Promises of banking restructuring have turned out to be sham. Meanwhile the Russian economy looks to be on hold until the war in Chechnya is resolved and a new president is installed.
But there are some signs of recovery, reports Ben Aris. “The only business in Russia is politics,” said Russian oligarch Mikhail Khodorkovsky. When he made this comment two years ago, it was true. But the devaluation of the rouble on August 17 1998 destroyed the so-called Russian oligarchs and broke their hold on power. Average incomes have tumbled, life expectancy has begun to fall again and hundreds of small and medium enterprises have been killed off. With a depressed economy, those in power scrambled to grab what little money was available. Russia is now the riskiest country in the world for investors and ranks among one of the most corrupt. The government has become more intrusive, returning to the principles of central planning in some sectors. Shareholder and investment rights abuses are now more blatant as businesspeople, facing an unpredictable future, have sought to consolidate their control over the best companies and businesses while they can. The picture is bleak, but not hopeless. Devaluation has also forced a much-needed restructuring on Russia. With a cheaper rouble and an absence of imports, the balance of payments has improved and Russian industry, smothered for nearly a decade by an overpriced rouble, has been booming. Many of the banks and firms have collapsed, but those that remain are leaner and more commercial as competition increases. While politics is still profitable, many companies have seen that money can be made from business alone. The rise in international commodity prices, especially oil, has put Russia on a solid financial footing. As long as oil prices do not fall again, Russia will no longer need to depend on IMF and World Bank handouts. For the first time since 1991 the economy is growing, albeit from a low base, and despite, rather than because of, government policy. With historic parliamentary and presidential elections over the next six months, politicians are distracted by electioneering and the war in Chechnya, and have left the economy on autopilot. All attempts at reform have stopped. Whether they will be started again, and what shape they will take, depends on which leader the people elect. Banks Russia's financial sector was the most sophisticated part of the economy and the worst hit by devaluation. The dominant banks at the centre of Russia's financial industrial groups (figs) belonging to the seven so-called oligarchs, were mostly destroyed. The financial crisis also tore through the smaller independent banks. From a peak of 2,500 banks in Russia, an estimated 1,500 are still functioning, and analysts think that no more than 200 or 300 of these are liquid. The government's greatest failure was not reforming the banking sector. The Central Bank of Russia (CBR) has shown itself incapable of forcing restructuring and seems to pander more to powerful business people rather than worry about health of the banks. Although the CBR withdrew a few licences the moves were too few, and too late. “I am surprised that CBR didn't install temporary administration in any of the banks [following devaluation]‚” says Sergei Ivanov, a bank analyst with Troika Dialogue, Russia's largest brokerage. “Nor have they said anything about these banks' ability to repay their debts.” Household names such as SBS Agro had their licences removed 18 months after they were first crippled and have moved everything of value into parallel banks or off-shore, leaving behind debt-ridden hulks. “There has been a transfer of SBS Agro assets. You only need to go to an SBS Agro branch, and there you will see a sign in black and white saying 1st OVK [mutual credit society],” says Richard Hainsworth, the Moscow representative of Thomson Bank Watch. He was referring to the new parallel bank that has taken over all SBS Agro's branches. In the midst of the financial crisis a raft of new banks sprang up. Rosbank has taken over Uneximbank's credit card business and custody service. St Petersburg Menatep now owns all 46 of Menatep's Moscow branches and its balance sheet ballooned eight-fold since devaluation. And Inkombank has collapsed, owing its 234,000 depositors about Rb5.74 billion ($250.76 million) that they are unlikely to ever see. The only winners from devaluation are the two smallest oligarch banks, Most Bank, controlled by would-be Russian Rupert Murdoch, Vladimir Gusinski, and Alfa-Bank, owned by Mikhail Friedman. While most of the others were little more than treasuries for their industrial holdings, these two received few of the industrial gems handed out during the notorious 1995 loans-for-shares deal and concentrated more on banking services. Most Bank had help from its old friend and mayor of Moscow Yuri Luzhkov, who placed some of the city budget funds through the bank to maintain its cashflows. That allowed Most Bank to offer depositors the encouragingly named “you-can't-lose” restructuring scheme and the “mutually-beneficial” scheme. Nevertheless, the bank is still struggling. “It is still not clear if it is going to make it,” says Margot Jacobs, a banking analyst with Moscow brokerage United Financial Group/Paribas. “If I were a depositor, I would not put my money in Most Bank, neither would I if I were a corporation that isn't connected to Gusinsky or Luzhkov.” Of all the figs, Alfa has come off best from devaluation. Analysts believe it had only a small exposure to state treasury bills (GKOs) and forward currency contracts that caused so much damage after devaluation. Over the last nine months it has been working hard to fill the gap left by the collapse of its bigger rivals. “We are at the start of the recovery process,” says Maxim Shashenkov, the head of Alfa's sales department. “Alfa is well capitalized and in a good position to rebound. Our highest priority is to open as many retail branches as we can afford.” Rankings in the rest of the banking sector look different. Pre-crisis niche players such as Sobinbank have leapt into the top five. Previously a little known bank, Euromoney named it one of the most profitable banks in the world in 1998. Other medium sized banks have been advertising heavily for new business and growing relatively quickly. The only effort the state has made to reform the sector has been to set up ARCO (Agency for Restructuring Credit Organisations). The idea was first floated after devaluation, but it took another nine months before the body was formed. And it wasn't until the end of this summer that ARCO began to tackle some of the most difficult cases, such as Rossiyskiy Kredit, Promstroibank and SBS Agro. Its position was improved in November with another Rb1 billion in cash ($38.3 million) to add to its Rb10 billion charter capital for deadwood banks. But the CBR estimates that more than Rb100 billion is needed to restructure the sector. “Creditors are agreeing to whatever terms the fig banks [in default] want to offer because they have nothing else to lose,” says Kim Iskyan, a bank analyst with Renaissance Capital, a Russian investment banker. “ARCO is just another piece in the Russian bank restructuring lie.” Not only have the names changed, but the role of banking has changed. Both companies and the state have taken more direct control over cashflows. Gazprom, for example, removed all its money from accounts in the National Reserve Bank, Imperial Bank and others to its own Gazprombank. The change killed off Imperial, and nearly killed NRB, while making Gazprombank one of the biggest in the country. Likewise Eurofinance has jumped into the list of top 10 banks. Previously little more than a money chute for the CBR to send cash abroad, it has recently increased its charter capital by Rb200 million in the summer to Rb1.4 billion and is now seen as one of Russia's most reliable banks. As part of the retreat to central planning practices, the state, previously happy to make use of commercial banks, has been putting the accounts of its most profitable businesses into banks it has more direct control over. Eurofinance now handles the accounts of state arms exporter Rosvooruzheniye and military plane producer MAPO, among others, which accounted for an estimated $2 billion in arms exports last year. While the state is taking more financial control of industry, industry is turning to the state for protection. The Titanic of Russian banking, the “unsinkable” Sberbank, has had a fillip as companies make more use of the only bank in Russia guaranteed not to collapse. It has regained its control over the retail banking business, holding 85% of all private deposits. For the first six months of 1999 Sberbank's loan portfolio grew by 90% — accounting for 35% of the bank's assets — against 25% at the end of 1998. Only a mini-boom If banking suffered the worst from devaluation, industry benefited the most and has been enjoying a mini-boom over most of this year. The picture looks bleak from the outside, but for many Russian producers 1999 will be their best year on record. As the population changes to domestically produced products, wage arrears tumble and barter is no longer the only way to get paid, Russian producers are working at full steam to meet demand. Industrial production fell rapidly following the crisis, but by September 1998 it had bottomed out as Russian producers raced to fill the gap. By May the cash from these sales began to percolate into the system, bringing with it a sense of improvement. And by the end of 1999 the government began to boast about a “Russian recovery”. In September Goskomstat (the state committee on statistics) reported that industrial production was up 20% on the previous year. Although this comparison is from a low base, analysts predict Russia's industrial production will end this year up about 7% and show the first GDP growth since 1991 of around 2%. By October imports had fallen by up to 45% on the previous year. In many sectors, industrial production is not only back to pre-crisis levels, but has risen to levels not seen since the fall of the Soviet Union. Energy All the raw materials producers have benefited from devaluation. The energy sector, earning dollars and paying costs in roubles, has not been the fastest growing, but it is the one driving the economy. Russia's low inflation — estimated to end the year at between 35% and 45%, rather than the 100% to 200% predicted early in 1999 — means that profits have rocketed. One of the fastest growing sectors is oil production, driven by the nine-year highs in international oil prices. The oil sector was partly responsible for the 1998 crisis, as oil production makes up to a quarter of all Russia's exports. When the price of oil fell to lows of $9 a barrel the loss in oil-tax revenue for the state unnerved investors in Russia's $20 billion worth of GKOs. The subsequent exodus sank the rouble. Many of those investors may be gone, but with a barrel of oil going for upwards of $25, profits are back. The leading companies in the sector are making at least $14 off each barrel exported and many are reporting estimated year-end earnings of more than $1 billion. Production is rising almost across the board. For example, Surgutneftgas, one of Russia's strongest oil companies, reported stronger than expected operating profits for the first nine months of 1999. Its operating margin was up to 49.8% with a net profit of $837 million, of which $414 million was earned in the third quarter alone. Tatneft did equally well, generating a margin of nearly 44%. Similarly, LUKoil, another Russian oil major, reported a 328% increase in production and earned a net nine-month income of $656 million. LUKoil is illustrative as, like all the Russian oil companies, (except Surgut) it owes a lot of money to foreign creditors. So while its profitability increased, margins rose less than they could have. LUKoil's net operating profit was up only 19%. Increasing cashflows and lower dollar costs have allowed Russian oil companies to invest more than expected in their production facilities and, as a result, overall crude oil output has been rising. In November the increase in output accelerated, up 1.5%, putting Russia on target for a total output for the year of 303 million tonnes, which bodes well for continued growth during 2000. These are good results for the oil companies, but the increased cash in their pockets reduces the pressure to tackle restructuring and investment. For heavily indebted companies such as Tatneft, which owes more than $650 million of short-term debt to foreign creditors, the boost from high oil prices has done little more than stave off disaster. Utilities The oil companies remain under the heel of their masters, but in the utilities there has been progress towards rationalizing the sector. With rising domestic oil prices the national power grid operator United Energy Systems has been trying to root out corruption and impose some fiscal order under its “young reformer” boss and leader of Russian privatization Anatoly Chubais. Unlike the oil sector, state-owned UES has a controlling stake in all but four of Russia's power generators and also controls the transmission system. Tackling a notoriously bad record of cash collection from the wayward regional power producers, or energos, Chubais has managed to raise cash collection from 15% a few years ago to more than 40% by the end of the second quarter. This is a huge increase considering that most of heavy industry was doing 90% of its business in barter until the crisis. At the same time power consumption — often taken as a proxy for industrial activity — has started to grow again for the first time since 1991. Electricity demand is estimated to have grown by 2.7% for 1999 and will reach 832 TWh by year end; the highest level since 1995. Chubais has been fighting to introduce a real wholesale market for power and has also managed to sack some of the worst-offending directors of regional energos who were creaming off payments for themselves. Cash collection in some of these facilities jumped from a paltry 9% to more than 20% though Chubais is being fought every step of the way. Caius-Roa Rapanu, a utilities analyst with Moscow-based investment bank Renaissance Capital says: “It is a slow and difficult process, but by the end of next year the utilities sector should look completely different from that of today.” Light industry Most of Russia's raw materials producers have received a boost from the double bonus of rising international commodity prices and the cheap rouble. But progress in Russia's light industry, especially the food processing industry, gives the most cause for hope. Import substitution has played a role as the imported food products have been priced out of the market and cleared from the shelves. But imports never accounted for a significant part of the market. Imported food as a percentage of total imports fell from 17% in the second quarter of 1998 (just before the crash) to less than 10% in the fourth quarter of 1998. Over the first nine months of last year imports of food products began to recover, but the make up of imports has changed considerably. They are now largely coming from CIS (Commonwealth of Independent States) countries, and finished goods have been replaced by raw materials to support domestic production. For example, pre-crisis Italian pasta products have been almost entirely replaced by the hard grain needed to make it locally. Likewise imported brands of beers' share of the market has fallen from 10% to less than one per cent over the last 12 months, but domestic production is up 33% in November year-on-year. Russian consumers have changed to domestically produced goods. Cheaper prices are important, but market research companies believe the deciding factor is that Russian goods are now seen as better quality than international brands produced locally. While consumer spending has fallen across the board, it has fallen fastest in the international brands. Consumer spending was down about 15% year on year in November, while sales of international brands fell by an average of 50%, according to German research company GfK. The domestic producers are taking up the slack. Across the board international brands that previously led the market are being replaced by Russian brands — some of which are more expensive than their better-known rivals. Russian producers are doing little or no advertising (with a few exceptions like Russian producer Wimm Bill Dann's promotion of the J-7 juices) yet their sales are rocketing. Some domestic producers report that sales were already back to pre-crisis levels by January of last year and have been growing strongly ever since, although they appeared to be slowing again in the last months of 1999. In beer production, the strongest of the food products, devaluation has only slowed growth. Consumption has been rising steadily from a low of 15.3 litres per capita in 1996 to about 23.3 in 1998. Despite the increase in production already recorded over the first nine months of 1999, there is still plenty of room for the market to grow. Producers such as foreign-managed Sun Interbrew are running at full capacity and are on a buying spree of privatized Russian brewers to increase production capacity. At the same time many international companies have arrived in the last six months to set up shop. South African Breweries has started producing its Golden Barrel brand and Turkish brewer Efes has opened lines of Old Miller and Efes Pilsner. The foreign-managed Bravo group has kicked off production of Bochkaryov, Lowenbrau and Yunkerskoye. “It is like a sailboat race,” says Mitch Krasny, vice president of finance for Sun Interbrew, which sold a 34% stake to Belgium giant Interbrew earlier this year. “Everyone is milling about before the start jockeying for position. The race in Russia is about to begin.” Investment climate As sales grow, food processing is now taking most of the foreign direct investment (FDI). In 1995 food processing accounted for 25% of all investment into industry, which has leapt to 60% by third quarter of 1999. However, food production is only a relatively small part of the economy, accounting for just over 5% of GDP over the first nine months of 1999, and is certainly not big enough to drive the economy. Russia is earning most of its money from raw materials exports and here the investment climate is bad and getting worse. Investors have little confidence in Russia, reflected in pitiful levels of FDI. Over the first three quarters of 1999 FDI fell another third on the previous year to a total of $6.47 billion, according to Goskomstat. Russia is at the bottom of the pile, however you look at it. Hungary leads the former Warsaw Pact countries in terms of per capita FDI between 1989-98 with $1,667 per person, whereas Russia has attracted only $63 per capita. Only four of the 25 former Soviet-bloc countries have done worse. The picture is equally bleak as a proportion of GDP. FDI in Russia accounts for less than 1% of GDP, whereas most central European countries receive between 4% and 6%. Only the Slovak Republic gets less than Russia in terms of GDP. Investors have been ripped off too many times and in the last few months of last year there has been a string of fresh abuses that has brought Russia some of its worst press. In November, a St Petersburg arbitration court ordered a US government-backed investment fund to return its majority holding of 54% in the Lomonosov Porcelain factory to the state. Setting a precedent, the court said that the privatization of the factory in the early 1990s was illegal and — in a move that must be particularly galling to the investors — turned the assets over to the management which organized the privatization. Unless they can overturn the ruling investors from the US Russia Investment Fund (TUSRIF), with its partner KKR, stand to lose $4.25 million. “We have been disenfranchised,” says Alistair Stobie, vice-president of Delta Capital Management, which manages TUSRIF's investments. “The whole story makes a mockery of legal process. It shows that political pressure can override the government's own legal process.” Dmitri Vasiliev, head of the Federal Securities Commission (FSC) that oversees share registration, was so disgusted with the decision that he quit his job. Vasiliev has been the champion of minority investors shareholders rights and his departure has been another big blow to confidence. In a letter to the State Property Ministry that began the proceedings against the Lomonosov factory, he wrote that the decision, “creates an extremely dangerous precedent and will be a real shock to investors, including foreign investors, and can provoke their mass exodus from Russia”. The day after Vasiliev's departure from the FSC another foreign investor, American container-king Kenneth Dart, lost his stake in several oil production facilities, ending a five-year battle. Dart had been fighting with oil major Yukos, controlled by oligarch Mikail Khodorkovsky, who has been trying to wrestle these producers away from the minority investors. On October 15, the FSC registered shares that would dilute Dart's stake in Yukos' subsidiaries Tomskneft, Samaraneftegaz and Yuganskneftegaz to virtually nothing, despite an injunction from one of the regional arbitration courts. Sharon Cornwell, president of Dart's advisory company Wellesley Advisers, says: “Now we have a government agency that is ignoring the law. [Our suit] is a test. Can due process force a government agency to follow the rules? Maybe not, but it is such a fundamental issue in investment — the protection of property rights.” The coup de grace came only a few weeks later when BP Amoco lost control over the Chernogorneft production facility that is nominally owned by Sidanko. BP acquired 10% of the oil major, controlled by oligarch Vladimir Potanin, in 1997, paying $571 million. The Chernogorneft facility is one of the most profitable subsidiaries in the Sidanko group, but was wrestled away by Tyumen Oil Company (TNK) at a “bankruptcy” auction in November. TNK paid a mere $178 million for the company, despite the fact that it sold more than $1 billion worth of oil in 1998. The Sputnik Fund, a Sidanko ally and one of the potential bidders at the disastrous auction, is now suing TNK in Russia and New York but is unlikely to get Chernogorneft back. Russia has become one of the most dangerous places to invest in the world. The assassinations of the early 90s have largely stopped, but Russia tops both the list of most risky countries in the world in a recent Economist survey, and lists of the most corrupt countries in the world. Legislation exists but is rarely enforced. “[Chairman of TNK Simon] Kukes and the others understand there is a need for foreign investors and that they have a role to play in the Russian economy,” says an oil analyst. “But they don't seem to care about their reputation at all. All they are thinking about is putting money in the bank now.” Short termism and the elections Russian big business leaders are thinking only of the short term for the time being. With no clear leadership they have been left to their own devices and are grabbing everything they can. With presidential elections in June, the future is so uncertain that there is little point in planning beyond next summer. To solve its worst problems Russia needs a strong leader, determined to impose change on the economy and uphold the rule of law. There is little chance of a return to central planning, but the pace of reform, which will no doubt continue to be slow, depends entirely on who wins the next elections. Four blocs are vying for top position: the Fatherland/All Russia coalition (FAR) headed by Moscow mayor Yuri Luzhkov and ex-prime minister Yevgeny Primakov; the Communists led by Gennady Zyuganov; the Kremlin-sponsored Unity party led by emergencies minister Sergei Shoigu; and liberal-reformers Yabloko led by Grigory Yavlinsky. At the start of the election season, FAR was the front-runner with well-respected Primakov the favourite to replace Yeltsin on the presidential throne. However, the Kremlin has played the game skillfully. Riding on the overwhelming popular support for the war in Chechnya, prime minister Vladimir Putin's popularity has soared from nothing to 45% in a matter of three months. He is now Russia's most popular prime minister ever. Treading cautiously, Kremlin-loyalist Putin came out in open support for Unity at the beginning of December. Unity is little more than a Kremlin vehicle designed to eat away at FAR's voters — and the party's popularity jumped 6% ahead of FAR's almost overnight. Although at the time of writing the exact composition of the new Duma was yet to be determined, it will be significantly different from that of the last four years. The last elections in 1995 offered Russians a simple choice between going forward (Yeltsin) or back to the old system (Communists). The communists won just less than half the vote and were by far the strongest power in the Duma, slowing efforts to push through reforms. In these elections the communists will lose a lot of their power, but perhaps more importantly the protest vote that went to radicals like ultra-nationalist Vladimir Zhirinovsky will be taken by a new middle ground. There will also be an increased number of independent unaligned deputies, bringing with them more power for the regions but without obvious affiliation to any of the national parties. While few of the parties — bar Yabloko and the communists — have any ideology to speak of, politics has taken a step towards the centre. With the communist grip over the Duma broken and the radical extremist failing to clear the 5% hurdle, debates will be less polarized, leaving more room for consensus and deals in the new Duma. Depending on who wins the presidential election, this is probably a good thing. Little noted, the fact that Russia is having elections at all — fought on hoardings and TV rather than on the streets or with guns — is a significant step in the reform direction and probably Yeltsin's biggest contribution to Russia's transition. While the OSCE and others will no doubt find plenty to complain about during the voting, Russia is now a democratic country, albeit a rough and ready one. The exact composition of the Duma is important for the presidential elections. Both Unity and FAR are convenient alliances between powerful regional governors and others and could easily fall apart after the Duma vote. Members of these two parties could realign to support one or other presidential candidate, depending on the division of power in the Duma. The increased number of independent deputies could be decisive in the run-up to presidential elections as many can deliver whole regions to their chosen candidate. The makeup of the new Duma will be crucial in their decision of who to back. Presidential elections are scheduled for June 4 2000, but were they held tomorrow, Putin would beat Zyuganov for the job hands down. Primakov is the only other candidate with a realistic chance of winning at the moment. What would Russia be like under these three men? Putin Putin has become popular because of the war in the south, but he has deliberately said little about his economic policy. His advantages are that he is young and healthy, but his meteoric rise has meant his political powerbase remains weak, leaving him vulnerable. “There are two scenarios for Putin,” says Roland Nash, head of research at Renaissance Capital. “There is a danger that he will be hijacked by the group of oligarchs that stand behind Yeltsin, or that he will try to get things done in the same way as he got the war in Chechnya done.” On the few occasions Putin has talked about economics he has said the right things. He admits that his command of economics is weak and is likely to hand over the running of policy to a group of technocrats, such as Mikhail Zadornov and Vladimir Ryzhkov. Primakov As prime minister for eight months, Primakov is better known. A canny political player, Primakov is also weak on economics. With him would probably come the same group of technocrats to make economic policy. On the positive side Primakov's open attack on oligarch Boris Berezovsky, while he was prime minister at the beginning of this year, suggests that he would be independent and maybe even anti-corruption. He has also shown himself able to balance the interests of the power fractions of the Duma and bring them together in consensus. On the downside Primakov is already 70 years old and has had back surgery recently. His health could fail in the next four years, leaving Russia with yet another infirm president. “The key question is how much support both Primakov and Putin would give to the technocrats who are running economic policy — how strongly they would enforce the rules and provide them with necessary authority,” says Nash. “It is na?ve to think either man would run a radical reform programme, but they should allow the important secondary goals — like reforming the tax code — to be reached.” There is little to choose between the two men. Putin is the more risky bet but offers the possibility of faster reform. Under Primakov progress would be slow, but most Russians would welcome the stability he offers. And for businesses working in Russia over the last eight years, stability, rather than economic reform, is what they crave the most. Zyuganov Zyuganov will almost certainly be the man to beat in the presidential elections. But it is also almost certain that he will be beaten. The communists have a hard-core of some 30 million voters that always vote communist, but the party — despite increasing its focus and improving its understanding of Russia's economic needs — has failed to appeal to a wider audience. The Communists have abandoned the traditional stance of central planning and are selling themselves as a “socialist party,” in the style of Britain's New Labour. They espouse policies that accept private land ownership and free enterprise, but would increase state control of key sectors. There is merit in their arguments that reform would have been less painful if it had been done more slowly, but a top-heavy intrusive administration would mean very slow progress. Despite some short-term benefits for the poor and old, mixing free markets and central planning only results in inefficiencies, leaving Russia wallowing in misery. Mystery Man Analysts agree that the possibility of an unknown Kremlin candidate could appear over the next six months. Since March 23 1998 Yeltsin has sacked four prime ministers and remains unpredictable. Putin could disappear as fast as he arrived. “A rational man would resign today and let Putin step into his shoes while his popularity is high,” says Nash. “But Yeltsin is not a rational man.” Russia will continue to drift for the next six months. Neither the new Duma, nor the government will have much to say on policy and, assuming that Putin remains as prime minister, the government will be preoccupied with getting their man into office. Putin himself is clearly concentrating on first winning the war and then being elected president. These concerns over-ride less pressing matters such as negotiating with the IMF over the release — now on hold — of the next tranche of its standby credit facility. That is the best-case outcome. The worst thing would be if when the Duma reconvenes the day after Orthodox Christmas on January 18, that it carries a vote of no confidence in the government. Under the Russian constitution, if the Duma votes no confidence three times Yeltsin has the right to dissolve the Duma. But the constitution also says that the Duma may not be dissolved during the first 12 months after it is elected, creating the possibility of a constitutional crisis. With so many unknowns Russian businessmen and industrialist see no reason to think long term. The best hope the country has is to get through a winter that will see power shortages, finish a war that could isolate the country from the international community and hope that oil prices don't fall until the end of next year. The Russian people are stoical and have a great capacity to endure suffering, making civil unrest unlikely. With an inexhaustible faith in the greatness of their country the poet Fyodorov Tyutchev summed up the Russian mentality with the words that are as true today as they were in 1866. “Through reason Russia can't be known, No common yardstick can avail you: She has a nature all her own — have faith in her, all else will fail you.” It's back to cash “Devaluation has given Russian industry a breathing space,” says Roland Nash, head of research at Renaissance Capital. “But there is little evidence that it is being followed by investment, which will carry through the restructuring of the economy.” Investment is down, but some economists say that is not important for the time being. A recent report by Moscow brokerage Troika Dialog points out that as Russian factories are only using about half of their available capacity, they have plenty of room to increase production without the need to invest in new lines. “Look at Poland,” says Al Breach, an economist with Goldman Sachs in Moscow. “It grew strongly for two years from 1992 while investment inflows actually fell. Investment only took off in 1994 after the companies were already profitable. The same thing could happen here.” Production is growing because one of Russia's worst problems has been solved. The reduction in rouble-denominated costs and the consumers' preference for domestically produced goods have been important factors in kick-starting the economy. But it is the death of the so-called “virtual economy” that has had the greatest effect. Non-payment of bills has been rife in Russia for eight years. In heavy industry up to 90% of business was done in barter, or unsecured and unregulated promissory notes, known as “veksels” were used in place of money. Barter has been popular because, under Russian tax law, wages must be paid before taxes. By doing all their business in barter, and keeping only enough money in the bank to pay wages, Russian firms effectively dodged taxes. While costs increased with the rising rouble, companies found that, instead of booking a real loss, they could inflate barter prices and book a “virtual profit” instead. For managers of these firms, inflated barter prices provided an opportunity to cream off fat margins for themselves. With devaluation the situation has changed. As costs have fallen Russian companies find themselves in the position where they can book real profits: as a result the amount of cash in the system has increased. For years Russia's companies have had a bad tax payment record, but federal tax collection rose a provisional 115% year-on-year in the second quarter of 1999 and tax receipts have outstripped the 1999 budget estimates since July. Unusually, Russia's biggest taxpayers — mainly oil, gas and electricity companies — paid their Rb2 billion for October in full, according to the tax minister Alexander Pochinok. This all points to a massive reduction in barter. Wages in the pocket of the worker and profits in the accounts of companies may be worth less, but at least they are being paid in cash rather than macaroni, sex aids and raw materials, as was standard practice until last summer. As a result government finances are looking healthy for the first time in years. The rise in tax receipts has broken the government's dependence on handouts from the international financial organizations. While oil prices remain high, Russia should be able to service its debt payments without going to the IMF. The IMF has been holding back on the next $640 million tranche of its $4.5 billion stand-by credit because of Russia's failure to meet specified targets. Given that Russia has always failed to meet these targets and has always been paid in the past, and is now meeting more IMF targets, the decision is clearly political. The international community wants Russia to stop the war in Chechnya and has hung the loan until Russia buckles under, which it is unlikely to do until the war is won or next summer's presidential elections are past. However, with high debt servicing obligations over the end of the year, and again next summer, the Central Bank of Russia (CBR) will have a struggle to find cash to meet its obligations. Recent press reports have claimed that the CBR has been borrowing from the state-run Sberbank in a series of covert bond sales worth $670 million in order to raise money. “These credits are essentially an extremely non-transparent way of printing money,” said Peter Westin, an economist at the Russian European Center for Economic Policy. The government has also issued new OFZ and GKO bonds and sold them to the CBR to meet foreign obligations. In a move that analysts are calling “little more than an accounting trick” and which calls the CBR's independence into question, the CBR issued loans of $6.7 billion to the government in November to help it service its foreign debts, and government securities worth Rb229.5 billion. Even with the present trade surplus of $2.5 billion a month it will be difficult to balance the books, and the rouble is weakening as a result. Analysts predict it will fall to about Rb35/$ by the end of next year from the current Rb26/$. The next budget assumes that the country will secure several billion dollars in external financing, which Russia is less likely to get since the Chechen campaign started, but it also assumes oil prices of $18 per barrel. If prices were to fall from $25 per barrel to $17 per barrel, export receipts would decrease by up to $10 billion, leaving the monthly trade surplus at somewhere between $1.0 billion. And that might very soon begin to threaten Russia's debt servicing abilities and the value of the rouble. “If oil prices stays high it will be good for Russia,” says Tom Adshead, senior political analyst at brokerage Troika Dialog. “But it if it falls below $16 they will be in trouble.”