Russia
Recent Economic Developments

This paper reviews economic developments in the Russian Federation during 1990–98. Output fell precipitously in 1992–94 in response to the withdrawal of subsidies and the disruption in traditional economic relations, but the decline then began to taper off, and real GDP registered a small increase in 1997. However, the recovery proved short-lived, and GDP was already on a downward trend by the first half of 1998. This contraction was severely aggravated by the economic crisis that erupted in mid-1998.

Abstract

This paper reviews economic developments in the Russian Federation during 1990–98. Output fell precipitously in 1992–94 in response to the withdrawal of subsidies and the disruption in traditional economic relations, but the decline then began to taper off, and real GDP registered a small increase in 1997. However, the recovery proved short-lived, and GDP was already on a downward trend by the first half of 1998. This contraction was severely aggravated by the economic crisis that erupted in mid-1998.

Russian Federation: Basic Data

article image
Sources: Russian authorities; and Fund staff estimates.

Data for 1997 or latest available.

I. Overview

1. The period since the last Article IV consultation with the Russian Federation has witnessed perhaps the greatest contrast in the fortunes of the economy since Russia became an independent state in 1992. This swing in economic performance and prospects was most emphatically marked by the financial and economic crisis that erupted with the events of August 17, 1998. Expectations reached a high-point in mid-1997, when aggregate output was at last growing, interest rates on treasury bills had fallen below 20 percent, the Central Bank of Russia (CBR) was accumulating about $1½ billion a month in reserves, the Moscow Stock Exchange was the best-performing equity market in the world, and inflation had virtually ceased. By September 1998, in contrast, the economy had descended to a point of collapsing output and trade volumes, disorderly disruption of relations with domestic and external creditors, paralysis of the banking system, decimated financial asset prices, and surging inflation.

2. Beneath these sharp swings in key economic indicators, however, there were steadier processes at work which, when not reversed, made a crisis such as that of August 1998 virtually inevitable. Most fundamentally, the erosion of federal government revenues, particularly cash payments, made a robust fiscal consolidation and durable macroeconomic stabilization impossible (Figure 1). The inability to collect adequate revenues in turn owed much to the lack of progress in structural reform—notably the failure to impose hard budget constraints throughout the economy—which was manifest most clearly in an inadequate restructuring of the economy and the steady growth of economy-wide nonpayments (see Annex II, “Nonmonetary Transactions and Arrears Accumulation”). The causation was not, however, unidirectional: the government’s fiscal policy itself contributed to the lack of financial discipline. In particular, recourse to tax offsets—mutual cancellation of tax and budgetary arrears—both reduced incentives for tax compliance and contributed to nonpayments more generally.

Figure 1.
Figure 1.

Russian Federation: Enlarged Government Revenues, 1992-98

(In percent of GDP)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: Russian authorities; and Fund staff estimates.

3. Despite the limited fiscal adjustment, the stabilization gains earned in 1993–95 were prolonged through mid-1998 by the maintenance of a fixed exchange rate regime supported by heavy external borrowing, much of it short term.1 However, the government’s decision to allow foreign currency-denominated and short-term obligations to account for a growing proportion of total government debt (Figure 2) made budget financing increasingly vulnerable to shifts in market sentiment.

Figure 2.
Figure 2.

Russian Federation: Composition of Sovereign Debt, 1993-98

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Sources: Data provided by the Russian authorities; and Fund staff estimates.

4. While the authorities’ inability to come to grips with the underlying fiscal problems made the financial stability that prevailed from 1996 through mid-1998 inherently tenuous, the timing of the shattering of that stability undoubtedly owed much to the souring of the external environment from late-1997 onward. Most importantly, there were significant spillover effects from the economic crisis that swept across Asia from mid-1997. That crisis led to a rise in interest rate spreads on debt issued by borrowers in emerging market economies (Figure 3). At the same time, Russia’s terms of trade deteriorated by about 37 percent between January 1997 and December 1998, led by steep declines in the price of oil, natural gas, and base metals. Compared to end-1996, the fall in the terms of trade by mid-1998 implied an annualized deterioration in the balance of payments of about $25 billion.

Figure 3.
Figure 3.

Emerging Market and Russian Bond Indices, 1995-99

(Inverse of total return index, end-1996=100)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: J.P. Morgan Emerging Market and Russian bond indices, and Fund staff estimates.

5. Clear though it is that these adverse exogenous developments played a key role in triggering the 1998 crisis, it is also evident that the external environment had previously been unusually positive. From 1995 through 1997 U.S. long-term interest rates were stable at relatively low levels, while spreads over U.S. government bond yields for emerging market borrowers (as measured by the benchmark Emerging Market Bond Index) fell rapidly from above 12 percent in late-1995 to a record-low of about 3 percent in the fall of 1997. Corresponding to that narrowing of spreads was a large increase in volumes of capital flows to emerging markets. The growth in emerging markets’ gross primary market financing on all instruments (equities, bonds, loans, and other fixed income) quickened from annual rates of about 15 percent in 1994–95 to about 40 percent in 1996 and the first three quarters of 1997. Apart from this positive global capital market environment, which prevailed until late-1997, Russia’s terms of trade also saw an improvement of 16½ percent from a trough in October 1995 to their January 1997 peak. Although the terms of trade index then began the fall that was to extend through 1998, in August 1997 it was still 11½ percent above its October 1995 level.

6. Although the undermining of financial stability by persistent fiscal imbalances was the salient feature of the 1992–98 period, slow progress in creating a favorable business environment also contributed to a stagnating economy throughout the period. The lack of decisive structural reform in areas such as corporate governance, bankruptcy procedures, property rights enforcement, labor mobility, and accounting standards was bound up with the continued failure of aggregate output to rebound, the slow pace of foreign direct investment, and the low and falling level of overall investment as a percentage of GDP (Figure 4). In addition, this meant that the very large upward move in the real effective exchange rate from 1992 to mid-1998 was not underpinned by a corresponding increase in labor productivity.

Figure 4.
Figure 4.

Russian Federation: Investment Activity, 1992-98

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: Russian authorities; Fund database; Fund staff estimates.

A. 1992–96: The First Five Years of Transition

7. The authorities’ reform efforts in 1992–94 were focussed on reducing macroeconomic imbalances that had widened in the final years of the Soviet Union, allowing markets to begin performing their allocative function, and developing the basic institutional and legislative frameworks required by a market economy. Although the authorities made some progress in these areas, stabilization was only partial, and many of the goals of the reform process were not met, particularly in terms of institutional reforms and enterprise restructuring. Inflation fell, but remained high, and federal revenues declined precipitously as a percentage of GDP. Moreover, there was a systematic tendency to relax fiscal and monetary policies in the second half of each year, damaging the credibility of the authorities and adding to uncertainty about the policy environment.

8. Against that background, the authorities resolved in 1995 to achieve a decisive reduction in inflation via a tight monetary policy supported by a halving of the federal budget deficit to under 6 percent of GDP. Also, chastened by the exchange crisis of October 1994 which saw a one-day drop of 20 percent in the ruble’s value against the U.S. dollar (on “Black Tuesday”), they sought to bolster confidence in their determination to achieve macroeconomic stabilization by legislating a prohibition on direct lending from the CBR to the budget. Finally, to foster stability of the ruble, they adopted an exchange rate band system from July 1995. Despite political pressures, the authorities stuck to their program, and their main goals were achieved: the federal budget deficit (on a cash basis) was contained to about 5 percent of GDP, inflation fell to 131 percent (December to December) from 215 percent in 1994, and economic activity in some sectors stabilized. However, continuing revenue shortfalls made the fiscal situation increasingly vulnerable. In response, noninterest cash expenditures were compressed well below the levels of previous years, but a lack of control of expenditure commitments led to an accumulation of arrears, and spending pressures built up late in the year. Also, inertial inflation combined with the exchange rate band led the ruble to appreciate in real terms by 65 percent in 1995 (December to December), creating increasing difficulties for the tradeables sector.

9. The pressures evident at the end of 1995 continued into the following year, when the run-up to the June 1996 presidential elections saw an easing of financial rigor. Tax collection efforts slackened and large tax offsets were permitted. Adding to the fiscal problems, the Chechen war is estimated to have cost at least 1 percent of GDP. While the federal (cash) deficit widened to 8 percent of GDP in 1996, inflation continued to decline, supported by the exchange rate anchor and reliance on nonmonetary government financing. At the same time a number of important structural reforms—such as land reform, the creation of an adequate legal framework for the capital market, and privatization—continued to lag.

10. The erosion of federal revenue and the lack of institutional reform during the first five years of transition were partly a function of the lack of the necessary political consensus. Such a large part of the economy was economically nonviable on the basis of normal market relations—and barriers to the reallocation of resources, especially labor, were such—that there was a powerful constituency against the hardening of budget constraints. The major appreciation of the ruble in real effective terms that characterized the period since 1992, and which was unusually marked compared to the experience of more successful transition economies (see Figure 5), tended to increase the number of nonviable enterprises, and may have swelled the constituency opposing necessary reforms. The result was that, despite a number of economic policy successes in the period through 1996—including taming hyperinflation, and progressively opening the economy to trade and investment—the inability to break the culture of nonpayment (Annex II) and reverse the revenue decline meant that fiscal deficits remained stubbornly high, while growing budgetary arrears led to further nonpayments throughout the economy (Figure 6).

Figure 5.
Figure 5.

Real Effective Exchange Rate Movements, Selected Transition Economies

(Index, first year of transition = 100)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: IMF database.
Figure 6.
Figure 6.

Russian Federation: Measures of Nonpayments, 1994-98 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Sources: Goskomstat.1/ For 1998 November data.

B. The Zenith of Expectations, January–September 1997

11. The policy mix of 1996, with high fiscal deficits and declining inflation reconciled by an exchange rate anchor and heavy government borrowing, continued through 1997. By early 1997 the fragility of this policy mix was well recognized, both by outside observers and within the government. There was, however, renewed optimism that the fiscal problems could be overcome. To begin with, the presidential elections were over, President Yeltsin’s health was less in doubt than it had been, and the position of market-oriented reformers in the government was seemingly strengthened. Further, the authorities had publicly recognized the seriousness of the problem of insufficient federal revenues, and had launched successive waves of measures designed to raise compliance and enhance collections. In addition, the completion of a rescheduling accord with Russia’s Paris Club creditors (and the nearing of final agreement with the London Club) removed concern about the government’s near-term debt service burden, while an apparent incipient turnaround in the output decline in Russia and through much of the former Soviet Union gave rise to widespread expectations of a resumption of growth in the region. Finally, Russia benefitted from an improvement in investor perceptions of emerging markets in general: private capital flows to emerging markets were again surging after the brief retrenchment following the Mexico crisis of 1995.

12. Thus, from late-1996 through much of 1997 there was a considerable appetite for Russian government securities, both domestically and abroad. Between November 1996 and December 1997 the federal government was able to issue $4½ billion in Eurobonds at spreads over comparable U.S. government securities of between 330 and 375 basis points. At the same time, GKO yields declined from around 100 percent in September 1996 to 18½ percent in July 1997. Net GKO/OFZ issues in 1997 amounted to 4.2 percent of GDP, with nonresidents making net purchases equivalent to $11 billion, and raising their share of outstanding GKOs from under 20 percent in December 1996 to about 33 percent by the end of 1997.

13. The resort to extensive foreign budgetary finance through Eurobond and GKO/OFZ sales from late-1996 through 1997 is understandable, as the government was able to borrow via the GKO market at relatively low real interest rates for much of this period (Figure 7). Also, the virtually uninterrupted real appreciation of the ruble against the U.S. dollar made dollar yields of around 10 percent on Russian government Eurobonds look very reasonable. It should be emphasized, however, that the decision of the government to open the GKO market to nonresidents in 1996 was premised on the ability of the government to overcome its fiscal problems which, in the end, it was unable to do.

Figure 7.
Figure 7.

Russian Federation: Interest Rates, 1995-98

(In percent, annualized)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Sources: Bloomberg, Reuters, SKATE Agency, Goskomstat, and Fund staff estimates.1/ Corrected by annualized monthly price change.

14. For much of 1997, the balance of macroeconomic news was positive, sustaining market optimism. In the third quarter, aided by a good grain harvest, Russia experienced its first positive real GDP growth since independence. At the same time, inflation fell to 2 percent at an annualized rate, with the CPI actually falling in August and September (Figure 8). In addition, until September 1997, the terms of trade were more favorable than in the corresponding period of 1996 (Figure 9). This positive environment helped propel the stock market to new highs: in the first nine months of 1997 the main index more than doubled in U.S. dollar terms. Also, the improvement in market sentiment allowed the authorities to reverse the shortening of the maturity profile of domestic government debt.2

Figure 8.
Figure 8.

Russian Federation: Consumer Price Inflation, January 1996-June 1999

(percent changes)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

1/ Adjusted with X11 multiplicative procedure from index data.
Figure 9.
Figure 9.

Russian Federation: Terms of Trade, January 1995 - March 1999

(Index, 1995=100)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: Fund staff estimates.

C. Rising Pressure and Policy Responses, October 1997–July 1998

15. By late 1997, however, the economic and financial environment was deteriorating. The realization that 1997 was not bringing the hoped-for rebound in federal revenues and associated fiscal consolidation, combined with the deterioration in market sentiment towards emerging markets following the onset of crisis in Thailand in July 1997 (and even more so following the turmoil in Hong Kong’s financial markets in October), meant that in November 1997 the authorities were forced—for the first of what was to be several times—to raise interest rates sharply to defend the exchange rate band and roll over maturing GKOs. At the same time, the CBR intervened heavily in the foreign exchange market: reserves declined by $6 billion in November 1997 alone.

16. From late-1997 onward, other developments also turned negative. Russia’s export prices declined by more than 20 percent between August 1997 and July 1998, driven in large part by the fall in oil and gas prices. Real GDP began to fall again, led by a sharp contraction in investment. With a more difficult external environment and a renewed downturn in domestic economic activity, combined inward foreign direct and portfolio investment—excluding purchases of government debt—shrank from some $8 billion in 1997 to an annual rate of only about $2½ billion in the first half of 1998. The Moscow Times U.S. dollar equity index retreated rapidly from its peak of August 1997, falling by 43 percent by end-November, and a further 31 percent by end-June 1998 (Figure 10). By August 13, even before the devaluation of the ruble, equities had lost nearly 80 percent of their value in U.S. dollar terms compared to their August 1997 peak.

Figure 10.
Figure 10.

Russian Federation: Moscow Times U.S. Dollar Equity Index, 1996-99

(September 1994=100)

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: Moscow Times.

17. There was also a growing awareness of the fragility of the Russian banking system, as many large banks had become reliant on GKOs and other securities whose prices were falling rapidly. From early-1998, this exposed some banks to margin calls, forcing sales of assets which further depressed financial markets and added to the pressure on bank balance sheets. Also, the banking system as a whole had become vulnerable to devaluation; foreign investors holding GKOs had hedged their ruble exposure by buying dollar forward contracts from Russian banks. As a result, the banking system was caught in the downward spiral of Russia’s fiscal fortunes, as a failure to solve the fiscal problem was leading to higher interest rates, lower financial asset prices, and an ever-higher probability of devaluation.

18. At the same time, deep-seated fiscal problems remained, while political uncertainty became an increasingly important factor. Federal government revenue as a percentage of GDP had fallen again in 1997, and the deficit remained close to 7 percent of GDP. Moreover, further government reshuffles and a standoff between the President and the Duma in March–April 1998 over the President’s choice for Prime Minister, Mr. Kiriyenko, weakened market confidence in the government’s ability to overcome parliamentary resistance to a reform agenda. The heightened risks were reflected in successive warnings and downgradings of Russia’s credit ratings by one or more of the main agencies in December 1997 and March, May, June, and August 1998.

19. A financing crisis ensued as interest rates rose sharply. After large, though short-lived, upward moves in GKO yields in late 1997 and January 1998, the pressure intensified in May–June 1998, when yields were briefly driven above 100 percent, and averaged about 60 percent. Faced with this crisis, the Russian authorities attempted to restore confidence by strengthening their efforts to correct the fiscal imbalance and accelerate structural reforms. In support of these efforts, the authorities sought the help of the international financial institutions in assembling an official financing package large enough to bolster confidence in the adequacy of reserves. At the same time, a voluntary swap of about $4.4 billion in GKOs into Eurobonds was arranged.

20. In mid-July 1998, after the announcement of new fiscal and structural policy measures and agreement with the IMF on a package of additional official assistance (the total value of which, including contributions from the World Bank and Japan, was to be about $17 billion), pressure on interest rates and reserves temporarily eased. GKO yields declined from nearly 200 percent on July 10 to 54 percent by July 15. However, when the Duma balked at passing certain key promised measures, the credibility of the program was crippled. By mid-August GKO yields had reached a new high of nearly 300 percent and reserves had fallen by some $3½ billion from late-July.

D. The August 1998 Crisis

21. Faced with dwindling international reserves despite the massive spike in interest rates, on August 17, 1998 the authorities announced a series of emergency measures. These included a de facto devaluation of the ruble (with an upward shift and widening of the exchange rate band), a unilateral restructuring of ruble-denominated government debt falling due between August 19, 1998 and December 31, 1999, and a 90-day moratorium on private sector payments on external liabilities. The measures, announced without supporting macroeconomic policies, only aggravated the decline in investor confidence and the associated outflow of private capital. Moreover, a new wave of political uncertainty was unleashed with the dissolution of the Kiriyenko government on August 23. Thus, despite continued heavy intervention by the CBR, the ruble rapidly reached the new ceiling of Rub 9.5 per U.S. dollar established on August 17, forcing the authorities to abandon the exchange rate band on September 2. The exchange rate quickly jumped beyond Rub 20 per U.S. dollar, before settling back to Rub 16 per U.S. dollar by the end of September. Driven by the depreciation of the ruble, monthly inflation hit 38 percent in September.

22. The most immediate and dramatic result of the August 17 measures was the virtual collapse of the banking system. Banks’ portfolios were generally heavily skewed towards government securities, and the effective default on GKOs had a powerful negative effect on the balance sheets of many banks. A large number of banks were also wrong-footed by the abandonment of the quasi-fixed exchange rate, holding major short-dollar positions in the forward market which they were unable to square after the devaluation. Interbank transactions virtually ceased, and the payments system was paralyzed for over a month. Also, in the chaotic post-August 17 environment, even nonmonetary transactions were temporarily disrupted. As a result, there was a severe contraction in output and trade. By October 1998 industrial production, which had been up year-on-year in the first half of the year, was down 15 percent relative to October 1997. Imports, affected also by the massive change in relative prices, fell to about $2 billion a month in the last four months of 1998, roughly half the level during the same period of 1997.

E. The Post-Crisis Period

23. After the initial aftershock of August 17, economic policy was initially passive, but the worst post-August fears concerning macroeconomic stability were not realized in the following months. Inflation remained higher than before the crisis, averaging about 7 percent a month from October 1998 through February 1999, but declined steadily, reaching 2 percent per month by May–June. Further, after the initial sharp depreciation, the exchange rate stabilized in the range of Rub 24–25 per U.S. dollar from March through mid-July 1999. A relatively tight fiscal policy, aided by efforts to restrain cash expenditures, allowed CBR ruble credit to the federal government to be contained to about 2 percent of GDP in the fourth quarter of 1998 and the first quarter of 1999. (The CBR also provided U.S. dollar credit for the payment of external debt service equal to about 5 percent of GDP over this period). Also, while the CBR was slow to begin withdrawing the licenses of insolvent banks, central bank liquidity support for ailing banks was moderate. Output, after declining sharply immediately after the onset of the crisis, stabilized in late 1998. By March-April 1999, owing to the depreciation of the ruble, there were incipient signs of an economic recovery led by import substitution and exports, as industrial output exceeded its level of the same period of 1998. Also, since mid-March 1999 real incomes and dollar exports have been boosted by the strong rebound in world oil prices.

24. It remained clear, however, that without strong measures to improve federal government revenue collection and advance structural reforms, this period of stability would represent only an interlude between crises. While cash revenues improved significantly in the first quarter of 1999 relative to the immediate post-crisis months, they remained at the pre-crisis level of about 10 percent of GDP, despite the positive impact on revenues of the large depreciation of the ruble. Further, the fiscal adjustment for 1999 outlined in the budget was initially based on a severe compression of real noninterest expenditures, including wages and pensions, which would likely not have been sustainable over the medium term.

25. Meanwhile, the effect of the ruble’s depreciation on the ruble value of the government’s debt service obligations was immediate. The federal government’s total foreign currency-denominated debt service stands at $17.5 billion in 1999, equivalent to about 80 percent of budgeted revenue. The government has initiated negotiations with its external creditors on a rescheduling of its Soviet-era debts, but even a full rescheduling of those obligations would leave foreign currency debt service at over 40 percent of budgeted revenue. The price of the government’s traded debt clearly reflected the perception of significant default risk; by early March, 1999, the interest rate spread on Russia’s Eurobonds had increased to about 6,000 basis points, although it subsequently declined to about 2,500 by end-May. Further, in February 1999 Russia’s sovereign credit ratings were again downgraded by two of the major agencies.

26. Moreover, until April 1999, structural reforms largely stalled, with reversals in some areas. Access to the oil pipeline was used as a lever to force energy companies to supply nonpaying customers. Privatization came to a virtual halt. Slow progress on bank restructuring facilitated asset stripping and capital flight. State initiation of bankruptcy proceedings against tax debtors was suspended. Interbank currency exchanges were first closed, then (from early October 1998) regulated to provide for a segmented exchange market. Also, as from the beginning of 1999 surrender requirements on export receipts were raised from 50 to 75 percent. At the same time, the trade regime became less liberal with, for instance, the introduction of a ban on alcohol imports and restrictions on food exports.

27. From April 1999 onward, however, there were signs that these trends were being reversed and the causes of the August 1998 crisis belatedly being addressed. In order to address the underlying fiscal imbalance, the authorities introduced several new revenue-enhancing tax measures and took action to force oil companies with tax arrears to move toward full compliance with statutory tax obligations. There was also a sharp change in direction in the structural policy area: in June, the authorities unified the interbank currency markets, passed legislation to facilitate bank restructuring and began to withdraw the licenses of major insolvent banks, canceled the state directives to oil companies to supply nonpaying refineries, and rescinded the decision to suspend new bankruptcy proceedings. After the trough of macroeconomic performance and sentiment in late-1998, by mid-1999 there were signs—on the basis of the relative macroeconomic stability in the last several months and the output recovery driven by the depreciation of the ruble—that the crisis was over.

II. Domestic Economy

A. Output and Expenditure

Overview

28. Output fell precipitously in 1992–94 in response to the withdrawal of subsidies and the disruption in traditional economic relations, but the decline then began to taper off, and real GDP registered a small increase in 1997.3 However, the recovery proved short-lived, and GDP was already on a downward trend by the first half of 1998. This contraction was severely aggravated by the economic crisis that erupted in mid-1998 (Table 1, Figure 11). A significant erosion of real income, a loss of trade financing, and a temporary disruption of the payments system contributed to a seasonally-adjusted real output decline of 6 percent in the third quarter of 1998.

Table 1.

Russian Federation: Selected Indicators of Economic Activity, 1991-98

(Annual percentage change)

article image
Source: Goskomstat.
Figure 11.
Figure 11.

Russian Federation: Output and Income, 1995-98

Citation: IMF Staff Country Reports 1999, 100; 10.5089/9781451832976.002.A001

Source: Goskomstat.

29. Recent developments have, however, proved more positive than had initially been expected. Seasonally-adjusted real GDP fell by less than 1 percent in the last quarter of 1998, and preliminary data indicate that it grew by 4 percent in the first quarter of 1999. Seasonally-adjusted industrial output grew by 12 percent over the last quarter of 1998 and the first quarter of 1999 combined, and in April–May it stood 4 percent higher than its level one year earlier. The recovery initially appears to have been led primarily by import substitution in response to the real depreciation of the ruble. However, with recent improvements in the prices of Russia’s key exports, there is now some evidence of a pickup in exports as well.

30. The fact that sustained growth has not materialized until now reflects, in part, the failure to advance reforms following the initial price liberalization, and in particular the failure to secure property rights, generate economic restructuring, and create a stable business environment (see Chapter VI for further details). Widespread corporate governance problems have prevented viable enterprises from improving efficiency and making the needed investments to enhance competitiveness. These problems have also dissuaded entry by new businesses, while the failure to impose hard budget constraints throughout the economy has allowed many non-viable firms to survive (see Annex II, “Nonmonetary Transactions and Arrears Accumulation”). The persistent fiscal imbalances have furthermore limited the channeling of resources for investment to the private sector. The lack of adequate investment has, in turn, resulted in the deterioration of the economic infrastructure, potentially affecting the long-term prospects for the economy as well.

The main components of demand: 1996–98

31. During 1996–97, movements in real output were dominated by domestic demand, which fell by over 7 percent before registering a small turn-around (Table 2). Changes in net exports were relatively less important. In contrast, in 1998 net exports exercised a significant positive influence: while the collapse in domestic demand acted to reduce GDP by almost 8 percent, the increase in net exports (occurring mainly in the last quarter) offset about half of this amount.

Table 2.

Russian Federation: GDP by Expenditure, 1991-98

article image
Source: Goskomstat and Fund staff estimates.

32. The decline in output over the transition period has been accompanied by an even sharper contraction in investment whereas consumption, in particular by households, has seen relatively little decline. The shift of expenditure towards consumption partly reflects a correction of policies in the Soviet planned economy, which heavily encouraged capital accumulation above all else. In this context, the decline in investment can partly be seen as a positive outcome of the transition process that reduced inefficient areas of investment. However, much-needed investment has not been forthcoming, and where it has occurred, it has not been broad-based, having increasingly concentrated in a few areas, including the energy sector.

33. From 1996 until late 1998, the growth in consumption continued to outpace GDP, fueled by rising real wages and income, and the lack of public sector adjustment. In the wake of the crisis, however, this relationship has been reversed. Real consumption growth outstripped GDP growth by at least 2 percentage points 1996–97, and seasonally-adjusted real household consumption grew by a further 1 percent during the first half of 1998. In the second half of 1998, however, the crisis reduced seasonally-adjusted real per capita income by over 14 percent. In response, household consumption was initially financed by a drawdown of personal savings and by nonpayment, but then contracted sharply, by about 21 percent during September 1998–March 1999. As for government consumption, it rose in each of the years 1995–97, and was largely unchanged in 1998 (Table 2).

34. With economic prospects still uncertain and the business climate remaining largely unfavorable, investment in capital goods continued to decrease in 1996 and 1997. After a fall of 19 percent in 1996, the decline moderated in 1997, reflecting a sharp one-time rise in imports of machinery and equipment prompted by the government’s plan to eliminate tax exemptions for imports of investment goods, and by an increase in inventories. In 1998, the investment decline accelerated, as economic prospects deteriorated. For the year as a whole, capital formation fell by 9 percent. Further contributing to the decline in investment, inventories dwindled rapidly as consumption shifted to domestically produced goods following the sharp depreciation of the real exchange rate.

35. Performance of net exports swung dramatically over 1996–98. In 1997, as the terms of trade deteriorated, exports decreased and imports increased by 10 percent each in dollar terms. In 1998, however, despite the continued worsening of the terms of trade, net exports rose by 5 percentage points of GDP, reflecting developments in the second half of the year. While export revenues continued to decline with commodity prices, imports were compressed, owing to the decline in incomes, the depreciation of the ruble, and the short-run impact of the breakdown in the payments system. In the last quarter of 1998, imports were less than half their level one year earlier.

36. The import compression has continued in 1999. In the first quarter, imports remained about half their level one year earlier. The limited available data suggests that this compression has been broad-based, with a particularly large reduction in imports of consumer goods. In contrast, there is only very recent evidence of a pickup in exports; in April 1999, the dollar value of exports was higher than its level one year earlier, the first such rise since 1997. One reason for the delayed response of exports to the devaluation is that the oil and gas sector, which accounts for 40 percent of exports, faces severe extraction and transportation constraints.

Sectoral developments

37. Despite the generally slow progress on structural reforms, the Russian economy has nevertheless undergone a significant transformation since 1991, with a sizable shift in resources from industry and agriculture to the services sector taking place alongside the secular decline in output (Table 3). By 1997, industrial activity accounted for less than 30 percent of GDP, compared with 39 percent in 1991. After a dramatic decline of about 45 percent in 1991–94, the contraction of the industrial sector slowed, as exports to new markets began to mitigate the impact of the earlier drop of demand in traditional markets and of the reduction in government subsidies, and as domestic income gradually recovered. Although industry has experienced an across-the-board decline, the sectors hit most severely have been light industry, construction materials, and machinery building. In contrast, those sectors which have managed to expand exports (such as fuels and metallurgy), and nontradeables (in particular electricity generation), have been able to cushion the decline (Table 4). The agricultural sector has also seen a decline, falling from 14 to 7 percent of GDP during 1991–97. This decline largely reflected the gradual reduction of government financial support to the sector, but was exacerbated by slow progress in land reform and farm restructuring. Over the same period, the services sector has been expanding, increasing its share of output from 36 percent to about 50 percent.

Table 3.

Russian Federation: GDP by Sector, 1991-98

article image
Source: Goskomstat and Fund staff estimates.
Table 4.

Russian Federation: Gross Industrial Output by Sector, 1991-98

article image
Source: Goskomstat.

38. In 1997, domestic demand contributed to a brief recovery in industrial output, but the momentum stalled quickly and the output decline resumed in 1998. As real incomes increased and the real exchange rate stabilized in 1997 (following a sharp appreciation beginning in 1995), demand shifted toward domestic products, eliciting strong growth in the automobile industry. This in turn underlay a 3.5 percent growth in the machine building industry, and stimulated ferrous metallurgy output. Robust activity in the nonferrous metal industry in 1997, owing to a continued expansion of exports, also contributed to overall growth. However, the decline in oil and gas prices and constrained external demand for steel products in late 1997 hit the export sectors hard, and their impact was felt quickly throughout the economy. In 1998, the decline in industrial output was aggravated across the board by the August crisis; industrial output ended the year 5 percent lower than in 1997. However, toward the end of 1998, output began to recover from low levels in September as demand for domestically-produced goods increased in the wake of the depreciation of the ruble.

39. While a bumper grain harvest allowed total agricultural output to increase slightly in 1997, a severe drought led to a 12 percent reduction in output in 1998. The drought affected almost a quarter of the sown area, and stocks accumulated in 1997 were significantly reduced. Livestock production has declined steadily, and is estimated to have fallen by 9 percent in 1998.

40. The services sector’s contribution to economic output has continued to increase. In 1997, activity in market services and trade rose by 4 percent, reflecting the generally buoyant consumer demand, before slowing significantly in 1998 as the economic crisis took its toll. Activity in nonmarket services (including publicly-provided goods such as defense, administration, education, health care, and culture) rose by more than 1 percent in 1997, and is expected to remain largely unchanged in 1998.

B. Labor Market Trends

41. The transition has seen a sizeable reallocation of labor within the economy. The share of total employment in industry was reduced by 7 percent during 1991–97, while the share of employment in commerce-related and non-market services increased. These trends were particularly marked in the period 1995–97.4 Within the industrial sector, a few sectors such as food processing, forestry, and machine building have seen productivity recover to 90 percent of the 1991 level, after falling sharply in the early years of transition (Table 5). Further, labor turnover statistics indicate a relatively active labor market, with an average annual separation rate of above one quarter of total employment during the period 1991–97, and annual rates of new hires of approximately 20 percent of total employment (Table 6).

Table 5.

Russian Federation: Employment and Labor Productivity in Industry by Sector, 1991-98

article image
Source: Goskomstat and Fund staff calculation.

As of November 1998.

Calculated as the ratio of output to employment.

Table 6.

Russian Federation: Labor Force Turnover, 1993-98 1/

article image
Sources: Goskomstat.

Data for large and medium enterprises.

42. Despite the significant reallocation of labor, the pace of labor shedding has in most cases lagged well behind the output decline. Compared with the major losses in output since 1992, formal employment has declined much more slowly, falling by just 12 percent during 1992–97, and by a further 2 percent between end-1997 and April 1999 (Table 7). This pattern is most pronounced in public administration and the social sector; employment has increased by 63 percent for the former and declined by only 3 percent for the latter in 1992–98, reflecting slow progress in public sector reform. There are several reasons why enterprises continue to hoard labor in the face of continued output declines, including legal restrictions on severing labor contracts,5 and potential bargaining advantages vis-à-vis regional and local government loath to see unemployment increase. While formally laying-off workers is considered to be difficult, managers resort to hidden unemployment—putting employees on administrative leave or part-time schedules—and to wage arrears to contain wage costs.6 Some 4–6 percent of workers work shortened workdays, and forced-leave days averaged about 30 days per person in 1997–98 (Table 8). Workers are often willing to tolerate wage arrears and lower wages because of the relative importance of non-wage social benefits provided by firms, an inadequate social safety net, and the limited opportunities for geographic mobility resulting from the high costs of moving and of housing, relative to workers’ cash incomes.

Table 7.

Russian Federation: Employment by Sector, 1991-98 1/

article image
Source: Goskomstat.

Average for the year; does not include students.

Table 8.

Russian Federation: Indicators of Hidden Unemployment, 1993-98 1/

article image
Source: Goskomstat.

In industry, construction, transportation, communication, services, science, and scientific support.

For 1993, 1995-98 data include number of people on shortened workday at the end of each quarter; for 1994 data show those on shortened workdays over the course of the period.

Without pay or with partial pay.

Data for last month of the quarter.

Full-quarter estimate based on data for last month of the quarter.

43. Open unemployment is increasing, while differences in regional unemployment rates remain large. By ILO definitions, the unemployment rate increased from 9.4 percent in 1996 to 13.3 percent at end-1998, and to 14.2 percent at end-April 1999 (Table 9). However, because of the low unemployment benefits and strict eligibility requirements, registered unemployment is much lower, and actually showed a decline from 3.1 percent in 1996 to 2.2 percent in 1998 (Table 9).7 Regional variation in unemployment rates, and more generally in economic activity, is extremely high, reflecting limited labor mobility (see Annex I, “Regional Developments”). For example, in October 1997, unemployment rates of 3–5 percent in the Evenkiyski Autonomous District and in Moscow contrasted with the rate of 58 percent in the Republic of Ingushetia (Table 10). Survey results indicate that unemployment spells have become slightly longer, with the average duration of job search increasing from 8.2 months in 1996 to 9.1 months in 1998 (Table 11). Accordingly, persistent unemployment has become increasingly significant, as the share of long-term unemployed has increased, in particular for those approaching retirement age. This suggests that there is a sizable group of Russians who lack the skills to find employment in an increasingly market-oriented economy.

Table 9.

Russian Federation: Selected Labor Market Indicators, 1992-98

article image
Source: Goskomstat.

Annual percentage change.

Table 10.

Russian Federation: Unemployment Rate by Regions (ILO methodology), 1993-97

(In percent; for 1993-95 and 1997, data are for October; for 1996, data are for March)

article image
article image
Source: Goskomstat.
Table 11.

Russia Federation: Unemployment Composition by Duration of Job Search and Age Group, 1996-98

article image
Source: Goskomstat Statistical Bulletin No.9 (48), 1998.