Russia's Devaluation Drama
Officials Spent Night Juggling Demands of Tycoons, IMF
By David Hoffman
Washington Post Foreign Service
Sunday, August 23, 1998; Page A21
MOSCOW, Aug. 22-As midnight passed at the Russian White House last Sunday, Anatoly Chubais, the tall, red-haired mandarin who had survived virtually every peak and valley of Russia's economic roller coaster, picked up the phone to Washington.
The news was grim.
Just hours before, Chubais and Prime Minister Sergei Kiriyenko had flown by helicopter to meet President Boris Yeltsin at a wooded retreat outside Moscow. They told Yeltsin the war to defend the ruble was lost. The time had come for devaluation. They also told him that the International Monetary Fund had given a tentative green light. Yeltsin went along.
But according to participants, when Chubais returned to Moscow, and went to his fourth-floor office at the White House, the government headquarters, he discovered the IMF's top leadership was now against devaluation. Chubais knew IMF opposition could turn a very bad situation into a deadly tailspin.
What unfolded over the next few hours was a drama of the new Russia -- on the brink.
The Russian economic reformers, facing their worst hour, desperately sought to erect what Kiriyenko called a "second front line," an attempt to devalue the currency without triggering panic. Chubais spent the night on the phone struggling to keep the IMF from abandoning Russia. The corridors filled up with the power brokers of the new Russia, the wealthy tycoons known as the "oligarchy." Their empires teetered close to bankruptcy, according to one of them, and they came to save themselves.
Chubais calmly told them of the decision to effectively devalue the ruble by allowing its value to sink as low as 9.5 to the dollar. "They are all bankrupt," recalled one leading Russian banker of the moment they heard the news. "All they wanted to do is protect themselves for as long as they could."
The devaluation makes Russian exports more attractive abroad but imports more costly at home. For Russia's banks, devaluation is especially painful because their ruble assets are worth less, but they still have big debts that must be paid in dollars.
The long night was the culmination of a painful, 10-month slide in which Russia, just barely climbing out of a six-year depression, fell back again into economic uncertainty. During those months, Russia was buffeted by outside forces it could not control, including the Asian financial crisis and a slump in the price of oil, a major Russian export.
But that is not the whole story. According to a range of Russian officials, politicians, bankers and some Western investors, a huge miscalculation in Moscow underlay the collapse of the ruble: Russia's elites repeatedly misjudged the world's harsher financial climate in late 1997 and early this year.
The Russian policymakers and politicians, including the parliament, failed to stanch the country's hemorrhaging public finances. They failed to curb widespread tax evasion, for example, and did not tackle important structural reforms, such as protecting investors and property rights. They did not realize until it was too late that markets at home and abroad had stopped listening to their rhetoric -- and were instead watching the lack of action.
Alexander Livshits, a veteran of Yeltsin's economic team, said the Asian crisis "radically changed the tactics of investors in developing markets. The miscalculation of the government and the Central Bank . . . is that they didn't catch that change."
It did not seem that way in mid-1997, when Yeltsin joined the leaders of the Western industrial democracies for a summit meeting in Denver. Russia was borrowing billions of dollars on world markets, there were signs of economic growth and a surge of portfolio investment made Russia the best performing stock market in the world.
But then came the turmoil in Asia, which caused many global investors to pull out of emerging markets, including Russia. The leading banker, who asked not to be identified, said there were three shock waves -- in October, January and May -- when investors fled Russia. "No matter what they thought about Russia, even if they thought Russia was on the right track, they just wanted to get out of the economy," he said.
When the risk seemed higher, investors demanded higher returns on Russian treasury bills, known as GKOs. But each time the Russian government had to pay higher returns for GKOs it got caught in a vicious cycle of having to borrow more and more. From 20 percent interest last year, the GKOs climbed to more than 170 percent. Russia had to sell about $6 billion worth each month just to keep up. The GKOs became a slowly tightening noose.
Another factor tipping Russia toward the precipice was Yeltsin's erratic leadership. In February, Yeltsin confidently told parliament that the IMF's current loans "should be the last." He was wrong. In March, Yeltsin abruptly fired his entire government, including the prime minister, Viktor Chernomyrdin, and replaced him with Kiriyenko, a young banker. The political battle over Kiriyenko absorbed most of April.
In early May, the lower house of parliament, the State Duma, which is dominated by Communists and nationalists, passed a bill to limit foreign investment in Unified Energy Systems, the huge Russian electricity monopoly. According to many analysts, the bill sounded the worst possible message to skeptical overseas markets -- foreign investment in Russia was not secure.
Kiriyenko pushed the parliament for action, and managed to narrow the deficit. But it was too little, too late, and the Duma was sluggish. Russian markets began to collapse in mid-May.
"Russia is always playing catch-up," lamented the senior banker, referring to the government. "We were always pushing them, always telling them, react, react, react. They always reacted, but they reacted late," he said, adding, "Kiriyenko couldn't consolidate power fast enough."
Then in late May came a particularly brutal shock wave, as Russian markets nose-dived, and the Central Bank had to raise short-term interest rates to 150 percent. The Central Bank was bleeding its foreign currency reserves to defend the ruble. Shaken by this crisis, Russia turned to the IMF for another bailout.
Chubais, deeply unpopular at home for his role in the early economic reforms, is widely respected in the West. He had just started a new job as chief of the electricity monopoly when Yeltsin called -- and sent him to Washington to negotiate a new loan.
Russia's quarrelsome tycoons also were growing fearful. Plans to merge two big oil companies, Yukos and Sibneft, fell apart. Several magnates had large dollar loan obligations coming due in the autumn, and the value of their domestic assets was tumbling. But the tycoons had mixed feelings. Some saw opportunity. The newspaper Nezavisimaya Gazeta, supported by the financier Boris Berezovsky, openly campaigned for devaluation.
In a surprising announcement, Andrei Illarionov, an economist who had been close to reformers, took the lead in predicting that devaluation could not be avoided. But the government vowed to stand fast; a stable ruble and low inflation had been Yeltsin's most positive accomplishments in more than six turbulent years of trying, fitfully, to shape a market economy.
The IMF rescue package, wrapped up in mid-July, was linked to progress on further reform. Russia would get a $4.8 billion initial installment. Chubais, who was in Washington, turned to a few aides, quite pleased. "Now we are safe," he said, according to one official.
But he misjudged. In fact, the IMF package only briefly salved investors' worries. According to the leading banker, the bailout was seen as a way for the investors to get out of Russia, not to stay in.
"The IMF package in the end was an exit for foreigners," he said. "It wasn't going to go." He added, "It failed because three times before the Russians reacted late on economic policy. The world was telling them what they needed to do, they were trying to do it, but they weren't doing it fast enough, and they weren't doing it decisively enough."
In fact, Russia had burned up most of the IMF's first tranche of aid in a few weeks of trying to support the ruble. According to Sergei Dubinin, head of the Central Bank, about $3.5 billion was spent supporting the currency between July 20 and Aug. 19.
The situation was now critical. George Soros, the international financier, called for devaluation in a letter to the Financial Times of London. "The meltdown in Russian markets has reached the terminal phase," Soros said.
The next day, visiting the ancient city of Novgorod, Yeltsin insisted, "There will be no devaluation, I state this loudly and clearly." But the storm was already breaking in Moscow, where the Central Bank rushed $100 million in aid to SBS-Agro, the largest private retail bank.
The same day, Chubais cut short a vacation in Ireland. He arrived in Moscow early Saturday morning. With Kiriyenko, Dubinin, as well as former prime minister Yegor Gaidar, still a key behind-the-scenes adviser, and others, Chubais began planning for devaluation.
In Washington, a Treasury official said the Russians had appealed to the IMF for additional aid over the weekend. But it wasn't in the cards.
At one point, however, two Russian sources said, Chubais got a green light for the devaluation plan from an IMF official, and told Yeltsin so, but then found the view had changed when he returned to the White House in Moscow.
Meanwhile, the financial tycoons converged on the White House in the middle of the night. They included Berezovsky, an oil, auto and airline magnate; Vladimir Potanin of Uneximbank; Petr Aven and Mikhail Friedman of Alfa Group; and Mikhail Khodorkovsky of Menatep and the Yukos oil company.
They were told the government was going to suspend the GKO market. There was silence. They all had big sums in GKOs. "We knew the minute they announced a freeze on the GKO market we can't make payments" on obligations, said the leading banker. Facing bankruptcy, the tycoons pressed for a 90-day moratorium on their overseas loans; that was put in the plan.
Chubais, meanwhile, remained on the phone throughout the night, cajoling and beseeching the IMF not to walk away from Russia.
Among others, Chubais spoke with IMF Managing Director Michel Camdessus, Deputy Managing director Stanley Fischer, U.S. Deputy Treasury Secretary Lawrence Summers and the undersecretary for international affairs, David A. Lipton.
Early in the marathon talks, according to participants, the Western officials urged Chubais to wait, to try to talk the Duma into action, perhaps a tax increase. Chubais told them it was hopeless and unrealistic. Next, the IMF position hardened, urging Chubais to call off the devaluation.
Then, close to dawn, the participants said, Chubais blew up.
"Do you realize what might happen here?" he said, according to a participant. "We will have Indonesia here! . . . There will be a collapse of the banking system of Russia."
The calls ended. "Good luck," said one of the Western officials in a farewell, but Chubais didn't know what the IMF would do when devaluation was announced.
A few hours later, he heaved a sigh of relief when Camdessus released a statement that said, in the last line, the world community should "show solidarity for Russia at this difficult time."
Staff writer Clay Chandler in Washington contributed to this report.
c Copyright 1998 The Washington Post Company
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