Publication: Monitor Volume: 6 Issue: 131

How can this case of “Russian exceptionalism” be explained? A number of possible causes present themselves. A sizable chunk of the capital stock inherited from the Soviet period turned out to be redundant in the market economy which took hold after 1992. Much of Russia’s unused production capacity therefore turned out to be “useless” rather than “excess.” Some of Russia’s most valuable assets were stripped and exported during privatization. And the large declines in investment spending since 1992 suggest that much useful machinery and equipment has simply worn out. A need to invest in new plant and equipment is greater than might appear to be the case.

A second set of explanations for Russia’s investment growth lies in changes in the composition of Russian GDP. Before the August 1998 financial crisis, spending by consumers and the government claimed relatively large shares of total output. But personal consumption dropped 9 percent in the second half of 1998, and another 5 percent in 1999. Shorn of its ability to borrow, the general government’s budget deficit went from 8 percent of GDP in mid-1998 to only 3 percent of GDP in the first quarter of 2000. In effect, workers and machines who and which used to make consumer goods or provide government services are now working on construction sites or making new equipment.

A third set of explanations lies in post-August 1998 changes in the enterprise financial environment. The Central Bank of Russia tightened the money supply and jacked interest rates up to 150 percent in the midst of Russia’s financial crisis. Russian banks lost all interest in providing companies with commercial credit, as banks, though, they tried instead to make a killing buying government treasury bills. Foreign banks and investors stopped providing Russian companies with capital, and government agencies tried to reduce their budget deficits by not honoring many of their obligations. Shorn of cash flow, companies were unable to maintain output and profit levels. By November 1998, enterprise net profits had dropped to some US$940,000, down from US$3.2 million in November 1997. Obtaining investment capital from internal or external sources was for most Russian companies simply out of the question.

After August 1998, however, the CBR brought interest rates down and let money supply growth accelerate, while inflation rates took off. At present, Russian banks are offering twelve-month commercial loans at 29 percent, while yearly inflation rates are in the 20-50 percent range. In real terms, interest rates are negative. While many corporate borrowers do not have the financial and political moxie to gain access to these cheap credits, some do. Meanwhile, the salutary effects of the ruble’s sharp devaluation and higher export prices boosted enterprise profits, which stood at US$3.1 million in March 2000. Because retained earnings were financing more than half of the investment spending undertaken in the first quarter, this improvement in enterprise profitability has played a key role in Russia’s investment boom.