Go Long On Russia - Russian economic conditions

International Economy, The, July, 2000 by Anders Aslund

Arguably, the Kirienko government should have resigned after July 20, as the Duma had in effect declared its lack of confidence in it. From that date, it was clear that Russia's financial situation was untenable, and it had to devalue or default. A devaluation was inevitable because of declining reserves, and it was better to devalue early on while reserves were still substantial. So this was done. The GKOs (domestic treasury bills) were primarily held by state banks and foreign investors, and a default on the GKOs would have the least negative social effects. Their legal base was flimsy, which facilitated such a default. Without a default on the GKOs, the devaluation would have been all the greater, and aroused near-hyperinflation. In a financial panic, some cooling is needed. The ninety-day moratorium was imposed for that purpose. The Russian government and central bank could hardly have acted better in the given situation. And they did so early enough to salvage some $10 billion of international reserves.

The financial crash was frightful. It devastated half the Russian banks and the savings of the burgeoning middle class, and international investors over-reacted. The lesson to the Russian society, however, could not have been clearer. And it has been learned. The budget has been balanced; enterprise subsidies of all kinds have been sharply reduced; real arrears have fallen by three quarters; barter has declined by nearly half as a share of payments; federal revenues as a share of GDP have skyrocketed from 11 percent of GDP in 1998 to 18 percent of GDP so far this year; and Russia registered almost 10,000 bankruptcies last year.

Most importantly, Russian society and business have experienced a fundamental change in mentality, evident in many areas. Even the Communist Party revoked its anti-market stand before the parliamentary elections last December, and a new reform consensus has emerged. Therefore, Russia's annualized growth of 8 percent in the last six months is a natural consequence of the financial crash and the reforms prepared just before it.

Anders Aslund is Senior Associate at the Carnegie Endowment for International Peace.