Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Russia: The Road to Hyperinflation

One recent morning, Klavdiya Matveyevna, a 64-year-old pensioner, saw inflation materialize in front of her eyes.

She had gone shopping for butter and found the price at one store was 625 rubles per kilo. But it was too expensive for Klavdiya Matveyevna, who lives on a pension of 2, 800 rubles a month, so she looked around for a better price. By the time she had returned to the first store the same morning, the price had risen to 825 rubles.

"I asked the clerks what had happened but no one would say anything", said Klavdiya Matveyevna, who referred to herself using her first name and patronymic.

A lot of Russians these days, struggling with the spiraling effects of inflation, are trying to figure out what has happened. How did the promise of market reforms degenerate into the chaotic reality of inflation, where consumer prices jumped by an average 33 percent a month in 1992 for a staggering 2, 600 percent over the year?

For people who have spent the last 70 years under a system of controlled and stable prices, in which they often had more rubles than they knew what to do with, the transformation to an inflationary economy has been dizzying.

It has forced pensioners like Klavdiya Matveyevna out into the street to sell sneakers to keep themselves fed; it has forced families to cut back on meat at the dinner table; and it has bred a whole new upper class of Russians who shelter themselves from inflation by dealing in Western goods and keeping overseas bank accounts in dollars.

In this three-part series, The Moscow Times takes an in-depth look at inflation, how it spun out of control and how Russians are coping. It will also look at Russia's nouveau riche, who have emerged wealthy from the reforms often by doing business by their own rules.

Among the conclusions:

Russia ended up on the brink of hyperinflation through a combination of government policy decisions (raising prices and wages, for example), reversals of policy in some areas (the relaxation last summer of tight monetary policy) and inaction in others (the failure to implement a solution to the interenterprise debt problem).

Russians have employed resourceful means for coping with inflation: They are growing and eating more vegetables, converting their rubles into goods of all kinds, taking second jobs and selling their household holdings to bring in extra rubles.

Russia's nouveau riche are having a far easier time of it than the rest of the population, but they have also had trouble adjusting to the new system. Being rich is not as easy in Russia as it is in the Western world.

Price Hikes by Design

At age 69, Lena Gorbacheva has survived the austere policies of six Soviet leaders, from Stalin to Gorbachev. But the changes she has experienced in the last 12 months under the Russian leadership of President Boris Yeltsin are like nothing she can remember.

"My pension used to be 75 rubles per month and I could buy what I needed", she said, standing behind a cart at a Moscow supermarket. "Now I receive 4, 600 rubles and I cannot buy two kilograms of sausage".

Thirteen months into its precarious reform program, Russia finds itself right where it does not want to be: Inflation this month is expected to hit 50 percent, the technical definition of hyperinflation.

Laden with $80 billion in debts from the former Soviet Union, and battling a decline in industrial production, runaway inflation was a malaise the Russian reform program did not need.

But at least part of the increase in prices was by design. In fact, the centerpiece of the reform program was the liberalization of prices. By March virtually all prices of consumer goods were free to float with the market.

The economy of the former Soviet Union largely lacked Western-style inflation because prices were controlled. But although it was hidden, inflation still existed, manifesting itself in shortages and long lines.

With price liberalization in January 1992, two things happened almost immediately: Most of the lines disappeared, and so did the so-called ruble overhang -- the vast amounts of rubles Russians held in savings that they could not spend.

The government initially maintained control of the money supply, so much so that a ruble shortage developed in the spring. After the initial shock in January of 245 percent inflation, the tight monetary policy brought inflation down to below 10 percent in August.

But other forces were at work that would beginning pushing the rate back up by the fall.

As prices rose, enterprises found they could not afford to buy each other's products. They began accumulating debts, which were counted on the ledger as sales. The Central Bank granted credits to these enterprises to pay off these debts and to increase worker's wages in line with inflation.

The inflationary spiral had begun.

Credit emissions have continued. In December alone, Russia injected 1 trillion new rubles into the economy, according to numerous concurring estimates. That is more than was emitted in all of 1991, and it resulted directly in inflation of 25 percent in December, according to Deputy Prime Minister Anatoly Chubais.

Staring hyperinflation in the face, the government announced new targets last week aimed at bringing inflation down to 5 percent per month by the end of this year. In an economy of looming unemployment, impending bankruptcies and a crumbling infrastructure, inflation was declared Public Enemy No. 1.

"I think they are quite correct in their analysis", said Charles Blitzer, chief economist of the World Bank's Moscow office. "At very, very high rates of inflation, people's confidence in the economy erodes. People are unable to invest, make contracts or to save".

'Straightforward' Inflation

The mechanism of inflation is straightforward -- at least at Moscow's food markets. Just ask Vladlen Kurbanov, standing behind his table of mandarins, apples and persimmons at the Dorogomilovsky market.

"Listen", Kurbanov said, impatient to explain something as obvious as price-setting. "Somebody here gets several good lemons and sets a high price. If he sells them then we all raise our prices to that level. and so on. Since December we have been raising our prices constantly, rapidly and people keep paying".

In this manner, the price of a Kurbanov apple has grown from 90 rubles per kilogram on Dec. 1 to 140 rubles last week.

Though price-setting through market "mafias" occurs, the rising prices are not simply price-gouging as Kurbanov's explanation would seem to indicate: The costs of doing business have also skyrocketed.

Those selling chickens, meat and eggs say that the rising prices simply reflect the growing cost of feeding the livestock.

Meanwhile, for imported goods traded at the market, the price is a direct function of the ruble exchange rate. Such inflation, which ran at about 2, 600 percent in 1992, trickles through an economy, creating havoc in many ways.

Perhaps none is more detrimental for the future of reforms than the obstacles it creates for businesses, which cannot get loans from banks.

"In such conditions it is impossible for the bank to assess whether the enterprise would be successful", said Blitzer. "It's impossible to predict what the correct interest rate should be".

Sergei Fadin and Sergei Prigozhin learned the hard way how this manifestation of high inflation can kill dreams.

After watching the real purchasing power of their salaries decline during the course of 1992, the two Moscow truck drivers this winter decided to reverse their fortunes by opening an auto painting business. It was just the kind of initiative advocates of reform might praise.

The two would-be entrepreneurs calculated that for 1 million rubles they could rent a large garage and buy the sprayers and paint. They asked a friend to help them write a business plan.

But then they hit a snag.

"We couldn't get a loan", said Prigozhin. "The bank said they were not giving credit to start-up companies like ours".

For Fadin and Prigozhin, the spiral of inflation continues to hold them in its vice.

While expenses increase on the one hand, their option for opening a business was closed when their business plan required a one-year loan repayment schedule.

Fadin decided to emigrate to the United States in May.

"I have to think of my two girls", he said of Lena, 11, and Natalya, 4. "They have a right to the best life possible for them".

Prigozhin, meanwhile, earns extra money in a vaguely defined business he calls "brokering products for commercial shops".

"It's chorny, naturally", he said using the expression for illegal trade. "Maybe I can get earn enough money to start the auto painting shop without a loan".

Tomorrow: How average Russians cope with inflation.