Russia: A superpower falls apart

"Russia," commented financier George Soros last year, "is like a canoe in which seven men are fighting over a hoard of gold. They are too absorbed by this to recognize that they are heading towards a waterfall." He was referring to what the Russian media often call the semibankirshchina or rule of the seven bankers, harking back to the semiboyarshchina - the brutal reign of Russia's aristocratic officials and landowners during the 17th century.

Unlike Asia's financial crisis, which followed decades of growth and vast infrastructural investment, Russia entered its crisis on the heels of a decade-long collapse, capital flight running into hundreds of billions of dollars and the kind of mass poverty not seen since the 1940s. Industrial production, according to one estimate, has dropped since 1991 by 80%, capital investment by nearly 90%.

By the time prime minister Sergei Kiriyenko announced a devaluation and default on August 17, the economy was already on its knees. "They were losing $2 billion a week in reserves," says Richard Gray, head of emerging markets research at Bank of America. "They asked the G7 and the IMF for more help, were turned down and decided to go it alone." A participant at the frantic talks between the government and the IMF in the days before the announcement describes them as akin to "a madman arguing with a deaf man".

With debt servicing costs running at almost half of tax revenues and no prospect of new money from the IMF, the government had two options: print money to finance the deficit or default. It chose the latter - even in Russia printing enough money to redeem the outstanding GKOs was impossible. With hindsight the decision seems inevitable. "Bond yields were already priced for default," says Alexander Pertsovsky, president of Moscow brokerage Rinaco Plus. Yields had risen above even those of October 1993 when the Duma was shelled, and of December 1991 when the Soviet Union collapsed.

Losses to foreigners from the default on GKOs could reach $40 billion, depending on the fate of the rouble. Commercial creditors, whose loans came under a 90-day debt moratorium, stand to lose up to $50 billion. Rating agency Fitch IBCA believes that Russia will be the largest single credit loss ever suffered by the international banking community. Private creditors are looking at losses of up to $100 billion.

This comes on top of the losses already incurred by equity investors. The capitalization of the Russian stock market had fallen from $120 billion in October of last year to around $20 billion by early September. In the month to September 7 the price of Lukoil common stock plunged 54% and other companies watched their shares lose more than 90% of their value.

The market is now totally illiquid. The bid for Surgut Holding common stock is $20; the offer is $60. One fund manager boasted wryly that his fund had outperformed the market, falling by only 73%, against 76% for the market as a whole.

In the build-up to the crisis, comment from western financiers in Moscow was marked by a stubborn refusal to confront its depth. A research report, from investment bank MFK Renaissance, dated May 29 and titled, "A strong rouble, GKO yields at under 30%: The dawn of a new era?" was full of talk of a "virtuous circle" of economic reform. Even four days before the government defaulted, Alex Knaster, until recently head of CSFB's Moscow operation, said: "The sovereign financial situation is fine, the key is to hold the course and not panic".

Remarkably, the government issued a 30-year Eurobond as late as June, racking up a total for the year of $4.8 billion. "Some of the Eurobond deals were piggy-backing on the expectation of more IMF money," says Gray at Bank of America, "but anybody issuing or buying a Eurobond issue has his eyes wide open."

The view from within the government in the build-up to the crisis was certainly bleak. "Kiriyenko's government was from the beginning a hostage to old debt policies," says former deputy prime minister and leading reformer, Boris Nemtsov. "His predecessor Chernomyrdin did not even bother to cut state spending. He used credits like a drug as a result of which the debts piled up. Sooner or later the country would have exploded or the financial system would have collapsed."

Yet the multilaterals coughed up again in July to the tune of $22.6 billion. In the weeks leading up the bail-out announcement - fearing that the loan spigot might at last be turned off - president Boris Yeltsin warned that Russia was in imminent danger from extremist forces. The tactic of evoking political bogymen evidently worked.

So why did the IMF, the World Bank and western investors get it so wrong in Russia? "In Russia as well as in both the IMF and the World Bank," says professor Grzegorz Kolodko, visiting fellow at the World Bank, and former deputy prime minister and finance minister in Poland, "people are having serious doubts about the inappropriate course taken by the transition in Russia. Advice was too often linked more with the interests of the advising countries, lobbies, organizations and individuals than with the interests of Russia."

In the name of deregulation and liberalization, so the argument goes, Russia's economy has been looted by a band of well-placed insiders, mostly Soviet apparatchiks. They now dominate the media and the state, and have moved as much as possible of their wealth abroad.

Seven bankers of the apocalypse

The identity of these insiders is well known though they escape publicity. Boris Berezovsky, a Rasputin-like figure in the Yeltsin court, declared a salary of $43,000 in 1997, but his personal assets have been valued at close to $3 billion. His interests include a car dealership and large stakes in the ORT television network, national airline Aeroflot and oil firm Sibneft. Vladimir Potanin, who beat Berezovsky in the auction for telecoms company Svyazinvest, controls Russia's largest bank, Unexim, oil company Sidanco and the Norilsk Nickel company, largest corporate supplier of nickel in the world. Potanin also controls the newspapers Izvestiya and Komsomolskaya Pravda. The other five of the original oligarchs are Mikhail Khodorkovsky, chairman of Bank Menatep; Vladimir Gusinsky, chairman of Most-Bank; Alexander Smolensky, chairman of SBS-Agro Bank; Mikhail Fridman, chairman of Alfa-Bank; and Vagit Alekperov, chairman of Lukoil.