Viktor Bobylev,
Irina Tischenko

H

eritage

Debts of the former USSR account for a considerable share of Russia’s total indebtedness. In the 1960s and 1970s it was an exemplary borrower fulfilling its obligations in time and to the full extent. But after the sharp decrease in prices for energy resources in 1984 the USSR failed to restructure the economy and had to resort to large-scale borrowings: it incurred debts of over $15 billion on foreign markets. In 1986 the total amount of loans exceeded $30 billion and in 1989 it reached $50 billion. In itself this amount was not critical. However, the absence of real progress in the economy was leading to the growth of borrowings on the domestic market, issue of naked debentures as well as to the total deficit of goods. All this resulted in a deep economic crisis (pic2) and later in the country’s political collapse.
In connection with the breakup of the USSR the former Soviet republics signed on December 4, 1991, a treaty on succession of the foreign debts. It was assumed that each of the new States would take its share of responsibility; at the same time it would get an appropriate share of assets inherited from the USSR. However, seven republics did not join the treaty and this option was not accepted. As a result, on April 2, 1993, the Russian government announced that it would take all obligations with respect to the foreign debts of the USSR and, thus, their total amount of $96.8 billion was passed on to Russia.

Debt situation

The process of forming the Russian foreign debts can be conditionally divided into two stages (pic1): building up debts in 1992 through 1998; the period of stabilization and reduction of the debt burden from the year 1999 on. Russia was actively attracting foreign sources to finance its economy in conditions of radical market reforms. However, the main reason for large borrowings was the growth of the State budget deficit (pic3) and increase in expenses on debt servicing.
The worsening of the world economic conditions in the second half of 1997 and the financial crisis in Southeast Asia destroyed the existing scheme of maintaining macroeconomic and social stability. Russia’s foreign exchange reserves went down fast. Funds invested in Russia earlier started to be considered high risk; new investments stopped. The high demand for foreign currency because of a considerable share of imports, inflationary anticipations and inclination to keep savings in dollars predetermined pressure on the ruble exchange rate. The budget crisis resulting from low tax collection and budget deficit as well as political instability sharply reduced investors’ interest in state securities of the Russian Federation: in the middle of 1998 the short-term state bond yield went up to between 100% and 150% interest per annum.
The government tried to prevent a default on the domestic debt through borrowings on the Eurobond market and converting part of the domestic debt into the foreign ones with high interest rates. This became one more reason for a sharp increase in the amount of the foreign debts.

Achievements

From 1999 through 2001 there was an evident resuscitation of the state economic activity in Russia. This was accompanied by a steady growth of prices for Russian-exported raw materials, above all, for oil, natural gas and metals. Between 1999 and 2004 Russia’s trade balance was positive and it ensured growth of the country’s foreign exchange reserves to the unprecedented high level. In its turn, this allowed to efficiently service the state foreign debts and to reduce their amount.
The status of state finances improved. Since 2000, as a result of the economic growth, improved foreign economic activity and rise of tax collection, through administering among other things, the federal budget stopped being in the red (pic3). The proficit of the State budget that was steadily increasing in ratio to GDP let establish a financial reserve in 2002 and no longer use credits from IMF as well as new unlinked loans of the World Bank to service the state foreign debts.
The pattern of changes is reflected by the following figures. At the beginning of 1999 the foreign debts amounted to $189.2 billion and at that moment they were equal to 106.9 % of Russia’s GDP. As of January 1, 2004, the amount of the Russian foreign debts went down insignificantly: from $185.7 billion but now their amount equals only 43% of GDP.
The current indexes of Russia’s "debt steadiness" developed in accordance with the international methods prove that the country has overcome consequences of the 1998 financial crisis (pic4 and pic5). In this period the debt load on the country’s economy decreased as much as almost 3 times. The load on the budget is also comparatively small. In 2004 the ratio of repayments on servicing the debts to the federal budget revenues amounted to about 12 %.

Obligations

The structure of Russia’s foreign debts is dominated by non-market debt obligations (pic6 and pic7). It is quite possible to single out four main groups of them:
– debts to international currency-and-financial organizations (IMF, IBRD, EBRD);
–debts to official creditors, i.e. to commercial banks of Western countries that provide loans on governments’ guarantees or with creditors insured in state structures. Regulating the indebtedness of this kind is included in the competence of the Paris Club of Creditors;
– credits provided by commercial banks of Western countries independently, without state guarantees. Debts on such credits are regulated by the London Club of Creditors;
– commercial debts to Western firms on credits related to supplies of goods and rendering of services.
Over 42% of foreign debts fall at agreements on indebtedness of the former USSR with member countries of the Paris Club, other countries being official creditors. Besides, approximately $6 billion (about 5%) represent unregulated obligations with respect to debts of the former USSR. Only 37% of the foreign debt are reflected in market instruments.
The bulk of foreign market debt obligations fall at Eurobonds issued for restructuring the indebtedness to the London Club of Creditors. Formally, Eurobond loans have no special status as compared, for example, with bilateral credit agreements or debts to international credit organizations. However, creditors preferred to fulfill all their obligations on Eurobonds because of a rather complicated procedure of restructuring: they are distributed among a considerable number of owners. As of January 1, 2004, debts on Eurobonds amounted to $26.8 billion. The major part of this amount is Russia’s debts to the London Club, which were redrafted into 30-year old Eurobonds in 2000.
The world financial history knows only a few single cases of default on sovereign Eurobonds. Despite the fact that credit ratings of sovereign Eurobonds are not high, the probability of repaying debts of this kind in time and to the full extent is high even in case of having not exactly optimistic scenario for developing Russia’s economic situation.
Another kind of debt obligations, which have the intermediate status, is bonds of domestic currency loan. By their origin they belong to the domestic debt but, as a rule, they are considered together with foreign debts. These are the Russian oldest bonds issued as far back as 1993 towards repaying debts of the USSR’s Vnesheconombank to resident legal entities. Restructuring debts of this kind along with a partial repayment of current debts is the most probable. To a significant degree parameters of restructuring will significantly depend on results of talks with IMF.

Forecasts

According to mid-term forecasts of Russia’s economic development, an economic growth is expected with year-on-year rates of 6% to 7%. Repaying and servicing debts will account for 3% to 4% of GDP. At the same time, in order to stir up structural reforms in the country, diversify the economy and implement a budget reform there will be a need for new loans.
As a whole, the debts policy set by the government of the Russian Federation for the period till 2008 will be directed at gradually reducing amounts of foreign debts with the simultaneous observance of the established regime of foreign debt payments. Till 2006 expenses on its settlement and servicing will amount to between $14 and $18 billion on the year-on-year basis. At the same time the new Russian debt will account for the main part of payments – up to $10 billion annually. This debt is not subject to restructuring (Eurobonds and payments to international financial organizations).
Thus, approximately 20% of the total amount of the main foreign debts will be repaid in the given period. Payments for their servicing will amount to about $18 billion till 2006. According to forecasting information, by the end of 2005 the State debt of the Russian Federation will go down to between 29% and 30 % of GDP.
The fact that the debt nominated in foreign currency exceeds many times over the one reflected in market instruments is a serious risk factor that puts the debt management in a rigid dependence on the foreign currency policy and state of balance of payments, That is why there is a need for a gradual replacement of foreign debts with domestic borrowings.
Settling the debt of the former USSR should also be completed in the shortest possible time. The indebtedness to the Paris Club can be settled in several ways:
– through settling obligations of the former USSR to the Paris Club, including the advanced repayment;
– through the securitization, i.e. transformation of the given category into market instruments (with the country’s credit rating getting better precisely this method of settling the debt problem can become the most efficient and less expensive one);
– through settling the indebtedness using other countries, which, in their turn, have debts to Russia.
It hardly makes sense to consider a possibility of writing off the debts. First, Russia does not come within the program developed in 1996 by the World Bank and IMF to provide help to countries, which experience problems with servicing their foreign debts. There is a clear-cut criterion set in the program: the share of GDP per head is less than $695, while according to forecasts of Russia’s mid-term economic development, this index will amount to about $3,500. Second, there has been no precedent of writing off debt of any Paris Club member country. And, as is known, Russia is not only a debtor but since 1997 the country itself has been a member of the Paris Club of Creditors.

Debtors

In its time the USSR was a large creditor. Just from 1970 to 1980 it provided developing countries with credits to purchase technical equipment and armaments for
$147 billion. Among the largest borrowers were Cuba, Mongolia, Vietnam, India, Syria, Iraq, Libya and some other countries. At present, these countries annually pay out from 4% to 5% of the aggregate debt to Russia as a successor to the USSR.
The Russian side is proposing various schemes to restructure the indebtedness and search for mutually advantageous options of settling it. For example, Cuba’s debt can be restructured through Russia’s share participation in developing nickel ores. Mongolia’s debts can be settled by the Russian participation in joint projects to develop copper ores as well as by repayment with State-owned property. Obligations from Iraq, Iran and Libya can liquidated by participating in exploring, developing and operating oil fields, etc.
Besides the above-mentioned countries there are 54 states more that owe debts to Russia, the majority of them being among the poorest countries. Some refuse to admit their debts insisting that loans were provided to support pro-Soviet regimes. What is more, by joining the Paris Club of Creditors the Russian Federation lost self-dependence in settling the question of repaying debts for supplies of arms by the Soviet Union. As a result, acting within the framework of the Paris Club Russia had to write off debts for a number of States by 60% to 80%.

Risks

The potential threat to the financial stability of the Russian economy is a rapidly growing indebtedness on the part of the corporate and banking sectors. For example, the foreign debts by the banking sector increased as much as 4 times: from $8.2 billion on January 1, 2000, to $32.9 billion on July 1, 2004. The foreign debts by the private (corporate) sector or non-financial organizations, if to use the international terms, increased as much as 3.3 times: from $19.6 billion on January 1, 1999, to $65.6 billion on July 1, 2004.
The so-called backbone Russian banks and companies with their considerable stakes owned by the State account for a large share of these debts. For example, Gazprom’s total debts on foreign and domestic credits exceed $14 billion or about 70 % of the company’s year-on-year volume of sales. And as the Asian financial crisis of 1997 and 1998 proved, the main reason for increasing negative processes in economy was precisely the huge private debt. Defaults caused by it led to devaluation of national currencies, panic on financial markets and mass-scale bankruptcies of credit organizations and companies of the real sector. That is why it is necessary to have a more distinct coordination of debt policy by State and leading (backbone) banks and companies.
In 2005 to 2008 the Russian economy will have to make large payments on the State’s foreign debts: from $15 billion to $18 billion a year, while only the servicing of the debts will account for about 36% of the amount. After 2008 the debt load on Russia’s economy may be reduced by almost two times and that will be in line with additional investments in the economy or will provide a base for a further reduction of the tax burden. But all this is possible only, if there is a consistent and rational policy of managing the state indebtedness.


Restructuring

It is assumed that new borrowings will be done only for restructuring the available debts: to transfer ‘short’ money to ‘long’ money, to replace loans, servicing of which is expensive, with the cheaper ones, etc.
The modification of the loan policy assumes transferring the accent in attracting foreign financial resources to borrowings in the form of bond loans. It is expedient to regularly increase volumes of debt refinancing through placing new Eurobond loans with a simultaneous diversification of financial instruments offered to investors with respect to terms of repayment, currencies, nominated forms of calculating coupon yield. Depending on the situation on the market of foreign borrowings it is meant to make issues of Eurobonds with terms of repayment no earlier than between 2011 and 2020.
The policy of managing Russia’s debts (and doing borrowings as well) to governments of other countries and international financial organizations needs to be corrected significantly. It is assumed that there should be a complete refusal to make new decisions on attracting "linked" credits from countries, which are members of the Organization for Economic Cooperation and Development. It is also expedient to make significant changes in the policy of attracting credits from international financial organizations and in particular:
– to put a limit on taking new obligations with respect to attracting credits from the World Bank for solving structural problems in the social sphere as well as in the sphere of public management;
– to put an accent on financing large projects concerning the infrastructure and having a national importance;
– to extend the range of international financial organizations that provide funds for projects on Russia’s territory;
– to provide a mechanism of guaranteed access to financial resources of international financial organizations on acceptable terms.
It seems that implementing such a policy will allow in 2005 and 2006 to reduce to between 5 and 10 a number of successfully operating programs being carried out with participation and funds of international financial organizations.
Conducting a reasonable policy on the State’s debts will lead to the consolidation of Russia’s positions as a borrower and it will ensure the country a guaranteed entry in international financial markets on favorable terms.


Pic 1. Dynamics of foreign debts of former USSR and Russian Federation from 1983 through 2004

Billion dollars
200
180
160
140
120
100
80
60
40
20
0

1983 1989 1992 1995 1998 2001 2004

New debt of Russian Federation
Debt of former USSR


Pic 2. Dynamics of Russian Federation’s economy from 1971through 2004

Rates of GDP growth, %
15
10
5
0
-5
-10
-15
-20
-25


oil price in 1995=100 %
250
200
150
100
50
0

1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Russia (national income from 1971 to 1990, GDP from 1991)
oil price ( %) as against 1995


Pic 3. Russia’s consolidated budget deficit and dynamics of new State-owned foreign debts in 1992 through 2004


billion dollars

80
60
40
20
0
-20
-40
-60
-80
-100
-120

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004


Deficit of consolidated budget with progressive total

New State-owned foreign debts (bodies of public management), as of 01.01.05


Pic 4. Dynamics of developing Russia’s economy and amounts of domestic and foreign debts in 1994 through 2004

billion dollars


600
500
400
300
200
100
0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

billion dollars
100
90
80
70
60
50
40
30
20
10
0

GDP, billion dollars, left scale
Foreign debts, billion dollars, left scale
Domestic debt, billion dollars, right scale


Pic 5. Dynamics of main parameters of Russian economy’s debt load

%
120
100
80
60
40
20
0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

%
250
200
150
100
50
0

Foreign debts /GDP, %, left scale
Domestic debt /GDP, %, left scale
Foreign debts /exports of goods and services, %, right scale


Pic 6. Dynamics of structure of Russian Federation’s foreign debts in 1998 to 2004

billion dollars
250
200
150
100
50
0

1998 1999 2000 2001 2002 2003 2004 October of 2004

Private sector
Russia’s banking system
Bank of Russia
Bodies of public management



Pic 7. Structure of Russia’s foreign debts

billion dollars

200
150
100
50
0

as of 01.01.1999 ($186.8 billion) as of 01.01.2004 ($185.6 billion)


Debts by private sector (non-financial enterprises)

Debts by banking sector

Russia’s other debts

New Russian debt on Eurobonds

New Russian debt on credits from international financial organizations

Other debts of USSR

Debts to former socialist countries

USSR’s debt to London Club of Creditors
USSR’s debt to Paris Club of Creditors