IMF's Russian Roulette

Almost one year after the August 1998 crisis, Russia has received a new $4.5 billion International Monetary Fund credit line, to be disbursed over the next 18 months. This can be seen as a victory for both the IMF and the Russian government. One year ago the ability of Russia to service its debt to the IMF was at risk. A Russian default would have been a hard blow to the credibility of the fund, which has lent Russia more than $19 billion since 1993, making Russia its largest debtor. Russia has been given another chance to revive its economy and continue market reforms. The new loan does not provide enough cash to ensure this, but the agreement offers other benefits, such as additional funds from the World Bank and Japan, and the possibility of reaching agreements with the London and Paris Clubs on restructuring Soviet-era debt. Furthermore, it gives Russia, which desperately needs foreign direct investments, credibility that would have been completely lost with a widespread default.

The IMF's decision to grant Russia this new loan was clearly mainly political, and re-confirms the suspicion that creditors view Russia as "too big to fail." The audit of FIMACO, the offshore company to which the Central Bank transferred $50 billion worth of reserves, shows that some of this money, partly derived from previous IMF loans, was used to speculate on the GKO market and to finance credit lines to Russian commercial banks. Speculation with reserves is strictly prohibited under an IMF agreement, and would have been enough to torpedo the agreement between Russia and the IMF. Furthermore, the credits given to commercial banks were not used for restructuring purposes. Instead they provided banks with additional liquidity which was then, most certainly, used for speculation on the GKO and currency markets, adding to the precarious state of Russia's banking system.

Russia's total external debt is approximately $150 billion, close to 90 percent of its gross domestic product. An agreement with the London and Paris Clubs on the Soviet-era debt, made possible by the IMF agreement, will be an important component in facilitating economic recovery. Without debt restructuring, Russia's total debt obligations will range between $13 billion and $18 billion per year until 2008, making a default likely.

A deal has been announced with the Paris Club. As expected, it does not include a write-off, but rather a two-year postponement of payments, during which time Russia will only pay around $600 million. Germany, the largest of the Paris Club creditors, has said that Russia does not qualify for debt forgiveness, but a write-off might ultimately be on the agenda. Negotiations with the London Club creditors may be more problematic. First of all, 600 creditors have to reach an agreement. Second, London Club debt has been restructured once already. Finally, the creditors are still unhappy with Russia's GKO restructuring deal.

Time will tell whether the IMF's decision to grant Russia fresh money was a mistake. Multilateral creditors have been severely misled in the past and loans have been misused. A common view, not without foundation, is that as soon as Russia receives financial assistance, economic reforms are put on hold. Some economists, such as Jeffrey Sachs, a former advisor to the Russian government, have continued to criticize the IMF for not coming to Russia's rescue early on in the reform process. It is likely, however, that this simply would have meant that the money would have been wasted earlier: FIMACO, after all, was set up in 1991.

From the IMF's point of view, the risk of the new loan being abused is eliminated by the fact that the money will not actually enter Russia.

It will instead sit at an IMF account that will be debited as Russia's repayments of previous obligations come due. And it is certain that monitoring of Russia's compliance with conditions for future disbursement of tranches will be intensified.

The economic collapse many expected after the August 1998 events did not materialize. In fact, a rather remarkable recovery has taken place. Industrial output has grown at impressive rates, inflation has been falling every month, and the trade surplus has reached a healthy level. At the same time, government policy has contributed very little to this development: The ruble devaluation and the increase in world oil prices have been the major contributing factors. This suggests that the foundations for a long-term sustainable recovery are weak, and that structural and institutional reforms are still lacking. In fact, the rate of growth in industrial production has slowed over the last several months, and inflation may be on the rise. In the last couple of weeks the Central Bank has been forced to spend several hundred million dollars of its international reserves to support the currency.

Nevertheless, the program produced by the Russian government and the Central Bank and submitted to the IMF, outlining economic policy for the rest of this year, clearly states that the authorities are committed to pursuing more structural reforms. And while one may question the government's ability to push through this program - especially regarding exchange-rate policy and bank restructuring - given that two elections are scheduled in the next 12 months, there is a tiny chance it will succeed and economic progress can continue. In this case, the IMF's decision will have been fruitful. If not, it might be Russia's last chance for the foreseeable future.

Peter Westin is an economist at the Russian European Center for Economic Policy. He contributed this comment to The Moscow Times.