Rebuilding Russia Initiative #6

CIAO DATE: 2/00

Rebuilding Russia Initiative: Economics Discussion Group
Discussion Paper # 6 _*

July 7, 1999

As part of the Rebuilding Russia Initiative of the EastWest Institute (EWI), the Economics Discussion Group serves as a forum for exchange of opinions on current economic and political developments in Russia and plays the role of a virtual task force on economic policies in Russia. The group includes prominent Russian and Western policy makers, economic experts, and business leaders, united by a common interest in rebuilding Russia’s economy. The Discussion Group’s analyses and policy recommendations are published as Discussion Papers and disseminated among a selected group of public and private sector leaders in Russia and the West. This discussion paper examines the economy of non-payments in Russia. It presents the findings of the Conference “Challenges of non-payments economy,” organized by the EastWest Institute Center in Moscow and the Russian Press-club. The conference, held on June 1 in Moscow, was attended by leading Russian economic experts and government officials.

I. Scope of barter and its effect on asset valuation

Barter has become a synonym for non-monetary transacting in Russia and represent a systemic characteristic of the business operating environment. ₁ The head of the Government Inter-Agency Balance-Sheet Commission, Piotr Karpov, whose analyses of barter became the basis of the famous article by Clifford Gaddy and Barry Ickes on Russia’s virtual economy, ₂ argued that the barter system allows a debtor to pay “in cash” no more than 5-7 percent of his accounts payable, with the rest covered by money surrogates. On a macro-level, the scope of barter transactions is reflected in the share of broad money (M2) to national GDP: 10-12 percent in Russia as opposed to normally 60-70 percent in the industrialized countries and over 100 percent in the U.S. This low level of monetization limits the capacity of the banking sector to credit the economy. The ratio of bank credit to GDP is estimated to be 10-15 percent in Russia whereas in the advanced industrial countries it is about 100 percent. Based on those comparisons, ₃ one can argue that Ì2 in Russia should increase three to four times and bank credit should grow five to six times to al low for normal functioning of the economy. The lack of liquidity and bank credit does not mean that economic activity grounds to a halt. By-passing money, however, results in poorly documented and hence legally unenforceable deals and dramatic drop in tax collection. The lack of transparency in clearing settlements and the self-sustaining virtual price setting render fruitless the spasmodic efforts to discount bad debts and soften monetary supply.

Participants in the conference agreed that reduction of barter and monetization of the economy would be difficult to achieve without reducing the stock of outstanding enterprise debt. In May 1999, total liabilities of organizations were estimated to be 3.1 trillion roubles, with almost 1.5 trillion considered to be overdue liabilities. The latter equals 50 percent of the Russian GDP. Profitable enterprises in Russia, which currently constitute 50 percent of all businesses, have an annual revenue growth rate of 5 percent, while their accounts payable increase by 25-50 percent annually. Due to bad liabilities, nearly 80 percent of Russian enterprises can be formally declared bankrupt. If this dynamics continues, any increase in money supply will be rendered meaningless by the way enterprises “absorb” and use money. Debts in Russia’s economy grow faster than sources of money revenues allow. Therefore, there are two principle options to be considered - either debt should be discounted, or revenues sharply increased.

Another speaker at the conference, Prof. Evgeny Yasin, former Minister of Economics and now Director of Research Programs of the State University “Higher School of Economics”, pointed to the failure of the Federal Government to formulate consistent policy in addressing non-payments and non-cash deals. The currently proposed by the Ministry of Economics scheme to clear inter-enterprises liabilities by “network” (mutual) offsets will provide only transient results and will not affect the genuine source of non-payments and barter transactions.

The conference participants agreed that the intrinsic problem with barter in Russia is that it introduces dual or even triple pricing in the economy: the same product is listed to have 1) cash price in rouble ("black cash” or nal’ychny raschet ), 2) bank account transaction price, and 3) special price nominated in different money substitutes. Barter prices are widely used for accounting purposes and cash prices for practical transactions. This leads to some significant distortions: the difference between barter and cash prices for electricity, for example, varies by a factor of two. This dual pattern of pricing causes serious difficulties in assessing and clearing mutual liabilities.

II. Patterns of barter

Speakers at the conference described how different economic actors in Russia employ different payment patterns, based on specific surrogates:

Extensive sub-federal non-cash payment systems emerged in the regions. In the last several years, dozens of regions developed organized system of payments relying on tax offsets and exemptions. Bashkortostan Republic, Tatarstan Republic, and Sverdlovsk oblast are the best known examples.
Corporate sector has also come up with sophisticated surrogates payment system, which allows transacting without cash. Big Russian companies such as Unified Energy Systems, Gazprom, Lukoil, and some others, participate in this system, using barter and promissory notes.
Some off-budget state funds like the Pension Fund also officially issue promissory notes (veksels).

III. Causes of barter and its effect on enterprise liquidity

Sergei Glaziev, who heads the Analytical Department of the Federation Council, argued that the main reason for the growing share of non-monetary transactions in Russia’s economy is the artificial and unjustified reduction of money supply, which led to a severe liquidity crisis. Glaziev’s research data shows that in comparison with fixed capital, the working capital of enterprises decreased almost by a factor of 100 in 5 years (1992-1997). Interest rates were kept high and banks extended little credit to the enterprise sector. Industrial credits were limited to inter-firm lending and companies had little choice but to increase the use of money surrogates to keep production going.

According to Glaziev, another reason for flourishing of non-monetary transactions is the lack of centralized clearing procedures to settle mutual liabilities. He suggested a system of financing the industry’s liabilities, based on bills of exchange (promissory notes) issued by industrial enterprises. The lack of such instruments now makes firms’ liabilities highly illiquid and displays little information on the true value of outstanding debts. This “fuzziness” also nourishes criminal activity in the payments settlement system.

Professor Yasin discussed the negative impact of the GKO market on the available liquidity in the enterprise sector. High returns on GKOs diverted money credit from producers. In the period 1995-98, the GKO market virtually “sucked” national finances and thus prevented the creation of a system for financing national producers. The effect of these practices became evident since August 17, 1998, when the share of profitable companies increased with the “death” of the GKO market, production grew, and banks began to accumulate capital. Russian banks remain cautious, however, in lending to an enterprise sector that remains enmeshed in the system of barter.

IV. Policies to reduce barter

The key dilemma for policy-makers in their effort to reduce barter is whether to limit the economic transactions involving barter to match the scarce money supply, or to increase the money in circulation to match the established pattern of economic activity in Russia.

Conference participants agreed that the choice would depend on the answer to the following principle questions:

Should one treat barter transaction as a deal that reflects no true costs and revenues for the bargaining parties? If yes, then it is just a matter of technicality how to enforce painful, but fundamentally healthy, reduction of the “virtual” part of Russia’s overestimated GDP. This is basically the approach suggested by the Brookings Institute economists Clifford Gaddy and Barry Ickes;
Should one consider barter an appropriately settled bargain, reflecting the true nature of value creating? If yes, then it is a matter of technicality how to displace money surrogates with legal money. This position is most forcefully argued by Sergei Glaziev.

The option chosen will also affect two important economic problems in Russia: 1) how does one treat the ruble—as over or under-valued? and 2) what strategies to use in order to reduce the discrepancy between economic turnover and money circulation.

All speakers came to a conclusion that immediate suppression of non-cash payments would result in dramatic fall in production, by at least 60-70 percent. There is no political will or economic rationale to do so. It was strongly argued that re-monetization should be the natural result of fighting liquidity crisis, rather than swamping the economy with money. Since foreign investment and loans are not expected to increase significantly, the Central Bank should become the main source of increased liquidity by issuing rubles. Andrey Klepach, former Director of the Central Bank’s Analytical Department, claimed that this can and should be done without simultaneously devaluing the ruble. Experts at the conference also conceded that no sustainable policy could be devised without addressing the restructuring of the enterprise sector. With the delay of structural reforms, increased money supply would lead to sharply negative macroeconomic effects.

Conference participants agreed that the first step in fighting barter is separation of the accumulated bad liabilities of enterprises from their current payments. The bulk of accumulated liabilities must be discounted:

First, it is necessary to reduce liabilities that resulted from unreasonably high fines and penalties;
Second, payables and receivables, including debts to the budget, must be allowed to be legally traded on an open debt market.

As for current payments, new regulations must prevent further accumulation of enterprise debt. Firms must be subjected to rigid controls in maintaining an acceptable ratio of overdue liabilities to current payments, but should not be pushed to bankruptcy over earlier accumulated debts.

The fundamental model for overcoming the crisis of non-payments is enforcing uniformity of payment schemes and restructuring the pattern of money circulation. There is no “quick-fix’ solution for reducing the plethora of money-surrogates to a single mean of legal payments. There are, however, three main directions for reform of the settlement system:

institutionalizing money inflows to firms-producers;
ensuring transparency of money surrogates in circulation and expressing them in monetary form;
making money supply more easily available to firms. This is seen as a necessary macroeconomic precondition for solving the problem of barter and non-payments.

Prof. Yasin stressed that reform of the banking system is crucial for successful economic restructuring in Russia, since the main channel of re-monetarization is an increase in commercial lending by the banking system.

Conclusion

There are two conflicting paradigms which dominate the debate on barter in Russia: The first contends that the Russian “virtual economy” overestimates the value produced and therefore the total output should be brought into correspondence with the actual “cash” available for economic transactions. The second argues that inadequate macroeconomic policies led to de-monetization of the Russian economy and forced enterprises to deal in barter thus tilting the proportion of goods to money in favor of goods and making the ruble overvalued.

The above dichotomy of approaches raises a strategic question for domestic and foreign investors. If “virtual value” should be ultimately legalized to become the “true value,” how much would it cost foreign investors to buy property in Russia? If the “true value” is something currently mediated by the scarce amount of money in circulation and three-fourths of the economy should eventually be cut off, then should one ever risk his money in Russia at all? In the end, if Russia’s “virtual economy” turns out to be a negotiable asset, who will negotiate its value?

Taken into its complexity and importance, the problem of barter in Russia is likely to generate even greater interest and debate in the coming months, may be years. That debate might result in reconsidering the theoretical framework for anti-barter strategies and rethinking agreements previously made with international financial institutions.

Endnotes

*: This Discussion paper was prepared by Aleksey Makushkin, Rado Petkov, and Nina Khrushcheva at the EWI. We invite your response and insights on the Russian economy, including criticisms or disagreement with what you read here. Please address your questions and comments to Rado Petkov at 212-824-4133, rpetkov@iews.org. Back.

Note 1: A recent EBRD working paper specifies the following non-monetary transactional forms: 1) barter where the transaction involves goods for goods; 2) money surrogates—primarily promissory notes (veksels); 3) offsets (zachety) where the dominant transactions involves debt for goods; and 4) debt swaps, sales and roll-overs. (Commander S. and C. Mumssen. Understanding Barter in Russia. EBRD Working paper, January 1999. Back.

Note 2: Gaddy, Clifford and Ickes, Barry. “Beyond a Bailout: Time to Face Reality About Russia’s “Virtual Economy.” Brookings Institute Working Paper, August 1998. Back.

Note 3: A word of caution is needed in taking these numbers at face value. Statistical data from the Goskomstat is often unreliable and official accounting standards make it difficult to assess monetary turnover and the extent to which “cash payments” correspond to true value created and distributed. Back.