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Russia: Financial Crisis Sent A Shock Around The World

Washington, 17 September 1998 (RFE/RL) -- The leaders of the global organization of commercial banks and financial institutions say that Russia's unilateral debt moratorium and rescheduling was a major factor in heightening and spreading the current global financial crisis.

The action, they say, left most developing countries with virtually no available credit or money to conduct normal business -- a crisis of virtually no liquidity.

Charles Dallara, Managing Director of the Washington-based Institute of International Finance (IIF), told reporters that the Asian financial crisis was serious, but that it was "deepened considerably" by Moscow's failure to even consult with lenders and investors before declaring the debt moratorium and rescheduling.

He said it sent a shock around the world that prompted a mass flight of capital out of all developing countries.

A vice chairman of the Institute, William Rhodes, who is also a vice chairman of Citibank, said that the failure of the International Monetary Fund (IMF) and the G-7 group of major industrial nations to quickly condemn the unilateral move compounded the panic and prompted investors and lenders to wonder if the basic rules of global finance were to be changed.

The problem is that investors and lenders did not differentiate between Russia and other developing countries in Central Europe, parts of Asia, and in Latin America where reforms are moving ahead solidly and government policies are appropriate. They simply pulled all their money out of emerging markets and put it in U.S. and other west European national treasury instruments, said Dallara and Rhodes.

World Bank President James Wolfensohn says the situation is critical. He told a conference on private sector development Wednesday that gross debt flows -- the amount of money available for normal business and investment credit -- available to developing nations has dropped from $300 billion last year to about half that level this year.

Even worse, portfolio investment into developing nations, which totaled over $30 billion last year, has been completely reversed and is showing a $30 billion outflow from the same poorer nations this year.

Wolfensohn said that enormous cutback at a time of crisis when countries are trying to refinance and revitalize their economies, is a "tremendous knock on the head for recovery."

The World Bank chief noted that direct investment into developing countries is only down by a small amount, by about $10 billion, to about $110 billion this year. But he says that still doesn't allow normal markets to operate in those nations.

U.S. Treasury Secretary Robert Rubin told a congressional committee Wednesday that this huge outrush of capital from developing nations, many of whom are doing the right thing with their reform programs, has created a combustible situation. " Just as capital flowed into emerging countries indiscriminately, and that was a mistake, capital is now flowing out indiscriminately, and that is also a mistake. Credit investment decisions need to be made with careful analysis of risks, rewards, strengths and fundamentals in the economy, in a manner unaffected by the mentality of the moment,." he said.

The bankers group's Dallara, speaking on a telephone press conference from Tokyo, and Rhodes, speaking from New York, said their organization was urging its 295 member banks, investment firms, pension funds and insurance companies to "differentiate" between those countries which have solid fundamentals and those which do not, and put their money back into the good ones.

Dallara said there is some early indication of this kind of differentiation beginning in the markets because they are recognizing that Russia's actions are not apt to be replicated in other parts of the world. The IMF and the G-7, among others, have now spoken out forcefully that no one in the international economy will support, condone or tolerate such unilateral actions.

Rhodes said a group of private western bankers is now organizing to start discussions with Russian officials, but he emphasized that Moscow will have to agree to not only negotiate the debt that was forcefully rescheduled, but also the pending forward ruble contracts which Russian banks are now unable to honor. The contracts, agreements to sell rubles at specific rates at specified future dates, are used by banks and other financial operatives to help mitigate the potential impact of currency devaluations.

Russian banks, caught by the sudden decision to allow the ruble to devaluate coupled with the debt moratorium, say they are unable to honor the forward contracts they hold. Western banking firms, which were on the other side of those deals, stand to lose hundreds of millions of dollars, experts say.

The Chairman of the U.S. Federal Reserve (Central Bank), Alan Greenspan, added his own warning to countries such as Malaysia, which has started to impose restrictions on short term capital flows, and Russia, which is talking about it: Such action only cuts a country off from the global economy, stops such legitimate and necessary short-term capital as trade finance, and even hurts most long-term direct investment, he said.

Governments which impose controls on capital flow, even temporarily, then find that removing them creates a whole set of new problems which are even more difficult to deal with, said Greenspan.

Greenspan joined with Rubin and the private commercial bankers in saying that Russia must make the political decision to adopt reforms, and undertake what Wolfensohn calls the entire culture of market economies -- international standards, controls and supervision.

Until then, he said, it would be foolish for any additional international loans to be made to Russia. "Merely giving money for money's sake is a terrible mistake," said Greenspan. It would only continue the imbalances in the system and create nothing of a positive nature.