The Russian economy faced a trial by fire in 1998, but has been on the rebound since

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There were too many reasons which led to the financial crisis of 1998 in Russia. It wasn’t obviously a one year thing but a long-lasting line of developments, which “prepared” the crisis. It was the absence of well thought out economic policies, weak monetary and fiscal conditions, a full collapse of control mechanism as far as the execution of laws was concerned, and, certainly, the unfavourable external conjuncture with the Asian crisis that led to the downfall of the ailing Russian economy.

It was liberalisation of prices and extrusion of domestically produced goods from the Russian market, which consequently decreased the tax base along with budget revenues, eventually leading the way to the budgetary crisis. Real tax rates were increased, but the collection of taxes was very poor. According to several sources, only 16% of the total enterprises paid taxes in Russia in 1998 with 40% of the economy functioning in shadow. Money laundering was prospering too. Actual inflation figures were intentionally lowered by decreasing social taxes and increasing deferred inflation (currency depreciation, non-payments, increasing of internal and external State debt, et al) which was already out of the State’s control way back in 1995-96. Attempts to curb this inflation with decreasing of money base led to a shortage of cash to serve commodity turnover. This absence of cash to pay taxes & salaries intensified the budgetary crisis and resulted in a flow of non-payments and high volume of barter deals.

Moreover, monetisation of the Russian economy was at 10% of GDP while the common figure for developed countries stood at 70% of GDP. If the State has no revenue, it has to either issue money or issue debt. Russia chose the second variant. The government started to finance budget deficit through borrowing. GKO pyramid started to develop and was promoted with non-residents getting an access to this market, which also fed speculative blowing of Russian stock market (in 1996-1997 it grew by almost 5 times) and further refusals to pay back debts, which the was not possible for the country to service. Privatisation led to the appearance of the institution of private owners, many of which were not effective. It also brought a spike of crime. However, I could not say that everything was done wrong. The situation was difficult and I am sure that in many cases there was no alternative in decision making.

Liberalisation was essential for the transition to market economy. In the result of a deformation of planned communist economy, GDP fell sharply: ~25% cut from GDP was due to a decrease of war production, ~15% cut due to a decrease of the production of consumer goods of low quality, which were previously bought due to the absence of alternative choices. However, on the other hand, the ruble was depreciating in the currency market and its declining demand was partially explained by the fact that companies, for example, could not care less about paying taxes because of the poor State control.

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Source : IIPM Editorial, 2008

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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