Monday, 6 of April of 2020

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Financial Crisis in Russia: the New Prospective

The global crisis is adding a new urgency to reforms towards political pluralism and competition in Russia.

When the financial crisis broke out in September, the Russian government quickly moved to reassure the business community that it had enough resources to prevent a meltdown. Announcing a multi-billion rescue package, Prime Minister Vladimir Putin remarked rather sarcastically: “We have been often asked in recent years: what do we need such large currency reserves for? To feel confident [in this crisis].”

Russia set up the so-called “stabilisation fund” in 2004 to sop up excessive oil-generated cash from the market and save it for a rainy day. As of August 1, the country had the world’s third biggest currency reserves — $595.9 billion. It is out of that pot that the government has promised to dish out more than $210 billion to support the banking sector and industry.

Many economists and industrialists agree that the injection of billions of dollars into the economy may ease the debt and liquidity crunch but they say the government strategy of building up such huge reserve funds instead of promoting growth was wrong and will aggravate the fallout of the current crisis on the economy. Deputy Prime Minister and Finance Minister Alexei Kudrin, the architect of the safety cushion policy, once compared himself to the biblical Joseph, who stocked up grain during seven fat years to feed his people over the next seven lean years.

Critics counter that while Joseph stored grain thereby encouraging production, Mr. Kudrin has been hoarding money taking it out of the economy and thereby slowing growth. As the government invested its currency reserves in the West in low-yield securities, Russian companies were forced to borrow from western lenders at a much higher rate. When the global crisis struck, Russian businesses owned close to $550 billion in foreign debts, which almost equalled the country’s hard currency reserves.

According to the critics, the government should have instead poured money into Russia’s still underdeveloped banking system to increase its capitalisation, which currently stands at just over 60 per cent of the country’s GDP, and enable banks to offer long-term credits at affordable interest. Had the oil windfall been used for investment to diversify away from over-dependence on oil and gas, it would have made the Russian economy more reliant on long-term Russian money, encouraged sustainable growth in non-oil industries and insulated the country from the U.S. contagion.

Penny wise and pound foolish

Mr. Kudrin’s penny wise and pound foolish policy meant Russia forfeiting a chance to build a robust manufacturing sector during the fat years and prepare the country better for the lean years ahead, independent economists say. Its 2009 budget will be in the red if oil prices dip below $70 a barrel as they did recently. The massive bailout effort now threatens to deplete the oil funds. This will jeopardise an ambitious programme of economic modernisation unveiled earlier this year when the government finally agreed to invest part of the oil money in infrastructure and high-tech sectors.

The crisis is bound to have a strong negative impact in the long term, the economists warn. Russian stocks have lost more than 70 per cent of their value since spring; the GDP growth plummeted from 7.6 per cent in January-August to 0.4 per cent in September. Net private capital outflows are expected to reach $20 billion this year, in stark contrast to the previous forecast of $40 billion in net inflow. Industries have started cutting jobs and people are spending less. The crisis threatens to wipe out the impressive economic gains of the past 10 years.

Russia’s leading economists and business lobby groups, including the Association of Russian Banks, the Russian Chamber of Trade and Industry and the Russian Union of Industrialists and Entrepreneurs, have been urging drastic changes in monetary strategies for years. But Mr. Kudrin successfully fended off all attacks. He is the longest serving Cabinet Minister who has not only survived three Prime Ministers — he was appointed Finance Minister in 2000 — but also exerted decisive influence on shaping the economic strategy in the last eight years.

Mr. Kudrin owes his fantastic survival, in the face of massive criticism, to one man, then President and now Prime Minister Putin, who firmly believes in the financial acumen of his long-time friend and ally. Mr. Kudrin’s story points to critical flaws in the system of “managed democracy” Mr. Putin set up during his eight-year presidency. He calls it “manual control.”

When Mr. Putin became President in 2000 after a decade of post-Soviet meltdown, he faced the Herculean task of pulling the country together, reasserting Central control and rebuilding the economy. The chaotic transition from the Soviet Communist system to a market democracy under his predecessor Boris Yeltsin had all but destroyed the institutional capacity of the state to govern. This convinced Mr. Putin that law and order must be restored before democracy was introduced step by step.

Mr. Putin brought the electronic media under the Kremlin’s control, cancelled elections of regional leaders, and marginalised opposition parties by tightening election laws and controlling financial contributions to parties from businesses. The Kremlin effectively removed political parties from the sphere of state governance. Centralisation of power helped Mr. Putin establish political stability and carry out painful reforms, and set the economy on the path of revival.

But as Russia moved from economic recovery to modernisation, the lack of political competition, absence of strong opposition parties and the presence of an obedient Parliament emerged as major hurdles to faster growth. The costs of “manual control” began to outweigh the gains. Corruption has grown to staggering proportions in recent years in the absence of effective parliamentary oversight and accountability of government officials.

Experts say Russians pay a 30-50 per cent “corruption tax” added to the price of all goods and services. President Dmitry Medvedev has just unveiled a new plan to combat corruption, but sceptics say the plan is likely to fail because its implementation has been entrusted to the law enforcement agencies, which are also deeply steeped in corruption. “These methods are useless when there are no external institutional checks and balances, such as a critical and independent media, independent courts, transparent government and fierce competition from political opponents,” said Georgy Satarov, a leading anti-corruption expert. Monopoly on power has stifled the contest of ideas and led to costly mistakes, analysts say. A sweeping reform of the Soviet-era social security net undertaken three years ago was necessary but was so badly prepared that it provoked large-scale protests, forcing the government to increase social expenditure, instead of trimming it. A pension reform launched in 2001 fell through and is being overhauled again.

Several years ago, the Moscow government decided to build a new ring road to cope with the growing traffic in the capital. Experts then warned that the road would not solve the problem of congested streets fanning out from the city centre to the outskirts in a star-like pattern, but the docile city legislature approved the project backed by Moscow’s powerful Mayor Yuri Luzhkov. The new road was laid at a cost of over $4 billion but it failed to unclog city streets. Notwithstanding this, the Moscow government is about to launch the construction of yet another ring road which, the experts predict, will be just as useless.

The Kremlin’s chief ideologist, Vladislav Surkov, compared Russia’s political system in which the main pro-government party, United Russia, dominates Parliament to a one-legged man and called for the establishment of another major party, “a second leg to which society can shift its weight when the first leg goes numb.”

Towards two-party system

Two years ago, the Kremlin started building a new two-party system with the establishment of a left-of-the-centre party, Fair Russia, to compete for power with the ruling right-of-the-centre United Russia. However, the effort to promote political competition suffered a setback when Mr. Putin threw his weight behind United Russia last year. This enhanced the monopolisation of power helping United Russia win a huge constitutional majority in the parliamentary elections in December 2007, while Fair Russia captured a mere 8 per cent of the vote, just enough to cross the 7-per cent threshold. In his first state-of-the-nation address this week, Mr. Medvedev called for liberalising political life, stating democracy “on orders from above” must give way to grass-roots democracy.

“I believe that the citizens of Russia today are far more ready for freedom in professional, social and political activity than they were at the start of the reforms,” Mr. Medvedev said proposing a raft of measures to encourage the “broad involvement of citizens, political parties and other civic institutions” in dealing with the challenges of “a new phase in the country’s development.”

The global crisis is indeed adding a new urgency to reforms towards political pluralism and competition in Russia, as the wasteful system of “managed democracy” becomes too costly to maintain when oil prices are falling.

A study commissioned by Mr. Medvedev’s think tank, the Institute of Contemporary Development, earlier this year showed that the Russian political and business elites think “managed democracy” no longer meets the challenges of modernisation and must be replaced with a full-fledged democratic system.

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Russia Can Escape the Financial Crisis in Real Economy

By: Former advisor to the Russian president, economist Andrei Illarionov

A Statement by the Liberal Charter alliance

The Liberal Charter alliance expresses its fundamental disagreement with the measures taken by Russian authorities in the financial crisis, and puts forth the principles of a fiscal policy that a government responsible to the citizens of Russia must take.

1. Today’s financial crisis in Russia has foreign and domestic causes. The most important external cause of this crisis is the world monetary system, which goes through cyclical phases of boom and bust. Such instability is created first of all by modern money, which governments can issue in any amount, combined with a wide range of government privileges and guarantees provided to commercial banks. Interest rates held at artificially low levels and government loan guarantees stimulate the growth of credit that is not backed by real savings, leading to less responsibility on the part of creditors and borrowers, and a collapse of confidence in financial assets.

The main culprits of the global financial crisis are the fiscal authorities in the U.S. and European countries, who have pursued a policy of so-called “cheap” money in recent years. The governments of other countries, including Russia, also carry their share of responsibility for spreading and worsening the crisis. Government encouragement of credit expansion has led to massive investments into overly risky, inefficient, and unsalable projects. The illusion of the accessibility of investment resources, created by governments, has led to a decline in the quality of issued loans and purchased securities. As result, many banks have been unable to meet their obligations before depositors.

2. The Russian authorities have contributed their share to the financial “bubble” in our country. Due to their privileged status, state-owned and partly state-owned banks and companies borrowed heavily on foreign and domestic markets. In doing so, short-term loans were used for long-term investments, and to finance expenditures growing out of control. The disappearance of cheap credit destroyed such financial “pyramids”. With a fall in equity prices, companies whose shares were put as collateral to private and partly state-owned companies to obtain credit were now under threat of handing ownership to those creditors, including foreign ones. The threat that companies would be punished for their irresponsible borrowing policies became an instrument of their pressure on authorities, and the basis for transferring their colossal accumulated debts to the federal budget.

3. Provoked by government intervention, the mistakes made by banks and businesses are at the present largely irreversible; serious problems can no longer be avoided. The economy must undergo a period to correct those mistakes.

4. Presently, the primary danger to the global and Russian economies are the so-called “anti-crisis programs” put on by governments, which are hidden behind demagogic statements that the “free market” is supposedly to blame for the current crisis. Government intervention, which hinders the culling of inefficient investment projects, blocks the review of mistaken decisions and puts off the bankruptcy of irresponsible businesses, only deepens and extends the financial crisis, turning an inevitable short-term economic decline into a long-term depression. In world history, it is precisely the interference with market mechanisms that has had such dire consequences, such as the US Great Depression from 1929-33, or the transformation of Great Britain into the “sick man of Europe” from 1961-79, or the Japanese stagnation from 1991-2004.

5. The Liberal Charter alliance expresses a fundamental disagreement with the actions already undertaken, as well as the stated intentions of the Russian authorities – the president, parliament, government, and the Bank of Russia. Their plans of uncontrolled intervention in the country’s economy are, among other things, a disregard for the rule of law and the existing legislation, the undoing of the separation of powers, and the dismantling of democratic institutions accountable to the people.

We believe that the proposed measures are wrong. [These include] the use of federal resources, administered by the Government and Bank of Russia, to finance irresponsible borrowers, to support banks and stock market speculators who risked their client’s money, as well as acquiring shares of those companies that the market has lost confidence in. These measures will squander the federal gold reserves, which guarantee the value and free convertibility of the Russian ruble. They will inevitably result in higher prices for the public, who will end up paying for benefits essentially doled out to businessmen and managers close with the authorities. The concentration of financial resources in the hands of bureaucrats and their “inner circle” is aimed at further monopolization of property and power in our country.

6. In this time of crisis, a government responsible before the Russian people must follow financial policies based upon the following principles:

-Maintaining the exchange rate of the ruble against the pre-determined dollar and euro currency basket. A guarantee of the sanctity of gold reserves in the Bank of Russia to back 100% of issued Russian rubles. Continuing a responsible monetary policy, dictated by the basic principles of respect for property rights and meeting ones obligations, even if these obligations were not explicitly formalized.

-Preserving a deficit-free budget, where expenditures do not exceed revenues, [and committing to] prohibit the growth of public debt. At a time of unavoidable economic stagnation, public expenditures must be lowered proportionately with the fall in government revenues.

-Establishing transparent mechanisms for distributing assistance from the state budget and special endowments. Excluding the possibility that these funds will head to privileged banks and companies. The main way to use the budget surplus, which has accumulated in special endowments, must either be the return of previously collected taxes, or a reduction in future taxes.

- Directing funds from the budget and special endowments to commercial banks only in exceptional cases, and only through the mechanism of returning money to depositors (the so-called “monetization of bank liabilities”). The banks subjected to this measure must undergo bankruptcy proceedings. This provides an effective countermeasure to owners stripping assets, and allows for an open and transparent sale of all assets, with revenues going to the state budget. The expansion of a government role in the banking system’s equity is impermissible.

-It is unacceptable to use budgetary funds to rescue bankrupt companies. It is unacceptable to increase the government’s direct or indirect control over the real sector of the economy. Irresponsible business owners and managers should be punished by having the encumbered shares of bankrupt Russian companies transferred to their creditors– independent from their citizenship or country of registration. Bankruptcy sales must be carried out in open and transparent auctions.

-Reducing government intervention in the financial sector. The reorganization of the financial regulatory system on the principles of competition and free enterprise.

-Reform of the monetary regulatory system. The Bank of Russia should maintain its aim of supporting the value of the ruble, even as it ceases the additional powers granted it under the “anti-crisis measures.” Regulation of banks should be transferred to a separate government body. [This would] eliminate the privileges given to commercial banks, which arise from the Bank of Russia’s joint function of “printing” rubles and regulating the banking system.

7. The Liberal Charter alliance marks that the result of the so-called “anti-crisis programs” proposed by authorities will be the deepening and widening of the financial crisis, and the transition of a short-term recession into an extended depression. Preserving mistakes made during an economic boom, continuing the policy of promoting risky loans, and the misuse of public resources for false purposes will inevitably lead to grave financial, economic and social consequences. Russia does not need to repeat mistakes made more than once by authorities in the US, the European Union and other countries.

The only guarantee of the Russian economy’s competitive edge and long-term success, and that of the whole Russian society– is the freedom of entrepreneurship by Russian citizens. [Further, the] government must respect property rights and carry out responsible, consistent and ethical economic policies.

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