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Moscow Times
August 30, 2004
When Turnabout Is Not Fair Play
By Mikhail Delyagin
Mikhail Delyagin, head of the Modernization Institute and chairman of the Rodina bloc's policy committee, contributed this comment to The Moscow Times.

In the spring of 1999, then-Prime Minister Yevgeny Primakov set off on an official visit to the United States. Over the mid-Atlantic, however, Primakov ordered his pilot to turn the plane around and return to Moscow. He canceled his visit to protest the bombing of Yugoslavia by the United States and its NATO allies.

Five years later, Russian capital moving through illegal channels -- below the radar of state regulatory agencies -- staged an equally dramatic turnaround. The balance of such capital movements falls under the heading of errors and omissions in Russia's balance of payments.

Throughout the period of economic reforms, this balance was negative or, in rare cases, it approached zero. Capital was leaving the country illegally. This trend continued in the first quarter of 2004, when capital outflow through illegal channels amounted to $4.4 billion. In the second quarter, however, a net inflow of capital ($1.4 billion) through these channels occurred for the first time in the 10 years that such flows have been monitored. In the space of one quarter, this turnabout amounted to $5.8 billion.

This change affected overall capital movements. In the second quarter of 2004, net capital outflow slowed sharply to $1.1 billion, down from $4.4 billion in the first quarter. This is a seasonal adjustment regularly observed in the second quarter. But this year capital movements through channels that are more or less subject to state regulation did not show any significant change.

The outflow of private banking capital, for example, rose by $400 million in the first quarter to $3.6 billion. This marginal increase occurred because a decrease in Russian banks' foreign assets from $3.6 billion to $2.4 billion was counterbalanced by a growth in liabilities: Foreign liabilities increased by $400 million in the first quarter, they shrank by $1.2 billion in the second quarter.

Improvement in total capital movements was achieved thanks to the nonfinancial sector, which generally accounts for errors and omissions: An outflow of $1.2 billion in the first quarter was followed by an inflow of $2.5 billion in the second. Meanwhile, growth of foreign liabilities was insignificant (up $300 million to $8.8 billion), while foreign assets -- that is, capital outflow -- jumped from $5.3 billion to $7.7 billion. Thus overall capital inflow occurred thanks to a shift in the direction of capital flowing through illegal channels.

Capital inflow through illegal channels seems to have resulted from a unique combination of a favorable economic situation and the extremely complicated -- from the business point of view -- domestic political situation.

The significant volume of the Russian market -- secured for the foreseeable future by continued high oil prices -- and the possibility for developing a business here using little more than standard, modern management techniques make Russia extremely attractive to investors, especially when compared to less favorable conditions in the developed countries. This assessment has become a commonplace in recent years.

At the same time, law-abiding companies are being frightened off by a number of factors, including: the incompetence of the state bureaucracy; its impotence when faced with real problems, as graphically illustrated by the recent banking crisis, which resulted largely from the Central Bank's failure to take timely and decisive action; its tendency to resort to propaganda rather than take action; and the widespread phenomenon of copycat crackdowns by government officials at all levels during the Yukos affair.

The best indicator of how this process works -- even better than falling stock prices, which are susceptible to speculation -- is provided by an analysis of overall capital movements.

According to Central Bank data, capital outflow in the first half of 2004 amounted to $5.5 billion, exceeding outflow during the first half of 2002 ($2 billion) and during all of 2003 ($2.3 billion). Keep in mind that in the first half of 2003, before the beginning of the Yukos affair, Russia enjoyed a net capital inflow -- of $3.9 billion -- for the first time during the entire period of economic reforms.

When you look at capital movements during the year that has passed since the Yukos affair began -- in other words, from July 1, 2003, to July 1, 2004 -- with the situation one year earlier, the deterioration of the situation becomes even more clear. In the 12 months preceding the attack on Yukos -- from July 1, 2002, to July 1, 2003 -- the net outflow of capital amounted to $2.2 billion. During the next 12 months, in far more favorable external conditions, net capital outflow skyrocketed to $11.6 billion.

In the second quarter of 2004, however, capital outflow through channels regulated by the state was increasingly offset by capital inflow through unregulated channels. Illegal business began to erode the position of its relatively upstanding competition. Essentially, illegal capital began to squeeze out not only legal but also quasi-legal capital that is at least partially monitored and controlled by the state. It is now clear that entrepreneurs who employ illegal schemes for moving money operate without fear of reprisals because they have carefully calculated the risks involved in such operations, they know how to seal a deal, and they are confident that, in terms of business acumen, they are far superior to the government bureaucrats who regulate them.

The consequences of this situation for Russian business and for society as a whole are clear. Just as they did during the years of stagnation under Leonid Brezhnev, the business and social life of the country will once more retreat into the shadows, where regulatory mechanisms are not transparent and subject to public control but entirely corrupt and destructive for the life of society.