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. Last Updated: 07/27/2016

The 12 Lessons of 1998 Default

According to old Soviet textbooks, Stalin ended the war with Nazi Germany in 1945 with 10 blows. The first blow was the battle of Moscow, then Stalingrad and so forth.

Thus, the history of World War II was fit onto a single page with a short description of Stalin's blows.

As concise and specific as Stalin's history books, presidential economic adviser Andrei Illarionov on Monday listed 12 lessons that the business and political elite has learned from the 1998 default.

And there are three more to be learned, he said.

"The default was a triumphant collapse of the populist socialist policies pursued under the guise of a reform effort," Illarionov, speaking on the fifth anniversary of the Aug. 17 default, told a news conference at Alexander House.

He said that among the 12 lessons the decision-makers learned are: Exchange rates should be set by the market, not by a market regulator; that the ruble should not be overpriced; that the money in circulation should be backed up by international reserves; that covering fiscal deficits with borrowings paves a road to hell; and that one cannot afford to borrow like there is no tomorrow.

Several issues remain, however, that the elite will have to address soon to keep the economy chugging ahead, Illarionov said. The public sector remains oversized, as are the so-called natural monopolies, including Gazprom, the power industry and railroads.

The real test for current policies, Illarionov said, will come when oil prices drop from current highs in the bear phase of the business cycle.

Mexico cut budget spending twice back in 1998, while Venezuela lowered fiscal expenditures six times the same year.

Russia was the only major oil-exporting nation that failed to even make a similar attempt after oil prices dropped to below $10 per barrel, Illarionov said.

On many counts, the economy is back at pre-crisis levels or, in some cases, higher.

Consumption, including that of the households sector and public spending, dropped from a decade-high of 76 percent of gross domestic product in 1997 and 1998 to a low of 61 percent in 2000. It has since crept up to 65 percent in 2001 and 68 percent last year.

The average salary is hovering around $185 per month, above the pre-crisis level of $170. Pensions are slightly exceeding the pre-crisis level of $60.

Illarionov, however, said he doesn't see any risk in overspending.

"The No. 1 thing to look at is the level of public spending, not overall consumption," he said.

But the government so far has ignored his advice and even drawn up an ambitious budget for 2004 that envisions a 10 percent increase in spending to 2.66 trillion rubles ($86 billion).

Apparently, 2004 will not be a year of change from that standpoint.

"It will probably change afterward," Illarionov said. "At least, I would like to hope it will."

President Vladimir Putin has set a goal of doubling the size of the economy, a task many economists consider undoable given the nation's dependence on oil and poor market infrastructure.

In addition, the population remains unwilling to sacrifice their current level of consumption for the sake of future earnings.

"It would worry me if everybody thought Russia was doing this by itself," Steven O'Sullivan, co-head of research at United Financial Group, told The Associated Press on Monday, referring to the nation's economic progress.

"Without a doubt, the economy is still to some considerable degree hostage to commodity prices."

Economists warned that Russia is still facing a Herculean task of reforming ailing industries.

"People are still falling for simplistic solutions," Evsey Gurvich, the head of the Economic Expert Group, said Monday.

Gurvich vehemently opposes the idea of cutting public spending, saying there are many other issues that should be addressed on a case by case basis, including improvements to market infrastructure and government institutions, a switch to energy-saving technologies and the development of industries outside the commodity sector.

Illarionov said Monday that the country might be better off by not stimulating the transfer of wealth from commodity industries to the manufacturing sector if manufacturing resulted in negative value-added to the economy.

The benchmark Russian Trading System stock index, meanwhile, set a new record on Monday, finishing the trading session up 2.47 percent at 523.47. It was its highest level in five years.