1999 International Monetary Fund

Transforming Financial Systems in the Baltics, Russia, and Other Countries of the Former Soviet Union

Edited by Malcolm Knight, Arne B. Petersen, Robert T. Price

1     Overview
     Malcolm Knight, Arne B. Petersen, and Robert T. Price
2     Monetary Operations and Government Securities Markets
     Eduardo Levy-Yeyati
3     Foreign Exchange Markets and Official International Reserve Management
     Bernard Laurens
4     Banking Sector Reform
     Claudia Dziobek and Jan Willem van der Vossen
5     Payment Systems Development
     Nicholas M. Roberts
6     Central Bank Accounting and Internal Audit
     John Dalton
7     Legislative Framework
     Tonny Lybek
8     Background Tables


Over the past seven years, the IMF, in cooperation with 23 industrial country central banks and the major international and regional institutions, has been engaged in a concerted effort to strengthen central banking operations and banking sector soundness in the Baltic countries, Russia, and other countries of the former Soviet Union. It is worth noting that, despite the financial turmoil that erupted in Russia in August 1998, with adverse repercussions for the region, many of these countries have made significant progress in restructuring their economic and financial systems.

In 1991, the Baltics, Russia, and other countries of the former Soviet Union set out on the road to establishing market economies by liberalizing prices, dismantling the instruments of central planning, and initiating a process of fundamental structural reforms. Since then, these 15 countries have taken substantial steps toward achieving macroeconomic stabilization, and are well advanced in many areas of the transformation to market economies. In particular, considerable progress has been made in developing market-oriented financial structures.

Given the magnitude of the task involved in this transformation, it was clear at the outset of the process that these 15 countries would need significant financial assistance and advice to carry the process to successful completion within a reasonable time period. The IMF has at various times extended its financial support to most of the countries involved, and has engaged in an ongoing dialogue with country authorities on a wide range of macroeconomic and structural issues. The World Bank and regional and bilateral donors have also extended significant financial assistance and advice. This volume focuses more narrowly on progress achieved in the area of market-oriented central bank and financial system reforms. This has been the focus of a special cooperative effort by which, under a Group of Seven mandate, 23 central banks agreed in early 1992 to cooperate with the IMF to provide intensive technical advice to the new central banks to help develop their capability to operate efficiently in all the main central banking areas.

The Monetary and Exchange Affairs Department (MAE) of the IMF has coordinated the work of the cooperating central banks in providing advice to the transition countries on the measures needed to attain the broad goals in the financial sector that I have outlined. The program has involved several components, including regular MAE technical assistance missions to most of the countries concerned, with participation by experts from the cooperating central banks; targeted follow-up visits; the placement of long-term resident advisors--including experts from the cooperating central banks; workshops on specific topics, with the participation of cooperating central bank experts; and training activities for the staffs of the respective central banks. The expertise and staff resources devoted to providing this assistance and advice have been considerable--about 116 staff years to date. Of this total, experts from the cooperating central banks contributed an impressive four-fifths of the total, or 94 staff years, with the remainder or 22 staff years coming from the IMF.

The material for this book was prepared in May 1998, and it therefore does not capture the impact of the recent turmoil in Russia. Nevertheless, in spite of the current uncertainties, the book's conclusions remain valid. I believe it is important not to lose sight of the notable progress that has been achieved since the intensive period of central bank reforms began in the Baltics, Russia, and other countries of the former Soviet Union in early 1992.

On the inflation and output fronts there have been major achievements. Inflation rates in most countries have declined steadily since 1992, reaching single or low double digits in many cases, while growth resumed in 1997 in 13 of the 15 countries for the first time since reforms began. Of course, progress has not been uniform across countries. Those countries that succeeded early on in lowering inflation by decisively reducing their domestic financial imbalances and proceeded rapidly to implement comprehensive structural reforms have benefited most in terms of output growth and exchange rate stability. These developments, in turn, have created a stronger basis for a continued deepening of structural reforms throughout the economy, including in the financial system. By contrast, those countries where restrained financial policies have been implemented less consistently, and where structural reforms have been embraced apprehensively, have experienced more difficulty in achieving stability--and in some cases have made less progress in realizing the structural transformation. Russia's performance on inflation and growth is suffering because of the recent turmoil. The same is true to a lesser extent for some other countries in the region. Nevertheless, with a strengthening of fiscal and monetary policies and a persistent application of market-oriented reforms, developments should return to the positive trend.

During the period covered here--from early 1992 to May 1998--most of the 15 countries under review demonstrated a strong and consistent commitment to undertaking deep financial sector reforms. From the outset, they adopted the broad goal of transforming their financial systems from the monobank structure of the Soviet era to a two-tiered financial system, anchored by an independent central bank presiding over a system in which interest rates and exchange rates were market-determined and commercial banks transacted business on a competitive basis. Important elements in this transformation included the development of active government securities markets and interbank markets dealing in short-term, liquid funds and foreign exchange. A further goal has been the creation of secondary markets in which banking system liquidity could be managed by the central bank through open market operations using indirect monetary policy instruments. Also important have been the reforms of the central bank lender-of-last-resort facilities, including the development of collateralized standing facilities. Finally, the design and implementation of central bank reform in the areas of banking supervision, payment systems, and central bank accounting systems have been key elements in meeting the broad objectives.

Recent developments have underscored the importance of maintaining a sound banking system, and more work is clearly needed here. The development of a well-functioning securities market has unfortunately suffered an abrupt setback in Russia, demonstrating the need to back up sound monetary policies and procedures with appropriate fiscal policies and far-reaching structural reforms in other areas. There is now a need to restore investor confidence that has been severely weakened by Russia's unilateral decision to restructure domestic debt obligations. Nevertheless, many of the basic elements of a successful structural transformation are still in place in Russia to serve as the foundation for a return to improved economic performance--provided, of course, that broad-based support can be found for carrying them through.

From 1992 to 1998, regular joint meetings of both technical assistance donor institutions and recipient central banks were held in Basle at the Bank for International Settlements (BIS). These meetings provided a useful occasion for technical assistance providers and recipients to review the progress and effectiveness of the IMF-coordinated technical assistance program, and to plan ahead for further assistance. One conclusion from these meetings was that although the financial reform process is far from complete, there are clear indications it has been exerting a favorable effect on the implementation of monetary and financial policies throughout the region. Nonetheless, further efforts will be needed to improve overall banking system soundness in most countries. Technical assistance will continue to be provided, both by MAE and bilaterally by the cooperating central banks.

This volume was originally prepared as one of the background papers for the eleventh, and final, coordination meeting held in Basle, May 1112, 1998. It has benefited from the substantial input of the central banks of the 15 countries covered by the survey, including their responses to a comprehensive questionnaire on which the tables in Chapter 8 are based. The report highlights the substantial progress achieved by the central banks of most of the 15 countries and the catalytic role these institutions have played in the overall development of their financial markets. To assess the technical assistance effort and provide countries with a way of determining the appropriate sequencing of further reforms, as well as to assist both recipient and donor central banks and institutions in identifying priorities for further technical assistance, the MAE staff has attempted to rank the countries' progress up to May 1998 in the key central banking areas and the financial system as a whole. These rankings are for technical assistance purposes only, and should not be viewed as an assessment of the countries' overall macroeconomic and financial policy stance.

The IMF staff and I would like to express our gratitude for the joint efforts of all cooperating central banks and international institutions that have been involved since this program of technical assistance to the central banks of the Baltics, Russia, and other countries of the former Soviet Union began. It is evident that this reform process has been an enormous task, rife with complexities. The challenges could not have been met without the extensive cooperation of the 23 central banks and financial institutions providing the technical assistance, together with the commitment of the participating countries to achieve their overall objective of establishing market-based economies. It has been a task clearly beyond the resources and capabilities of any one institution. Although the work is not yet completed--as has been dramatically demonstrated by recent events--the overall coordinated technical assistance program has been a very successful effort, both for recipients and donors. Most of all, the central banks of the Baltics, Russia, and other countries of the former Soviet Union are to be commended for embracing challenging reforms during this period. Finally, we are all most grateful to the BIS for its valued assistance in organizing the high-level coordination meetings that have been held in Basle over the past several years.

  Stanley Fischer
First Deputy Managing Director
International Monetary Fund