IV Summary and Conclusions
- Donal McGettigan
- Published Date:
- February 2000
The virulence of recent external crises—both in Asia and in countries such as Russia and Ukraine—highlights the importance of a continuous assessment of a country’s vulnerability to crisis. The main objective of this paper was. therefore, to consider the potential usefulness of external crisis indicators for the Baltics, Russia, and other countries of the former Soviet Union.
To this end, the paper first summarized the evolution of the countries’ current account positions since shortly after independence. Although high current account deficits have been recorded throughout the group since independence—with Russia as the main exception—the external debt burdens of most of the countries remain relatively low. Debt-to-GDP ratios, however, have increased since independence, especially in the cases of Armenia, the Kyrgyz Republic, Moldova, and Turkmenistan. Although much of the external financing has comprised official disbursements, grants, and rescheduling of debt, private capital flows and foreign direct investment have been increasing rapidly in relative importance in recent years.
A review of the main findings that have emerged from both the theoretical and empirical external crisis literature revealed a fundamental lesson that no single indicator is sufficient for the accurate prediction of crises. Instead, it is generally agreed that several different indicators, covering many aspects of an economy’s performance, are needed. Therefore, several indicators were analyzed covering the real exchange rate, fiscal policy, savings and investment, trade, economic growth, debt composition, foreign exchange reserves adequacy, and the financial sector.
The conventional mode of analysis—whereby statistical techniques are employed to gauge the usefulness of indicators based upon previous episodes of external crisis—is not possible in the Baltics, Russia, and other countries of the former Soviet Union, given the short period since the transition process began and the relative scarcity of crisis episodes to date. Instead, another approach is employed whereby the most successful indicators are examined from the perspective of these countries. Throughout the analysis, it is clear that transition countries have several features that complicate the use of crisis indicators. The main conclusions to emerge from the analysis are highlighted below.
The real exchange rate—considered to be one of the most useful external crisis indicators elsewhere—is very difficult to interpret in the context of these economies, where the equilibrium exchange rate is very uncertain and is constantly changing as transition proceeds. Moreover, it appears that the currencies of many of these countries remain significantly undervalued. Nevertheless, several of the currencies are moving toward their equilibrium levels as transition proceeds, thus implying that a more careful monitoring of this important variable (and the closely related dollar wage) is now warranted.
The importance of fiscal indicators was highlighted by the recent Russian and Ukranian crises. Nevertheless, it appears that the fiscal situation has generally improved within this group of countries over the sample period, reflected by expenditures that are falling more quickly than revenues, relative to GDP. In 1997, although mean expenditures and revenues increased relative to GDP, mean general government deficits have continued to decline. However, certain countries—such as Russia and Ukraine—have exhibited marked weaknesses on the fiscal front, while others, such as Armenia, Kazakhstan, the Kyrgyz Republic, and Moldova, continue to exhibit some signs of fiscal vulnerability. The difficulties caused by the lack of comprehensive data on the lower tiers of government and off-budget entities, and by the sometimes large quasi-fiscal deficits of central banks and other entities—all important omissions in the context of these economies—were emphasized throughout the discussion.
The largely fiscal nature of the countries’ external debt situation was noted, as was the increasing tendency for current account positions to reflect private sector, rather than public sector, savings-investment imbalances as transition proceeds.81 On the other hand, the data did not provide much support for the widely expressed view that current account deficits are mainly being used to finance consumption in these countries, rather than investment.82
On openness indicators, the large undervaluations of these currencies make such indicators very difficult to interpret. To the extent that the currencies are undervalued, the export-to-GDP ratio (a widely used openness indicator) will tend to be overstated, and the ratio will tend to decline as exchange rate equilibrium is restored. In terms of intragroup vulnerability to contagion, countries such as Belarus, Moldova, and Turkmenistan are more susceptible on this score than the others, based on the proportion of exports accounted for by Russia.
On economic growth, previous analyses indicate that medium-term growth prospects are generally very good, which should provide some form of protection against external crisis. Nevertheless, the lack of reform in certain of these countries—such as Belarus, Turkmenistan, and Uzbekistan—could impede growth prospects over the medium term.
As for the composition of external liabilities, sources of external financing have been very different from those elsewhere. Official disbursements, net use of Fund credit, and debt rescheduling agreements have formed the bulk of financing in these countries since independence. Nevertheless, foreign direct investment, although starting from a low base, has increased rapidly in relative importance in recent years, especially in the Baltics. Such trends tend to allay concerns about the changes in the composition of debt. However, in certain of these countries, such as the Baltics, private capital flows have been increasing rapidly in importance, thus providing possible grounds for concern on external uncertainty. Overall debt service and debt stock ratios were observed to be very high in relation to gross reserves in Russia, Tajikistan, and Ukraine. In addition to these countries, debt stock ratios are high in Georgia, the Kyrgyz Republic, and Moldova, thus indicating possible vulnerability to external crises from this angle.
On foreign exchange reserves adequacy, it was seen that—apart from Russia and Belarus—the widely used M2-to-reserves ratio did not appear to be cause for concern in most of the others, reflecting the generally undeveloped state of the financial sector in this group of countries. With the exception of Turkmenistan, reserves do not appear to provide strong import coverage, with Belarus and Tajikistan displaying reserve coverage of less than one month of imports.
Finally, on financial indicators, the generally underdeveloped state of most of the countries’ banking sectors may serve to weaken somewhat the strong links that exist elsewhere between financial and external crises. This is perhaps best illustrated by the fact that countries such as Latvia and Lithuania continued to grow during their respective banking crises. Beside the generally low ratio of M2 to reserves, it was also found that private sector credit did not appear to be growing strongly, other than in Estonia, where the authorities have instituted various measures to protect against any potential banking sector problems. Data on nonperforming loans are of such poor quality that their usefulness is largely invalid. Nevertheless, the bad loan problem is considered problematic in Azerbaijan. Lithuania, and Tajikistan. Except for Belarus, the Kyrgyz Republic, and Latvia, banking sector capital adequacy ratios appear to be acceptable, even though, once again, data problems suggest caution in relying too much on this indicator. In the same connection, the ratio of commercial bank reserves to deposits appears to be generally quite high in these countries.
The Baltics, Russia, and other countries of the former Soviet Union could be classified into various categories, such as late reformers—Belarus, Uzbekistan, and Turkmenistan—where external crises, if they arise, are likely to emanate from the continuous application of misguided policies. In such cases, medium-term indicators, such as those covering fiscal policy and economic growth, may be most useful. In the case of advanced reformers, such as the Baltics, it may be more useful to focus on more immediate indicators, such as financial sector indicators, debt composition, and foreign exchange reserves coverage. Others, including Russia and Ukraine, could usefully concentrate on fiscal indicators. Finally, in the case of the remaining countries, a broadly based analysis with no particular emphasis may be most appropriate. Overall, however, the use of indicators should be regarded as only one part—albeit a potentially important part—of any investigation of a country’s external sustainability.