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Russia and the IMF: A sordid tale of moral hazard
Demokratizatsiya, Winter 2001 by Hedlund, Stefan
The first summer of the new millennium was marked by renewed controversy around the issue of Russia's relation to the International Monetary Fund (IMF). As Swiss prosecutors pressed on with their probes into alleged Russian money laundering, suspicions again came to the fore that billions of dollars of IMF funds intended to support the ruble had been illicitly diverted via a maze of accounts in Western banks, notably the scandal-ridden Bank of New York.
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Although allegations of this type constitute a serious embarrassment to those concerned, there appears to be little danger of anyone's actually having to accept personal blame. Given the massive amounts of money involved, the investigations are likely to drag on for many years, as are the debates on what really happened. But few if any significant truths or admissions of guilt are likely to come on record. There is, quite simply, too much high-level politics involved for truth or justice to prevail.
However, there may be some benefit in mapping, as far as possible, the story of IMF involvement in Russia, how it unfolded, and how it was brought to such an embarrassing end. I argue that there have been significant problems of moral hazard involved that should have been taken into account from the outset.
The merits of the argument should be sought in a different direction from simply looking for the trail of a few billion dollars that are missing. At stake is the very essence of Western relations to Russia, at a crucial point in that country's development. And, as I argue below, the role of the IMF in shaping these relations has been a highly unfortunate one.
Storm Clouds
The first wave of criticism against the IMF was triggered by the series of financial crises that erupted in Thailand in summer 1997 and then spread via Indonesia to Russia and on to Brazil. The simple fact that several of the subsequent currency collapses (most notably the Russian one) occurred in cases that were under intensive IMF bailout supervision did little to enhance the standing of the Fund, and its critics, some of long standing, came out in force.
At first, the discussion was mainly technical, concerning the modus operandi of the IMF. Some, such as Milton Friedman, argued that the Fund itself was the problem and that it should quite simply be abolished. Others saw the task as saving the Fund, rather than burying it. Taking the discussion all the way, we could find George Soros arguing that the IMF should be transformed into a lender of last resort for the global economy, coupled with firm controls over the financial markets. This wide spread of opinions reflected the fact that there was an underlying problem, one that had involved economists in harsh debates for quite some time. The issue, still unresolved, concerns the relative merits of fixed versus floating exchange rate regimes.
When the IMF was established in 1944, it was designed to operate in a postwar world of fixed exchange rates. In 1973, however, when the U.S. administration decided to decouple the dollar from the gold standard, that world came to an end. Some would argue that the IMF has been struggling ever since to adjust. But my focus is not the technical dimension of IMF operations but the political economy of faulty policy advice and of financial blackmail, both in the specific Russian case. The simple fact that even people who served in senior IMF positions have begun to admit in public that the Fund botched its Russian mission makes it rather urgent to investigate what it was that went wrong.
One of the voices in question belongs to Augusto Lopez-Claros, who served as head of the IMF Moscow office from 1992 through 1995. During that time, the Fund issued about $4 billion in loans to Russia, money that few would now argue was spent in the intended manner. Referring to the variety of murky Russian schemes that were devised in those years, under the very nose of the IMF, to promote insider privatization deals and tax exemptions for favored groups and organizations, Lopez-Claros asks (and answers) the pertinent question: "Should the international community have continued to support Russia in the presence of these non-transparent schemes? My own private view is that, no, they shouldn't have."1
In the following I shall map out how the IMF got involved in a mission that it really should have stayed well clear of, and look at the consequences both for the Russian side and for the IMF and the West in general. Has the West "betrayed" Russia by doing too little, as some of those who have been involved in high-level policy advice have argued rather aggressively? Or is it perhaps the case that the West has betrayed Russia by doing too much, in the wrong ways, and that the latter may have far more sinister repercussions than having failed to help at all?
Let us begin by looking at the most immediate evidence, in the form of the Russian financial meltdown that occurred in August 1998.
The Crash of August 1998
In retrospect, it seems predictable. From the very beginning, in 1993-94, Russia's financial markets (GKO and OFZ state securities) were set up to function as a giant Ponzi game, and such games all collapse in the end. How then was it possible for so many to get so badly burnt by the dual decision taken on 17 August 1998 to devalue the ruble and to freeze parts of the foreign debt? In a comment after the fact, Stanley Fischer, the IMF's first deputy managing director, found it "hard to credit that sophisticated investors who had earned an average of 50% a year on GKOs since 1994 really believed these investments were safe."2 These remarks came close to adding insult to injury. Many investors must have realized that the game was eventually unsustainable, but there was also the question of timing.
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