Russia and the IMF: Meeting the Challenges of an Emerging Market and Transition Economy
April 1, 199898/7 Address by Michel Camdessus
Managing Director of the International Monetary Fund
at the U.S.-Russia Business Council
Washington, D.C. - April 1, 1998
It is a great pleasure to join you here once again. These days, so much discussion of the world economy and the IMF revolves around the crisis in East Asia. But as you know, East Asia is not the only part of the world where the IMF is helping countries open their markets, strengthen their financial systems, and manage their economies more transparently. And so I appreciate this opportunity to discuss another economy in another part of the world, where the stakes for the international community are also very high.
Since Russia joined the Fund in June 1992, the IMF has been at the center of international efforts to help Russia become a stable and prosperous market economy. Certainly, there have been a number of ups and downs in the process, and the transition is by no means complete. But during this time, the Russian economy has passed from the brink of hyperinflation to single-digit inflation; from substantial isolation to substantial integration in global markets; from the demise of central planning to the rise of a dynamic private sector; and from output collapse to a long-awaited renewal of output growth.
But if the Russian economy has evolved in recent years, so have global capital markets. In particular, the crisis in East Asia provides a fresh reminder of just how quickly private capital can flow out of a country when market sentiment changes. It also underscores how important it is for countries that are tapping international markets to develop economic and financial institutions that are strong and transparent enough to retain market confidence--and resilient enough to accommodate tighter policies when the need arises. So Russia still faces a number of long-standing challenges in its transition to a market economy. But it also faces some new ones in its role as an emerging market economy. Let me give you my perspective on where Russia stands in meeting these overlapping tasks, and where we hope to see Russia go in the years ahead.
When I last met with you, two years ago today, our Executive Board had just agreed to support the Russian government's medium-term program of stabilization and reform, with a loan under the IMF's Extended Fund Facility. Since then, the main accomplishment has been the significant further progress toward macroeconomic stability. Inflation has declined--from nearly 50 percent in 1996 to about 15 percent in 1997; the exchange rate has stayed within its predetermined band; and the balance of payments has remained broadly favorable. And last year the Russian economy grew for the first time since the breakup of the former Soviet Union--if only by a modest half of 1 percent of GDP.
How has this progress been achieved? First of all, a large and increasing share of economic activity is being channeled through private markets, which now account for 70 percent of Russia's GDP. For all its imperfections, this dynamic private sector has become the major agent of economic transformation and growth.
At the same time, Russia has been setting up institutions to manage the economy indirectly, instead of through direct commands. In part because of IMF support, Russia now has a professional central bank. During most of 1997, the Central Bank of Russia kept monetary policy appropriately restrained, including in the face of large capital inflows in the first half of the year. And in late 1997 and early 1998, it fought off the contagion from East Asia by allowing interest rates to rise sharply. In response to this decisive action, the exchange market has stabilized, and the three-month Treasury bill rate, which peaked at close to 50 percent in late January, has declined to around 25 percent at present.
But while monetary policy has been very effective, the same cannot be said of fiscal policy or of the institutions needed to underpin an efficient market economy.
Turning first to the fiscal situation, I would say that, even though the federal deficit remained well within the program target on a cash basis, overall fiscal performance still leaves much to be desired. Once again, cash revenues fell short of the level on which the budget law was based, and the government was only partly successful in cutting back on spending in response. So, even though the government succeeded in eliminating arrears to employees and pensioners, large new arrears to suppliers emerged, and the overall problem of arrears remained unresolved. Moreover, the practice of offsetting arrears of taxpayers against the payment arrears of the government continued to undermine the budget system.
The origins of these problems are well known. Part of the problem lies in Russia's outmoded tax system, accounting rules, and administrative procedures, which are only slowly changing. But also at fault are the exceedingly close ties between the government and a number of large enterprises. These cosy relationships allow many firms to benefit from explicit or implicit tax exemptions, to exploit flaws in the tax system to avoid paying taxes and, in some cases, simply to withhold their tax payments. Indeed, the government has had problems demonstrating the political will required to enforce tax obligations, even following the establishment of the Emergency Tax Commission.
The immediate result, of course, is that the government cannot always pay wages and pensions, and provide basic public services. But that is not the only concern. These problems also hold back investment and growth and impede Russia's transition to a stable market economy. Moreover, the continued large fiscal deficit leaves Russia highly vulnerable to swings in market sentiment. Indeed, market perceptions that the government is not dealing forcefully with the fiscal problem could lead to destructive pressures on the exchange rates and interest rates.
What about the rest of Russia's reform agenda? Russia is moving ahead in establishing the institutions needed for a market economy. For example, progress is being made on bank restructuring, with some 200 bank closures and another 300 banking licenses revoked last year. A new bankruptcy law entered into effect on March 1, which, though not perfect, should provide a powerful tool for enforcing tax compliance and hard budget constraints. Meanwhile, the authorities are beginning to give greater attention to protecting shareholder rights. And despite considerable domestic pressure for greater trade protection, a generally open trading system has been maintained.
Nevertheless, much remains to be done to strengthen the banking sector, establish a more favorable business environment, and level the playing field for private sector activity. Indeed, in this regard, one cannot help but observe the similarities between the relationships that existed among chaebols, banks, and government in Korea under the system of "crony capitalism" and the system that is now taking shape in Russia under the elegant name of "oligarchy." And as we have seen in East Asia, when the structure of ownership is not transparent, when regulation is inadequate and unevenly applied, and when market forces are prevented from playing their normal disciplining role, serious imbalances and inefficiencies can build up. And, once exposed, these problems can provoke an abrupt market correction.
A little over a month ago, I traveled to Russia to discuss these problems with President Yeltsin, his economic team, and leaders of the Duma. In particular, I wanted to share our experience in East Asia with them and encourage them to consider its lessons for Russia. One key lesson is that in today's global environment, persistent macroeconomic problems, underlying weaknesses in the banking sector, and a lack of transparency can leave countries vulnerable to changes in market sentiment. A firm monetary stance can go a long way in stabilizing exchange markets. But it is neither feasible nor desirable to rely on monetary policy alone for any extended period of time. Thus, I urged the Russian authorities to reflect on three aspects of Russia's situation: continuing deficiencies of fiscal policy; the weakness of the banking sector; and the pervasiveness of "crony capitalism." And I urged them to consider the obstacles that these factors pose for Russia's transition, as well as, possibly, for its ability to attract and retain stable, long-term capital inflows. The President and his team agreed with this analysis and, on the basis of this common understanding, the technical work on the 1998 program has by and large been completed. With the recent dismissal of the Cabinet, we will be reconfirming these understandings with the new government. This program, which tackles the problems Russia faces on a broad front, is shaping up as follows.
On the fiscal side, the 1998 program will aim for a substantial reduction in the fiscal deficit through a marked improvement in budgetary practices. On the revenue side, this will involve pursuing taxpayers with large arrears and abandoning the practice of offsetting tax arrears against arrears in government payment for goods and services. On the spending side, it will involve cutting lower-priority programs and establishing better control over spending units.
Already there have been some important breakthroughs: the budget will be implemented strictly on a cash basis--with no more payments in commodities and no more offset arrangements. Likewise, the government is developing a strategy for settling remaining expenditure arrears through a combination of cash payments and securitization. Also, the budget allows the government to reduce expenditure in line with any revenue shortfalls.
In addition, the government submitted a revised tax code to the Duma in January, which contains many of the reforms suggested by the IMF, including fewer and more efficient taxes, the introduction of accrual tax accounting, improvements in taxpayer rights, and simpler administrative procedures. Further improvements could be made, and indeed, Fund staff have made a number of suggestions to that end. But the proposed code still represents a vast improvement over existing legislation. Thus, we have urged the government to spare no effort in ensuring its passage in the Duma.
The structural reforms to be included in the program, which were formulated in consultation with both the World Bank and the IMF, focus is on creating an environment conducive to private sector-led investment and growth. Thus, the reforms emphasize improving transparency and accountability in the public utility and transport monopolies and the privatization process; enhancing corporate governance and investor protection; and encouraging competition. Let me give you some examples.
To encourage openness and transparency in the so-called "natural monopolies," quarterly accounts consistent with international accounting standards will be published for Gazprom, UES (the national electricity company), the Railways, and Transneft (the oil transportation monopoly).
In the area of privatization, greater use will be made of independent financial consultants to evaluate the companies to be privatized and carry out final sales in order to ensure a level playing field for all potential bidders. Moreover, the government has indicated that the eight largest enterprises (measured by asset value) will be sold in line with the competitive privatization procedures developed in consultation with the World Bank. Indeed, the government has already announced that independent financial consultants will be involved in the upcoming privatization of the oil company Rosneft.
In the area of trade reform, the program calls for further steps to lower tariffs and streamline the trade system.
And in the area of banking sector reform, discussions have centered on introducing appropriate accounting standards and reporting requirements for commercial banks, and strengthening prudential supervision and regulation.
Indeed, the authorities do understand the need to publish data on economic and financial developments in a more timely and transparent manner. Thus, they have indicated their intention to improve their data practices in line with the guidelines set out under the IMF's Special Data Dissemination Standard. On our side, the IMF staff is reinforcing its efforts to collect and analyze data on financial and banking sector developments.
So what does all of this suggest for the future?
Clearly, the recent experience shows that unless the underlying weaknesses in Russia's financial and economic situation are addressed, Russia will remain exposed to shifts in market conditions and sentiment. Addressing these weaknesses in a convincing manner is the challenge that will face the new government when it takes office. In this regard, I could envisage two different scenarios:
- in the positive scenario, all policy steps planned under the EFF-supported program are
implemented in full. This would lay the basis for a steady improvement and resolution of the
problems noted above. In this case, economic growth would gain strength without financial
disruption caused by loss of investor confidence. This scenario is predicated on firm
commitment, and implementation on the government side, which has not always been there
- under an alternative scenario, the pace of reform falls short of the program plans, giving rise to financial market disturbances and allowing continued "crony capitalism" that in turn prevent an economic recovery. I cannot emphasize strongly enough that the Russia cannot afford to take this route. As a friend of Russia, the IMF will urge the new government to implement the program in full, as this is a sine qua non for the renewed economic growth needed to secure a stable and prosperous Russia.