Is Russia's recovery sustainable?

By Batara Simatupang

AMSTERDAM (JP): On Aug. 17, 1998, the Russian government decided to float the ruble, to default on part of its foreign debt payments and to cease temporarily payments on Russian government treasury bills (GKO). The financial meltdown was triggered by a combination of unfavorable exogenous and endogenous factors.

The year 1998 was the bottom of the Asian economic crisis which led to a large drop in output and a fear of competitive devaluations, investor withdrawal of capital from emerging markets, including Russia, and a flight to safety.

Commodities account for about 70 percent of Russia's merchandise trade. According to the Economist, the all-items commodity price index fell 30 percent since mid-1997. For instance, the Brent oil price fell to US$10.60 a barrel on June 16, 1998, from about $22 in early October 1997, while fuel and refined products exports comprised about 46 percent of total Russian exports.

Russia has long shouldered a too large budget deficit: some 8 percent of GDP in 1996 and 1997. Efforts to cut the budget deficit in 1998 were unsuccessful and came too late. Most of the budget deficit was financed by GKO, which had accumulated to an excessively large volume. Costs of borrowing grew rapidly and the fiscal situation in 1998 became unsustainable.

Almost one in every three rubles in public spending in 1998 went to debt servicing, while all new borrowings went to repay old debts.

Unfavorable exogenous factors combined with poor debt management, the weak banking sector, flagging structural reforms and a lack of political credibility contributed to the Russian financial meltdown.

The initial results were catastrophic: consumer prices, which were flat in July, rose to 43 percent during August and September, and a further 5.7 percent in November and 11.6 percent in December.

The ruble depreciated from 6.3 to the U.S. dollar on Aug. 17 to 20 in September 1998, plunging further to 23.06 on Jan. 12, 1999. The stock market (RTS index) slumped about 70 percent in the first week of September 1998 compared to early August.

Imports dropped by nearly one-half and industrial output fell drastically. The number of people living below the subsistence level has increased rapidly. Many observers and research institutes predicted a further worsening of the economy.

Economists forecast the GDP would fall 9 percent in 1999, preceded by a fall of GDP by 5 percent in 1998 and a long-term economic decline. It should be noted that the Russian economic depression during the transition period was very dramatic; the estimated level of real GDP in 1998 was only 55 percent compared to the level of GDP in 1989. Excessive money printing, according to predictions, would lead to hyperinflation.

The cataclysmic economic predictions did not pan out. The government under premier Primakov has kept a relatively tight rein on the money and credit supply, with budget spending coming under control.

As a result of a default on part of the foreign debt and treasury bills, the cost of servicing the debt was reduced substantially. The surge in international prices of oil has exerted favorable impacts on Russia's trade balance and tax revenue.

The considerable depreciation of the ruble has stimulated exports while imports have fallen drastically. The ruble depreciation has improved the competitive position of a large part of Russian industry, leading to significant growth in industrial output. Foreign investors began to buy Russian stocks and bonds, partly stimulated by improved international liquidity and an expectation of Russian economic recovery.

Stock market prices rose to the precrisis level. The volume of non-cash transactions in the total economy fell considerably as the financial meltdown stimulated hard budget constraints among corporations.

The International Monetary Fund recently granted $4.5 billion credit to Russia, which has helped the country avoid further default. Credits from the World Bank and Japan are assured. No doubt the loans can be seen as strategic and political act. Former Soviet debt to the Paris Club falling due between August 1998 and the end of 2000, which amounted to $8 billion, has been rescheduled at least until the end of next year and it is hoped that in the future part of the debts will be forgiven. Negotiations on debts to private international banks, the London Club creditors, are expected to move toward long-term resolution.

Is the Russian economic recovery sustainable?

Long-term economic recovery and the present budget stabilization depend on the success of much needed structural reforms, which will eliminate a large part of the loss-making industries and will stimulate investments.

The credibility of the government to implement the necessary structural reforms depends on the outcome of the parliamentary elections in December 1998 and the presidential election in June 2000.

The writer is a guest fellow in the Department of Economics and Econometrics, University of Amsterdam.