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. Last Updated: 07/27/2016

On the Edge of a Debt Crisis

Recently there has been a lot of talk about how, despite being in debt up to its ears, Russia is taking out more and more loans.


The government has been issuing Eurobonds, building treasury-bill pyramids and doing its monthly dance before the International Monetary Fund. Borrowing can be fun -- but repaying the loans isn't. And when the time does comes to pay back, and there's no money, that's when you have a debt crisis.


Theoretically, a debt crisis can occur within a country when domestic savings are no longer adequate to cover interest payments on debts raised domestically and abroad. Just by virtue of the constant one-way flow of capital going out of the country, such a situation could occur in Russia.


And when such a debt crisis does occur, the only way that a country can cover its debts is to begin printing money.


Russia has yet to reach such a tragic point. Its domestic savings are still covering interest payments on internal and external debt. However we do have what is called a primary deficit -- when total government expenditures, minus interest payments on outstanding debt, exceed total government revenues.


In other words, the situation is growing progressively worse.


When compared to Russia's gross domestic product, the ratio of funds it applies to debt servicing falls within world norms and even meets the EU membership limit of 60 percent. However, when you look at the ratio of debt to tax revenues, the figure is exorbitant.


Russia is still very much at risk. The interest rates the country pays on domestic state debt fluctuate from 25 to 35 percent annually -- high by world standards. Analysts say a debt crisis is only one or two years off if Russia doesn't get serious about reducing the interest rates it's paying and the amount of debt it has in general. That is, of course, if the country's citizens continue to save their money in dollar accounts and don't suddenly convert them into rubles.


In the long term, only economic growth can save the country from a debt crisis. And it will have to be significant growth at that. Gross domestic product will have to increase by 4 to 6 percent annually. Analysts say such economic growth will have to begin in the very near future if the desired effect is to be achieved.


It is possible that if economic growth doesn't start up immediately, but takes another year to begin, in order to avoid a debt crisis it will have to average something like 6 to 8 percent a year. To free up the investment funds needed to achieve this, the primary deficit will have to be brought down to zero. The first step in that direction would have to be a presidential decree. But none of this looks very likely.


With all of its economic success, even the United States found itself faced with the prospect of a debt crisis at the beginning of the 1980s. But nothing came of it. Appropriate measures were adopted and fulfilled -- almost -- and the U.S. Congress has approved budgets with zero primary deficits for the past five straight years.


The most important thing today is to avoid aggravating the situation. The latest Eurobond emission serves as a graphic example. Russia's failure to bring down its borrowing costs results directly from its desire to plug current leaks now with no thought for the future.


Facing a Russia-wide strike at the end of March, it was understandable that funds were needed to assuage the discontented. And so the government agreed to maintain borrowing costs at their current rates with its March Eurobond emission. Specialists have not hesitated to call the emission an expensive failure at 9 percent, considering the falling Deutsche mark, the emission's currency. And all of this just because an order went out from Moscow to get everything that could be had from the market.


If we hadn't been so greedy, we would have taken 1 billion Deutsche marks rather than two billion and allowed borrowing costs to fall. Then we would have been able to count on a continued downward trend in borrowing costs until next time. Now it's certain that the next emission -- in yen -- will be just as expensive as its predecessors.


But this isn't the worst thing. Ideally, a borrower tries to use loans to establish future stable sources of income from which his loans can be paid back. But we throw money that our children will have to pay back -- plus interest -- at presidential elections and Russia-wide strikes.


We use money raised abroad for paying wages, pensions and so forth -- we just eat it up. The country has had plenty of experience with this. The last generation, strapped with Brezhnev's stagnation, ate up all the rich, easily accessible oil reserves that were not locked away under permafrost. Their own children won't have any oil, but they'll spend their entire lives paying off the debts their parents racked up.


However, it's possible that this is only the beginning. The real troubles will start up when regional governments go out of control with their borrowing on world markets. Issuing Eurobonds has become a fashion trend. Moscow, Nizhny Novgorod, Tatarstan and many, many other less-prosperous regions are all getting ready to issue their own Eurobonds. If regions encounter problems servicing their loans, they will likely turn to the federal authorities for assistance.


As opposed to the federal government, regional governments are not authorized to print money -- so they will have to be very careful. A draft law "On Regional Government Borrowing" is slated to go before the Duma at the end of March. Government experts expect it to pass rapidly through that body, but they anticipate a substantial slowdown when it gets to the Federation Council. It's clear that neither the country as a whole nor individual regions want to live within their means.