Bailout of the Kremlin: How U.S. Pressed the I.M.F.

By Michael R. Gordon and David E. Sanger, The New York Times, 17 July 1998

Seven weeks ago the chief of the International Monetary Fund, Michel Camdessus, assured the world's financial markets that there was no reason to panic about Russia.

Contrary to what markets and commentators are imagining, Camdessus insisted as investors were fleeing the Russian markets, this is not a crisis. This is not a major development.

This week, in a complete reversal, the I.M.F. and the Russian government announced a bailout package that will inject $17.1 billion in new loans to the beleaguered nation over the next 18 months.

The Clinton administration was the driving force behind the reversal, impelled by the specter of Russia's financial collapse. United States Treasury officials were worried that while negotiations with the Russians dragged on over forcing real economic change, the political peril to the government of President Boris Yeltsin was growing. They pressed the fund to nearly double the amount of money it was willing to lend to Russia, even though it depleted the I.M.F.'s own resources for fighting the economic contagion that is spreading beyond Asia.

The Russian saga once again casts a spotlight on the critical decisions made by the I.M.F. at a moment when the Asian financial crisis has made the institution more powerful than at any time in its 52-year history. I.M.F. critics charge that in this case, fund officials underestimated the gravity of the crisis and dragged out the negotiations while the markets turned against Russia and the eventual cost of the bailout rose. I.M.F. officials counter that it would have been a waste of money to offer yet another bailout to Russia without extracting a commitment to fundamental economic changes that are painful and politically unpopular.

By last week, the negotiations turned into a race to rescue the Russian economy before the government's financial reserves were exhausted. Without new funds, Russian officials feared they would run out of money to prevent a default on Russia's debt and prop up its currency by the end of the month.

Last week was the most dangerous period, Yegor Gaidar, the former prime minister who is now an economic adviser to Yeltsin said in an interview. If we followed all the standard procedures, the money would have arrived too late. I think the position of the leading industrial nations was very constructive and the U.S. Treasury helped a lot.

The final package is not a permanent solution; it buys time for what U.S. officials believe is the most reform-minded government in Russia in years. In Washington, however, there is palpable nervousness about the deal that was struck. It is unclear whether Yeltsin and his new prime minister will be able to fulfill their commitments to remake their economy.

The accord has sparked a rally in Russian markets. On Thursday, after a series of ups and downs, the lower house of Parliament approved key parts of the package as the Kremlin rushed to fulfill the I.M.F. requirements before the fund convenes on Monday to consider the rescue package. We view this very much as a last chance for Russia, said Stanley Fischer, the No. 2 official at the I.M.F., who directed the negotiations for the fund. The country is running out of time. leaders, the two U.S. officials who have focused on Russia's economic reform went to Moscow to take the temperature.

One was Lawrence Summers, the deputy Treasury secretary, a former Harvard economist who has come to personify the new face of U.S. financial power around the world. The other was David Lipton, a Treasury under secretary for international affairs, an intense, 44-year old who has cultivated a strong relationship with Russian economic strategists.

The economic crisis that began a year ago in Asia has been a worry for Russia for months. As investors fled emerging markets, it was becoming more difficult for Russia to finance its chronic budget deficits by selling treasury securities. European and U.S. bankers were offering loans but they were pricey, and Russian officials had been exploring the possibility of additional credit for the Central Bank's reserve of foreign currency.

But the new Russian government, fresh from a bruising battle in the Communist-dominated Parliament to confirm the new prime minister, was still trying to find its footing.

In talking with their Moscow counterparts, Summers and Lipton cautioned the Russians that they were too absorbed in their own political and economic problems and insufficiently focused on the risk that they would catch the Asian flu, a panicked retreat by investors.

The Russians, however, were not alone in underestimating the potential fallout from the Asian crisis. The I.M.F. was also slow to respond, and when it did, critics say, it fueled investor anxiety by refusing to disburse the next part of a loan to Russia.

The monetary fund, which was created after World War II to stabilize currencies and foster economic growth, has been a leading proponent of better management of Russia's shaky economy; lower inflation, smaller deficits and better tax compliance. And while the fund has been impressed with Kiriyenko and his new team, the relationship between the fund and the government is not always good.

I.M.F. officials complain that the Russians have failed to keep a series of promises they have made since 1992. For their part, Russian officials say the fund is constantly changing its Russian team and that some officials have a shallow understanding of the nation's complicated politics.

Most of the time, however, the tension is kept under wraps. But it burst into view in late May when the two sides tried to settle what Russia needed to do to receive the next $670 million disbursement of a three-year, $10 billion loan.

The talks went badly and Russia did not get the money. Martin Gilman, the chief I.M.F. official in Moscow, warned publicly that Moscow had not done enough to get the money and pointedly said he could not predict when the matter would be discussed again.

Such a statement was very bad news for the market, Sergei Alekshashenko, the deputy chairman of the Central Bank, said in an interview. I have negotiated with the fund for five years and I cannot think of a single case in which the fund has made such a statement.

If the Russians were shocked, alarm bells rang when the bond and stock markets began a new week. Interest rates on loans to Russia shot up, a sign that investors considered them a risky buy, and the Russian stock market sank. Last year, Russia was the world's best performing emerging market, but it is down 50 percent since the start of the year and tied with Indonesia for the world's worst performance.

With the markets deteriorating, Kiriyenko made a late-night phone call to Camdessus, the fund's managing director, and assured him that the Russians were serious about changing their ways. The I.M.F. then rushed out a statement praising the Yeltsin government's reform program and Camdessus issued his this is not a crisis line. To try to stop the panic, John Odling-Smee, the head of the monetary fund's Russia department, flew to Moscow to complete the negotiations for the $670 million disbursement the fund had been blocking.

But investors were pressing for a new, larger loan package to strengthen the Russian Central Bank and to restore their confidence in the economy. The problem was that the bank's hard currency reserves were shrinking as it was using millions of dollars each business day to pay off investors and prop up its currency.

Judging by the I.M.F.'s public remarks, though, it looked like it had little interest in organizing a rescue and did not understand the extent of the crisis.

So Yeltsin went directly to the power behind the fund: the Clinton administration. He dispatched to Washington the Russian with the most credibility in the West, Anatoly Chubais.

Chubais had run Russia's privatization program and was highly regarded, although he is one of the most contentious figures in the country. Many Russians blame him for the pain and confusion of their country's jerky transition to capitalism, and powerful business leaders have never liked the fact that he had refused to do their bidding.

Chubais had left his top Kremlin post as part of the shake-up that brought Kiriyenko to power in the spring. He now runs Russia's electrical monopoly, United Energy Systems.

Chubais was joined by Sergei Vasiliev, deputy chief of staff for the Russian government and aveteran of the behind-the-scenes battle for economic reform.

Arriving just before the long Memorial Day weekend, the Chubais team headed straight for the Treasury building next to the White House.

They came not for money but for reassuring words of praise and for a public commitment from Clinton that if Russia needed more aid, the United States would lend its support.

The next morning, Chubais and his associates drove through the diplomatic enclave of northwest Washington to the home of Strobe Talbott, deputy secretary of state and longtime Russia expert.

Talbott told them that Clinton was willing to support additional financial help to Russia under the right conditions.

The Russians drove on to Summers' house in the Maryland suburbs. Lipton and other top Treasury officials were there, all wearing blue jeans and sport shirts. The Russians were in suits and ties, preparing to meet later with the ever-formal Alan Greenspan, chairman of the Federal Reserve.

Over bagels, muffins and orange juice, Chubais made his appeal: Washington had an historic opportunity to help Russia.

It used to be that there were only a few reformers, Chubais said. Then there were a good number of reformers. In this government, he said, They are all reformers.

As the conversation shifted to tactics, the group decided that the United States would send a signal that it stood behind Russia. But it would have be carefully worded so that Congress would not be inflamed at the idea of another bailout. In return for aid, there had to be substantial reforms. The Russians would also have to tap commercial banks so that it was clear that not all of the burden fell on the monetary fund.

It had to be clear that we would help out, that if they didn't take real action this time, they were headed over the cliff, a senior U.S. official said.

The next morning, a Sunday, Clinton issued a brief statement saying the United States would support assistance with conditionality.

Clinton never mentioned any figures but Russian officials say the two sides agreed on $5 billion to $10 billion. The Americans favored the smaller number; the Russians the higher number. Quietly, the I.M.F. and the Russians opened negotiations over the rescue package. Their focus was not on how much money was needed, but on what Russia had to do to qualify for the loans.

Fischer, the fund's No. 2 executive and a former economics professor at the Massachusetts Institute of Technology, said his principle was simple: The amount of aid would be linked to the depth of the reforms. More reform, more cash. The fund was not in the business of throwing money into a country to calm financial markets, he said.

It is fund doctrine that the stronger the measures the country takes the more assistance the fund can provide, he said.

Some Western economists however, insisted that the I.M.F. was too doctrinaire. They insisted it would make more sense for the fund to first determine what was needed to ease market turmoil and then tell the Russians what they would have to do to earn it.

Nor was meeting the requirements an easy task.

In a confidential memorandum, the fund handed Russian officials a tough list of demands A main one was that the Russian budget deficit had to be drastically reduced from 5.5 percent of the nation's output to between 2 percent and 2.5 percent.

The plan made fiscal sense. Interest payments on Russia's debt were eating up 30 percent of the Russian budget. But the Russians were worried that they could not meet such an ambitious target and that they would be faulted for again promising something they could not deliver. Yeltsin had submitted his own anti-crisis plan to the Parliament. But the I.M.F.'s analysis indicated the plan only went half way to meeting the goals.

To meet that target the government would not only have to slash spending, it would have to beef up tax collection , an enormous challenge in a country where major companies thumb their nose at the State Tax Service and only 4 percent of the population filed tax returns.

While the demands were considerable, it was far from clear that the money the fund had in mind would be enough. The I.M.F. informed the Russians in early July that it was prepared to offer $5.6 billion in additional loans.

As the negotiations dragged on, the Russia economic picture worsened. A second attempt to sell off Russia's state oil company, Rosneft, stalled. To attract investors, interest rates on Russian debt had risen higher than the rates paid by Nigeria, which was convulsed in its own political turmoil. Russian coal miners, angry that they had not been received their wages, set up a squatters camped outside Kiriyenko's government offices and demanded Yeltsin's resignation.

Returning from Clinton's nine-day trip to China, U.S. officials focused anew on Russia and were alarmed by what they saw.

We had a sense that Kiriyenko was running out of steam and that the Russian government was getting politically more vulnerable a senior State Department official said.

The sense of crisis was driven home when the Russians offered record interest rates at an auction for Russian treasury bills on July 8 but were unable to attract enough buyers.

Now, Chubais and other top Yeltsin aides were becoming increasingly desperate. The finance ministry's ruble reserves to pay off maturing treasury securities were shrinking fast. The Russian government's internal forecast also showed that the Central Bank reserve of hard currency, the funds it uses to prop up the ruble, would soon fall to $12 billion from twice that level a year ago. (By comparison, China has reserves of about $150 billion.)

Worse, every day the markets were open, both reserves were dwindling and it looked like the government would be out of money before the negotiations with the I.M.F. would be wrapped up at the end of the month.

Chubais urgently appealed to Washington and, at Treasury's urging, the I.M.F. doubled its offer to Russia to $11.2 billion. The World Bank kicked in several billion more. Japan made good on a $1.5 billion loan promised to Yeltsin last April.

But the United States, which had offered $3 billion each in direct, backup financing to Indonesia and South Korea last year, offered nothing to Russia. Officials feared that if they did, Congress would rebel, further threatening long-standing efforts in the House of Representatives to increase funding to the I.M.F., itself increasingly stretched.

Instead, the United States and its allies agreed to lend the fund $23 billion through an I.M.F. loan program not used in 20 years. The I.M.F. insists that its tough approach worked. Yeltsin committed himself to a far-reaching effort to get Russia's runaway budget under control. What we had to do was accomplish real reform, to get the Russians out of this cycle of a crisis every six months, Fischer said.

But there are doubts about the I.M.F.'s approach.

The I.M.F. was slow to recognize how serious the problem had become, Marc Holtzman, the president of corporate finance for ABN Amro, a large Dutch bank said this week. When they were finally pushed, the fund did the right thing. But had the fund done the same thing four to six weeks earlier, it could have averted a lot of pain. The fund would have gotten away with a package half the size.