The negotiations between the Russian government and the International Monetary Fund, which began Jan. 17 and will last at least until the end of this week, are serious financial business. Recent political uncertainties -- aggravated by military misadventure in Chechnya -- are jeopardizing the multilateral loans which underpin the draft budget for 1995.


Much has been made of the war's financial effect: Harvard economist Marshall Goldman has argued that "the cost of financing the war all but assures that economic reform in Russia will fail." In fact, the cost of keeping troops active rather than in barracks, and of replacing spent artillery, and the leverage of a strengthened military lobby in the Duma are far from certain.


Suggesting that Russia's reforms will grind to a halt -- or even be hindered significantly -- because of Chechnya is premature. However, if the Chechen war compels the IMF to give Russia the "thumbs down," reform efforts will suffer a serious blow. Were the $6.25 billion IMF standby loan -- linked to an additional $1.5 billion from the World Bank -- to be refused, the damage would go far beyond a hole in Russia's budget.


Although the war in Chechnya may marginally widen the budget deficit, the killer blow is that it could undermine plans to avoid plugging the deficit by printing money. Budget deficits per se do not necessarily cause inflation. But they are highly inflationary -- and devastating for reform -- when financed by credits from the Central Bank.


Pre-war budgetary plans recognized this. Central Bank financing was to be partly replaced by bond issues -- the sale of government debt to the tune of 4.6 percent of the projected gross domestic product on Russian and international capital markets. The political uncertainty caused by the war makes this a bold assumption. Rumors that hard-currency accounts are to be frozen have led to a run on the deposits of Russia's "commercial banks," depriving them of the liquidity required to buy bonds. Russia's credit rating has also tumbled -- and is yet to recover following the removal of State Property Committee maverick Vladimir Polevanov -- making overseas bond sales less plausible.


The cornerstone of government plans to rein in Central Bank financing, though, was loans from international financial institutions. And this was not only because Central Bank credits would be directly replaced by loans from the IMF.


It was largely the inclusion of multilateral finance -- in fact, a further $6 billion ruble-stabilization fund -- which drove projected bond sales. A fixed exchange rate encourages the sale of bonds not only by lowering inflationary expectations, but also by drawing money away from currency speculation. Without the stabilization fund, a pegged ruble -- with its bond-selling advantages -- remains out of the question. For this reason, an early exit by the IMF would have far-reaching effects.


Most damaging is the signal that a pessimistic IMF verdict would convey. Without a green light from Washington, investment in Russia ceases to be a valid proposition for most overseas investors. This is especially true given the fall from favor of "emerging markets" since traders zeroed in on Mexico. The effects for Russia of an IMF withdrawal in terms of capital flight -- as well as bond sales foregone -- would be particularly severe given the current tightness of international liquidity.


The IMF's decision will take at least some account of the recent mood change on Capitol Hill. The Republican takeover of Congress has led to calls for a radical scaling back of foreign aid and the implementation of strictly performance-based loans. Of course, loans should always be tied to conditions. But conditions can relate to the way money is used after a loan has been made, as well as criteria which secure the loan. Furthermore, such criteria, while usually stated in terms of macro-economics, can alternatively insist upon institutional reform.


While endorsing the potential of the Russian economy, the IMF should release a portion of the $6 billion ruble-stabilization fund, provided it is used for its intended purpose. The presence of foreign money will do a great deal to stem speculative attacks on the ruble over the coming months of uncertainty.


Quarterly tranches of the $6.25 billion standby loan should then be tied to concrete institutional reform -- serious bankruptcy legislation and the addressing of crippling logistic gaps in Russia's securities markets. In the context of economic transition, macroeconomic performance is determined first and foremost by micro-level change.


It was never likely that the government would avoid printing money altogether during the coming year. Early budget drafts indicated that at least a third of bond sales would be to the Central Bank itself and some 1995 credit emissions have already been approved. However, any reversal of the old credit-issuing habits looks far less likely in the absence of external loans. The removal of IMF and World Bank support would imply the monetary free-for-all which both institutions hope to avoid.


In fact, the political case for IMF support is more emphatic than the economic one. A "Russia is lost" verdict would deal the pro-reform lobby a serious political blow. It would consolidate the anti-Western sentiment evident in recent talk of renationalization, the rallying of counterintelligence forces and accusations that foreign investment is designed to undermine Russia's national sovereignty. It is not out of the question that the IMF would not be invited back.


Although Chechnya in no way implies the end of reform in Russia, its financial implications are largely in the hands of the Washington institutions. Moreover, while the IMF is ill-equipped to make what amount to political judgments, the political implications of their verdict cannot be ignored.





Liam Halligan is an economist at the Moscow-based Center for Economic Reform. He contributed this comment to The Moscow Times.