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The principal reason underlying the financialcrisis was the failure of all the successive cabinets in Russia to adoptand, more importantly, execute a realistic budget.2 As a result, the positivetrends dominant in 1996 and 1997, such as falling inflation rates,stabilization of the ruble exchange rate, declining interest rates, and anincipient economic uplift, were maintained solely by a tight monetarypolicy pursued against the background of highly unbalanced government finances.The considerable government finance shortages pushing up government debt anddebt servicing, while at the same time depressing the national savings andthinning out the current balance of payments surplus, were a majordestabilizing factor in the nation’s socio-economic development.

One of the worst performers among thedemocratic nations in terms of economic growth, Russia stands level with theUSA, and is just behind Britain, in terms of budget strain. The budgetarycrisis in post-communist Russia has political roots, not because its governmentlacks the political will to fight tax evasion and tax arrears. The politicalcolor of the budgetary crisis reflects the incompatibility between the level oftax collection by the government, on one hand, and the democratic character ofthe political regime and the country’s economic development, on theother.3

The inability to understand the above-namedunderpinnings of the budgetary crisis has led to wrong moves to end it. It isarguable what extent of tax revenues corresponds best to the growth level ofthe national economy, its sectoral structure, public well-being, publicconsumption structure, law-abiding traditions, comprehensiveness of the laws,and many more factors. The fact that attainable tax collection does notrise above 30 per cent of GDP, give or take a few percentage points, may beassumed to have been proved by practical economic experience. Restructuringexpenditures, not least cutting them, must, therefore, be pivotal to a balancedbudget, a painful admission in both political and social terms.

Between 1991 and 1997, the government slashedpublic spending by approximately two-thirds, with spending on social programshaving dropped by about a third. For all that, the government moved too slowlyto cut its spending, far below what was needed to put the budget in balance.Furthermore, budget spending was commandeered by an assortment of lobbies(agribusiness, the military-industrial complex, banks, primary industries,etc.), causing the structure of budgetary spending to get twisted tortuouslyout of shape, unable to create conditions for economic growth or maintain adesired level of socio-political stability.

In the period under review (particularly, atthe juncture of 1997 and 1998), the government made repeated attempts todiscipline federal and local budgetary spending. The Kiriyenko cabinet went, inJune and July 1998, as far as developing and adopting a program tailored tothese aims. The measures undertaken in this area were, however, hardly morethan efforts to identify and plug the drain holes, the problem being far morecomplex overall: the government had to go back on many of its commitments thatcould no longer be honored without piling up a precarious pyramid of publicdebt.

Beginning in 1995, the internal public debtstarted running up, above all, because of the heavy borrowing on the securitiesmarket (see Table 1.1). By early 1998, the domestic debt had gone up to 18.9per cent of GDP, and to 26.0 per cent of GDP (annualized) toward the close ofthe year.

Table 1.1

Dynamics of domestic government debt
and expenditures on its service

as at 1 January 1994

as at 1 January 1995

as at 1January 1996

trln

Rbs

per cent of GDP

trln

Rbs

per cent of GDP

trln

Rbs

per cent ofGDP


Domestic government debt, of which

35,2

21,7

88,4

14,5

188

11,5


- debt on securities

0,3

0,2

18,9

3,1

85,2

5,2


- debt to Central Bank

29,2

18,0

58,8

9,6

61,0

3,7


Domestic debt service

0,99

0,6

16,1

2,6

38,2

2,3


as at 1 January 1997

as at 1 January 1998

as at 1January 1999

in trillions of Rbs

per cent of GDP

in trillions of Rbs

per cent of GDP

in blns of Rbs

per cent ofGDP


Domestic government debt, of which

365,5

16,2

501

18,7

751

28,0


- debt on securities

249

11,0

449

16,8

480

17,9


- debt to Central Bank

59,6

2,6

0,0

0,0

0,0

0,0


Domestic debt service

105,7

4,7

96,3

3,6

106,6

4,0


Sources: RF Ministry of Finance, RF CentralBank, Institute for the Economy in Transition

Table 1.2

Dynamics of RF external debt

USSR debt

(in blns of USD)

RF debt

(in blns of USD)

Debt service as per cent of GDP

1992

104,9

2,8

0,7

1993

103,7

9,0

0,3

1994

108,6

11,3

0,5

1995

103,0

17,4

0,9

1996

100,8

24,2

0,9

1997

97,8

33,0

0,7

1998

95,0

55,0

1,2

Sources: RF Ministry of Finance, RFGoskomstat, Institute for the Economy in Transition

The swelling domestic debt was pulling up itsservicing costs. Between 1995 and 1996, they almost doubled, from 2.6 per centof GDP to 4.8 per cent of GDP. In 1997 and the first six months of 1998, theservicing costs dipped to 3.6 per cent and 3.9 per cent of GDP, respectively,still unacceptable.

At about the same time, 1996 to 1998, thegovernment started borrowing indiscriminately on foreign financial markets.Table 1.2 illustrates the growth of the federal foreign debt.

The total debt load on thecountry’s economy, at49.8 per cent of GDP (as at 1 January 1998) was relatively light, by themeasure of many other countries across the world.4

The domestic debt burdening Russia in 1997was singularly short-termed, with a large proportion of non-residentdebt.

The duration of Russia’s domestic debt (the average timebefore retirement of outstanding GKOs-OFZs) increased from 60 to 90 days over1995, to 150 days in 1996, and 250 days in 1997. Even though debt duration hadcrept up to 330 days by August 1998, the funds needed monthly to retire theprevious bond issues alone (leaving aside coupon payments on two- to three-yearcoupon securities, OFZ) had shot up to between 10 per cent and 15 per cent ofmonthly GDP.

The ratio of short-term domestic debt tohousehold bank deposits, giving an inkling of the total domestic financialsavings in Russia, points to a long lead of domestic debt, whichcontinued into the fall of 1997, from spring 1996, when it had toppedone.

This situation forced the decision to openthe internal public debt market to non-residents. Given the persistent fiscaldeficit and limited domestic borrowing sources, the government had noalternative to non-residents: it was either to contrive to narrow the fiscaldeficit or to throw the door to the domestic debt market wide open tonon-residents.

Starting on 1 January 1998, theCentral Bank and the Russian government announced the removal of allrestrictions for non-residents entering the Russian debt market (guaranteedyields were waived and restrictions on profit repatriation periods lifted). Thepresence of non-residents on the GKO-OFZ market was steadily growing. Accordingto the Russian Finance Ministry, non-residents accounted for almost 28 per centof the market in April 1998.

Another point to be made, the significanteasing of foreign capital controls and the consequent decline of governmentdebt servicing costs gave the government an illusion of trouble-free reality,with enough funds to finance the government fiscal deficit, at least in themid-term. From this perspective, the admission of non-residents to the domesticdebt market had a disastrous effect on the government’s economic policy by intensifyingthe moral risks of the soft budgetary policy option, which did not anticipate arapid contraction of the fiscal deficit and, hence, the need for more publicborrowing.

Although foreign borrowings have longermaturity dates than domestic market securities, Russia is beginning, in 1999,to repay the credits and loans it received from international financialorganizations in the relatively distant past, while from 2001 on it will haveto retire the Eurobonds placed in 1997 and 1998. In the next 10 years, theannual costs of repaying the debts falling due to the internationalorganizations and the interests payments to investors who have purchasedRussian Eurobonds will range from $3.5 billion to $5 billion. As if it were notenough, the grace period on debt repayment to the London and Paris clubs endsin 2002, boosting significantly annual foreign debt repayments.

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