But starting in late April 1998, foreigners’ appetites for GKOs and other Russian securities diminished appreciably, as the forces of contagion hit Russia with the same fury that had undone the Asian economies. The plague came from two distinct sources, one of them trade-related. The recession in Asia’s biggest economies dampened world demand for oil and gas, Russia’s most important export, causing the price of crude to fall by nearly half from the early 1997 level. As a result, Russia’s trade balance, as measured by the current account, fell to a deficit of $1.5 billion in the first quarter of 1998; it had posted a surplus of $3.9 billion in the same period the year before. This shortfall deprived the country of a critical source of hard currency it needed to bolster confidence among investors concerning its ability to maintain the ruble’s fixed exchange rate.
Second, Asian financial markets, which had rallied in early spring, reversed themselves, casting a new pall over emerging markets worldwide. From February to May 1998, as evidence mounted of continued economic weakness in Japan, the yen lost more than 10 percent of its value against the dollar, and since the yen’s drop undermined the competitiveness of neighboring countries’ products, other Asian currencies—including the Korean won and Thai baht—receded in May as well. Rumors that China would devalue its currency, the yuan, raised the specter of the region undergoing a fresh round of depreciations. The Herd’s skittishness, in short, had returned with a vengeance, and Russia was its primary focus of anxiety. From the last week of April until the third week of May, Russia’s main stock index—already down considerably from its 1997 highs—fell by more than one-third.
Among emerging markets, Russia was particularly pregnable because as market Jitters intensified, the more intractable its budget problem became—which of course caused the Jitters to intensify even further. The vicious cycle in which the country was caught is known among economists as “exploding debt dynamics.”
Most countries running perennially large budget deficits suffer some adverse economic consequences, but the cost often manifests itself gradually and subtly. The U.S. federal deficits during the 1980s and early 1990s, for example, made interest rates moderately higher than they would otherwise have been, stunting American economic growth by some amount of indeterminable magnitude. But Washington’s budget woes never produced the financial blowout that some had feared.
Russia’s deficit was not only proportionately much larger, at 7.4 percent of GDP in 1997, but the government’s reliance on short-term borrowing subjected it to heavy costs with every uptick in interest rates. Having raised so much money on the GKO market, the government had to shell out a major portion of its expenditures on interest payments—nearly one-quarter of its total spending in the early months of 1998. And since the Finance Ministry had to borrow more than $1 billion each week by selling GKOs to replace the ones that were maturing, its interest expense was susceptible to steep increases as GKO investors demanded higher yields. That is exactly what happened in May 1998, when the ministry, after raising money on the GKO market at an interest cost of about 25 percent in April, had to offer yields exceeding 60 percent to entice buyers in the final week of May.
Against this backdrop, IMF officials working on Russia began receiving frantic entreaties from investors in spring 1998. Jorge Marquez-Ruarte, the Fund’s mission chief, complained to colleagues about getting one phone call in his Moscow hotel room after midnight from a man who opened the conversation Jocularly by saying, “I know you guys don’t sleep anyway.”
IMF staffers were indeed accustomed to being disturbed at all hours of the night, but these sorts of calls stuck in their craws. The callers were Western investment managers who had plunged enthusiastically into Russian stocks and bonds in 1996 and 1997. Now that Russian markets were sinking fast, these investors were imploring the IMF to mobilize a bolshoi paket—a “big package”—for Moscow. Even though Russia was still in the third year of the $10 billion EFF loan it had received in 1996, advocates of the bolshoi paket argued that a new IMF program, with tens of billions of dollars more in loans, was necessary to keep Russia’s debt dynamics from reaching an explosive finale. With market tremors causing interest rates to rise, and higher rates causing the budget deficit to widen, and wider deficits generating more tremors, the potential cataclysm was plain for all to see. If large numbers of GKO holders concluded they were unlikely to be repaid and started cashing in their GKOs for dollars, Russia would quickly run out of the $10 billion to $15 billion that it held in hard-currency reserves, with frightful implications for the ruble and the country’s stability.
Other senior members of the IMF’s Russia team received similar pleas from financiers—also often at absurdly late hours. “They were saying, ‘It’s got to be a big package, or everything will blow up!’” recalled one of these economists. “One guy got to the point where he was calling me three, four times a day.”
The case for the bolshoi paket went something like this: Russia was to a large extent the victim of circumstances beyond its control. The contagion effect from falling oil prices and Asian markets explained why investors were pulling money out of the country. Furthermore, saving Russia from financial calamity was especially urgent because the reform movement had Just regained control of the government and was being given one final chance to redeem itself. In one of Yeltsin’s trademark shockers, he had sacked the old bull Viktor Chernomyrdin as prime minister in March 1998 and replaced him with Sergei Kiriyenko, a gentle-faced thirty-five-year-old with a background in business and strong free-market credentials. A bolshoi paket, by assuring investors that Russia had plenty of dollars to meet its obligations, would put the country on a virtuous cycle of market calm and lower interest rates, thereby giving the Kiriyenko government time to launch an ambitious reform program. Without it, Kiriyenko was doomed.
But the counterargument went like this: IMF rescues were supposed to go to countries that were genuinely committed to putting their economies on a sound footing. Russia’s history suggested that giving it another IMF loan would be akin to handing a shot of vodka to an alcoholic. As serious as Kiriyenko might be about reform, opposition from the oligarchs, the red directors, and the Communistdominated State Duma would thwart his efforts. So even if an international rescue restored calm temporarily, the country would still be operating a virtual economy, still running enormous deficits, and still borrowing huge sums of money—which would eventually put it right back in the same fix it was already in. Russia could save itself, of course—but with actions, not another large international loan.
Skepticism toward the bolshoi paket ran high among the staff of the IMF’s European II Department, which was responsible for the countries of the former Soviet Union. Many in the department believed that Russia lacked both a widespread consensus for the far-reaching reforms that were needed and an effective government for accomplishing them. Yeltsin’s support for reform, they noted, was episodic; he would deliver impassioned speeches on occasion and appoint a few reformers like Chubais to top posts, but then he would undermine the effort, often because of complaints from the oligarchs or other powerful parties who considered their interests threatened. The reform movement itself increasingly resembled a “Potemkin village” that was maintained to impress the West—in particular the U.S. Treasury and the IMF—and to disguise the fact that its members had little power to implement change. The Russian negotiating teams with whom the IMF dealt often seemed interested in only one goal—figuring out what modest fixes in the system would suffice to obtain the next monthly disbursement under the $10 billion EFF.
Reflecting the mood within European II was an indignant fax that Martin Gilman, the IMF’s resident representative in Moscow, sent to William Browder, the head of an investment advisory firm who authored an op-ed in The Wall Street Journal Europe in late May calling for a $20 billion IMF-led loan package. “I find your views curious, to say the least,” Gilman wrote. “If the situation really is as you describe, perhaps it would be appropriate for you and other invest
ors to both save Russia and profit in the process by providing the ‘$20 billion’ yourselves.”
Gilman and other members of the IMF’s European II department privately nicknamed the proposed package the FIEF, or “Foreign Investor Exit Facility.” The black humor underlying the term evinced the fear that the Fund’s money, instead of bringing tranquillity to Russian markets, would end up providing the dollars for which wealthy investors could cash in their Russian securities before the country went bust. Since many of those investors had been pocketing returns upward of 50 percent per annum on their GKO investments—yields that supposedly reflected the high degree of risk involved in buying such securities—the prospect of an IMF bailout protecting them against loss was especially galling.
The sour attitude in European II was a source of amusement to economists elsewhere in the IMF, who felt their colleagues had bent over backward for years to accommodate the Russians. “There was a quality of the Jilted lover” to the attitude of the economists in European II, one senior staffer recalled. “After ten times saying, ‘We’re really confident they [the Russians] are going to do it this time,’ this group had swung from one side to the other.”
Facing such resistance, the Russians resorted to going over the heads of the IMF staff and appealing directly to the Clinton administration. Chubais, serving as Yeltsin’s special envoy, arrived in Washington shortly before the Memorial Day weekend of 1998, accompanied by Sergei Vasiliev, Yeltsin’s chief of staff. Russian financial markets had Just taken a serious turn for the worse following the government’s failure to obtain any bids in the privatization sale of a state-owned oil company. On Saturday, May 30, the Russians visited the home of Deputy Secretary of State Strobe Talbott and then Summers’s home in Bethesda, Maryland, where they met with a small group of Treasury officials over orange Juice and bagels.
Chubais warned that a devaluation, which would make imports much more costly, would rekindle triple-digit price hikes, wrecking one of the reform movement’s most important economic achievements—the taming of inflation and the establishment of a sense of stability in the value of the currency among the population at large. He also offered a strong testimonial about the reform credentials of Kiriyenko, who wasn’t well-known to the Americans, assuring them that the new prime minister had good intentions.
Summers had prepped his troops with a simple message: “We want to keep the markets calm and the Russians scared.” But Chubais succeeded in deepening the Americans’ own sense of fright over the nasty tumble the markets had taken. So the Treasury team embraced his suggestion that although Russia didn’t need funds immediately, the United States could issue a statement indicating the West’s willingness to come to the rescue should the situation deteriorate further. The Americans were also heartened by Chubais’s assertion that the Kiriyenko government was willing to prepare significant further reforms. (As a downpayment on the new reform push, Yeltsin had Just fired the head of the nation’s tax service and replaced him with Boris Fyodorov, a liberal economist renowned for his advocacy of harsh punishments for tax cheats.)
On June 1, IMF staffers in Washington picked up their morning papers to read that the White House had issued an unusual Sunday statement, in Clinton’s name. The United States “endorses additional conditional financial support ... as necessary” from the IMF and the World Bank, “to promote stability, structural reform and growth in Russia,” the statement said.
As far as members of the European II department were concerned, Clinton’s statement left them no room to continue fighting against the bolshoi paket. If there was ever a chance for Russia to restore market confidence without a large pot of new money, the White House rhetoric had obliterated it. “Once that announcement was out there, it was the end of the debate,” said one senior IMF staffer. “It affected expectations in financial markets, and they would not have been satisfied after that had money not been forthcoming.” Asked whether he and his colleagues had been upset by the White House move, the senior staffer replied: “Well, you know, we accept the world as we find it. Presidents do make statements, and we live with that.”
President Clinton was in the Oval Office shortly after 1 P.M. on July 10, 1998, when the White House signal operator put through a call from Boris Yeltsin. Negotiations between Russia and the IMF staff on the terms of a new program were stalled on several issues, and Yeltsin was pulling out all the stops, calling not only Clinton but the leaders of Germany, France, and Britain as well as Camdessus in an effort to break the impasse.
Russian markets were in the midst of one of their deepest swoons of the year. During June, the government had been forced to sell GKOs at annualized yields of 40-65 percent to obtain the rubles necessary for paying off principal on maturing GKOs and interest on outstanding ones. In early July, yields had topped 100 percent; moreover, the borrowing was for shorter and shorter terms (some of the GKOs auctioned had maturities of one week), reflecting Moscow’s desperation for cash. The central bank’s reserves had dwindled by more than $3 billion as investors swapped their rubles for dollars.
Clinton told Yeltsin he had Just returned from a trip to China and was paying a lot of attention to the IMF recommendations concerning the Russia program. An impatient Yeltsin broke in and got straight to the point. This is an urgent situation, he told Clinton. If things don’t go well with the IMF, Russia’s reforms would be over. It would be “basically the end of Russia,” he blustered, the consequences “catastrophic.” He needed a decision by July 16, Yeltsin said, adding that not Just his credibility was on the line, but that of the whole international community, including the United States.
Clinton said he knew Yeltsin had talked to Camdessus, and he told Yeltsin he had to take major steps to shore up Russia’s tax system; he had to use all of his leadership powers to get the necessary legislation through the State Duma, and if he couldn’t get the Duma’s approval, he should use all the powers of his presidency to implement the measures anyway.
Yeltsin retorted that he was doing a lot—he had gone after Gazprom, the state gas monopoly, and forced it to pay taxes. He would do the same with other major tax debtors as well, he vowed. Clinton tried to recover the initiative in the conversation, asking how quickly Yeltsin could get the Duma to act once an IMF program had been announced. It would be good for members of the Duma to recognize how serious the crisis is, Clinton said. The American president said he understood how difficult parliaments could be, given his own nettlesome relations with the U.S. Congress, but when a country’s future is on the line, a leader has Just got to do the right thing.
Yeltsin replied that Clinton was right, adding that he would go to the Duma and tell its members, Just as Clinton had put it, that they should set politics aside and do the right thing. In response, Clinton expressed the hope that Yeltsin could move fast. If Yeltsin promised to get the Duma to act quickly, Clinton vowed, he would go to the wall for Yeltsin with the IMF, but Russia had to come across with its part of the bargain.
Okay, Yeltsin replied, he would take care of the Duma, and he was counting on Clinton’s leadership.
A television screen flickered in a large conference room on the twelfth floor of the IMF’s headquarters building, as a rare videoconference briefing of the Fund’s Executive Board began on July 13, 1998. Appearing on camera from Moscow was John Odling-Smee, director of the IMF’s European II Department, who was explaining the agreement he had Just struck with the Russian authorities on the terms of a rescue package. Under the plan, Russia would be lent a total of $22.5 billion over the following eighteen months, with $12.5 billion to come from the IMF in 1998 and another $2.5 billion in 1999, plus $6 billion from the World Bank and another $1.5 billion from the Japanese Export-Import Bank.
The video transmission was mediocre, giving an oddly reddish tint to the sandy hair of the fifty-five-year-old Odling-Smee. But the reception was clear enough that several directors detected a notable lack of enthusiasm in his voice as he read off the list of items in the Letter of Intent t
he Russians had signed. “He looked uncomfortable,” one of them recalled. “I felt he didn’t believe in the program.” Another concurred: “More than usual, he was finding this rather difficult.”
Tall and aristocratic, Odling-Smee exuded the urbanity and wit one would expect in a man with a hyphenated name who graduated from Cambridge, taught at Oxford, and spent much of his career in the British Civil Service, where he rose to the position of deputy chief economic advisor in Her Majesty’s Treasury. His colleagues admired his analytical and managerial talents but professed to have cracked little of his English reserve. (The wildest exploit recounted about him was that at a Robert Burns evening held at the home of a Scottish friend, he read one of Burns’s poems in Russian.) About the tone of his presentation of the July 1998 rescue for Russia, he maintained that at the time, he believed the program had a better-thaneven chance of working. He added, however, “No one in this building felt 100 percent sure it would restore confidence.”
The numerous strings attached to the program reflected the ambivalence that many in the Fund and the High Command felt about extending yet another loan to a country with such a history of vacillating on reform. Moscow pledged to bring the budget, excluding interest payments, into a surplus equal to 3 percent of GDP in 1999. Specifically, it promised to collect tax arrears from the government’s twenty top debtors, including oil companies, which would be automatically denied access to the country’s pipelines for exporting petroleum until they paid their taxes. This condition was a tighter version of a similar provision in previous Letters of Intent that the Russians had been circumventing—a revealing indication of the problems involved with making reforms stick. Moscow had issued an exemption from the pipeline ban for oil companies whose products were pledged as collateral for foreign loans, an exemption that turned out to benefit nearly all of the country’s petroleum industry and thereby subverted the whole purpose of the provision. “Any measure that looked effective, there was always a loophole,” one IMF economist recalled bitterly. So now the IMF was insisting that the ban on pipeline use be applied to tax deadbeats with no exceptions.
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