Finance

RUSSIA'S BLACK TUESDAY: THE BLOOD OF A FREE MARKET

Rumors of the Russian economy's imminent collapse into chaos have been greatly exaggerated.

When the ruble lost 27% of its value against the dollar in one day, traders were quick to call it Black Tuesday. The panic began when central bank officials decided they would stop supporting the declining ruble and let it reflect the rising money supply. Currency traders, scared by the lack of accustomed intervention and already worried about a possible resurgence of inflation, started a selling frenzy. The rout stopped only when the central bank stepped in. On Oct. 12, the ruble rebounded 4.8%, closing at 3,736 (chart).

Russian President Boris N. Yeltsin sacked Finance Minister Sergei Dubinin and demanded that lawmakers dismiss central bank Chairman Viktor Gerashchenko. But while the strong show of leadership may have helped soothe the market, Yeltsin is aware that the central bank isn't completely to blame. "The main reason for the crisis is the adoption of an unrealistic budget for 1994," says Grigory Yavlinksy, who heads a reform-minded parliamentary faction. Had the government not spent 13 trillion rubles on subsidies this year to farmers, the defense industry, and other groups, the bank wouldn't have had to support the ruble artificially. Just as in any other country, Russia's financial markets respond principally to the threat of inflation--or its absence.

Indeed, what happened in Russia on Black Tuesday is not unlike what happens to a Western bond market when a growth forecast is revised upward or a central banker makes dovish remarks. The difference is that Russia's market is still crude and lawless. No automatic mechanisms halt trading when a stock, bond, or currency goes into free fall. There are no limits to how much speculators can buy or sell. "Basically, there's a total lack of financial infrastructure," says Ronald Lauder, chairman of Estee Lauder International, who opened one of the first Western stores in Moscow in 1989. "You're missing the laws, the checks and balances, that in other economies prevent such excesses."

The ruble rout caused significant hardship on Black Tuesday. Consumers bought all the supplies they could carry, to hedge against price increases. Merchants sharply marked up prices on both Russian and imported goods. A liter of milk that had cost 670 rubles on Friday fetched 1,100 rubles four days later, while a Snickers bar rose to 1,500, from 1,000. Some retailers took big hits because they could not exchange their ruble revenues as fast as the rate dropped. Since all cash transactions must be done in rubles, only merchants that can accept credit cards were safe.

AMBITIOUS PLANS. But despite the carnage and Yeltsin's Cabinet shuffling, officials at the International Finance Corp., which has invested $130 million in Russia, said the currency crisis wouldn't undermine the trust of Western investors. Lauder believes such episodes are inevitable in an immature market, and his confidence in Russia is unshaken.

Yeltsin can show he is serious about controlling inflation by forcing his government to slash expenditures. Early hints of the 1995 budget proposal are ambitious, with an average monthly inflation target of 2%. Like leaders all over the world, Yeltsin must walk the fine line between stimulating his economy and keeping prices from spiraling. Black Tuesday, though painful, was a reminder that the laws of economics apply fully in Russia. Now, the country must learn financial damage control.Patricia Kranz and Joan Warner

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