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  •   Upheavals Threaten Free Market Goals

    By David Hoffman
    Washington Post Foreign Service
    Sunday, August 30, 1998; Page A01

    MOSCOW, Aug. 29—On the eve of President Clinton's arrival for a summit with President Boris Yeltsin, Russia's economic upheaval has profoundly shaken confidence in the goals of free markets and democracy that the West has so long championed here.

    The sudden implosion of the ruble, a power-grab by tycoons, and the return of skyrocketing prices and currency black markets, as well as the faint rhetoric of an ailing leader, have all taken their toll on the ideals of "reform" and "democracy," according to conversations with professionals, politicians, academics and businessmen.

    Perhaps more than at any time in Russia's 6 1/2-year quest to remake itself after the Soviet collapse, the concepts of liberal market reform and democracy are in retreat.

    It's not that Russians have given up on the West; they still long to be part of it, and have had more exposure to Western influences than at any time in their history. But they have grown disillusioned with the kind of free-market democracy that has unfolded under Yeltsin, who is seen more as a sorry symbol of stagnation and frustration than as a beacon of progressive change.

    The disenchantment has long been building, from the 1993 violent confrontation with parliament to the war in Chechnya. But devaluation of the ruble nearly two weeks ago and the chaos that followed have provoked an outpouring of bitterness among those who supported Russia's transformation into a market economy and liberal democracy.

    "What kind of Russia do we have? One where the attempts to build a liberal market economy have come to a complete crash," said Alexei Pushkov, a television commentator. "All the people behind it are marginalized, and I don't think they have a lot of chances to survive. It's a country where this type of Western liberalism has degenerated into an oligarchic type of regime, and big money -- not free markets and democratic institutions -- mainly big money is defining the policy moves."

    A Different Summit

    The changed Russian mood may present a serious challenge to Clinton when he returns to Moscow for the first time in more than two years. In the past, Clinton saw Yeltsin as the focal point of change in the new Russia. But now that argument will not work, many Russians say. Yeltsin has all but lost control of the political process, and there are enormous pent-up pressures for a shift in economic policy, which may be anathema to the West.

    "This summit is different from any Soviet-American or Russian-American summits," said Sergei Rogov, director of the Institute for the Study of the United States and Canada here. "The real agenda is not the strategic issues and arms control and regional conflicts and regulation of the geo-strategic competition. The real agenda? It's the economy, stupid! The Russian economy is collapsing."

    Alexei Arbatov, a member of parliament from the centrist Yabloko faction, said Yeltsin could be expected to tell Clinton that Russia "will continue on the path of reforms," and that Clinton could be expected to reply that the United States "will support Russia in whatever is needed to continue on the path of reforms." But "neither of the two statements has any validity," he added.

    In fact, Russia has long zigzagged between reform and reaction. But the latest phase of reform seems to have ended Aug. 17, when the government devalued the ruble, defaulted on its domestic bonds and froze banks' debts to Western creditors. The ruble went into a tailspin. The Russian stock market now is lower than on the day it opened three years ago. Russian international credit ratings are at rock bottom. Banks are paralyzed. Russians are again hoarding dollars, and whatever confidence they were beginning to show in commercial bank deposits has been shattered.

    Yeltsin's major accomplishment in recent years was to stabilize the ruble exchange rate and tame inflation. But the cost was enormous in economic pain inflicted on the country, including workers not being paid and the rise of a crude barter system. Now, in reaction, there are mounting demands, across the political spectrum, for the Central Bank to start printing money, even though it would probably unleash massive new inflation and evoke disapproval in the West.

    "Yeltsin will have to abandon this model of low inflation, balanced budget, macro-stabilization to go for a large-scale emission [of money]," Arbatov said. "There is no other way, and the only argument now is about the mechanism of this. And that will effectively end the economic aid of the West."

    "Now we are in a period when we have to take emergency measures, we do not have a luxury to be concerned about markets anymore," he said. "We have to save the country and the economy from total collapse and chaos." Arbatov said he was hoping for an approach "that would eventually let us in a few years start once again another attempt to build a market economy and preserve democracy."

    Russia is unlikely to return to the Soviet era of central planning and fixed prices. Too many people, especially young adults, have been exposed to the market economy, and many of those in Moscow, a citadel of relative prosperity, have tasted its fruits.

    But it is clear Russian economic policy is headed toward a period of increased state control. Among other emergency economic measures now being discussed is stopping privatization of state-owned companies, especially those in the oil and gas industry. This would mean scrapping plans to sell off part of the natural gas monopoly Gazprom and Rosneft, a state-owned oil company, which had been on the block. Some other industries deemed "strategic" to Russia, such as metals and former defense factories, could be renationalized.

    Reformers Depart

    Another sign of change is that the public figures so often associated with Yeltsin's reforms -- and vilified because of them -- departed from the government when Yeltsin fired Prime Minister Sergei Kiriyenko. A banker and oilman, Kiriyenko was a product of the Gorbachev- and Yeltsin-era market liberalizations. He was close to policymakers associated with Yegor Gaidar, Yeltsin's first prime minister and a champion of free-market liberalism, including the highly controversial Anatoly Chubais, the architect of Russian privatization. Now Chubais, Kiriyenko, and deputy prime minister Boris Nemtsov all have left the government, although Chubais remains head of the electricity monopoly.

    Perhaps the harshest criticism of the Yeltsin economic policy is that it fell short of a truly competitive, liberal economy with a rule of law and turned into a playground for wealthy barons who gobbled up valuable resources from the state. Rogov, of the U.S.-Canada research institute, said that "reform" wasn't really attempted, just "virtual reform," and the outcome had "some elements of capitalism, some elements of Soviet-style socialism and plenty of elements of pre-capitalism, like barter."

    Rogov said the United States bears some responsibility for Russia's plight. "For seven years, the United States has been playing the role of mentor, of teacher, for Russia," he said. "So the present crisis is not only the collapse of virtual reform in Russia, but it is also the collapse of American policy. . . . Clinton's policy was not the reason for Russia's misfortune, but it was not the solution."

    Undeveloped Civil Society

    Russia's fragile democracy also is under enormous stress. Although there have been successful elections at the national and local levels, the more difficult task of building a civil society -- connecting the rulers with the ruled through such institutions as a free press, the church and associations -- has stalled.

    "The role of civil society has not even developed," said Pushkov, the TV commentator. "All the democratic procedures -- no one even uses them. All is decided at the top. Take all those rumors about Yeltsin stepping down. He is not doing it because of people on the street, but because the oligarchs say so."

    Rogov said the rollback of civil society "was the greatest Russian failure" of recent years. "It was growing seven years ago, it was quite vibrant seven years ago, it stopped the coup seven years ago," he recalled. "Today it is dead."

    Lilia Shevtsova, a senior associate at the Carnegie Endowment for International Peace, said liberal democratic values have been discredited under Yeltsin. "Why? Because Yeltsin has not been building a liberal democratic state, but an electoral monarchy, a clannish capitalism." Shevtsova said Yeltsin failed to nurture a democratic opposition and a successor who could advance the cause of democracy. Now, she noted, the front-running candidates to succeed Yeltsin are all more authoritarian.

    Clinton has staked his approach to Russia on his personal relationship with Yeltsin, but that may be as devalued as the ruble. Yeltsin seems to be sinking politically, and ailing physically. The parliament is trying to use the financial crisis to revise the 1993 constitution and whittle down the broad powers given to the president. Sergei Karaganov, a former adviser to Yeltsin, said in a newspaper commentary this week that Yeltsin's infirmities have created a vacuum in Kremlin leadership.

    "President Yeltsin for a long time now has been almost completely incapacitated," he said. "He can't work, he can't absorb an adequate amount of information and can't make reasoned conclusions. His repeated gaffes always give rise to doubts, and rightly so. I say this with bitterness and respect."

    Shevtsova said the outlook is bleak for Russia with Yeltsin at the helm. "While Yeltsin survives as a nominal president, we'll have this all-omnipotent impotence. He has all powers, and can do nothing. It will be a stagnating regime, with a patchwork quilt of decay."

    Russia's Slide Into Economic Crisis

    Last summer, when Russian President Boris Yeltsin joined the leaders of the seven richest nations for a summit in Denver, the Russian economy showed signs of growth and portfolio investments surged, making Russia a hot emerging market. But by the fall, the price of crude oil -- one of Russia's biggest foreign currency earners -- plummeted, the Asian economic crisis began to affect Russia, and the Kremlin did not change budget policies fast enough. By last Sunday, Yeltsin had to admit economic defeat and devalue the ruble, touching off post-Soviet Russia's worst crisis.

    The Causes

    The Asian economic crisis, rooted in overcharged economies, overbuilding, overlending and overconsumption, began in Thailand in the spring of 1997. By mid-1997, one of the consequences was declining oil prices around the world due to a slump in demand. This quickly resulted in a drastic decline in Russia's foreign currency earnings. . . .

    . . . as the Asian currencies and stock markets collapsed this spring, many investors pulled out. Investors also lost confidence in the once-hot Russian stock market.

    Price, per barrel, of West Texas intermediate crude oil, weekly closes

    December 1996: $26.23

    Friday: $13.27

    Russian trading system index, daily closes

    October 1997: 571.66

    Friday: 66.77

    -- Russia's fiscal policies for years have suffered from inefficient tax collection, revenue needed to pay workers' salaries and cover other government expenses. Yeltsin's sometimes erratic policies and continuing struggles between economic reformers and communists also made investors skittish.

    The Fallout

    1. Russia began to run up an alarming budget deficit. To keep the government going, it had to borrow more and more money.

    2. One way to cover government expenses is to issue bonds. Russia issued ruble-denominated treasury bills, called GKOs. But investors, taking larger risks in shaky markets, demanded higher returns; interest on the treasury bills rose from 20% last year to more than 170% this month. The government had to borrow more and more to pay the huge interest.

    3. The government deficit and mounting debts made speculators lose confidence in the ruble, and they began selling rubles for dollars and other stable foreign currencies on the Moscow currency exchange. The government defended its currency by buying huge amounts of rubles with scarce dollars, draining its reserves.

    4. The more dollars Moscow used to buy rubles, to shore up the currency's value, the fewer dollars were left to pay back Russia's mounting foreign debts.

    5. To obtain financial aid from the International Monetary Fund, the government had to promise tough fiscal reforms, including more aggressive tax collection, drastic spending cuts, acceleration of privatization and bankruptcy procedures to liquidate state companies.

    In May, the IMF released a $700 million loan installment, part of a $10 billion three-year lending program.

    In mid-July, Russia received a $4.8 billion installment of a promised $22.6 billion loan. The next installment of $4.3 billion has been promised for late September.

    6. In order to comply with IMF conditions, the lower house of parliament, or State Duma, had to pass legislation, which it failed to do in full. The impasse further weakened investors' confidence in the ruble, and the government continued to shore up the currency with scarce dollars from the IMF rescue package. Yeltsin, meanwhile, insisted that the ruble would not be devalued.

    7. Finally, on Aug. 17, Yeltsin announced the ruble would be allowed to float to 9.5 to the dollar by December, an effective devaluation. The ruble immediately plummeted to about 8 to the dollar on the currency exchange. By Thursday, it fell as low as 16 to the dollar, and currency trading was suspended. Millions of Russians, who were trying to rescue their ruble savings by buying dollars, were left stranded.

    The government also closed domestic bond markets to restructure them. In effect, investors will get only 20 to 30 cents to the dollar.

    It also declared a 90-day moratorium on payments by businesses on their overseas debts.

    The political fallout is still playing out. On Sunday, Yeltsin fired his prime minister, Sergei Kiriyenko, 36, and replaced him with his predecessor, Victor Chernomyrdin, 60. There were vociferous calls for Yeltsin's resignation, but on Friday, he vowed to stay in office, although he promised to yield some power to the Duma.

    Dollar value of the ruble, daily closes

    Aug. 14: 15.94 cents

    (6.2725 rubles per dollar)

    Friday: 8.33 cents

    (12 rubles per dollar)

    SOURCE: Staff reports, Bloomberg News

    © Copyright 1998 The Washington Post Company

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