- Donal McGettigan
- Published Date:
- February 2000
This appendix provides a brief description of the factors underlying the ongoing situation in Russia and assesses the relevance of the indicators already discussed.
External factors undoubtedly had a role to play in the Russian crisis. Contagion effects arising from the Asian crisis began to be felt in Russia in the latter part of 1997. as manifested by reduced foreign investor confidence in the country’s economy. Declines in commodity prices—especially in the cases of oil and gas, two important Russian products—arose partly from the Asian crisis, and contributed to balance of payments difficulties. Ultimately, however, internal factors are mainly responsible for Russia’s current predicament.
Perhaps the main internal factor contributing to the Russian crisis was the persistent failure to bring fiscal problems under control. Lack of commitment toward fiscal reform at the highest political levels, political opposition to such reform, lack of cooperation by regional governments, and the emergence of influential oligarchs unwilling to share the tax burden all helped stifle the pace of fiscal reform. On the expenditure side, control over spending, particularly in the military area, was also lax.
Such difficulties are clearly reflected in the set of fiscal indicators presented earlier. As Table 3.2 shows, government imbalances have barely fallen since 1993, when the Russian general government deficit stood at 8.6 percent of GDP, the median government imbalance at the time for the Baltics, Russia, and other countries of the former Soviet Union. This deficit remained at 7.9 percent in 1997. the second highest in the group, and far higher than the new, lower median deficit of 3.3 percent. Table 3.3 illustrates that falling government revenues, combined with only modest reductions in government expenditure, were to blame. Of the financial indicators, only two provided some indication that a crisis may have been imminent: the overall debt stock and debt service relative to reserves (Table 3.10) and the high ratio of M2 to gross foreign exchange reserves (3.6 percent), the highest of the countries (Table 3.12).
Other, more long-term, structural factors were also responsible for the Russian crisis. Lack of competition in the banking and enterprise sectors, the persistence of soft budget constraints in the form of arrears tolerance and continued subsidies, and weak property rights are among the main structural problems that have persisted in the absence of fundamental reform. While such lack of reform is not directly reflected in any of the indicators, certain long-run indicators, such as low GDP growth performance (Table 3.9) and lack of openness, reflected by the decline in its export-to-GDP ratio (Table 3.7), showed that Russia’s performance was much worse than that of most of the other countries, thus signifying underlying structural difficulties.
Of the indicators that did not provide accurate signals, Russia’s current account imbalance is the most notable, in that a surplus was recorded in 1996 followed by an almost balanced current account position in 1997 (Table 2.1). As a result, its external debt-to-GDP ratio declined sharply to 27.5 percent in 1997 from 61 percent in 1993 (Table 2.2). Its budgetary debt service had not increased sharply by 1997 (Table 3.5), and its real exchange rate appreciation was not excessive in comparison with the other countries (Table 3.1). Also, its investment rate was not particularly low and stood at almost 27 percent of GDP in 1997 (Table 3.6). Russia’s gross foreign exchange reserves in months of imports increased to 2.3 in 1997 from 1.7 in 1993 (Table 3.11). while none of the banking indicators, except for M2 relative to reserves, provided any idea that a crisis was imminent.
The main implication of this preliminary discussion, and one that is commonly drawn in the indicator literature, is that it is necessary to rely upon a wide variety of indicators when gauging the likelihood of an incipient crisis. Although, invariably, several indicators will convey the signal that all is well, if a number of important indicators are raising danger signals, such as the fiscal and liquidity signals in the Russian case, then it is important to investigate in greater depth the likelihood of a future crisis. This idea has recently been formalized by Kaminsky (1998). who constructs composite crisis-leading indicators based on signals emerging from different sectors of the economy.
Czech Republic, 1997
Unlike Hungary, the Czech Republic achieved early progress in the stabilization of its economy. From the mid-1990s, however, it began to experience increasing macroeconomic imbalances. Large capital inflows under a fixed exchange rate regime led to excessive domestic demand and wage pressures. When the exchange rate band was widened in February 1996, to ±7½ percent, from ±½ percent, the Czech National Bank used its greater independence to increase interest rates and curtail the money supply. Unfortunately, a balanced policy package was not achieved, because supporting fiscal and wage policies were not forthcoming. As corporate governance problems persisted, real wages continued to outstrip productivity growth rates, while fiscal balances, excluding the use of privatization revenues, moved to a deficit of 1.8 percent of GDP in 1995, from a surplus of 0.5 percent in 1993. This deficit declined to 1.2 percent in 1996. Furthermore, while the investment ratio rose because of increased infrastructure and environmental investment, the savings ratio declined as resources moved from the high-savings enterprise sector to the low-savings household sector as a result of excessive wage increases. The combined impact of these policies led to a sharp change in the current account to deficits averaging 7 percent of GDP in 1996 and 1997, from a surplus of 1.5 percent in 1993. These external sector developments, together with internal political uncertainty and the contagion effects from Southeast Asia, weakened confidence in the Czech koruna and, ultimately, led to a foreign exchange crisis in May 1997.
How well would the Czech crisis have been forecast by traditional external sustainability indicators of the types previously outlined? In addition to the worsening of the current account over 1993–96, real GDP growth declined to 4 percent in 1996 from 6 percent in 1995 and, subsequently, to between 1 and 1½ percent in 1997. Poor output performance is symptomatic of underlying problems that may ultimately be reflected in a weakening of confidence in the economy. Furthermore, slower growth makes it more difficult to sustain large current account deficits. Real appreciation, arising from large capital inflows and combined with a pegged exchange rate regime, led to competitiveness problems, as did excessive wage increases. Lack of competitiveness, combined with the diversion of exports to the home market and a slowdown in trading partner markets, led to a sharp slowdown in exports. Merchandise export growth, another indicator previously examined, slowed sharply to zero growth in 1996 from 15½ percent in 1995.
Other signals were not so helpful, however. The Czech Republic had high investment levels and the savings-investment imbalance was driven primarily by private sector, rather than public sector, imbalances, although fiscal imbalances had widened somewhat. The Czech Republic did not have an exceptionally large debt-to-GDP ratio, which stood at 43 percent in 1997, or high debt-service ratios. Also, its share of short-term debt was just above 20 percent in 1997. Broad money growth decelerated sharply in 1996 and even further in 1997, and there was no evidence of diminished public confidence in the banking system, such as widespread deposit withdrawals.
Like other transition countries, Hungary suffered steep output losses at the start of its transition process.83 The effects of the various shocks during this period were, however, exacerbated by policy efforts to shield the household sector from economic turbulence to the greatest extent possible. Fiscal imbalances worsened, to annual deficits greater than 7 percent of GDP in 1992-94 from a consolidated government surplus of 1 percent in 1990, as the tax base shrank and public expenditures did not adjust commensurately. Reflecting continued soft budget constraints, real wages declined less than output, thus lowering savings as resources shifted from the high-savings enterprise sector to the low-savings household sector. Monetary policy was relaxed in 1992. with negative real interest rates remaining until late 1993. Exchange rate policy, which was used to contain consumer price increases, nevertheless led to a sizable appreciation of the real exchange rate.
All these policies harmed the overall savings-investment balances of the Hungarian economy. The consequence was unsustainably large current account deficits, moving to negative balances averaging 10 percent of GDP in 1993 and 1994 from surplus positions in each of the years 1990 to 1992. As a result, net external debt, which already stood at 35 percent of GDP at the end of 1992, increased to 45 percent of GDP by the end of 1994. The authorities’ adjustment program, initiated in March 1995 and including a 9 percent devaluation of the forint on March 13. 1995, succeeded in bringing down the external deficit to a sustainable level, thus avoiding a wide-ranging external crisis.
Thus, many of the indicators examined would have been relevant to the Hungarian situation, especially those relating to the real exchange rate, the fiscal and current account positions, and debt. What of the other indicators considered? On Hungary’s savings-investment balances, these were largely driven by fiscal problems, with the consolidated government position worsening to a deficit of 7½ percent of GDP in 1993 from 3 percent in 1991, before falling back to 6½ percent and 3½ percent in 1994 and 1995, respectively. In contrast to the case of the Czech Republic, real exports increased by more than 13 percent in real terms in both 1994 and 1995, following a real decline of 10 percent in 1993. After a period of decline, real GDP growth of almost 3 percent took place in 1994, although this rate halved in the following year.
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