IMF Survey: With hindsight, was Russia’s 1998 debt default avoidable, given the Asian financial crisis and the oil price collapse?
Odling-Smee: Russia could have avoided default by adopting a more flexible exchange rate regime much earlier. But it was deeply committed to the fixed exchange rate policy as a means of disinflation. That left only fiscal policy. Russia could have avoided the crisis by running a much tighter fiscal policy, which the IMF urged it to do, not only in 1998 but as far back as the early 1990s. Fiscal policy was Russia’s Achilles’ heel.
IMF Survey: If there were rational steps that could have been taken, why weren’t they?
Odling-Smee: You have to remember that during the 1990s, in Russia and all the other countries in the CIS [Commonwealth of Independent States], governments were very weak. As a result, strong vested interests were able to avoid paying taxes, wages, and even bills in general when it suited them. Had the government been stronger, it could have collected taxes, insisted that people pay up, and punished those who did not. But, in reality, very few people were punished for not paying their taxes. The government also contributed to this fiscal indiscipline by not paying its own bills, wages, and pensions when it was short of funds. This led to an elaborate system of offsetting unpaid government payments against unpaid taxes that further undermined the fiscal system.
IMF Survey: Would it have made a difference if the international community had called Russia’s bluff and simply cut off all lending?
Odling-Smee: The availability of those loans clearly made it somewhat easier for the government to not impose strict fiscal discipline. But I don’t think the unavailability of the loans would have resulted in significantly more discipline or a much higher collection of taxes. A more likely outcome would have been even more bills left unpaid by the government, with consequent social hardship and economic disruption. Or the crisis could have come earlier.
IMF Survey: Is the government strong enough now to follow through with strict fiscal discipline?
Odling-Smee: The situation has changed considerably since 1998, although it’s important not to make too sharp a distinction between the precrisis and postcrisis years. There was a growing realization before the crisis that things had to change, and the government did move to end the offsets and clear its tax and pension arrears in 1996-97.
Also, it’s always easier to follow a good fiscal policy when the economy is growing. So when growth resumed in 1999—initially because of the high oil price and the 1998 depreciation—it was easier to take the necessary fiscal steps. Moreover, when the depreciation brought a big jump in prices and thus revenues, the government resisted the temptation to boost spending to a similar extent. As a result, real expendi-tures—and especially real wages—fell, creating a lot of room in the budget and passing the burden on to the recipients of government wages. That was a very tough move. And for a time in early 1999, the IMF opposed this policy on the grounds that it was too tough!
Russia and the IMF
Following the dissolution of the Soviet Union, the Russian Federation began its move toward a market economy and joined the IMF on June 1,1992. Over the next seven years, it borrowed $21 billion from the IMF, receiving its final disbursement in 1999. Russia’s sound economic policies have paid off, enabling it to repay over two-thirds of its obligations to the IMF, often ahead of schedule.
IMF Survey: For quite a long time in the 1990s, Russia seemed to struggle with high inflation, no growth, severe fiscal problems, corruption, and so on. But, in the past three to four years, it seems to have made a breakthrough. Is that because of the temporary benefit of higher oil prices and greater competitiveness from the 1998 depreciation, or is there more to it than that?
Odling-Smee: The big test for Russia will come when oil prices fall and the benefits from the depreciation have been totally eroded. My view is that Russia won’t go back to where it was before. The recent years of growth and strong oil prices have created confidence in the prospects for future growth, and the liquidity cushion makes it unlikely that the old nonpayment crisis will reemerge. Moreover, both economic agents and the government fully understand that the pre-crisis behavior was an aberration and a successful economy cannot be built without financial discipline. There’s also much more agreement throughout the leadership about what needs to be done now, whereas before 1998, the Duma was always fighting the government.
IMF Survey: How important a role did the IMF play in turning Russia around?
Odling-Smee: It’s always very difficult to say what role the IMF plays. One thing I don’t take terribly seriously is the idea that our impact occurs wholly through the imposition of conditionality in IMF programs. To begin with, the policies included in IMF supported programs don’t work very well unless the government really wants to implement them. And, in Russia, the problems were often a lack of implementation and not a lack of an intellectual commitment to a good idea. So, in the short term, I don’t think we had much influence.
However, over the longer term, I do think that we had a lot of influence through our educational, pedagogical role. From 1992 on, we worked with key policymakers and technicians in the central bank, ministry of finance, and elsewhere on the importance of macro-economic stability and how to bring it about. So when the political climate changed and the political leadership became convinced of the need for macroeco-nomic stability, the Russians were able to act.
To cause serious fiscal problems, the oil price would have to fall a long way—to below $15 a barrel—and stay there for quite some time.
IMF Survey: How would a military conflict in Iraq affect economies in the region?
Odling-Smee: The biggest impact would come through a change in the oil price. The oil producers—especially Russia, Kazakhstan, and Azerbaijan—could be expected to gain considerably if the oil price rose sharply in the early stages of a conflict. Government revenues and oil-sector profits would increase. Further benefits would depend on whether the windfalls were saved. Azerbaijan and Kazakhstan have oil funds for this very purpose, and Russia is beginning to talk about an oil fund, which would be highly desirable. The other countries in the region, which are mostly oil and gas importers, would both lose and gain. They would lose on the higher oil price, but they could gain a bit from stronger exports to the three oil producers. Russia is still the biggest market for most countries in the region. On balance, the oil importers would not be hurt very much.
How about over the longer term? If a conflict in Iraq came to an end and the oil price fell, then some of those things would go into reverse, meaning that the oil-producing countries would have lower revenues and external current account surpluses. We advocate saving the windfalls to shield fiscal policy as much as possible from the fluctuations in oil prices. To cause serious fiscal problems, the oil price would have to fall a long way—to below $15 a barrel—and stay there for quite some time.
IMF Survey: Russia’s real exchange rate depreciated dramatically after the 1998 default but has since returned to only about 20 percent below its precrisis level. Should the government continue to try to slow the appreciation to help non-oil exporters?
Odling-Smee: As long as oil prices are strong, the government recognizes that it will be very difficult to prevent some real exchange rate appreciation. Non-oil exports are still fairly competitive at the current exchange rate. It will, however, be important to prevent a rapid real appreciation, which could be disruptive. It is important to use fiscal policy rather than monetary policy to slow appreciation, which means saving as much of the windfall revenue from high oil prices as possible. The problem with using monetary policy to slow nominal appreciation is that you risk ending up with a higher inflation rate.
IMF Survey: What is the desirable pace of slowing inflation as Russia confronts this trade-off between inflation and the real exchange rate?
Odling-Smee: There is no absolutely optimal pace, but the Russian authorities aren’t being ambitious enough in reducing inflation. There’s a risk, and we’ve seen this in other countries, that if inflation stays in the 10-20 percent range for a number of years, it will be difficult to get it below that range. We think the authorities should commit themselves to reducing core inflation—that is, inflation before adding the impact of special administrative price increases, such as for housing and communal services and energy—from 10 percent now to less than 5 percent by the end of 2004. Last year, Russia’s headline inflation was 15 percent, and the authorities are targeting a headline rate of 10-12 percent in 2003 and about 9 percent—consistent with core inflation of 7 percent—in 2004.
IMF Survey: To what extent should capital inflows be regulated or controlled?
Odling-Smee: We wouldn’t favor any controls on long-term capital [portfolio or foreign direct investment] inflows. But it’s sometimes difficult to distinguish between long-term and short-term portfolio inflows. Right before the 1998 crisis, investors heavily bought longer-term GKOs [government securities] as a speculative move. Our concern now is that a situation could arise again where foreign investors want to speculate on a short-term basis in Russia, potentially complicating macroeconomic management. Under these circumstances, we would support some kind of market-friendly capital controls, such as the Chilean-type controls, to try to discourage speculative inflows.
IMF Survey: The IMF has generated much controversy by suggesting that the tax burden should be shifted from the nonenergy sector to the energy sector. And can the non-oil sector be stimulated without a major push for structural reforms to improve the investment climate?
Odling-Smee: The government is trying, quite rightly, to gradually diversify the economy away from an overdependence on natural resources. One way to do that is to lower the tax burden on the non-oil sector and shift it to the oil sector, which carries a lighter burden than oil sectors in comparable countries.
However, if the government does this soon, it won’t necessarily help because the problems that the non-oil sector faces are much more deep-rooted than taxation. The authorities’ highest priority should be to improve the business climate throughout the economy to encourage growth in the non-oil sector. This will have a bigger impact on growth than tax cuts.
IMF Survey: What reforms are needed to improve the business climate?
Odling-Smee: Four reforms top the list. First, the government needs to reform the banking sector, which is small, weak, and unable to properly intermediate savings between savers and investors.
Second, it needs to reform the natural monopolies, especially Gazprom and the electricity sector. This will mean raising prices to cover costs and create proper market pricing. This step will have to go hand in hand with a social safety net that enables the lower-income groups to afford the higher oil prices. Third, Russia needs to reform the social sector, reducing the subsidization of communal services and housing while strengthening income transfers to low-income households. Fourth, it needs to reform the civil service and public administration, which are still too large, intrusive, arbitrary, and underpaid-of course, encouraging corruption.
But tackling these four reforms will be very difficult politically. In fact, not much will happen before the elections scheduled for late this year and early next year. That’s why it is vital to prepare the ground now and undertake a major push on reforms after the presidential elections in March 2004, when there will be a window of opportunity before the next round of elections.
IMF Survey: Are you hopeful that Russia can achieve these reforms?
Odling-Smee: I am always hopeful about Russia. I am a long-term optimist, although sometimes a short-term pessimist. I am hopeful now for a number of reasons. One is that, despite the difficulties of the past decade, we have, by and large, year after year, seen progress, reflecting the underlying wish of the people and the leaders to move in a reformist direction even during the tough times. Second, the whole of the leadership now wants reforms. It is true that there are various vested interest groups whose positions would be threatened by reforms, and they are resisting. That said, I don’t think that they’ll be strong enough in the long run to prevail. We are already seeing cases of some of the vested interests switching sides. Some of the big oligarchs have backed reforms even when they themselves didn’t gain. True, they haven’t yet backed reforms where they would lose a lot, but they are no longer a reactionary force; they’ve made their money and are willing to look at the big picture and take a philanthropic view of the country’s future. Third, there is a tremendous will, especially among younger generations, to make up for the time that Russia has lost and the missteps taken in the past decade, not to mention during communist times. With only the older generations now questioning the desirability of completing market reforms and integrating with the world economy, I believe that this strong drive will keep Russia moving in the right direction.
With only the older generations now questioning the desirability of completing market reforms and integrating with the world economy, I believe that this strong drive will keep Russia moving in the right direction.
Photo credits: Denio Zara, Padraic Hughes, Pedro Marquez, and Michael Spilotro for the IMF, pages 65-67, 74-76; Alexander Natruskin and Viktor Korotayev for Reuters, page 68; Bernardo Rodriguez for AFP, page 69; Pedro Ugarte for AFP, page 70; Peter Williams for WCC, page 72; and Arne Dedert for AFP, pages 79 and 80.