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O C C A S I O N A L   P A P E R     
Macroeconomic Developments in the Baltics, Russia, and Other Countries of the Former Soviet Union, 1992–97

Luis M. Valdivieso

List of Abbreviations
I    Introduction
II Inflation, Growth, and Financial Policies
Financial Policies
III The Current Account, Growth, and Competitiveness
IV Debt- and Non-Debt-Creating Capital Flows
V The Initial Impact of the Asian Crisis on the Baltics,
Russia, and Other Countries of the Former Soviet Union

Financial and Foreign Exchange Markets
International Bond and Credit Markets
Spillover Effects
Appendix: Background Tables
 1.   IMF-Supported Adjustment Programs
 2.   Status of Most Recent IMF Programs
 3.   Consumer Price Inflation
 4.   Average Real GDP Growth
 5.   General Government Fiscal Balance
 6.   Net Domestic Assets and Reserve Money
 7.   Growth in Broad Money
 8.   Current Account Balance
 9.   Real and Nominal Exchange Rates
 10.   Exports of Goods and Services
 11.   Total External Debt
 12.   Debt Service
 13.   Access to International Private Financial Markets
 14.   Foreign Direct Investment
II1.   Growth and Inflation
 2.   Inflation, General Government Deficit, and Broad Money
III3.   Real GDP Growth and Current Account Balance
 4.   Exports in Percent of GDP and Real Exchange Rate Indices
 5.   Average Monthly Wages


I   Introduction

During 1992–97, most of the Baltics, Russia, and other countries of the former Soviet Union have made significant progress toward macroeconomic stabilization. While average inflation has declined steadily since 1992, output fell significantly for many of these countries during this period, and it was not until 1996–97 that as a group they experienced positive growth. Throughout this period, these countries have relied heavily on foreign savings to supplement their relatively low domestic savings. The composition of net external financing has gradually started shifting away from official external sources toward private capital flows, attracted by high rewards. This signaled an important change in the perception of sovereign risk in response to the progress achieved in implementing sound domestic financial policies and structural reform.

Progress in macroeconomic stabilization has not been uniform across the Baltics, Russia, and other countries of the former Soviet Union. Differences in performance can be attributed in part to diverging initial conditions: uneven productive factor endowments; various degrees of financial policy restraint; and, equally important, differences in the pace of implementation of comprehensive structural reforms. There is growing evidence1 that those countries that have succeeded in lowering inflation by decisively reducing their domestic financial imbalances and have proceeded rapidly to implement comprehensive structural reforms have benefited the most in terms of output growth, exchange rate stability, and access to private international capital markets. By contrast, those countries where financial policy restraint has been pursued inconsistently and structural reforms have been embraced apprehensively seem to have experienced short-lived episodes of stability and only sporadic or no revivals in economic activity. If sound macroeconomic policies are not adequately supported by comprehensive structural reforms, the sustainability of the stability achieved is put at risk, and vulnerability to external and domestic shocks increases.

The efforts to achieve macroeconomic stability have generally been framed in the context of IMF-supported programs. During 1992–97, of the 15 countries comprising the Baltics, Russia, and the other countries of the former Soviet Union, 14 had adopted IMF-supported programs, with cumulative commitments close to SDR 20 billion--the equivalent of about $28 billion (Appendix, Table 1).2 Russia, Estonia, and Latvia were the first to obtain access to IMF resources starting as early as 1992, while financial support to Tajikistan only materialized in 1996. During the period under study, Turkmenistan was the only country in the region that had not had an IMF-supported program, mainly because there was not a clear initial need for balance of payments financing, and, subsequently, there was no internal consensus on the reform approach to be pursued. Increasingly, IMF support has been provided through multiyear arrangements, either under the Extended Fund Facility (EFF), as for Azerbaijan, Kazakhstan, Lithuania, Moldova, and Russia, or the Enhanced Structural Adjustment Facility (ESAF), as for Armenia, Georgia, the Kyrgyz Republic, and, more recently, Tajikistan.3 The Stand-By Arrangement has been used to support programs in countries that were not ready for an EFF, such as Ukraine, or for those that have preferred precautionary arrangements, such as Estonia and Latvia. In Lithuania, following the successful completion of an EFF, the authorities have so far chosen not to embark on a successor arrangement. Belarus and Uzbekistan, while in need of a broad-ranging stabilization and reform drive, do not have IMF-supported programs but maintain a policy dialogue with the IMF (Appendix, Table 2).

Although progress has been achieved, many sources of vulnerability remain, which, if left unattended, may complicate macroeconomic management. First, the Baltics, Russia, and other countries of the former Soviet Union face for the most part considerable fragility in their public finances. There is a need for further fiscal consolidation to achieve not only reasonable fiscal balances, but also to address severe revenue collection problems, contain overall expenditure levels (mainly by increasing the cost-effectiveness of social spending), improve the institutional framework of the budgetary process, and increase the transparency of the fiscal accounts.4 Second, despite noticeable improvements, many of these countries still need to bolster their banking systems. The weaknesses in this sector have contributed to fiscal imbalances and excessive foreign borrowing and, at times, have significantly constrained monetary policy. Financial intermediaries need to be subjected to stricter prudential and regulatory requirements, and efforts at developing further the supervisory framework and enforcing prudential requirements must continue.5 Finally, there are increasing concerns about the sustainability of the sizable external current account deficits, particularly in countries where these deficits have been financed through borrowing rather than through foreign direct investment.6 The experience of some of these countries in addressing the initial spillover effects of the Asian crisis (see Chapter VI) illustrates how external shocks can magnify the potential adverse impact of the remaining sources of vulnerability, even with timely and adequate short-term financial policy responses.

This paper does not review the progress achieved in the areas of structural reform. Given that the achievement and sustainability of macroeconomic stability cannot be seen in isolation from the progress in implementing structural reforms, however, the macroeconomic indicators for individual countries7 are presented in a way that permits inferences to be made on how their current stages in the transition may be correlated with their macroeconomic performance. Countries are classified into four categories: advanced, intermediate, and slow reformers, and a special group of countries that have been significantly affected by military conflict, whether internal or external, sometime during the first six years of transition.8

1For further reference, see Marcelo Selowsky and Ricardo Martin, "Policy Performance and Output Growth in Transition Economies," American Economic Review, Papers and Proceedings, Vol. 87 (May 1997), pp. 349–53; Ernesto Hernández-Catá, "Liberalization and the Behavior of Output During the Transition from Plan to Market," Staff Papers, International Monetary Fund, Vol. 44 (December 1997), pp. 405–29; and Jeffrey Sachs and Wing Thye Woo, "Structural Factors in the Economic Reforms of China, Eastern Europe, and the Former Soviet Union," Economic Policy: A European Forum, Vol. 9, No. 4 (April 1994), pp. 101–45.
2IMF support to the Baltics, Russia, and other countries of the former Soviet Union has also encompassed broad-ranging technical assistance and training, and this type of support has been provided to each of these countries.
3Azerbaijan also uses the ESAF combined with the EFF.
4For a discussion on progress with fiscal reform, see International Monetary Fund, World Economic Outlook, World Economic and Financial Surveys (Washington, May 1998).
5For further reference, see International Monetary Fund, forthcoming, Status of Market-Based Central Banking Reforms in the Baltics, Russia, and Other Countries of the Former Soviet Union (Washington).
6For further reference, see Ishan Kapur and Emmanuel van der Mensbrugghe, "External Borrowing by the Baltics, Russia, and Other Countries of the Former Soviet Union: Developments and Policy Issues," IMF Working Paper 97/72 (Washington: International Monetary Fund, June 1997); and, John Odling-Smee and Basil Zavoico, "External Borrowing in the Baltics, Russia, and Other States of the Former Soviet Union: The Transition to a Market Economy," IMF Paper on Policy Analysis and Assessment 98/5 (Washington: International Monetary Fund, June 1998).
7While most countries have made considerable progress in the production and reporting of economic data, the information used in this paper should be interpreted with caution and only as indicative of trends.
8Countries falling in the first three groups were classified according to the liberalization index presented in Martha De Melo, Cevdet Denizer, and Alan Gelb, "Patterns of Transition from Plan to Market," World Bank Economic Review, Vol. 10 (September 1996), pp. 397–424. There are several alternative classifications, including the most recent one prepared by the EBRD in its 1997 Transition Report. According to the EBRD classification, Russia would be ranked among the most advanced reformers, together with the Baltics; Armenia, Georgia, Ukraine, and Uzbekistan would cluster among the intermediate reformers group, together with Kazakhstan, the Kyrgyz Republic, and Moldova; and Azerbaijan, Belarus, Tajikistan, and Turkmenistan would have the lowest rankings in terms of reform.