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The GKO Pyramid


The political uncertainty caused by the president’s ill health was compounded by mounting economic problems. The government’s efforts to tighten monetary policy produced in the short term an impressive reduction in inflation and a significant improvement in confidence in the rouble. In 1996 inflation was lowered to less than 50 percent and to under 15 percent by the onset of the Asian financial crisis in the autumn of 1997. 

During the spring and summer of 1997 expectations about Russia’s prospects reached a high point. Market sentiment surged, boosted in part by President Yeltsin’s election victory the previous year, and with the news that, after a long and painful decline in output and living standards, the Russian economy had finally begun to grow and inflation was being brought under control.

A silver GKO coin 

During this period of increased confidence in monetary policy, Russia took full advantage of the surge in liquidity in international capital markets by allowing foreigners to acquire government-issued paper. By 1996 operations with state securities, such as short-term government bonds (GKOs), had emerged as one of the most lucrative financial activities. The GKOs yields in some months exceeded an annual 300 and even 500 percent.

This “financial stabilization,” however, was fragile and short-lived, as it proved extremely vulnerable to negative trends in the global economy. During this brief period of economic stability and growth, investors overreacted and policymakers misjudged the degree to which they could take advantage of the situation. The GKO short-term treasury bills turned out to be a pyramid-type financial scheme, set up by the state that was unable to come to grips with the fundamental problem of fiscal viability. Instead of reducing the budgetary deficit by improving tax collection and by cutting back on federal spending, it preferred to finance that deficit with the help of foreign loans and state securities, such as GKOs. 

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The Yeltsin Era

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