Russia Rebounds by David Owen and David O. Robinson

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Transcript of an Economic Forum
Russia Rebounds

Thursday, December 11, 2003
Washington, D.C.

(View a webcast of this Economic Forum using Windows Media Player.)

Participants:

John Odling-Smee (Moderator)
Former Director, European II Department
IMF

Anders Åslund
Senior Associate
Carnegie Endowment

Aleksei V. Mozhin
Executive Director for the Russian Federation
IMF

David Owen
Assistant Director, North Eastern Division
European Department
IMF

MR. STARRELS: Welcome to the International Monetary Fund, for those who do not work here; welcome to staff who do. This is yet another Economic Forum that the IMF is putting on. Today's event will be "Russia Rebounds."

Before I turn the chair over to Mr. Odling-Smee, a couple of very brief announcements.

First of all, there is an abundant body of literature available to you on the outside as you're coming into the auditorium. Please avail yourself of it if interested.

And, secondly, during the discussion period, please make use of the microphone. We're going to be recording these events, so we need to have them on.

Okay. On that note, Mr. Odling-Smee, the floor is yours.

MR. ODLING-SMEE: Thank you, John. Good morning, ladies and gentlemen.

The theme of this is "Russia Rebounds," the idea being that the economy has done rather well in recent years, and that is a question of interest in itself. But perhaps of even more interest is where is it going to go, and I hope that this morning we will discuss both of those.

The three panelists will introduce their own thoughts on this topic, and then we'll have a general discussion. I've asked the panelists to keep to 15 minutes so we will have--we should have 40 minutes or so of general discussion.

I should explain that we are unfortunately unable to have with us today Pekka Sutela, who had originally been planning to come, and actually tried to come yesterday, but he missed his connection in London and couldn't get a plane out of London early enough to get here by this morning. And he sends his apologies.

I'm very pleased, however, to say that Aleksei Mozhin has very kindly agreed to join the panel so that we can have three people, and he actually asked me to point out that it was only yesterday we spoke to him, and so he hasn't had the same time as the other two panelists had to collect his thoughts. But he, as Executive Director for the Russian Federation in the IMF, is well-known in Washington and, of course, an expert on the Russian economy.

The other two speakers are, first, David Owen from the IMF Staff, Assistant Director and Chief of the Northeastern Division in the European Department, and that division includes Russia and also Belarus and Norway, and he has been working on Russia for some time. He is one of the joint editors of the book, "Russia Rebounds," the same title as the title of this session, and this book covers very much this recent period of good performance in Russia. And those of you who haven't bought it, I encourage you to buy it. And those of you who have bought it and not read it, I encourage you to read it also.

Then after David, Anders Aslund will speak. He is the Director of the Russian and Eurasian Program at the Carnegie Endowment, and he is a very well-known expert on Russia and on the whole CIS region. He recently, a year or two ago, wrote, published a book, "Building Capitalism," which is the most comprehensive and thorough study of the 1990s in the region. He was, in the early 1990s, an adviser to the Russian Government and continues to advise governments in the region. We're very pleased to have Anders with us.

So those are our speakers, and now let's start, and I'll ask David to begin.

[View David Owen's presentation (72 kb PDF file)]

MR. OWEN: Thank you very much, John.

As John said, Russia's rebound since the 1998 crisis has been much stronger than most observers expected, and the book that John referred to, "Russia Rebounds," examines this period in particular and looks at the main factors behind the success and the implications for the future, particularly regarding the sustainability of the current high rate of economic growth.

Now, I'm going to focus on the broad conclusions that we reach in that book, particularly the conclusions that are summarized in the opening chapter of the book. But just before I do that, let me begin by briefly illustrating the scale of the rebound in the economy over the last five years.

First of all, let's look at GDP growth, as shown in this chart. This was almost entirely negative in the period up to 1998. But following the crisis, activity recovered very rapidly. Growth has been strong in every year since the crisis. It's averaged about 6 percent a year. That's just below, incidentally, the rate of growth, 7.25 percent a year, that's required to double real GDP over a decade, which, as many of you know, President Putin has set as a target.

Next, the balance of payments. The turnaround here I think is best illustrated by what's happened to the international reserves. They fell to around $12 billion at the time of the crisis. They've risen steadily ever since. They reached--I heard this morning, there was an announcement that they had risen $2.5 billion just over the last week and reached over $70 billion. That's, of course, partly a reflection of high oil prices, but is also a reflection of a marked reduction in capital flight.

Improved external and fiscal balances positions are also, I think, illustrated by the dramatic reduction in external debt. External public debt, which is shown here, has fallen from nearly 80 percent of GDP just after the crisis to under 30 percent now. And I think it's fair to say that nobody really is concerned about Russia's ability to service its debts anymore.

And, finally, the rebound has been dramatic also in the financial markets. The stock market index, shown here in red, is substantially higher than it was before the crisis, even after some recent fallback associated with the Yukos affair. And the bond spreads have narrowed enormously. They're shown in blue here. And, of course, Moody's recently upgraded Russia to investment grade.

So why was the rebound so much stronger than anybody expected? And I'm going to begin with what we might call some temporary factors, the role of some temporary factors.

First, the gain in competitiveness that occurred was associated with the post-crisis real depreciation of the ruble. That was both larger and more sustained than experienced by many other countries that had crises at around that time. And this very large depreciation, which is shown here, stimulated import substitution on a massive scale, and that itself, I think, was facilitated by the cumulative impact of structural reforms that happened during the 1990s. But, clearly, the boost to net trade from the real depreciation is coming to an end. Macroeconomic policies have ultimately been unable to prevent a substantial reversal of the real depreciation. This chart shows that the real trade-weighted ruble exchange rate now is only about 12 percent below the level it was before the crisis.

The second sort of temporary factor I'll point to is oil prices. They started to rise very strongly from the third quarter of 1999. Now, while economic recovery had begun before that, triggered by the real depreciation, the huge gain in the terms of trade associated with the oil price rise--and we estimate it was worth perhaps 10 percent of GDP between 1999 and 2000--that was clearly an enormous help to the economy.

But few observers, I think, expect current oil prices to be sustained indefinitely, so at some point--that's why I call this effect temporary--the economy is going to have to adjust to oil prices at more normal levels.

Turning now to the role of macroeconomic policies, clearly these also had an enormous impact. There was a huge improvement in macroeconomic policymaking. Recently, however, we have seen some slippages in macroeconomic policy, and they're, arguably, less supportive of growth, medium-term growth, than they were previously.

But let's look first at fiscal policy, where I think the change has been most dramatic. In the years before 1998, the general government fiscal balance was a deficit averaging around 8 percent of GDP. By 2000, in just two years, that had been turned around to a surplus of 3 percent of GDP. This partly, of course, reflected the rebound in oil prices, but it was not just that. More than half of it was accounted for by reductions in expenditures relative to GDP that were achieved largely by holding public wages and benefits below the rate of actual inflation.

Now, given the mechanism that was used to reduce spending, it's not surprising that there was going to be some rebound, some reversal, and that has occurred, especially since 2001. It's only a partial reversal, but, nonetheless, the result is that there has been some slippage in fiscal policy since 2001, although continued high oil prices ensure that the budget is still running a small surplus. The fiscal stance has been loosened by perhaps 3 percent of GDP in underlying terms over the last two years, and if oil prices were at more normal levels, then the budget would now be running a significant deficit.

Fiscal surpluses have helped to sterilize the central bank's foreign exchange purchases, and they've allowed a strong increase in international reserves, which we saw earlier, to be accompanied by declining inflation, and, as we also saw, a relatively slow rise in the real exchange rate. But, in general, the central bank has given a higher priority to restraining ruble appreciation than to its inflation objective. The result has been that even relatively unambitious inflation targets--the inflation targets are shown here by these ranges, and there's really been little reduction in the targets over the last two to three years--even those targets have been missed, admittedly by fairly small amounts.

This year, I think a more worrying development is that core inflation, inflation after excluding administrative prices and seasonal factors, core inflation has been edging up for most of the year. This has been achieved by holding back on administrative price increases, and that's regrettable, I think, because many of these prices for electricity, for gas, communal services, are very much below the level they need to be to cover costs.

So what are the implications of these recent developments in macroeconomic policy? First of all, whereas fiscal policy after the crisis created more room for private spending and supported monetary policy, the recent slippages risk undoing some of those benefits.

In addition, the fact that there's now an underlying fiscal deficit implies that there's less room for maneuver in the event that the oil price falls. And, in fact, a sharp fall in the oil price now would require quite a significant fiscal tightening, something which, in the short term, could add to the dampening effect on the economy that would be there, anyway, from the effect of lower oil prices.

And, thirdly, continuing with relatively high inflation, core inflation still above 10 percent, is going to hamper medium-term development of the non-oil economy. It's going to hurt the poor especially, and it's going to raise the eventual costs in terms of lost output of getting inflation down to the level of Russia's competitors.

So that's macroeconomic policy, and the third factor I'll talk about is the role of structural reforms. There, the contribution to growth is difficult to assess. The effects of structural reforms tend to accumulate over time. They're subject to quite uncertain lags. There was certainly a marked acceleration in the reform effort, particularly in the second half of 2000 and 2001, and some of the measures undertaken during this period since the crisis, particularly, I would say, the tax reforms and measures to harden budget constraints and reduce barter in the economy, those have clearly improved the business climate and helped to stimulate investment and consumption.

Before that, the extensive privatization of the economy in the 1990s certainly facilitated the response of the economy to the real depreciation after the crisis. But in the case of many other reforms, recent reforms particularly, it's really too soon to be expecting much of an impact, in particular because some of these reforms have very long implementation schedules stretching out into the future.

So I would say while many important reforms are underway, in our view the structural transformation has not yet reached the point at which it could on its own support strong and sustained growth. Broader-based reforms are needed to allow the emergence of the dynamic small and medium-sized enterprise sector and to reduce the dependence of the economy on just a few very large conglomerates, enterprises in the natural resource sector, primarily.

And I think it's, therefore, a cause for concern that the reforms have clearly slowed down in the last two years, 2002, 2003, partly perhaps because of the elections but also because some of the reforms that still need to be done are meeting very substantial opposition from vested interests.

I'll mention three important areas. First of all, while the banking sector is undoubtedly in much better shape than it was in 1998, there's still a long way to go before it can effectively intermediate between savers and investors and support the development of a more diversified economy.

Similarly, the reforms of the natural monopolies, especially in the power sector, have been continuously delayed, and the implementation is going to be very drawn out. I think only when subsidies associated with low prices in these sectors are phased out will the old inefficient enterprises that depend on these subsidies be forced to restructure, and that would create room for more dynamic enterprises to develop.

Perhaps most importantly, reforms of the civil and public services have hardly begun. These, I think, are needed to reduce the still intrusive role of the government in the economy and, in particular, to try to reduce corruption, without which other reforms that are underway, such as the deregulation reforms, partly designed to make it easier for new enterprises to start up, those reforms will not be fully effective.

So, finally, I'll move on to looking briefly at the future and what conclusions we draw from this. We've not attempted to quantify the effect of these various factors that I've discussed, but I think we have a very strong impression that the temporary factors, the real depreciation and the high oil prices, have been quite important. And as the benefits of these factors are dissipating, then it's going to be particularly important that macroeconomic and structural policies are even more supportive of growth if high rates of growth are going to be sustained. And I think there are three key challenges in the policy area that we would identify.

First, will monetary policy evolve in such a way--and I would say, incidentally, that these are in ascending order of importance. So, first, will monetary policy evolve in a way that can give top priority to achieving low and stable core inflation? And to do this, I think it will have to stop focusing so much on the maintenance of competitiveness. That's a role that's better suited to some extent to fiscal policy, and especially to structural policies.

Secondly, will fiscal policy be tightened to create more room for private expenditure and to provide a larger cushion when oil prices fall? I think the introduction of an oil stabilization fund next year is a very positive development, but this may not be enough to avert the need for a substantial fiscal tightening, and in our view, it would be important that that tightening takes place as soon as possible and doesn't wait for the oil price to fall, because at that point the environment, the conditions for fiscal tightening, will be much less favorable.

And, finally, and most importantly, will structural reforms be speeded up after the elections, as President Putin has indicated? We're not arguing that growth would slump without an acceleration of reforms, but I think to meet the sort of target that President Putin has set of doubling GDP over a decade, then deeper reforms are clearly going to be necessary to diversify the economy and allow small and medium-sized enterprises to develop.

Until we have the answers to those questions, and especially the last one, we're likely to remain somewhat cautious about whether there have been sufficiently fundamental changes in policymaking to ensure that the strong growth that we've seen recently can be sustained.

Thank you.

MR. ODLING-SMEE: Thank you very much, David. I think it is an achievement to talk about what is going to come in the future with virtually no reference to the Yukos affair and the elections, both of which I think are going to have an influence on future developments. But maybe the next two speakers will have something to say on one or both of those issues.

I call now on Anders Aslund to take the floor.

MR. ASLUND: Thank you very much, John. It's a pleasure to be here, and congratulations upon this book, "Russia Rebounds." I think it's both important to emphasize how much positive has happened in the economy, and I think it's important that the IMF comes out with this.

I would like to deal with three issues in my presentation here, and the first is looking back upon the crisis of '98; the second, to discuss briefly the Putin reforms; and, thirdly, to query where we're standing now and what are we seeing happening to Russian economic policy today.

Going back to the Russian crash of August '98, of course, the perspective today is totally different than then. At the time it looked as the end of the market economic experiment in Russia. Today it looks as the confirmation of a proper market economy in Russia. The perspective is totally the opposite, and we then need to go back and see what was right and what was wrong.

What was wrong was very much the period '94 to '98 in Russia, which was a time of minimal reform, just keep floating. The substantial reforms were undertaken '92-'93, a bit overflow of privatization continuing in '94 and '95. But the fundamental problem, which is well emphasized in this book, was the fiscal policy. The crash of '98 was really a question of a long time of an excessive fiscal deficit that tended to be about 8 percent of GDP. And if you continue with that and finance it with government debt, you come to a point where the government debt becomes excessive, and then interest rates go up.

So the problem here was twofold what happened in the fall of '97. On the one hand, there was a disastrous budget agreement in October '97, increasing the budget deficit, contrary to prior policy between Prime Minister Chernomyrdin and the communists in the Duma. A few other parties were involved, but these were the key actors. And because of this agreement in October '97, it was very difficult to do something about the fiscal deficit when it became critical.

And the other thing that was happening was that Russia in '97 got a portfolio investment of $46 billion. So that was 10 percent of GDP at the time. Russia was afloat in money. And if you're afloat in money, your currency goes up. So the exchange rate policy which has been made to be such a crucial issue, it would have gone up if it had been totally flexible under these conditions, and the banks would have come crashing when the exchange rate would have gone down. In any case, I don't think that this was critically an exchange rate crisis which particularly Andrei Larionov now is preaching as the main thing. I think that this book has a much sounder take on it while it avoids to go into polemics with Andrei Larionov, as I think it should.

So then we come to the summer of '98. Of course, the Russian Government was too late to act, but this was very much because of this budget agreement of October '97. And, of course, Prime Minister Chernomyrdin didn't do anything, so he had to be sacked in April '98, to my mind a very sensible decision given that he was the main culprit. The problem was that it took time to get a new government confirmed, to get it appointed, and people didn't realize how short time was. So they did too little.

Coming into July '98, I think that we saw exactly what everybody wanted to see: a full-fledged agreement with the Russian Government under Sergei Kirienko, the IMF, and the World Bank. These were the three parties that should be there, and it contained substantial fiscal measures, essentially moving revenues from the regional level, which was starved for money. And it also contained considerable assistance from the IMF, the World Bank, and Japan, admittedly as a loan, a package of $22 billion, of which $4.6 billion was paid out by the IMF, and I think this was good. It was a substantial down payment showing that the international community was serious about helping Russia to get onto the right track.

What happened immediately after that was--this is the 18th, 19th of July '98--was that the Duma miserably failed to adopt all fiscal measures that would move revenues from the regions to the federal government because of an alliance between three groups: regional governors, oligarchs, and communists. And these are the three groups to be blamed for what happened in the summer of '98.

In August '98, we saw a crash, and I think that the essential element here is that policies were not sustainable. It's not important exactly what the Russian Government did. It was left in a hopeless situation after the Duma situation, decisions in mid-July. And the West did exactly what should be done. It let Russia fall like a hot brick, not providing any more money, because these policies could not be defended. They were unsustainable.

This is how I think that conditional assistance of the Bretton Woods institutions should work. And as a result of this, we are now seeing that the Kirienko-IMF-World Bank program has turned out to be holy. Everybody has complied with it afterwards. You can say that the program is essentially a new addition of that program.

So the lesson was that the oligarchs, the communists, and the regional governors were to blame, and the Kirienko government policy has worked. And while people don't quite say it, there is a sort of implicit understanding of it.

My second point, David here talked about the post-'98 rebound, and I would just emphasize here it was not only devaluation in oil prices. We have seen a broad front of a comprehensive reform program with fiscal policy coming out even before this was adopted, balanced budgets. We are now seeing that big fiscal deficits provide no stimulation. The problem is not only fiscal stability. The additional state expenditures were typically provided to companies that did not use it very well. These were subsidies, and we have a World Bank paper assessing that total implicit and explicit enterprise subsidies in '98 were 16 percent of GDP. The important thing here was to cut useless government expenditures, then you get a more competitive market economy, and that is what has happened.

Another part--and indeed with this virtual economy, the barter and non-monetary payments that (?) here so well elaborated upon in '98 disappeared.

We also saw a splendid tax reform with a particular flat income tax of 30 percent. The income tax revenues have increased from 2 percent of GDP to 3 percent of GDP, with the abolition of loopholes and with stronger incentives to pay taxes. People prefer to be honest if they are given a fair chance to be honest.

We have also seen substantial deregulation on a broad front. The problem is that these are by and large half-measures. A typical statement is that only one unplanned inspection should be undertaken a year of an enterprise, and then you ask why are there planned inspections, and why are there inspections at all? You shouldn't have inspections of this kind.

There's also been a substantial judicial reform. We don't know how it works as yet, but at least it has been legislated. We are seeing big reforms of natural monopolies underway in the electricity and railway sector in particular. What has not happened is small enterprise promotion, and I think here there's one clear lesson that the IMF should be pushing, and that is lump-sum taxes work. They worked in Ukraine. They worked in Poland and East Germany under communists. They will work in Russia also, and this is really a matter of the Bretton Woods institutions, both the World Bank and the IMF, effective low taxes for individual entrepreneurs, then you get millions of small enterprises. Otherwise you don't.

And then turning to the situation today, and the short of it is it looks bad. The last half-year has essentially seen only bad news. In these elections, we saw nationalism, egalitarianism, and the oligarchic feelings rising. And I would emphasize five different challenges or dilemmas today.

The first is that central control is rising, and it's replacing checks and balances. There's no reason to believe that that will work better.

The second point is that media are now increasingly controlled, and what is being abandoned is transparency and openness. If you pursue such policies, you promote corruption.

Thirdly, we seem to see an attempt at state control over the energy sector, and this has been a massive failure everywhere. The OPEC countries have shown us for the last 30, 35 years how badly state oil companies can work, in particular state monopoly companies. There's no reason to promote that. Russia seemed to be on the track of the U.S., Canada, and the U.K. in its energy policy, with private competitive energy companies. These three countries have shown how well a private energy sector can work. And I think that this is one of the biggest queries today, if Russia shall abandon the successful model.

And then, of course, I come over to the fourth point, closely connected with this, the arrest of Mikhail Khodorkovsky. He is very much the symbol of the successful private competitive energy model. And if you arrest the top businessman for obvious political reasons and do so with the apparent purpose to ground his assets, it doesn't provide a good view of rule of law or of reformist endeavors if the most open and transparent company is being maltreated and possibly even slaughtered.

And more profoundly what we are seeing now seems to be that the law enforcement agencies are allowed to run wild, or I should specify the secret police agencies, primarily the FSB, but also other inheritors of the KGB. These agencies are now in opinion polls and enterprise surveys pointed out as the most corrupt agencies. And if you allow the most corrupt agencies to become more corrupt, possibly get concentration of corruption to these agencies, but hardly any improvement.

And then a fifth problem with new political setup is that virtually all the good economic legislators have been ousted from parliament. Checking a list for 20 good economic legislators, I could only see two who had been elected to parliament this time around. You need good legislators to get good economic legislation. A parliament doesn't work well if it's just a transmission belt. In the last few years, the parliament has turned around a lot of government proposals and made them much more reformist. For example, the flat income tax was introduced by parliament rather than by the Ministry of Finance, and there might be some relief in competent economic legislators now being appointed to government positions. But this does not look good. These are quite serious challenges.

Of course, if you have had 6.5 percent growth on average for five years, you need to make rather many mistakes in order to break that growth. But the new policies that we have seen here do not look good. I think that this will be a major concern for President Putin to contain these developments in the near future.

Thank you.

MR. ODLING-SMEE: Thank you very much, Anders.

Now I call on Aleksei Mozhin.

MR. MOZHIN: Thank you very much, John.

First of all, like Anders, I wish to congratulate John and David and other authors of this book, "Russia Rebounds." There is a very strong analytical content in the book, but I believe that first and foremost this is a very effectual historical account of what really happened in Russia over the last ten years of transition. And I would definitely strongly recommend anybody to have a look and read this very good book.

Now, I think that after we heard from David a very good presentation of what really happened in Russia and the most recent trends in the developments in the Russian economy, it is perhaps a good moment to try to look into the future and to address the issue which was raised as "What next?"

I will only address the outcome of the recent parliamentary election in Russia because this is, I think, the most interesting topic, widely commented in the press and elsewhere.

Let me first say that these elections took place against the background of five years of very strong economic growth, and as one would expect in such circumstances, the feel-good factor should have played a role, and I believe it did play a role. And this was reflected in a very strong showing by the pro-government party, which is called United Russia Party. And they, of course, are seen as the main victors in the elections. They were able to obtain almost 50 percent of the seats, and they may get more if they are able to attract some of the independent deputies.

The main sensation of the elections, of course, was the failure of the two liberal parties to pass the 5-percent threshold and their elimination from the new Duma, and also the very weak showing of the Communist Party, whose support fell almost by half, from 24 percent in 1999 to about 13 percent in these new elections, and at the same time, some perhaps fairly significant increase in the support to various nationalist groups.

I think this is something which has to be explained, at least attempted to be explained. I think the best way to describe the elections is to see them as a backlash against the oligarchs. The electoral campaign was fairly messy, but the main topic of this campaign was indeed the topic of the role of the oligarchs in the Russian economy and in Russian politics.

In fact, one can talk about various tactical mistakes made by both liberals and communists. For example, on the liberal side, many observers point to the failure of the two liberal parties to unite, to get united, although I think it was fairly unlikely and difficult for them to unit because the two liberal groups represent very different segments of the electorate. One of the groups, which is called the Union of Right Wing Forces or Right Forces, these are the people who are very strongly associated with the government policies over the last decade. Their main base of political support are those who gained over the last ten years from economic reforms in Russia. And they have always been seen as representing the interests of business, the business community, and, in particular, the big business community. And, of course, Mr. Chubais is widely seen as the father of all oligarchs in Russia.

The other group, the other liberty party, which is called Yabloko, "Apple," headed by Mr. Yavlinsky, they represent a very different liberal trend, and their main basis of support is those among the electorate who lost from economic reforms. These are mainly so-called intelligentsia who lost from economic reforms and who are very critical towards the economic policies of the Russian Government over the last ten years. So, you know, one cannot see how these two absolutely different political sort of trends could easily be united in one.

But the main way these liberal groups and, paradoxically enough, even the communists were attacked was on the basis of anti-oligarchic sentiment. The competitors of especially the new group, the nationalist, socialist group called the Motherland, they attacked the liberals--both liberals and the communists on anti-oligarchic platform. And the fact that the electoral list of the communists, for example, as well as the electoral list of the Yabloko Party included a significant number of millionaires was the very crucial element in the debate during the political campaign. So it is very sort of clear that both the communists and liberals from Yabloko were very strongly discredited in the eyes of their own electorate by the fact of their decision to include money interests into their electoral lists.

Now, whatever the reasons, but what we have now, what we seem to have now is a very strong pro-government majority in the Duma. It is, you know--based on numbers, one can say that President Putin has firm majority, the United Russia Party has firm majority in the Duma on its own, and together with some potential allies, they can even get two-thirds majority which is needed to make constitutional amendments. So this is a very strong pro-government majority, which should be helpful from the point of view of promoting structural reforms that were mentioned by previous speakers. What we had in the past, of course, was, first of all, in the early years of the Yeltsin administration -- [tape ends].

-- did not have substantial, sufficient support in the Duma, and that's what happened in 1998 when the Duma failed to approve any of the fiscal legislation which was needed to address the fiscal crisis. And at the same time, I believe that the role of the vested interests in the Duma will be significantly reduced because this was another part of the previous Duma when various vested interests, including the oligarchic interests, were very strongly represented and effectively able to block many pieces of reformist legislation which they did not support. So from that point of view, I believe that the new composition of the Duma provides an excellent opportunity for very strong and rapid progress in many structural reforms, which are still pending. So this is the hope, and, of course, it is difficult to say what is going to happen in practice.

The main political conflict in the immediate future and maybe perhaps even for the medium term, I believe, will continue to be the conflict between the oligarchs and the society. I think the most fundamental problem, which is both economic and political, Russia is facing now is the fact that the majority of Russians, perhaps the great majority of Russians, do not recognize the oligarchs as legitimate owners. And that's a huge problem because in a situation when the largest owners in the country are not seen as legitimate owners whose ownership rights are being questioned, for good or bad reason, but they're being questioned by the great majority in the society, the very concept of ownership rights, protection of ownership rights, becomes sort of elusive, and this situation will continue to--and I don't know what is the way to resolve this. I'm not certainly--I'm not prepared to make any proposals in this respect. But what is very regrettable, I believe, is that that's a conflict which will continue to haunt us in the future.

I am being told that I have only five more minutes, but, in fact, I have already finished, John.

[Laughter.]

MR. ODLING-SMEE: Very good. Thank you very much, Aleksei.

Well, now, let's have an open discussion. Comments are welcome, also questions. Let me remind you this is on the record, and this occasion is being web cast as well.

Could you I ask you to identify yourselves before you make your remarks? You can address your questions to individuals or more generally to everybody if you so wish.

MR. STARRELS: Also, may I ask you to use your microphones, please? You are being recorded.

MR. ODLING-SMEE: And please be brief so as to allow as many people as possible to comment or question. Then here?

QUESTION: What I would like to understand and know, perhaps, is who is driving the American media in a recent criticism of how Putin is trying to deal with the problem of oligarchs in Russia. After all, during the Yeltsin administration, not exactly immune to corruption, favoritism, and drunkenness, a small group of ethnics infiltrated the Kremlin, and under less than legal and equitable conditions, corralled under its control or their control the bulk of the Russian people's patrimony. Imagine a situation where a small group of ethnics in the United States in the 1990s had managed to get control of Exxon, Chevron, General Motors, Alcoa, Neumont (?) and others, what outcry would have been here in our media concerning that situation.

The difference, though, could have been that the Mafia in the United States would have been Sicilian. The Mafia in Russia was almost entirely Jewish.

One has to understand how the Jewish cohesion, the Jewish people cohesion in a country that is not their own operates in a way that is very difficult to understand, usually not understood. I have personally witnessed how it operates here in the United States in the last 50 years. The problem is that the Russians have had-

MR. ODLING-SMEE: Could you finish, please?

SAME QUESTIONER:...I'll finish. The problem is that the Russian privatization process has been flawed, and somehow somewhere people are clamoring for redress. Thank you.

MR. ODLING-SMEE: Thank you. I'll take other questions before asking the panelists to reply. There was a question here and then there.

QUESTION: I wanted to ask the panelists to make projections, which is the hardest. Mr. Owen made a projection in the form of the questions, three questions, so how do you answer those questions? What will Russia look like, say, in five years, in your opinion? And maybe the same thing for the other panelists. And Mr. Mozhin also posed a question, a core question of this relationship between the oligarchs and the public. How do you feel it will be resolved?

MR. ODLING-SMEE: Thank you.

QUESTION: I have a question for David Owen about the banking sector. In your book about Russia rebounds, you talk about the banking sector in Russia, mainly focusing on private banks, some--most (?) private banks without referring to foreign banks. As we know, the success of Hungary banking system is due to the success of the introduction of foreign banks. So what's the rationale for less foreign banks in Russia, I mean, strategic investor, something like that? It's a kind of worry about the potential threat of stability for national security of finance or some other similar reason for less foreign banks in Russia. That's my question. Thank you.

MR. ODLING-SMEE: Thank you.

Any other questions at this stage? Yes, please?

QUESTION: I would be interested in the panelists' view on the prospects for Russia joining the World Trade Organization in the foreseeable future. One of the issues overhanging this particular enterprise is the low level of energy prices in Russia to which particularly the European countries object. On the other hand, in Russia it seems to be an article of faith given, as it is understood, the abundance of energy resources in Russia.

So I would be keen on your point of view how this may play out if, say, the World Trade Organization would be more amenable or if we would see some movement on energy prices in Russia.

Thank you.

MR. ODLING-SMEE: Thank you. I'll ask the panelists to respond to the first four questions now. Anders, would you like to go first?

MR. ASLUND: Okay. I can start with this question about the American media reaction to the oligarchs. It is very striking how the American media have really very sharply turned around, but I think that there are mainly quite natural reasons for this. One, it's so obvious that the security services are on top now, and the media normally supports the underdog. You can say that the first three years of President Putin's role, it was a balancing of the oligarchs against the security services.

From July this year, it seems as if President Putin is firmly standing on the KGB side, and then, of course, the American media are taking the opposite side.

Another element of this is that the oligarchs talked to the media. The security services don't talk to the media. The Kremlin has become pretty impenetrable today. Previously, it was more open than ever, you can say more open than hardly any government in terms of media access. Of course, journalists react to that.

Moreover, you have now quite a few of the old Soviet KGB manners that haven't really been seen since '89 coming back, and you often hear now the statement -- [Russian] - this is not a telephone conversation. And I've only heard this this year coming back, and it's quite standard now, while it disappeared in '89 when glasnost really broke through.

Drawing on American history, I think that's the good parallel, you had the robber barons. How did they make their money? Nine of 22 robber barons made their money on railways and several of the other servicing the railways with their industries. And to make money on railways was to get land for free from the government, and this was quite similar to the (?) for share privatizations. So I think from an American perspective, one should realize it's important to have private ownership. It's important that it's competitive. It's not so important how it started. We can do the same with those European countries, but in the U.S. it's quite recent, and one should be aware of it and appreciate it.

The problem here is what Aleksei Mozhin said, that these property rights are not now respected. As a result of this, the oligarchs try in each election to reinsure their property rights by substantial campaign contributions. And the biggest oligarchic contributions in this election of course, went to United Russia. Communist leader Zyuganov claims that this was about $400 million. I would guess that he had a good understanding of the real amount. Most of this comes from about the 20, 30 biggest businessmen. It's a very small group. And indeed it seems that Khodorkovsky gave most of his money to United Russia. He got a rather small return on it, it turns out--

[Laughter.]

MR. ASLUND: --in terms of insurance. But this is the nature of the problem.

My view is give an amnesty by any means to the property rights, however it's possible, because then you can stop this massive overflow. So Russian elections cost far more than American elections, although the American GDP in dollar terms is 25 times bigger.

On the WTO, the question here, I think indeed you pointed out that the main question is the gas prices. Electricity I don't think is so central, and oil is not much of an issue. The wholesale price of gas domestically in Russia today with our taxes is on average $27. The average export price to the West--on the western border of Russia is $129 for one thousand cubic meters. So this is the issue.

And Russia is increasing the prices by about 20 percent in ruble terms each year, and it should be within a few years at $40, $45, and I think that's the level where it should be.

Gas and electricity do not have world markets. The prices are local. Price discrimination is typical because it depends on the transportation system. I think that the European Union has a very poor case to argue for any kind of equal prices, in particular as the European Union has an almost fully regulated gas market still. Most of the liberalization of the gas market is ahead, and the European Union has excessively priced gas because of domestic monopolization.

I think that this will be resolved, and it appears to me that President Putin is likely to continue to emphasize early accession of Russia to the WTO. And since the current political tendencies cause a lot of troubles on other fronts, I think that there will be rather more Russian emphasis on getting into the WTO earlier.

MR. ODLING-SMEE: Thank you, Anders.

David, would you like to go next?

MR. OWEN: Thank you. I'll just deal with the question about what Russia might look like in five years' time and the one on foreign banks.

I think that, regarding the predictions, the prospect of achieving growth rates sufficient to double GDP in ten years is possible. It's not unrealistic. It does, though, as I implied in my presentation, require a continuation of strong macroeconomic policies and an intensification of structural reforms in many areas.

In the macroeconomic area, I mentioned two things, two challenges: one, to focus more on bringing inflation down to the level of competitors. I'd be fairly optimistic that this will happen, maybe not quite as quickly as we would like, but I think that there is a determination to bring it down over the next few years.

On fiscal policy, I think the track record over the last five years has been very good on balance, despite the slippage in the last couple of years. So I would not be too concerned about a major reversal there, although whether policy will be tightened in advance of, say, a fall in the oil price, that is not so clear. It is clearly very difficult to tighten up when revenues are abundant.

I think the biggest question mark, though, is about the pace of structural reforms, and there I would just agree with what Aleksei Mozhin said, that the outcome of election, shouldn't be regarded in too negative a way in that regard. I think that clearly if President Putin wants to accelerate the reform program and push ahead rapidly, he has clearly a very stable and supportive political environment to do that. And we would certainly hope that he would.

On the question of the foreign banks, we would certainly agree that it's very important for foreign banks to develop more than they have so far. They would provide very important competition to drive the rest of the banking sector to strengthen. And I think that to the extent that there is resistance to it, it comes from major large state banks that currently dominate the system and clearly are looking to protect their position as long as possible. But I think that two pieces of legislation that are close to being finalized provide some hope that this situation will change, particularly the law recently passed by parliament to liberalize capital account transactions. One aspect of that is that enterprises--residents generally--will be able to open bank accounts in foreign banks outside the country as well as inside. And that I think will provide tremendous competition over time to drive the rest of the sector to become more efficient.

MR. ODLING-SMEE: Thank you, David.

Aleksei?

MR. MOZHIN: Let me take up two questions. One is how to resolve the conflict between the oligarchs and the Russian society, if I only knew; and then the second one, the question of the WTO.

I don't know how to resolve this conflict. There are two extreme views, obviously. One is presented by the communist, nationalist position, which is everything that has been stolen has to be returned back to the people, which means effectively renationalization of the oligarchic companies, and that's something which does not seem to be practical.

The second extreme view is let's forget and forgive, what happened, and that's the issue of blank amnesty and just look into the future. This may be a pragmatic and practical decision but I don't think it has any chance politically. That's not how the great majority of the population in Russia feel.

So both extreme ideas I believe are, you know, totally unworkable, and, therefore, one has to look into something in between.

As far as the prospects of a successful conclusion of Russian negotiations with the WTO, I think I can echo what David Owen has just said, that--I mean, obviously, the way I understand it is that this is a hard bargaining process. A lot of give and take is involved; a very significant political component is involved. But at the same time, if one looks at the substance of these negotiations, it is clear that with the new composition of the Duma, with the very strong pro-government majority in the Duma, it will become certainly much easier for the authorities to resist the pressures from the vested interests, many of which are strongly anti-WTO. I mean, one has to understand that there are important vested interests in Russia who are not going to gain but are, in fact, going to lose significantly in case Russia joins the WTO. And all these interests were very strongly represented in the outgoing Russian parliament. So now with the stronger government control, it will--one may hope that it will become much easier for the authorities to resist this.

So I think I can be fairly optimistic that the process of Russia joining the WTO can be accelerated after the elections.

MR. ODLING-SMEE: Thank you, Aleksei.

If I could just allow myself one comment on the picture you present of two extremes, two extreme solutions to the relationship between oligarchs and society, and you were concluding that the solution ought to be in the middle. All I would say is that I hope the solution is found quickly because the uncertainty that is created by this stand-off, as it were, is obviously going to discourage major economic and financial commitments and postpone the period when these very rapid growth rates could be achieved, I think most people believe could in principle be achieved. So I think that this is an issue which has great importance from the point of view of creating an environment in which economic growth can really be established at a high rate.

Let's continue now with questions from the floor. One there, one there, and two on this side. Yes?

INTERJECTION FROM AUDIENCE: I come from a community of private investors in emerging markets, and I would disagree strongly with Anders Aslund's assertion about causes and consequences of the '98 crisis. It's not that the Duma rejected the Kirienko program that was their--you know, the main cause of their crisis, but the whole pretty much Washington Consensus policies at that end, maintaining a huge debt pyramid with very large interest rates, keeping, again, with large interest rates overvalued to currency, and this was pretty much 100 percent confirmed with a crisis later in Argentina which was at the time of Russian crisis kind of was offered as an example of a really good emerging market country. You can compare it with (?) programs, pretty much doing the same thing as Kirienko and Russian Government at the time, and this was completely at a dead end. I mean, it was clear to me and people whom I talk on the Internet, emerging market investors, that this was a complete dead end which was going to crash. And actually government which come after, Washington Consensus type government, first Primakov, then Putin offered pretty much a way out, which is, again, now repeated in Argentina, in some sense (?) civilized situation like Primakov, and Kirchner now has a chance of being like a Putin. Well, I mean, I can go on for a long time, but I guess I will finish now.

QUESTION: This is a question for Mr. Mozhin. Taken up Mr. Owen's point that the civil service is in need of reform and that represents effectively a buffer between the Federal Government and the percolation of reform down to the rest of the country, do you think given the non-transparency of the Kremlin there is actually a commitment to reforming the civil service? And what are the possibilities given the all-pervasive problems with that?

Thank you.

QUESTION: I have two questions for Anders Aslund. First, you stressed the fiscal adjustment that has taken place since '98, and Mr. Owen stressed the oil revenue-based aspect of that. And given that we expect oil prices to return to some mean, potentially around $20, which could be a 30- or 40-percent adjustment from current levels, do you expect this adjustment to be easy? And do you discount this factor? Did I understand that from your presentation?

The second question is you compared the oligarch situation to the robber baron period in the U.S., and I'm wondering if in that period there was also a real problem of legitimacy which led to the election of Teddy Roosevelt, who had a platform of breaking up the oligarchs of that period. Are you suggesting that we are to view Mr. Putin in that light as a new Teddy Roosevelt era? And would the American model of that period be a good model to follow?

QUESTION: For us [DuPont Corporation], the future to some extent can be boiled down to a single question, and that is, should we invest now? And investment, of course, is viewed in a larger context than single Russia. And in that regard, I think China's public relations effort has been superior to Russia's. Certainly as you walk around the halls of my building, China's mentioned far more often than Russia is.

But one avenue to investment would be via the privatization process, and in your opinion, have the reforms reached down far enough into the privatization process and the auctions as they exist today to have improved them from being rather dark processes carried out in back rooms?

MR. ODLING-SMEE: Any more questions at this stage?

[No response.]

MR. ODLING-SMEE: Then maybe I could ask the panelists, in the same order perhaps as before, but just on the first question, if I may just say, I don't myself understand the Washington Consensus to be a policy of big fiscal deficits [inaudible]--

[Laughter.]

MR. ODLING-SMEE: --that led to the problems in '98.

INTERJECTION FROM AUDIENCE: Well, in practical terms, in many countries, in Latin America and Russia, what the Washington Consensus really is is a policy which was really supported is borrowing lots of money in international markets at pretty high interest rates and running the debt pyramid in Russia and Argentina and now still in Brazil, and Turkey is pretty much constantly near bankruptcy continuing the same policy. And maintaining an overvalued currency rate with practically declining economy, but only due to their high interest rate, again, which was pretty much (?) for the economy. And I think the end of this policy was actually--brought a great success to Russia, and maybe it will bring success to Argentina.

MR. ODLING-SMEE: Thank you. It's probably not our business to try and define the Washington Consensus, but we'll answer the substantive question on [inaudible]. Anders?

MR. ASLUND: Well, I would just like to say that if you're attacking something, you should know what you're attacking. As John Odling-Smee already pointed out, the Washington Consensus was for limited budget deficits. So if you're attacking the opposite, you're not attacking the Washington Consensus. This is an elementary thing, but people like Joe Stiglitz--I should note this, if you read his book about globalization, where he criticized the IMF policy towards Russia, he avoids mentioning the fiscal deficit. This kind of--what should I call it? I prefer not to call it but just notice it--is what one has to deal with. And if you ignore the budget deficit, if you ignore the debt that comes from that, then one is in big trouble.

Of course, if you have an excessive debt, you get an excessive interest rate. And you have a point in an overvalued exchange rate which was the cause of the corridor, and it was not adjusted fast enough. You now see that there has been broad consensus, as you point out, towards more flexible exchange rates. That's the point. It's not about the Washington Consensus. Fixed exchange rate was never part of the Washington Consensus. You can read about this in repeated publications by John Williams, and so that you are aware of what the Washington Consensus is.

Regarding the questions on adjustment, it has taken place. Public expenditure in Russia, if I remember rightly, has fallen by 9 percent of GDP. So there has been a massive adjustment. I think that the Russian Government, most of all, of course, the Ministry of Finance, is enormously aware of the danger of falling oil prices. We see each year that the oil price in the budget is several dollars below what is really the expected value of--price of oil for the next year.

On the robber barons, yes, indeed, I totally agree. The ideal would be that Putin turns out to be a Teddy Roosevelt, but Teddy Roosevelt didn't try to nationalize. He didn't throw John Rockefeller into prison. He only pursued antitrust. What we had in the U.S. at the beginning of the century was populism rather than socialism. We are now seeing the populism in Russia. I hope that it won't take a socialist turn. But, of course, Russia has a far huger state, and in particular much bigger law enforcement organs than the U.S. had at the time. So if you try to pursue a policy as the one Teddy Roosevelt pursued at the beginning of the last century in Russia today, you might end up with a totally different result because of the different conditions.

Thank you.

MR. ODLING-SMEE: Thank you.

Aleksei?

MR. MOZHIN: Regarding the first question, I mean, I agree absolutely with what Anders Aslund has just said. I would only want to add that the very fact that the Russian Government had to erect this GKL(?) pyramid was exactly because the Duma was approving--you know, five, six years in a row the Duma had approved budgets, totally irresponsible budgets with very huge fiscal deficits. So the question, how do you finance this deficit? You can either print money, which was not good, or you can issue debt, and this was effectively what the Russian Government did and could not avoid simply because--

INTERJECTION FROM AUDIENCE: [inaudible] contracting economy, and that was pretty much the lesson of Kirienko government and Argentina, [inaudible], which ended in failure. [inaudible] policy Russian--

MR. MOZHIN: Right, right. Absolutely. You're absolutely right here. The only solution in a situation Russia faced in late '97 or early 1998 was to make a fiscal effort, to reduce fiscal deficit, to make significant fiscal correction, and that's what was the basis of Russia's IMF program. But it failed completely because of the Duma resistance.

MR. ODLING-SMEE: Can you go on to the question about civil service reform?

MR. MOZHIN: Yes, civil service reform, very quickly, I mean, I think when--first of all, civil service and public administration reform is very much on the agenda of the government, and there is a special task force working on that, on the concept of this reform. I think--you mentioned non-transparency in the Kremlin. I think what Anders meant when talking about lack of or reduced transparency in the Kremlin was mainly the fact that there is some reluctance of certain Kremlin officials to comment, to be easily accessible to the press people. But if they talk about the broader issue, it is clear that Russia has made enormous progress in the transparency area in terms of fiscal accounts, central bank accounts, statistical accounts. I mean, this is simply a new world in comparison to the way we were, let's say, five, seven years ago. So I would not see any obstacles on that transparency side, in fact, and this is very much on the agenda.

MR. ODLING-SMEE: Does one of you want to say something on the question about the transparency of the privatization process?

MR. MOZHIN: I think there is not much that is left to be privatized, although there are some chunks of state property. But, you know, one has to understand that the kind of great bulk of state assets have already been released, and the process was certainly not flawless, to put it mildly, in the 1990s.

But your broader question is--you had a broader question whether one should invest in Russia now, and obviously you also made a comparison with the Chinese that they are much more forthcoming and they advertise much better than the Russians do, advertise the opportunities in the Chinese economy.

To this, my first reaction is it's much easier for the Chinese to advertise their opportunities. They don't have the opposition which would go out everywhere and say not invest, not invest. That's what obviously is very different between Russia and China. We have opponents of the government, and they do not hide their views.

As far as the fundamental question whether one should invest in Russia now, my answer is I don't know.

MR. ODLING-SMEE: Anders?

MR. ASLUND: Let me add to this. I'm very optimistic about the possibilities of economic recovery. I think that the critical query is property rights, and this is very much a matter of having a good understanding with the regional governors. And you can say one should only invest where one sees that there are successful foreign investors already in that region.

On the question of privatization, I would say that what we are really seeing in Russia and Ukraine, it is that it's the locals are best at taking over big enterprises that have been privatized. They know how to manage the politics, which is very difficult, of big enterprise. They know what the social demands really are because you have very many social demands that are not for true but are formalities, while others are truly important. They know also how to sort out criminality, which was typical on Soviet enterprises. They knew, for example, (?) whole transportation department because the transportation department was something for the stealing of goods (?) , and this is not something that you really desire and so on.

So it's a standard advice, I think, to foreign investors in Russia. Don't take on an unrestructured Soviet enterprise which has more than 1,500 people or so because as a foreigner you don't really understand this. Russians and Ukrainians are better at that than outsiders. So it's after the enterprise has been restructured that I think that there is a good room for foreign big companies to come in, and then often in terms of joint ventures that we are seeing the progressive companies doing. And it's better to deal with private companies in that country than with the state.

Thank you.

MR. ODLING-SMEE: Thank you.

We've run out of time, I'm afraid, and so we will have to end now. I'd like to thank very much our speakers for opening the discussion and answering the questions, and especially to Aleksei Mozhin for stepping in at the last moment.

Thank you all very much for coming.

[Applause.]




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