The ability of financial markets in a free-market system to raise capital is virtually unrivaled. So much so that even communist governments have turned to them for loans. The Soviet Union was no stranger to the sovereign debt markets and the Soviet state raised money by selling bonds in Western financial capitals during the last decade of the Cold War. However, this was only after turning to their own population for loans. The fate of these Soviet bonds has been in limbo since the fall of the Soviet Union in 1991. The story behind these bonds is closely tied to the collapse of the Soviet Union and Russia’s volatile transition to a capitalist system.

Soviet Public Finance

            Yegor Gaidar, one of Russia’s first post-Cold War deputy prime ministers, and briefly acting prime minister under President Boris Yeltsin, once said that the economic collapse of the USSR is a story of grain and oil. His book, “The Collapse of an Empire: Lessons for Modern Russia” offers his own account of the fall of the Soviet Union. The history is significant to understanding what caused the Soviet Union to borrow money, at home and abroad, in the years just before its fiscal meltdown in the 1980s. According to Gaidar, the beginning of the end could be traced back to the decision to collectivize farms during Stalin’s rule.

           In the short run, the result was famine, and production did not improve much as time went on. The “Black Earth Region” of southern Russia was considered with the American prairies and Argentine pampas as among the most fertile regions of the world. Yet, according to Gaidar, the USSR experienced the “sharpest fall of [agricultural] productivity experienced by a major country in the twentieth century.” The result was that Soviet net grain exports turned into net grain imports. In 1963, the Soviet Union imported 12 million tons of grain; by the early 1980s, it was importing about three times that amount per year. A declassified 1982 US Cabinet Briefing memo projected Soviet grain imports of 45 million tons for that year. It was reported that between 1970 and 1980, food imports grew from $700 million to over $7 billion.

           The other leg of Gaidar’s account of the strains facing the Soviet economy in the 1980s was oil. Following the discovery of oil in western Siberia, exports of oil would balance out Soviet purchases of foreign grain. Fortunately for the Soviets, production started coming on line just as oil prices surged in the 1970s, from under $5 a barrel in 1973 to almost $40 in 1980. This windfall financed increased imports and military spending. However, prices then began to fall, first slowly and then collapsing in early 1986, taking the price to $12 a barrel. At the time, falling oil prices cost the Soviet state $20 billion per year according Gaidar. Rather than engage in structural reforms or cut state spending, the Soviet government turned to the debt markets to finance its deficits.

Bonds     

           In 1982, a year which saw a poor grain harvest, the Soviet government turned to its citizens for money. This was not unprecedented, but during the 1970s, the USSR was in good enough financial shape to actually redeem the remaining of its outstanding bonds, many issued during the Second World War. Nonetheless, in 1982 the state issued bonds internally.

           The so-called 1982 Premium Bonds had a 20-year maturity and paid 3% per year in interest, the same rate paid on older Soviet bond issues dating back to the war. They were sold in small denominations, starting at 25 ruble; at the time, the average Soviet monthly wage was just under 180 ruble for comparison. The bonds were also negotiable securities, they could be bought and sold by their holders freely.

Repayment

           It is not clear how many of the bonds were sold in the 1982 issue but the Russian bank Sberbank estimates that the value of all Soviet-era bonds still outstanding in Russian territory when the USSR collapsed was 9 billion ruble. Keep in mind that this does not include those held by investors in the other republics of the Soviet Union (e.g. Ukraine, Kazakhstan, etc.). Unlike other successor states to the USSR, the Russian government at first attempted to honor the Soviet-era bonds. There were buyback operations conducted from 1992 to 1995 that resulted in the repurchase of a portion of the outstanding bonds.

           However, the significance of these bonds to modern Russia took a notable turn in 1995, when President Yeltsin signed a law promising that Soviet-era bank deposits and bonds would be honored based on their 1990 purchasing power. The significance of this could hardly be overstated. Given the inflation of between 100% and 1000% per year suffered in Russia during its early transition to a market economy, the liabilities following the 1995 law ballooned accordingly.

           It has been estimated that to honor the Soviet-era obligations according to their 1990 purchasing power, as the Yeltsin-era law proscribed, would cost 25 trillion ruble given the currency’s massive devaluation over the years. Such a sum is equal to roughly US$380 billion, roughly a fourth of Russian annual GDP, and is larger than the state budget. As such, Russia has stalled on making payments after some progress in repaying the bonds in the early 2000s. This of course would have been around when the old bonds would have matured; growing Russian oil production and rising prices allowed budget surpluses to be put to use repaying the old bonds. However, budget surpluses slowly disappeared and the Russian government has been only earmarking small sums to restoring old bank deposits and bonds.

           Lack of progress has led to lawsuits in Europe around the Russian commitment to honoring the old bonds. In 2012, cases made their way to the European Court of Human Rights. In two cases that year, the Court ruled that bondholders of the 1982 issue had a right to be repaid and found the Russian state had failed them by neglecting to put together a redemption program. For its part, the Russian government has said that redeeming all the bonds would be an excessive burden on the state. President Vladimir Putin himself has said that repaying the bondholders would mean that there would be “nothing left to pay salaries to soldiers, to doctors, to teachers.” Thus, the government has stressed the cost of honoring the debts to defend its inaction in lawsuits.

           As recently as 2018, the European Court of Human Rights ruled once again on the side of bondholders and added more detail about the case in its judgment statement. It noted that Russian legislation regarding redemptions has been continuously suspended since 2003, but has not actually been formally repealed. The Court found a prioritization of social expenditures over repaying creditors in circumstances like this to be reasonable. However, it argued that states must respect and consistently apply their own laws and in the case of the 1982 bonds, the Russian government was ignoring laws it itself had enacted.

           Russian commentators have described the Yeltsin-era promises as being legislated without any serious thought as to how they could be fulfilled. Given the size of the potential liabilities though, it is easy to see why the heirs to Yeltsin are in no hurry to correct for past mistakes and take on that challenge.          

Lesson

           The fate of Soviet bonds is an interesting example of a financial obligation whose life became even more interesting after the demise of its original obligor. Of course, the same could be said about a lot of bankrupt companies whose creditors get to work salvaging what they can in bankruptcy. However, the story of these bonds has continued for well over three decades and shows no sign of ending soon. Embedded in the instruments is the history of the Soviet economy in its final decades and the fiscal challenges that forced it to borrow, first from its citizens, and eventually in Western capital markets. All this happened in an economy supposedly at odds with capitalist practices; but economic reality trumps ideology, as figures like Gaidar and Yeltsin, and their predecessors who lived through the Soviet collapse, came to realize. 

Further Reading

1.     Alexashenko, Sergey. “The Collapse of the Soviet Fiscal System: What Should Be Done?” Review of Economies in Transition, vol. 4, 1992.

2.     Burns, John F. Soviet Grain Crop: One More Failure. The New York Times, 21 June 1982.

3.     “Case of Volokitin and Others vs. Russia.” HUDOC – European Court of Human Rights, 3 July 2018.

4.     Gaidar , Yegor. “The Soviet Collapse.” American Enterprise Institute – November 13, 2006.

5.     Rose, Scott. “The Soviet Relics That Would Sink Modern-Day Russia.” The Washington Post, WP Company, 1 Sept. 2012.

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