Excerpts from a Presentation by Roger W. Robinson Jr. before the Heritage Foundation Symposium on ‘The Meaning of the Russian Financial Bailout’

Washington, D.C.

23 July 1998

As mentioned in Ariel’s kind introduction, my earlier experience as an East-West banker with
responsibilities for Chase Manhattan’s portfolio in the former Soviet Union and the region was
particularly helpful when I went to work at the National Security Council. Indeed, it is the nexus
between global finance and national security which I would like to focus on during these brief
remarks.

First, it is worth underscoring the predictability of the $22.6 billion emergency rescue package
for
Russia forged by the U.S. and International Monetary Fund (IMF) just a few days ago.
When a
country has some $1.3 billion in short-term debt obligations coming due per week on
total
hard currency reserves of some $12-15 billion, it does not take a banker to recognize the
sharp escalation in the bailout amount which will ultimately be required.

Initially, the IMF appeared to understand that its past disbursements of the existing $9.2
billion
facility for Russia had been largely politicized by Washington and other G-7 capitals. To its
credit, the Fund at least tried to hang tough against Russia’s rhetorical pledges of
reform in the
interest of preserving its already damaged institutional integrity….It demanded that meaningful
systemic change be implemented by Moscow before it would commit to new multibillion-dollar
outlays. Regrettably, it was again not to be.

***

During this relatively brief six week period, the cost of the IMF portion of the bailout
doubled,
from $5.6 to $11.2 billion. This sad state of affairs — particularly for U.S. and other Western
taxpayers — was eerily reminiscent of the countless warnings concerning the unsustainability of
the Soviet debt structure which went unheeded in the late 1980’s.

In fact, my first Heritage lecture in February 1986 was on the subject of why Moscow would
ultimately be unable to service its hard currency debt owed Western governments and commercial
banks due primarily to a lack of systemic transformation, capital flight, the outflow of hard
currency to support an aggressive foreign policy and strategic modernization efforts and the
undisciplined, unconditioned and largely non-transparent lending practices of Western creditors.

Russian Bonds

In the current circumstances, however, there exists an important additional complication,
fortunately not as evident in the Soviet era — namely, the use of bond offerings as a
principal
means of offsetting revenue shortfalls and advancing Moscow’s economic and political
agenda. Unlike loans from Western governments and commercial banks (nearly the
only forms of
Soviet borrowing) bonds cannot be rescheduled. [Issuing bonds] also permits Moscow to tap into
a large number of new lending sources including: Western securities firms, pension funds,
insurance companies, corporations and even individuals.

The funds Russia attracts via bond offerings is also so-called “general purpose” or
“balance-of-payments” financing, with no specific underlying trade transactions or projects which
would
potentially advance the country’s economic vitality. In short, it is simply cash disbursed
with
few, if any, questions asked concerning where the money is going or how it is being used —
a proven formula for a financial train wreck.

Make no mistake, the Russian leadership is keenly alert to the political windfall of
this new
borrowing method: the creation of politically-powerful new constituencies throughout the
U.S. and the West which would henceforth have a vested financial interest in opposing the
imposition of economic sanctions or other penalties against Russia for its proliferation and
other global misdeeds and supporting future bailouts.

Accordingly, I concur with Marshal Goldman’s assessment that we have not seen —
nor will we
see in the next few critical months — the kind of systemic transformation necessary for the
$22.6 billion package to gain sufficient traction to turn around Russia’s structural crisis.

Neglecting the National Security Dimension

Not surprisingly, amid the flurry of discussions about Russian debt restructuring, tax
collection,
budget deficit reduction, privatizing energy and other monopolies, property rights and the
construction of genuine commercial and legal codes, virtually no G-7 or IMF attention
has
been directed to the funding of sophisticated Russian military programs and associated
expenditures. Similarly, no Western cash flow calculations appear to have been made
with
respect to the hard currency costs of the robust and belligerent “Primakov Doctrine” which
governs Russian foreign policy.

[The fact is that] Russian foreign policy adventurism and strategic force modernization
continue
apace, in some cases with more than adequate budget allocations. For these and other reasons,
my guess is that Moscow will return to the West for a bailout “supplement” or an official
request for the acceleration of disbursements before the end of the year — well short of the
minimum two year period the $22.6 billion package is advertised to cover….

[A] partial list alone [of Russian military modernization programs] involves expenditures of
probably as much as $10 billion or more — an amount representing roughly half of the
$22.6
billion bailout package. Perhaps the Congress is operating under the assumption that
these
questionable military expenditures were a significant agenda item in the configuring of
IMF conditionality or, at minimum, the “quiet diplomacy” of G-7 capitals with Moscow. If
so, they should ask some tough questions of the Clinton Administration, and be prepared
for some disappointing answers.

Regrettably, there is an equally ominous list associated with
Russian foreign policy priorities and
attendant financial outlays. Among these priorities are: the political sheltering of Iraq’s weapons
of mass destruction programs and a reported commitment to provide a multi-billion dollar credit
line to bolster Baghdad’s oil production as soon as UN sanctions are lifted; the transfer of
sensitive ballistic missile technology and components to Iran as well as providing at least two
nuclear reactors to Tehran; a concerted effort to destabilize the Western-oriented, secular Muslim
states in the oil-rich Caspian Sea region (i.e. Azerbaijan and Turkey); and monopolize regional
pipeline routes (notably, through Georgia); the fostering of a crisis on Cyprus with the scheduled
November delivery of S-300 missiles to the Greek Cypriots; and efforts to disrupt U.S. and
NATO responses to the crisis in Kosovo.

Moreover, in recent months the Kremlin has renewed its commitment to complete an
irretrievably-flawed nuclear reactor complex in Juragua, Cuba, and continued its large-scale
sharing of military technology and intelligence with China. Unfortunately, these and other
malevolent Russian actions (e.g., supplying military equipment to North Korea and fueling
tensions on the Indian sub-continent and the Middle East) are threatening American interests as
well as geopolitical stability throughout the world. How is it that the insidious portfolio of
Yevgeni Primakov goes almost completely unchallenged at a moment of unique Western financial
leverage? Clearly, this must change when Congress reconvenes.

The Gazprom Bond Precedent: A Case Study

For those who doubt that national security issues are impacting on the global capital markets
as
never before, consider what befell the huge Russian natural gas monopoly, Gazprom, in the
United States in October and November of last year. Put simply, in the summer of 1997,
Gazprom came under withering pressure to pay as much as $4 billion in tax arrearages to the
Russian government in order that it might, in turn, pay back wages to miners, pensioners and
other workers. This action left Gazprom in a liquidity bind that they sought to remedy by
concluding two major international financings in the November time-frame. The first was a
syndicated loan collateralized by natural gas receivables (primarily those of Gaz de France and
Germany’s Rhurgas) and the second was a $3 billion bond offering in the U.S. market.

In the immediate window of the bond offering, Gazprom signed on as 30% shareholder in a
consortium configured by the French oil company Total to develop Iran’s South Pars offshore gas
fields. This action was judged to be in violation of U.S. law under the Iran-Libya Sanctions Act
(ILSA). The Senate Banking Committee subsequently convened hearings on this subject on 30
October 1997 and a Senate Banking subcommittee held companion hearings on November 5.
Gazprom was confronted with the withdrawal of a roughly $750 million U.S. ExImbank credit
line to facilitate U.S. equipment supplies, among other penalties.

What the company did not count on, however, was a blistering critique of its intention to go
forward in the U.S. bond market with a $3 billion-plus offering. The level of security-related
concerns expressed by members of the Senate Banking, Foreign Affairs and Intelligence
Committees — combined with some deterioration in market conditions — were sufficient to cause
the withdrawal of the Gazprom bond, even though its activities in the private U.S. capital markets
were not covered by the statute.

While there are many who argue that Gazprom and its lead U.S. investment bank were solely
reacting to adverse market conditions catalyzed by the Asian financial crisis, the facts prove
otherwise. In short, Gazprom desperately needed those funds and was not stepping back to await
more favorable borrowing terms and conditions. Indeed, when it became apparent that
U.S.
congressional opposition to the bond offering was serious, Gazprom abandoned the bond
issue and increased significantly the amount of its more expensive collateralized syndicated
loan in Europe which was being readied for market at the same time as the U.S. bond
offering. Coincidentally, the ultimate amount of this eight-year syndicated loan brought
to
market on 4 November 1997 was $3 billion. A managing director of a major commercial bank
who followed these transactions closely termed the congressional hearings of 30 October 1997 on
the ILSA legislation ” the coup de grâce” for the Gazprom bond.

To my knowledge, this was the first major foreign bond offering in the private U.S. capital
markets ever derailed by primarily U.S. national security considerations. As such, it is an
immensely important precedent in demonstrating that foreign governments and enterprises cannot
expect to enjoy completely unfettered access to the U.S. capital markets when engaged in
activities harmful to U.S. security interests.

Conclusion

It is highly unlikely that the two-year $22.6 billion Russian rescue package will be sufficient to
restore investor confidence, allow the implementation of requisite radical reform measures or to
restructure the maturities of the country’s large remaining short-term debt (roughly $28.5 billion
of which is coming due by the end of this year). In part, this pessimistic prediction
is predicated
on the continued unwillingness of the IMF and G-7 leaders to press Moscow to reallocate the
multibillion-dollar sums currently earmarked for strategic modernization programs and Mr.
Primakov’s aggressive, global foreign policy initiatives.

Accordingly, the Congress must begin immediately to scrutinize Russia’s hard currency cash
flow
— that is, all sources and uses of cash — as well as its activities on the U.S. debt and
equity
markets — on a routine basis. It should be recalled that U.S. taxpayers are still being
penalized
for undisciplined, imprudent Western lending practices with regard to the former Soviet
Union which resulted in roughly $100 billion disappearing into long-term debt
reschedulings concluded over the past five years in the London and Paris Clubs. Under
these circumstances, continuing to neglect to integrate relevant national security considerations
into provisions of future funding measures for Russia and the IMF would be unwise and
counterproductive.

Finally, U.S. and other Western financial policy-makers — as well as private
investors and
lenders — should include existing and emerging national security issues in their future due
diligence and creditworthiness evaluations, despite their seeming antipathy for this
potentially
“disruptive” portfolio of concerns. Past efforts to construct a firewall between global finance and
national security are no longer sustainable or desirable. For example, the current push by the U.S.
business community on Capitol Hill to eviscerate economic sanctions as a policy response to
dangerous geopolitical behavior on the part of foreign governments (or their surrogates) in the
name of market stability and “engagement” is misguided and irresponsible.

Borrowers like Russia and China will continue to take actions which periodically endanger
American interests and those of our allies. When they do, the American people, the Congress and
the media will demand a swift and credible U.S. reaction which will, more often than not, disrupt
trade flows and the markets more than would have been the case if national security concerns had
been taken into account at the outset. In short, no firewall can hold up against the
advent of
the proliferation of weapons of mass destruction and ballistic missile delivery systems, not
to mention other security-related challenges of the 21^st century. Regrettably, the
costs of
denying this reality have been high — and are rising.

— End of Excerpts —