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ent or accountable. A recent internal audit

of borrowed money and delayed payment of

leaked to the Russian parliament, for exam-

arrears would work long enough to allow the

ple, showed that the central bank moved

economy to recover, start generating more

$37 billion over five years through a shad-

taxes, and repay the government's debt.

owy offshore money management firm and

Some observers, including the present

used part of the funds to invest in Russian

authors, were skeptical that Russia could

government bonds from offshore, which

have a sound currency and a good banking

system with its current institutions.8

was illegal at the time. The profits from the

bond speculations appear to be missing.7

However, as recently as a year ago the gam-

ble was looking successful. Then came the

second factor precipitating the financial

The Road to Default

crisis: the spillover from the Asian currency

crisis. That other developing countries with

better government finances and better run

Russia has modified rather than disman-

central banks were experiencing trouble

tled the centralized control of credit that the

made investors look more carefully at

Bolsheviks established. The ruble is, so to

Russia's situation. The arithmetic of the

speak, a currency of socialism: the govern-

Unless the

government debt did not add up. The gov-

ment uses it as a tool to redistribute wealth

government

ernment was borrowing rubles at annual

from the great mass of Russians to politically

interest rates in the mid double digits. At

powerful groups, notably unproductive

devalued the

the same time, the Central Bank of Russia

firms. The banking system, which also oper-

ruble or default-

was maintaining the exchange rate of the

ates in socialist fashion, increases the waste of

ed, its real debt

ruble within a narrow target zone against

resources. Real banks would cut off lending

the dollar, the world market price of oil--a

to unproductive firms, but many Russian

would increase at

major export and source of tax revenue--

banks serve as conduits for subsidies to such

double-digit rates

was falling, economic growth in Russia was

firms rather than as market-oriented alloca-

unimpressive, and growth elsewhere was

tors of credit.

while its ability to

slowing. Unless the government devalued

So, even before the August financial crisis,

repay the debt

the ruble or defaulted, its real (inflation-

the financial system was poorly run, weak,

would hardly

adjusted) debt would increase at double-

and not well integrated with world markets

digit rates while its ability to repay the debt

and the liquidity they can provide. Two other

grow at all.

would hardly grow at all.

factors affected the system at vulnerable spots

From August 1997 to August 1998, the

to precipitate the current financial crisis. The

average weighted interest rate on short-

first factor was the shaky finances of the

term government debt in rubles rose from

Russian government. In the early 1990s the

under 19 percent to 135 percent. The gov-

government had budget deficits in double

ernment was unable to repay its accumulat-

digits as a percentage of Russian gross nation-

ed debt from current revenue, because it

al product. It financed them by printing

was running substantial budget deficits

money, causing inflation that peaked at 2600

(equal to 6.8 percent of official gross

percent a year in 1992. Starting in 1994 the

domestic product in 1997 and 4.9 percent

government made great progress in reducing

in the first half of 1998). Very high interest

inflation through a combination of measures:

rates further increased the burden of refi-

reducing spending; delaying payment of

nancing the debt. On July 20, 1998, the

wages to government employees and pen-

International Monetary Fund gave the gov-

sions to old people, thus creating arrears; bor-

ernment a loan of $11.2 billion, to be dis-

rowing from private investors at home and

bursed in "tranches" (slices). The Central

abroad; and borrowing from official sources,

Bank of Russia almost exhausted the first

notably the International Monetary Fund.

tranche of $4.8 billion within three weeks

The government gambled that a combination

6