Fascinating NY Times article. Bailout of the Kremlin: How U.S. Pressed the I.M.F.
nytimes.com
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By MICHAEL R. GORDON AND DAVID E. SANGER, July 17, 1998
Seven weeks ago the chief of the International Monetary Fund,
Michel Camdessus, assured the world's financial markets that
there was no reason to panic about Russia.
"Contrary to what markets and commentators are imagining,"
Camdessus insisted as investors were fleeing the Russian markets ,
"this is not a crisis. This is not a major development."
This week, in a complete reversal, the
I.M.F. and the Russian government
announced a bailout package that will inject
$17.1 billion in new loans to the
beleaguered nation over the next 18 months.
The Clinton administration was the driving force behind the reversal,
impelled by the specter of Russia's financial collapse. United States
Treasury officials were worried that while negotiations with the
Russians dragged on over forcing real economic change, the political
peril to the government of President Boris Yeltsin was growing. They
pressed the fund to nearly double the amount of money it was willing to
lend to Russia, even though it depleted the I.M.F.'s own resources for
fighting the economic contagion that is spreading beyond Asia.
The Russian saga once again casts a spotlight on the critical decisions
made by the I.M.F. at a moment when the Asian financial crisis has
made the institution more powerful than at any time in its 52-year
history. I.M.F. critics charge that in this case, fund officials
underestimated the gravity of the crisis and dragged out the
negotiations while the markets turned against Russia and the eventual
cost of the bailout rose. I.M.F. officials counter that it would have been
a waste of money to offer yet another bailout to Russia without
extracting a commitment to fundamental economic changes that are
painful and politically unpopular.
By last week, the negotiations turned into a race to rescue the Russian
economy before the government's financial reserves were exhausted.
Without new funds, Russian officials feared they would run out of
money to prevent a default on Russia's debt and prop up its currency
by the end of the month.
"Last week was the most dangerous period," Yegor Gaidar, the former
prime minister who is now an economic adviser to Yeltsin said in an
interview. "If we followed all the standard procedures, the money
would have arrived too late. I think the position of the leading industrial
nations was very constructive and the U.S. Treasury helped a lot."
The final package is not a permanent solution; it buys time for what
U.S. officials believe is the most reform-minded government in Russia
in years. In Washington, however, there is palpable nervousness about
the deal that was struck. It is unclear whether Yeltsin and his new
prime minister will be able to fulfill their commitments to remake their
economy.
The accord has sparked a rally in Russian markets. On Thursday, after
a series of ups and downs, the lower house of Parliament approved
key parts of the package as the Kremlin rushed to fulfill the I.M.F.
requirements before the fund convenes on Monday to consider the
rescue package. "We view this very much as a last chance for Russia,"
said Stanley Fischer, the No. 2 official at the I.M.F., who directed the
negotiations for the fund. "The country is running out of time." leaders,
the two U.S. officials who have focused on Russia's economic reform
went to Moscow to take the temperature.
One was Lawrence Summers, the deputy Treasury secretary, a former
Harvard economist who has come to personify the new face of U.S.
financial power around the world. The other was David Lipton, a
Treasury under secretary for international affairs, an intense, 44-year
old who has cultivated a strong relationship with Russian economic
strategists.
The economic crisis that began a year ago in Asia has been a worry for
Russia for months. As investors fled emerging markets, it was
becoming more difficult for Russia to finance its chronic budget deficits
by selling treasury securities. European and U.S. bankers were offering
loans but they were pricey, and Russian officials had been exploring the
possibility of additional credit for the Central Bank's reserve of foreign
currency.
But the new Russian government, fresh from a bruising battle in the
Communist-dominated Parliament to confirm the new prime minister,
was still trying to find its footing.
In talking with their Moscow counterparts, Summers and Lipton
cautioned the Russians that they were too absorbed in their own
political and economic problems and insufficiently focused on the risk
that they would catch the Asian flu, a panicked retreat by investors.
The Russians, however, were not alone in underestimating the potential
fallout from the Asian crisis. The I.M.F. was also slow to respond, and
when it did, critics say, it fueled investor anxiety by refusing to disburse
the next part of a loan to Russia.
The monetary fund, which was created after World War II to stabilize
currencies and foster economic growth, has been a leading proponent
of better management of Russia's shaky economy; lower inflation,
smaller deficits and better tax compliance. And while the fund has been
impressed with Kiriyenko and his new team, the relationship between
the fund and the government is not always good.
I.M.F. officials complain that the Russians have failed to keep a series
of promises they have made since 1992. For their part, Russian
officials say the fund is constantly changing its Russian team and that
some officials have a shallow understanding of the nation's complicated
politics.
Most of the time, however, the tension is kept under wraps. But it
burst into view in late May when the two sides tried to settle what
Russia needed to do to receive the next $670 million disbursement of a
three-year, $10 billion loan.
The talks went badly and Russia did not get the money. Martin Gilman,
the chief I.M.F. official in Moscow, warned publicly that Moscow had
not done enough to get the money and pointedly said he could not
predict when the matter would be discussed again.
"Such a statement was very bad news for the market," Sergei
Alekshashenko, the deputy chairman of the Central Bank, said in an
interview. "I have negotiated with the fund for five years and I cannot
think of a single case in which the fund has made such a statement."
If the Russians were shocked, alarm bells rang when the bond and
stock markets began a new week. Interest rates on loans to Russia
shot up, a sign that investors considered them a risky buy, and the
Russian stock market sank. Last year, Russia was the world's best
performing emerging market, but it is down 50 percent since the start
of the year and tied with Indonesia for the world's worst performance.
With the markets deteriorating, Kiriyenko made a late-night phone call
to Camdessus, the fund's managing director, and assured him that the
Russians were serious about changing their ways. The I.M.F. then
rushed out a statement praising the Yeltsin government's reform
program and Camdessus issued his "this is not a crisis" line. To try to
stop the panic, John Odling-Smee, the head of the monetary fund's
Russia department, flew to Moscow to complete the negotiations for
the $670 million disbursement the fund had been blocking.
But investors were pressing for a new, larger loan package to
strengthen the Russian Central Bank and to restore their confidence in
the economy. The problem was that the bank's hard currency reserves
were shrinking as it was using millions of dollars each business day to
pay off investors and prop up its currency.
Judging by the I.M.F.'s public remarks, though, it looked like it had
little interest in organizing a rescue and did not understand the extent of
the crisis.
So Yeltsin went directly to the power behind the fund: the Clinton
administration. He dispatched to Washington the Russian with the most
credibility in the West, Anatoly Chubais.
Chubais had run Russia's privatization program and was highly
regarded, although he is one of the most contentious figures in the
country. Many Russians blame him for the pain and confusion of their
country's jerky transition to capitalism, and powerful business leaders
have never liked the fact that he had refused to do their bidding.
Chubais had left his top Kremlin post as part of the shake-up that
brought Kiriyenko to power in the spring. He now runs Russia's
electrical monopoly, United Energy Systems.
Chubais was joined by Sergei Vasiliev, deputy chief of staff for the
Russian government and aveteran of the behind-the-scenes battle for
economic reform.
Arriving just before the long Memorial Day weekend, the Chubais
team headed straight for the Treasury building next to the White
House.
They came not for money but for reassuring words of praise and for a
public commitment from Clinton that if Russia needed more aid, the
United States would lend its support.
The next morning, Chubais and his associates drove through the
diplomatic enclave of northwest Washington to the home of Strobe
Talbott, deputy secretary of state and longtime Russia expert.
Talbott told them that Clinton was willing to support additional financial
help to Russia under the right conditions.
The Russians drove on to Summers' house in the Maryland suburbs.
Lipton and other top Treasury officials were there, all wearing blue
jeans and sport shirts. The Russians were in suits and ties, preparing to
meet later with the ever-formal Alan Greenspan, chairman of the
Federal Reserve.
Over bagels, muffins and orange juice, Chubais made his appeal:
Washington had an historic opportunity to help Russia.
"It used to be that there were only a few reformers," Chubais said.
"Then there were a good number of reformers. In this government," he
said, "They are all reformers."
As the conversation shifted to tactics, the group decided that the
United States would send a signal that it stood behind Russia. But it
would have be carefully worded so that Congress would not be
inflamed at the idea of another bailout. In return for aid, there had to be
substantial reforms. The Russians would also have to tap commercial
banks so that it was clear that not all of the burden fell on the monetary
fund.
"It had to be clear that we would help out, that if they didn't take real
action this time, they were headed over the cliff," a senior U.S. official
said.
The next morning, a Sunday, Clinton issued a brief statement saying the
United States would support assistance with "conditionality."
Clinton never mentioned any figures but Russian officials say the two
sides agreed on $5 billion to $10 billion. The Americans favored the
smaller number; the Russians the higher number. Quietly, the I.M.F.
and the Russians opened negotiations over the rescue package. Their
focus was not on how much money was needed, but on what Russia
had to do to qualify for the loans.
Fischer, the fund's No. 2 executive and a former economics professor
at the Massachusetts Institute of Technology, said his principle was
simple: The amount of aid would be linked to the depth of the reforms.
More reform, more cash. The fund was not in the business of throwing
money into a country to calm financial markets, he said.
"It is fund doctrine that the stronger the measures the country takes the
more assistance the fund can provide," he said.
Some Western economists however, insisted that the I.M.F. was too
doctrinaire. They insisted it would make more sense for the fund to first
determine what was needed to ease market turmoil and then tell the
Russians what they would have to do to earn it.
Nor was meeting the requirements an easy task.
In a confidential memorandum, the fund handed Russian officials a
tough list of demands A main one was that the Russian budget deficit
had to be drastically reduced from 5.5 percent of the nation's output to
between 2 percent and 2.5 percent.
The plan made fiscal sense. Interest payments on Russia's debt were
eating up 30 percent of the Russian budget. But the Russians were
worried that they could not meet such an ambitious target and that they
would be faulted for again promising something they could not deliver.
Yeltsin had submitted his own "anti-crisis" plan to the Parliament. But
the I.M.F.'s analysis indicated the plan only went half way to meeting
the goals.
To meet that target the government would not only have to slash
spending, it would have to beef up tax collection , an enormous
challenge in a country where major companies thumb their nose at the
State Tax Service and only 4 percent of the population filed tax
returns.
While the demands were considerable, it was far from clear that the
money the fund had in mind would be enough. The I.M.F. informed the
Russians in early July that it was prepared to offer $5.6 billion in
additional loans.
As the negotiations dragged on, the Russia economic picture
worsened. A second attempt to sell off Russia's state oil company,
Rosneft, stalled. To attract investors, interest rates on Russian debt had
risen higher than the rates paid by Nigeria, which was convulsed in its
own political turmoil. Russian coal miners, angry that they had not been
received their wages, set up a squatters camped outside Kiriyenko's
government offices and demanded Yeltsin's resignation.
Returning from Clinton's nine-day trip to China, U.S. officials focused
anew on Russia and were alarmed by what they saw.
"We had a sense that Kiriyenko was running out of steam and that the
Russian government was getting politically more vulnerable a senior
State Department official said.
The sense of crisis was driven home when the Russians offered record
interest rates at an auction for Russian treasury bills on July 8 but were
unable to attract enough buyers.
Now, Chubais and other top Yeltsin aides were becoming increasingly
desperate. The finance ministry's ruble reserves to pay off maturing
treasury securities were shrinking fast. The Russian government's
internal forecast also showed that the Central Bank reserve of hard
currency, the funds it uses to prop up the ruble, would soon fall to $12
billion from twice that level a year ago. (By comparison, China has
reserves of about $150 billion.)
Worse, every day the markets were open, both reserves were
dwindling and it looked like the government would be out of money
before the negotiations with the I.M.F. would be wrapped up at the
end of the month.
Chubais urgently appealed to Washington and, at Treasury's urging, the
I.M.F. doubled its offer to Russia to $11.2 billion. The World Bank
kicked in several billion more. Japan made good on a $1.5 billion loan
promised to Yeltsin last April.
But the United States, which had offered $3 billion each in direct,
"backup financing" to Indonesia and South Korea last year, offered
nothing to Russia. Officials feared that if they did, Congress would
rebel, further threatening long-standing efforts in the House of
Representatives to increase funding to the I.M.F., itself increasingly
stretched.
Instead, the United States and its allies agreed to lend the fund $23
billion through an I.M.F. loan program not used in 20 years. The
I.M.F. insists that its tough approach worked. Yeltsin committed
himself to a far-reaching effort to get Russia's runaway budget under
control. "What we had to do was accomplish real reform, to get the
Russians out of this cycle of a crisis every six months, Fischer said.
But there are doubts about the I.M.F.'s approach.
"The I.M.F. was slow to recognize how serious the problem had
become, Marc Holtzman, the president of corporate finance for ABN
Amro, a large Dutch bank said this week. "When they were finally
pushed, the fund did the right thing. But had the fund done the same
thing four to six weeks earlier, it could have averted a lot of pain. The
fund would have gotten away with a package half the size."
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