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Still, it is safe to say that thegovernment debt management policy in 1997 and 1998 did not make full use ofexternal borrowings instead of loading up with domestic debt. The advantages ofexternal borrowings include their longer terms and absence of risks of rubleexchange rate fluctuations for the investors, which together make the price ofborrowings less dependent on the current exchange rate policy. In our view, theattempts made in that period to step up external borrowings by floatingEurobonds were not consistent enough. A total of $14.9 billion worth ofEurobonds was floated in 1997 and 1998. Had consolidation (that is,substitution of long-term debt for short-term debt by altering the ratio ofinternal to external borrowings) been more forceful, the threat of financialcrisis could have been deflated, if not averted.

1.2.2. The Balance ofPayments

In analyzing the major changes in thebalance of payments figures, it is important to remember the inherentcontradictions of Russia’s economic situation in summer 1997. On one hand, the plunge ofoil prices at the source fed fears that the ruble was overvalued in thechanging market conditions and that, therefore, devaluation could be expected.These expectations were fomented by the rising costs of foreign debt servicingand repayment. The need for an adjustment of the current exchange rate policyand a moderate devaluation of the ruble was obvious in the last quarter of 1997when a clear trend emerged for the official gold and forex reserves to be usedas an important source of deficit financing and the forecasts for the worldenergy markets pointed to a stubborn price downtrend.

On the other hand, in an economic situationhighlighted by a short-term government debt and a high-profile presence ofnon-residents on the debt market, any attempts to tamper with the exchange ratepolicy (in particular, attempts to accelerate the gradual devaluation of theruble) send foreign investors scampering from the financial markets, interestrates shooting up, demand for foreign exchange soaring, the forex reservesthinning out, and the risk of default on government debt and biting devaluationlooming up. In the end, the policy of letting the ruble devalue gradually tobring the balance of payments back into equilibrium grinds to a halt. That waswhat we witnessed in 1997 and 1998.

Starting in the second quarter of 1997, thecurrent account balance was moving solidly into the red (with the soleexception of the fourth quarter of 1997 when the balance stood at no more than$400 million). The key factors accounting for the contraction of the currentaccount balance include the bad market for Russia’s main export commodity groups(Figure 1.1 shows Russia’s trade balance almost following the fluctuations of world oilprices), and the increased interest payments to non-residents by the governmentand private sector (the 1997 bottom line puts the total revenues paid forcapital services at $8 billion, or 1.75 per cent of GDP, see Figure1.2).

Despite the continued drop in world oilprices, the Russian trade balance surplus surged thunderously in the thirdquarter of 1998, propelled by the ruble’s devaluation, to $4.35 billion,largely as a result of a cut in imports (to $13.5 billion down from $17 billionin the second quarter). The BOP current account also showed an improvement overthe preceding period, to $217 million, which can, matter-of-factly, be fullyattributed to the trade balance growth, with the revenue balance surplusstanding at $3.4 billion in the third quarter, a tad below the second quartershowing.

Despite the poor showing of the currentaccount, the balance of the current capital and financial account in 1997 and1998 stayed in the black, at $19.5 billion, or 4.2 per cent of GDP, in 1997,pulling the total balance of payments up into surplus. The 1997 financialaccount surplus was, however, created by the influx of foreign portfolioinvestments showing up in the balance of payments,5 the balance for the remainingitems of the capital and financial account wereswinging over the year between faded red and grayish black.

Fig.1.1

RF trade balance and world oil prices
1995 to 1998*

*- trade balance for the 4th quarter of 1998as estimated by the Bank of Russia.

Sources: RF Central Bank, InternationalFinancial Statistics

Fig.1.2

RF сurrent account and balance of capitalservices
1995 to 3rd quarter of 1998

Source: RF Central Bank.

Fig.1.3

Reconstructed balance of investment accountsin RF balance of payments and overall balance
1995to 3rd quarter of 1998

Source: RF Central Bank, estimates by thebook’sauthors

The poorshowing of the financial balance of payments account in 1997 was precipitatedby the restructuring of Russia’s liabilities for the debts of the former USSR to the membersof the London Club by a bond issue to cover the principal ($22.1 billion) andinterest arrears ($6.1 billion). The restructuring was shown in the balance ofpayments as a reduction of the debt owed by the public sector on contractedloans (reduction of debt arrears) and a corresponding increase in the debt onnon-residents’portfolio investments (as a result of securities issue). In order to arrive atBOP accounts giving a true picture for the fourth quarter of 1997, wereconstructed the Уportfolio investmentФ and Уgeneral government liabilitiesФaccounts of the Russian balance of payments by reducing residents’ liabilities on portfolioinvestments by the amount of restructured debt and simultaneously increasinggeneral government liabilities (see Fig.а1.3).

An analysis of Russia’s 1997 reconstructed balance ofpayments shows a significant reduction in the balance of the portfolioinvestment account in the fourth quarter to $906 million (0.72 per cent of GDP)and the total net balance of payments to $9.9 billion (-7.9 per cent of GDP).The movement of foreign portfolio investments reached a critical turnaroundpoint in the fall of 1997. Alongside the sudden collapse of Russian exportprices, this factor set off, in late 1997 and the first six months of 1998, acatastrophic swell of the balance of payments deficit held under control byinfusions of the Central Bank’s diminishing external reserves.

In the last quarter of 1997, its gold andforex reserves dropped by a further $5.9 billion. Even worse, in the secondquarter of 1998, Russia posted a trade balance deficit, its first since late1993, which spread to the non-factor services as well (at over $300 million),the current account deficit continued to run up (hitting well above $4billion), and foreign debt servicing costs were steadily on the upgrade (netcapital services went over the $4 billion mark). The situation made a U-turn inthe third quarter of last year: as we said above, the growing trade balancepulled up the current account balance at the cost of an insignificant decreasein capital gains. The default on GKO-OFZ debt falling actually on the lastmonth of the quarter and the huge securities payoffs in July and August helpedmaintain the net gains deficit at a high level.

The net capital and financial account heldin the black through the three quarters of 1998, dipping slightly, to $1.5billion, in the third quarter. An analysis of the third quarter financialaccount figures shows the most shattering changes to have occurred in theportfolio and other investment accounts. In particular, foreign portfolioassets in Russia shrank by $726 million over this period, a striking contrastto the quarterly growth of foreign portfolio investments by between $2 billionand $8 billion in the preceding periods.

Among the unfavorable changes in thefinancial account figures for July to September 1998, the deepest imprint wasleft by the growth of Russian foreign assets and the dwindling of foreignliabilities, in particular, the bulging of residents’ current accounts and depositsabroad ($83 million), draining of non-residents’ Russian deposits and currentaccounts ($1.48 billion), the swelling of Russian export credits and drying upof export of revenues ($4.2 billion), bloating of residents’ forex holdings ($1 billion), andeven the flight of loans from the banking sector ($3.25 billion).

While in the spring and early summer of 1998the current balance of payments deficit was contained by attracting foreignportfolio investments and IMF loans and by a run on the CentralBank’s gold and forexreserves, by August 1998 the foreign exchange reserves as a source of deficitfinancing had virtually been bled white (from July 1997 through August 1998,the Central Bank’sgold and forex reserved had been left $12 billion short). The crisis shut offall avenues for a continued inflow of portfolio investment, while the first IMFtranche had been spent within a record time to support the ruble exchangerate.

Under these conditions, the BOP deficit inthe third quarter of 1998 was financed from two sources: an IMF loan ($4.8billion) and, until August 25, forays into the foreign exchange reserves (thethird quarter claimed $2.3 billion in forex reserves). With the reserves driedup, the only way to maintain a balance of payments equilibrium was to devaluethe national currency, which was actually done on August 17, followed soon by acontraction of imports.

When we worked on this survey, we lackedofficial figures on the Russian balance of payments for the whole of 1998.According to the Central Bank’s provisional estimates, however, the trade balance surpluscontinued to climb up in the fourth quarter of 1998 as well: with exportshaving dived by 30 per cent from the third quarter, imports had been dentedmore significantly (by all of 54 per cent). Again, according to Central Bankestimates for 1998 as a whole, the current account posted a deficit of $-0.8billion, while the trade balance showed a net gain of $14.7 billion, down from$+3.56 billion and $17.5 billion, respectively, in 1997. In respect of the BOPcapital account, it is expected that at the 1998 bottom line the net influx ofcapital into the Russian Federation will pan out at $17.8 billion, including anet capital drain of $6.5 billion from the banking sector and an inflow of $7.1billion to the corporate sector (in 1997, the corresponding figures were $44.1billion, $+8.9 billion, and $13.5 billion, respectively). A look at the Russianbalance of payments provokes a further question about the sources to repay theexternal debt principal and interests due in 1999 and pay off the third trancheof the external debt on foreign currency-denominated bonds, the OVVZs (atotal of about $18 billion, including $9.2 billion owed by Russia proper). Mostlikely, given the mix of the above factors (the growing current accountdeficit, contraction of the Central Bank’s gold and forex reserves, thegloomy outlook for loans from international financial organizations or anyother investment), this amount will not be paid off. And more, a furtherdevaluation of the ruble would not trigger the coveted cash-earning exportsbecause of their price inelasticity. The only option still left open to theexternal debt managers in 1999 is to seek a further restructuring ofRussia’s foreigndebt.

Table 1.3

RF balance of payments
1995 to 3rd quarter of 1998 (in millions of USD)

	Q1	Q2	Q3	Q4
	1995а
Current account	5506	2849	-819	425
Goods and non-factorservices	4532	3742	1308	1629
Goods (trade balance)	5751	5980	4855	4221
Exports of goods	19059	20399	20494	22711
Imports of goods	-13308	-14419	-15639	-18490
Non-factor services	-1219	-2238	-3547	-2592
To nonresidents	2139	2766	2733	2887
By nonresidents	-3358	-5004	-6280	-5479
Balance of labor and capital services (revenuebalance)	886	-883	-2071	-1299
Of which: balance of capital services	897	-813	-1923	-1226
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