Starting Over

Yevgeny Primakov inherited a collapsing mess of an economy. He improved matters to the extent that he leaves behind just a mess.

Now there will be a new government. Whether it's led by acting Prime Minister Sergei Stepashin or someone entirely new, the new Cabinet will meet the same economic problems as the old: a crippled banking sector; a bloated bureaucracy that is excellent at spending taxes but weak at collecting them; a moribund industrial sector where the de facto bankrupt somehow stay in business; a crushing foreign debt burden; and a national economy that depends like a drug addict on oil and gas.

Stepashin has wavered between talking up a "technocratic" Cabinet that would follow International Monetary Fund and World Bank recommendations and promising a push-me pull-you coalition like Primakov's. President Boris Yeltsin has said ram through reforms. It remains to be seen what Yeltsin and Stepashin will actually attempt - but here is a list of problems they ought to be targeting.


The banking sector has been said to be populated by "undead banks," but they should more precisely be described as vampires - almost impossible to kill, acting under cover of darkness and living off the blood of innocents. According to a recent World Bank report - commissioned by the Central Bank and still unpublished at Central Bank chief Viktor Gerashchenko's request - only three of the country's top 20 banks could be considered solvent.

The attitude of the Primakov government to the banking sector was set early. For all the occasional outbursts against "banking bums" and talk of grandiose restructuring bodies, the government stayed hostage throughout to the idea that certain large banks could not be allowed to fail, because their demise would be too disruptive.

The day of his approval by the State Duma, Primakov said that he would essentially leave the existing banking sector in place, a pledge he kept.

"Instead of destroying the financial sector in place, we will use it for developing industry and the national economy," the new prime minister told the parliament Sept. 11.

The arguments for avoiding real reform also rested on claims that fixing the decimated banking sector would have been too costly. Yet the Central Bank has printed at least 30 billion rubles (that's more than $1 billion) to bail out leading banks, either through debt retirement schemes or by handing out so-called stabilization credits.

The results have been to keep many of the worst banks alive and more dependent than before on the public purse. Take SBS-Agro. Run by the well-connected Alexander Smolensky, it seems to be the worst of the budget-fund addicts, soaking up massive amounts in stabilization credits as it angles to retain its role as the government's conduit of choice for agricultural credits.

Very little if any of the money that went streaming into SBS-Agro and numerous other banks went to pay depositors and other creditors. At one stage Smolensky's bank was offering office furniture or near-worthless agrobonds to settle claims with depositors - even as it was eagerly accepting millions of dollaars in "stabilization loans."

Someone has to drive a stake through the heart of these banks, if only so that they stop sucking off tax revenues. Mountains of unpaid taxes are stuck in insolent banks that remain open for business with Central Bank approval. On April 24, Tax Minister Georgy Boos put the figure for such taxes at 20 billion rubles ($800 million at the prevailing exchange rate) up from 1 billion rubles in October.

Even worse, Russia is making no progress convincing the citizenry to deposit its savings in banks - where, in a healthy financial system, they would be safer than ever and put to work building the nation. The government begs and wheedles and threatens the West in return for a few billion dollars - while ordinary Russian citizens have an estimated $30 billion to $50 billion stuffed under their mattresses. At this point, the mattress remains arguably the most rational place for that money.

True, the wooden stakes at hand don't have a very sharp point on them. The legislation on bank bankruptcies, for example, is weak. Foreign banks, who might be willing to put some money into the Russian banking system, are also kept largely out of the market by Russian law and state paranoia.

But what is really lacking so far is bold, decisive action from the Central Bank, which in theory is supposed to regulate the commercial banking system and has enormous powers over it. In practice, the bank seems more interested in doing nothing, and jealously preventing upstarts like ARKO, the Agency for Restructuring Credit Organizations, from accomplishing anything.

If it chooses to, the Central Bank can pull a sick bank's license, bringing about de facto bankruptcy. Period. Simply by insisting on more public disclosure, it could also force transparency on the sector, a move that would also stop the use of insolvent banks in corporate tax evasion schemes.

Any new government should bring pressure to bear on Gerashchenko to be more transparent and to work together with ARKO to clean up the banking sector. A push for transparency would be welcome - starting at the Central Bank itself, which is a commercial empire with profit-spinning subsidiaries across the world and 86,000 employees.

Former Finance Minister Boris Fyodorov - a man, by the way, often mentioned as a future member of the new Cabinet - once observed that "talking to Gerashchenko is like talking to a wall." So any new Cabinet would be foolish to bank on Gerashchenko's cooperation.

Happily, there are plenty of measures the new government can take on its own. Most obviously, it could move to set up a proper treasury system - something Russia still lacks. Despite proclamations from various Cabinets over the years that the authorized banks system had been slain, it still walks among us. Government funds are handed out to banks without any real competitive bidding, and the banks skim off enormous commissions, costing Russia billions.

The government could also abolish some of the aid loan programs in their various forms, of which the agricultural loans program is only the most obvious.

As long as banks can milk cash from access to state "loans" - on which they know repayment is optional - there is little incentive for them to get into the normal financial business of handing out loans on merit and investing for concrete returns.

It is not that easy, of course. Before banking reform can take hold, Russia must recreate a securities market that provides effective liquid assets for banks to hold. While a return to the treasury bill pyramid-scheme days would be an unpardonable error, the lack of investment-capable paper helps drive all the available money circulating in the ba nking sector straight to the greenback. Nothing else exists that offers anything like the returns and security of the mighty dollar.

That helps fuel a final banking sector woe, capital flight. Since 1994, an estimated $15 billion to $20 billion a year has been lost to Russia through capital flight; 1992 and 1993 probably saw even greater amounts flee the country. This money is "lost" to Russia not in the sense that it should have gone into government coffers, but in the sense that its owners find it more expedient to take cash earned in Russia and invest it abroad - creating jobs and growth everywhere but here.


The Primakov government made much of its desire to turn Russian industry around, and boasted that its intervention was helping. But the minor growth in industrial output that has come so far this year has been due to the stimulatory effects of ruble devaluation and buoyant oil prices. With imports priced out of popular reach - even in Moscow, which had become addicted to imported goods of all sizes and shapes - demand for domestic goods has rushed in to fill the gap.

However, selling more goods at a lower real value is not much of a recipe for long-term success.

One of the Primakov government's biggest mistakes was its attachment to keeping Soviet flagship companies alive - usually through tax relief and budget subsidies. The criteria used to select companies were sentimental rather than economic, a policy-making approach that ought to be rejected outright by the next government. Giving them enough government help to keep them moving will never truly resurrect these undead behemoths, just keep them roaming the earth in torment and begging for more.

Despite perceptions to the contrary, Russia does have a bankruptcy law that makes it feasible to liquidate hopeless firms. Sadly, the law is rarely used for this purpose. This is largely because the Arbitration Court judges that rule on bankruptcy cases and the Federal Bankruptcy Service that is empowered with a major regulatory role in the process are both similarly Soviet in their reluctance to liquidate loss-making firms.

Much could be done simply through "bully pulpit" rhetoric linked to concrete steps on the government's part. Treating struggling firms in a tough but fair manner would be a huge leap forward, as would debunking the myth that the state can intervene to save bankrupt companies. Such attempts have simply helped make the government as bankrupt as the firms it has been paying to save.

The government can also set an example through the treatment of its own still-massive industrial holdings. It should sell its ownership stakes in many companies, and do so in such a way as to help the companies, not the revenue line-item in the budget. Those ownership stakes it keeps it should use to demand effective company management.

Russia's stock market could be one way to corral investment into industry. But that will never happen, and the stock market will remain little more than a glorified casino, unless Russia gets serious about shareholders' rights. Even Wall Street has plenty in common with Las Vegas, especially now - but it does act as a conduit for capital to flow to areas that can make use of investment.

Russia has a Federal Securities Commission with broad powers to make inquiries and right wrongs in this field, but the body's political isolation has left it ineffective. As a result, oil majors like Yukos and Sibneft have been able to trample over the rights of minority shareholders, Russian and foreign. Russian shares are, therefore, even less popular with the populace than Russian banks. The only exception is that many individuals own shares in the company where they work. As the workers at the national oil pipeline Transneft know well, that kind of share ownership is mostly a chance to get ripped off, as unscrupulous managers bribe, cajole or threaten workers into either giving up their shares or voting for measures that destroy their value.


Setting aside the money stuck in insolvent banks, this is an area where the Primakov government made some gains. It raised tax collection from pitifully low levels to less pitifully low levels - so that it was only missing its targets by 20 percent instead of by 40 percent. Even so, some of this growth was illusory, as periods of rapid ruble devaluation made it less costly in real terms to pay taxes.

Two problem areas remain. The first is the state's inability to collect money from rich, powerful companies - prime among these being Gazprom and the oil majors. One of the first thing that Stepashin should have done on becoming acting prime minister was to sign into effect the already prepared decree to slap a 5 euro ($5.30) tax on every ton of exported oil. Not only would this have doubled the revenues from oil export taxes to $50 million a month - which seems fair enough since oil prices have risen dramatically - it would also have acted as a salutary signal of the new man's intentions.

Instead, one of Stepashin's first moves was to meet with the chiefs of the oil majors. Few details are available as to what the meeting was about. The decree remains unsigned.

Then Boos, the acting tax minister, proudly announced Monday that the oil companies would start paying 100 percent of their taxes in cash - rather than through barter or other non-cash offsets - as of Nov. 1. Whether or not they will do so is another matter, but the oil majors have a much ground to make up. As of March 1, the Tax Ministry put their outstanding tax liabilities at 8.9 billion rubles (about $360 million), of which 5.5 billion rubles were arrears and the rest had been deferred by the government for various murky reasons.

That murkiness underlines the biggest difficulty with Russia's taxation policies, the impossibly convoluted nature of every area of taxation assessment. Coupled with the lack of any allowance for normal business practices - such as, for example, the keeping of a free float of petty cash - this means that tax avoidance and evasion is far more than a national hobby, it is a way of life.

Unfortunately, most of Russia's tax chiefs have decided that heavy-handed crackdowns are the best way to achieve compliance. But international experience shows that simpler, lighter tax burdens are more likely to be paid.


Russia needs a long-term solution to its extraordinary debt burden. The problem is not that Russia necessarily borrowed too much over the past few years, but that it did so unwisely and put the money to no good use. Almost $5 billion in IMF funds were wasted last year, and one wonders how cycling billions of dollars - some of them from IMF loans - through an obscure offshore company in the British Channel Island of Jersey was supposed to help revive the Russian economy. (It may have done wonders for the Channel Islands, of course.)

Russia's debt-servicing obligations this year were $17.5 billion, or about three-quarters of all projected revenues in the 1999 federal budget. If the state, as seems possible, falls 30 percent short in tax collection - which makes up the bulk of budget revenues - Russia could actually end up with less in revenues than it owes in debt servicing this year.

The government has responded by unilaterally deciding which debts it will pay and which it won't. While that gets Russia off the hook - restricting to a "manageable" $8 billion or so its obligations for this year - it does less than nothing to deal with the $150 billion in total debts it has outstanding.

Nor does it build long-term partnerships. The government has treated all debt negotiations - whether with Western mega-financiers or Russian middle-class depositors - as though they were a zero-sum game. This approach has infuriated the people, soured T-bill holders and other investors and turned IMF negotiations into sparring matches.

And it has accomplished little. As Finance Minister Mikhail Zadornov admitted earlier this month, Russia looks like it will remain behind on its debt servicing for at least the next decade. That acts as a tremendous brake on the country's development.

Russia's shattered economy desperately needs stimulus to counteract the contraction in the gross domestic product - the economy is predicted to shrink somewhere from 3 percent to 8 percent this year after shrinking 5 percent last year. Meanwhile, large sums are desperately needed - for investment in infrastructure, decaying at an alarming rate; for paying wage and pension arrears; for reforming Russia's rotting corpse of an army and for much more.

Zadornov's honesty has been a one-off event, without the necessary follow through. Russia should come clean and state what the world already knows: The country is broke. It doesn't have a chance of paying all it owes this year or next. It would like to apologize for what has happened and work with its creditors on a serious program to restructure its debts - so that the people and institutions who lent the nation billions can see that they will get some return, when they will get it and how they will get it.


So that's what should happen. What will happen? Probably very little. The post-Primakov re-emergence of oligarchs such as Boris Berezovsky suggests Russia's crony capitalism is alive and well. At this point, there is no reason to believe that real transparency or tax reform are on the way.

Once the Duma looks up from impeachment and the Cabinet, it will be the summer - time for the dacha! - and then it will be a fall of populist campaigning for re-election in December. The new government, whoever is in it, will be making the same December calculations and is unlikely to engage in bold policy-making. Instead, the nation will count on the rising price of oil to lift all of Russia's boats - and if it doesn't, well, there is always hope that 2000 will be better.

Of course, not the first half of 2000, as that will be devoted to presidential electioneering. Perhaps once the new president is selected in June 2000. Of course, that will also be just in time for the dacha.