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STANDARD & POOR'S CREDITWEEK

Two Views on Russia

MARCH 10, 1999

The thoughts expressed in Guest Opinion are those of the writers and do not necessarily reflect the views of Standard & Poor's.

Commenting on the article, "Russian Banks: Desperately Seeking Solvency", are two prominent Russian politicians, Grigory Yavlinsky and Boris Nemtsov, who present their views on the current status of the Russian economy and prospects for the future.

The Solution Lies in the Details
Grigory Yavlinsky
Leader of the Yabloko faction in the Russian Duma

There could be little objection to the overall picture portrayed by the Standard & Poor's analysts in their recent article on the Russian banking system. Indeed, the problems inherent in the Russian banking system have been explained accurately and concisely, including the origin and background of the present banking crisis in Russia. Still, there are some points that should be emphasized and stated more clearly to prevent misunderstanding of the nature of the banking collapse and implications for possible future scenarios.

It is certainly true that the government's inability to cope with the fiscal crisis has been the primary reason for the all-embracing banking crisis that followed the notorious decisions made last August. Indeed, the ruble default and the near-complete freeze of short-term government securities could have destroyed a far more viable banking system, especially with so little assistance rendered to it by banking and fiscal authorities.

There are also reasons to believe that the fault has not been wholly with the government. More likely than not, the banking crisis would have been there irrespective of the state of government finances. In fact, the largely irresponsible fiscal policies of the government that preceded and actually caused the August crash benefited the banking system in general and the larger "systemic" banks, major commercial private banks that form the base of the bank system of the country, before anyone else. Paradoxically, a more responsible and prudent management of public funds could have worsened rather than alleviated many of the problems that had been faced by systemic banks. While claiming the government to be responsible for the present insolvency of systemic banks, their owners are well aware of the fact that the profits they extracted from trading in government bonds far outweighed their present losses.

Part of the reason for the weakness and fragility of the Russian banking system, apart from Russia's political instability, lies with managerial problems. The latter part of my article lists several basic flaws of the system that were evident not only to the banking authorities, but even to the general public. For instance, such flaws as excessive reliance on government resources or, at best, a rather limited number of corporate clients as a resource base, generally scarce but highly volatile private deposits, excessive concentration of assets in certain domains related to owners' interests, etc., were widely known, and the risks associated with them rather widely accepted.

What was more important is that these flaws resulted not so much from poor knowledge or skill, or lack of experience, but rather from the specific role that the banks played in the recently established Russian edition of liberal capitalism. The Russian banking system in its pre-crisis form was no more (and no less) than a subordinate part of greater structures serving particular business and sometimes political interests. To put it plainly, the individuals who ultimately owned those banks did not regard them as self-sufficient businesses, but rather as a subordinate means to build their rapidly growing holding empires. The banks themselves were of a species specially bred to serve very specific needs, such as diverting cash flows from newly acquired enterprises (especially exporters) to channels easy to control and manipulate; and transferring capital from the country back into it, providing their owners with ample cash to privatize new coveted pieces of government property, etc. These specific functions were performed as efficiently as was only possible under the circumstances, but meeting the internationally recognized standards of commercial banking was not among their priorities. Their growing insolvency since the beginning of the last year was a mere reflection of the environment in Russia rather degradation of the system itself.

Consequently, talk of a complete collapse of the banking system should also be treated with caution. It is rather a collapse of a certain type of business than of the organizations that have been engaged in that business. The individuals and organizations that stood behind them are still here (perhaps with some notable exceptions) and find no problem in providing the controlled businesses with new institutions to perform the minimally required banking services for them. Indeed, while most of the large banks are bankrupt according to Western standard of accounting, there is surprisingly little panic and even less anxiety over the issue on the part of industrial businesses that have affiliated or connected to them.

It is correct to state that the nowadays Russia does not possess a workable modern commercial banking system. But we must bear in mind that it never did possess one, crisis or not. Talk of achievements made since the start of liberal reforms comes from emphasizing form over essence, and market infrastructure over working market forces. And, if we look at the essence of things, we see a system designed not to supply finance to industries, but rather to turn public money into offshore assets.

It is exactly this understanding that also be the basis for evaluating the efforts of the government and Central Bank to reconstruct and revitalize the banking sector. In fact the system should be rebuilt on new foundations with the principles of banking deeply revised and established anew, unless the government wants to have crises of such scale every two or three years. Radical change in ownership and new principles of supervision are essential to ensure that Russia comes out of this crisis with new banks able to trade in financial resources and not in power relations.

In this respect, the situation is not too encouraging. The Central Bank's program for restructuring the banking sector is heavy on general principles but too light on means, mechanism and resources. Too little has been said on details. How will the lists of needy banks be compiled? Who will get the Central Bank's stabilization loans? Who will determine the appropriate amounts and how? What will be the terms and conditions attached? The talk of "socially important" banks is nice, but usually it doesn't go as far as determining what precisely is to be saved. The banks' names? Their businesses and networks? The clients' money? With criteria vague and independent outside control absent, chances are low that in the end we'll have a system much different from the one that went bankrupt in last year's financial crisis.


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"It is correct to state that the nowadays Russia does not possess a workable modern commercial banking system." - Grigory Yavlinsky
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Reforms Are Only Skin Deep
Boris Nemtsov

Leader of the Rossiya Molodaya movement

Former First Deputy Prime Minister of the Russian Federation

As painful as it is to admit, Standard & Poor's analysis of the Russian situation is objective and realistic.

The situation in Russia is extremely uncertain and the prospects are vague. On the one hand, there is an almost guaranteed default on external debt, including Eurobonds, enormous delays in salary payments (around 75 billion rubles), continued decline in production, and sharp decreases in investment activity.

On the other hand, we have the absence of any positive and clear actions on the part of the government along with dubious-at best-decisions, such as: the renewal of offsets (writing off mutual debts between enterprises, with no money being involved in the transaction), the reduction in the value-added tax to 15% (perhaps the only tax we've learned to collect), and the support of certain banks without any transparent criteria (we can only guess under what circumstances decisions on supporting banks are made).

As a result, there is rather high inflation and very low tax collection (in January less than $1 billion). For instance, the government has a "separate" agreement with Gazprom that allows Gazprom to pay only $100 million a month instead of the at least $400 million a month it should be paying in accordance with the tax laws.

There is an obvious crisis of power. The authorities are weak and there is no trust in them. This leads to corruption and the overwhelming unwillingness to pay taxes. This also leads to the flight of capital, which apparently is increasing since the trade balance is positive and investment activity continues to fall.

What are the prospects?

The reason for these problems is that liberal reforms, despite the presence of reformers in government at a certain point, did not take place. Therefore, real reforms still are required, including the following points:

- Anti-corruption actions. A rejection of the practice of offsets, the abolition of privileges when it comes to paying taxes (Gazprom is an example), the establishment of public rules, transparency, for giving support to problem banks;
- An acceleration of bankruptcy proceedings for enterprises not paying taxes or wages;
- A simplification of the tax system;
- A strengthening of the judicial system;
- Legal protection of property rights.

I am convinced that one of the key problems in the country is weak management, both on the state level and on the business level. The realization of a massive program of management training will accelerate positive changes in Russia.

In the upcoming Duma elections to be held this December, the democratic candidates (Pravoe Delo coalition, Yabloko Party) have a good chance, first of all because they are in opposition to the regime, and secondly, because at last they are more or less united. Their chances will increase if an agreement can be reached between Yabloko and Pravoe Delo on at least the elections in single-mandate districts.

On the whole, democratic forces can be count on 20-25 seats, which is not bad. If we add the deputies elected from Otechestvo (Luzhkov's party) and Lebed's party, that could be a controlling packet of votes on key issues in the state Duma.

The picture in the presidential for next year is more complex.

There are five obvious candidates: Gennady Zyuganov, Yuri Luzhkov, Aleksander Lebed, Grigory Yavlinsky, and Yevgeny Primakov.

None of them, except Yavlinsky, is capable of carrying out substantive economic policy. However, Yavlinsky is unlikely to make it to the second round of voting. This means that Russia cannot expect good news in the year 2000, and all hopes must go to the elections of 2004, when the voters will be people who have never lived under the Soviet system and do not want to go back to it.

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Editor's note: Grigory Alekseevich Yavlinsky, 47, is the co-founder and chairman of both the Yabloko Party and its Duma faction in the Russian Parliament. A prominent economist, he also serves as the chairman of the Board of the Center for Economic and Political Research (EPIcenter), a private, non-governmental research institution based in Moscow. In 1996, Yavlinsky ran for President of Russia on a platform of liberal opposition to the Yeltsin government. He placed fourth with more than 5.5 million votes. Yavlinsky has declared his intention to run for presidency in the year 2000.
Boris Yefimovich Nemtsov, 39, was first deputy prime minister of the Russian Federation in Prime Minister Sergei Kiriyenko's Cabinet from March 1997 until August 1998 and previously served as governor of the Nizhny Novgorod region for six years. Nemtsov has joined a newly created coalition of liberals and democrats running in parliamentary elections. He says the group, Pravoe Delo (Just Cause), will wait for the results of the December vote before deciding whether to field a presidential candidate.

Translated from the Russian by Antonina W. Bouis.

STANDARD & POOR'S CREDITWEEK, MARCH 10, 1999