U.S. Department of the Treasury

My colleague from the State Department has already addressed the broader security issues relating to Russia's current situation. I would like to begin my remarks with a few words about Russia's evolution over the past seven years and the problems leading up the crisis. I will then describe the considerations that have guided the United States approach to Russian economic reform throughout this period and the main policy challenges going forward.

I. Russia's Transition Since 1992

Mr Chairman, since the dissolution of the USSR, Russia has been struggling with the profound challenge of creating an entirely new kind of economy, a new kind of politics, and a new geo-political setting. While recent events will have very severe consequences for Russia and raise a great many uncertainties, it is important to begin any discussion with a recognition that Russia is already a very, very different country than it was seven years ago:

• Russia has a democratic leader and democratic system, even if it has also experienced the uncertainties that democracy can bring with it.

   

• Russia has been greatly demilitarized and is no longer channeling one fifth of its national resources into the maintenance of military forces directed at America. Last year Russian military spending was only 1/7 of its peak in 1988 and 2/5 of its level in 1992.

   

• 3/5 of the Russian workforce now works in the private sector after 70 years of central planning. Russia has private banks and private capital markets.

   

• Russia is now a country that is open, whose people know what happens in the markets and systems beyond their borders and have access to all the ideas and products that the rest of the world has to offer.

Bringing about change on such a scale is enormously difficult in any country and uniquely challenging in a country with 150 million people, countless ethnic and nationalist groups, ten time zones -- and 3/4 of a century of communism to overcome. Russia is now a functioning democracy and a market economy. But it is widely recognized by outsiders and Russians themselves that the new Russian economy is also seriously flawed. It is these flaws that helped sowed the seeds of today's crisis.

II. Roots of the Crisis

Russia's economic policy framework collapsed in the middle of last month as the Russian authorities -- in the face of severe market pressures -- decided on the enormously risky course of simultaneously devaluing the ruble, imposing a debt moratorium and restructuring government bonds. This was the Russian government's decision and not one which we supported. In this regard, as in so many others, Russia is a unique case and should in no sense be viewed as a precedent or guide for other emerging markets under pressure. Indeed, the government's actions served to undermine confidence still further, unleash spending, lending, and inflationary pressures, and prompt a change in government. The result is an economic and financial crisis as serious as any since the reform process began.

The immediate problems leading up to this crisis are simply stated: an inability to control the budget deficit, an excessive reliance on short-term debt and -- partly as a result -- enormous difficulties with maintaining a fixed exchange rate peg. During the past ten months investors had become increasingly doubtful that Russia would be able to maintain the fixed exchange rate while paying its mounting debt service costs. This led to ever-higher interest rates, and a rapid depletion of foreign reserves -- a vicious cycle which culminated in the very unfortunate events I have already described.

Thus, at a purely financial level, this crisis was caused by the usual problem of too much borrowing, creating too little ability to repay. But at a deeper level the crisis can be traced to two broad political problems that have dogged Russian reforms since the beginning.

The first of these has been a failure to resolve a basic mismatch between the government's spending needs and its available resources -- a mismatch in many ways inherited from the previous regime but exacerbated by political stalemates and disagreements of the transition period. At 9 percent of GDP, the tax revenues the federal government was able to collect last year is at odds with the role the government and its electorate envision for the state, indeed, cannot credibly sustain the operations of the most minimal state. Yet there has been a repeated political failure, either to increase sufficiently the supply of revenues to the center or to reduce sufficiently the central government's spending commitments.

The second, related problem that Russia has failed to overcome has been a fundamental weakness of post-Communist institutions. This weakness has come through particularly in the inability to collect sufficient tax revenues and, critically, in the failure to build and institutionalize a favorable investment climate and the rule of law.

The broader consequences of these failures are severe and wide-ranging. The Russian private sector has been starved of the private capital it needs; large parts of the economy have been left off-the-books, under-monetized, vulnerable to crime and dependent on barter; the financial sector is poorly regulated and a poor intermediator funds for investment; the terms of privatization have frequently been noncompetitive, and private ownership often failed to improve company management. Worst of all, corruption remains pervasive and fundamentally undermines peoples' faith in the legitimacy of the political and economic system. And social payments are not adequately targeted and, as a result, the truly needy often receive little or no support.

While it was possible for such a flawed system to go on for some considerable time, in the end it was Russia's inability to service the most basic institutions of an effective state that led to the financial collapse that occurred last month.

III. The Approach of the United States and the International Financial Institutions

Mr Chairman, starting with the Vancouver Summit in 1993, President Clinton has made clear that the United States would take a leading role in international efforts to help Russia develop the institutions and policies of a functioning market economy. We have done this because we believe that a successful market transition in Russia is critical to American interests -- and because we believe that, when policy makers themselves are committed to reform, IMF and World Bank programs can raise the chances of it being achieved.

Recent events have not altered this judgment. Indeed, since 1992 the IMF and the World Bank have played an important role in achieving many of the positive changes in Russia that I have described and have helped to underpin a valuable period of exchange rate stability after the costly hyperinflation of the early 1990s. What the crisis has underlined, however, is that international support cannot succeed where domestic policy makers have failed.

In light of increasing uncertainties in Russian markets -- and emerging markets more generally -- both the United States and the international financial institutions had been increasingly aware that Russia's situation was becoming more problematic. These concerns were expressed to Russia both bilaterally and in the Russian authorities' ongoing contacts with the IMF.

In the worsening market climate the IMF -- backed by the United States -- decided to support the Kiriyenko government because that government had begun to address the fiscal and broader institutional failures that threatened Russia's economic stability and because we believed that the risks of inaction far outweighed the risks of action. An additional, $22.6 billion multilateral financing package was mobilized in July to provide tightly conditioned assistance to the government so that it would have financial breathing space to press on with these reforms.

The first element of this support was a $4.8 billion tranche from the IMF on July 20. The disbursement of these funds was based on completion of a long list of prior actions. These included steps to streamline the tax code and reduce tax rates, reform to tax administration procedures and a budget code; more uniform application of the VAT, including application to barter transactions; and reductions in federal subsidies.

Cutting the deficit was not the extent of the Kiriyenko government's reform horizon. Additional IMF and World Bank financing was to be made available to support important structural reforms that would help tackle corruption and support private sector growth and investment. For example, as part of this program Russia was urged to make the privatization process more transparent and open; cut substantially the number of "strategic firms" exempted from privatization; accelerate reform of the banking and energy sectors; eliminate non-cash payments for utilities and infrastructure; increase capital market transparency; strengthen measures to enforce minority shareholder rights; and improve bankruptcy legislation and enforcement.

With important actions already having been taken, and firm commitments of more to come, the United States supported the disbursement of IMF funds for Russia because we believed there was a reasonably good chance -- not a certainty, but a reasonably good chance -- that reform would move forward in the period ahead.

In the end, opposition to the Kiriyenko reform agenda and the deterioration in market conditions helped fuel great market scepticism. This culminated in a comprehensive breakdown in confidence in the first weeks of August.

Of course, it would have been vastly preferable if the Kiriyenko government had been able to forge a broad political consensus in favor of the full program of fiscal restraint and deeper structural reforms to strengthen state institutions and tackle corruption. But the reality is that there was, and is, strong opposition in the Duma and elsewhere from powerful special interests and from those who seek a return to communism. It was this opposition that helped fuel great market skepticism, and the breakdown in confidence that followed. But if the IMF had not acted quickly to support key elements the government's anti-crisis program, it and we would have been rightly criticized for timidity and for a failure to seize a critical opportunity to support reform and stabilize Russia's economy.

The failures of Russian reform -- and their culmination in the present crisis -- have led some to argue that the international institutions and the United States have been overly forgiving in their support for Russian reform. On this view, international financial support has merely lined the pockets of corrupt officials and oligarches while weakening the incentive to carry out deeper reform. The facts of the international community's support for Russia tell a different story -- of support given only on the basis of concrete reforms and reform commitments, many of them expressly designed to tackle the scourge of corruption.

IMF support has consistently been delayed or cut when the Russian government has not made good on its commitments. And since 1992, Russia's persistent failures to achieve solid reform in some areas have led to ever tighter conditionality. For example, Russia was the first country to have monthly tranching as part of its IMF program. As a condition for disbursing the first tranche of official funds in July, the IMF required more than legislative proposals: it required laws passed or actions that had the force of law. Because two actions were not taken -- a rebalancing of personal income tax revenue sharing and closure of the pension fund deficit -- the IMF Board cut the disbursement from $5.6 billion to $4.8 billion. As I have already stressed, we very much share the concern in Congress about corruption in Russia and so do the international financial institutions. It is a fundamental threat to Russia's stability, democratization, and prospects for a broadly-shared rise in living standards. But let there be no doubt: the world's best antidote to corruption is economic reform.

A large share of corruption and illicit behavior in Russia -- below-market-value sales of government assets to favored buyers, protection payments extorted from firms in the "informal" sector, the prevalence of barter rather than cash payments to avoid the punitive tax system, violations of minority shareholder rights, crony bank lending to clients with ownership ties, and bribes extorted by government officials -- can be traced to policy or regulatory failures. It is precisely these problems that the IMF has been trying to correct, through its support for competition, tax reform, improved corporate governance, more firm and government transparency and disclosure, stronger bank supervision, and restraints on the discretion and scope of government regulation.

Moreover, on a bilateral level, legal reform and the battle against corruption have long been a central focus of Vice President Gore's work with the Russian Prime Minister and President Clinton's dialogue with President Yeltsin. To cite just one Treasury-related example, we are working with Russia to curb money laundering through promoting passage of legislation which criminalizes money laundering and consulting on the creation of a financial intelligence unit.

IV. Prospects for the Future

It would be difficult to exaggerate the uncertainties of a moment such as this one. Until there has been a resolution of the direction in which the Russian political authorities will go it is difficult to calibrate an appropriate international response. The United States has a strong stake in Russia successfully overcoming today's crisis and laying the grounds for a more stable future -- by carrying out the kind of macroeconomic and structural reforms included in the IMF program. We will strongly support a Russian government that is determined to carry out these changes and continue the process of democratization. But international programs have always to be built on the recognition that countries shape their own destiny: the Russian authorities and the Russian people themselves have to choose their own path.

With this basic warning in mind let me just make three basic points that will guide the approach of the international community going forward.

First, it is critical in the present climate of mistrust that the government present a coherent economic strategy and that the strategy be Russian- "owned". The new government of Russia has asked to be judged on its actions. And so it will be. But Russian commitments must precede its actions. A critical step toward regaining the confidence of Russians themselves and winning the support of the international community will be for the government to explain its approach to restoring stability and fulfilling its international obligations -- and to describe clearly how this approach is to be implemented.

Second, while any plan must be pragmatic and respond to the political conditions facing the government, it has also to recognize that Russia cannot repeal basic economic laws. Russia has its own unique history and traditions and it will have to make its own decisions about specific institutions and market arrangements. Yet, as President Clinton said in Moscow earlier this month, if the past year has taught anything it is that no country can escape the imperatives of the global marketplace. Money cannot be printed in excess without causing inflation. And an exchange rate peg that is not combined with appropriate monetary and fiscal policies will not hold.

By devaluing and restructuring debt, Russia has taken drastic measures to cope with failed policies. Russia's authorities urgently need to clarify those steps and begin a cooperative dialogue with official and commercial creditors. They must resist pressures to spend and lend which will doom the economy to another bout of high, perhaps hyper- inflation. Just as important, they need to take on the failings of the financial system and finally put in place the core institutions and policies of a private market economy.

The broader long-term challenge that Russia faces in the wake of this crisis is finally to create an environment in which business and investment can flourish. That means sound money, the rule of law, fair tax laws and enforcement; private ownership and free land markets; independent courts that enforce laws and contracts; strong banks that safeguard peoples' savings and channel those savings to productive private investment; securities markets that deter fraud and protect legitimate investor rights; social spending targeted to those really in need, and it means the prevention of hidden, anti-competitive ties between government and business interests.

Finally, let me add that to the extent that international finance is used to support Russia we will and must work to ensure that they reach the parts of the population that need help -- not just enrich off-shore bank accounts. Our confidence in making this judgment will speak to the Russian authorities' commitment to rooting out some of the underlying flaws of Russia's reform process that have held it back for so long -- not least, the growing popular belief that only those with poor connections play by the rules.

Many will argue that the present crisis and politics make the chances of Russia taking this course remote. But if the greater connectivity within the world economy and more rapid flow of capital around the world has meant that these kinds of problems come to the surface more quickly -- it can also mean that where they are addressed, capital and growth can return that much faster. And while it is true that reforms can cause economic dislocation of workers that may have negative consequences for reform-minded governments, the economic political consequences of a failure to reform -- and continued decline in the economy -- would be graver still.

Russia faces a choice, to restart, accelerate and deepen reform, or to drift in dangerous policy directions. As President Clinton said, "There is no shortcut to developing a system that will have the confidence of investors around the world. These are not American rules or anybody else's rules. These are [the rules] in a global economy." We all have an interest in Russian economic success and the President made clear that the administration is ready to offer further assistance if Russia stays with the path of reform. But the choice is for Russia, and Russia alone, to make.

Thank you. I would now welcome any questions.