If You Like the Rigging of the Lebed Dismissal, You’ll Love the Rigging of the Global Credit and Securities Markets

(Washington, D.C.): It is ironic that
the firing of Russian National Security
Advisor Aleksander Lebed — a key
indicator of the political instability
and potential for turmoil in Russia —
occurred just hours after the last U.S.
presidential debate passed without a
single question about the security
policy challenges that will confront the
next occupant of the White House. Few
actions could more forcefully underscore
the folly of believing that the world can
be safely ignored or demonstrate more
clearly the dangers of the Clinton
practice of over-investing in the
Kremlin’s ruling elite.

Specifically, the transparently
orchestrated dismissal of General Lebed
put into sharp focus the recklessness of
several Clinton initiatives designed to
prop up the Yeltsin-Chernomyrdin
government. These include the following:

Unjustifiable Lending by
the IMF

In the months leading up to this
summer’s presidential elections in
Russia, the International Monetary Fund
responded to intensive pressure from
Washington and other Western capitals by
relaxing the criteria and the
conditionality terms that borrowing
nations are expected to meet before
receiving disbursements on IMF loans. As
the Casey Institute of the Center for
Security Policy noted on 10 September:

“…The IMF, after
temporarily suspending the July
tranche of a $10.1 billion loan
to Russia, suddenly deemed that
Moscow had finally come to grips
with its tax collection problem
(despite the fact that tax
collection fell by 62% in the
first six months of 1996). This
decision, made only two weeks
after the original suspension,
came on the heels of comments
made by the new Russian Finance
Minister, Aleksandr Livshits,
that equated Russian tax
collection with a ‘black hole’
and said that Russia is an
unusual country because it is
possible to ‘pay no taxes at all
and nothing whatever will
happen.’

“Moreover, the IMF agreed to
raise Russia’s budget deficit
target from 4% to 5.25% of GDP,
allowing it to qualify for
further disbursements of the
loan, despite a ballooning
deficit. It appears to many
informed observers that these IMF
decisions were designed to allow
President Boris Yeltsin to make
good on at least some of his
outrageous election campaign
promises and to ensure that the
Clinton Administration’s
misguided Yeltsin-centric Russian
policy does not collapse prior to
the November elections.” href=”96-C100.html#N_1_”>⁽¹⁾

On 24 September 1996, the Casey Institute
called attention to relevant remarks made
in Washington five days earlier by Grigori
Yavlinsky. href=”96-C100.html#N_2_”>⁽²⁾
Before a Radio Free Europe/Radio Liberty
audience, the economist and former
self-declared democratic candidate for
the Russian presidency, confirmed the
Center’s long-held suspicion that IMF
disbursements to Russia were directly or
indirectly being used to help finance
what Yavlinsky described as
“genocide” in Chechnya, saying
in part:

“…It looks like
our government is collecting
taxes from you…via IMF — and,
by the way, spending them on the
war, the war in Chechnya.
Nobody can say that this money is
not used for that. It [is
being] used to finance the war.
But they’re not collecting even a
half of the taxes they have to
collect, but they have money from
the IMF to use it for the war in
the same time.”

The OPIC Scam

The Clinton Administration next moved to turn
the Overseas Private Investment
Corporation (OPIC) into the latest White
House slush-fund-of-choice for extending
aid to the Russian government. In July
and August alone, OPIC provided $830
million toward guaranteeing or insuring
against political instability and other
country-of-risk factors in Russia. The
intensifying instability there has only
served to reinforce concerns that these
contingent liabilities will become
due-and-payable liabilities, in a manner
reminiscent of other
taxpayer-underwritten guarantee schemes
gone sour (e.g., the Savings and
Loan crisis, the Agriculture Department’s
Commodity Credit Corporation
multi-billion debacles in Iraq and the
Soviet Union, etc.)

Worst yet, in September, the
Administration sought congressional
approval to double its credit guarantee
and insurance ceilings to roughly $45
billion. The Center joined with a number
of other organizations across the
political spectrum to oppose this
unwarranted expansion of U.S. contingent
liabilities. Thanks to the leadership of
Reps. John Kasich (R-OH), Ed Royce (R-CA)
and others, this ill-advised initiative
was soundly defeated in the House of
Representatives.

The Penetration of Western
Securities Markets — It Begins…

Russia currently has total
indebtedness of roughly $130 billion —
the vast majority of which has been
“rescheduled” due to the former
Soviet Union’s default on Western private
sector and government credits. Even the
estimated $19 billion in loans extended
to Russia since 1991 has experienced late
interest payments, with the prospect that
this debt could also be rescheduled down
the road.

Against this backdrop it is
stupefying that credit rating agencies of
Europe and the United States are giving
Moscow an inflated credit rating
— so much so that it is higher than that
of Brazil, Turkey, Argentina or Venezuela
and on a par with Mexico, India and
Hungary. Not surprisingly, the
most egregious rating was provided by the
European agency IBCA of BB+ (i.e., one
notch below “investment grade”).
Moodies offered a rating of BA2 (two
notches below investment grade). And
Standard and Poors gave Russia a rating
of BB- (three notches below). According
to some experts, the European rating
would serve to encourage even
conservatively managed pension plans to
hold Russian paper. href=”96-C100.html#N_3_”>⁽³⁾

In short, Russia is in a
position to secure a roughly $500 million
bond issue with a probable five-year
maturity following what money managers
almost universally judged to be an
unexpectedly high (read, unwarranted) set
of credit ratings. As soon as
November 1996, Moscow plans to go to
market with an initial Eurobond offering
and expects to receive an interest rate
of only 300-350 basis points (3-3.5%)
above comparable U.S. Treasury bonds.
Prior to this surprise rating, Russia
could not have expected a rate less than
400-450 basis points. According to
Russia’s draft 1997 budget, the Kremlin
is planning to raise at least $1.3
billion in Eurobonds next year alone. The
lead managers for Russia’s first issue
are J.P. Morgan and SBC Warburg.

Prime Minister Viktor Chernomyrdin is
likewise looking to the Western
securities markets to raise capital for
the enterprise that serves as his
political base and source of immense
personal wealth, Gazprom. The world’s
largest gas company is expected to raise
$500 million by selling 1.5% of its
equity to international fund managers. It
will first issue a $380 million offering
of American Depository Shares (each of
which represents 10 ordinary shares) for
a total of 23.7 million shares this year.
These international shares will sell for
about $1.40 apiece — substantially
higher than the $0.40 per share domestic
price — and will be traded initially on
the London Stock Exchange. A New
York offering is expected within as
little as 12 months.

What Will Russia’s
‘Financial Breakout’ End up Funding?

The prospect that the Kremlin will for
the first time begin selling securities
not only to European and Japanese
investors but to American securities
firms, mutual and pension funds,
insurance companies, corporations, and
individual portfolios is made all the
more ominous by the potential uses to
which such new sources of funds may be
applied. Probably unbeknownst to
the typical American investor or employee
who may wittingly — or unwittingly —
wind up holding Russian paper, these
undisciplined, unconditioned and largely
non-transparent revenue streams flowing
into the Kremlin’s coffers could be used
to underwrite activities inimical to U.S.
and Western security interests.
These might include:

• The funding of Russian
  supplier credits to facilitate
  the transfer of nuclear reactors
  to the fanatical Islamic
  government of Iran, a
  regime determined to divert the
  associated technology,
  infrastructure, know-how and
  training to the production of
  nuclear weapons.
• The completion of
  irretrievably flawed Soviet-era
  VVER 440 reactors under
  construction at the Juragua
  nuclear complex near Cienfuegos,
  Cuba.
• A contribution to
  Russia’s ongoing
  strategic force modernization
  programs including new
  classes of mobile ICBMs (the
  TOPOL-M), SS-N-24/26
  submarine-launched ballistic
  missiles and retrofitted Typhoon
  submarines on which they will be
  deployed.
• Helping to finance
  Moscow’s efforts to intimidate,
  coopt and coerce secular Muslim
  states involved in the
  extraction, processing and
  transmission of the estimated 200
  billion barrels of oil in the
  Caspian Sea basin.
• Underwriting a major new
  initiative by the Russian
  intelligence services intended to
  secure critical military,
  industrial and financial
  information at the expense of
  Western interests.
• Enabling Moscow to meet
  its existing pledge of a $10
  billion credit to expand and
  accelerate Iraqi oil production
  the moment UN-imposed sanctions
  are eased or lifted. And
• Providing new revenues to
  be skimmed by corrupt officials,
  joining untold billions of
  dollars already diverted to
  secret bank accounts in
  Switzerland, Cyprus and
  elsewhere.

What Will Be Reaped

If allowed to go forward under present
circumstances, two further developments
seem predictable: First, the
politicized process that has given Moscow
today’s inflated credit ratings will, in
due course, improve further — ultimately
passing the threshold of “investment
grade” securities. At that
point, it will be highly problematic to
impose the necessary discipline,
transparency and conditionality on this
sophisticated funding mechanism for the
Kremlin’s activities.

And second, the large number of likely
holders of Russian paper and the
secondary markets for these instruments
make it virtually impossible to
reschedule bonds and notes. This, in
turn, can be expected to give
rise to a potentially large number of
constituencies that will almost
certainly demand U.S. government or
multilateral bailouts in the event of
liquidity crises that impede Moscow’s
ability to redeem its bonds on the
respective maturity dates. (Recall the
circumstances that led to the misuse of
the Exchange Stabilization Fund of the
U.S. Treasury to redeem Mexico’s tesobonos.)

Worse yet, these
constituencies can be predicted to
produce powerful new political advocacy
groups that could come to rival the China
Lobby, which has successfully
emasculated many U.S. foreign, economic
and security policies toward Beijing,
lest American financial and commercial
interests be adversely affected.

The Bottom Line

These ominous prospects demand that
Moscow’s stealthy financial breakout be
subjected to urgent and close scrutiny.
Even though Congress is out of session
and otherwise preoccupied at the moment,
the stakes are such that committees like Senate
and House Banking and Commerce
Committees, House National Security and
International Relations Committees,
Senate Armed Services and Foreign
Relations Committees and the respective
bodies’ Intelligence Committees
should elicit as much information as
possible from relevant executive branch
and independent agencies.

The latter should include: the Treasury
and State Departments, the Federal
Reserve, the Securities and Exchange
Commission, the CIA and FBI.
Formal hearings should then be held
promptly next year upon the convening of
the new Congress as the horse will
already be out of the barn in Europe and
at least some U.S. fund managers will
probably have begun taking Russian paper
into their international portfolios.

If Congress does its job, it will
clearly establish the increasingly
strategic dimension of the international
efforts being mounted by governments like
that of Russia and China to diversify the
way they fund themselves and their global
activities. It can only be hoped that the
national security implications of these
seemingly benign and legitimate market
initiatives will be addressed in time.

– 30 –

1. See Double
Trouble at OPIC: Exposing Taxpayers and
Underwriting Foreign Adventurism
(No. 96-C 82,
10 September 1996).

2. See Yeltsin
Has Been Politically Terminal for Months;
What Did Al Gore Know — and When Did He
Know It? ( href=”index.jsp?section=papers&code=96-C_89″>No. 96-C 89, 24
September 1996).

3. The Casey
Institute will shortly publish a more
detailed examination of the forthcoming
Russian bond offering and its
implications for the equities of both
Western governments and private
investors.