Doomsday Scenario: Aspin Nomination Sets Stage For Dellums Chairmanship, Grim Tidings For Defense Community

As Presidents George Bush and Boris Yeltsin meet this weekend to discuss the status of Russia’s structural transformation — and ways in which the United States and other Western nations can best help in its realization — one item should top the agenda: The untenable debt burden the new democratic leadership in Moscow has inherited from its communist predecessors.

This debt is currently estimated to run as high as $80 billion. (Western estimates vary by as much as $20 billion.) Meeting the interest and principal payments due on this debt in the years immediately ahead are one of the main drivers behind Russian (and other Soviet successor states’) desperate bid for infusions of "new money" from the West. To the extent that scarce hard currency resources must be outlayed to repay debt obligations, such funds are unavailable for urgently needed investment and other stimuli to economic growth. What is more, the requirement under present circumstances to meet these obligations lest creditors (sovereign and commercial) refuse to lend further funds is encouraging the continued — and probably burgeoning — effort to earn hard currency through major arms sales overseas.

Obviously, it is not in the interest of the United States (or, that of the world more generally) to aggravate Russia’s internal problems or to provide any additional encouragement to the proliferation of advanced Soviet weaponry. Accordingly, the Bush-Yeltsin meeting should produce an American commitment to take the lead among the G-7 partners in advocating the meaningful, yet conditioned relief — if not partial forgiveness — of Russia’s debt. Naturally, this allied policy initiative should be predicated on a complete inventory taken of the true assets and liabilities — both at home and abroad — of Russia and other CIS member states to help determine the economic trade-offs involved in assuming responsibility for the debt obligations of the former Soviet Union.

Background

During Mikhail Gorbachev’s disastrous stewardship over the Soviet economy, the former USSR’s total hard currency indebtedness rose from roughly $30 billion to as much as $80 billion or more. The former Soviet republics had very little, if any, decision-making role in taking on the bulk of this crushing debt burden or, for that matter, in the use made of the proceeds of Western borrowings.

Indeed, most of the roughly $40-$50 billion attracted from the West by Gorbachev was used to: support the modernization and expansion of an already bloated Soviet military-industrial complex; fund bankrupt client states from Havana to Hanoi; and finance technology theft, hostile espionage, disinformation campaigns and subversive activities overseas. Only a modest fraction of these funds wound up going toward civilian economic development, health care, and consumer goods.

Incredible as it may seem, Western governments and banks chronically ignored established and disciplined lending techniques in their financial relations with the former Soviet Union. They routinely eschewed the use of conditionality, transparency and "specific-purpose" (i.e., tied) credits. For example between 1985 and 1988, about 80 percent of all Western commercial bank credits to the former Soviet Union took the form of untied, balance-of-payments loans — with no effort made to identify where the money was going or how it would be used. This, in turn, provided Moscow center with substantial flexibility in the diversion of borrowed funds to finance communist party activities at home and abroad, as well as foreign operations inimical to vital Western security interests.

In addition, Western creditors in general acquiesced to Moscow center’s refusal to engage in standard economic and financial data disclosure requirements. This dramatic departure from normal practice with other sovereign and commercial borrowers has contributed significantly to the present inability of Western experts to determine the true assets and liabilities of the ex-USSR.

Western governments, particularly that of Germany, knowingly politicized financial relations with the former Soviet Union. Among other things, this was accomplished through the device of allowing their credits to be used to "purchase" narrow national objectives such as German reunification, the removal of Soviet troops and preferential treatment in cleaning up large payment arrearages to German firms. In the end, this political "purchase" scheme was successful — indeed, a bargain — for the roughly $30 billion expended by Bonn.

In short, most European governments knew in rather precise terms what they were getting for their "loaned" money — and never really expected (or required) full repayment. This is also true of the $3.75 billion in U.S. Commodity Credit Corporation loan guarantees which were pledged and largely disbursed to the former USSR over the past twelve months, despite irrefutable evidence that Moscow’s creditworthiness had evaporated in private Western credit markets. Although this $3.75 billion is currently excluded from official debt rescheduling arrangements for 1992, this amount and all allied debt contracted after 1 January 1991 should be immediately folded into the rescheduled debt.

Political Merits of Debt Relief and Select Forgiveness

At a time of economic austerity — and, in some cases, recession — in the West, prospects for mobilizing large-scale, taxpayer-underwritten "new money" flows for Russia (and other Commonwealth of Independent States, or CIS, nations) from the United States and other Western nations will be exceedingly difficult. In fact, it may as a practical matter be politically impossible.

"New Money" Is Hard to Come By: Accordingly, with the possible exception of short-term disaster assistance, there are few options available at this critical juncture to provide Russia (and other reformist CIS nations) with meaningful structural help — other, that is, than through debt relief/select forgiveness. It is hard, moreover, to imagine a more unsustainable idea than that of having such "new money" as Western taxpayers can muster going into Russian or other CIS states — only to have it be substantially paid out through the back door to the German government and banks (and other Western creditors) who previously helped create this financial disaster by propping up the communist Moscow center with undisciplined lending practices.

The financial "breathing space" offered by debt relief is absolutely critical to the ability of Russia, Ukraine and other CIS states to maintain critical imports and continue economic reforms. Western governments and commercial banks have agreed to reschedule principal payments (amounting to roughly $8 billion) falling due in 1992 on medium and long-term debts contracted by the USSR prior to 1 January 1991. Russia has stated it may not be able to service interest payments in full but will try to make periodic interest payments. This, in effect, means that some level of debt relief is already underway. What is called for now is expanded debt rescheduling covering several years beyond 1992 (including the debt contracted after 1 January 1991), to say nothing of debt forgiveness.

The American people would be far more receptive to writing down, if not writing off, former Soviet debt on U.S. government books than they would be toward providing new money out of a limited foreign aid budget at the direct expense of other worthy claimants. The value of Soviet debt on the secondary market is now about 30-50 to the dollar — allowing for heavily discounted debt forgiveness for faltering CIS member states.

A Precedent? It should be remembered that the former Soviet Union defaulted on czarist debt owed to U.S. citizens and never settled those outstanding obligations. Similarly, in 1974 Moscow center declined to repay U.S. Lend Lease debts after committing to do so in the early 1970s. (Together these debts are conservatively valued at about $1.5 billion.)

These facts beg the following questions: Why should Russia and other CIS members now be held to a higher standard of accountability for financial liabilities incurred by the Soviet Union than the Soviets themselves were? Specifically, since Western creditors were willing to accommodate themselves to the Soviets’ refusal to take responsibility for the outstanding debt obligations of the previous czarist regime, why should they be unwilling to do so as a contribution to the success of a democratically-minded Russia and other successor states?

Dangerous Arms Sales to Pay Debts? Roughly 80-90 percent of the total annual hard currency income of the former USSR is comprised of exports of oil, gas, gold and arms. With oil production and exports in sharp decline and with the Yavlinsky-announced firesale of about 90 percent of strategic gold reserves, massive Soviet arms sales worldwide will be necessary to pick up the slack — assuming Western creditors are to continue to be serviced during this wrenching transformation process.

Debt relief/forgiveness, therefore, would alleviate some of the pressure that the Russian government and other CIS states might otherwise feel to engage in arms transfers, possibly including sales to irresponsible state sponsors of terrorism around the world (e.g., Iran, Iraq, Libya, Syria, North Korea, Cuba, etc.)

Downside Risks and Mitigating Considerations

Inevitably, there will be strenuous efforts made by the Bush Administration, other Western governments and numerous private banks to stampede the former Soviet Union into a commitment to secure all debt obligations beyond the very limited rescheduling of principal payments already agreed for 1992. Some of the arguments likely to be used in this connection — and appropriate rebuttals — are as follows:

• Risk: Western governments and banks will threaten to deny any new credits to Russia or other CIS member states if the latter insist on substantial debt rescheduling or forgiveness.

 

Mitigating Considerations: Although this scenario is possible, it is highly unlikely that Western creditors would be prepared to follow through. Whatever risk remains, moreover, can be substantially reduced by the proper structuring and conditioning of debt rescheduling/forgiveness.

 

For example, rescheduling both principal and interest payments for Western governments but only principle payments for Western commercial banks would keep loans current on the latters’ books. Arguably, such a step would permit the relatively rapid reentry of certain CIS member states into private credit markets — assuming structural reforms remain on track. New collateralized loan arrangements could also be attractive to private Western creditors, despite non-repayment of most Soviet debt.

 

• Risk: The precedent established by granting long-term rescheduling or forgiveness for a resource-rich nation such as Russia will be called intolerable, and sure to lead to as many as 30 other debtor nations demanding the same preferential treatment from Western creditors.

 

Mitigating Considerations: Ample precedents exist for debt rescheduling/forgiveness even in countries with considerable resources. For example, in Poland some 50 percent of official debt was forgiven to assist the transition to a market economy. What is more, the United States forgave outright some $7 billion on official Egyptian debt in exchange for Cairo’s assistance during the Gulf War.

 

The historic opportunity to consolidate democratic revolutions on the territory of the former USSR — and essentially remove the horrific threat posed by thousands of nuclear warheads aimed at American cities, military installations and industrial centers — should be more than sufficient justification for making conditioned debt relief the centerpiece of the West’s efforts to assist Russia and other CIS member states.

 

• Risk: It will be argued that Western banks — and possibly the international financial system as a whole — will be badly damaged by any interruption in repayment of outstanding principal and interest due on Soviet debt beyond the already agreed debt rescheduling of principal-only for 1992.

 

Mitigating Considerations: It is a matter of public record that the major German banks (who hold somewhere between DM 6-10 billion in uninsured Soviet debt) have — with the possible exception of Commerzbank — already established loan loss reserves which cover 100 percent of Soviet debt exposure. Other European banks have taken similar steps.

 

Indeed, the Germans have proudly advertized the fact that their banks would not be materially affected by Soviet write-offs. Western governments have similarly resigned themselves to the fact that long-term debt relief/debt forgiveness is inevitable. They have also begun to put into place the arrangements that will make it manageable. Consequently, the proposed strategy would not cause undue strain on the international financial system.

 

Conclusion

Properly structured and conditioned debt relief and possible forgiveness represents a potential savings for Russia and other qualifying CIS member states of as much as $40-50 billion over the next four or five years. There is simply no comparable, politically feasible Western assistance measure that would contribute as much to the former Soviet Union’s economic revitalization, democratic institution-building and reduced arms proliferation as would conditional debt relief/forgiveness. It would also offset, to a substantial extent, the probable inadequacy of new, near-term financial flows from the West.

Those Western creditors who knowingly bet their taxpayers’, shareholders’ and depositors’ money on an unworkable, centrally-controlled economic system — for political or commercial reasons — should be accorded little sympathy in weighing appropriate levels of debt rescheduling and forgiveness. Such creditors entered into these transactions with their eyes wide open concerning the dubious prospects for full repayment. It is only sensible and fair that the true democratic forces in the former USSR not be penalized by those in the West who contributed so enthusiastically to propping up a repressive communist regime.

Finally, it is essential to clear the decks of past Soviet indebtedness in an orderly fashion and as quickly as possible if new Western credit, investment and trade flows are to be resurrected for Russia, Ukraine and other qualifying CIS member states.