II Inflation, Growth, and Financial Policies
Author:
Mr. Luis Valdivieso
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Language:
English
Print Publication Date:
06 Jan 1999
Keywords:
OP; reformer; deficit; SBA III; exchange market pressure; intermediate reformer; single-digit inflation; IMF measure; reducing inflation; monetary management; consumer price inflation; Inflation; Monetary base; Government debt management; Fiscal stance; Baltics
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Abstract

The sustained and significant reduction in inflation observed in the first six years of transition constitutes one of the key achievements of the Baltics. Russia, and other countries of the former Soviet Union. In 1997, the average inflation rate for the region—measured on the basis of the consumer price index—was about 29 percent, compared with nearly 120 percent in 1996, and an annual average rate in excess of 1,500 percent in 1992–94 (Appendix, Table 3). The Baltic countries, the most advanced reformers, experienced close to single-digit inflation starting in 1997. Substantial progress has been made among the intermediate reformers—particularly Russia. Kazakhstan, and Moldova—and in countries that have successfully weathered a period of civil unrest, such as Armenia, Azerbaijan, and more recently, Georgia. In contrast, delays in undertaking comprehensive adjustment and reform have rendered price stability more elusive, as evidenced by the continued high inflation in Belarus, Turkmenistan, and Uzbekistan. The disinflation process has not been free from reversals either. Slippages in financial policies in the face of political instability have reignited inflation in Armenia and Tajikistan.

Inflation

The sustained and significant reduction in inflation observed in the first six years of transition constitutes one of the key achievements of the Baltics. Russia, and other countries of the former Soviet Union. In 1997, the average inflation rate for the region—measured on the basis of the consumer price index—was about 29 percent, compared with nearly 120 percent in 1996, and an annual average rate in excess of 1,500 percent in 1992–94 (Appendix, Table 3). The Baltic countries, the most advanced reformers, experienced close to single-digit inflation starting in 1997. Substantial progress has been made among the intermediate reformers—particularly Russia. Kazakhstan, and Moldova—and in countries that have successfully weathered a period of civil unrest, such as Armenia, Azerbaijan, and more recently, Georgia. In contrast, delays in undertaking comprehensive adjustment and reform have rendered price stability more elusive, as evidenced by the continued high inflation in Belarus, Turkmenistan, and Uzbekistan. The disinflation process has not been free from reversals either. Slippages in financial policies in the face of political instability have reignited inflation in Armenia and Tajikistan.

Table 3.

Consumer Price Inflation 1

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Sources: National authorities; and IMF staff estimates.

In simple unweighted averages.

These projections were prepared by IMF staff in March 1998 for the World Economic. Outlook, May 1998.

For 1992, Turkmenistan uses Retail Price Index.

Growth

Enhanced price stability throughout the region, supported by deepening structural reform, has paved the way for a revival of economic activity. After five years of steady decline, average real GDP growth in these countries reached an estimated 2.6 percent in 1997, following a small increase in 1996, and an annual average decline of 13 percent in 1992–95 (Appendix, Table 4). Advanced reformers have experienced positive and progressively stronger growth in the last three to four years. Among the intermediate reformers, Kazakhstan and the Kyrgyz Republic have grown for two consecutive years, while Russia and Moldova experienced a turnaround in economic activity only in 1997. Growth—at quite a rapid rate—has also reemerged among several of the countries earlier affected by conflicts, including Armenia. Azerbaijan, and Georgia, albeit from a very low base. Growth performance among slow reformers continues to be very erratic. In 1997, Belarus recorded significant growth but only at the expense of rising inflation. Ukraine continues to struggle to come out of a deeply seated recession. Uzbekistan has recorded low growth in the last two years, mainly reflecting the lasting adverse impact of tight foreign exchange and trade restrictions on economic activity since 1996. Turkmenistan endured yet another steep decline in economic activity in 1997, primarily due to a breakdown in gas exports.

Table 4.

Average Real GDP Growth 1

(Annual percentage change)

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Sources: National authorities; and IMF staff estimates

In simple unweighted averages

In simple unweighted averages.

The diverse experience of the Baltics, Russia, and other countries of the former Soviet Union during 1992–97 supports the widely accepted proposition that low inflation is a necessary, but not sufficient, condition for growth.9 In addition to reducing inflation, it is necessary to address forcefully the structural deficiencies that underlie the macroeconomic imbalances and have contributed to financial market pressures and impeded growth.10 Not coincidentally, the most advanced reformers have reestablished growth earliest and have succeeded in sustaining it at relatively high levels (Figure 1). The determined pursuit of reforms not only helps to increase current and potential growth, but also reduces countries’ vulnerability to disruptive shifts in investor sentiment.

Figure 1.
Figure 1.

Growth and Inflation

(In percent change from previous year)

Sources: National authorities; and IMF staff estimates.

Financial Policies

The pursuit of financial restraint in the Baltics, Russia, and other countries of the former Soviet Union has been instrumental in achieving the progress observed with respect to inflation and growth (Figure 2). Between 1991–97, these countries made substantial progress for the most part toward achieving a reasonable fiscal balance. The overall deficit of the general government for the region as a whole declined to an annual average of close to 3 percent in 1997 from an annual average of around 5 percent of GDP in 1995–96, and l0 percent in 1992–94.11 In 1997, 11 of the countries recorded a general government deficit of 4 percent of GDP or less-including Latvia and Estonia, both of which ran small surpluses—compared with 7 countries in 1996, and only 4 in 1993 (Appendix, Table 5). Advanced reformers have generally recorded low fiscal deficits, with Lithuania recording the highest annual average deficit in this group at about 4½ percent of GDP in 1993–96 before reducing it to close to 2 percent in 1997. By contrast, intermediate reformers and countries affected by conflict, which started the transition with very high deficits, have undergone considerable fiscal retrenchment. Fiscal deficits in these two groups have declined to an annual average range of 5 percent to 8 percent of GDP in the period 1995–96 from 10 percent to 40 percent in the period 1992–94. Nevertheless, deficits are still above 6 percent of GDP in all intermediate reformers, excluding Kazakhstan. Among the slow reformers, Ukraine has maintained a deficit in excess of 5 percent of GDP in 1997. The relatively low average deficits in the other countries in this group, however, have been caused largely by reduced availability of direct budgetary financing and the practice of subsidizing other economic sectors through the banking system, rather than by deliberate fiscal effort.

Figure 2.
Figure 2.

Inflation, General Government Deficit, and Broad Money

(In percent change from the previous period, unless otherwise specified)

Sources: National authorities; and IMF staff estimates.
Table 5.

General Government Fiscal Balances 1

(Cash basis;in percent of GDP)

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Sources: National authorities;and IMF staff estimates.

In simple unweighted averages.

Primary balance is defined as general government balance minus interest payments.

Assumes IMF measures taken.

The prevalence of deficits in most of these countries reflects the underlying weaknesses of their tax and expenditure control systems. The poor performance of government is pervasive throughout the region, although the extent varies widely across countries. Aside from the adverse effect of high inflation and prolonged recessions on the tax bases in most of these countries, collection weaknesses are also associated with heavy reliance on taxes with low buoyancies, growing evasion, and poor tax and customs administration. Expenditure management has been burdened by political pressure on the government to provide a broad variety of public goods and services, and the reluctance to embark on comprehensive civil service reform and reduce employment in the budgetary sector. Fiscal management has been further complicated by the prevailing culture of nonpayment, both on the part of government and the tax payers, and, as a result, there have been sizable accumulations of tax and expenditure arrears. The persistence of deficits has led to a buildup of government debt and a consequent servicing burden that could become unsustainable and threaten macroeconomic stability. While some countries have used the proceeds from privatization for budgetary support, in many of them government deficits have been financed in large measure through external borrowing. As a result, the government accounts for most of the outstanding stock of external debt in many countries. In some cases, most of the borrowing has been from official sources, highly concessional, and with long maturity periods. However, governments in some countries, like Russia and Ukraine, have turned to commercial borrowing to finance either unbudgeted current expenditures, like paying off wage and pension arrears or to retire domestic debt, or both. If the cost of such borrowing exceeds the rate of real GDP growth for a long enough period of time, fiscal deficits will become unsustainable sooner rather than later, and the fiscal effort required to reduce public sector debt, as measured by the required improvements in primary balances, will become much greater.12

The substantial fiscal adjustment that has taken place in the Baltics, Russia, and other countries of the former Soviet Union and the reduction in quasi-fiscal operations13 have helped in cutting the rate of expansion of key monetary aggregates. The countries that did better at lowering inflation were those that achieved the steepest deceleration in the growth of net domestic assets (Appendix, Table 6). In 1997, some advanced and intermediate reformers, including Latvia, Kazakhstan, the Kyrgyz Republic and Moldova, recorded an increase in the rate of expansion of net domestic assets without visible consequences on inflation, presumably because this reflected an increase in the real demand for credit, whereas net domestic asset growth in all other countries in this group continued to decline. The expansion of net domestic assets was generally strong among slow reformers in 1997 and in Tajikistan. Consistent with the developments in net domestic assets, the rate of expansion of reserve and broad money generally dropped between 1993–96, although it remained quite high for slow reformers and in Tajikistan—the latter because of the adverse financial impact of renewed civil conflicts, which spilled over into 1997 (Appendix, Table 7). In contrast, in 1997 broad money growth accelerated in advanced and intermediate reformers, whereas it slowed down somewhat in slow reformers and in those countries affected by conflict. While the growth in broad money in the advanced and intermediate reformers look place in a context of declining inflation and a revival in economic activity, slow reformers faced either renewed inflationary pressures, such as Belarus, or a decline in activity, such as Ukraine and Turkmenistan.

Table 6.

Net Domestic Assets and Reserve Money 1

(Annual percentage)

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Sources: National authorities; and IMF staff estimates.

In simple unweighted averages.

in percent of reserve money at beginning of period

Excluding Turkmenistan.

Table 7.

Growth in Broad Money 1

(In percent; excluding foreign currency deposits)

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Sources: National authorities: and IMF staff estimates,

In simple unweighted averages.

Figures from 1995 exclude assets and liabilities of banks which were removed from the monetary data in December 1995.

Monetary management has significantly improved throughout the region. Most countries have abandoned the direct allocation of credit and have reduced considerably the subsidization of lending interest rates. Liquidity management has been facilitated by the creation and gradual deepening of government securities markets, although money markets remain generally thin.14 In some countries, the central bank’s claims on the government have been converted into securities to help in the conduct of open market operations. Special lending facilities, which are increasingly being collateralized, have also been created to facilitate the central bank's activities as lender of last resort. Most countries have also greatly enhanced the payments and settlement system. Bank restructuring is now under way in many countries, and although the process is not yet complete, this is having a generally favorable effect on the transmission mechanisms of monetary policy.

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Cover Macroeconomic Developments in the Baltics, Russia, and Other Countries of the Former Soviet Union, 1992-97
Macroeconomic Developments in the Baltics, Russia, and Other Countries of the Former Soviet Union, 1992-97
ISBN:
9781557757807
ISSN:
0251-6365
Publication Date:
06 Jan 1999
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557757807.084
Pages:
35
  • Figure 1.
    View in gallery
    Figure 1.

    Growth and Inflation

    (In percent change from previous year)

  • Figure 2.
    View in gallery
    Figure 2.

    Inflation, General Government Deficit, and Broad Money

    (In percent change from the previous period, unless otherwise specified)

Figure 1.

Growth and Inflation

(In percent change from previous year)
Figure 2.

Inflation, General Government Deficit, and Broad Money

(In percent change from the previous period, unless otherwise specified)