.).

Thus, producers have not yet sold almost three quarters (74 percent) of the harvest. In the past, the state made up the entire grain market. The excessively-optimistic hopes that commercial companies could take its place in just one year ended in failure: under conditions of a harsh financial policy and tight money, it could only "take over" 14.5 percent of the market.

Thus, the sudden withdrawal of the state from the grain market could lead to the collapse of the latter. In all likelihood, the grain will be shipped away from Russia and subsequently imported back, however, at an elevated price (this has already happened with sunflower seeds). If the events take this turn, forecasts that bread prices in Moscow will not climb higher than to 6,000-7,000 rubles per kilogram appear questionable. The country might experience an outbreak of inflation and social problems caused by the deterioration of the standard of living of the poorest strata of the population for whom bread is the main food. To avoid this the government, as was reported, began talks with the IMF seeking permission to shift to a milder monetary-credit policy in order to be able to fulfill the plan of grain purchases.

Meanwhile, it has to be noted that time has been lost for the state to successfully accomplish a grain purchasing campaign. However, it is not the growth of the state’s internal debt and not the imminent price increases for bread and other staple items that pose the greatest danger today. The greatest danger comes from the slow growth of the public’s effective demand, which is an indicator of the public’s standard of living.

The experience of 1992 through 1994 convincingly demonstrated that a situation in which people’s standard of living declines (or at least does not improve) for more than three months in succession (naturally we discount such seasonal phenomena as the December climb and January relapse) must be regarded as a serious warning and an indication that the government’s economic policy needs immediate correction.

To put it more simply, as soon as an economic policy proves to be unable to solve the main problem facing Russia–restoration of the standard of living–society’s spontaneous "self-preservation mechanism" (which involves the interaction of economic, political, and social forces, concealed from observers’ eyes) goes into effect, and the ineffective economic policy is changed.

Chechen Crisis: A "Small Victorious War"

The introduction of Russian troops in Chechnya led to a sharp decline in the public’s real incomes in January and February of 1995.

The restoration of real incomes is going so slowly and with such a serious lag behind the analagous period of 1994, that it illicits fear for political stability in the near future.

The cumulative crisis of Russia’s financial system has grown beyond the limits of the economy giving birth to a serious political crisis which might lead not only to a victory of the Communists in the upcoming presidential elections, but to a situation where the Communists might not have any serious opposition. Given the fact that the Communists won a clear victory in the 1995 State Duma elections there are reasons to presume that a one-party system might form in Russia based not on "Russia Is Our Home" led by Viktor Chernomyrdin, who is oriented towards reforms and export-oriented production, but on the Russian Communist party led by populist Gennady Zyuganov.

The presence of a considerable number of the so-called "independent" (without a definite party affiliation) deputies in the present State Duma should not delude anybody. Experience tells us that deputies of this kind (informally called "boloto," or "the swamp") always take the side of the strongest faction.

The financial crisis, which is changing before our eyes into a social and political crisis, and the toughening of financial policy which caused it, are not the subjective mistakes of individual government officals, but the result of a fundamental change of russia’s economic development model, which has confronted a whole complex of objective, and hence, insurmountable limiting factors.

Limits on Russia’s Economic Development

The major factors hampering Russia’s development at this point are:

1. Regional differences. The fact is that any move (by the government) designed to stimulate progress would do good primarily to those regions which are best prepared, i.e., most advanced in the reforms. Therefore, contradictions between the regions would aggravate. These contradictions can only be alleviated by taking money from the most developed regions and giving it to the backward ones, which would reduce said stimulating efforts to naught.

2. Acute social differences. Any effort by the government designed to promote progress would give rise to income stratification among the population groups. In order to combat the inevitable growth of social and political tensions the government will have to spend money on relevant programs and these expenses would diminish gains obtained from said stimulating efforts.

3. Defective structure of national economy. As a rule any increase of production volume of even the most competitive items is achieved (in Russia today) using the old and outdated technological base. The increase of production in these segments of domestic economy is, therefore, not a result of the enterprises becoming more efficient but just a result of nation’s funds being reallocated among segments of the economy.

It became clear in 1994-1995 that if the policy of bringing domestic prices into line with the corresponding world prices was to be continued at its former pace, it would render even the country’s most promising (export-oriented) industries inefficient. The state could not afford to have these industries pushed out of business; sometimes, it was not even acceptabl to that they become less profitable, and therefore the process of price normalization has slowed down. Today’s reality is that all we can achieve by structural reforms (with the existing technological base) is a minor improvement of efficiency. The only significant reserve at our disposal is to raise the quality of management. However, it will hardly be possible to do this in a brief period of time.

Any serious breakthrough in the national production is only possible with a "technological revolution." This will take the time and effort of a generation. Furthermore, before this can take place, it will be necessary to overcome the investment crisis.

4. "Weakness" of national capital. Russia’s extensive national capital is too closely connected with the state; national financiers tend to rely on the state (seeking potential support from the state power structures) rather than on their own abilities to make their business more efficient (in the first place by improving the quality of management).

As for Russia, free market relations have just begun to penetrate into the "pores" of society and this process is far from comple. The country’s domestic market is not very capacious due to the fact that large part of the population is poor. Not the population, but the largest companies are the major taxpayers, the main source of money for the state. The state, in return, serves them. It is these corporations which determine the nation’s development today. But the interests of these corporations do not coincide with the interests of the population. The result is that the large corporations (and the state which is to a large extent controlled by them) may act against the interests of the nation. The owners of capital constitute only a small part of the nation but determine the development of the entire nation.

For example, Russia’s national capital is primarily export-oriented; therefore, the big capital owners are not interested in seeing the capacity of the domestic market increase. The fact is that such an increase would be accompanied by an increase in the cost of labor force and hence in the reduction of export profits.

5. Ineptness of the state apparatus. This, to a considerable extent, is a consequence of the concept of "government on the cheap." The fact is that the authorities are unable to preserve their secrets from not only the commercial structures but also from their political opponents. Suffice it to recall that in the presidential decree of September 19, 1993 (ordering the dissolution of the Supreme Soviet), Boris Yeltsin wrote (in his "Presidential Notes") that Khasbulatov was familiar with the text of this "top secret" document several hours after the decree was signed. The cost of the leak was the bloody events of October 2-4, 1993. Further, during the peace talks in Grozny, the Chechens (according to Arkady Volsky) showed a better knowledge of the plans of the Russian leadership than the members of the Russian delegation.

The approach to forming the state apparatus proceeds from such principles as: "let’s hire more people at a lower cost," or "we must not send people packing into the night even if they are good for nothing" and leads to a permanent chaos.

The External Pressure: Aims and Restraints

The financial crisis began in April 1995 when it hit the commercial – non-banking – domain; in July 1995 it engulfed the sphere of the state budget; in August 1995 it spread to the banking domain and by October it developed into a political crisis. The very rigid financial course which resulted in this cumulative crisis of the Russian financial system was determined by Russia’s agreement with the International Monetary Fund,which fixed the bounds for the growth of the money supply, proceeding from an inflation rate in Russia equal to 1 percent a month. The agreement has been in effect since July 1995 and despite the fact that actual inflation in the country has been 5-7 percent per month, Russia had to abide by the IMF demands. It is for this reason that the financial pressure became too strong for the national economy to bear. Loans provided by the IMF only partially compensate for the negative results caused by the IMF conditions. One of the most important of these negative consequences is Russia’s increasing dependence on the IMF. Due to the depletion of domestic sources to cover the budget deficit, external sources of finance become increasingly important. For example: During January through September of 1995, 27.1 percent of the federal budget deficit were covered at the expense of external sources while in 1994 the share of external sources in covering the federal budget deficit was only eight percent.

Russia today is a hopeless "addict" and the "drug" is loans provided by the international financial organizations. The fact is that Russia’s government financial policy is determined precisely by what these financial organizations demand. But the interests of Russia’s creditors do not necessarily coincide with Russia’s national interests. Many international financial circles are not interested in Russia as a competitor on the market but are interested in having Russia as a raw material adjunct of the developed countries of the world. This is definitely good for the developed countries. On the other hand, orientation on raw-material production is a factor of strategic instability for any country.

The fundamental aim of external pressure on Russia’s economy (which is exerted spontaneously, as the result of an objective coincidence of the goals of various groups of international capital) is to help the economy recover while restraining the growth of national capital. Its global goal is to clear the field of action for world capital to take over Russia’s domestic market (which is one of the last markets in the world not yet divided up among them.)

Government’s Options

The major factors hampering Russia’s economic development (formulated above) are generally of an objective character. The state (government) is unable to overcome them, therefore, these factors have to be duly taken into account during the elaboration of an economic course.

It appears probable that these factors are inherent of the stage of "depression" and will persist all over this stage.

If this is true Russia will be forced to shift to a different model of economic development: To abandon the course of rapid integration into the world market and to place emphasis on combating the interior distortions which have become the major obstacle on the way toward progress.

For the time being the government has made a first step in this direction. By introducing a semi-fixed ruble/dollar rate and maintaining the dollar undervalued, the government has forced the exporters to partially re-orient towards the domestic market. Now it is necessary to take measures to raise the capacity of the domestic market, i.e., to raise people’s standards of living. If such measures are not taken the above mentioned reorientation of the exporters toward the domestic market will not serve to combat the social and regional distortions in the country and hence will be useless for Russia’s progress.

In addition, the government has to resolve a very difficult problem of maintaining a balance between foreign and domestic capital. From what has been said, it follows that it is natural for the government to rely on foreign capital which is oriented towards capturing Russia’s domestic market to counterbalance export-oriented national capital, which is not interested in smoothing Russia’s regional and social inequities. At the same time, it is important to be aware that the weakness of national capital is in itself a very serious factor of society’s global instability. This conclusion follows from both the world’s and Russia’s own experience.

In elaborating an economic course for Russia it is also important to be aware of the fact that the general and comprehensive character of restraints (both external and internal) that limit Russia’s opportunities to develop leaves almost no chance for the country to accomplish a rapid transition to a period of economic growth; hence the country is doomed to remain in "depression" (economic growth not higher than 3 percent a year) until at least the end of the century.

Translated by Aleksandr Kondorsky and Mark Eckert

Aleksandr Zhilin is the National Security Issues Editor for Moskovskie novosti.