Publication: Monitor Volume: 5 Issue: 199

Russia in early August seemed to be making progress in restoring its external creditworthiness. The first quarterly tranche of the IMF standby had added US$640 million to Russia’s reserves, and a deal was concluded with the Paris Club of official creditors postponing some US$8.0 billion in debt-service payments until late 2000. Russia was racking up US$2.0-2.5 billion monthly trade surpluses, monthly inflation rates were down sharply, and the average exchange rate rose from US$1 = 24.7 rubles in April to US$1 = 24.3 rubles in July. The deficit on the balance of payment’s capital account dropped to US$1.6 billion in the second quarter, from US$4.1 billion in the first quarter, suggesting that the flows of capital out of Russia, while still large, were at least slowing.

This momentum has now dissipated, and capital flight has accelerated. The average exchange rate dropped from US$1 = 24.3 rubles in July to US$1 = 25.5 rubles in September. This decline would have been worse if the Central Bank of Russia (CBR) hadn’t intervened on the foreign exchange market to support the ruble. But these interventions also reduced the CBR’s cash foreign exchange reserves from US$8.2 billion at the end of June to US$6.6 billion at the end of September. Preliminary CBR data released this week by the Finance Ministry show that a capital flight broadly measured during the third quarter rose to US$10.9 billion (https://www.eeg.ru/review.html). This is more than triple the second quarter’s US$3.3 billion outflow (thus defined), and is on par with the US$11.4 billion capital outflow recorded in last year’s disastrous fourth quarter.

A number of factors are responsible for the acceleration in capital outflows. The government and CBR since July have partially liberalized the foreign exchange market, in order to bring Russia’s foreign exchange regime back into conformity with IMF requirements on currency convertibility. The terrorist bombings in Moscow and other Russian cities, the resumption of a full-scale war in Chechnya, and the intensification of the media mudslinging in the run-up to the December 1999 parliamentary elections have brought domestic political instability to new heights, and no doubt helped convince more Russian companies and households to keep their money overseas or under their mattresses.

Perhaps the most important cause of the increased capital flight have been the rising tensions in Russia’s relationship with the International Monetary Fund (IMF). Moscow’s relations with the Fund have deteriorated noticeably since August, even though Russia has been hitting most of its fiscal targets. At the behest of G7 governments, the IMF in late September attached additional conditions to the release of the next US$640 million tranche, which had been slated for September. Release of the tranche is now conditioned on proof that the CBR’s internal control systems have been improved, as well as on selling off the CBR’s foreign subsidiaries and introducing more transparency into the Russian banking system. Statements by IMF (and World Bank) officials suggesting that higher military spending on the war in Chechnya could run afoul of Moscow’s fiscal targets and endanger continued lending have further complicated an already difficult situation.

Should the Fund’s new conditions not be met, the IMF could declare Russia to be out of compliance with the program upon which the standby credit is based. This could halt the on-going negotiations with Moscow’s London Club creditors, and undo the limited progress that has recently been made in repairing Russia’s external creditworthiness.