Is Moscow's Control Falling To Pieces?

As the ruble falls, local authorities grab power

In Kalmykia, a Buddhist region on the shores of the Caspian Sea, President Kirsan N. Ilyumzhinov is refusing to pay $10.3 million in taxes owed to Moscow. Local officials in the Volgograd region, part of Russia's Southern grain belt, are banning railroad authorities from transporting grain outside of its borders. And far to the east, Mikhail Nikolayev, president of the resource-rich region of Sakha, is trying to seize control of gold production from Moscow.

Russia's regions are grabbing economic power. Spurred by the fiscal crisis and a political near-vacuum in Moscow, the leaders of many of the 89 regions are doing everything they can to keep tax revenues, natural resources, and food in their own territories. The power shift is putting an even tighter squeeze on Prime Minister Yevgeny M. Primakov's floundering government. The economy is expected to contract 10% this year, and the ruble, now trading at just 22 to the dollar, has plunged 11% since Jan. 1. Says Nikolai Petrov, an analyst at the Carnegie Moscow Center: "Regions are becoming used to solving problems on their own. It's very dangerous."

BARTER. As regions take matters into their own hands, the use of barter and other nonmarket mechanisms is growing apace. With little cash coming from Moscow, money surrogates, such as ious issued by the local government or major enterprises, are becoming an even greater part of economic life. Although sellers of food and other consumer goods still demand cold, hard cash from the average citizen, enterprises use the ious to clear debts with each other or to pay local taxes. Petrov estimates that money surrogates account for 60% to 80% of the economy in many Russian regions--compared with 40% a year ago.

Barter is growing because the federal government doesn't have enough money to pay its bills. It is not sending money to the regions to pay for services such as electricity, or to pay the wages of state employees. Primakov's policies are only making the problem worse. For example, he is allowing natural gas giant Gazprom to pay off nearly $400 million in federal taxes with food that it received in barter deals with customers.

Local leaders are taking advantage of the growing virtual economy to buttress their power, too. Regional banking empires are growing and elbowing aside national banks that were owned by Moscow tycoons. For example, Omskpromstroibank is picking up business from Inkombank and SBS-Agro Bank in the central Siberian city of Omsk. Some governors, such as Yuri Goryachev in the city of Ulyanovsk, are trying to grab control of key enterprises by swapping tax debt for equity.

Others are using bankruptcy courts. Almost every business owes back taxes and is technically bankrupt. That means enforcement is often arbitrary, based on political relationships rather than hard finance. And the use of noncash mechanisms also spawns corruption by making it easier to mask payoffs or asset-stealing. "In barter deals, the value of tax offsets depends on how close you are to the governor," says Yulia Latynina, an analyst at the Moscow weekly Expert. "And if he has a bad relationship with an enterprise and wants to bankrupt it, he will demand immediate tax payment in cash."

POLITICAL HAY. In the midst of this bleak scene, there are a few rays of light. The ruble's plunge in value has made Russia's exports, particularly raw materials, more competitive. Russian industry, primarily consumer goods and food processing, has rallied as imports became prohibitively expensive. Industrial production in December was 7.1% above its November level. But unless Russian companies use this devaluation-driven window of opportunity to restructure and become more efficient, the gains will be short-lived.

Overall, though, the newest explosion of barter rolls back even further any gains that Russia made in its six years of trying to create a market economy. What Russia has now is "a nonmarket economy, even though you can't call it communist," says Dirk Damrau, head of research at Moscow investment bank Renaissance Capital. With his eyes on upcoming elections for the Duma and the presidency, Primakov has decided to sacrifice reform to preserve political peace in Moscow. Away from the capital, local leaders see this decision mainly as an opportunity to amass more power--and perhaps wealth--for themselves.