In the first two months of 2001, Russia’s foreign debt suddenly became the focus of an intense and acrimonious debate. Although a political crisis was averted, the issue remains explosive and at center stage.
The significance of the first serious flare-up of Vladimir Putin’s one-year-old presidency extends well beyond quotidian politics. The battle over the debt reflects a clash of competing visions of Russia’s future and her place within the global capitalist system. It highlights deep divisions over key policy choices and confirms their urgency. The controversy also brings into a sharp relief both the style and the substance of President Putin’s rule and poses serious questions about his priorities and commitments.
Coping with a Crushing Legacy
Of the many severe congenital defects with which a post-Communist Russia was born, the debt burden has been among the most debilitating. In the last six years of the Soviet Union, 1985–1991, Mikhail Gorbachev’s government borrowed almost $70 billion, or twice the amount of debt amassed by the Soviet Union in the previous sixty-eight years. An attempt at sharing the debt between the former Soviet republics proportionate to their contribution to the Soviet budget (with Russia paying 60 percent of the total) failed. In 1993 Russia officially assumed the responsibility for the entire amount. Of Russia’s $150 billion foreign debt today, $105 billion stems from Soviet-era obligations.
In 2000 the so-called London Club of creditors—a group of commercial banks that meets in London to negotiate rescheduling of commercial debts—agreed to exchange $32 billion of Russia’s Soviet-era debt for $20 billion in Eurobonds. The club provided further relief by lowering the interest rate on the outstanding debt and giving Russia an eight-year grace period on principal payments.
No such relief has been forthcoming from the Paris Club—a group of eighteen creditor-nations that negotiate rescheduling of sovereign debt of debtor countries in or near default. As of January 1, 2001, Russia’s debt to the Paris Club was $48 billion (the Soviet Union had borrowed $39 billion of that figure). While never seeking forgiveness for the post-Soviet part of the debt and while making all payments on time and in full, Moscow has tried hard to restructure the servicing of the Soviet debt. To bolster their case, Russian negotiators cited the 1953 forgiveness rate of 60 percent for Nazi-era obligations inherited by the Federal Republic of Germany and the 50 percent cut in Poland’s Communist debt in 1992.1 At the 2000 G-8 meeting on Okinawa, Prime Minister Mikhail Kasyanov added to the list of precedents the Marshall Plan (estimated at $88 billion in current dollars) and the annual transfer of $70 billion from western to eastern Germany since 1990.2
Having rescheduled approximately one-fifth of the Russian debt following the 1998 financial crisis, the Paris Club refused to make further adjustments. The International Monetary Fund, whose recommendations are a necessary condition for the club’s restructuring decisions, has cited insufficient progress in structural reforms as a reason for withholding its approval.
But the main reason for the club’s unwillingness to compromise was Russia’s improved economic condition. Compared with 1999, Russian GDP grew by 7 percent in 2000 (at least a twenty-year record); inflation diminished from 36 percent to 20 percent; investments increased by 17 percent; and “real” (inflation-adjusted) household income was up 10 percent. High oil prices resulted in an unprecedented current account surplus, with exports exceeding imports by $45 billion. As a result, the Central Bank’s hard currency reserves more than doubled, to $28 billion. The ruble has perceptibly strengthened, and only the Central Bank’s periodic purchase of dollars has kept the ruble from appreciating against the dollar (to help domestic producers by making imports more expensive and exports cheaper).
Germany, by far the major creditor of Russia’s Paris Club debts, has been especially adamant in opposing the restructuring. Germany’s Soviet debt is $20 billion, or 51 percent of the entire Paris Club Soviet-era amount, including $8 billion in Soviet obligations to the defunct German Democratic Republic.3 In 2000 Moscow unsuccessfully tried to tempt Germany with a debt-for-equity swap in which German companies or German subsidiaries of multinational corporations (such as the German subsidiary of the Swedish furniture retailer IKEA) would be given stakes in Russian companies.
Such stratagems having failed, Moscow tried blackmail: it announced in January that it would make no payments on the Soviet portion of its Paris Club debt in 2001. Confronted with a united front of the creditors at the February 17 meeting of G-8 financial ministers in Palermo (the locale perhaps chosen to concentrate Russia’s mind on offers that cannot be refused), Russia backed down and announced that it would resume servicing the entire debt.
Interest payments in 2001 will amount to $7 billion.4 In 2003 the servicing of the debt will cost the Russian Treasury more than $18 billion. In comparison, Russia’s 2001 budget is $40 billion, and the country’s GDP is projected at $277 billion.
Amending the Budget
The Russian government found itself in an embarrassing bind. Counting on its ability to sway the IMF and the Paris Club, the Kremlin had not included $3.7 billion in Soviet-era debt obligations in the 2001 federal budget. (The budget law does include servicing the post-Soviet portion of the Paris Club obligation, $1.24 billion.) The first officially nondeficit budget since 1991—and probably in at least the past two decades—the document was adopted with great fanfare and hailed as a signal achievement of Putin’s government: a sign of a dramatic and hopeful change for the better. Amending the 2001 budget law required a vote in the Duma. At this point the Soviet-era portion of the Paris Club debt suddenly spawned a domestic political battle.
The original budget, passed by the Duma in December 2000, divided additional revenue (an anticipated 108 billion rubles, or $3.7 billion) evenly between debt payment and other expenses, with the rest of the funds— should any materialize—split 70/30 between the debt and raises for public sector workers and the armed forces. The amendments to the budget law, introduced by the government, reapportioned the allocations: first, the payment of the debt; second, salary increases; and third, other outlays.5
The Duma greeted with skepticism and hostility the government’s request to rewrite the budget law. Charges ranged from incompetence to deliberate deception of the legislature and sabotage. In the end the deputies added only 41 billion rubles ($1.3 billion) to the budget expenditures for servicing the Paris Club debt and preserved the original 50/50 division of the surplus. The sum appropriated slightly exceeded one-third of the amount owed the group this year. Although the government put on a brave face and declared that it would make up the additional amount through increased tax collection, privatization sales, and domestic borrowing, the legislature’s rebuff was widely seen as a major setback that seriously weakened the government and prompted rumors of Kasyanov’s departure.
The Communists, together with their rural allies, the Agrarians, stormed out of the chamber before the final vote and later orchestrated a no-confidence motion—a first step toward the dismissal of the government or the dissolution of the Duma. Underscoring the erosion of Communist sway over the Russian legislature, the motion garnered only 127 votes—far short of the simple majority of 226 votes needed to pass the motion.
By the beginning of March Russia sent the entire repayment amount due in February and half of the missed January installment to Paris with promises to pay the rest shortly. To make the payments, the government spent 60 percent of February’s budget revenues. Nevertheless Prime Minister Kasyanov promised that subsequent installments would be made in full and on time.
Debate over National Priorities
In many ways the battle over the debt obligations is a clash between the executive and legislative branches, each jealously defending its prerogatives. Normal in a democratic political system, in younger democracies such contentions are often raw and raucous. Yet in this case the intensity of the fracas reflects deeper and wider strife over the basic priorities in the Russian post-Communist transition.
On the one end of the political spectrum are the Communists, supported by one-fifth to one-quarter of the Russian electorate. Shell-shocked by the results of the Dec-ember 1999 legislative elections—which cost the Russian hard-line Left a plurality in the Duma—and stunned by the routing of the party’s chairman, Gennady Zyuganov, by Yeltsin’s handpicked successor, Vladimir Putin, in the presidential poll three months later, the Communists used the debt issue to rally their followers and energize their allies in the “national patriotic” opposition.
The issue allowed the Communists to reemphasize and link three of their key policy positions: defense of the decrepit and wasteful welfare state inherited from the Soviet Union, support of state subsidies for obsolete and unprofitable industrial enterprises, and opposition to Russia’s integration into the global capitalist system. The Communists, who hold the chairmanships of the Duma’s key social policy committees,6 charged the Kasyanov government with “neglecting social spending to divert funds to service foreign debt.”7 The statement by the Communist-dominated National Patriotic Union of Russia, signed by Zyuganov, called for nonpayment of the Paris Club debt and declared it “immoral and unacceptable to pay billions of dollars to save the so-called positive international image of the bankrupt heads of financial agencies at the expense of our country’s future.”8 Zyuganov later accused the Kasyanov government of “continuing to crawl in the rut [dug] by Boris Yeltsin and his cronies.”9
The opposite pole was staked by the leading free-market reformers in the government: the president’s chief economic adviser, Andrei Illarionov, and the minister of economic development and trade, German Gref. Months before the debt issue moved to the center of the Russian political stage, Illarionov had urged the government to use the unusually favorable economic circumstances to push through structural reforms, ease government regulations, and—instead of increasing domestic budget expenditures—pay down foreign debt.10
When the government announced in January that Russia would not service the Soviet-era portion of the Paris Club debt, Illarionov warned that such a decision would be most damaging to the Russian stock market and would “inevitably” lead to another financial crisis.11 “It is worse than a crime, it is a mistake to say that we are not going to pay,” he declared. “Debts are paid back because they were borrowed—this is a sign of a civilized society. That’s why the refusal of a country to pay her debts differs little from routine hooliganism.”12 For Gref, too, it was “very important to meet our international obligations.” A default, in Gref’s view, was fraught with “dire consequences.”13
The architects of the debt repayment policy, Prime Minister Mikhail Kasyanov and Deputy Prime Minister and Minister of Finance Alexei Kudrin, have articulated a position somewhere in between. While they believe that, in Kasyanov’s words, “without solving the problem of Soviet debt, Russia cannot create a basis for sustained economic growth,”14 the goal must be balanced against the need for “social economic stability,”15 the code words for state welfare programs and industrial subsidies.
Refuting Illarionov, Kudrin pointed to “numerous factors” that had to be taken into account—a reference to pensions, social programs, and wage arrears.16 “I assure you,” Kasyanov told the viewers of Russia’s most popular television talk show, “that the government will never, as long as the situation is manageable, cut public spending and it will deliver on the promises to the population.”17
Until the debt issue intruded, the unprecedented economic boom brought about by the record-high oil prices had allowed the government to pursue all its declared policy priorities simultaneously: to resume liberal reforms by reducing income taxes by half; to eliminate arrears and to raise pensions and salaries for millions of public sector employees and in the armed forces; to run a nondeficit budget; to keep inflation in check; to strengthen the ruble; to meet debt obligations; and to begin gradually to restore the confidence of foreign investors. Kasyanov vowed to pursue reforms that would “keep the economy growing, enforce strict budgetary discipline, will allow Moscow to find the funds necessary to pay its debts to the Paris Club.”18
The Real Choices
Few Russian experts, however, believe that—barring the continuation of the record-high oil prices and an equally soaring and sustained level of tax revenue (or major relief by the Paris Club)—Russia can meet its obligations in 2003 and beyond without painful sacrifices. The prime minister himself admitted in 2000 that Russia was already spending 3.5 percent of its GDP on servicing its debt and could not “do any more” without exacerbating “sociopolitical tension.” In Kasyanov’s words the government is “torn between social [outlays] and debt payments.”19 (At least one Russian expert believes that the Kasyanov government had already made a choice when in November it introduced the budget in which the fiscal policy “changed from tough to soft and the surplus from oil income was directed not at settling with the creditors but at servicing populist projects.”)20
Paying off the debt while keeping the ruble stable and holding the line on inflation requires making choices. “To withstand such a [financial pressure], the government would either have to sharply increase revenues or to reduce social programs,” a Russian expert predicted. “It cannot produce the former and, thus far, does not want to do the latter.”21
Reformers see in the predicament an opportunity to push through a package of structural changes that the Kasyanov government claims to have been working on to widen the tax base, encourage foreign investors, and reduce budget expenditures. Measures include the privatization and sale of state-owned enterprises; a land code that would permit the privatization of agricultural land; amendments to the tax code to reduce further the tax burden on private businesses; a pension reform to begin to shift the burden from the state to employers and employees; reform of the state-owned “natural monopolies” (gas, electricity, railway); the so-called deregulation package to reduce significantly bureaucratic constraints on business; banking reform and restructuring; a bankruptcy law; and a new labor code. (The government’s reform blueprint is outlined in the summer 2000 issue of the Outlook, “A Second Go at the ‘Second Economic Revolution’?”)
Yet, in the aftermath of the debt contretemps, Kasyanov and his government, which advertises itself as “pragmatic,” may well be tempted to cite the Paris Club’s “recalcitrance” and the very real difficulties of repaying the debt as an excuse for diluting or even abandoning complicated and painful structural reforms that entail serious political risk. The Russian prime minister hinted at such a scenario when he put Russia’s Western creditors on notice that “it would be very difficult for Russia to succeed in transforming its economy, or at a minimum, a successful reform will be seriously delayed without significant Paris Club debt relief.”22
As a leading Russian economic reporter puts it, “Disappointed Western creditors seem to be a lesser threat than disappointed public sector employees.”23 A default is likely to signal a retreat along the entire front and touch off a backward drift toward the paternalistic autarchy of Soviet days. Instead of welfare state reform, for example, such a development would bring increased budget outlays (financed by the printing press, if necessary) or instead of bankruptcy, sale, or restructuring of loss-making enterprises, a continuing flow of budget-busting state subsidies.
The difficulties with debt servicing have already made the reforms vulnerable to extortion and blackmail by both the reactionary Left and populists across the political spectrum. As a result of the compromise over the debt payment, the amended budget law prohibits privatization sales of state-owned enterprises without the Duma’s explicit permission in every single case. (The government counted on such auctions to contribute at least $500 million toward the debt service.) A probable next victim is Russia’s entry into the World Trade Organization, which mandates the end of state subsidies and protectionism.
Putin’s Choice
In such circumstances, the role of the president as the ultimate arbiter is critical. Yet a year after Vladimir Putin’s election, his core beliefs and priorities are still unclear. A professional intelligence officer until ten years ago, he holds his cards close to the vest. What does seem clear (and distinguishes him greatly from his predecessor Boris Yeltsin) is his reluctance to make hard policy choices.
Putin sees himself as a consensus builder, the gatherer of stones, the peacemaker in a society that longs for a modicum of stability after a decade of revolutionary turmoil. Thus far a skillful projection of this image has proved a winning political strategy, one that, along with the rapidly improving economy, has procured Putin an astronomically high level of popularity.24
Putin is seemingly loath to alienate any major political or institutional players. Some Russian analysts believe that Putin’s reluctance to solidify and formalize a pro-Kremlin majority in the Duma (where progovernment and right-of-center factions hold a clear majority) stems from his aversion to conflict because such a move would solidify and formalize parliamentary opposition as well.
Throwing symbolic bones to parties and movements across the entire political spectrum from left to right appears to be Putin’s modus operandi. One day the president unveils a memorial plaque to the founder of the Soviet secret police, Felix Dzerzhinsky; next he meets with Alexander Solzhenitsyn. Putin receives in the Kremlin the editor of the notoriously antisemitic leftist newspaper Zavtra; then he attends the dedication of a Jewish community center or treats the Israeli president Moshe Katsav to the first kosher state dinner prepared in the Kremlin (with two Russian rabbis supervising the cooking, supplying kosher utensils, and blowtorching the facility to eradicate the remnants of nonkosher food).
Putin’s behavior during the debt fracas was typical. He did say that Russia had “never refused and would not refuse to meet its financial obligations to creditors,”25 but he would not be more specific. Putin withstood Duma pressure to fire Kasyanov, but he did not publicly support his prime minister. (As usual, Putin’s hesitance reflects sharp divisions in public opinion: in January 43 percent of a national sample thought that Russia should “pay the USSR’s debts,” while 44 percent felt that it should not.)26
In a stable, mature democracy in times of economic growth, such political ecumenism might be sustainable (though hardly indefinitely). But Russia does not fit such a profile. While the national consensus is emerging and the polarization on every key economic and political issue recedes along with the violent “irreconcilable” Left-nationalist opposition, the differences between competing visions of the economy, society, and the country’s place in the world are still deep—both in the nation at large and within the political class.
In such circumstances the president’s desire to be loved by everyone will likely produce very damaging policy paralysis. As the debt battle has demonstrated, the time of painless compromise and concealment might be nearing an end. Half reformer, half restorer, Putin may soon be pressed into choosing—or into realizing that avoiding a choice is also a choice, one that could prove the costliest in the long run.
The Debt Issue as a Bellwether
The handling of foreign debt is one of the myriad battles between the new Russia and its Communist legacy that are fought daily in the country’s politics, economy, and culture. Yet because the issue goes to the heart of some of the major and urgent policy choices, it is in many ways a bellwether. As the controversy continues to surface, the issue will resonate powerfully throughout Russian politics and economic policy and will reveal a great deal about the prospects for Russia’s complicated transition to free-market democracy.
Notes
1. John P. Hardt, “Russia’s Paris Club Debt and U.S. Interests,” CRS Report for Congress, July 24, 2000, p. 17.
2. Ibid., p. 14.
3. Italy is the second single largest holder of the Soviet-era debt, with $7 billion, or 18 percent of the Paris Club total. The United States is owed $2.6 billion (6.6 percent).
4. Interview with Prime Minister Mikhail Kasyanov, Zerkalo (NTV), February 20, 2001. Federal News Service, found March 9, 2001, at www.nexis.com/research, p. 3.
6. The members of the Communist faction chair the Committees on Labor and Social Policy; Education and Science; Women, Family, and Youth; Social and Religious Organizations; and Culture and Tourism.
7. “Communists Hope to Avoid Putin Showdown,” Gazeta.ru, March 8, 2001. Found March 8, 2001, at www.gazeta.ru/print/2001/03/07/CommunistsHo.shtml.
8. “Russia’s Left-Wingers Urge Government to Ignore Foreign Debts,” Interfax, February 13, 2001. Found at www.russiatoday.com/news.
9. “Russian Communists Bid to Oust Kasyanov Government,” Agence France Press, February 20, 2001. Found March 9, 2001, at www.nexis.com/research.
10. “Russian Presidential Advisor Assails Government’s Handling of Economy,” Kommersant, November 30, 2000, supplied by BBC Worldwide Monitoring. Found March 13, 2001, at www.nexis.com/research.
11. “Kasyanov Concedes to Paying Debts on Time,” Gazeta.ru, February 14, 2001. Found February 15, 2001, at www.gazeta.ru/2001/02/14/KasyanovConc.shtml.
12. Peter Baker, “Kremlin Divided over Debt Payments,” Washington Post, January 19, 2001, p. A34.
13. Interview with Kasyanov, p. 7.
14. Ibid., p. 5.
15. Ibid., p. 7.
16. Baker, “Kremlin Divided.”
17. Interview with Kasyanov, p. 12.
18. “Special Cabinet Session Focuses on Economy,” RFE/RL Newsline, March 2, 2001, p. 1.
19. “Premier Interviewed on Foreign Debt Proposals,” Vedomosti, December 7, 2000, BBC Summary of World Broadcasts, December 15, 2000. Found March 13, 2001, at www.nexis.com/research.
20. Sergey Shelin, “Nevynosimaya legkost’ resheniy” (The unbearable lightness of decisions), Novoe Vremya, February 25, 2001, p. 5.
21. Boris Kheyfets, “V dolgovoy zapadne” (In a debt trap), Novoe Vremya, January 21, 2001, p. 13.
22. Mikhail Kasyanov, “A Financial End to the Cold War,” Financial Times, July 20, 2000, p. 23.
23. Dmitry Orlov, “Otmorozhennyi byudzhet” (A frostbitten budget), Novoe Vremya, January 21, 2001, p. 7.
24. Shelin, “Nevynosimaya,” p. 5.
25. Yevgeniya Pis’mennaya, “President Takes the Government’s Side,” Vremya MN, January 20, 2001, p. 3.
26. A. S. Petrova, “Dolbi SSR: plait’ ili ne platit’?” (USSR’s debts: to pay or not to pay?), Public Opinion Foundations, January 25, 2001. Found at www.fom.ru/reports/frames/body/of010204.html.
Leon Aron, resident scholar and the director of Russian studies at AEI, is the author of Yeltsin: A Revolutionary Life.
