Publication: Prism Volume: 5 Issue: 20

By Valery Virkunen

In the wake of major scandals involving the illegal movement of Russian capital abroad, the International Monetary Fund has postponed a decision on issuing Russia with the latest US$640 million credit. Many experts, both in Russia and abroad, are presenting this as signifying the complete and utter collapse of Russia’s economy. It is doubtful, however, that it will collapse for the want of a few hundred million dollars, given that, according to Russia’s Central Bank, more than US$1 billion is illegally exported from the country every month.

In fact, no one knows how much money has left Russia since Boris Yeltsin has been at the helm. The Central Bank, the Interior Ministry and the Prosecutor General’s Office all give different figures, ranging from US$220-450 billion. The beginning of this headlong capital flight can be traced back to one of Yeltsin’s decrees in November 1991, which gave all economic subjects permission to make foreign commercial transactions with no state control whatsoever. Immediately, hundreds of firms sprang up like mushrooms, channeling out of the country everything which Russia was rich in and which was in steady demand on international markets: Oil and other energy sources, metal, wood, raw materials for the processing industry. The hard currency proceeds sat abroad, mainly in the accounts of offshore banks and companies which were also controlled by Russian nationals. Only in 1994 was a control body–the Federal Hard Currency and Export Control Service–set up.


The issue of ownership in Russia today is an acute one. Russia’s new parliament and president will soon have to take a shovel to the mountain of problems thrown up by the frenzied privatization of state property. The riches which unexpectedly descended on yesterday’s junior managers and hungry civil servants–in the shape of enterprises, banks, companies and corporations–was a serious temptation for them. The vast majority of proprietors considered the corporate interests of the company they owned to be a minor issue in comparison with their own personal interests. None of the new owners therefore bother with expanding production, accruing investments, improving competitiveness or creating new jobs. A millionaire in Texas, unlike his Russian counterpart, knows that if he sells oil more cheaply, then his standard of living, and that of his family, will decline. In Russia, the reverse is true: If a Russian oil dealer sells oil more cheaply, then he and his family will be better off, because he sells oil to himself–to his own offshore company–at the lowest possible price, and then resells it at world prices. The margin goes straight into his own pocket.

For this reason Russia’s leaders have come up with a new idea: creating responsible owners. What sort of an economy is it in Russia which has allowed irresponsible owners to emerge? Society is increasingly coming to the conclusion that, as a result of the reforms, Russia’s chief reform ideologue Anatoly Chubais has created a class which sees its own future and that of its children abroad. There are countless cases where proprietors invest no money in their enterprises, but export the profit abroad and hide it in personal accounts in offshore banks. While entrepreneurs in the West devote their lives to the goal of owning a corporation, Russia’s proprietors got everything free of charge from Chubais. This is why they plunder their own corporations.

Russia’s businessmen and bankers have a very simple explanation for why they send money abroad: They are worried what might happen to their money in Russia. Figures from the Prosecutor General’s Office show that Russian citizens have set up about 60,000 offshore companies to hide capital illegally transferred from Russia.


Yet another scandal recently broke concerning the illegal export of Russia’s billions. Citing Central Bank data, America’s reliable and well-informed Washington Post reported that in 1998 no less than US$70 billion was transferred from Russia to offshore banks in the Republic of Nauru–a sum equal to three-and-a-half times Russia’s annual budget!

Nauru is a tiny coral island in the southwest Pacific. Offshore business is its main source of income, followed by tourism. It covers an area of 21 square kilometers, with a population of 10,700 and a per capita income of US$10,740 per annum. Nauru is one of the world’s richer countries.

I turned for elucidation to the deputy head of the Bank of Russia, Viktor Melnikov, who thinks that there is nothing out of the ordinary in the Washington Post report. Yes, this figure had been quoted in the State Duma during the debate on changing the law on banks and banking, in order to stop the drain of Russian capital out of the country and into offshore banks. But then to illustrate his point, Mr. Melnikov pointed to the sums transferred out of Nauru banks in 1998, totaling some US$70 billion. If, for example, US$10 is registered ten times in a offshore account, it does not mean that the balance on the account is US$100. This simply represents the total turnover for the year. The Bank of Russia does not believe that this sum has left Russia forever.

Russia’s Central Bank does not deny that these US$70 billion did go through the banking system in Nauru. But it is difficult to ascertain what they were used for and where they went after that–back to Russia or elsewhere. It is impossible to track the movement of money from offshore banks.


The Bank of Russia believes that the manipulation of Russia’s billions by the Nauru banks is linked to the sudden increase in activity of a number of Moscow consultancy firms. Not long ago, representatives of these firms rang round Russia’s commercial banks and showered them with advertising offering to open accounts for them in a foreign bank, without having to step outside their Moscow offices, within just one or two days–all for a few thousand dollars.

In fact there is no bank behind this operation. There is simply a registered address and a post office box. Due to the remarkable ease and speed with which a bank account can be opened, Nauru has become a headache not just for Russia, but also for other developed countries.

But Nauru’s offshore zone, and the dozens of other similar havens for capital of dubious origins, are not the only issue. A more serious problem is developing, next to which the shady business of offshore zones looks like child’s play. So-called “Internet banks”–entirely virtual entities–are rapidly gaining in power. They are phantoms. They only exist within the computer network. However, they figure quite regularly in the international financial system. They have account numbers. They can send money all around the world. It is practically impossible to determine their location. Law enforcement bodies in Russia and other countries are tearing their hair out. They have no idea what to do about this openly criminal phenomenon.


Capital flight from Russia’s national borders is an entirely natural phenomenon. Money always heads for quieter climes. From international experience one can identify the signs which suggest that a major outflow of national capital is likely. Above all, these are: Political and economic instability, criminalization and the dollarization of the economy, and a heavy tax burden. Just one of these signs creates a strong pull towards capital flight; in Russia they are all present in abundance.

But it is wrong to suggest that as soon as the state creates secure conditions for capital investment, then capital flight will cease. Money is exported illegally even from developed countries. This is why the Russian government is drawing up measures to tighten currency regulation.

Measures to control capital exports are not a Russian invention. In France, for example, until very recently citizens were able to exchange only up to US$800 a year into foreign currencies to take abroad. Until 1990 Italians were not entitled to take more than US$500 of foreign currency out of the country each year. Currency control has been in place in Japan and other countries. Even the United States repealed its last currency restrictions only in 1973.

In Russia the volume of capital flight greatly exceeds the size of the federal budget. Russian government officials recognize that the country is facing capital exports on such a scale as to present a threat to national security. After the introduction of harsh restrictive measures in June 1999, the number of operations transferring Russian money to offshore zones dropped dramatically. During the first six months of 1999, of the total amount bought on the Russian currency market, US$1 billion was moving abroad each month, whereas now US$550 million is being exported.

The Russian authorities claim that their attack on the illegal export of capital is continuing. A broad information base is being set up within the Central Bank to record the details of those involved in any shady dealings and financial machinations. Detailed information has already been collected on around 40,000 suspicious operations.


It looks as if Russia is the only country in the world which accepts large-scale capital flight without a murmur. No other country would endure such unremitting destruction of its financial system. International experience demonstrates that if taxpayers start hiding their income in offshore companies, punitive measures ensue forthwith.

American financial executives describe how–if there is proof of tax evasion using offshore accounts–the United States holds talks with the governments of the states involved and pretty much compels them to adopt the accepted standards of the civilized world with regard to banking law, with all that that entails: Regulation, external audit, transparency and refusal to handle dubious operations.

Unfortunately, without international support, Russia is in no position to resolve on its own the problem of capital flight to offshore zones. Russia’s currency control bodies believe that the international community should tackle the problems of capital flight to criminal offshore zones. Without international support, Russia has only one means of fighting the illegal export of capital: A return to the politics of the “iron curtain.” The G7 could devote one of its summits to this issue, which is such a thorny one for Russia. It is essential that joint efforts are taken to force offshore territories to raise their banking and corporate standards, thus seriously limiting the financial capabilities of international crime.

Valery Virkunen is a correspondent for “Argumenty i fakty.”