The Kremlin just doesn’t Get it

Russian economist Konstantin Sonin, a professor at the New Economic School/CEFIR and a columnist for the Vedomosti newspaper, writing in the Moscow Times bravely admits what is obvious to the outside world:  Vladimir Putin’s Kremlin just doesn’t get it.

Last week, the government announced policies aimed at expanding the credit available to businesses. The banks that were the major recipients of government bailout funds were instructed to increase the amount they lend by 2 percent per month. At the same time, the government refused to consider taking toxic assets off banks’ balance sheets, even though all leading countries of the world are moving in that direction. Unfortunately, this shows that the government does not understand how to treat the severe blood clot that is blocking the flow of money into the economy.

There are two reasons banks are not lending more money. First, they need those funds to pay off their own debts. Second and more important, they know that most borrowers won’t be able to pay back the loans during the crisis.

In developed economies, bankruptcy is the best tool for protecting a creditor when a debtor is insolvent. But in Russia, the bankruptcy process is slow, costly to lenders and ineffective, particularly when applied to large corporations. It is well-known that the country’s court system is not an effective resource for regulating bankruptcy cases.

Before the crisis, the loan return rate was relatively high. In Russia’s booming economy, corporate earnings were sufficient to cover credit payments, investors’ dividends and new investments at the same time. During the crisis, however, all of this is grinding to a halt.

What should the government do to solve the credit crunch? First, what it shouldn’t do: It should not force banks — even state-owned banks — to give out credit. If banks extend credit against their will, it only increases the number of loan defaults. On the other hand, if the government can guarantee that it will force borrowers to repay their bank loans, it would be a concrete step toward expanding available credit.

Second, the government should help creditors meet their own debt obligations. The greater the chance a financial institution has of paying off its own debts, the more desire it will have to extend credit to others at reasonable rates.

Third, the government should force major banks to revalue assets on their balance sheets to reflect their drop in value. This is tough medicine, but it is beneficial in the long run. The Swedish government adopted this practice in 1992, and although it cost the country 6 percent of its gross domestic product, the move prevented a prolonged recession.

In contrast, the Japanese government allowed banks to retain assets on their balance sheets at book value, and this contributed to the stagnation that lasted a decade. When the Japanese government forced banks to extend credit to firms unable to repay the loans, they allowed political goals to eclipse fundamental market principles. This led to the creation of numerous “zombie” firms that became an additional burden to the Japanese economy.

The two tasks that the government needs to place at the top of its priority list — protecting creditors’ rights and increasing the flow of credit to businesses and homeowners — require significant political will and effort.

In this respect, the crisis can be beneficial. During the good years, politicians can sit passively on the sidelines and reap the benefits of a boom economy. But during a crisis, politicians need to fight for their political survival, and this forces them to act quickly to find tough solutions to save the economy.

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