David J. Kramer, Associate Director, Russian And Eurasian Program

Testimony before the House Committee on Banking and Financial Services,June 10, 1999

Mr. Chairman, it?s an honor to appear before your Committee today to testify on a most important subject, "The State of the Russian Economy and the U.S. Policy Response." This hearing comes at a time when U.S.-Russian relations and Russia?s relations with the West more broadly are arguably at their lowest point in the post-Cold War era. Notwithstanding the recent cooperation Russia provided ? belatedly ? on seeking a resolution to the conflict in Yugoslavia, U.S.-Russian relations have soured over a number of issues. These include, in addition to the bombing of Yugoslavia, competing interests in the Caspian region, NATO expansion, Russian technology and weapons transfers to rogue states such as Iran and Syria, differences over policy toward Iraq, the failure of the Russian Duma to ratify Start II, American intentions to develop an anti-missile defense system, even claims of Russian dumping of steel on the U.S. market.

Once hailed as a "strategic partnership," the relationship between Russia and the United States began floundering well before the latest disagreement over Yugoslavia. Many in Russia, a weakened former superpower, resent the U.S. for its perceived muscle-flexing and unilateralism. Russia?s decline as a major global player was epitomized by former Prime Minister Yevgeny Primakov?s dramatic move in March to turn his plane around over the Atlantic on the eve of NATO?s bombing campaign; this was the best response Russia was able to muster. Before Russia was brought into the search for a diplomatic resolution to the Kosovo crisis, Russian objections to military action were completely dismissed, reinforcing Russia?s sense of weakness and irrelevance. Overall, the clumsiness and disregard with which the Clinton Administration is perceived to have handled relations with Moscow encourages a growing anti-American sentiment on the part of Russian politicians.

Even before NATO?s actions against the Serbs, anti-American sentiment in the halls of the Russian State Duma and among Russia?s policy elite was on the rise. Since the NATO bombing campaign, in addition to the damage done to prospects for START II ratification, Russia?s participation in the NATO Partnership for Peace was suspended, and Moscow chose to sit out NATO?s 50th anniversary summit meeting in Washington in April. Based on the Russian military?s negative reaction to the peace deal struck last week, the issue of Russian participation in the peace-keeping operation in Kosovo could further sour relations. From Moscow?s perspective, the frustration of no longer being a superpower is compounded by continual affronts by the United States to Russian diplomacy.

Despite the widespread opposition to NATO?s campaign in Yugoslavia (the share of Russians with a "mainly bad" or "very bad" view of the U.S. more than doubled from January to April, from 23% to 49%), the majority of Russians recognize that maintaining good ties with the West is in Russia?s long-term interests. Moreover, Russia?s dependence on international financial support requires such good relations, though seven out of ten Russians polled last month believe Russia is excessively dependent on the West.

Unfortunately, among many in the U.S., there is growing apathy toward Russia. And often when people in this country do pay attention to what is happening in Moscow, they view matters with a highly critical and even anti-Russian attitude. Russia, of course, provides ample justification for such criticism with its behavior and rhetoric. With news reports about corruption appearing almost daily, Russia appears to many critics as a hopeless and helpless sinkhole undeserving of any further financial support. After the disappearance of last July?s $4.8 billion International Monetary Fund tranche and the continuation of capital flight out of Russia, many have argued against the IMF?s recently promised resumption of support, saying that this new installment of $4.5bn simply amounts to "throwing good money after bad." Moreover, critics charge, we should not be held hostage to the Russian scare tactic that, without assistance, control over Russia?s nuclear weapons may become less secure.

Mr. Chairman, this hearing is a welcome opportunity to discuss Russia and to examine how the West has responded to developments in that country. I have been asked to set the scene for our discussion and to provide a context that I think is necessary for considering the whole issue of U.S. and Western aid. Let me say up front that I support, albeit reluctantly, the new $4.5bn being proposed for Russia from the IMF, with one crucial caveat: the entire $4.5bn should be transferred from one IMF account to another IMF account in order to help offset Russia?s debts this year to the Fund. It should not be transferred to Moscow where it will quickly vanish as happened with the $4.8bn last July. We simply cannot risk the possibility that billions of dollars will once again disappear into foreign bank accounts or be misused by corrupt officials.

The reason I am a reluctant supporter of the IMF money is that I, like many observers, am troubled by the constant political machinations in Moscow. The replacement of Yevgeny Primakov with Sergei Stepashin underscores the unpredictability and instability of Russia?s political system, which is subject to the whim of one man, Boris Yeltsin.

But my support is not predicated on whether Primakov or Stepashin is premier ? or even whether Yeltsin, whom I consider the biggest obstacle to Russia?s hopes, remains president. Quite simply, regardless of who heads Russia?s government, it is in our interests for Russia to avoid a default on its debts, an outcome virtually guaranteed without IMF support and with unpredictable consequences. A default would shut Russia out from any possibility to receive international support for years, a price Russia should not have to pay in the future because of weak, incompetent, and corrupt leadership now. Despite the Russian government?s economic mismanagement, the West should do what it can -- understanding that there are limits to what it can in fact do -- to prevent Russia from becoming a rogue state, an outcome the chances of which would be increased by a default. As Russian commentator Otto Latsis recently observed, with slight exaggeration, in the Russian newspaper, Novye Izvestiya, IMF support is crucial: "Its failure or success will determine whether we will be able to solve the problem of foreign debt for years to come or whether the avalanche of payments will bury us here and now."

As it is, Russia is facing great difficulty in meeting its foreign debt payments, which in 1999 alone amount to more than $17bn. To put this in perspective, Russia?s federal budget revenues are projected to be slightly more than $20bn this year. Just last week, Moscow failed to meet a payment of over $500m on its Soviet-era debt to the London Club of commercial creditors. More than two-thirds of Russia?s foreign debt is from the Soviet era. The $4.5bn proposed by the IMF would, in essence, amount to a rescheduling of Russia?s debt to the Fund. Additional rescheduling of Russia?s debt payments by both the London and Paris Clubs and possibly even forgiveness of some Soviet-era debt should follow an IMF package. These steps would amount to a recognition by the West of what will happen in any event, and the West might as well claim some credit for it. It should not, however, be viewed as a waiver of Russia?s financial obligations nor an endorsement of the Russian government, given that its handling of the economy has not merited such backing. To underscore Western concern about the lack of reform, World Bank money that has been expected to follow an IMF accord should be withheld. World Bank money would not solve, even temporarily, Russia?s debt problems; instead, given the Bank?s track record with past loans, new money would likely disappear if lent directly to Russia.

Some observers have argued that the West missed an opportunity at the outset, in 1992, to have provided a massive amount of aid to Russia on the scale of the Marshall Plan. Leaving aside the difficulty in rallying Western support for a massive aid package, the inability of Russia then to have absorbed large inflows and the government?s wavering path toward reform would have resulted in the misuse and loss of billions of Western dollars. We kid ourselves and grossly exaggerate our influence if we think the West could have tipped the balance early on in favor of the reform-oriented government. The failure of people like Yegor Gaidar and Anatolii Chubais to build a political base for their program and their inattention to the social implications of what they were trying to do were their fault, not the West?s.

Moreover, since 1992, Russia has received tens of billions of dollars in assistance from the West, including more than $2bn from the U.S. (not counting Nunn-Lugar military assistance) through the Freedom Support Act. My main complaint with U.S. assistance is that it has tried to cover too much ground and as a result has spread itself too thin; instead, our aid program should concentrate on just a few goals. Germany has provided tens of billions of dollars in aid, largely as compensation for the reunification of Germany and the withdrawal of Soviet troops from former East Germany. While not intended, the large sums of money lent to Russia in the past seven years have significantly added to Russia?s debt burden. Furthermore, international assistance has, paradoxically, contributed to Russia?s problems to some extent by removing the incentive to reform and serving as a crutch for Russia to fall back on.

The IMF has loaned Russia roughly $20bn over the past seven years. Last July, on the eve of Russia?s financial meltdown, the IMF agreed to provide $11.2bn in new loans, part of a $22.6bn aid package involving the World Bank and Japan. Under pressure from Western governments eager to appear to be doing something with Russia on the verge of economic collapse, the Fund lent Russia $4.8bn weeks before the economic crisis last August. That money quickly disappeared, achieving absolutely nothing, as Russia soon thereafter devalued the ruble, defaulted on its debt, and froze debt payments. Treasury Secretary Robert Rubin, testifying before a House appropriations subcommittee this past March, acknowledged that much of the $4.8bn lent to Russia last summer "may have been siphoned off improperly." The IMF?s record in tracking its loans to Russia leaves much to be desired. Former Central Bank director Sergei Dubinin has admitted that a secret offshore firm, Fimaco, now under investigation was used to manage some of the IMF funds dating back to 1993, a practice that continued until 1996.

The IMF?s sister institution, the World Bank, has not fared much better in Russia. The Bank has approved more than $11bn in loans for 40 operations in Russia since 1992, and pledged an additional $3.2bn to Russia last July. Following the economic crisis, the Bank suspended this aid until this past April, when it announced it would restart the aid. After the sacking of Yevgeny Primakov, however, whom Bank President James Wolfensohn called Russia?s "best chance," the Bank once again suspended its lending to Russia. That, in my opinion, is just as well, given problems with some of the Bank?s loans. A $500m loan to help restructure the coal industry in 1996 and 1997, for example, is unaccounted for and has been the subject of several investigations in Russia. The Bank, in fact, much like the IMF, does a poor job of tracking where its money goes.

With all this money lent to Russia in support of the country?s reforms, why aren?t Russia and U.S.-Russian relations in better shape? For one thing, some of the advice and technical assistance that has been offered to Russia has been faulty, to say the least. Under IMF pressure to increase government revenues in 1995, for example, Anatolii Chubais launched the notorious loans-for-shares program which contributed enormously to the discrediting of Russia?s privatization efforts. More recently, the IMF, with its emphasis on boosting revenues, has insisted that Russia?s Duma pass legislation that would include postponing a cut in the country?s Value Added Tax from 20% to 15% and increase taxes and tariffs on alcohol and imports, among other things. Russians need tax relief, not higher taxes. An increase in rates and fees will certainly not solve the problem of tax compliance. That is why I am not enthusiastic about the conditions attached to the latest IMF package, even though the Duma has shown a surprising willingness to consider some of the legislation the IMF says must be passed before any loan is made.

Attributing Russia?s problems to faulty advice from the West, however, tends to overstate the influence of Western advice and support. The responsibility for what has happened in Russia lies first and foremost with Russia?s leaders since 1992.

More importantly, Russia has an enormously difficult legacy to overcome and to expect that its development would be much better than it has been is to expect too much. Contributing to the perception that things are so bad has been a tendency, particularly in the first half of this decade, among many analysts and government officials¾ Russian and Western¾ to overbill and exaggerate the progress Russia has made since 1991. They have prematurely treated Russia as a democratic market economy. Similar exaggeration has been made regarding the state of U.S.-Russian relations, particularly when Andrei Kozyrev was foreign minister.

On the economic front, Clifford Gaddy and Barry Ickes have aptly described the "virtual economy" in Russia. Until last August, inflation was held in check largely by not paying workers or pensioners, creating a vicious circle of nonpayments in both the public and private sectors. The ruble remained relatively stable until the August 17 depreciation because most people engage in barter rather than cash payment. An enormous government bureaucracy and insider deals have created a country rife with corruption, and an inadequate rule of law and a terribly burdensome tax system discourage not just foreign investment but domestic investment as well. (According to a recent United Nations report, foreign direct investment in Russia, one of the best gauges for measuring a country?s economic progress, dropped from $6.2bn in 1997 to $2.2bn in 1998.)

This is not to say that there has been no economic progress in Russia in the past seven years. De-statization of much of the economy, the emergence of a private sector and middle class, and the downsizing of military spending are all laudable achievements. But Russia still has a long way to go before it can be properly classified as a market economy.

According to some indices, the dire predictions for Russia?s economy stemming from last August?s crisis have not come true. Inflation, which rose to 84% last year, has slowed to 22% over five months so far this year (in May it was 2.2%), and Russia?s Central Bank reserves have held at roughly $11.6bn. Unemployment, by comparison, has risen by 2.3 million since last August to 10.4 million, and the percentage of Russians living below the poverty line has reached nearly 40%. By elevating Russia to "G-8" status?even if this move was not made for economic reasons?the U.S. and the West contributed to the sense that there is more to Russia and its economy than actually meets the eye. Russia?s attendance at next week?s annual G-8 meeting in Cologne, Germany as the country teeters on the brink of default will be farcical.

Politically, Russia has discarded the Soviet system and maintains a constitution that all political forces have observed since 1993. But the set of rules laid out in the constitution heavily favors the president and was approved in a December 1993 referendum without significant debate or reflection. Perhaps it is only due to an often weak and ineffectual Boris Yeltsin, who has exploited the vast powers endowed to the presidency only intermittently and erratically, that the Russian constitution has been accepted so widely. Certainly it is better that Russian politicians continue to play by the rules, but let us not forget that those rules fall short of an ideal system of government. While elections remain the way to power, the 1996 presidential election was far from pristine and the next election, whether in 2000 or sooner, is unlikely to be much better.

If more realistic assessments of Russia had been offered in the past, the disappointment we are now feeling over Russia?s current plight might not be so serious, or surprising.

After all, it is difficult to overstate the challenge Russia faces in trying to overcome the horrible legacy and debilitating impact of seven-plus decades of authoritarian, centrally planned rule. Upon the breakup of the Soviet Union, many observers said it would take a generation at least for Russia to recover from this legacy. We are only eight years into this transformation. Some observers have been premature to declare the worst over and the battle won; others have set unreasonably high hurdles for Russia to clear and short timetables for Russia to meet.

Soviet-style thinking led Russia?s so-called reformers in the early 1990s to rely on Yeltsin?s authority and power to bulldoze reform measures through the parliament rather than build a wide social and political base in support of reform. When Yeltsin was engaged, that approach had moderate success. However, more often than not, Yeltsin failed to provide the support that the reformers needed?and which they could not find elsewhere. Unfortunately, Yeltsin has demonstrated over the years that he cannot be relied upon to provide sustained support for any policy; instead, he chooses the politically expedient route to keep himself in power?often at the expense of reform. Moreover, Russian reformers? dependence on Yeltsin created a situation where the West, the United States in particular, blindly supported the Russian leader. This reliance on one man?Boris Yeltsin?has come back to haunt both Russian reformers and U.S. policy.

This is the other important issue to keep in mind about Russia. Until Yeltsin leaves office, there is no chance that the situation in Russia will improve. He is Russia?s biggest obstacle to a brighter future. Since winning reelection in July 1996, Yeltsin has squandered opportunities to lead Russia on the right course. His ill health has sidelined him repeatedly and accounted for erratic behavior. He has become practically irrelevant politically, yet until he is replaced, Russian politics will remain in a state of suspended animation as everyone awaits his successor. Until then, the United States has little choice but to continue to deal with Yeltsin. After all, he remains Russia?s duly elected president. But we should recognize that the agreements he signs or promises he makes are often worth very little (one can recall his March 1997 pledge in Helsinki to move the START II treaty through the Duma). Even his recent decision to weigh in on Kosovo might prove to be ephemeral, for not too long ago he was warning that NATO?s actions could precipitate World War III. There is talk in Moscow that the "Yeltsin Family"-- as the extended circle of influential advisers around the Russian leader, including his daughter Tatyana, is called ? is figuring out a way to postpone next summer?s presidential election to keep Yeltsin in power. If these rumors get more serious, the U.S. should do all it can to persuade the Russian president that this would be disastrous for his country and for Russia?s relationship with the West.

Despite the weakness of the current president, the Russian presidency remains a powerful position, as evidenced by the three times in the past 14 months that Yeltsin has exercised his constitutional authority to dismiss his prime minister. The Chernomyrdin firing in March 1998, in particular, created a sense of instability and unpredictability in Russia that badly shook investors?both foreign and domestic. Chernomyrdin was certainly not the staunchest reformer in Russia, yet he was someone with whom many investors felt comfortable. His abrupt dismissal, while certainly not the trigger of Russia?s crisis, was a major contributing factor.

The firing last August of Sergei Kirienko was no surprise ? Yeltsin needed a scapegoat for Russia?s economic plight. Yet his decision last month to sack Primakov underscored the whimsical nature of Russian politics and the influence wielded behind the scenes by people like business magnate Boris Berezovsky. The fallout from that move has shown that power politics and competition among various interest groups drown out any prospect for responsible leadership in Russia.

Some analysts in Russia and the West demonized Primakov and rejoiced at his firing. He was too close to the Communists, argued Chubais on a recent trip to Washington; he was too anti-American, critics in this country charged. Yet Primakov, the ultimate pragmatist who had emerged as Russia?s most popular politician and succeeded in stopping the economic hemorrhaging inherited from his predecessors, represented, to the extent one can, consensus thinking among Russia?s policy elite. His intervention on behalf of Saddam Hussein in 1991 and Slobodan Milosevic this year were irksome, to say the least, but they were not free-lance operations. His successor, Sergei Stepashin, who played a major role in the fateful decision to send Russian troops into Chechnya in 1994-95, has been touted by Chubais and others as "representative of the new generation of Russians." The new generation, in my opinion, can do better than this.

There are those who argue that Russia should be allowed to deteriorate to a point where the current regime fails and the "reformers" are brought back to power. Their return is highly unlikely, however, and would not be supported by the Duma in any event. Moreover, viewing them as "saviors" is inconsistent with the fact that Russia?s crisis occurred under the reformers? watch.

Notwithstanding the political shenanigans in Moscow, Russia has survived another winter despite dire predictions of starvation in some remote regions. Indeed, life has been tough for many people since the crisis last August. Yet for most, life has been difficult for many years, both during and since the Soviet period. Russians have an uncanny knack for "getting by" and have demonstrated once again a high level of tolerance for erratic and often inept government behavior. Fears of starvation, voiced in the early 1990s, were never realized. Without underestimating the seriousness of the current problem, the picture that has been painted over the past few months is equally overblown.

The U.S. Department of Agriculture, eager to help domestic farmers, has been the major force behind food aid. But the aid that was supposed to have helped Russians survive a tough winter only started arriving in St. Petersburg in mid-March. As in the early 1990s, the risk again is that U.S. food aid will not help those in need, but instead line the pockets of corrupt government officials. Stepashin just last week ordered an investigation into how food aid to Russia is distributed because 30% of humanitarian aid was "routinely stolen" in the past, he said.

That we are back once again to providing emergency aid nearly five years after the West moved from sending humanitarian assistance to Russia to more sophisticated technical assistance programs is disappointing. In particular, Russia could face a serious shortage of pharmaceuticals. But as with food aid, there is an enormous problem in properly distributing emergency drug shipments.

What else can we do? Frankly, not much beyond supporting the IMF package. Student and professional exchange programs, a staple of U.S. assistance since the Freedom Support Act in 1993, remain the most effective way of helping Russians help themselves. We also need to place greater emphasis on the regions and bring governors (who are also members of the Federation Council) and others from Russia?s regions outside of Moscow to the United States. "Nunn-Lugar" defense conversion assistance is important to maintain as well.

The United States is faced with a true dilemma: while recognizing the little influence and serious limits of what it can achieve in Russia, the U.S. also has too big a stake in Russia to avoid action entirely. It is almost truistic to point out Russia?s importance as a major nuclear power, its geostrategic location, and its economic potential. Moreover, Russia?s role toward the end of the Kosovo crisis shows it can at times play a positive role in world affairs. At the same time, until Yeltsin makes his departure from the scene in one way or another, little will change in Russia, with or without our help.

Nevertheless, staying engaged during the remainder of Yeltsin?s tenure is vital for our future relationship with Moscow, and the IMF deal, if handled properly, will demonstrate that the West still cares about Russia. Neglect and disengagement now would only lead to a much higher price to pay in the future.

As Secretary of State Madeleine Albright said during a speech in Chicago last fall, "We cannot say that Russia has lost its way when in fact it has just begun its journey. Nor can we say that Russia is ours to lose. We can help Russia make tough choices, but in the end Russia must choose what kind of country it is going to be." Indeed, Russia is not ours to "lose," just as Russia is not ours to "win." All the support and aid in the world will not make a difference if Russia and her leaders do not get serious about reform and overcoming the Soviet, communist legacy. Where we can make a difference, we do so at the margins at best.

Mr. Chairman, just as many observers were premature in declaring victory for democratic, market forces in Russia, we now need to avoid prematurely sounding the deathknell for that country and the U.S.-Russian relationship. Realistic expectations and honest assessments of "where we are" are long overdue on both sides of the ocean.

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