Russia’s traditional capacity to puzzle and surprise observers has been revealed again in the economic developments of the past decade. Early in the transition, few outsiders could understand how the population survived such a massive decline in output, the collapse of basic infrastructure, and the nonpayment of wages. Similarly surprising has been the recovery since the financial crisis of 1998. Most observers at the time predicted that it would take many years for Russia to recover from the debt default and ensuing loss of international confidence. Instead, Russia has experienced its first period of sustained growth, and financial markets have become increasingly bullish about Russia’s economic prospects, despite a high degree of uncertainty about prospects for the world economy. This recent optimism should not, however, obscure the fact that there are widely divergent views of the nature of Russia’s newfound prosperity and the extent to which it reflects fundamental changes in the economy that can translate into sustained growth. In this book, IMF staff put forward their interpretation of the startling swings in Russia’s economic fortunes that have marked the past five to six years. The following chapters thus attempt to explain recent developments and identify the key economic challenges that Russia faces.
In early September 1998, the Russian economy was in a dire situation. The exchange rate peg that had been the linchpin of the stabilization effort had been abandoned, with the exchange rate promptly falling from Rub 6.2 per U.S. dollar on August 1 to Rub 20.8 per U.S. dollar on September 9, and inflation soaring to 38 percent for the month of September. The banking system was in disarray—the capital of many of the large private banks had been wiped out and they were struggling to preserve their solvency by delaying processing of transactions and limiting access to deposits. As a result, the payments system broke down as settlement risk became too high, enterprises were unable to access trade financing or even working capital, and output fell sharply. The government, having run out of financing sources and facing declining revenues, simply ran arrears.
Russia’s economic transformation is not yet complete enough to support high and lasting growth. This chapter considers what impediments remain in the way of sustainable growth and what reforms are necessary to remove them. As the postcrisis boom dissipates, reform efforts need to be both appropriately focused and front-loaded, to ensure a smooth transition from the postcrisis boom to a long-term growth path. The chapter assesses the government’s reform agenda in view of these requirements, to sketch out the prospects for Russia’s medium-term growth.
The failure to arrest the slow decline in government revenues since the early 1990s was one of the key causes of the 1998 debt crisis. While some initial revenue decline was expected during the transition as the economy was restructured and new tax systems put in place, by the mid-1990s tax collection in Russia still showed few signs of turning around. Intensive efforts, drawing on large technical assistance resources provided by the international financial institutions and other donors, produced few concrete results, owing to a combination of weaknesses in the tax structure, the poor legal basis of tax administration, and a lack of political support to reduce graft and ensure compliance by large politically connected enterprises.
The failure to address fiscal imbalances was clearly at the heart of Russian debt crisis. Typically, this failure is seen as largely a revenue issue. Indeed, the repeatedly demonstrated inability (or unwillingness) to collect revenues made it difficult to pursue a rational expenditure policy as expenditure sequestration—ad hoc reductions in spending outside the normal budgetary process—became the norm. However, there were also more deep-rooted problems. One of the key areas of institutional development in transition countries has been to convert the ministry of finance from an entity that effectively just did bookkeeping for the plan in Soviet days (a largely passive role, which meant it was clearly subordinate to the other ministries) to a lead agency that establishes expenditure priorities and exercises effective control over the spending of the other ministries. Limited institutional capacity distorted expenditure allocations and spawned a range of nontransparent budgetary operations as strong players—such as the large enterprises—exploited opportunities afforded to them. As a result, actual expenditures bore only limited relation to the government’s priorities, and service delivery suffered.
The August 1998 crisis had an immediate and significant impact on the banking system. The combination of the government’s de facto default on its domestic debt and the sharp devaluation of the ruble provided the visible classic triggers for a collapse of the system. Much of the system became formally insolvent, though it continued to operate—in a fashion. Indeed, the crisis only brought into focus the underlying weaknesses of a banking system proliferated by weak institutions that held banking licenses but possessed few of the characteristics of typical commercial banks. Nonetheless, these institutions were exceedingly vulnerable to asset quality, foreign currency, and counterparty risks. These weaknesses and exposures can in large part be traced to Russia’s poor record of macroeconomic stabilization and to failures to address structural weaknesses of the financial sector and of the economy at large.
The history of Russia’s debt is a central element in understanding the 1998 crisis. Russia’s debt stock at the time of the crisis was not overwhelmingly high—especially once account is taken of the fact that the bulk of the debt stock was Soviet-era debt that the Russians rarely paid, and for which creditors had little political will and imperfect mechanisms to enforce payments. The debt problem that drove the crisis was mainly a failure to bring fiscal deficits under control and, therefore, a failure to limit the growth of short-term financing needs. If this flow problem could have been addressed, the stock issue relating to the Soviet-era debt, although a heavy burden, could likely have been resolved. Indeed, international financial markets appear to have operated on this assumption—for example, Russia was able to issue significant amounts of new Eurobonds in 1996–97 while having large external arrears.
International Monetary Fund. External Relations Dept.
This paper highlights that the 1980 Annual Meeting of the Board of Governors of the IMF affirmed the willingness of the IMF to evolve, under its charter, to meet new circumstances; but in some ways there was a departure from the past. Two substantive problems dominated the Meeting: the persistence of high inflation as a worldwide problem and the large payments deficits engulfing the non-oil developing countries. There was general agreement that these were the immediate threats to international monetary stability.
This Selected Issues paper and Statistical Appendix on Brazil looks at price developments following the floating of the Real in mid-January 1999. The paper highlights that the experiences in East Asia—Indonesia, Korea, Malaysia, Philippines, and Thailand—all show that the pass-through from devaluation to inflation has been lower than expected, with the exception of Indonesia. The paper analyzes the competitiveness and export performance of Brazil. Effects of high interest rates and currency depreciation on Brazilian enterprises are also analyzed.
This Selected Issues paper on Cameroon identifies impediments to growth acceleration in the country. A two-step approach is followed: first, the characteristics of middle-income countries currently experiencing growth accelerations are examined; and, second, the extent to which Cameroon shares these characteristics is assessed. The focus of the analysis is a set of variables the literature has identified as helping to accelerate growth. This paper also presents a possible fiscal strategy for Cameroon based on the permanent income approach.