Russia: The End of a Time of Troubles

Presented by:Mevin MathewMohit Madaan

FLOW OF PRESENTATIONBackground• Fall of USSR• Rise of Boris YeltsinEconomic reforms• Between 1917-1991• Between 1991-1999Political Impact of economic reformsEconomical Policies• Liberalization and stabilization• Privatization (between 1992-1994 and 1995-1999)Economic trouble(1991-1999)• Ruble, barter, Demonetization• Region, Federal Authority, Taxes• The legal system• Crisis of August 1998• Demographic CrisisPutin to Power

Background• Fall of USSR• Rise of Boris YeltsinEconomic reforms• Between 1917-1991• Between 1991-1999Political Impact of economic reformsEconomical Policies• Liberalization and stabilization• Privatization (between 1992-1994 and 1995-1999)Economic trouble(1991-1999)• Ruble, barter, Demonetization• Region, Federal Authority, Taxes• The legal system• Crisis of August 1998• Demographic CrisisPutin to Power

FALL OF USSRUNDERLINING CAUSES

• Years of Soviet military buildup at the expense of domestic development

• Economic growth stalled/stagnant economy

• Failed attempts at reform• War in Afghanistan • General feeling of discontent,

especially in the Baltic republics and Eastern Europe (i.e. Chernobyl)

August Coup• August 1991 – “hard-line”

Communists tries to take over the government

• Last effort to save USSR• Country went into an uproar;

massive protests• Soldiers themselves rebelled –

“can’t fire on our countrymen”• Coup collapsed after 3 days• After the coup, Estonia and Latvia

declared their independence.• Other republics soon followed

Collapse of the Soviet Union• A new entity was formed

“Commonwealth of Independent Republics"

• Russia and 15 independent former USSR countries

• Complete political independence, linked to other Commonwealth countries by economic, and military ties

• The Soviet Union, with its centralized political and economic system, had ceased to exist in December, 1991

RISE OF BORIS YELTSIN• Gorbachev was unable to

reestablish real control• Yeltsin negotiated the transition

of power made inevitable by the will of the people.

• December 1, 1991 all non-Russian republics declared independence (population wanted democracy)

• Boris Yeltsin was the first democratically elected president of Russia

RUSSIA’S ECONOMIC REFORM

• Soviet system focused on industrial and military development• Institutions of state made decisions about what and how much

to produce• State coordinated inputs and outputs and set prices• State allocated credit and resources and hence budget

constraints were soft• Managers of the firms were concerned primarily with meeting

production targets

Between 1917-1991

The Soviet years

1920s-1950s

• Soviet system achieved a rapid economic growth based on massive mobilization of resources

• Created a formidable industrial and military power• Rapidly expanded employment and invested in physical capitalization

1960s

• Growth rates declined due to diminishing returns• Technological innovation stagnated• Mandated increased production in heavy industrial sectors such as steel

than to create incentives for high technology and consumer products

1980s

• Economic growth disappeared• Restructuring of the economy required

RUSSIA’S ECONOMIC REFORM

• In June 1991, Boris Yeltsin had been elected as president• In October 1991, he announced that his administration

would radically reform the economy from socialism to capitalism

• He entrusted the reform process not to politicians, but, in his words to “professionals”

• This turned out to be ideologically committed group and came to be known as “young reformers” all under the age of 40

Between 1991-1999

• Yeltsin authorized to mandate components of his economic reform program by decree, change the structure of government, and appoint all cabinet ministers without parliamentary approval.

• Yeltsin adopted “shock therapy” to deal with the suffering Russian economy

Yeltsin declared “It will be worse for everybody for about half a year”

• Reformers planned to free most prices (three quarters of which were still state-controlled)

• Liberalize Imports• Overhaul the tax system• Eliminate the budget deficit• Tighten monetary policy• Privatize the majority of state-owned firms

Political impact of economic reforms

• Economic reforms were quite controversial

• Russian voters also did not support these reforms

• This was evident in the 1993 elections for seats in the state Duma

33%

40%

27%

SEATS WON IS STATE DUMA ELECTIONS

Parties of Economic Reform (Russia's choice and Yabloko)Centrist Parties, ambivalent about reformsParties against Capitalist Reforms

ECONOMICAL POLICIES OF BORIS YELTSIN

Policies

Price and Trade Liberalization

Macroeconomic stabilization Privatization

LIBERALIZATION AND STABILIZATIONReformers sought

tight monetary policy to rein in

inflation

Reformers achieved some initial success

Opposition to this policy

Tight monetary and fiscal policies were progressively

relaxed due to powerful political and economic

forces

1992-Viktor Gerashchenko was made Chairman of the Central Bank of

Russia (CBR

Gerashchenko (chairman of CBR)

was in hands of the parliament

Disagreed with the reformers’

approach to monetary policy

Offered liberal credits to Russia’s

struggling industrial

enterprises

Thus government was unable to impose

monetary discipline and a hard budget

constraint on Russian firms

Indian Liberalization (1991)Reforms

• Abolition  License- Permit Raj• Reduced tariffs and interest

rates• Automatic approval of FDI in

many sector

Impact

• A huge private sector emerged.• Income Tax Department and

Customs Department became efficient in checking tax evasion

India reported its highest GDP growth rate of 9.6% in 2006 after reforms

US$ 132 million US$ 5.3 billion

Foreign Investment Growth:

PRIVATIZATION

Anatoly Chubais: “They steal and steal and steal. They are stealing absolutely everything, and it is impossible to stop them. But let them steal and take their property. They will then become owners and decent administrators of this property ”

1992-1994: Vouchers and Auction• Every Russian was given a “voucher”, which could be exchanged for

stock in privatized firms, invested in voucher fund, or sold for cash• The direct exchange of stock was supposed to take place at “voucher

auction”• The reformers achieved their goal of rapidly privatizing large number

of firms• Between Jan 1992 and June 1994, the government privatized 16,500

firms, shares of which were held by over 41 million Russians, either directly or through voucher investment funds

Very quick process: Citizens were not

able to understand

• The directors of Russia’s large industrial enterprises opposed as the move “threatened their control” over much of the economic structure Russia had inherited from Soviet industrialization.

• To compromise with the industrial directors opposition, government offered preferential access to their firm’s shares through 3 separate programs

• Most popular among these was the “option 2”, with which managers received 51% of the voting shares in their firms at a nominal price

• Some managers acquired even greater control over their firms through a variety of complex but illegal schemes

Privatization, 1995-1999: Pledge AuctionsNatural gas, oil, and

mineral deposits were excluded from the process of mass

privatization

Boris Yeltsin and the reformers faced

huge fiscal crisis in 1995

Vladimir Potanin proposed that the banks would give a

large loan to the government for one

year

As collateral, banks would hold and manage

the state’s block of shares in 29 large state owned oil and mineral

assets

If government is unable to repay back the loan,

ownership would be transferred to bank holding the shares

GKI( State Property Committee) authorized

Oneksimbank and other banks to

organize the pledge auctions

Most of the banks agreed among

themselves in advance which bank would bid

for each block of shares

Outside bidders were disqualified on the

technical grounds and foreign bidders were

excluded from 7 auctions

Government raised $800

million in loans from the auction

Case of NORILSK NICKELFactory at Norlisk

Oneksimbank won auction for $170.1 million and starting price was $170 million

Rossiiski Kredit (interested in the bid)- was informed on the day of auction that it was having procedural irregularities

Rossiiski Kredit Chairman later on revealed that they were ready to pay $355 million

PROFITS LOST= $ 184.9 MILLIONS

AUCTION PRICE= $ 170 MILLIONS

Privatization in India (1991)

Disinvestment Commission was set up during 1991 -92 for identifying PSUs equity disinvestment and for suggesting modalities of disinvestment

Enunciation of the National Telecom Policy in 1994-95 which opened up basic telecom services to competition.

Foreign equity participation up to 49% was permitted in case of a joint venture between an Indian and a foreign firm

A key reform in infrastructure development was the creation of a major new source of funding for national, state and rural road construction, called the Central Road Fund (CRF) under the Central Road Fund Act of 2000.

The Rise of the “Oligarchs” (1995-1997)

• During 1990s, Russians began to refer to a handful of powerful businessmen as “the oligarchs” indicating their political influence

• Reasons that forced the government to bend towards oligarchsInability of the state to meet its fiscal obligations, the government needed funds the oligarchs provided

Upcoming presidential elections, 1996

Russia has the most billionaires per trillion dollars of national output. India comes second

The predominant source of plutocratic wealth in India is from three factors — land, natural resources and government licenses.

Most of India’s billionaires have benefited from sweet deals in real estate, mining, telecom, oil and such like.

Billionaire businessman Mukesh Ambani is quoted as bragging that the ruling Congress Party is "Apni Dukan“ (our shop), implying that he owns the ruling party.

Telecom minister Andimuthu Raja left an estimated $40 billion on the table by accepting bribes in exchange for lower bids from Indian and foreign bidders on 2G cellular spectrum auction

India's Highway Minister Kamal Nath is alleged to skim 15% on all the projects his ministry overseas.

Presidential Elections, 1996

• Presidential elections was a “crucial event” for both Boris Yeltsin and oligarchs

• Major problems confronting them were:

• In January 1996, just few months before elections Zyuganov led the polls by substantial margins, followed by Yeltsin at 5th place

Yeltsin’s Zyuganov’s

Economic Dissatisfactio

n

Public support

Unpopularity

Threats posed by Possible Zyuganov’s Presidency

Zyuganov would end Russia’s experiment with markets and democracy and would promote communism again

Would not honor the pledge auctions arrangements

Oligarchs would to lose not only millions of rubles but political power as well

Therefore it was necessary for them to derail the ambitions of Zyuganov

THE DAVOS PACT

• At Davos, Switzerland in Feb 1996, Russia’s most powerful businessmen agreed to cooperate to support Yeltsin’s reelection bid

• They offered all their resources-1. Media2. Funding3. Regional contacts• Although Russian law limits presidential candidates to spend

only $3 million, Yeltsin’s campaign team admitted to spend $ 100 million ( in reality it was $ 500 million- 1 billion)

The Ruble• The currency that Russia inherited in 1991 was the “Soviet Ruble”, the currency used by all 15

former Soviet states

• Only Russia’s central bank could actually print new rubles and provided it to other new states

• But central banks of other states could issue Ruble credit

• Russia’s central bank did not have any complete control over the country’s money supply

• In July 1993, Russia’s central bank issued the new currency- Russian Ruble

Problems of the Barter System

January 1992( 10%)

January 1999( 50-70 %)

• Without cash revenues, firms were unable to pay salaries

• The federal government could not effectively tax industries that relied on barter

• Government was unable to evaluate accurately the value of a firm’s assets and transactions

• So many firms relied so much on barter that few firms had cash to pay taxes at all

• Provincial governments began to tax in kind and eventually the federal government forced to do so.

Demonetization

• New monetary surrogates emerged, mainly as local currencies• Examples:

Tatarstan’s government issued their own money substitutes

Local commercial banks and firms, issued promissory notes called vekselia or twechels (from German word from bill of exchange)

FEDERAL UNITS IN RUSSIA• There are 89 Federal Units, or “subjects”

organized into six legal categories

21- Republics, each of which bears name

of a non-Russian ethnic group

49- oblasts 6- Krais, populated by ethnic Russians

Moscow and St. Peterbergs as “federal cities”

10- autonomous okrugs

1- autonomous oblast

Regional authority v/s

Federal Authority• Yeltsin provided too much sovereignty to regional leaders- a few adopted their own “REGIONAL” constitution- some violated federal laws

• As a result bilateral treaties were signed by Yeltsin with regional leaders but Still not able control them

• Goods were not allowed to move freely across regional borders

• Local govt was able to collect tax but the Federal govt not able to collect their share from the local govt

Taxes

Problem due to Russia’s inefficient federal system• Goods could not move freely across

regional borders• Federal system was unable to acquire

its share of tax receipts from regional and local authorities

Problems due to complex and confiscatory tax laws• Government taxed gross revenues

rather than profits• Firms were subject to 17 different

taxes that added 110% of revenues• Limited deductibility of items• Required frequent reporting

Efforts to Crack Down Tax EvasionGovernment created a “ Tax Police”, complete with guns and significant executive authority

Tax collectors were treated harshly by citizens, in 1996, 26 were murdered, 74 injured, and 6 kidnapped

Ultimately , government had difficulty in meeting its budgetary obligations

Russian Orthodox Church intervened

Morbid legal system leads to violent Entrepreneurship

Legal system

Was Not having

effective court system

Judiciary Was Not

independent

Federal govt was not

able to pay judges

Maintained by regional heads,

manipulated laws

Privatization of Security• There was a high rise in several niches

such as private security, contract enforcement, and transaction insurance

• Russians had a perception that Arbitrazh courts were slow to rule and unable to enforce decisions

• Because of high entrepreneurial risks associated with the failure of business partners to observe contracts or pay debts

3 basic types of private protection • Units of police and security forces

that sold their services privately and illegally

• Illegal organized criminal groups, so called Russian mafias

• Private protection agencies

Growth of Russia’s Private Security Industry1992 1993 1994 1995 1996 1997 1998

Private Protection Companies 0 1,237 1,586 3,247 4,434 4,705 5,650

Private Security Services 0 2,356 2,931 4,591 5,247 4,973 4,720

Private Detective Agencies 0 947 2,088 149 182 809 434

Total 0 4,540 6,605 7,987 9,863 10,487 10,804

Costs of their services varied• 20-30% of profits for business transactions• Up to 50% for collecting bad debts

THE AUGUST 1998 CRISIS PM a

1.• Government defaulted on its domestic debt

2.• Devaluation of Ruble

3.• Suspension of repaying of foreign private

debt

Defaulted on its domestic and foreign debt

Government

Domestic Banks

Foreign Investors

Devaluation of Ruble

Devaluation

Promotes export

Reduces Imports

THE AUGUST 1998 CRISISPossible Reasons for August Crisis

• Government stated falling oil prices

• Asian financial crisis• Overvalued ruble• Excessive borrowings• Debt was too costly and too short

term

Consequences of crisis

• Sharp drop in real income, living standards and employments

• Temporary paralysis of payments and settlement system

• Ruined the balance sheet of the large private banks whose holdings were primarily government bonds

• Government defaulted on $ 40 billion in ruble-dominated bonds, heavy losses for private investors

PRESIDENT PUTIN IN 2000 Diagnosis about the problem

Russia at the turn of the Millennium• State should have

power

Open letter to the Russian voters• Emphasized need of

Law and Order

Putin in Power

Re-organized the fedral system- additional layer of political authority between centre and regions- 7 federal super-regions

Abolished treaties that created special tax privilages for several regions

Controlled the oligarchs

In short 1. Made state more powerful

2.Stability in law and order

Oligarchs during Putin's presidency

Roman Abramovich Mikhail Khodorkovsky