RUSSIA - The Financial Situation

Russia, basically a dollar-indexed economy, has fallen to the most severe financial crisis since the collapse of the Soviet Union. There is the threat of a rouble devaluation, which would have devastating effects on the country and on Europe in general. The crisis directly affects the hydrocarbon sector as the government, acting on IMF terms, has raised taxes and excise duties on oil and gas exports and on other sales. The Duma (parliament), which is dominated by Communists and nationalists, has omitted important parts of the government's anti-crisis programme forcing the authorities to keep oil taxes high.

The government has already used up $14 bn of its foreign exchange reserves since the Asian crisis began in 1997. By mid-June, gross reserves were down to $15 bn, and virtually all of these had been borrowed. Because the sustainability of the exchange rate was doubtful, domestic interest rates were as high as 80%, having shot up to 150% a few months earlier. With inflation below 10%, these rates imply an explosive rise in the burden of debt service, which is already a third of the federal budget.

The government ran a primary budget surplus of about 1% of GDP in the first five months of 1998. The stock of short-term treasury obligations was only 13.5% of GDP at the end of 1997. But the government has to redeem about $60 bn of short-term treasury bills over the rest of 1998 alone. Investors suspect it will not be able to do so.

On July 20, the IMF agreed to a $22.6 bn support package for Russia to stave off a devaluation. Premier Kiriyenko argues that the government's plan is strong enough to enable it to raise Rbs105.2 bn ($17 bn) of revenues by end- 1998 to fulfill its budget and IMF obligations as well as meet the redemption schedule on its short-term domestic debt. But yields on benchmark treasury bills (GKOs) leapt again to above 80% before closing on July 29 at 59%, marginally below the central bank's refinancing rate.

The more interest the government pays the less sustainable its position. A devaluation would trigger a banking collapse and flight from the rouble. The result could be outright monetisation, as the central bank is forced to create money to finance the budget. Domestic interest rates would rise further.

August is the key month, during which the government will have to convince the IMF and the international community, as well as the domestic market, to have faith in the rouble and to continue to hold rouble assets. But experts have warned that the government's drastic fiscal squeeze, the thrust of its anti- crisis programme, could prove worse than a devaluation. Andrei Illarionov,

director of the Institute of Economic Analysis, said on July 29 a devaluation would be preferable to the government's austerity programme. He said there were "striking parallels" between Russia's stock market performance and Indonesia's before the Asian country was forced into a devaluation and sharp economic contraction.

On July 30, Fitch IBCA, the international credit rating agency, downgraded the country's sovereign debt rating by one notch to BB minus. The move, which also affected ten Russian entities rated at the sovereign ceiling, followed disappointment at Duma's rejection of key elements of the government's anti- crisis plan. The agency, saying Russia would be rated even lower, warned of a potentially "bitter and destabilising" battle between the Duma and government over the 1999 budget. It said efforts to improve tax collection would be vital for the country's creditworthiness and its qualification for disbursements under the IMF's support package. But it could take much longer than expected for Moscow to resolve these huge problems.

The government's plan includes the following measures: cutting Rbs61.3 bn (about $9.9 bn) from expenditures originally planned in the 1998 budget, with non-interest spending to fall by Rbs74.2 bn - but the high interest rates will eat up some of these savings; keeping oil and gas excise duties high; allowing access to export pipelines only if taxes are paid in full, selling state equity in 10 major companies by end-1998; closely monitoring 1,000 prominent Russians to make sure they pay their taxes; and accelerating bankruptcy procedures and selling the receivables of tax debtors. The government is hoping these measures would bring the budget deficit down to 5.1% of GDP this year, a target accepted by the IMF, and improve state finances to the tune of Rbs105.2 bn ($17 bn).

Three-quarters of Russia's exports consist of raw materials, metals and semi- finished goods. Their added value is minimal and a devaluation would have little effect on exports. Russia's export industry is mainly dollar- denominated, with the rouble's link to the dollar having been the anchor for monetary stability.

Venyamin Sokolov, director of Russia's Chamber of Accounts, said in an article published by the 'New York Times' in early June 1998 that "the main culprit" of the economic crisis was "the alliance that the Russian government has formed with powerful business interests". He added: "This alliance has been raiding the public treasury and depriving the Russian people of a secure and democratic future... Tax revenues are collected only to be stolen. Losses on the federal and regional levels are huge. The Finance Ministry compounds the problem by having no accounting system to keep track of revenues and spending. The Russian people are paying the price".

Sokolov said these and other problems he mentioned in the article "created the debt that is strangling the economy", with 45% of the state's income now used to service that debt. "Little is left over to provide services", a situation worsened by a 30% budget cut made by Yeltsin in April and an additional 12% cut made in May. "This means no money is left to pay workers or to support education, public health or scientific research. No wonder unrest is mounting. Scientists unpaid for months have blocked railroads, and miners have gone on strike. This year the Russian stock market has suffered the world's steepest decline, and its precipitous recent fall may herald much worse to come".