Publication: Monitor Volume: 7 Issue: 24

While Moscow had to be dragged kicking and screaming to honor its financial obligations, there are a number of compelling arguments in favor of fully covering Russia’s sovereign debt obligations in 2001. As Illarionov has pointed out, many current economic problems would be helped, not hurt, by increased debt-service payments. Russia’s rapid economic expansion is fueled by booming growth in investment (which, according to official estimates, grew 18 percent last year) and by personal consumption, which was reported up nearly 10 percent as of mid-2000. Rapid export growth due to high prices for Russia’s energy exports and the weak ruble is placing further demands on the economy, and flooding the financial system with dollars. The foreign exchange reserves of the Central Bank of Russia (CBR) rose to a record high of US$28.6 billion on January 26 (Reuters, February 1), which has caused the money supply to surge as well. Russia’s monetary base (cash in circulation plus required reserve deposited at the CBR by commercial banks) grew by 70 percent in 2000. Too many good things all at once are keeping inflation relatively high–consumer prices rose by 20 percent last year–and are eroding the competitiveness of the manufacturing sector, which has been a driving force being the economic recovery. Growth in industrial output, which averaged 9 percent for 2000 as a whole, dropped to only 2.5 percent in December.

Increasing the payments on Russia’s foreign debt could attenuate many of these problems. If–as it is now considering–the government borrows dollars from the CBR to pay off the Paris Club, the CBR’s bulging reserves would shrink and growth in the money supply would slow. This would slow inflationary pressures, and help Russian enterprises preserve their competitive edge against imports. Redirecting budgetary expenditures away from domestic items to foreign debt repayment would help keep growth in domestic spending under control. And in the longer term, fully servicing its debts in 2001 would help Moscow to credibly bargain for a general restructuring of its Paris Club obligations in the future.

But while such arguments may seem convincing to Illarionov, they fly in the face of domestic Russian political reality. Formally changing the government’s expenditure priorities would mean revising the 2001 budget, which could open up a Pandora’s box of demands for increased spending and tax cuts. Moscow’s problems with its foreign creditors are an abstraction to many Russians, particularly to the thousands of residents of Siberia and the Far East who have gone for weeks without heat and electricity in their apartments and schools.

Perhaps most important, the February 2000 agreement which wrote off 37 percent of Russia’s London Club debt–even though Moscow had paid virtually nothing on these debts since August 1998–was viewed as a great success in Moscow. According to many observers, it played a key role in Putin’s decision to appoint Kasyanov as prime minister in May. In contrast to the London Club deal, Kasyanov’s handling of the Paris Club seems quite inept. Not only has Kasyanov failed to wrestle a similar concession from the Paris Club–his failure has forced Moscow to fully pay its foreign debts for the first time in two and a half years. If rumors about an imminent government reshuffling should prove true, his failure to deliver on the Paris Club could cost Kasyanov his job.