RUSSIA ON THE EVE OF THE 21ST CENTURY

By Mikhail Matytsin

THE NEW SITUATION IN THE RUSSIAN BUSINESS COMMUNITY

What is in store for Russia on the threshold of the 21st century, economic collapse or gradual emergence from crisis? What are the prospects for the Russian reforms, which by consensus have only just begun? Is there a light at the end of the tunnel, or can Russia’s future only be painted in bleak colors? Can Russia’s business community play the role of savior? Does the business elite have the resources to pull Russia from the mire?

At first glance the current state of the Russian economy offers no grounds for optimism. As a result of the economic crisis which struck in August 1998 the ruble plummeted (by the beginning of 1999 it had fallen almost fourfold against the first half of last year), and inflation took off, reaching more than 80 percent for 1998.

The decline in industrial output for 1998 is estimated at 3-5 percent. GDP–which in 1996-97 was US$440-470 billion at the exchange rate of the time (2.2–2.6 trillion new rubles)–fell in 1998 to US$350 billion at the current exchange rate (about 3 trillion rubles). Incomes fell by 15 percent in real terms by the end of last year, and the average salary fell from US$160 to the equivalent of US$60 at the market rate. At the beginning of 1999 there were 25 percent more poor people in Russia, and the middle class had shrunk by about one-third, currently accounting for no more than 20-25 percent of the population by the most optimistic assessments. Perhaps even greater losses were borne by the institutional structures of the economy. The stock market and banking system are in ruins. The confidence of a significant proportion of the population has been undermined, not just in the banks and the authorities, but also in the liberal economic model itself.

1999 began with 8 percent inflation in January and a further fall in the Russian currency. None of the available forecasts for the current year envisage economic success. The situation in the Russian economy is undoubtedly extremely grave–more so than at any time in the last few years. But it is worth looking at some of the more promising factors which have been noted in the last few weeks and months, both in the financial sphere and in society as a whole. First of all, the new leaders of the government (Yevgeny Primakov) and the Central Bank (Viktor Gerashchenko) have managed to hold Russia’s finances and economy on the very edge of the precipice. There has been no economic collapse. Russia has managed to avoid a sovereign default on the foreign debt. The apocalyptic predictions of famine this winter and the freezing over of entire regions have not come true.

Furthermore, the government has managed to alleviate to some extent the crisis surrounding the nonpayment of salaries and pensions, to revive tax collection and to reactivate payments through the banking system. All of this is certainly not yet enough to restore economic growth. However, one of the positive results of the government’s activities over the last few months has been the political stabilization of Russian society. Judging by the numerous opinion polls, the government enjoys considerable public support, particularly against the backdrop of previous years. It has managed to come to terms with the State Duma and the regional elites, as demonstrated by the budget reading in parliament. Prime Minister Primakov’s initiatives put forward at the end of January are aimed at concluding a sort of nonaggression pact between the branches of power and between the authorities and society. Finally, the signs are that there has been a softening in the attitude adopted by the International Monetary Fund (IMF) and the G-7 countries with regard to offering Russia financial assistance and restructuring the foreign debt.

Against this background, it is worth highlighting a number of unique conditions which have arisen as a result of the August 1998 crisis and are capable of reversing the current trends, fundamentally changing the business climate in the Russian business community and helping its new leaders to emerge. The following number among the more significant of these conditions.

1. The system of oligarchic control of the economy has been considerably undermined. The “throne”–firmly occupied by the so-called oligarchs and their structures both in public opinion and in economic and political decision making–is to all intents and purposes vacant. The reasons are obvious: the catastrophic undermining of authority and the severe financial problems. The consequences of the collapse of the oligarchic model of development could be very positive for the Russian economy. If the government and the business community follow a consistent line then the opportunity arises to draw up new “rules of play” based on honest competition and antimonopolistic policies.

According to some forecasts, in the near future many banks which head financial industrial groups–and which were until recently highly influential–will have to give up control of industrial enterprises. This will undoubtedly facilitate the diversification of the ownership structure and the “de-monopolization” of economic influence. In other words, today the conditions potentially exist for replacing the oligarchic economic model with a polycentric one.

2. In the banking and financial sphere a major redivision of the market is taking place. At its present stage it has particularly taken the form of a primary redistribution of clientele. During the first stage, it was the banks with state participation–Sberbank, Vneshtorgbank and Vneshekonombank–which most noticeably strengthened their positions. Moreover, Sberbank did not just reinforce its monopoly position in the private investment market (its share of the total volume of individual investments has risen from 76.3 percent to 83.9 percent since August 1998), but attracted many new corporate clients and also noticeably strengthened its position in handling foreign trade deals (the number of export deals made by clients of Sberbank increased by 230 percent in September 1998 alone, while the value of the deals rose 330 percent in comparison with the corresponding average monthly indicators for 1998).

However, the opportunities for state banks to service the new clientele are not unlimited. Following the initial consequences which have manifested themselves today there will be other stages: a redistribution of financial flows, spheres of political influence, and control of the media, and a secondary redistribution of clientele. For financial corporations and banks bidding for influence it is important both to get involved in this process as quickly as possible and to take the lead. It is much easier to do this since the August crisis–the competition is weak. The main thing is not to build “pyramids”–on the national debt market included–or to go “hunting” for budget accounts, but to build the banking business on the established market principles of attracting investment, credit activities, and settlement and cash services. Under the current conditions this strategy alone can restore the confidence of investors and attract new clientele. In its turn, the redistribution of financial flows (both budget and corporate)–which up to now were almost completely controlled by the financial structures of the oligarchs–creates the potential not just to revive the banking sector, but also to reactivate many spheres of Russian business.

3. A revolutionary situation is developing in the Russian business community. The “lower classes” do not want to live as they did before, because medium- and large-scale nonoligarchic businesses are not happy with a system in which their interests are totally unrepresented at the top. In their turn, the “upper classes” cannot live as they did before: Oligarchic businesses are no longer in a position to reconstruct the old systems and implement their old agreements. The business community objectively needs updating and needs new leaders, both corporate and individual.

4. It is extremely important for Primakov’s government–which is preoccupied with achieving social and economic stability and with its own image–to offer the public a new model for relations between the authorities and business in place of the oligarchic and corrupt model so firmly entrenched in the public consciousness. The signs are that the government–and above all the prime minister himself–understand both that it is impossible for the old oligarchic systems to function under the new conditions, and that it is dangerous to establish a “state capitalist” economy, where the role of small and medium business will remain insignificant or absolutely negligible.

Of course, during the last few months tendencies have appeared which could be interpreted as signs of state monopolization of the economy: stricter measures for controlling the turnover from the production of alcohol and similar measures proposed for the tobacco industry. It can be assumed, however, that from the government’s point of view these are, in fact, tactical measures designed on the one hand to supplement the budget income and on the other to curtail the hidden economy. This latter factor, alongside the real steps taken to reduce the tax burden, should–if the steps are successfully implemented–give a positive boost to the prospects for honest and legal business in Russia.

It would seem that any constructive suggestions from the business community regarding the creation of a new system of mutual relations will be given very close attention by the government.

5. For the future development of banking and investment business in Russia the public must be offered a new form of financial institution, and a new, more honest and open system for attracting private investors. Today Russia’s citizens are rightly seen as the biggest potential investors in the country. It is well known that Russia became a veritable “dollar vacuum cleaner” a long time ago. According to Central Bank figures, from January to November 1998 alone authorized banks imported cash currency into the country to the value of US$15.3 billion. Export of cash currency for the same period was just US$355.4 million. Thus the net import-export balance for less than a full year last year was about US$15 billion. This has been the scenario for several years now. As a result, according to various estimates, the population is holding anything from several dozen to several hundred billion dollars, which is basically not part of the economy. Obviously, some of these funds are of dubious origin and are partially involved in the hidden economy. However, most of the dollar savings are the result of a total lack of confidence in the authorities and in the banking and financial structures which have cheated the public more than once in the last few years. The August crisis only served to intensify Russians’ mistrust both of the government and of the oligarchic banking structures which held the majority of the “frozen” accounts and other financial assets of the public.

At the same time, it is clear that the public and the financial credit institutions have a mutual interest in channeling these savings into the economy, all the more so given that in recent years people have definitely become interested in the way savings can “work.” All which is needed is to restore and reinforce the confidence of private investors in credit organizations, various types of investment funds, insurance companies and so on. And for this, absolutely clear and transparent rules are needed, together with reliable state guarantees at a legislative level.

6. The postcrisis situation gives Russian companies, including those working in the investment and financial sector, the chance to form new relationships with their foreign partners. It is well known that the decisions taken by the government and the Bank of Russia on August 17, 1998 disastrously undermined the confidence of western creditors not only in the Russian authorities, but also in domestic banks and their Russian clients. As at August-September last year, the total debt of the Russian banking sector to non-residents was more than US$19.2 billion (including US$6-10 billion of forward contract debts), of which about 16 billion had repayment terms of less than one year. The repayment of all these debts was already seen to be highly problematical back in the summer, but after the more than threefold devaluation of the ruble it became simply unrealistic: According to expert assessments, Russian banks have at their disposal funds sufficient to cover only approximately 1 percent (US$70-100 million) of the total forward contract debt to nonresidents.

However, for all the complexity of the situation, it should be borne in mind that the vast majority of the debt to Western creditors is owed by the large oligarchic financial credit structures which were very active in the foreign loan market. Meanwhile, despite the moratorium, a large number of Russian companies and banks did not stop meeting their obligations to their Western partners; today it is these representatives of the Russian business community who have a real chance of becoming western creditors’ main contract partners.

On the whole, as regards investor confidence, it makes no fundamental difference who performs this role–a private Russian investor or a sound Western bank. Both will strive to reduce the risk to their investment as much as possible. Clearly, in the future only those Russian financial companies whose dealings are clear and transparent, and which are managed and positioned along Western lines will have the chance to win the trust of serious foreign partners.

7. Under the current conditions, the demands and abilities of regional business elites are growing, as are their requirements for new forms of relations with the authorities and financial groups on a federal level. This tendency is due both to the visible rise in self-sufficiency of the subjects of the Russian Federation, and to the increased influence and self-organization of regional business communities, although it is certainly not possible to provide a single explanation for it. What is clear is that at regional and local levels another “oligarchic” system of relations is being created, in some respects an even more monstrous one. At the same time, it is the appearance of “growth points”–even in separate Russian territories–which gives the whole economy a chance for economic revival. Up until now, the concentration of all financial resources in the center (up to 85 percent of all financial flows in Russia were channeled through Moscow) has seriously hampered the opportunities for economic revival in the regions. Today there is a real chance to shift the financial balance in favor of the oblasts and republics. This may also be facilitated by the plans which the government has announced to change the procedure for levying taxes on large companies: from now on they will have to pay not at the location of registration and the head office–that is, Moscow–but where the actual production, trade or other activity occurs.

The conditions noted above may be seen only as a potential opportunity to change the economic climate in Russia, to form a new model for relations between the authorities, business and society, and as a result to revive the country’s economy. Along the way Russia will encounter many obstacles of a sociopolitical as well as economic nature. We can thus expect that on the threshold of the parliamentary and presidential elections, when politicians are particularly interested in financial support, new candidates will appear who want to occupy the places vacated by the former oligarchic structures. It will not be easy to give up the familiar state paternalism which is so deeply embedded in the public consciousness. Nevertheless, Russia’s future is tied to those who are prepared to rely on their own abilities, rejecting state guardianship and support. Stakes should be placed on the dynamic development of business and on public initiative.

Mikhail Matytsin is a doctor of economics and executive director of “Cooperation” Reform.