Crisis and Aftermath
- On December 21, 1991 the Alma-Ata treaty was signed by the all member states of the USSR(Union of Soviet Socialist Republics), leading to it’s dismemberment and disintegration. After this change in the political nature of the Soviet Union, the Russian government, decided to implement an economic reform program, aimed at transforming the country’s economy to a dynamic one, from one that was centrally planned. This led to a price surge for commodities due to various reasons.
Firstly, during the Communist era, due to artificially low prices, there wasn’t much for Russians to spend their rubles on and so they hoarded them. Upon the announcement of liberalization, there was created a massive influx of rubles, and no commodities to spend them on. So prices were raised, to ensure the transfer of rubles, but this price rise, led to inflation.
Secondly, the government subsidized money losing establishments, in order to prevent the massive unemployment by rushed privatization, which led to a rise in the budget deficit, to the tune of 17% by the end of 1992. Not wanting to increase taxes, the government decided to print money, and this added to the already rising inflation, caused by excess money supply and lack of supply of goods.
Yes this could have been avoided. Since raising taxes was not a good option, as people would evade them, the ideal thing for Russia in the face of rising inflation would have been to introduce cuts in spending in the budget, and shift the financing of the budget, from central banks, to public bonds and international grants and loans.
- The decline of the value of the Ruble against the dollar between 1992 and 1998, points out the Purchasing Power Parity theory, which states that when there is rising inflation in one country, the value of it’s currency will depreciate, relative to the value of the currency of the country with lower inflation. In this case, the value of the ruble in Russia, tumbled against the value of the US dollar, due to increasing inflation in Russia, throughout 1992 to 1998.
Also based on the reactions of the investors to the Asian Financial Crisis, one is reminded of the impact of investor behavior, which well led to them pulling out of Russia, and looking and far more stable markets. This is turn led to other investors following suit, leading to the bandwagon effect.
- In 1996, IMF supplied Russia, with a loan of $10 billion, and stated some terms and changes that it wanted in the Russian economic system.
The Asian Crisis, made investors decide to invest their money in safer and stable economies, that resulted in many such investors pulling out from Russian economy.
Unfortunately that year there was a fall in oil prices, which led to a lower tax collection on oil sales. Also the Russian tax collection system was inefficient and corrupt, which led to massive tax evasion. There was also the problem that most of the economic activity that occurred in Russia was unaccounted for, and hence they paid no taxes, this also was a product of corruption. There was also a lobby within the Russian parliament that rendered the bill to raise corporate taxation and cut government spending ineffectual.
- The government of Vladimir Putin in the year 2000, decided to reduce government spending and reduce the income tax to 13% from the original 30%, and corporate tax was reduced to 24% from 35%. This reduction in taxation led to a massive increase in government revenue from tax collection, as people decided to pay taxes since the rates were quite reasonable.
Also the Russian recovery was helped by increase in global oil prices, which in turn increased Russia’s collections from tax on oil sales.
No the IMF policy prescriptions were absolutely correct, as the Russian banking system is very weak, and the manufacturing facilities are poor. There is rampant corruption and foreign investment in Russia is low. The Russian economy is over dependent on oil and commodity prices, therefore a sudden fall in prices would lead to a massive collapse of the economy.