Barter is now a common method for doing business in Russia with large ramifications for the economy and for the aerospace industry

Published: 7/5/1999

Barter is now a common method of doing business in Russia, the Ukraine and much of the former Soviet Union. Large sectors of the economy, including the aerospace industry, now operate without cash, at least for the customer and the producer. In its autumn 1998 report, "World Economic Development Forecasts," the International Monetary Fund (IMF) estimated that bartering accounted for 50% of sales in Russian industrial firms. It predicted that the domestic Treasury bill default of August 17th 1998 would increase arrears, debts, barter deals and the use of the dollar in Russia. Experts from the Russian Economics Ministry have drawn a similar picture of the proportion and growth of barter trading in Russia. According to polls conducted by the ministry among industrial managers, the share of barter in industry increased from 22% in 1996 to 42% in 1997, reaching 52-54% in 1998. Independent experts have been even more pessimistic. Speaking at a round table meeting entitled "Anti-inflation Policy and Strategy of Economic Growth in Russia," Mr Vladimir Shinayev, Vice President of the Russian Academy of Economic Sciences and Private Business, stated that, by 1999, up to 70% of settlements in Russia were made in "non-monetary" form. He added that half of these non-monetary settlements involved IOUs and other substitutes for money and that barter accounted for the remainder. In Russia, IOU settlement schemes are frequently used to conceal barter transactions. Mr Vyacheslav Zakharov, Vice President of the Russian Banks Association, believes that the proportion of monetary settlements is even smaller, amounting to only 15% of total payments in the country. Barter badly affects the efficiency of tax collection. It diminishes opportunities for loans, as cash for repayment is not available with a commensurate impact on investment to increase production and undertake modernisation. Its lack of visibility combined with rich pickings also fosters corruption and attracts organised crime. Barter has caught Russia in a dangerous trap, too many people benefit from it. As it constitutes one of the foundations of Russia's black and criminal economy, all attempts to abolish it will inevitably meet with fierce resistance. The reasons for the emergence of barter are complex. Often it has simply been the only effective of means of providing basic liquidity to a system where none exists. Its use of middlemen and multi-layered transactions to facilitate the trade however, has led to the proliferation of the lucrative 'agent turns' being taken, so siphoning off the value for the benefit of the intermediary or those undertaking trades for personal gain, rather than the supplier or customer. The ongoing liquidity crisis in Russia combined with high profits for the unscrupulous have meant in many cases what was intended as a short-term solution to immediate shortages or failures in supply, has become a much more sinister activity, often having strong links with organised crime. An analysis of barter rates in different branches of industry clearly indicates that the share is larger among industrial companies that are subject to closer government scrutiny and where the government or other large enterprises are often the key non-paying customers. It is in these firms that the lack of cash has been most noticeable and where the need to trade products with equally handicapped companies has been essential. Examples include the bartering of cars for steel; with the cars then being traded by the steel plant for electricity in order to keep its plant in operation. In many companies, the barter department has also become a lifeline, often trading products for basic foodstuffs for the workforce. Within the airline industry, tickets are traded for maintenance, spare parts and fuel. The middleman then takes the tickets and turns them into cash or another commodity for a further trade or passes them to another party for cash. Each trade is transacted at a deep discount to the cash value, in order to provide the agent's 'turn'. While regional and enterprise variations make precise assessments impossible, Russia's barter market breaks down as follows: Barter is practically absent in the retail trade and entertainment sector. In Russia, 40% of all monetary payments are made in untraceable cash, in contrast to 5-6% in Western economies. Barter is used to pay the suppliers of these sectors of the economy primarily as a means of payment for raw materials, electricity and taxes to local budgets in this sector, with the share of barter estimated at 10%. Its proliferation is held back by the fact that its products have limited shelf life and also by the fact that much of Russia's distribution is a small-scale cash business. In consumer goods production, barter is estimated at 20 -50%. In this sector, the practice is stimulated by the low quality of domestic consumer goods and poor management. Enterprises foist their goods onto their own employees and suppliers of raw materials, which, in turn, pay wages to their employees in these goods. This results in the common sight of workers selling, at the roadside, either their factories' own products, or whatever may have been traded for them and then distributed as wages. Export-oriented enterprises are even more dependent on barter, not necessarily from necessity, but often from desire. As it allows them to keep their cash and to use the barter trade to lower their costs. They can conduct about 30-60%of their domestic transactions in barter. The utilities are particularly active in the barter trade, receiving a very large proportion of their payments in kind. Energy grid operator, Unified Energy Systems (UES), reports that non-monetary payments constituted 83-85% of the total in 1998. This is partly because electricity cannot be stored for future use or sale. UES is also obliged to ensure an uninterrupted supply of electricity to vitally important industries, military facilities and social infrastructures. The barter model allows enormous scope for corruption, when a method for pricing is not in place. An illustration of this problem is the question of how much a Lada car is worth in electricity, when the utility supplier is desperate to get a commodity it can trade for coal. In this type of pricing opaqueness, it is easy for values to become inflated by intermediary turns as the transaction moves down the line from the initial supplier. A recent purchase of a Tu-154M by a regional government involved a multi-layer transaction, which covered not only the acquisition of the aircraft, but the payment to the aircraft producer, component manufacturers, metal providers and utility companies in order to fulfil the contract. Such payment was in the form of gas, steel and in the common currency of Russian barter, cars. In the end there is little doubt that the transaction cost the customer a great deal more than a cash trade, as they sold forward their gas production at a deep discount and yielded the suppliers considerably less in illiquid commodities. Oil companies enjoy money from exports, while the domestic market for gasoline and motor oils is large and oriented primarily around individual buyers who pay exclusively in cash. However, these companies must also participate in state-sponsored programmes to supply fuel and a lubricant to state-run enterprises and to the military, whose ability to pay is extremely limited. This inevitably involves oil companies, although sometimes willingly, in barter exchanges. The natural gas companies are in a similar situation according to Mr Eduard Ivanov, Head of the Securities Department at Gazprom. Cash constituted only 33% of payments for natural gas in 1998, compared with 50.5% in 1997. Without foreign transactions, the figure would be as low as 7 %, since domestic and CIS consumers of natural gas make settlements with Gazprom only through barter. The high level of barter for the gas companies has led to some interesting trades. The Ukraine has paid for Turkmen gas in condoms and Ukrainian-made Electron television sets. The latter were priced at $1,000 each, more than 10 times their price in Ukraine. Ukraine has also paid for Russian gas in fodder-grade grain. The proportion of barter is also high in the metals industry, owing to the presence of export earnings and the poor solvency of domestic consumers, such as the defence, machine-building and engineering industries. It has meant that, in the aerospace component industry particularly, products are bartered at a very high cost, as these industries have a ready hard currency cash market for their products. This is especially true of titanium producers. Those companies involved in the setting up of multi-layered transactions can be divided into two groups. Firstly, overtly fraudulent enterprises operating through connections (of friendship or kinship) with the top managers of companies they serve. Secondly, smaller groups of professional brokers who set up with minimal capital and exploit the inefficiency of the market. Intermediaries can make large profits operating in sectors with the highest shares of barter (electric power and railway transportation) and, although competition is tough, they can take between 3-10% of the value of a deal. In other branches of industry-specifically where goods are less liquid or where the level of crime is high, such as the coal industry-intermediary profits can reach 30%, and so can exceed 100% depending on the level of desperation of the customer for the product. This is because there is plenty of real cash margins potentially available in the trades to oil the wheels of negotiation with the managers of enterprises and government officials. The money is obviously untraceable and often deposited in bank accounts offshore. Speaking recently in the Federation Council (upper house of parliament), Mr Mintimer Shaimiev, Tatarstan's President, described barter trading as a "pie for criminal structures." Government attempts to break the vicious circle inevitably meet with resistance. The Russian government claims that it wants to relieve its economy of barter trading, but that it is not possible in the short term. Efforts are being made to create greater transparency in the transactions and the National Barter Corporation (NBC) could be a good interim measure. Designed to give the transactions a value that has a broadly monetary equivalence, the intention is to wean Russian business off the barter trade, in favour of a rouble based pricing mechanism that is more transparent, liquid and easier to transact The Russian Exchange initiated the organisation in late 1998. NBC founders include UES, the Railroads Ministry and several industrial associations including the Union of Industrialists and Businessmen. Mr Konstantin Borovoy, Chairman of the Russian Exchange's Expert Council and State Duma Deputy has said that negotiations are under way with Gazprom and that a number of oil companies could join the list of NBC founders. However, it should be remembered that, in 1998, it was the oligarchs who were probably the biggest tax evaders, and who appealed to the public to pay their taxes. Many of these enterprises enjoy close and lucrative association with the barter trade. There are spheres where bartering is however necessary and where operation without it can cause heavy losses. One example is Russian arms and military equipment export. According to Mr Ruslan Pukhov, Head of the Centre of Strategies and Analysis, "Almost nobody is paying cash on the world market today. This market is ruled by buyers, not by sellers." The former Soviet Union and then Russia almost always bartered weaponry and it has therefore become part of the accepted terms of trade. In the Soviet Union, barter bore a pointedly ideological character. Military equipment was supplied in exchange for loyalty to the U.S.S.R. After the Soviet collapse, Russia had to learn the essentials of commercial bartering. India and China appeared the most promising recipients, for they needed military equipment and could supply various goods in exchange. Russian arms traders therefore took up barter as a principal strategy in order to hatch plots in these markets, primarily in China. "The Chinese were the first to offer us a barter deal," recalls an expert who worked in military-technical co-operation in early 1990s. But the Chinese supplies consisted mostly of poor quality consumer goods. There was a time when nearly all employees of Rosvooruzhenie wore Chinese fur coats and leather jackets. The Chinese often set excessively high prices. For example, they supplied 45cents lighters at $1.50 apiece. Nonetheless, owing to the shortage of such goods on the Russian market at the time, Rosvooruzhenie (which had an extensive network of sales outlets) still managed to make a profit on goods bartered from China. Barter, some employees of Rosvooruzhenie confessed, allowed evasion taxes. Initially, barter accounted for 70% of Rosvooruzhenie's trade turnover. According to the agency it now accounts for 30% of turnover. Rosvooruzhenie experts agree that barter deals in arms trading often lead to abuses. According to Mr Pukhov, it is theoretically possible to sell goods received under barter terms directly in the provider country for unaccounted and untraceable cash; as it only requires a "gentleman's handshake" with a top local official. Returning to the supplier considerably less than the transaction yielded. Barter, Mr Pukhov claims, has become an unalienable part of international weapons trading. Unlike the USA, Russia is unable to provide any political or military guarantees to its customers. He contends that: "Russia may lose quite a few profitable contracts if it demands payment in cash." Barter will therefore remain for the foreseeable future, unless there is a genuine commitment to change the financial system and provide it with sufficient liquidity. It will continue to make a few rich and leave an economy of 150m people shackled to a system that substantially hinders growth and generates little of the surplus capital or investment required to reform the economy. It should also not be forgotten that barter does and will continue to provide at least residual liquidity where none exists, but in the long term at what cost.

Article ID: 650