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Doc. 8294
8 January 1999
Economic situation in Russia and Ukraine
Report
Committee on Economic Affairs and Development
Rapporteurs: Mr Juhan Telgmaa, Estonia, European Democratic Group, and Mr Andrzej Wielowieyski, Poland, Group of the European People's Party
Summary
The report examines the evolution of economic transition in Russia and Ukraine, with particular emphasis on the present situation. Although many opportunities have been lost and prospects look difficult - especially for Russia - Europe and the world, says the report, have a duty to continue to assist while encouraging further reform efforts. Such assistance includes food, medicine and other necessities, where large areas and social groups are already facing serious shortages. Economic development, the report concludes, depends vitally on strong democratic institutions and the rule of law, and on the willingness of all political forces to reach the necessary compromises capable of mustering popular support and involvement.
1. The Assembly views with great concern the worsening economic situation in Russia and Ukraine. In Russia, events since the summer of 1998 have highlighted the country's plight as shown in a widening budget deficit, a much reduced ability to attract foreign and domestic credit, and a threatening spiral of inflation. With efficient remedial action yet to be taken in either country, the crisis is leading to a sharp fall in already precarious living standards. It is also having a negative effect on neighbouring countries in transition, and even on Europe as whole and the world economy in general.
2. The Assembly expresses alarm over the difficult food situation and the lack of medical and other necessities in Russia in particular, but also in Ukraine. It welcomes the considerable international efforts undertaken to supply food and medicine to the populations concerned and the new readiness on the part of the host authorities to ensure efficient and fair distribution. It calls for additional humanitarian assistance, especially to remote areas in northern Russia where the winter is severe and transportation difficult and to the poor regions of Ukraine – Chernivtsy Oblast and, especially Zakarpattia Oblast, where a disastrous flood disaster has complicated an already difficult situation. The Assembly also calls on Russia and Ukraine to do their utmost to facilitate the ways in which humanitarian assistance transits their borders and reaches the needy.
3. The many opportunities offered in recent years fundamentally to reform the economy in Russia have not been seized, although considerable, irreversible changes towards a market economy have been made. It is nevertheless essential that a way forward be found, based on compromises between all political forces and reflecting popular will.
4. The massive assistance provided by the international community in recent years has proved largely ineffective, in that banks have not been modernised, industrial and agricultural production has decreased, the state budget is not balanced, a considerable part of social aid is wasted and a lot of Russian capital continues to leave the country. The Assembly calls for a profound examination by both donors, especially the International Monetary Fund, and recipients of how foreign funds have been used, so that any repetition of mistakes can be avoided in future when urgently needed assistance beyond that for humanitarian purposes can be resumed under secure conditions.
5. For this to occur, it is now for Russia and Ukraine themselves to take the lead in creating the conditions under which lasting economic recovery can take hold. This is all the more important as only a prosperous Russia and Ukraine can assure continued stability, peace and cooperation in Europe and beyond.
6. The Assembly strongly believes that every country must independently choose and develop its own political system but that democracy and the rule of law are necessary for lasting development. In Russia and Ukraine, the transition and modernisation process will inevitably last many years, perhaps decades, given the historical legacy of a deep social, economic and moral disintegration of society. It is therefore essential that it enjoys growing support from the people and that it is accompanied by ever stronger democratic mechanisms, the development of local autonomy and greater citizen involvement in accordance with the European Charter of Local Self-Government. A better coherence between the presidential and governmental administration on the one hand and parliament on the other is vital for effective government. In the case of Russia, the Assembly believes that the support given by the Duma to the present government sets a good example for the future and hopes that it will last.
7. The deep economic crisis in Russia results mainly from major difficulties in carrying out structural change. This has led to a situation characterised by:
i. a privatisation process which has not yielded the desired results, but which has instead preserved, strengthened or even created monopolies and oligopolies; and insufficient modernisation of enterprise management;
ii. inadequate regulation of economic life;
iii. a weak banking system;
iv. the formation of conglomerates in the fields of finance, industry and the media with considerable power over state affairs but beyond democratic control;
v. a weak social dimension in economic reform projects, reducing critically needed popular support;
vi. a serious imbalance in wealth, and especially low purchasing power or even poverty among populations, including salary, pension and other social arrears;
vii. a growing barter and shadow economy;
viii. a narrow tax base and a weak tax administration;
ix. a worrying spread of crime and corruption;
The above circumstances contribute to the grave budgetary crisis, in which monetary and fiscal policies are insufficiently coordinated, and to a threatening increase in internal and external debt.
8. Ukraine has had to face many of the same challenges of transition as Russia and is still encountering many of the problems and difficulties mentioned in paragraph 7 above, especially since the economies of the two countries are so closely linked. Ukraine today stands a fair chance of weathering the crisis since it has attracted limited quantities of speculative capital and has pursued a cautious budgetary policy incurring manageable quantities of foreign debt. Finally, its central bank has established a fair measure of control over the money market, has introduced a modern system of accounts in the banking system and therefore enjoys a measure of confidence on the part of international lenders.
9. Europe and the international community at large today face a vital question: should they and are they capable of supporting Russia financially and materially, with Ukraine presenting a similar though less dramatic case ? The Assembly believes that the immediate need of Europe and the world economy for a stable, internationally predictable and economically viable Russia and Ukraine implies that these countries be helped to stimulate their economic development, balance their budgets, reform their financial structures and systems and be provided with indispensable social and humanitarian assistance. Even if structural reforms proceed slowly and some assistance is not used rationally, Europe and the international community must continue to promote financial and other forms of assistance, since the necessary accompanying reforms, if too rigid, could lead to such resistance that reform is blocked and the destabilisation that might follow would be much more costly to all sides.
10. The Assembly calls on Council of Europe member states to pursue, individually and within the framework of international institutions, their assistance to Russia, Ukraine and other countries of the Commonwealth of Independent States so that these countries:
i. adapt their human resources to the requirements of a market-oriented economy;
ii. achieve privatisation leading to a competitive economy, and a greater separation between political and economic powers leading to fair competition;
iii. establish clear, stable and transparent legislation, including in the banking sector where adherence to internationally recognised accounting principles is particularly needed, and an efficient judicial system, including tough measures to combat all forms of crime and corruption;
iv. reach true economic co-operation between regions in Russia and in Ukraine, as well as with neighbouring and other states, based on internationally accepted principles of trade.
11. In social assistance, one important principle must be to try to establish direct contact between European donor countries and regions on the one hand and regions in Russia and Ukraine on the other. A better utilisation of resources would result from such close cooperation with leaders of regional administration and representative bodies, which are better controlled by public opinion in the accomplishment of their tasks. The Assembly also calls on Russia and Ukraine to sign and ratify the European Social Charter and its Protocols as soon as possible.
12. The Assembly recalls the rich human potential and natural resources of both Russia and Ukraine. For the peoples of these countries to be able gradually to strengthen their contribution to recovery, a greater diversification of the economies must be made, away from their current excessive dependency on raw materials and energy toward a greater role for more advanced production and services. Only in this way can the effects on the overall economy from recurrent falls in the prices of these resources be avoided and the people be fully involved in economic development. For this the economy will need new capital - domestic and foreign - and the only way to raise it will be to ensure sufficiently attractive conditions in each region.
13. The Assembly supports long-term, systematic action to harness these human resources for the development of a market economy and the formation of a strong middle-class in Russia and Ukraine. Such a strategy should include:
i. assistance in the reform of educational systems and in the creation of study and practice opportunities in Europe for students from these countries;
ii. wide-ranging cooperation among universities, especially faculties of law, economics and management;
iii. support for cooperation among trade organisations, chambers of commerce, trade unions and small and medium-sized enterprises in sharing experiences and in training personnel to strengthen those organisations;
iv. support for cooperation with local governments as regards sharing experiences, the training of personnel, the twinning of communities and cross-border cooperation;
v. aiding these two countries to adjust their educational systems and retrain workers in accordance with the needs of a market economy.
14. Other Council of Europe member states and the international community as a whole must, despite recent disappointments, fully support all of the above-mentioned efforts while encouraging Russia and Ukraine to liberalise trade and investment between themselves and with others. If indispensable liberalisation and deregulation of foreign trade and investment as required by the World Trade Organisation are realised, then this will be a crucial factor in ensuring greater openness in these fields by other Council of Europe member states, including those in the European Union. Council of Europe member states for their part should reduce protectionist measures. All sides must work steadfastly toward the "common pan-European market" called for in Assembly Resolution 1078 (1996) on the economic situation in Belarus, Russia and Ukraine.
15. Finally, the Assembly expresses its confidence that Russia and Ukraine will in time, with the support of Europe and the international community as a whole, be able to overcome their present difficulties and arrive at strengthened democracies and sustainable economic growth for the benefit of overall peace and prosperity.
II. Explanatory Memorandum by MM Telgmaa and Wielowieyski
Contents
Introduction
I. RUSSIA
The Productive Economy
Monetary Policy and Exchange Rate
Fiscal Policy, Deficit and Financing
Foreign Trade and Balance of Payments
Forecasts Prior to August 1998
The Current Russian Economic Crisis: Conclusions from the
Rapporteurs Visit in October 1998
II. UKRAINE
The Productive Economy
Monetary Policy and Exchange Rate
Fiscal Policy, Deficit and Financing
Forecast
The Current Economic Situation in Ukraine: Conclusions from the
Rapporteurs' Visit in September 1998
III. CONCLUDING REMARKS
Appendix I: Dignitaries Visited During the Rapporteurs' Visit to Russia
(28-30 October 1998) and Ukraine (28-29 September 1998)
Appendix II: The Belarus Economy
Appendix III:Economic cooperation and development among countries
of the former Soviet Union Customs Union
Unified Economic Zone
Statistical Appendix
Table 1: Russia, Productive Economy Indicators (1992-1997)
Table 2: Russia, Fiscal Operations (1992 - 1997)
Table 3: Russia, Monetary Data (1992-1997)
Table 4: Russia, Balance of Payments (1992-1997)
Table 5: Ukraine, Productive Economy Indicators (1992-1997)
Table 6: Ukraine, Fiscal Operations (1992-1996)
Table 7: Ukraine, Monetary Data (1992-1997)
Table 8: Ukraine, Balance of Payments (1992-1997)
List of abbreviations and names in the report
BRB Belarus rouble
CBR Central Bank of Russia
CIS Commonwealth of Independent States
CU Customs Union (Russia, Belarus, Kazakhstan, and Kirgizstan)
CMEA Council for Mutual Economic Assistance – the socialist common market organisation
Duma Lower House of the Russian Parliament (Federation Council is the Upper House)
EFF Extended Fund Facility – IMF credit arrangement extended approximately at market interest rates with repayment terms of 5-10 years and covering a planning period of 3-4 years.
FDIs Foreign Direct Investment
FIG Financial-industrial Group
FSU Former Soviet Union
Gazprom Natural gas exploration and distribution holding company, with the Russian Government holding 40 per cent of assets and the rest owned by management, employees, and foreign and domestic banks and companies. It is the largest Russian company with a market value of USD 32 billion, controlling around 30 per cent of world gas reserves. According to the Financial Times ranking of the world’s 500 largest enterprises, Gazprom held 91st place in 1997 (421st in 1996).
GDP Gross Domestic Product
GKO & OFZ Russian Government Treasury bills and bonds
IEC Inter-state Economic Committee of the CIS
NBB National Bank of Belarus
NBU National Bank of Ukraine
NSRA New Style Rouble Area
OTC Over-the-counter market
ROW Rest of World
Svyazinvest Telecommunication company ( monopoly); in 1997, 25 per cent of assets were sold to the consortium of ONEKSIM Bank and George Soros for the highest price ever bid in the Russian privatisation process (USD 1.8 billion).
UAH Hryvna, the Ukrainian currency which replaced the Karbovanets in September 1996
UEZ Unified Economic Zone (including Kazakhstan, Kirgizstan, and Uzbekistan)
UES United Energy System: in Russia: a state-owned electricity production and distribution company; the third largest company in Russia (after Gazprom and LUKoil); in Ukraine: a privately owned gas trading company
1. Seven years have passed since the collapse of the Soviet Union and the start of economic and political reform in Russia, Ukraine and Belarus. These countries were – in addition to the Baltic republics –supposed to be the most developed in the former Soviet Union (FSU) and to possess favourable conditions for growth, such as an educated and low-cost labour force, a developed though partly outdated industrial sector, and a favourable geographic location. Additionally, Russia is one of the richest countries with respect to mineral resources. Ukraine has a better climate and soil fertility than most European countries.
2. From a political perspective Russia, as the successor of the Soviet Union and a country with a strong national identity, was able to overcome the collapse of the old system and concentrate on economic reform. This was the foremost goal up until 1992, but after a year or two the political window of opportunity for radical economic reforms began to close. In Ukraine the political and sociological situation was less favourable than in Russia from the very beginning of transformation.
3. In adopting the Independence Declaration on August 24, 1991, Ukraine started along the road leading to independent statehood. Although democracy was chosen as the basis for political life, market economy principles were accepted as the fundament for economic life only with a certain delay. Thus, during the first few years of independence (1991-1994), there had been no unanimity among the political elite concerning the kind of economic system to be chosen. Only Leonid Kuchma’s presidential election victory in 1994 may be considered as the moment when Ukraine entered upon the road leading toward a market economy. Although there may be some reservations concerning the speed and method by which the reforms were launched by consecutive governments, the declared ambition to establish a free market economy based on the principles of private property and free competition could no longer be doubted.
4. This report in the first place evaluates the economic developments in Russia and Ukraine from 1992 and up to the present time from the perspective of the situation in the real sector of economy, monetary policy and exchange rates, fiscal policy, deficit and its financing, foreign trade and balance of payments performance, as described in separate chapters which discuss the current situation and prospects, based on the visits by the two Rapporteurs to Russia and Ukraine in the autumn of 1998. A final chapter, draws conclusions, looks to the future and evaluates the past. Finally, one appendix looks at the economic situation in Belarus and the larger issue of economic tendencies within the Commonwealth of Independent States, the Customs Union, the Unified Economic Zone, and other regional co-operation developments.
5. The Rapporteurs wish to draw attention to a previous Assembly report on this subject, drawn up within the Committee on Economic Affairs and Development and with Mr Blaauw and Mr Novāk serving as Rapporteurs. It gave rise to the Assembly’s Resolution 1078 (1996) on the economic situation in Belarus, Russia and Ukraine. That report has served as a valuable point of departure for our work. We also wish to thank the Russian and Ukraine parliament and government for their very positive and welcoming attitude to our work. We hope that whatever critical points we may be raising regarding the situation in their countries will be understood as constructive rather than destructive. Finally, our gratitude also goes to our colleagues in the
Committee on Economic Affairs and Development who during the different readings of the report made most valuable contributions to it.
6. The report uses data (see Statistical Appendix) from the national banks of Russia, Ukraine, ministries of finance, and ministries of economy of relevant countries, international organisations such as the IMF and the World Bank, as well as research papers and bulletins.
The productive economy
7. The causes behind the recent crises in Russia are multiple and well identified. During the 1992-1997 period, Russia achieved only monetary stabilisation (lower inflation and a more stable exchange rate) and partial structural reforms (liberalisation and privatisation). However, the successive budget deficits, large by any measure, reveal a permanent lack of fiscal adjustment. Large exposure to short-term debt is the direct result of unsustainable financing of the deficit. Additionally, recent political crises in connection with shake-ups of various government formations and social unrest have shaken investors’ confidence. The crisis in Asia and unfavourable conditions in international markets for energy caused Russia's underlying problems to surface more readily.
8. Economic growth in Russia was expected for years, but the economy remained stagnant until it began what threatened to become a free fall in August 1998, when the government let the rouble depreciate sharply, announced a 90-day moratorium on overseas debt and a restructuring of short-term government bonds (see Chapter IV). Prior to that, however, in the third quarter of 1997 official statistics showed the first signs of real growth, as GDP grew by 1 per cent (compared with the third quarter of 1996) and by 0.8 per cent for the whole year.1 The cumulative decline in GDP between 1990 and 1996 amounted to over 40 per cent and was one of the most severe among the countries of the FSU (excluding those involved in military conflict). The decline in industrial production slowed already in 1995-1996, and there were periods of recovery in production. However, 1997 for the first time brought increases in industrial output in all quarters, as well as a 1.9 per cent increase for the whole year (4 per cent and 5 per cent declines in 1995 and 1996, respectively).
9. Production in the principal industrial sectors (fuel, machinery, equipment, and consumer goods) has been uneven over the last few years. Generally speaking, the production of consumer goods showed the largest increases in the 1995-1997 period. Energy production strongly depends on fluctuations in world energy prices and on payment problems domestically and abroad. Production of electricity and oil stabilised during last two years. However, in 1997 there was a serious fall in the output of natural gas (about 10 per cent in the third and fourth quarters), in part due to lower domestic gas consumption in Ukraine (owing to acute financial problems).
10. The true performance of the industrial sector is concealed behind barter transactions and alternative means of payments (bills of exchange, promissory notes, or IOUs), which are widespread in the Russian economy. Barter emerged spontaneously as the shortage (or high cost) of bank credit and cash became acute, and as the latter were introduced by the Russian government to cover its debts. Banks and enterprises followed suit. Such “barterisation” of transactions resulted in massive avoidance of tax payments (as the real value of barter transactions is known only to the traders) and in the prolonged functioning of bankrupt enterprises issuing worthless commercial paper. Symptomatic of this is the fact that producers of goods of both highly tradable goods and those traded only with great difficulty are involved in barter transactions.2 Since the beginning of 1998, the payment of federal taxes in the form of goods, services, or other means besides monetary ones has been abolished. Also, utility suppliers (e.g., Gazprom, UES) have been allowed to cut debtors off, including those in the public sector. This change is of fundamental importance, as trade in energy resources is at the centre of barter transactions. If the government had remained faithful to the principles mentioned, the year of 1998 could have changed the Russian economy at both micro- and macro level. Unfortunately, this did not happen.
11. Agricultural output began increasing only at the end of 1997 (by 0.1 per cent) following a rather pronounced decline (8 per cent and 5 per cent in 1995 and 1996, respectively). Investment continued to be very modest and, again, differences for various sectors do not allow the identification of a clear trend. However, main investment indicators remained stable during 1997. However, without new capital formation it was clear that any growth would be fragile at best.
12. The Russian industrial and agricultural sectors still suffer from a lack of restructuring and a clear ownership structure. Lax budget constraints during the 1992-1995 period, combined with voucher privatisation (the only acceptable form of privatisation from a political standpoint), resulted in a slow (and unclear) formation of ownership rights and in delayed restructuring at the microeconomic level. The situation does not create a firm basis for private investment, whether domestic or foreign. In fact, FDIs in Russia are rather symbolic and increased in 1995-1997 only as big privatisation tenders for (foreign) cash were conducted to cover a fiscal gap (e.g., Svyazinvest). However, controversies among powerful groups wishing to acquire valuable state-owned assets serve to undermine political support for privatisation and reformers.
13. Since the beginning of the privatisation process in late 1992, around 120,000 enterprises have become private. Private companies (privatised and newly established) accounted for 70 per cent of all enterprises and over 70 per cent of GDP at the end of 1997.3 Various methods of privatisation include (in order of popularity): buyouts of leased property, allocation of a portion of shares to employees and management (placing the rest of them on the stock market), and commercial tenders that favour the highest bidder but include certain conditions, for instance in the social field. The first two methods were designed for insiders to take effective control over their enterprises. The last is most often used for the sale of large and valuable companies and also, most often, a cause for two-dimensional political struggles – between the government and parliament, and among Financial-Industrial Groups (FIGs). The pace of the privatisation process slowed down as the total amount of private firms stabilised after 1995. The same is true for the unemployment rate (around 9 percent since 1995, using ILO definitions, even though the situation is now deteriorating). The political and social burden of state-owned enterprises in need of financing postpones private take-overs and the formation of newly established private businesses that capable of absorb the unemployed.4
14. The government recently took some liberalisation measures to foster privatisation, even as the Lower House, the Duma, did its utmost to postpone them. The presidential decree of November 1997 removed the 15 per cent limit on foreign stakes in Russian oil companies. The reason is a desire to attract additional revenue through share auctions, and to restructure several oil companies (e.g., Slavneft, LUKoil, NORSI-OIL, Tyumen Oil Company, Rosneft) which possess rich oil pools, although the latter are often geologically and environmentally devastated through excessive use. Although these companies seem attractive at a first glance, they require massive investment. Additionally, record-low crude oil prices and the continued fall in the Russian stock market (due to the Asian crisis and the events of the summer of 1998) may make potential investors reluctant to offer a price satisfactory to Russian authorities.
15. The privatisation of land is still a problem, not least because of severe opposition in parts of the parliament (mostly the Duma). In mid-1997, President Yeltsin used his veto and left unsigned a conservative draft land code, which would have prevented the purchase and sale of land. As agreed earlier in “round table” discussions involving the parliament and government, any proposal would have to ban the use of agricultural land for other purposes and limit the right of foreigners to own land; on the other hand, the process of land purchases would have become more transparent. Finally, in May 1998, the Federation Council the parliament (the Upper House) passed the land code, overriding a presidential veto. This being said, private land ownership is spreading in the Russian regions. In April 1998, the Tatarstan Republic – following the Saratov and Samara regions – approved its own land code with liberal ownership rights, overriding the federal legislation. (In these regions, foreigners are allowed to lease land.)
16. The Russian Federation consists of the 89 administrative units: 21 republics; 55 ordinary Russian provinces (oblasts or krais); 11 autonomous oblasts or okrugs; and the two cities of Moscow and St. Petersburg. The chain of events leading to the present legislative and administrative sharing of power between the centre (Moscow) and the regions has its origin in Boris Yeltsin’s fight (then Chairman of the Parliament of the Russian Republic) against Mikhail Gorbachev (then President of the Soviet Union). Mr Yeltsin suggested that territorial units of the FSU should try to acquire all the power they could in an effort to undermine Mikhail Gorbachev. The competition between the USSR parliament and the Russian parliament, both of which vied for jurisdictional control over enterprises, led to the offering of reductions on tax rates or exemptions from them. The second factor was a decentralised process of privatisation which consolidated the power of regional élites. At present, the federal government uses carrots and sticks in dealing with enterprises and provincial governments. Moscow cannot directly challenge any territorial unit for fear of provoking separatist sentiment. Instead, the presidential administration monitor events in each province. The existence of an elected President (in the republics) and Governors (in the other provinces) complicates relations between the centre and regions, since these officials have extensive powers. (These are either poorly defined or not mentioned in the Constitution). Currently, the federal authorities attempt to sign bilateral treaties on the sharing of responsibilities with various provincial governments.)
17. Russia’s FIGs (Financial-Industrial Groups) fall into two categories: bank-led and industry-led. FIGs are defined as legal entities that pool assets in order to pursue technological or economic integration, with a view to increase efficiency, jobs and competitiveness. FIGs were originally introduced by presidential decree in 1993. Subsequently, a federal law of November 1995 established the basis for FIG registration and activities. More broadly, FIGs are holding companies connecting financial institutions with enterprises (and vice versa). An elite group of bank-led FIGs have become prominent in the Russian economy and have certain features: a single, powerful “baron” as a leader; a top-rated banking or financial institution that forms the core of the holding company; and an “empire” of financial and industrial holdings. FIGs enjoy close relations with the government.5 FIGs were supposed to receive special benefits, including tax breaks, state share transfers, government loan guarantees, lower reserve requirements for FIG banks, and privileged access to state investment projects. However, due to budgetary difficulties, the government claims that it cannot afford to grant these benefits. On the other hand, the state holds stakes in some FIGs. At present, “state” FIGs are moving away from active state-led management and are managing state shares in trusts. Many FIGs received government stakes under the “loans-for-shares” privatisation programme, under which the government granted them the right to manage state stakes in return for loans (which were perhaps never meant to be returned). The impact of FIGs is difficult to measure, as most of their activities are unregistered. The contribution to GDP of registered FIGs is equally unclear, with estimates ranging from less than 1 percent to 10 percent of GDP. The total capital of bank FIGs accounts for nearly half of the total Russian bank capital, but represents less than 1 percent of GDP. They are clearly not able to fill Russia’s need for capital and are not likely to generate broad economic growth, though in some cases they have been actively reconstructing their major components.
18. Industry-led FIGs differ markedly from the elite group of bank-led FIGs, and competition between these two has been intensifying although there are also examples of close co-operation. The Association of (industry-led) FIGs estimates that, in addition to the 72 officially registered FIGs, there are some 110 unofficial FIGs. The main sectors include aviation, agribusiness, metallurgy, machine building, automobiles, appliances, textiles, and construction. Industry-led FIGs are also perceived as a means to re-establish Soviet-era production links across present national borders. (The merger of the Yaroslavl motor building complex and the Belarus truck and tractor producers created one such widely mentioned trans-national FIG. It remains to be seen, however, whether the two companies will be able to solve their difficulties through this merger.)
19. The establishment of new financial and/or industrial holdings may not the best way to reform the monopolistic or oligopolistic sectors in the Russian economy. It is not only a matter of the degree of concentration (as measured in output, employment or assets) among the largest four or fewer firms. A large number of products are manufactured only in a single enterprise in the whole of Russia. Additionally, these enterprises are highly vertically integrated, a heritage from the uncertainties and chronic shortages of the old Soviet supply system. Large public monopolies or oligopolies have often simply been turned into large private ones. These now work closely with the government, trying to raise barriers against the entry of new (domestic or foreign) competitors. Therefore, the problems are fundamentally and manifestly political, and official anti-monopoly policies have little effect.
20. Close ties between the government and business sectors in Russia (and other FSU countries) have a long tradition. During Soviet days, government officials formed partnerships which controlled lucrative “black” or “grey” markets. Indeed, the entire Soviet system had long operated with a flourishing unofficial market, supervised and controlled by groups of corrupt officials, black-marketers and common criminals. (Russians first began to use the word “Mafiya” in the 1970s and 1980s to describe the large networks of corruption inside regional and central government ministers.) Regional communist party chiefs often became chieftains overseeing criminal networks. Even today some politicians are not entirely free from such connections. A number of deputies and high ranked government officials have even been killed or injured in gang-style shootings. Some have run for office to avoid prison sentences.
21. Finally, it is worthwhile to look at the demand side of the Russian economy. Declining government consumption – forced about by weak revenue and attempts to reduce the fiscal deficit - was offset by rising household consumption spurred by the payment of government wage and pension arrears in 1997. And the slowdown in inflation since 1995 pushed real incomes higher. Increased household spending raised the demand for goods and services (registered and unregistered GDP growth) at home as well as abroad (bringing the current account deficit to record levels, as will be shown below).
Monetary Policy and Exchange Rate
22. In 1995, contrary to the years preceding, the Russian Government decided to switch from money-based to exchange-rate-based stabilisation and announced a fluctuation band for the rouble. The latter is perceived as a more effective stabilisation instrument, but for its functioning it requires macroeconomic fundamentals to be in order. In 1992-1994, both expansionist monetary policies by the central bank (financing of the rouble zone till mid-1993, plus “standard” credits to industrial and agricultural sectors) and huge budget deficits monetised by the central bank served to fuel inflation. In 1993, so-called ‘broad money’ (M2) increased by 287 per cent; currency in circulation soared by 540 per cent; and CPI inflation amounted to 843 per cent. In 1995, a reduction in budget subsidies and the fiscal deficit, together with a tightening of monetary policy (broad money went up by 113 per cent compared to 217 per cent in 1994), helped lower inflation to 131 per cent. In 1997, broad money and CPI inflation fell to 30 per cent and 11 per cent, respectively.
23. Until the fourth quarter of 1995, the main factor behind reserve money creation was the increase in domestic credit, mostly to the government to finance the budget deficit (either through direct credits or through purchases of government bonds by the CBR). As the exchange rate was pegged and the budget deficit cut to single digits (although arrears soared), inflation went down and short-term capital started to flow into the country. As a result, in 1996-1997 foreign investors, attracted by high real interest rates, replaced the CBR as holders of government paper. Most of these inflows from abroad went ‘unsterilised’, as the budget deficit increased again in 1996. However, more often the CBR ‘sterilised’ the outflows, increasing domestic credit (to the government), especially in the second halves of 1996 and 1997.
24. After 1995, money demand appears to have at least stabilised, and in 1997 it increased. The monetised portion of the Russian economy is still based on cash, although monetisation6 is very modest (in 1995-1997, it stood at only about 13 per cent of GDP). (Demonetisation and remonetisation are highly asymmetric processes, and lower inflation in 1996-1997 does not automatically lead to a growth in money demand and remonetisation of the Russian economy. Conversely, in 1992 high inflation lowered money demand and monetisation of the economy.) Hence, any increases in money supply without growth in real output or at least in money demand lead to price hikes. Through 1994-1996, total savings remained very limited, at 4 per cent of GDP. In 1997, monetary indicators suggest transaction demand in line with the growth in consumption and output, but decreased savings (3.4 per cent from 4.3 per cent of GDP in 1996).
25. Large external inflows helped to slow down the rouble’s nominal depreciation (21 per cent and 6 per cent in 1996 and 1997, respectively, compared with 44 per cent in 1995). The loss in external competitiveness is balanced by growing labour productivity but also by the non-payment of wages and inter-enterprise arrears. Besides, exports consist mostly of primary products (see below). In November 1997 (following the financial turmoil spreading from Asia), the authorities announced the widening of the rouble fluctuation band to +/- 15 per cent, from 5 per cent. The new regime, together with a re-denomination of the currency (the dropping of three zeros) went ahead on January 1, 1998. The band now had a lower limit of 5.25 rouble per USD and an upper limit of 7.15 rouble per USD. The mid-points of the band at 6.1 rouble per USD and 6.2 rouble per USD were set for 1998 and 1999, respectively, until a much wider band for fluctuations was set in August, 1998.
26. In 1996-1997, an inflow of foreign capital boosted equity prices in Russia. The Russian Trading System Index increased in rouble terms from 197.9 to 396.9 during 1997. Considering the real appreciation of the rouble, this represented a doubling of profits in USD. The number of companies listed on the Russian Trading System reached over 170 at the end of 1997, but most of the trade remains centred in two dozen ‘blue chip’ companies (mostly in energy, oil, and mining) accounting for one-third of the market capitalisation. The equity market development is, however, hampered by serious organisational and regulatory deficiencies, in particular weak supervision and excessively decentralised share registries.7 Struggles between the CBR and the Federal Commission for the Securities Market over the former, and among financial groups to take control over the latter (registration of equity trade), raise doubts as to the chances for any radical improvement in the situation. In the meantime, any crisis started by financial turmoil in the world, as at present, will trigger the withdrawal of capital by foreign investors and put pressure on the CBR foreign reserves and the rouble exchange rate.
27. The banking system in Russia (and Ukraine) did not face foreign competition due to the legislation in place. The system remains undercapitalised and poorly supervised, as the number of banks is too high (almost 1,700 in Russia and 180 in Ukraine), and as they are not obliged to report according to the so-called International Accounting Standards. Banks are also overburdened by non-performing loans, and they face a series of risks, including those involved in foreign exchange, as Russian and Ukrainian banks have borrowed heavily in the syndicated loans and Eurobond markets to invest in domestic assets and lend to the private sector. As a result, today their foreign liabilities exceed foreign assets, increasing the risk of bankruptcy. Obviously, a sound banking system could have attracted deposits from individuals as well as companies, increasing remonetisation (and decreasing dollarisation) of the domestic economy.
Fiscal Policy, Deficit and Financing
28. Fiscal policy remains the weakest link in the chain when it comes to the stabilisation programmes in Russia (and Ukraine). Firstly, however, one should make a distinction between the performance of the federal budget and that of the general government budget.8 Revenue in the federal budget remains relatively constant - though it has declined somewhat since reforms began (from 16.6 per cent to 12.1 per cent of GDP in 1992 and 1997, respectively) . General government revenue declined more sharply – from 41.6 per cent in 1992 to 31.8 per cent in 1997. (This is still, however, large compared with countries with a similar per capita income). Hence, one problem with the Russian budget lies in the level of expenditure and in unrealistic estimates of budget revenue. On the expenditure side, two burdens are the heaviest: the cost of debt servicing borne by the federal government and regional budget subsidies to enterprises and municipal services.
29. Russia made some progress in designing a tax system suited to a market economy, in introducing personal income taxation, in replacing profit remittances with corporate income taxes and in substituting VAT for complex turnover taxes. However, the tax system suffers from a number of methodological and political weaknesses. Massive tax non-compliance by the largest and most politically sensitive state or quasi-state enterprises is the best example of the former. As for the latter, VAT is collected on cash rather than on an accrual basis, and different sectors are treated differently. Hence, unfinished tax reform and administrative problems have contributed to serious difficulties in collecting revenue. Additionally, the use of tax offsets instead of cash revenue collection has reduced fiscal discipline. (It was one reason why the IMF suspended disbursements of funds in October 1997).
30. Fiscal imbalance continue to plague some transition economies. It crowds out resources from investment; and when deficits persist it leads to a build-up of debt, whose may eventually become unsustainable and lead to macroeconomic instability. (The high share of foreign portfolio investors on the government bond market makes the exchange rate volatile and vulnerable in serious crises). The fiscal deficits in Russia were and are high by any standard. After 1994, when the federal government deficit reached 10.6 per cent of GDP, it fell to single digit levels but remained in the range of 5-7 per cent of GDP until the events of August 1998 (Primary deficits amounted to about 2 per cent of GDP from 1995 to 1997).9
31. At the top of the fiscal gap there is a problem of budget arrears (inter-enterprise arrears are huge and growing). Arrears began to grow together with fiscal ‘tightening’ in 1995. Despite considerable money transfers to the regions at the end of 1997, public sector arrears were not paid off (as required by the Russian President). At the end of 1997, the amount of wage arrears was estimated at 49 billion roubles. The problem was particularly acute in some regions. For example, coal miners demanded unpaid wages estimated at 3.6 billion roubles, but the government maintained that only about a third of this sum could be considered as being owed by the state, the rest being a debt by (private) mines to miners. And the lack of transparent ownership structure, resulting from the privatisation methods chosen, does not allow for proper evaluation of government arrears.
32. Financing of the budget deficit through the sale of highly attractive government bonds (GKO & OFZ) to domestic and foreign investors helped lower inflation and increase CBR reserves (USD 20 billion in mid-1997, but only USD 14 billion in May 1998). Purchases of GKOs by foreign investors were higher than for Eurobond issuance. Total foreign holdings of domestic government papers can only be estimated. (In addition to the official “S” account system for investment in government paper, so-called “grey account” schemes exist.) Data indicate that they held about 30-35 per cent of the market in mid-1997 (about USD 14 billion). At the end of 1997, total public debt was not high in Russia compared to other countries: around 42 per cent of GDP or USD 200 billion (USD 130 billion and USD 70 billion in foreign and domestic borrowing, respectively). However, the average maturity of GKOs issued is close to one year and can hardly be increased. And fluctuations in yields due to external and internal factors raise the cost of debt servicing, making short-term crediting difficult. The seriousness of the situation is illustrated by the fact that the government must raise an average 8 billion roubles (USD 1.3 billion) each week in the second half of 1998 in order to roll over existing GKO & OFZ debt as it matures.
33. In the fourth quarter of 1997, the Russian government finally reached agreement with the London Club to reschedule the repayment of debt contracted in Soviet times (Russia assumed all liabilities of the Soviet Union). The deal rescheduled USD 24 billion of principal payments over 25 years with a 7-year grace period, and USD 8 billion of overdue interest over 20 years (Russia was obliged to make a down payment of USD 3 billion in December 1997). In September 1997, Russia also became a full member of the Paris Club. By August 1998, as we shall see, the situation worsened considerably.
Foreign Trade and Balance of Payments
34. The gradual dismantling of the restrictive export regime (centralised management, quotas, licensing or registration of contracts, taxes and fees) and the substitution of multiple exchange rates for the system of import restrictions (licensing) did not change foreign trade as much as one might have expected.10 A few factors influence the Russian balance-of-trade situation. Firstly, the break-up of inter-republican ties and of the Council for Mutual Economic Assistance (CMEA or Comecon) resulted in a shift of exports of primary products (mostly energy) from the transition countries to the rest of the world (ROW). Because of the (partial) liberalisation in foreign trade and the declining in the home market, overall exports grew after 1992. Also, price liberalisation in trade with the FSU countries increased the value of exports by 70 per cent from 1992 to 1997 (a 60 per cent increase with respect to ROW). Secondly, overall imports, after falling in 1993 to USD 44 billion, recovered and started to increase. Interestingly enough, the growth was more pronounced in Russia’s trade with the other FSU countries than in its trade with ROW countries (almost a 200 per cent versus 8 per cent in the 1992-1996 period). In 1997, the trends both in exports and imports changed. Stronger growth in imports (from ROW) and stagnant exports (largely due to a decline in oil prices) coupled with higher interest payments narrowed the current-account surplus from USD 11.7 billion in 1996 to USD 3.3 billion in 1997.
35. In the 1992-1997 period, almost half of Russian exports in value terms came from fossil fuels (oil, gas and coal). The growth in the volume of exports of mineral resources to ROW countries and better prices in the trade with FSU countries did not, however, result in any major increase in export earnings. The growth in the volume of oil exports occurred at a time of decline in its extraction; thus, the share of exports of the total oil production increased only a little (from 23 per cent in 1993 to 28 per cent in 1996). Growing demand for natural gas from EU and CEE countries served to reduce the problems caused by unpaid gas deliveries to some FSU countries, especially Ukraine. The growth of export of coal at the end of 1993 (following the liberalisation of coal prices) slowed down already in 1994, in part because of an increase in transport fares in Russia.
36. During the period 1992-1997, Russian exports became less diversified and more vulnerable to commodity price fluctuations, with a growing share of fossil fuels and declining proportion of manufactured goods. (The share of minerals and metals in total exports increased to 62 per cent in 1997 from 58 per cent in 1991).11 Already in the late 1980s this tendency was observed, as Russian exports of armaments to eastern European and developing countries started to decline. The reduction in budgetary subsidies beginning in 1992, together with difficulties in the conversion of defence-related enterprises toward civilian production, resulted in a fall in the export of machines and equipment to ROW. Hence, the FSU markets are now becoming more attractive for Russian industrial producers.
37. At USD 30 billion, the Russian net capital outflow in 1994 was the highest in the whole 1992-1997 period. However the “errors and omissions” position in the balance of payments would lead us to be cautious in drawing conclusions (see footnote 10). The capital outflow resulted mainly from a large capital flight out of Russia, but also from a fall in disbursements, rising amortisation payments, and a continuing build-up of inter-enterprise arrears. The latter factor was especially significant for the energy products supplied to the FSU countries. On the other hand, capital outflow represents not only capital flight from Russia, but also prepayments for import, often illegal (e.g., evasion of duties and taxes, non-fulfilment of administrative regulations or avoiding other ‘bottlenecks’ in trade). There was also a growing “shuttle” import financed entirely by cash transactions. The inflow of foreign direct investments grew, but remained modest relative to the country's size (It did, however, double from USD 1.7 billion in 1995 to USD 3.7 billion in 1997). In 1997, the overall balance of payments improved, showing a surplus of USD 16.4 billion (a deficit of USD 22.7 billion in 1996), as a huge short-term capital inflow took place.
Forecasts prior to August 1998
38. The Russian President and government have made deficit reduction a priority for the coming years. The budget for 1998 set the deficit at 4.7 per cent of GDP, with expenditure at about 500 billion roubles and revenue at about 368 billion roubles (CPI inflation 5.7 per cent). While the government subsequently announced that both figures were unrealistic, it said it would nevertheless try to keep the deficit around the projected level. This was deemed feasible, at least in theory, since the government can limit its expenditure on the basis of received revenue.
39. In May 1998, President Yeltsin announced an action plan for the years 1998-2001, containing twelve priorities.12 The main points of the plan, worked out in detail by the then Prime Minister Kiriyenko and presented to the Parliament as a package of 21 laws in June 1998, supported the goals set in co-operation with the IMF – the latter having agreed on a one-year continuation of a USD 10.2 billion EFF Agreement until early 2000. Originally, the agreement covered the years 1996-1998. The extended EFF has not yet been published, but it most likely includes: a reduction in the federal deficit; scrutiny of (large) companies with considerable tax arrears; cutting low-priority programmes and tightening control over budget expenditure; an increase in the transparency of energy and transport monopolies; and continuing privatisation. Finally, improved monitoring of financial markets and the banking sector (bank supervision) was held out.13
40. When the Rapporteurs weighed the situation in Russia in the early summer of 1998, it seemed to them that the country might avoid further crises if two conditions (endogenous and exogenous) were met; namely, that the government observed fiscal responsibility and managed to reduce the primary budget deficit to close to already in 1998, and that (foreign) creditors would not lose faith in the progress of reform. On the basis of these assumptions – of course belied by the events of the late summer of 1998 – we drew up two main scenarios. In an optimistic scenario we forecast zero primary deficit starting from 1998, a measure which would lower inflation and nominal (and real) interest rates. Also, we recommended that over the next few years, a primary surplus be reached in order to stabilise the costs of servicing debt. Obviously, lowering the deficit would have required a fundamental fiscal reform, with expenditure cuts and the phasing out of all tax privileges being a priority, especially as we deemed significant improvements in tax collection to be rather unlikely, at least in the short-term. Successful fiscal adjustment would have lowered the cost to the budget of domestic and foreign debt servicing (lowering the yield and lengthening average maturity of debt instruments). Any significant improvement of the fiscal stance of Russia would have been a sign of seriously meant stabilisation efforts.
41. However, already by the early summer we though that a more pessimistic scenario was more probable than the optimistic one - and even that turn of events now has turned out to have been too hopeful. Our assumptions differed only with respect to the size of the primary deficit, its sources of financing, and interest rates. The difference in the figures of the optimistic and the pessimistic scenarios were not very large. In the pessimistic one, an increased primary deficit (2-3 per cent of GDP) was forecast to trigger higher interest rates on government paper, increasing the cost of debt service in the budget. We also feared that this scenario could switch to a very pessimistic one if the above assumptions were not met; for then there would have been a danger of default as revenues from GKO/OFZ did not cover current budget expenditures on its roll-over; as deficit financing would have caused foreign investors to leave the Russian markets; and as increasing pressure on the rouble would have lead to devaluation. We believed that the CBR would be able in this case to prevent a rouble devaluation and a government default on T-bills only at the expense of interventions in the foreign exchange market (selling foreign currency reserves) and in the bond market (rolling over GKOs), respectively. We pinned our hope on the determination of the Russian government and the CBR to maintain the rouble band, as the exchange rate is here the only anti-inflationary anchor. We knew that if significant devaluation occurred, inflation would soar very quickly, fuelled by rigid structure of import (mostly consumer goods) and a flight from the domestic currency (repeated demonetisation). The domestic banking sector would be severely affected, as foreign exchange exposure would become unsustainable. And the whole stabilisation effort would be over immediately, with all the political consequences thereof. Alas, this last, most pessimistic scenario, which we did not wish to put down on paper in our earlier draft of this report, has now come true in more or less unmodified form.
The Current Russian Economic Crisis. Conclusions from the Rapporteurs' Visit to Russia in October 1998.
The financial crisis of 17 August
42. The Rapporteurs visited Moscow at the end of October 1998 at the kind invitation of the Russian Parliament. They were very well received by their Russian hosts and wish to express their gratitude to the Parliament and to the Russian government for the very full exchanges of views they were able to have with leading representatives. (For the various meetings, see Appendix I).
43. The visit took place two months after the financial crisis that occurred on 17 August 1998 and only a few days before the so-called "Anti-Crisis Programme" presented by the Russian government and the central bank on 31 October.
44. The August Crisis, it will be recalled, was the decision by the Russian government to allow the value of the rouble to fall and to declare a moratorium on some government debt, including debt to foreign lenders amounting to 17.7 billion dollars. That became unavoidable as it became clear to everyone that Russia was spending vastly more than its budget would permit, and that the value of the rouble could no longer be defended against those Russians and foreigners alike who had lost faith in the stewardship of the country's economy. Paradoxically – demonstrating the lack of information given or sought - it happened only a month after the international community, through the IMF and others, had prepared a $22.6 billion rescue effort. (However, some of our interlocutors insisted that the 17 August decision was taken by a small group of people surrounding the President, and that the parliament had not been consulted.)
45. There were of course external contributing factors behind the events in Russia. The financial crisis in Asia drove investors away from all emerging markets including that of Russia. World-wide demand for oil and gas, where Russia is a major exporter, sank, leading to depressed prices and hence reduced export income. (Indeed, Russia's production suffers from problems related to depletion of certain oil and gas fields, leaks in pipelines and waste in domestic consumption. This further reduces profits, especially at times of depressed prices.)
46. However, the underlying domestic causes for the crisis were, on the one hand, legerdemain governmental borrowing from Russia’s own citizens and from abroad (and the even more legerdemain use of those funds) and, on the other, the inability of various governments over the years to finance the budget. To cover the gap, the government started borrowing heavily, and on increasingly short-term conditions. As long-term funds, including from the IMF, started to be used to pay back short-term debt come due, it was clear that the situation could not last.
47. The Anti-Crisis Programme presented by the Russian government after close consultation with the Parliament on 31 October 1998 was no doubt intended to facilitate new IMF and World Bank loans. The programme centres on added financial support to the population such as the payment of salary, pension and social arrears; tax cuts in particular for industry; and the printing of about 20 billion roubles in new money. Neither the IMF nor international markets seem sufficiently happy about what they no doubt consider too timid an effort and the absence of a coherent strategy to overcome the crisis. No doubt, therefore, the government and the Parliament will have to go back to the drawing board and present new versions more capable of winning the trust of foreign creditors.
48. The August Crisis and its continuation in September and October thus formed the background to the Rapporteurs’ visit. (Since August, GDP has sunk by 16%, real incomes by 11% and imports by 75%). Today the difficult choice is between, on the one hand, rapid reform at the risk of causing temporary social and political destabilisation and, on the other, no meaningful reform, eventually leading to much higher cost to Russia and the world.
49. If the Rapporteurs were to try to sum up the Russian economic dilemma in a single paragraph, it would look somewhat as follows:
— a crippling foreign debt coming due in the very near future;
— an inability to cover a major and rapidly growing budget deficit, due both to too high a level of expenditure and insufficient tax income, the latter resulting from the contraction of the tax base, the general lack of resources on the part of broad layers of the population and insufficient tax collection capabilities;
— finally, as if the above were not enough, a disastrous 1998 harvest due to inclement weather, conjuring up the prospect of serious food shortages as the winter approaches; a lack of privatisation and modernisation of management in agriculture (still today, the largest share of agricultural production is produced by quasi-state-owned farms).
Let us look at these and related issues in turn.
50. Clearly the debt burden issue was foremost on the minds of all our very competent interlocutors, who really did their utmost to portray the situation and its causes fairly. Some 3.5 billion dollars will have to be repaid in late 1998, and 17.5 billion dollars in the course of next year. None of our partners was able to state the total level of public and private debt with exactitude, however. One gave the total as about 150 billion dollars, while another put the figure at up towards 180 billion. A third held that, of that sum, only about 25 billion was still in Russia and the rest in safe havens abroad. About 70 billion dollars in debt were said to have been inherited from the Soviet Union, a sum which in the meantime is to have grown to about 100 billion. Government borrowing since the restoration of Russia was reported at about 50 billion dollars; and it was said to have been used essentially to cover budget deficits over the years, or to have disappeared.
51. Further complicating the situation is the fact that there has been no oversight by the Central Bank over the use by private banks of the money they had borrowed, even as they began increasingly to prefer government bonds, so called GKOs, over investments in the productive sector. At the centre of Russia's financial difficulties therefore stands its inability so far to develop a government budget separated from the central bank and the private sector, including banks. There has been only one common pot, one budget, one credit card, so to speak, used for all transactions. All losses and debts have been passed back to federal budget and the central bank. A proper bankruptcy legislation is therefore urgently needed, as is a clear-cut separation between different economic actors. The government now foresees the nationalisation of a fairly large number of banks in difficulty. Banks with predominant or exclusive foreign capital will apparently not be affected.
52. It would be wrong to view all Russian banks as being in the same desperate situation. We were told that big banks in particular are in trouble, as they had, so to speak, placed all their eggs in the GKO, or government bond, basket. Smaller banks, especially in the provinces, have, we were told, invested much more in productive assets and may therefore be in better shape. If, however, the government chooses the inflationary path, these latter banks will of course also be affected through an erosion of their monetary assets. There has therefore been a tendency in the provinces and in provincial banks, since the August events, to dissociate themselves from the centre.
Insufficient tax collection and its reasons
53. If Russia had not assumed so much foreign debt, it would have stood a much better chance of covering its by now yawning budget deficit. Against an expected revenue for the last quarter of 1998 of 65 billion roubles stands minimum expenditure of 135 billion roubles. To cover the 70 billion shortfall, the government is planning an increase in excise taxes for commodities such as alcohol, and an export tax on raw materials (which can now be sold at particularly favourable prices given the 65% depreciation of the rouble since August). If a 2.5 billion dollar loan could be obtained from the IMF, the gap could be covered, so our interlocutors assured us. The question is only: for how long?
54. There are three main reasons why an already scanty tax collection can be improved only marginally under the present circumstances. Firstly, people are too poor to be taxed additionally on their income. Income taxes are in any case less than 10% of total revenue. We were told that between 50% and 70% of the population are now below the poverty line.
55. Secondly, the barter economy accounts for almost half of the economy, in particular in transactions between companies. One interlocutor maintained that only one-fifth of all transactions are in cash, while another said that the value of all transactions in Russia amount to three times the amount of money in circulation. Apart from being slow and cumbersome - as traders try to assess the value of, say, a tonne of steel against a tonne of coal - the tax collector cannot be expected to carry any of either away with him. Additionally, barter provides a poor basis indeed for statistics, without which economic policies become exceedingly difficult to shape.
56. Undeterred by the above, however, the tax authorities now wish to introduce a new programme meant to simplify the system, ease the taxes on profits from 35% to 30% in order to stimulate production, keep a better check on the doings of the tax administration and punish tax evasion more severely. They hope in this way to be able to increase tax revenue by 10% in 1999 over 1998 (and maintains that tax collection in October 1998 was up by 5.67 billion roubles over that in September). However, they have not yet been able to introduce the more modern system of collecting VAT on an accrued rather than cash basis. This is a major drawback.
57. Of course, there are still dollars in Russia, although, today, less in banks and companies. Russian citizens are reported to hold about 30 billion dollars in cash in reserve for hard times. Many of our speaking partners were searching for ways of mobilising this money for the country's good. However, before Russians can be persuaded to go along, inflation will have to come down considerably and trust restored.
58. A third reason for poor tax collection is a shadow economy, which some of our interlocutors claimed represents about 45% of the official one. Though not healthy from the tax collection and budget deficit points of view, such a large shadow economy would nevertheless suggest that the Russia’s real economy may not be as ailing as official figures would indicate.
59. Covering the budget deficit is rendered more difficult by a level of expenditure which many of our interlocutors consider, if not too high, then at least slanted. Some referred to defence, which was allowed to grow excessively during the Soviet era but now appears to cost far too much in relation to the security needs of the country. Our interlocutors pointed to the some 200 recipient categories for social support, the approximately 1,000 types of payments involved and the 100 million people in Russia who receive assistance in one form or another. 350 billion roubles were reported to be given in total social support each year, whereas one of our Russian hosts suspected that only about a fifth of the money actually reaches the truly needy. The system is clearly not rational and it is extremely complicated. Any changes to it risk provoking great resistance. They thus called for close cooperation with other countries and international institutions in order to streamline procedures.
60. Inter-company arrears are a problem both for tax collectors and for the survival of the companies concerned. One parliamentary colleague told us that a footwear factory in his constituency had received a major order from the government on behalf of the army. The factory obtained the necessary credits from the local bank, bought the raw materials and fabricated the shoes. However, on the day of payment it learnt that there was no room for it in the state budget. Out interlocutor, who was in principle against any easy printing of new money, at this stage threw up his hands and said that he would rather have new money that no money at all for the factory in question.
61. Many of the people we spoke to saw no way out other than renewed borrowing from abroad, with the IMF and possibly the World Bank as the only likely lenders remaining (if one excepts humanitarian aid where other donors are already appearing). The IMF, which had prepared a 22.6 billion rescue effort in the summer of 1998, is still holding back on a first instalment of 4.3 billion dollars while waiting for bolder reform. The World Bank for its part, as of late October 1998, was still delaying a 500 million dollar loan for social purposes and another of 200 million dollars to restructure the coal industry. However, at least one of our partners said he was against any more foreign borrowing. If such borrowing was undertaken, he argued, why should the state guarantee it?
62. In a meeting with economic forecasters, we were told of three scenarios for 1999: the first, assuming IMF assistance, foresees a decrease of GDP of 3% and an inflation of 25-30%. The two other scenarios – that which forecasts the suspension in the issuing of credits (second scenario) and that which foresees the absence of support from the IMF (third scenario) - are of course much worse.
Inflation
63. The printing of new money will deter foreign creditors and investors, and many of our interlocutors said they were also against it on principle. However, they also saw no alternative, given the budget deficit.
64. Inflation after 1992 appears driven both by the printing of new money unmet by productivity increases and by the scarcity of goods. Furthermore, if inflation/depreciation helps exports, it also drives up inflation by making imports more expensive. Given Russia’s heavy orientation towards raw materials and semi- manufactures (even though Russia is also a leader in certain fields such as space technology), the Russian economy through this becomes extremely sensitive to any fall in the prices of such products. Thus, any world recession will reduce export earnings, and there is little in the way of a vibrant domestic economy to keep the wheels turning, as is the case in, say, the United States or even China. Meanwhile, since so many daily necessities, including food, have to be imported, inflation increases even more.
65. Even though currency depreciation/inflation will reduce the domestic debt expressed in roubles, it will also make it more expensive to repay the foreign debt, However, some emission of new money in the months to come seems likely, perhaps amounting to the 20 billion roubles announced in late October 1998. There could also be a so-called "cold emission", in that old rouble bills, officially withdrawn from the market and supposedly destroyed, may be furtively sluiced into it again. There are reports that this is already happening. At any rate, even a 20 billion rouble emission would be a small in comparison with the enormous accumulated and future financial obligations of the government. All in all, whether the stated goal told to us of containing inflation to below 5% per month in 1998 and below 30% in 1999 can be realised remains highly questionable.
66. Some of our interlocutors said the new emissions can only be avoided if loans are obtained from abroad to the tune of about 7 billion dollars in 1998 and 10-12 billion dollars in 1999. Alternatively, and this call was made by almost all our partners, foreign creditors should accept a restructuring of the debt.
Government arrears vis-ā-vis citizens
67. Governmental arrears to citizens were set to total about 100 billion roubles. Categories include soldiers, teachers, doctors and state-funded workers. Salary arrears were reported to stand at 80 billion roubles: 20 billion from the budget deficit and 60 billion due to non-payment by state-owned companies. Add to this that many payments have to travel long distances by rail or by road across the vastest country on earth. In 60 of the country's 89 political regions, more than one thousand mail cars stuffed with up to 18 tonnes of letters, newspapers and parcels have been side-tracked, the reason being that the Ministry of Railways refuses to carry more mail until the Post Service makes good on 210 million roubles in debt. Although the government says it remains determined to acquit itself of the arrears as soon as possible, but it is uncertain whether and how this can be done in the present circumstances, except through the printing of new money uncovered by government revenue.
68. Many employees affected by arrears stay in their jobs in the hope of eventually being paid and out of fear of not being able to regain their employment if they leave. The Ministry of Employment estimates the number of unemployed at around 8.5 million people, or 11.5% of the workforce. Only 1.75 million of these receive unemployment benefits. The discrepancy between the two figures may be explained by the fact that millions of people refrain from notifying the authorities of their predicament. 60% of the unemployed are women. The most affected groups are young people, the handicapped and former army recruits.
69. Some observers hold that there are in fact four different Russias. The first is the Russia of the big cities, where many young people have tasted change and like it. A second is that of the older people in big cities. They are often against change and nostalgic of the past, but not actively resisting change. A third Russia is that of older people in smaller cities and rural areas. They are generally in a more passive state. Finally, a "fourth Russia" is that of young people in rural areas who are against everything, frustrated without hope. Palermo is thus very close to the Russian provinces, especially in the case of the young. Social aid for Russia and Ukraine must take into consideration not only the immediate needs of the population. Both countries need long-term cooperation in the fight against marginalisation and social exclusion, especially in rural areas and small towns with millions of people. It will be one of Europe's most important and difficult challenges in the coming years to help these people integrate into society and give them new hope.
70. As the Rapporteurs began working on their report in the summer of 1998, they felt that one important cause behind the crisis in Russia was the political situation in the country. By this they meant the seeming inability of those who govern to take true responsibility for the situation; to reach the kind of compromises that are the linchpin of wise government and democracy; and perhaps even a feeling among part of the élite in the country that the rest of the world would not let the situation get out of hand out of fear for the gruesome alternatives to Russian democracy as it stood.
71. Indeed, during the summer we felt that there was a kind of ‘lobotomy’, as it were, in the Russian government, as between the president and the parliament; that there was no ‘give-and-take. In a parliamentary democracy of the European type, the parliament has to agree on a candidate for the post of Prime Minister. Having expressed its confidence in this person, it has to think twice before disavowing him or her. However, in the Russia of the summer of 1998, this incitement to discipline, responsibility and search for parliamentary compromise seemed to be lacking almost entirely. The President would, independently and without consulting parliament, suggest a candidate for the post of prime minister, towards whom parliament would subsequently feel no responsibility. Obstructionism and time and energy lost in rivalry between the two poles of authority, we felt, had characterised Russian policy in recent times. (Various members of the Committee on Economic Affairs and Development during the elaboration of this report also expressed the view that the Russian constitution contains shortcomings. Others emphasised the importance of a well-functioning democracy for economic development.)
72. However, during their visit in late October, 1998, the Rapporteur discovered a new spirit of co-operation between the Presidential administration and the Parliament. No doubt this is part induced by the crisis and by a realisation that everybody is in the same boat. However, it also probably reflects a greater compatibility between the main personalities now involved. Whether this new climate will be enough for coherent and economically efficient policies to see the light of day is less certain, especially in view of approaching presidential and parliamentary elections.
The view of the Governor of a Russian Republic
73. In order to secure an "out-of-Moscow" view as well, the Rapporteurs in September, 1998, met Mr Nikolai Fyodorov, Governor of the Chuvash Republic and Vice-Chairman of the Russian delegation to the Parliamentary Assembly, when he visited Strasbourg. The Chuvash Republic is situated some 600 km south-east of Moscow and has 1.4 million inhabitants. Mr Fyodorov said that the economic results of the Chuvash Republic are among the best in all of Russia. This holds, he said, for industry, agriculture and investment, where a 5% growth was registered in 1997 compared to the year before.
74. Mr Fyodorov said that the Chuvash Republic had started basically from scratch at the beginning of the transition period. It had concentrated on the development of its human resources and on sophisticated production. He maintained that crime was low, and organised crime held at bay. Some two-thirds of the tax revenue stayed within the Republic, with about one-third going to Moscow (and some coming back in the form of social payments, pensions, etc.). Much of the Republic's 3 billion rouble budget had to be spent trying to keep some 20 military enterprises alive economically, and to upkeep a major hydro-electric plant built in communist times. The plant apparently caused major environmental damage such as flooding, but Mr Fyodorov saw no easy way out of the situation.
75. The Governor insisted that the first priority for him was to establish a political system which was honest and which could prevent the Republic's resources from being usurped by what he called the "centre". Mr Fyodorov maintained that previous Russian governments had taken to sharing out resources “robbed” from republics to around a dozen “oligarch” groups. He saw it as essential to reduce the power of the “oligarchs”, but was confident that this could be done over time. A top priority for Russia, he said, had to be to eliminate corruption and the theft of resources. He was confident that Russia could manage without further IMF support, provided integrity could be made to prevail. He also deplored the absence of true budgetary federation in Russia, leading to disorderly (if not lawless) tax collection and distribution.
76. Finally, Mr Fyodorov said that his Republic was taking precautionary measures in the event of some kind of collapse of central Russian authority. Food had been set aside for the winter and would be given to the needy. He felt that the role of Russia's region could only increase in the future.
77. Mr Fyodorov's discourse no doubt reflects a growing "regionalisation" of Russia. (At the same time, he seemed to fear that Russia's federal structure is not strong enough to accommodate this process.) The Republics and Provinces of the Russian Federation have reacted to the weakening of the presidential power and to the depreciation of the rouble with various measures, many of them taken without consulting Moscow. These include price controls, bank oversight and trade limitations. Some have introduced a state of emergency (an action which the constitution reserves for the Russian President alone). Some governors have issued moratoria for their regions’ debt. Others have re-nationalised previously privatised companies. Some have stopped the export of food to sustain them in the winter. We were told that the region of Murmansk in the far north-west, which the Economic Committee visited in May 1998, had agreed with Norway and other Nordic countries to receive humanitarian assistance. Yet other provinces, more dependent on Moscow, have shown less enthusiasm for independent action. It is uncertain how far the centrifugal tendencies sketched above may continue to develop, for many of the republics and provinces appear far too small to be able to "go it alone".
78. Naturally enough, the looming food crisis for the winter and spring of 1999 was very much at the centre of our discussions with our Russian hosts. Russia consumes about 70 million tons of grain per year, of which 22 million tons are used for such things as bread and pasta, and the rest for cattle and seed. However, the grain harvest in 1998 was only some 45 million tons, the worst since 1953 and 35% lower than the 1997 harvest. We were told that in particular the European part of Russia and the north of Siberia would be affected. A Norwegian member of the Committee on Economic Affairs and Development made an impassioned plea for help also to the region of Murmansk which is very close to northern Norway and of which she had first-hand experience. The latter region of course can grow little itself, and relies on shipment by rail, road or river. However, the rivers freeze over already in the autumn, making transport impossible. The government by the end of October has set aside some US$ 600 million for the building up of food reserves. Furthermore, in order to facilitate transport, railway tariffs and other state fees are to be lowered.
79. Mrs Matvienko, Deputy Prime Minister, made an impassioned plea for European and international help. She said the Russian authorities were ready to provide any information about the situation, and that a governmental Supervisory Commission, which she chairs, had been set up to prevent any diversion of supplies as happened in the past. As these lines are written (early November 1998), negotiations are under way with the United States, the European Union and various international institutions for shipments of food and medicine. Ways should also be explored to use not only central channels but also to establish direct co-operation with governors and regional and local authorities. It can only be hoped, however, that over the longer term foreign aid and credits can be used for purposes beyond those of sheer survival, in order to enable the country to raise itself again.
A view from the City of Moscow
80. The city of Moscow, with its around 10 million inhabitants, seems to be faring better than most other parts of the country. In our talks with Mr Luzhkov, the city's Mayor, we were given his side of the story. Under his stewardship, he said, Moscow had been careful in privatising, choosing the gradual rather than the abrupt path. Companies had not been sold precipitously or "on the cheap". There had been a deliberate promotion of small and medium-sized enterprises, whose taxes, he said, now provided half of the Moscow budget. If there were 800,000 SMEs in all of Russia, 240,000 were in Moscow. People of every political persuasion had been encouraged to work together for the city’s good. Mr Luzhkov also maintained that Moscow continued to receive considerable foreign investment in spite of the August crisis, with all of it going into productive investment. Moscow, he said, had not followed the Russian decision on a moratorium on foreign debt, but would repay all it owed on time.
81. Mr Luzhkov called for an abandonment of the "game of speculation" he said had been practised so far in Russia and instead wanted investment to focus on the productive part of the economy. Only in this way could the production bottle-necks be overcome and foreign debt repaid. He saw a restructuring of the debt as the only way out as matters now stood. He was even in favour of convening an international conference for this purpose, an idea which we as Rapporteurs, however, consider less likely in the present circumstances.
82. Mr Luzhkov also proffered his views on why things had gone wrong in Russia since 1991. Firstly, he said, market reform had been carried out the wrong way. Privatisation had been done virtually overnight and helter-skelter. Liberalisation of prices had been too abrupt, when it should have been gradual. And uncontrolled privatisation coupled with uncontrolled price liberalisation had led to distorted relations among prices themselves. In the chaos that followed, a small group of people, he said, had been able to take control. Privatisation had been subordinated to political and private ambitions, not to that of the economic development of the country as a whole. The aim had been to take the state precipitously out of its property, causing the latter to be bought at rock bottom prices by obscure groups. Mr Luchkov termed the ‘voucher privatisation’ the "greatest mismanagement example of the century". It had, he argued, caused the ordinary people to lose any confidence in both the market and the state. Mr Luchkov also felt that too much power had been given to people who lacked the necessary knowledge. Finally, he said, western creditors, including the IMF, had given money without checking sufficiently how it would be used. The government, acting under stress, had let it disappear, or used it just to cover the deficits of the moment, without consideration for the longer-term future. Whether one talked about pyramid schemes or GKOs, it amounted to the same. The masses, he concluded, had been left in despair, while those who had taken the money or wasted it had escaped scot-free.
A new Russian determination
83. If the Rapporteurs have dealt at length with Mr Luzhkov's analysis of the situation, it is not for the purpose of giving undue coverage to anyone in particular among our many distinguished interlocutors, but rather because his views seem to reflect a growing sentiment among the country’s elite as to the direction of future policies. Thus, the Russian parliament seems intent on increasing its role in setting policy and ensuring greater accountability and transparency. Foreign creditors are not likely, for a long time to come, to engage in the kind of speculative placements that preceded the August crisis; nor is the Russian people likely to place trust in banks until full confidence in the latter’s integrity can be restored. Therefore, policies will now have to focus on production, also because depreciation of the rouble makes imports more expensive, indeed inaccessible to virtually all.
84. Mr Ryzhkov, First Deputy Chairman of the State Duma, in fact gave us a whole list of projects which the Russians would like to see started with the aid of foreign capital: a gas pipeline to western Europe; a modern railway linking Berlin, Warsaw, Minsk and Moscow; and a Helsinki-St. Petersburg-Moscow motorway. He outlined projects in rocket-launching space technology, as well as in the nuclear energy field. He also called for a greater European openness in things that Russia can export at favourable prices, such as fertilisers, metals and pipelines. He called for the mutual opening of markets between Russia and her neighbours to the west and said that his country was doing its utmost to prepare for entry into the WTO. Of course, the Rapporteurs were equally eager for a greater Russian opening for imports from abroad, basing themselves on the difficulties encountered in this regard by their own countries Estonia and Poland.
85. The international community must ask itself how it, too, may have contributed to the current Russian debt prices, for as the saying goes, it takes two to tango. How could private western banks, for example, continue to lend so carelessly up until the summer of 1998 to borrowers offering to pay 80%, 100% or even 150% per year? Since such rates are so way beyond what any productive investment can deliver, it must have been clear to them that things were not right. For example, in June 1998, a major American investment company acted as an intermediary to help the Russian government raise $1.25 billion in GKO bonds. After collecting sizeable fees, the company left the scene, leaving previously credulous investors now incredulous at being stuck with nearly worthless paper.
86. This of course does not exonerate the Russian Government from its share of responsibility. Why did it not ensure proper use of the funds borrowed? Was it aware that money made to disappear by the few would have to repaid over many years by the many, that is, the entire Russian people? Why did it not permit parliament greater insight into what happened to the funds? Where were the checks and balances in the system, and the controls over those entrusted with the money?
87. A few words need to be said about the developments in Russia up until early January 1999. The economic programme heralded by the government and parliament during our visit in late October, was published on 17 November 1998. It focuses on reduced taxes, loans on better terms for industry and the printing of money to pay wage and pension arrears. It is based on the assumption that annual inflation in 1999 will be only 30%. Such a rate now, however, seems unrealistically low, for the 1998 inflation, it was announced in late December, was 84.4%, as against 11% for 1997. With the government set to print an additional 25 billion roubles (1.2 billion dollars) in the last quarter of 1998 – meant to cover a fourth-quarter deficit of 64 billion roubles (3 billion dollars) – and with a clearly inflationary 1999 budget, inflation seems bound to be high
88. On 10 December, the Russian Parliament gave the initial approval for the 1999 budget. It calls for the spending of 575 billion roubles (27.4 billion dollars), revenue of 473 billion roubles and a deficit of 101 billion roubles. Like the economic programme just referred to, it envisions inflation in 1999 to remain at 30%, and the rouble to trade at 21.5 to the dollar. (It stands, as these lines are written in early January 1999, at around 21 roubles.) The passing of the budget, whose initial approval was by large majority, is seen as an achievement on the part of Prime Minister Primakov, showing that he is able to command results in dealing with a parliament that was in rather bitter opposition to his predecessors. The budget's easy passing probably also reflected fear in parliament that any delays could further sap Russia's economy.
89. It remains to be seen whether the budget and the economic programme will be enough to move the International Monetary Fund to release at least portions of the 22.6 billion dollar aid package which was agreed with Russia in the summer of 1998 but which was not implemented following the August crisis and the lack of movement forward thereafter. On December 22, however, the World Bank in a heartening development did approve a 400 milllion dollar loan for Russia for the rehabilitation of roads and bridges and for the setting up of a road tax system to increase government income.
90. If the World Bank loan is encouraging, the situation as regards Russia's foreign loans is less so. A 362 million dollar payment of Soviet era debt to foreign commercial banks come due on December 29 was not honoured, boding ill both for Russia's ability to meet its foreign financial obligations and for the preparedness of foreign creditors to extend new loans. (The August default was in regard to debt owned to foreign governments and public institutions.) At the time these lines are written, there is disagreement whether the non-payment should be counted as default. The creditors, grouped around the so-called London Club, maintains that 95% of creditors need to agree to the less advantageous terms for repayment suggested by the Russian Government. Russia, however, considers that only two-thirds are necessary, and that this figure has been reached.
91. Part of the aversion of foreign creditors may be explained by the degree of corruption in the Russian economy mentioned elsewhere in our report. In December 1998, the Prosecutor General of Russia, Mr Skuratov, said that economic crime meant that 18 billion dollars due in taxes in 1998 could not be collected. Mr Skuratov maintained that almost half the banks and 40% of state-owned companies are controlled by what he referred to as criminals. The rise in economic crime, he said "blocks all normal operations of banking institutions, enriches businessmen from the shadow economy and causes budget deficits".
92. Finally, your Rapporteurs wish to mention one area where Russia's economic crisis may have particularly dangerous consequences, namely the control of weapons grade nuclear materials and expertise. Europe and the United States are doing their best to assist. In cooperation with the US Department of Energy, Russia is selling the United States large quantities of weapon-grade uranium in non-weapons-usable form – 36 tons so far. Russia is also accepting cooperation to protect and account for nuclear materials at some 40 nuclear facilities. A US-Russian programme aims to render 15 tons of weapons-grade plutonium in each country unusable for nuclear explosives. This is one area where Europe must do more, for if there is a nuclear accident due to inadequate storage or control, or if nuclear material is diverted and used by rogue states or terrorists, then all of Europe (and the world) will stand to suffer.
Russia at the crossroads
93. Russia now stands at a crossroads. It can either choose a path leading to more central planning and a loosening of monetary discipline, with much higher inflation as the more than likely consequence. It is clear that if this road is chosen, foreign creditors are even less likely to return. The other path would be a policy of stabilisation, as a basis for new growth. This road requires bold reform and strict monetary discipline.
94. Needless to say, the Rapporteurs favour and hope for the second course. They fully recognise – coming, as they do, one from a former part of the Soviet Union (Estonia) and the other from a central European country within the Soviet orbit at the time (Poland) - that the communist past weights heavily on today's Russia. They remain convinced, however, that a great country like Russia now needs to harness its enormous human potential in order to become truly great. This is not ‘great’ in the sense of spectacular projects or greatness over others. This is ‘greatness’ in finally permitting the noble Russian people to build a more prosperous life, one in which they can hope for a better future for their children.
95. One of our interlocutors said that all he wanted for his country was to be "normal" - a constructive citizen in the world community, economically and otherwise. This is a wish fully shared by the Rapporteurs. The Assembly's last text on the economic situation in Russia and Ukraine - Resolution 1078 of 1996 - made the plea for a "pan-European common market". Only a functioning, prosperous Russia can make its full contribution to such a market, for the benefit of herself and Europe in its entirety. Saddened as the Rapporteurs were to learn about the full extent of Russia's current crisis, they nevertheless remain confident that she will overcome it in the end. Moral, conceptual and humanitarian assistance from other parts of Europe is more crucial than ever in Russia’s present crisis, while we eagerly await the moment when renewed financial support becomes possible. If the rest of Europe and the world was prepared to help Russia over the past few years when the going seemed smooth, how could we allow ourselves to abandon her in her perhaps greatest hour of need since the war?
96. And perhaps this is a turning point for the country. Russia must now essentially rely on herself to redress the situation. Investment now must go toward production, since the speculative path is shut for the foreseeable future. The Russian parliament is pressing ahead with demands for greater share of the power and greater transparency and accountability. We found a new determination on the part of our parliamentary colleagues in particular to tackle reality and achieve change in order to avoid disaster. We must support them in any way we can, for the good of Russia, Europe and the world.
The productive economy
97. In Ukraine, attempts to continue economic policies based on central planning led to collapse of the economy. By the autumn of 1993 and early 1994, the country was in a crisis - one of the deepest in any in the FSU area. The economy teetered on the brink of hyperinflation. There were severe shortages of goods in the stores due to panic buying, while the industry faced cuts in energy supply. Inflation in 1993 exceeded 10,000 per cent. GDP dropped by 23 per cent and industrial output by 28 per cent in 1994.
98. The years 1995-1997 saw a period of macro-economic policies that were closer to the market. These led to a significant reduction in inflation (below 10 per cent annually) and to a stabilisation in the rate of exchange (especially in 1995-1996), permitting a new national currency to be introduced – the hryvna. However, many structural and institutional changes were left unimplemented. Insufficient fiscal adjustment – or, rather, the absence of fundamental fiscal reform – combined with delayed liberalisation and privatisation to cause repeated instability at both macroeconomic and microeconomic level. As a result, the principal economic objective – economic growth – has yet to be attained.
99. The real sector in the 1995-1997 period saw a dramatic decrease in GDP, industrial output and agricultural production. The fall in GDP between 1989 and 1997, as measured by official statistics, was more than 60 per cent. After a rapid drop in 1994, GDP fell by a yearly 12.2 per cent, 10 per cent, and 3.2 per cent between 1995 and 1997. According to official projections at least, 1998 may become the first year since independence which will not see a decrease in GDP (although that may be too optimistic a prediction given the Russian economic crisis). A rapid drop in GDP in 1994-1997 resulted in a change in the structure of the economy, in that the share of investments decreased significantly while that of consumption increased.
100. The value of industrial output fell along with GDP, decreasing in 1996 and 1997 by 12.5 and 1.8 per cent, respectively. While in 1994-1995 the fall applied equally to all industries, in 1996-1997 it started to differ according to the type of production. Some industries started to overcome the crisis. Those suffering the largest drops of output, again according to the official data, included machinery, foodstuffs, light industry, construction materials, paper and mining. In 1997, the first signs of a halt in the further decrease of output were registered in the gas industry and, partly, oil refining, steel and non-ferrous metals.
101. Several reasons for the dramatic drop in output in the 1990s can be found. A primary reason, especially pronounced at the beginning of the decade, was the decrease in domestic demand due to a drop in real income, itself a result of high inflation. There was also a decrease in foreign demand caused by the dissolution of the Soviet Union. For most of the enterprises it meant the disruption of long-established ties and a loss of traditional markets. Concurrently, difficulties related to the introduction of a market economy started to play a role - in the form of increased prices for raw materials for the energy sector and the emergence of positive real interest rates following more stringent credit conditions. Russia’s measure in 1994 to adapt its energy export prices to those at world level created an external price shock. Since March 1995, Ukrainian companies have been forced to pay almost the full amount of these prices for its imported crude oil and natural gas.14 Simultaneously, the Ukrainian national bank (NBU) tightened monetary policy, resulting in a drastic reduction of preferential credits and introducing positive real interest rates. Industrial output indexes in 1996-1997 already depended entirely on structural changes in particular industries and on business conditions in international markets. Some steel industry enterprises are a good example. On the one hand they benefited from a restructuring of their debt to state suppliers of energy. On the other hand they in many cases acquired foreign investors (and invested in necessary modernisation) and were able to profit from the good market in steel products.
102. Structural reform in the industry are connected first of all with privatisation. In the years 1995-1997, out of the three forms of privatisation used - mass privatisation, privatisation of smaller companies and cash privatisation - the first two were the ones employed most frequently. The mass privatisation program announced in December 1994 initially provided for the privatisation of 8,000 enterprises through auctions, using certificates. By the end of 1996, over 80 per cent of entitled persons had claimed their certificates. Additionally, in the middle of 1996 a distribution of additional certificates to compensate for the loss of the real value of savings deposited in the State Savings Bank was set in motion. For both types of certificates, separate enterprise auctions were organised. By the end of 1997, the total number of privatised medium-sized and large enterprises had reached over 8,300. Most of them were privatised through auctions using privatisation and compensation certificates. In 1996, 3,250 large and medium-sized enterprises were privatised.
103. In 1997 the privatisation process was considerably slowed down, and out of 6,500 large and medium size enterprises only 899 were privatised in the first three-quarters of the year. This was a direct result of the domination in the parliament of post-communist and other anti-reform groups. These blocked the approval of the privatisation plan for 1997 (which plan was approved only by the middle of the year) and adopted a resolution calling for the halt to the privatisation of 5,125 enterprises considered “strategic”. The classic cash type of privatisation was fully started only in the first quarter of 1998 and is to be completed by the end of 1998 - a time span which seems highly optimistic since case-by-case privatisation requires time and (foreign) strategic investors. During the first three months of 1998, 271 enterprises were sold, 48 of them large. Twelve regional enterprises involved in electric power distribution also underwent this process. This enabled the government to meet for the first time its budget provisions for privatisation revenue.
104. The small-enterprise privatisation process was completed by the middle of 1997. About 90 per cent of the total number of 42,000 small enterprises were sold through public tenders, or transferred to employees. Monthly budget revenue from this privatisation, at its peak in 1996, amounted to around UAH 200 million and constituted the main source of budget revenue from privatisation.
105. So far, however, privatisation has had only a small impact on the quality of management in the privatised companies. The companies privatised through the voucher sale in most cases were not taken over by strategic investors intent on enforcing changes in management. Most of the stock (over 85 per cent according to an IMF estimate) was taken over by the employees and managers in the first stage of subscriptions (reserved for them by law) and the average tenure of management in the company was over 10 years, a circumstance which did not bode well for innovation.15
106. Bankruptcy regulations are relatively ineffective and in practice not applied by banks or other businesses. It is the tax inspection authorities who in cases of tax arrears initiate most bankruptcy proceedings. This tends to keep the old management in place and makes the effective re-allocation of productive resources more difficult. As a result of imperfect bankruptcy procedures, the mutual debt of the companies grows. The total amount of inter-enterprise arrears of the amounts payable at the end of 1997 exceeded 100 per cent of GDP.
107. In 1996 and at the beginning of 1997, the government tried to restructure the power and fuel sectors. In 1996, the basis for a market in electric power was created. Power producers were made separate from distributors; local companies distributing power to users were established; and a regulatory office was established to supervise the markets of electricity production and distribution, promote competition and protect consumer rights. A new settlements system was introduced in order to reduce barter trade in energy (e.g., between coal mines and power stations) and to limit the growth of debts in electricity supply.
108. In the natural gas sector, the government in 1996 withdrew its earlier guarantees of payments for gas to foreign suppliers, in the face of growing arrears on the part of domestic gas buyers. Simultaneously, licenses for the import of gas were issued to strengthen competition among intermediaries. Initially they were given to eight companies - among which United Energy Systems, Ukrgazprom and ITERA (importing gas from Turkmenistan) soon achieved a dominant position.
109. Unfortunately, this did not strengthen payments discipline to any noticeable extent; nor did it manage to reduce the enormous arrears accumulated vis-ā-vis gas suppliers. (It should be noted, however, that most industrial enterprises pay for their gas deliveries on time, indirectly subsidising debtors such as households, budget institutions, and local stations producing heat for municipal authorities. Arrears towards gas suppliers resulted in disruptions of supplies. (Turkmenistan temporarily stopped gas supplies in the spring of 1997 and the Russian Gazprom reduced supplies in the middle of the same year). Subsequent to this, the United Energy Systems company was excluded from the arrangement. The measure against the UES, which had a 30 per cent share of the gas market in 1996-1997, caused total disorganisation in supplies and contributed to a further erosion of payment discipline among buyers.
110. The government also attempted to restructure coal mining, for example by closing (at the end of 1996) several dozen mines that had shown the highest deficits. This restructuring project, supported by loans from the World Bank, also provided for a reorganisation of the social environment of the miners, including coverage of benefits paid to those laid-off. The introduction of the program was halted, however, due to miners’ protests, an action which found support in many political quarters in this pre-election period. The current state of the mining industry is dramatic: over 600,000 miners, working under very difficult and dangerous conditions, produce not more than 80 million tonnes of coal per year. To make matters worse, there is a lack of employment restructuring possibilities, due to the lack of other significant industries in the mining regions (e.g. the Donetsk region).
111. In recent times, agricultural production has been falling yearly, with fluctuations only as regards the size of the decline. Both bad weather and lack of reform were at the origin. In 1996, as a result of long and severe winter and a short growing period due to the sudden arrival of a hot summer, agricultural production fell by almost 15 per cent from the year before. In 1997 the decline was a further 6 per cent. The fall has occurred primarily in the state sector, whereas in the private sector production increased slightly. Apart from more problems with the weather (rains during harvest time), which made it difficult to use machinery and store the harvest, there were administrative obstacles. First of all, there is the system of obligatory contracts, used by local authorities to impose prices lower than in neighbouring regions on producers. Local authorities would even go so far as to ban the transporting of grain from their territory in order to stop sales at higher prices, even for foreign destinations. Monopolies over silos and agricultural storage facilities (the state monopolist Khlib Ukrainy possesses most of the grain silos) and a near monopoly in agricultural supplies additionally tie producers’ hands. Indirect administrative control over sales prices and the prices of means of production (such as through a system of state orders for agricultural machinery) makes it difficult to measure productivity. However, in November 1998 the Committee on Economic Affairs and Development was informed by a Ukrainian member about agricultural reforms in his country aiming to reduce the role of barter in agriculture and a more modern accounting system.
112. Furthermore, there has been no real change in the agribusiness sector as a whole. Although the enterprises concerned were offered for privatisation in 1996-1997, most have not found any strategic investor, nor did they manage significantly to improve their management structure. The situation is made worse by the fact that the legislation provides for 51 per cent of the stock of the privatised enterprise to be transferred to suppliers of the company (which themselves are in most cases state owned enterprises and farms). This considerably limits the interest on the part of potential investors.
113. There are other institutional obstacles. The main reason for the lack of ownership restructuring in agriculture is the ban on land sales. Although the 1996 constitution allows for private land ownership, the relevant provisions are inoperative due to the 1993 moratorium on land sales. True, a presidential decree on land lease and the transfer of related rights was issued in 1997, creating legal possibilities for trading rights related to lease and use. However, this and other decrees, issued in an attempt to override parliamentary opposition, are not effective in practice and only serve to complicate the legal system by making it less transparent.
114. To this day, state farms (sovkhoz) and quasi co-operative farms (kolkhoz) cultivate most of the land. They occupy over 80 per cent of the acreage and employ over 60 per cent of all employees in agriculture. Privatised kolkhozes and sovkhozes, converted into companies, occupy the remaining land. So far, privatisation of land has in the main consisted merely in the transfer of shares in existing large state-owned farms, without any possibility of dividing and physically taking over land and equipment. The privatisation process is thus more formal than real and normally does not lead to changes in management. As in the privatisation process, the farm stock is transferred to the staff of the farm and enterprises co-operating with it. Farms created in such a way in many cases have no strategic investor, and control remains in the hands of the previous managers. Only a small portion of the land belongs to private farms; thus, in a nation of 52 million people, 30 per cent of whom live in rural areas, the number of private farms does not exceed 50 thousand. The lack of full land ownership rights is the primary factor impeding the development of Ukrainian agriculture.
115. The employment situation started to change in 1996-1997. A majority of the workforce (approximately 60 per cent at the end of 1997) were still in the state sector. Official unemployment, which in 1994-1995 stood at less than 0.5 per cent, started to grow in 1996, reaching 2.9 per cent by the end of 1997. The official statistics, however, do not include hidden unemployment – owing to the fact that employees who do not receive remuneration and do not show up for work are still registered as employed (in order to receive social benefits such as health care, pensions, etc.). Many people who are formally employed in state enterprises but do not receive any pay in fact work in the shadow economy. Actual unemployment is certainly higher than the official figure (10%): it may even reach 20 per cent.
116. While official statistics indicate a drop in GDP and output, the shadow economy seems to grow. This impression is corroborated by a smaller-than-expected drop in electricity use, and in examining specific industries. For example, an enormous slump of construction output is belied by the only slight decrease of sales of basic building materials, such as cement. Estimates put the size of the shadow economy at between 30 per cent and 100 per cent of the official GDP. In our opinion, the Ukrainian shadow economy certainly exceeds half of the official one, and as a share of GDP it is likely to exceed that in Russia. Basic reasons for such a high share of the ‘grey market’ include: an tax system combining very high rates with a large number of exemptions; an unstable and complicated legal system; administrative restrictions imposed by central authorities (e.g., in foreign trade, such as tariffs) or local ones (licenses, registration procedures connected with business activities, unrealistic sanitary and security standards, etc.). Therefore, the official number of small and medium-sized enterprises in Ukraine is incomparably smaller than in Poland, a country with about the same population.
117. The government and the president have declared that the creation of an encouraging environment for the development of private business is their main economic policy goal. This credo underlay a programme, presented by the president at the end of 1997, of a program to support business development. However, the reality is that complications and bureaucratic obstacles still abound. For instance, at the beginning of this year of a new VAT tax regulation was introduced. In order to receive a tax reimbursement exceeding UAH 10,000, a company must wait until the whole book-keeping documentation, such as invoices, is audited and compared with the documents of business partners by an inspector from a local tax office. After this, reimbursements must be approved by a higher level tax office.
Monetary Policy and Exchange Rate
118. Following an expansionary monetary policy started in 1992, the Ukrainian economy went into inflation, resulting in hyperinflation by the end of 1993. The inflation index for the whole of 1993 was over 10,000 per cent. The end of that year was a milestone for the National Bank of Ukraine. Mr Victor Yuschenko, elected Chairman of the NBU at the beginning of 1993, implemented a drastic reduction in the emission of money. In 1994 and 1995, the NBU continued its policies to limit inflation. This was largely thanks to the NBU Chairman who, faced with an ambiguous legal framework (the absence of a Law on the National Bank of Ukraine) fought to strengthen the central bank’s position and sought its independence in matters of monetary policy. Under his leadership, the NBU several times reduced the impact of parliamentary decisions on granting credits. Nevertheless, a few times in the 1994-1996 period the NBU had to issue - under pressure from groups representing various lobbies - large amounts of money, requested mainly for seasonal needs in agriculture such as planting and harvesting, and for building up fuel reserves in the fall. This, of course, help fuel inflation.
119. A stabilisation of prices was accomplished in the summer of 1996, when the index did not exceed a monthly 0.1 per cent. A significant surge in inflation took place in August 1996 (5.7 per cent) due to an increase in home lease rates and in the prices of municipal services, as well as to a seasonally related increase in the prices of foodstuffs. However, stabilisation remained on course. In 1996, annual inflation amounted to 39.7 per cent. In September 1996, the government and the NBU, profiting from this less inflationary environment, implemented monetary reform. This reform was more a re-denomination operation than any real monetary reform, since beside a physical exchange of money there were no changes in the currency regime, or in monetary or fiscal policies. The temporary currency, called ”karbovanets”, was replaced at the ratio of 100,000 to 1 by the long-awaited new national currency baptised the ‘hryvna’. (New hryvnas had been stored in the NBU vaults since 1992.) The reform did not have the confiscatory character that had been feared by the population, who remembered the monetary reforms in the former Soviet Union as well as in Russia in the summer of 1993. The operation was successful.
120. 1997 brought the awaited results, first of all in the form of increased confidence in the hryvna, which in turn led to a greater monetisation of the economy. In spite of a relatively significant expansion of the monetary base and ‘broad money’ (over 44 per cent and 29 per cent, respectively) inflation dropped considerably. In 1997, the NBU stopped its direct crediting of the budget; however, financing of government operations continued through purchases of treasury bills. Most of the monetary expansion had in fact occurred during the first nine months of 1996, largely through the inflow of foreign funds into treasury bills. This trend reversed itself in the middle of 1997, however, and the NBU was forced to intervene in the currency market, selling currency reserves in order to defend the hryvna. This even led to a nominal decrease of the monetary base in the last quarter of 1997. Thanks to this, inflation could be kept at a low level. For the whole of 1997, the price index rose only by 10 per cent. In the first quarter of 1998, the NBU carried out a stringent policy of not allowing the monetary base to grow any further. Therefore, in spite of the difficulties in the fiscal policy field and a pressure to ease credit policies in time for the election campaign, excessive inflation could be held at bay.
121. It would not have been possible to achieve such good results without a satisfactory exchange rate policy and favourable conditions in the currency market. The currency regime in Ukraine was changed repeatedly and utilised many mechanisms of exchange rate regulations typical of a socialist economy (such as the mandatory sale of currencies, the official allocation of currencies for importers, and a ban on the sale of currencies to non-residents). All these different kinds of administrative restrictions had, until the end of 1995, led to a considerable difference between the official rate of exchange and the market one (such as in street exchange offices).
122. The end of 1994 marked the start of a process towards a unification and stabilisation of the exchange rate (or rates). After September 1995 - when the rate had broken down due to increased credit issuing an announced relaxation in financial policies - the exchange rate remained stable during 1996 and most of 1997. This was possible due to an inflow of foreign capital into the treasury bond market, which started growing rapidly as from the beginning of 1996. In March 1996 the NBU was forced to intervene periodically in the currency exchange market to avoid excessive appreciation of the hryvna. Initially, the exchange rate regime applied by the NBU consisted in the adoption of an informal band (unannounced officially) between 1.6 and 1.9 hryvna per USD, with a trend to oscillate at around 1.8. At the beginning of 1997 a band of 1.7-1.9 was announced, and the actual rate was maintained at the level of 1.85 hryvna to the dollar. As a result of the inflow of foreign capital, the foreign currency reserves - depleted in the 1993-1995 period – could be rebuilt. At the end of August 1997, net reserves increased to USD 700 million, and gross reserves reached the value of six weeks’ worth of imports (about USD 2.3 billion).
123. This favourable trend took a turn for the worse, however, when, in August 1997, a dramatic outflow of foreign capital occurred. Domestically, the main reason was a less than prudent policy of the Ministry of Finance in the area of public debt management and in the financing of the budget deficit. Foreign investors’ entry into the treasury bill market in 1996 and in the first half of 1997 allowed for a considerable increase in the supply of government paper (higher than planned) and permitted an extension of their maturity. This success encouraged the Ministry to decrease the yield on the T-bills (from about 60 per cent at the beginning of 1997 to about 20 per cent for one-year bills in August 1997) and to decrease the supply in the summer months. Additionally, the Ministry allowed delays in the redemption of individual issues several times. This led to reduced confidence on the part of investors and to their starting to withdraw their assets from the Ukrainian market, especially as progress in institutional reform was slow. The outflow gained momentum as the Asian crisis took hold, with international investors increasingly sceptical about emerging markets in general.
124. Because of the build-up of the crisis in the currency market, the NBU was forced to undertake drastic measures, such as significantly increasing interest rates. Furthermore, the mandatory reserve requirement was raised by 4 percentage points (to 15 per cent). In January 1998, a new ‘currency corridor’ of UAH 1.75-2.25 per USD was announced. In view of rapidly dwindling currency reserves, the NBU in February allowed for a gradual depreciation of the hryvna to the level of UAH 2.02 per USD.
Fiscal Policy, Deficit and Financing
125. One characteristic trend in the fiscal indicators in Ukraine is a gradual decrease in the revenue of the state, both absolutely and as a share of GDP. This phenomenon is grounded in both falling real GDP and a growing reluctance to pay taxes on the part of the population. Increasing pressure from the tax apparatus and a tightening of tax rigors may bring adverse effects, such as an growing inclination to try to avoid paying taxes and take refuge in the shadow economy. In spite of a gradual decrease of revenues, the level of redistribution of GDP through the budget was and is still high when compared to other FSU republics. In 1996, revenues of the consolidated budget amounted to 37.5 per cent of GDP, and in 1997 they reached 37 per cent. The main sources of revenue are the VAT, corporate income tax and social premiums calculated on the basis of payrolls (mainly financing pensions and the Chernobyl Fund). In 1997, there was a strong decrease in the revenue from social premiums. This was a result of unmet expectations related to a decrease in the rate of the payroll tax by as much as 50 per cent. The first three months of 1998 brought further decreases in revenue. According to the data from the Ministry of Finance, the difference between planned and actual revenue amounted to 45 per cent. This is mainly due to a drastic fall in the revenue from basic taxes, including VAT.
126. On the expenditure side, trends in 1996-1997 included a falling share of subsidies supporting the national economy (which during the 1992-1993 period had formed the largest post in the budget), reduced expenditure for defence, and an increasing share for social benefits, pension payments and debt servicing.
127. The official budget deficit in 1996 decreased by 1.8 percent, or 4.9 per cent of GDP. It was the lowest deficit in the history of independent Ukraine. This did not, however, reflect the real state of the budget. In order to meet criteria agreed on with the IMF concerning the deficit level, the failure to obtain the planned level of revenues resulted in the government’s inability to meet its liabilities; i.e., the budget became indebted to those entitled to payments. At the end of 1997, the debt reached UAH 6.4 billion (about 6 per cent of GDP), of which 18 per cent was made up of unpaid salaries of government employees. In the second half of 1997, in view of the upcoming elections, the government started acquitting itself of its debt, leading to its gradual reduction. This, however, caused the budget deficit to rise, in 1997, to 7 per cent of GDP. In the first quarter of 1998, according to preliminary data, the deficit again stood at 7 per cent of GDP - mainly due to payroll and pensions payments made in March 1998, just before the election. In spite of such spectacular measures, the budget debt started to rise again slowly in early 1998. Officially, the planned deficit target for 1998 is 2.5 per cent of GDP. Without drastic fiscal adjustments, i.e. deep cuts in expenditure, this goal will be exceedingly difficult to meet.
128. As from the middle of 1996, financing of the deficit was based on the issuing of treasury bills. However, it soon became apparent that the market was rather limited and highly dependent on outside confidence in the economic policies pursued. The crash of the T-bill market in the second half of 1997 forced the Ministry of Finance desperately to seek alternative sources of external financing. In the second half of the year the government received a commercial loan syndicated by the Nomura investment bank. In total, the government had contracted almost one billion USD worth of commercial loans before the end of the year. In spite of a very low rating (B2), it was possible to issue two-year Eurobonds denominated in German marks (DM 750 million) in February 1998, and an issue of three-year bonds, denominated in ECU, in the following month. The government of Ukraine has paid, however, a huge premium for the risk – 15-16 per cent annually. In view of a slump in demand for treasury bonds, the government receives support from the NBU, which intervened in the treasury bills market (primary as well as secondary markets). In the first quarter of 1998, 70 per cent of the treasury bills offered in the primary market were purchased by the NBU. Obviously, financing of the deficit by the NBU may within a short time cause inflation to rise.
129. The critical budget situation grew worse in 1996, when the government decided to increase the budget deficit in 1997 to 6.7 per cent (from 4.9 per cent the year before). The government saw the increase as part of a complex reform programme called the ”Economic Growth Package”. Its main objective was to stimulate economic activity through the reduction of administrative restrictions, a deregulation of the economy, restructuring, a reduction in social benefits and a simplification and reduction of taxes. The programme was expected initially to reduce tax revenue. It presupposed that after a period of one to two years, initial losses to the budget would be compensated for by revenues generated by a shift of business activity from the shadow toward the official economy. The initial larger deficit was expected to be financed by loans from the IMF (within a three-year program of the EFF) and from the World Bank. (The loans would in the first place permit a reform in coal mining, agriculture and the administration).
130. Unfortunately, the government was unable to mobilise the necessary political support for the project. The main problem was to convince parliament which, after months of debate, rejected the basic proposal for structural changes while approving the tax cuts and the increased budget deficit. The government admitted defeat in the summer of 1997, including the inability to meet the IMF criteria. Nor could the criteria for structural loans from the World Bank be met. As it happened, none of the structural reforms was put into effect, leaving the government with the task of having to finance an increased budget deficit without assistance from international financial institutions. At the beginning of 1998, the government again started negotiations with the IMF on a new EFF program, many conditions of which were similar to those of the reform project previously rejected. Also, the government’s periodic attempts (the last one in August 1998) to improve the fiscal situation and liberalise the economy were based on the “Economic Growth Package”.
131. Thus, by mid-1998 Ukraine was more or less back to the ‘square one’ of 1996. The situation is if anything worse now, in that the budget will have to carry the additional burden of having to repay expensive credits obtained in 1997-1998. Meanwhile, the financial crises in Asia and Russia may add to investors’ apprehensions about the Ukrainian market.
Forecast
132. In the light of available data and the experiences of recent years, there are three possible scenarios for the future.16 The first two assume that monetary policy will not change considerably. The first scenario is based on the assumption that the government will start implementing the reforms agreed upon with the IMF, making it possible to start the EFF program. These reforms have three basic parts: a reform of the tax system (changes in the tax management and the simplification of related laws) and the budget (primarily a reduction of expenses and changes the methods for controlling such expenses); structural reform in sensitive sectors of the economy (coal mining, agriculture, etc.), and a reform of the financial system. Such broad reforms would initially require some additional expenses from the budget, while their first effects would begin to show only after a year or so. The government would have to change the budget assumptions in order to achieve the planned deficit level (requiring a reduction in subsidies and a rapid increase in the prices for subsidised services, e.g. heating). It would also have to ensure co-operation from the parliament in carrying out the necessary legislative changes. Under this scenario, a further GDP decrease could be expected for 1998. On the other hand, such action might give expected results in 1999, such as a drop in inflation and modest growth in GDP.
133. Under the second scenario we assume that the budget policies will be as stringent as before, while the government will not be able to implement structural reform. We also assume, however, that the government will not entirely lose the confidence of foreign investors, and that in spite of the absence of loans from the IMF it will be able to finance part of the deficit through commercial loans contracted in foreign markets (e.g. through further issues of eurobonds). In such a situation we may expect a stabilisation of GDP and a small increase of GDP (about 1 per cent) in 1999. Under this scenario there is no place, however, for any changes in the structural basis of the economy, signifying that there cannot be any stable or strong growth in the following years. Meanwhile, increasing debt and service costs may create severe budget problems. Under such a scenario we may expect an accumulation of structural problems over three to five years.
134. In the present situation, a more pessimistic scenario, provoked by a financial crisis, is more probable. Such a crisis may erupt following a panic in financial markets - caused by a significant further fall in budget revenue, continued difficulties in prolonging the maturity of public debt, a prolongation in negotiations with the IMF, political instability, populist political action or unfounded rumours of a relaxation in economic policies. Or it may be caused by external factors such as the present difficulties in international financial markets, including those in neighbouring Russia. Under such a scenario it is difficult to forecast accurately the likely changes in macroeconomic indicators. Generally speaking, we could, however, expect a continued steep devaluation of the hryvna; a breakdown in the confidence in the national currency; an increase in interest rates; the partial suspension of the public debt service; a wave of bank and business closures; the return of high inflation; and a rapid drop in industrial output and GDP. In the political and social area such a scenario could include political disturbances, weakening Ukraine’s position in the international arena and even the country’s young statehood.
The Current Economic Situation in Ukraine: Conclusions from the Rapporteur's Visit in September 1998
135. The Rapporteurs visited Kiev at the end of September 1998 at the kind invitation of the Ukrainian parliament. They were very well received by their Ukrainian hosts and wish to express their gratitude to the parliament and the country's government for the very full exchanges of views they were able to have with leading representatives (see Appendix I).
136. The visit took place only a few days after an emergency programme had been presented by the Ukrainian President and the Cabinet of Ministers to the Parliament. The programme in particular includes measures to consolidate the state budget and overcome various trade obstacles. Thus, financial support (dating from Soviet times) to several special groups in society is suggested to be eliminated or curtailed due to the heavy burden they place on the budget. The programme furthermore insists on continued privatisation of state enterprises, not least in order to permit payment of some of the resulting income toward substantial salary and pension arrears. (Privatisation in 1998 has been slow, and so far only a quarter of the planned contribution to the budget, about 105 million dollars, have been forthcoming.) In addition, the programme foresees less red tape for exports. Bureaucratic customs procedures are proposed to be abolished.
137. The programme is intended to meet the conditions posed by the IMF for a recent 2.2 billion dollar credit. In early September 1998, 257 million dollars were awarded as a first instalment, followed by a credit of 600 million dollars from the World Bank. This support is above all intended to render possible the development towards a competitive banking system and the establishment of so-called International Accounting Standards (a priority mentioned by many of our interlocutors).
138. Several of those we spoke to talked about the present time as a ‘crucial hour’ for Ukraine, a sort of "do-or-die" situation for the country. All recognised the negative effects of the Asian and, especially, the Russian crises, but they were also adamant in asserting, that "Ukraine is not Russia" economically speaking. Many of them held that psychology was largely behind the fall in the value of the hryvna, from around 2 to the dollar in mid-summer to around 3.50 by the end of September – that is, an inability on the part of the world to distinguish between the Russian and the Ukrainian situations. This may be true. (Still, it should be noted that the value of the hryvna has held firm at around 3.5 to the dollar, since September 1998 up until the writing of these lines.) However, given Ukraine's strong economic links with Russia, the latter's difficulties cannot be expected to have anything less than a direct effect on its south-western neighbour.
139. The future of the emergency programme proposed by the President and the ministerial cabinet is, however, uncertain due to considerable resistance on the part of many of the parties in the Ukrainian parliament. Indeed, in early September 1998 an effort was made in the parliament to seek the impeachment of the President. The latter's future, like that of the Cabinet of Ministers, is likely to depend to a large extent on the social and economic developments in the coming months.
140. It is not the intention of the Rapporteurs to meddle in the internal politics of a member country. However, it was clear from our exchanges with the members of Parliament that they were not satisfied with the rather particular dualistic presidential-parliamentary system in place in Ukraine - to which one could add the, largely autonomous, third power of the Cabinet of Ministers. Nor can one be happy with the all-too-frequent changes in government, making each new formation less efficient and less responsible for its actions. (This is, then, another consequence of the country's quasi-parliamentary system). The two Rapporteurs, who come from countries with more pronounced parliamentary systems - Estonia and Poland - could not help but feel sympathy with the concerns expressed by their Ukrainian parliamentary colleagues.
The virtue of the parliamentary system
141. Parliaments represent a country's people. A parliamentary majority permits the formation of a government, which makes proposals to the parliament. If policies fail, parliamentary majorities will change, a new government come to power and new proposals be made. Parliaments can make mistakes – as, by all means, also the Estonian and Polish experiences show. However, mistakes can be corrected and political directions changed. What happens under parliamentary rule is that politicians have to learn how to make compromises, how to enter into dialogue with each other, how to explain to their constituents the reasons for their policies, agreements and possible alliances. In this way, the people have a better chance of understanding, accepting, supporting or opposing as the case may be, and become partners in the political process.
142. However, in Ukraine, as in Russia, the two powers of the Presidential administration and the Parliament collide, with the Cabinet of Ministers as a third and partly autonomous force. The President and the Cabinet of Ministers may be guided by the highest motives, as may the parliament, but because of this permanent, built-in conflict in the system, a way forward is exceedingly difficult to find and blockages difficult to overcome. In other words, the President or the Ministerial Cabinet proposes, while the Parliament blocks, or vice-versa. Over the past few months, over forty presidential decrees have been issued, many of them languishing at parliament’s door. But even those that eventually do enter into force are likely not to change things much for the better, due to the absence of parliamentary, that is popular, support. Nor can it be guaranteed that policy proposals by the President or by the Cabinet of Ministers are not inspired by considerations vis-ā-vis special pressure groups in society.
143. In conclusion, we could not discern any tangible movement forward in Ukraine toward reform, and we believe the fundamental reason is the one we have just mentioned. Indeed, given the economic difficulties of the country - which contrast with progress made in many other countries in transition – one may even doubt whether any serious structural, far-reaching reforms were ever undertaken over the years since transition began. In reaching this sad conclusion we do recognise, however, Ukraine's great difficulties: the humanitarian, economic and social burden of Chernobyl; the country’s newness as an independent country, with institutions that had to be built, basically, from scratch.
The struggle of the National Bank of Ukraine
144. Waging a staunch, though largely solitary, battle against the deteriorating economic situation, is the National Bank of Ukraine. Indeed, the rather rapid depreciation of the hryvna seems to be led more by unmet consumer demand than by the emission of new money. It is therefore to be regretted all the more that virtually the entire burden of economic policy in Ukraine falls on its central bank which, our interlocutors emphasised, is now independent of the government. The Head of the Executive Board of the Central Bank was proud to point out that the country's total debt stands at only 12 billion hryvna, of which 8 billion are owed by the Bank itself. As for the 1.3 billion hryvna reportedly owed to non-residents, we were told that an offer had been made for this sum to be transferred into Eurobonds with a two-year maturity. Only 160 million hryvna would have to be repaid, we were told, over the next few months (although such repayment is of course made more difficult with a depreciating currency). The total national debt (domestic and foreign) was reported to represent only 24% of GDP (ie considerably less than in some western countries), although this does not include pension, salary and other arrears. Negotiations with the IMF and World Bank were said by our interlocutors to be tougher than those these institutions would have with other crisis-ridden countries in the world. There was also the complaint that these bodies are now focussing too much of their attention on such other countries, to the detriment of a country like Ukraine.
145. The shadow economy is reported to amount to over 40% of the total economy. This figure is by definition difficult to establish with accuracy. It could be, however, that the real economic situation in Ukraine is slightly less difficult than official figures would suggest. In reply to our questions about the food situation before the approaching winter, some of our interlocutors pointed out that many Ukrainians have small private plots in the agriculturally fertile countryside. Avoiding starvation does not, however, mean avoiding privation.
146. Our partners, though seemingly unable to agree on the best way forward, nevertheless do agree on the priority areas where reform is most urgent. We have already mentioned privatisation, where the timing of that of state monopolies such as those in telecommunications or gas and oil is still uncertain. Many so-called strategic sectors are excluded from privatisation, which begs the question what criteria are used to determine ‘strategic’. Furthermore, how is privatisation undertaken? Is the process transparent in terms of the prices paid by those who take over? In how many cases has public monopoly simply been replaced by a private one?
147. Such were the complaints heard in many of our conversations with members of the Ukrainian parliament. Some said that privatised companies do not function at all, but were robbed by the managers. Private groupings with criminal ties, if not themselves criminally involved, were said to be in control of much of privatised industry. It was of course impossible for the Rapporteurs to verify this, but to the extent that corruption is - as we fear it is - widespread in Ukraine, then this will only make economic progress all the more difficult.
148. Administrative reform will be essential to combat corruption and economic crime. It may, however, be difficult to realise to the extent that the government bureaucracy itself may be involved in or benefit from these ills and may therefore resist reform. Deregulation is long overdue, as is pension reform. However, reducing the budget deficit and achieving budget reform were priorities on everybody's lips. The need to reduce taxes which are comparatively high (compared to say Russia) collides with those of enhancing tax collection or widening the tax base. (The Committee was informed by a Ukrainian member that there would in future be only one land tax, for the sake of transparency.) Without banking sector reform, the efficiency of banks and the attraction of foreign capital will be more difficult. It seems particularly important to adopt International Accounting Standards (IAS) in the banking sector. We were told that there is an effort now underway to spread such standards to other economic sectors. Judicial reform is crucial, for without a functioning and incorruptible judicial system business will be unable to progress. Finally, it is important to create a true and sizeable middle class in Ukraine to lay the groundwork for economic reform and stability. The present system, by contrast, rather creates polarisation in society, by rendering a few very rich and the many in poverty.
149. In conclusion, Ukraine is in serious difficulties and is worthy of continued international moral and conceptual support. The main conclusion we can draw from our visit is the need to move toward a more pronounced parliamentary system of government, for the reasons indicated. Only in this way can structural reform and the other reforms mentioned be lastingly undertaken and enjoy popular support. Ukraine also faces the challenge of moving away from an economy based essentially on raw materials and low value-added manufactures. Reform in the mining sector, which burdens the state budget with around one billion dollars a year, seems inevitable. Structural reform will also permit the pronounced dependency on trade with Russia to be at least somewhat reduced.
150. Many of our interlocutors stressed that Ukraine wants to develop its economic ties also with western Europe. The free trade regime now in force between Ukraine and Estonia was mentioned as a good example of what can be achieved, and particularly heartening to your Estonian Rapporteur. However, there were several complaints about trading difficulties with the European Union, which was characterised as being overly protectionist in its trade dealings with Ukraine.
151. Finally, much needs to done to encourage the formation and growth of small and medium sized enterprises. The experiences from other countries of transition in central and eastern Europe, not to mention western Europe, show that these form the lifeblood of a nation's economy. In Ukraine, if properly furthered, they can create a new middle class, so essential also for political stability. They bring new ideas, and they are likely to be in particularly active in more sophisticated products and services. They can thereby favour the country's transformation from its present excessive dependency on raw materials and low value-added manufactures. SME's could also counter the economic crime and corruption that seems to be associated with at least parts of Ukraine’s big industry. However, they will depend for their growth on a crime-free environment, where their activities are not constantly sapped by obligatory contributions to organised crime. On the other hand, it should be underlined that the various regulations governing SMEs appear to have highly harmful effects in that they open the way to corruption. State corruption seems to be a even greater problem than the mafia. It therefore becomes very important to abolish such regulations before Ukraine can hope to join the WTO and the EU apart from the good this would do to the economy.
152. In conclusion, therefore, Ukraine gave us the impression of a sleeping giant. It has such a potential - in its people and natural resources, including agriculture. For too long Ukraine has not been allowed - and over the last decade not really allowed itself - to reach potential capabilities. Europe and the world must stand ready to assist it as soon as it does.
153. Russia and Ukraine at the outset of transition enjoyed comparatively favourable conditions for growth and transition to a market economy. However, the very gradual - indeed hesitant and often incoherent - transformation approach actually used only served to raise the final economic, social, and political reform bill. Russia and Ukraine achieved monetary stabilisation in appearance only; and since it happened too late and was accompanied by increasing budgetary arrears, it soon threatened to ruin whatever fragile stabilisation had been achieved. In addition, the democratic framework was always weak and under challenge. The determined continuation of transformation in Russia and Ukraine is therefore now a necessity. It involves fiscal adjustment and structural reform (privatisation, liberalisation, and deregulation). At the same time, monetary policy must be strengthened, irrespective of the situation in the real sectors of economy.
154. The lack of fiscal adjustment resulted in the continuation of very high budget deficits, which were largely financed by the inflow of foreign capital or through domestic credit expansion. Fiscal imbalances of this magnitude left little in the way of private investment into the productive sectors of the economy. As deficits persisted, this led to a build-up of debt and, in the end, to an inability to service it, again threatening macroeconomic stability. The more recent turmoil on the financial markets in Asia soon spread to all emerging markets, revealing the weaknesses of such ‘quasi-stabilisation’ as soon as capital flight started. Macro- and microeconomic reforms in Russia outstrip those in Ukraine by some two to three years, and this lag will be maintained as long as the Ukrainian government and parliament refuse to take resolute action. At the end of 1996 Ukraine had the chance – in the end not seized - to implement a package of fiscal and liberalisation reforms very similar to that provisionally agreed on (but yet to be implemented) between the Russian government and the IMF in mid-1998.
155. Russia and Ukraine started structural reform aimed at privatisation and liberalisation. However, these reforms remain unfinished to this day, and so only raise the eventual economic and political cost of transformation. Privatisation in Russia and Ukraine has slowed down. The most popular privatisation method – mass or voucher privatisation – turned out to be ineffective. It does not allow for the establishment of transparent ownership structures, thus postponing microeconomic restructuring and investment. Case-by-case privatisation (cash privatisation) seems to the Rapporteurs to be better equipped to achieve significant changes in the real economy. It is gaining in popularity, but alas often only as another method of deficit financing. Whatever the reason, cash privatisation must continue in Russia and gain pace in Ukraine.
156. Russia and Ukraine will need to liberalise external trade relations more to become members of WTO. However, the continued deregulation of both economies can become a problem, and a necessity, if privatisation continues merely to transform state monopolies into private ones. Additionally, both countries need radically to curtail the many bureaucratic obstacles standing in the way of normal business relations, within the countries and in relation foreign trade and investment. In spite of many assurances to the contrary, the Ukrainian government still multiplies administrative complications for private businesses and does not pursue any liberalisation policies such as those implemented at the beginning of the transformation process in Russia (in 1992) or Poland (in 1990).
157. The limited foreign direct investment can be explained by the fact that liberalisation of the economy and of foreign trade and investment has been so partial and piecemeal. There is also a lack of law enforcement and of proper and cohesive rules. Additionally, monopolisation and the unchecked formation of cartels, such as through the FIGs (Financial and Industrial Groups), negatively affect the development of free and transparent markets. Suffocating administrative regulations - combined with tightly knit networks of companies in Russia and Ukraine with large financial resources at their disposal - result in excessively close relations between administration and business. This in turn leads to corruption and Mafiya-type connections. The most telling sign of the power of lobbies is the so far effective resistance against tax reform and against attempts to increase transparency and the flow of information (shown, for instance, in the maintenance of decentralised share registries or the non-observance of international accounting standards in the banking sector).
158. The abundance of mineral and energy resources favours the formation of administrative-business structures and connections. Obviously, the benefits of possessing such resources are high, but so are the potential costs. Among the latter are an insufficient diversification of exports and a heightened vulnerability to fluctuations in commodity prices in world markets. There is also the temptation to use such resources excessively to develop heavy industry (consuming much energy) producing low value added goods, which are particularly sensitive to changes in world prices.
159. This latter point is important, in that it makes us understand the crux of the, say, Russian dilemma. As long as the economy is not liberalised and democratisation not further pursued, the hold over the former by privileged groups will tend to perpetuate the concentration on raw materials and low value-added products. Any world recession - which automatically leads to a lowering of raw materials prices such as oil - will therefore hurt the economy in question much harder than, say, a more developed and diversified economy. Eventually, the privileged groups themselves will be hurt (at least as long as they have not placed their money in safe havens abroad). Logically speaking then, they themselves should have an interest in initiating true economic reform.
160. The ‘trap of the resource economy’ will be rather difficult to overcome over the next few years. Russia and Ukraine maintain comparative advantages in the resource sectors since liberalisation and the formation of new economic sectors are rather limited. Therefore, (foreign) investment will be concentrated there in the short-term. Only growing purchasing power in the domestic market and the formation of a middle class, in contrast to the current oligarchy, stands the chance of ensuring balanced economic and social development.
161. The poor performance of Russian and Ukrainian banks finds its explanation in the lack of liberalisation in the banking system (such as the ban on access by foreign banks) and in the weak banking supervision. The situation is made worse by the lack of accounting transparency (such as through the International Accounting Standards). Monetisation in both economies remains modest, as banks are not able to attract the deposits of ordinary people. (The holding of foreign currency, usually USD, is the most popular means of saving, whether under mattresses or abroad, for the wealthy, in the form of capital flight). Nor do enterprises trust financial intermediaries. The risk of bankruptcy is enhanced not only through high exposure to debt incurred in foreign currencies which tend to appreciate, but also through the high proportion of non-performing loans, especially as the lack of economic growth will not make ‘bad debt go good’.
162. The establishment of the CIS and the CU (customs union) served different, often contradictory goals. Where politics takes precedence over the economy, one does well in reflecting over the possible financial price to pay. Integration tendencies within the CIS or the CU are challenged by regional co-operation agreements based on real needs - such as the UEZ or GUAM on the one hand, and ‘regionalisation’ within Russia itself on the other. The governors of the regions - sitting on the Federation Council, or the upper house of the Russian Parliament – represent particular local interests and often compete among themselves vis-ā-vis the federal government for financial and political advantage. The overriding of federal regulations if they go against their interests (e.g. legislation on land ownership) can raise serious doubts in the future as to the legal structure of the Russian state.
163. Most of the FSU countries, including Russia and Ukraine, have developed strong presidential systems, which have served to fragment the political landscape with the exception of the post-communist ones. Generally speaking, while political parties are in the process of being formed, this process is undermined by the lack of a stable electorate which itself cannot form unless there is economic development. Hence, ensuring lasting support for any particular government has become a particular challenge. The presidents in the FSU countries often need to reshuffle cabinets to reflect the changing influence of particular lobbies. There is an overall consensus as regards the direction of reform. However, the devil is in the detail, and proposed programmes or draft laws often do not find support in parliament. In both countries, a highly cautious approach towards change, especially radical change, prevails in parliament and in public opinion, with the dream of an elusive ‘Third Way” or a more evolutionary approach continuously reappearing. And a prolonged process of economic transformation without significant improvements in social conditions only adds to the ammunition of the radical left or right.
164. The social aspects of transformation in the countries studied have not been extensively covered in this report, as they require separate and detailed treatment.17 However, we must at least mention the vast ecological problems inherited from Soviet times (such as obsolete nuclear power stations or deposits of nuclear waste), and the social problems as these are reflected in a critical public health situation (declining life expectancy, alcoholism, and low birth rates). These and other ‘social diseases’ may be more permanent than transitory, but they nevertheless inevitably slow down the process of transformation and increase its costs. Various members of the Committee on Economic Affairs and Development have also pointed to the importance of improving the educational system, including as regards foreign languages.
165. Another issue requiring separate treatment is the paradox that, while there has doubtless been progress in modernising various laws (such as civil and penal/criminal codes), these cannot be effectively applied due to the general weakness of the juridical system and the heritage of the weak position of courts in Soviet days. The tardy improvement in the efficiency of courts is a further weak spot in the progress of transformation.
Dignitaries visited during the Rapporteurs' visit to Moscow (30 October 1998) and Kiev (28-29 September 1998)
Moscow:
Mr L.I. ABALKIN, Director, Institute of Economics, Russian Academy of Sciences
Mr V. AVERCHEV Member of the Parliamentary Assembly of the Council of Europe
Mr G.V. BOOS, Head of State Tax Service
Mr A.V. DANILOV-DANILIAN, Head of the Economic Department of the Administration of the President of Russia
Mr V. FILIMONOV Member of the Parliamentary Assembly of the Council of Europe
Mr G.V. GABUNIA, Minister of Trade
Mr M. KASYANOV, Deputy Minister of Finance of the Russian Federation
Mr B. KUZNETSOV Member of the Parliamentary Assembly of the Council of Europe
Mr G.O. KURANOV, Head of Macroeconomic Forecasting Department of the Ministry of Economics
Mr LUZHKOV, Mayor of Moscow
Mrs V.I. MATVIENKO, Deputy Chairperson of the Government of the
Russian Federation
Mr V.A. MAY, Deputy Director of the Institute of Current Economic Problems
Mr N.Y. PETRAKOV, Director of the Market Economy Institute of the Russian Academy of Sciences
Mr A.G. PUZANOVSKI, Deputy Chairman of the State Duma Committee
on Economic Policy
Mr V.A. RYZHKOV, First Deputy Chairman of the State Duma of the Russian Federation
Mr A.N. SHOKHIN, Member of the PACE Committee on Economy and Development
Mr P.S. SMIRNOV, Director of the Department of International Financial and Economic Relations of the Central Bank of the Russian Federation
Mr V.S. ZAHAROV, Vice-President, Association of Russian Banks
Mr A.D. ZHUKOV, Chairman of the State Duma Committee on Budget, Taxes, Banks and Finance
Ukraine:
Mr BONDAR Deputy Chairman of the Executive Board of the National Bank of Ukraine
Mr KOSATSKI Member of Parliament
Mr V. LITVITSKIY Assistant to the President
Mr MARMESOV Member of Parliament
Mr I. MITYUKOV Minister for Finance
Mr POPESCU Member of Parliament
Mr RACHANSKI Member of Parliament
Mr A. RYABCHENKO Member of Parliament, Chairman of the Committee of Privatisation Control
Mr I. SHUMYLO Deputy Minister of the Economy
Mr S. TERIYOHIN Member of Parliament
Mr S. TIHIPKO Deputy Prime Minister of Ukraine
Members of the Permanent Delegation of the Supreme Rada of Ukraine to the Parliamentary Assembly of the Council of Europe
Members of the Committee of the Supreme Rada of Ukraine for Economic Policy, National Economy Management, Property and Investments
Appendix II: The Belarus Economy
1. In Belarus, two periods in political and economical development can be distinguished: that before and that after the presidential elections (bringing to office Mr Lukashenko). Both periods are rather difficult to analyse, due to insufficient data from the first period (1992-1994) and a lack of reliable data covering the second (1995-1998). Over the last two to three years, a tightening of state control, especially in foreign and domestic private business activities, has reversed the liberalisation process observed until then. It has been accompanied by credit expansion and price controls on consumers and producer goods - as well as on the currency itself (through the official exchange rate). Although the fiscal situation looks quite good - the official budget deficit in 1996 amounted to 1.6 per cent of GDP and in 1997 it even showed a surplus – this is so only because of the use of credits from the National Bank of Belarus (NBB). Another problem is the lack of structural reform. Small-scale privatisation, or rather “co-operativisation”18, has continued, but only 10 per cent of the large enterprises had been privatised by mid 1997, involving only about 10 per cent of the workforce. Additionally, in February 1997, new re-registration procedures were imposed on existing companies, the obvious goal being to make it difficult to register them. Although the economy for some time showed a tendency to grow (after a steep decline), the market exchange rate has slumped, and hidden inflation accelerated.
2. The Belarus economy is highly dependent on imported energy. Almost 98 per cent of the natural gas and 87 per cent of the crude oil is imported from Russia, a dependence which has not changed since Soviet days. Belarus receives gas from Russia at artificially low prices (about 65 per cent of the world price). These gas subsidies are estimated to amount to almost 2 per cent of the Belarus GDP. Prices differ for households and enterprises. (In mid-1997, households were paying about one third of the real cost of the energy they consumed.)
3. Obviously, such interventionist policies will not help improve the rather poor financial position of Belarusan enterprises. Although there is some economic growth, the share of loss-making enterprises has recently increased. Unfortunately, there is not sufficient information on this issue, but at the beginning of 1997 the share of unprofitable firms was around 18 per cent of the total, and growing. Official statistics show enterprise arrears to have decreased to less than 1 per cent of GDP in mid-1997 (compared with 5 per cent at the end of 1995). Gas arrears, however - owed not only by industrial enterprises but also by households - present a bigger problem. At the beginning of 1997 they amounted to 63 per cent of total consumption.
Monetary Policy and Exchange Rate
4. Belarus managed to bring down inflation to moderate levels by the beginning of 1996. Average monthly inflation fell from 4 per cent in the first quarter to 1.5 per cent by the middle of the year. However, this changed as a result of the credit expansion and the nominal wage increases that took place in this period. Inflation accelerated to 13.3 per cent in January 1997, only to come down to 4.3 per cent in April 1997, a level still above that of 1996. Inflation as measured by the CPI was 43 per cent at the end of 1996 and 66 per cent a year later. From time to time, the government takes measures to reduce inflation by introducing price controls or by setting profit margins (in August 1996 a profit margin of 25 per cent was set by the Ministry of Finance), or by setting mark-ups on imports. Also, wage policies are under the strict control of authorities. The government sets the minimum wage and makes recommendations to enterprises. To compensate for inflation, nominal wages were increased significantly in 1996, but the minimum wage is still very low. (In April 1997 it was BRB 150,000, equivalent of 5.6 USD ).19
5. From 1996 onwards, the presidential administration and the government took control over monetary policy. The National Bank of Belarus lost its decision-making autonomy. Both money and credit expanded in 1996. The rapid growth of credit to the banks was related to the growing demands for financing of the agricultural sector. About 90 per cent of the credit extended by the NBB to banks was in the form of direct credit at low interest rates, ranging from 2 per cent per annum for housing construction to 17 per cent for other purposes. In 1996, direct credit became the main source of money creation, with NBB claims on banks rising by 188 per cent and its loans to the government by 66 per cent.
6. Belarus is still a multiple-exchange-rate economy. The official rate is the lowest, some 25 per cent less than that practised by exchange offices. The official NBB exchange rate is used for government transactions (e.g., sale of foreign exchange to the NBB by enterprises). Foreigners and Belarusans use the exchange offices. Although the selling and buying of foreign exchange through exchange offices is not forbidden, in practice it is not easy to use their services (unless one has a receipt showing an earlier sale of foreign exchange). Due to restrictions of this kind a black market has sprung up, in which the prices for foreign exchange are 15-20 per cent above those at the exchange offices. Finally, there is the so-called ‘inter-bank clearing exchange rate’ - used by companies for transactions among themselves – which stands at almost twice the official exchange rate.
7. The banking sector in Belarus is on the whole very weak. The absence of proper laws and lenient licensing regulations contributed to the rapid growth in the number of banks in the years 1992-1994. (There were 52 banks in 1994). Most banks were undercapitalised and held large numbers of non-performing loans. From the beginning of 1996, the NBB started to encourage banks to merge, and in some instances dissolved them. By mid-1997 there were 37 banks holding licenses, 28 of which were active and 9 in the process of liquidation. This restructuring included new regulations and prudential measures. Although the situation has improved since 1994, problems remain. One is the high concentration in the banking sector. In 1997, the previously specialised banks accounted for more than 80 per cent of all domestic currency deposits and provided more than 80 per cent of all loans (compared with 66 per cent in December 1995). Out of 37 banks registered, one was fully state-owned, 31 were joint stock companies and three were limited liability companies. One bank was fully private, while two were affiliates of foreign banks.
8. In 1991, the Belarus Stock Exchange was created. However, the development of the stock market has been hindered by the slow pace of privatisation, non-transparent accounting rules and the general absence of any liberalisation of the economy. The Belarusan inter-bank market is dominated by short-term loans (one-day or overnight) aimed to satisfy the liquidity requirements of the NBB.
Fiscal Policy, Deficit and Financing
9. It is difficult adequately to describe the state of government finances in Belarus. This is so because the general government budget comprises many items (state budget, social funds, and off-budget funds). For the years 1992-1997, the state budget showed deficits ranging from 4.2 per cent of GDP to 1.8 per cent. Belarus is a country with very high levels of budget revenue and expenditure (the highest among the FSU countries). This reflects the still large share of the state in the economy, as well as the lack of structural reform.
10. The structure of tax revenue has changed over the period 1992-1997. Although taxes on goods and services remain the main source, the importance of income and profit taxes declined (from 13 per cent of GDP in 1993 and 1994 to less than 8 per cent in 1996 and 1997). In 1996, many companies were granted tax exemptions, mainly from VAT and custom duties. In mid-1996 the government carried out a clearing of arrears between enterprises and the budget. In 1997, many of the exemptions were withdrawn in order to improve the budgetary situation, negatively influencing that of enterprises. Facing a decline in real revenues, the government had to cut expenditure. From 1993 onwards, we see a decrease in government spending relative to GDP (from 56.2 per cent in 1993 to 43.6 in 1996). The only areas where expenditures increased as a percentage of GDP were education, health and defence.
11. Since most international organisations have virtually withdrawn from Belarus, the financing of the budget deficit essentially has to come from the nation itself. The main source is credit from the NBB. Even though the budget was in surplus in 1997, the government continued to borrow from the NBB, also issuing securities.
Foreign Trade and Balance of Payments
12. The major foreign trade partners of Belarus in are the other FSU countries. They account for more than 65 per cent of exports and around 65 per cent of imports. Exports are mainly manufactured products (vehicles, machinery), fertilisers, and army equipment. The main imports are raw materials (energy, in particular crude oil and natural gas) and food. The most important partner is the Russian Federation – indeed it is the only supplier of crude oil and natural gas. In 1996, exports to Russia accounted for almost 80 per cent of all exports to the FSU area; similarly, imports from Russia account for 75 per cent of imports from the FSU. As already mentioned, Russia subsidises the Belarus importation of gas by charging only 65 per cent of the world price. Belarus exports to ROW countries consist mainly of raw materials (timber, steel), textiles and chemicals, while food products and machines are main imports. Other important partners of Belarus are Germany and Poland.
13. The trade balance of Belarus has been deteriorating since 1992, when it was in surplus. Although there is a growth in exports (USD 5.4 billion in 1996 compared with USD 2.5 billion in 1994), the increase in imports is even bigger. While in 1995 the trade deficit amounted to 7.6 per cent of GDP, in 1996 it was 8.6 per cent and in 1997 it stood at 10.8 per cent. The development in the trade balance influences the overall balance of payments, as the trade deficit is too large to be offset by the inflow of capital or by net transfer receipts.
14. Little information exists on the so-called presidential sector. There exists an “Office for Presidential Matters”, which serves as a technical base for the presidential administration. This sector controls many economic activities, such as factories producing souvenirs, sanatoriums, game-preserves for sportsmen, companies importing alcohol for re-exporting to Russia, and the best real estate in Minsk. (This last area made the international headlines in the summer of 1998, as apartments belonging to the diplomatic community were simply taken over by the government.) Earnings from these sectors are transferred, not to the budget, but to a special presidential fund. The money is supposed to cover expenses connected with the activity of the presidential administration, but the break down of actual spending is not available.
15. In 1998, the official GDP is expected to grow unless the current crisis in Asia and Russia does not change matters for the worse. Broad money supply should rise by about 110 per cent. Inflation measured by CPI is forecast at around 80 per cent. Although the authorities hope to be able to lower inflation, it is doubtful whether this will happen. Furthermore, the government is likely to have to depreciate the currency further.
16. Even though the authorities try to put the best face on the economic performance, the situation is bad. GDP as measured in USD is actually in decline. Economic experts from the Belarus opposition foresee a deep crisis by the end of 1998. Although the economic situation is deteriorating and made worse by the situation in Russia (there have recently even been delays in the payment of salaries and pensions), the people as a whole do not overly eager to change the political situation. And without political changes, lasting improvements in the economic situation are impossible.
Appendix III: Economic cooperation and development among countries of the former Soviet Union
1. The date of the dissolution of the Soviet Union became the birthday of the Commonwealth of Independent States. On 8 December, 1991, the President of Russia (Mr Yeltsin), the President of Ukraine (Mr Kravchuk), and the Prime Minister of Belarus (Mr Kiebich) agreed to establish a Commonwealth of Independent States, sharing a common economic area and systems of transport and communications. The command over the strategic forces was to be common, and foreign policy co-ordinated. The Commonwealth was opened to the FSU countries as well as others, at least in theory. Former republics supporting the idea of preserving some form of co-operation joined the CIS and signed a protocol and a common declaration with Russia, Ukraine, and Belarus in Almaty, on 21 December 1991. All the FSU countries except the Baltic states, Georgia, and Azerbaijan signed the Almaty Declaration (with the latter two joining the CIS two years later).
2. Since its beginning, the CIS has had to face three fundamental sets of problems, which have hampered its functioning, let alone its development: the splitting up of assets inherited from the Soviet Union; the sharing out of competencies (and influence) within the CIS and abroad; and, finally, ethnic conflict. As for the heritage from the Soviet Union, the simple rule was adhered to that the successor states should keep the assets situated on their territory. Soon, however, the first conflict arose around the division of the military forces in general, and of the Black Sea Fleet in particular.20 The way the conflict was resolved illustrated the real, though not declared, way of reaching decisions in the CIS. Initially, all the FSU republics demanded their share in the Black Sea Fleet, as all of them had shared in its funding. However, Russia and Ukraine decided to share the Fleet between themselves only, thus establishing the non-written rule (of force) of solving the disputes within the CIS. This method was mirrored in the division of competencies in the international arena. The CIS - an entity without any real representation and above all not a subject of international law - could not become a legal successor to the Soviet Union. Against the will of Ukraine and the Baltic States, this role was simply assumed by Russia, which took over all the international assets and liabilities of the Soviet Union, including diplomatic and trade agencies.
3. The collapse of the Soviet Union gave rise to the formation of previously dormant national identities within many of the former republics and autonomous regions, in turn leading to intensified regional conflicts. These were a consequence of Soviet policies vis-ā-vis nationalities started under Stalin, when for the achievement of politic goals considered urgent, borders between republics were arbitrarily changed, peoples re-settled and repressed, and neighbouring countries occupied. Current conflicts between FSU countries or regions therefore often concern border disputes or nationalities seeking independence or autonomy. The most serious have been, or are, the conflicts between Armenia and Azerbaijan (the Karabakh region), Russia and Ukraine (the Crimean Peninsula), in Chechnya and in Georgia (Abkhazia).
4. Efforts to preserve or revive inter-republican ties include a number of agreements signed at summits of CIS states. In general, these were often lacking in concreteness and in effective implementation mechanisms. The first was the “Agreement on a Uniform Monetary System and Unified Money, Credit, and Currency Policy in the States Using the Rouble as a Legal Mean of Exchange”, signed in October, 1992, during the CIS summit meeting in the Kirgiz capital Bishkek by eight states (Armenia, Belarus, Kazakhstan, Kirgizstan, Moldova, Russia, Tajikistan, and Uzbekistan). In Bishkek, it was also decided to create an Inter-state Bank (Mezhgosudarstvennyi Bank), whose “task of first priority” would be the “realisation of mutual inter-state settlements”. It was not clear, however, whether this bank would be the central emission bank for the rouble area, or only a clearing bank. The internal organisation of the Bank became a subject of conflict between the signatories of the Bishkek Agreement. Russia wanted a quota system modelled on that of the IMF, which would obviously have given it the major say. The other partners preferred the principle of ‘one-country- one-vote’, which in turn was not acceptable to Russia. Finally, after long negotiations, at the next summit in Minsk in January 1993 it was agreed that the Inter-state Bank would be an institution for multilateral clearing based on the Russian rouble. Russia would receive half the votes in the Board of the Bank - with most decisions, however, requiring three-fourths of the votes for approval. Neither the economic union nor the Inter-state Bank did, however, come into being, in spite of repeated political assurances to the contrary.
5. At a summit in Moscow in May 1993, a new document - the Economic Union Treaty - was signed. It reaffirmed the earlier agreement concerning the Inter-state Bank and the intention to preserve the common currency (the rouble). On this basis, negotiations for a New Style Rouble Area were conducted (although it was not generally understood how the NSRA was to differ from its predecessor). The July 1993 rouble exchange no doubt served as an encouragement in this regard, as the FSU countries, which were still officially using the old banknotes, witnessed a massive flight from the currency. The next agreement concerning the NSRA - signed in September 1993 by Russia, Kazakhstan, Uzbekistan, Tajikistan, Belarus and Armenia - included an agreement to harmonise monetary, fiscal, banking, and currency regulations (an agreement to maintain stable exchange rates between national currencies and the rouble). Indicators to be set by Russia included the money supply, the consolidated budget deficit, interest rates on central bank refinancing credit, and minimum reserve requirements. This agreement paved the way for bilateral negotiations between Russia and the other CIS countries. The next step involved signing the standardised bilateral agreements between Russia and the countries mentioned. The date for the conclusion of the transition period (completion of appropriate legal regulations and co-ordination with Russia of monetary and fiscal policy) was set for the end of 1994. However, this agreement was not implemented either.
6. The last serious attempt at least partly to rebuild the rouble area was the “Agreement on the Unification of the Monetary Systems of the Republic of Belarus and the Russian Federation and on the Conditions of Functioning of a Common Monetary System” of April 1994. It was also the first sign of closer co-operation between Russia and Belarus. Belarus tried to use the political changes in Moscow at the beginning of 1994 to realise the idea of an NSRA. The document as signed called for a number of far-reaching steps to harmonise the economic systems of the two countries. The most important were: adapting Belarus custom duties and taxes affecting foreign trade to those of Russia, and eliminating tariffs in mutual trade; establishing the Russian rouble as a common monetary unit (control over the NBB was to be handed over to the CBR); replacing Belarus roubles with Russian ones; and harmonising the budgetary systems of the two countries. Undoubtedly, this treaty was the most concrete agreement to date, concluded with the aim of bringing about a return to a common currency in at least a portion of the territory of the former Soviet Union. However, like its forerunners, it was never ratified or implemented. The NBB’s tough stance during the negotiations on the final exchange rate between the two currencies made the Russian side fear that the cost of unification would be too high. Belarus demanded a one-to-one exchange rate, a situation which would have caused serious inflation in Russia. Furthermore, the Belarus economy would have required further subsidies to be paid out.
7. In October 1994, at the 16th CIS Summit in Moscow, the presidents of all twelve CIS countries signed several agreements – among them one on the establishment of an Inter-state Economic Committee, a memorandum on the development of integration within the CIS and an agreement foreseeing the creation of a payments union. The IEC was to be located in Moscow, against the wish of Belarus which expected Minsk to become the seat of the CIS institutions. The structure of the CIS was to be similar to that of the Inter-state Bank. Russia would have 50 per cent of the votes, but the majority of issues were to require 80 per cent of the votes for approval. The IEC’s decisions would be binding on the juridical and executive organs of the signatory countries. Furthermore, the IEC was to manage trans-national assets such as transport, telecommunications and the power-engineering industry. A summit held in February 1995 in Almaty did, however, bring into the open the conflict of interest between Russia and other CIS members. The Russian side attempted to reach detailed agreements on military co-operation, such as on a common command for the safeguarding of the external borders and airspace of the CIS area, and a joint early warning system against missile attacks). This, however, met with strong opposition from Ukraine, Azerbaijan and Turkmenistan in particular. Thus, some motives going beyond the purely economic area were becoming more apparent.
8. Some CIS leaders outside Russia fought until the very end for the rouble zone. They represented countries that had benefited heavily from Russian financial aid in the past. They believed that remaining in the rouble zone would allow them to preserve the inter-republican economic relations of the Soviet period: large fiscal or quasi-fiscal transfers; unlimited, cheap deliveries of energy and raw materials (from Russia); and an easy market for their manufactured goods (in Russia), many of which did not meet world standards. These expectations were, however, unrealistic. Beside the purely economic expectations, political motives also played an important role. This was clear in the case of the two most active advocates of closer ties with Russia – Kazakhstan and Belarus. Kazakhstan feared a conflict between the native populations of the country and the Russian population in the event of a definitive economic separation between Kazakhstan and Russia. The Belarus delegation leader, Mr Kebich, wanted to secure a victory in the presidential election of June 1994 by holding out the possibility of reaching Russian living standards, which were higher than those in Belarus at the time. He also considered the monetary union as obviating the need for radical market reform and macroeconomic adjustments.
9. On the Russian side, the main advocates of preserving and later rebuilding inter-republican ties were to be found among conservative and moderately conservative forces interested in at least partly reviving the Soviet era and taking no heed of the enormous financial costs this would entail for Russia. The opponents included almost all politicians and economists in the camp of the radical reformers. In the middle ground between the two camps were a lobby consisting for the most part of Russian industrialists and businessmen wishing to establish so-called Financial-Industrial Groups (FIGs). FIGs were also supposed to take over the assets of the CIS countries in exchange for debt owed Russia (the so-called debt-equity option).
10. Growing conflict among the CIS countries - or perhaps rather between Russia and the other CIS members considered as a group – caused that country to shift its interest in favour of bilateral agreements and ties with individual countries more willing to co-operate. This willingness took different forms, as only Belarus fully supported the Russian efforts at integration. As for Kazakhstan and Kyrgyzstan (members of the Customs Union), forceful economic arguments were used. In 1994, Russia closed the pipelines for Kazakh oil for “ecological reasons”, the only transportation route for this land-locked country. Already a member of the CU, Kazakhstan used a similar type of ‘argument’, in that it imposed excessively strict border controls against Kyrgyzstan, which reluctantly ratified at least most of the CU agreement in 1997.
11. In January 1995, Kazakhstan entered into a Customs Union Agreement with Russia and Belarus. In May 1995 Russia and Belarus signed a bilateral agreement meant to signal: a) a harmonisation of external import and export duties; b) the establishment of common rules for trade with third countries; c) the adoption of new excise tax rates on goods imported into Belarus, meant to conform with those in Russia; and d) the harmonisation of non-tariff regulations. The harmonisation of trade regimes is, however, not yet fully achieved and faces difficulties resulting from the fact that they are constantly the subject of cost and benefit analyses carried out by all the participating members.
12. The formation of the CU holds different political and especially economic consequences for all the countries involved. Firstly, there are two stages in the implementation of a custom union: the harmonisation of tariff regulations between member countries and the establishment of a common tariff wall for trade with third countries. Secondly, the benefits and the costs for the countries involved can be very different. They will depend on the level and form of protection in each prospective member relative to the joint external tariff agreed on. If potential new members are able to influence the external tariff – by lowering the overall level and modifying its structure so that it reflects their own interests as producers and potential exporters – then they can improve the prospects of obtaining some benefits from the joining the CU. In practice, however, smaller countries have found it difficult to influence the overall protective structure of a customs union, including tariff levels. It tends to reflect primarily the interest of the largest and more industrially advanced members.
13. Countries with a more liberal trade regime joining a less liberal CU could be worse off than before. This holds for Kyrgyzstan, which has only one flat import tariff rate of 10 per cent and which has cancelled all export restrictions. If the CU external tariffs were made lower and more uniform, however, then the costs of joining could be dramatically reduced. Indeed, joining the WTO – which Kyrgyztan has recently done - with a low and uniform tariff is still the best policy choice. The existing tariff system unduly favours products made in the CU itself. Therefore, tariffs
will likely be high for products currently produced in the CU, and lower on those exclusively made in countries joining the customs union.
14. A customs union may well complicate the fiscal revenue situation. There will be a need significantly to harmonise various taxes. There could also be a shift toward more imports of products with lower tariffs from partners within the region, leading to reduced tax revenue from such tariffs for new members.
15. On 10 and 16 January 1994, Kazakhstan signed the Treaty on a Unified Economic Zone (Edinaya Ekonomicheskaya Zona) with Uzbekistan and Kirgizstan, respectively. Most of the meetings were devoted to microeconomic issues (e.g., co-operation and co-ordination of production in particular enterprises) or to working out a joint political platform for negotiations with Russia during the CIS meetings. Hence the purpose of the UEZ was in reality never met, in spite of the establishment of common intergovernmental institutions such as the Interstate Council between Kazakhstan, Kyrgyzstan and Uzbekistan, or the Central Asian Bank for Co-operation and Development.
16. Politics can at least in part be blamed for the lack of economic results. The Treaty on the UEZ among the three Central Asian countries was meant to counterbalance the integration tendencies coming from the CIS and the CU. Given the dominant position of Russia, this could be justifiable from the political and economic perspective. Also, the goals of the signatories differed, with Kazakhstan attempting to play a leading role among the Central Asian countries while Uzbekistan conducted a more independent economic and foreign policy and Kyrgyzstan stood somewhere in-between the two. It should also be borne in mind that, unlike Uzbekistan, Kazakhstan and Kirgizstan are sparsely populated. The common economic interests of the countries in the region (Kazakhstan, Kirgizstan, Uzbekistan, Tajikistan, and Turkmenistan)21 remain the most important motivating factor for co-operation between them, and these interests are not always identical to those of Russia. That is why the UEZ and other regional co-operation agreements have indeed sprung up.
17. Georgia, Ukraine, Azerbaijan, and Moldova started to develop closer economic and political ties around the common task of making good use of the rich oil deposits in the Caspian Sea. An international consortium - including European, American, and Russian companies as well as the Azerbaijani government - won the tender to explore the Azeri oil. However, the transportation route to be chosen became the subject of fierce dispute. Russia wanted to expand the existing pipeline network going through Russian territory only (including Chechnya) and thereby gain strong control over transport. Other partners, however, opposed this idea. Azerbaijan for one was not eager to surrender its newly discovered natural resources to Russian control. Hence, in co-operation with Georgia and Ukraine an alternative route was proposed. Finally, in 1997 a compromise was reached to transport oil via two routes: one across Russian territory and another through Georgia, Ukraine, Moldova and Turkey. But much can still happen as regards the final routing of pipelines, given the high political status involved.
Reporting committee: Committee on Economic Affairs and Development
Budgetary implications for the Assembly: none
Reference to committee: Doc. 7823 and Reference No. 2189 of 28 May 1997
Draft resolution unanimously adopted by the committee on 5 January 1999
Members of the committee: Mrs Degn (Chairperson), MM. Elo, Bloetzer, Valleix
(Vice-Chairmen), Aliko, Andreoli, Barsony, Behrendt, Billing, Mrs Blattmann, MM. Bonet Casas, Brunhart, Mrs Calner, MM. Cunliffe (Alternate: Davis), Cusimano (Alternate: de Carolis), Dumitrescu, Mrs Durrieu, MM. Eyskens, Figel (Alternate: Prokes), Frey, Mrs Freyberg, Mrs Frimannsdottir, MM. Galvao Lucas, Gonzalez Laxe, Lord Grenfell, MM. Gusenbauer, Gylys, Gyuga, Kacin, Kiratlioglu, Kirilov, Kittis, Kuznetsov, Lambergs, Lazarenko (Alternate: Kosakivsky), Leers, Liapis, Mateju, Mautner Markhof, Mitterrand, Nothomb, Obuljen, Pereira Coelho, Popesku, Poppe, Puche, Regenwetter, Rigo (Alternate: Mrs Pozza Tasca), Rutskoy, Sceberras Trigona, Siebert, Sorocean, Mrs Squarcialupi, Mrs Stepova, Mrs Stoyanova, MM. Sungur, Telgmaa, Townend, Tripunovksi, Upton, Vasile, Verbeek,Verivakis, Wielowieyski.
NB. The names of those members present at the meeting are printed in italics
Secretaries of the committee: MM. Torbiörn, Mezei and Ms Ramanauskaite
Table 1: Russia, Real Sector Indicators (Thousands of roubles)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |
Gross Domestic Product (GDP) 1/ |
19,006 |
171,510 |
610,745 |
1,630,079 |
2,256,120 |
2,675,000 |
Real GDP (% change) |
-15.0 |
-9.0 |
-13.0 |
-4.3 |
-4.9 |
0.8 |
Absorption (A) |
7,845 |
80,870 |
343,250 |
913,760 |
1,337,842 |
1,495,242 |
Consumption (C) |
5,175 |
53,746 |
237,036 |
663,760 |
961,842 |
1,086,442 |
Gross Investment (I) |
2,670 |
27,124 |
106,214 |
250,000 |
376,000 |
408,800 |
Foreign Balance (X-M) 2/ |
174 |
14,222 |
35,120 |
51,435 |
90,470 |
70,173 |
Income from Abroad (Net) (Yf) |
-1,996 |
-5,272 |
-5,695 |
-15,021 |
-26,867 |
-48,715 |
Gross National Income (GNI) |
17,010 |
166,238 |
605,050 |
1,615,058 |
2,229,253 |
2,626,285 |
Current Transfers (Net) (TRf) |
-316 |
455 |
905 |
-2,320 | ||
Gross National Disposable Income (GNDI) |
17,010 |
166,238 |
604,733 |
1,615,513 |
2,230,158 |
2,623,965 |
Average monthly wage (roubles) |
6,000 |
58,700 |
220,400 |
472,400 |
790,000 |
965,000 |
Average monthly wage (USD) |
14 |
48 |
70 |
104 |
144 |
166 |
Unemployment rate (%) |
4.7 |
5.3 |
7.5 |
8.9 |
9.3 |
9.2 |
Privatisation 3/ |
... |
89 |
112 |
122 |
126.8 |
128.1 |
Source: IMF IFS, July 1997; Russian Economic Trends, different issues; CBR |
||||||
1/ Production based GDP for 1992-1993 |
||||||
2/ Goods and services |
||||||
3/ Number of privatised firms in thousands; in 1997 data for mid-year |
||||||
Table 2: Russia, Fiscal Operations (per cent of GDP)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |||||||
Federal government |
||||||||||||
Revenue |
16.6 |
13.7 |
11.9 |
12.1 |
11.1 |
12.1 | ||||||
Expenditure |
27.7 |
20.6 |
22.5 |
17.4 |
18.9 |
19.0 | ||||||
Transfers: to sub-national budgets |
1.8 |
2.7 |
3.6 |
1.8 |
2.1 |
... | ||||||
to four extra-budgetary funds 1/ |
... |
... |
0.1 |
0.5 |
0.3 |
... | ||||||
Interest payments |
0.8 |
2.1 |
1.8 |
3.0 |
5.8 |
4.8 | ||||||
Balance |
-11.1 |
-6.9 |
-10.6 |
-5.3 |
-7.8 |
-6.9 | ||||||
Primary balance |
-10.3 |
-4.8 |
-8.8 |
-2.3 |
-2.0 |
-2.0 | ||||||
Subjects of the Federation |
||||||||||||
Revenue |
14.4 |
17.6 |
15.4 |
12.6 |
12.2 |
... | ||||||
Transfers from the Federal budget |
1.8 |
2.7 |
3.6 |
1.8 |
2.1 |
... | ||||||
Expenditures |
12.8 |
17.0 |
14.9 |
13.0 |
13.1 |
... | ||||||
Balance |
1.6 |
0.7 |
0.5 |
-0.4 |
-1.0 |
... | ||||||
Extra-budgetary funds |
||||||||||||
Revenue |
12.5 |
9.1 |
9.9 |
8.9 |
9.4 |
... | ||||||
Transfers from the Federal budget |
... |
... |
0.1 |
0.5 |
0.3 |
... | ||||||
Expenditures |
9.9 |
8.4 |
9.4 |
9.1 |
9.5 |
... | ||||||
Balance |
2.6 |
0.7 |
0.4 |
-0.2 |
-0.1 |
... | ||||||
General government |
||||||||||||
Revenue |
41.6 |
37.5 |
33.4 |
31.3 |
30.4 |
31.8 | ||||||
Expenditure |
60.5 |
45.1 |
43.1 |
37.2 |
39.2 |
40.0 | ||||||
Balance |
-18.9 |
-7.6 |
-9.7 |
-6.0 |
-8.8 |
-8.2 | ||||||
Financing |
||||||||||||
Foreign |
11.7 |
2.0 |
0.0 |
-0.2 |
0.6 |
... | ||||||
Disbursements |
12.8 |
2.8 |
0.9 |
0.7 |
1.3 |
... | ||||||
Principal repayments |
-1.1 |
-0.7 |
-0.9 |
-0.9 |
-0.6 |
... | ||||||
Domestic |
6.7 |
5.6 |
9.7 |
6.2 |
8.2 |
... | ||||||
Monetary authorities |
9.4 |
6.2 |
8.1 |
1.6 |
2.1 |
... | ||||||
Banks |
-3.9 |
-0.9 |
0.8 |
3.3 |
4.6 |
... | ||||||
Privatisation proceeds 2/ |
... |
... |
0.1 |
0.3 |
0.1 |
... | ||||||
Net sales: gold, precious metals, and stones |
1.1 |
0.3 |
0.6 |
0.6 |
0.8 |
... | ||||||
Source: OECD |
||||||||||||
1/ Pension Fund, Employment Fund, Social Insurance Fund, and Medical Insurance Fund |
||||||||||||
2/ Privatisation proceeds for 1992-1993 included in item “Net sales” |
||||||||||||
Table 3: Russia, Monetary Data (Thousands of roubles)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |
Net foreign assets |
2,480 |
17,483 |
24,544 |
54,045 |
35,352 |
47,908 |
(Billions of USD) |
6.0 |
14.0 |
6.9 |
11.6 |
6.4 |
8.0 |
Net domestic credit |
4,599 |
18,831 |
83,898 |
131,436 |
184,537 |
215,940 |
Claims on general government (net) |
1,577 |
9,799 |
67,402 |
113,681 |
172,303 |
204,734 |
Other items (net) |
-1,299 |
-13,108 |
-45,817 |
-55,767 |
-54,046 |
-53,373 |
Reserve Money |
5,780 |
23,206 |
62,625 |
129,714 |
165,843 |
210,475 |
(percent change over the year) |
301.5 |
169.9 |
107.1 |
27.9 |
26.9 | |
Money and quasi-money (broad money) |
10,600 |
40,983 |
129,731 |
275,781 |
367,032 |
458,933 |
(percent change over the year) |
286.6 |
216.5 |
112.6 |
33.1 |
25.0 | |
Currency in circulation |
1,678 |
10,730 |
34,493 |
80,815 |
103,795 |
130,474 |
(percent change over the year) |
539.5 |
221.5 |
134.3 |
28.4 |
25.7 | |
Quasi-money |
... |
17,102 |
61,187 |
124,514 |
169,637 |
189,570 |
(percent change over the year) |
257.8 |
103.5 |
36.2 |
11.8 | ||
Savings and time deposits |
... |
8,720 |
29,256 |
69,249 |
97,419 |
91,838 |
Savings/GDP (%) |
... |
5.1 |
4.8 |
4.2 |
4.3 |
3.4 |
Foreign currency deposits |
... |
8,382 |
31,931 |
55,265 |
72,218 |
97,733 |
Interest rates (%, average) |
||||||
Refinance rate |
62.5 |
139.2 |
180.0 |
185.0 |
110.0 |
32.0 |
Treasury bills rate (GKO) |
... |
119.6 |
172.3 |
161.8 |
85.8 |
26.0 |
CPI (percentage change) |
||||||
End-period (December to December) |
2,526.1 |
843.0 |
215.0 |
131.0 |
21.8 |
11.0 |
Period average |
1,542.1 |
878.1 |
307.4 |
197.7 |
47.6 |
14.3 |
PPI (percent change) |
||||||
End-period (December to December) |
3,275.0 |
895.0 |
233.0 |
175.0 |
25.6 |
13.0 |
Exchange rate (Rub per USD) |
||||||
End-period |
415 |
1,247 |
3,550 |
4,640 |
5,560 |
5,960 |
Period average |
434 |
1,226 |
3,164 |
4,552 |
5,483 |
5,799 |
M2/GDP (%) |
44.4 |
19.0 |
16.0 |
13.5 |
13.1 |
13.5 |
V(M2) |
... |
16.7 |
6.9 |
7.4 |
6.8 |
6.1 |
Multiplier |
1.83 |
1.77 |
2.07 |
2.13 |
2.21 |
2.18 |
Source: IFS IMF, July 1997; CBR |
Table 4: Russia, Balance of Payments (Billions of USD)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |
|
||||||
Current account balance |
-4.2 |
5.9 |
9.3 |
8.0 |
11.7 |
3.3 |
Trade balance |
5.9 |
16.9 |
17.8 |
20.8 |
22.8 |
17.3 |
Exports (fob) |
52.4 |
61.7 |
67.8 |
82.7 |
90.2 |
88.7 |
Of which: Oil and gas |
28.5 |
31.5 |
30.5 |
32.3 |
41.0 |
... |
Imports (fob) |
-46.5 |
-44.7 |
-50 |
-61.9 |
-67.4 |
-71.4 |
Non-factor services (net) |
-5.5 |
-5.3 |
-6.7 |
-9.5 |
-6.3 |
-5.2 |
Income (net) |
-4.6 |
-4.3 |
-1.8 |
-3.3 |
-4.9 |
-8.4 |
Current transfers (net) |
... |
... |
-0.1 |
0.1 |
0.2 |
-0.4 |
Capital account |
3.0 |
2.8 |
2.1 |
-0.3 |
-0.5 |
-0.8 |
Financial account |
-4.2 |
-21.1 |
-31.4 |
-13.0 |
-26.8 |
21.1 |
Direct investment |
0.7 |
0.4 |
0.5 |
1.7 |
2.2 |
3.7 |
Short-term capital |
-5.1 |
-22.4 |
-30.1 |
-15.8 |
-27.4 |
17.4 |
Adjustments |
0.2 |
0.9 |
-1.8 |
1.1 |
-1.5 |
0.0 |
Errors and omissions |
-3.3 |
-5.2 |
-1.6 |
-5.8 |
-7.1 |
-7.3 |
Overall balance |
-8.7 |
-17.6 |
-21.6 |
-11.1 |
-22.7 |
16.4 |
Total financing |
8.7 |
17.6 |
21.6 |
11.1 |
22.7 |
-16.4 |
Net International Reserves (-; increase) |
-0.8 |
-3.4 |
1.9 |
-10.4 |
2.8 |
-1.8 |
Use of IMF credits and loans |
1.0 |
1.5 |
1.5 |
5.5 |
3.8 |
1.5 |
Exceptional financing |
8.5 |
19.5 |
18.2 |
16.0 |
16.1 |
-16.1 |
Debts rescheduled (net) |
7.1 |
16.8 |
12.4 |
12.1 |
8.4 |
3.1 |
Source: CBR |
Table 5: Ukraine, Real Sector Indicators (Millions of UAH)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |
Gross Domestic Product (GDP) |
51.0 |
1,483 |
12,038 |
54,516 |
80,519 |
92,484 |
Real GDP (% change) |
-9.9 |
-14.2 |
-22.9 |
-12.2 |
-10.0 |
-3.2 |
Absorption (A) |
46.6 |
1,309 |
11,024 |
54,411 |
80,864 |
... |
Consumption (C) |
32.9 |
949.0 |
8,166 |
41,651 |
64,032 |
... |
Gross Investment (I) |
13.7 |
360.0 |
2,858 |
12,760 |
16,832 |
... |
Foreign Balance (X-M) |
-2.6 |
-307.9 |
-1,600 |
-3,454 |
-7,859 |
-7,826 |
Income from Abroad (Net) (Yf) |
-0.1 |
-8.4 |
-179 |
-764 |
-1,045 |
-1,199 |
Gross National Income (GNI) |
50.9 |
1,475 |
11,859 |
53,752 |
79,474 |
91,285 |
Current Transfers (Net) (TRf) |
0.0 |
14.7 |
136 |
301 |
931 |
1,573 |
Gross National Disposable Income (GNDI) |
50.9 |
1,489 |
11,995 |
54,053 |
80,406 |
92,858 |
Average monthly wage (hryvnas) |
0.2 |
7.9 |
33.1 |
122.5 |
137.8 |
156.2 |
Average monthly wage (USD) |
48 |
65 |
49 |
82 |
75 |
84 |
Unemployment rate, % |
0.3 |
0.4 |
0.4 |
0.6 |
1.6 |
2.9 |
Source: the Ministry of Statistics; NBU; Ukraine in Numbers by Michael Zienchuk and Marcin Luczynski, different issues |
||||||
Table 6: Ukraine, Fiscal Operations (per cent of GDP)
1992 |
1993 |
1994 |
1995 |
1996 | |
State budget |
|||||
Revenues |
29.0 |
42.4 |
41.9 |
37.8 |
37.2 |
Expenditures |
45.5 |
46.9 |
48.1 |
42.5 |
40.4 |
Off-budget subsidies and capital transfers 1/ |
15.7 |
7.7 |
2.5 |
0.2 |
0.0 |
Balance |
-32.2 |
-12.2 |
-8.8 |
-4.8 |
-3.2 |
Extra-budgetary funds |
|||||
Revenues |
14.5 |
1.3 |
1.8 |
1.3 |
... |
Expenditures |
10.1 |
0.9 |
0.8 |
1.3 |
... |
Balance |
4.4 |
0.4 |
1.0 |
0.0 |
0.0 |
General government |
|||||
Revenues |
42.6 |
43.7 |
43.7 |
39.1 |
37.2 |
Expenditures |
70.4 |
55.5 |
51.5 |
43.9 |
40.4 |
Balance |
-27.8 |
-11.8 |
-7.8 |
-4.8 |
-3.2 |
Financing |
|||||
Foreign |
0.0 |
0.0 |
0.7 |
-0.9 |
-0.1 |
Domestic |
27.8 |
11.8 |
6.9 |
5.6 |
3.1 |
Bank |
27.8 |
11.7 |
6.9 |
5.5 |
2.2 |
Privatisation receipts |
... |
... |
0.2 |
0.1 |
0.2 |
Source: IMF |
Table 7: Ukraine, Monetary Data (Millions of UAH)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |
Net foreign assets |
-6.1 |
-3.8 |
295.6 |
-811.7 |
-571.8 |
-162.0 |
(Millions of USD) |
-814.4 |
-15.2 |
273.7 |
-453.5 |
-302.5 |
-85.5 |
Net domestic credit |
36.2 |
258.3 |
1,583.0 |
4,957.5 |
6,696.5 |
8,629.3 |
Claims on general government (net) |
17.5 |
112.6 |
1,244.0 |
4,295.4 |
5,995.2 |
7,096.1 |
Claims on DMBs |
18.7 |
145.2 |
334.2 |
662.1 |
701.2 |
1,533.2 |
Other items (net) |
-12.0 |
46.6 |
-350.5 |
-588.7 |
-1,149.8 |
-1,056.7 |
Reserve Money |
18.1 |
301.1 |
1,528.1 |
3,557.1 |
4,974.9 |
7,410.6 |
(percent change over the year) |
... |
1,563.5 |
407.5 |
132.8 |
39.9 |
49.0 |
Money and quasi-money (broad money) |
24.8 |
481.7 |
3,216.1 |
6,930.3 |
9,364.6 |
12,541.3 |
(percent change over the year) |
... |
1,842.3 |
567.7 |
115.5 |
35.1 |
33.9 |
Currency in circulation |
4.8 |
127.7 |
793.1 |
2,623.3 |
4,040.6 |
6,132.3 |
(percent change over the year) |
... |
2,560.4 |
521.1 |
230.8 |
54.0 |
51.8 |
Demand deposits |
16.0 |
214.0 |
1,067.0 |
2,059.0 |
2,275.0 |
2,918.0 |
CC/Demand |
0.3 |
0.6 |
0.7 |
1.3 |
1.8 |
2.1 |
Quasi-money |
4.0 |
140.0 |
1,356.0 |
2,248.0 |
3,049.0 |
3,491.0 |
(percent change over the year) |
... |
3,400.0 |
868.6 |
65.8 |
35.6 |
14.5 |
Savings and time deposits |
2.0 |
41.0 |
335.0 |
671.0 |
1,331.0 |
1,819.0 |
Savings/GDP (%) |
3.9 |
2.8 |
2.8 |
1.2 |
1.7 |
2.0 |
Foreign currency deposits |
2.0 |
99.0 |
1,021.0 |
1,577.0 |
1,718.0 |
1,672.0 |
Interest rates (%, average) |
||||||
Refinance rate |
39.5 |
205.0 |
218.0 |
106.3 |
55.0 |
24.5 |
Treasury bills rate |
... |
... |
... |
143.3 |
77.4 |
33.0 |
CPI (percentage change) |
||||||
End-period (December to December) |
2,730.0 |
10,155.0 |
401.0 |
181.7 |
39.7 |
10.1 |
Average monthly change |
40.4 |
49.1 |
15.2 |
9.2 |
2.8 |
0.8 |
Exchange rate (UAH per USD) |
||||||
End-period |
0.007 |
0.25 |
1.08 |
1.79 |
1.89 |
1.90 |
Period average |
0.004 |
0.12 |
0.68 |
1.50 |
1.83 |
1.86 |
M2/GDP (%) |
44.7 |
25.8 |
18.2 |
9.8 |
9.5 |
11.8 |
V(M2) |
4.3 |
6.2 |
7.0 |
9.7 |
10.1 |
8.1 |
Multiplier |
1.37 |
1.60 |
2.10 |
1.95 |
1.88 |
1.69 |
Source: Statistical Bulletin of the NBU, TACIS Ukrainian Economic Trends, Ukraine in Numbers |
||||||
Table 8: Ukraine, Balance of Payments (Billions of USD)
1992 |
1993 |
1994 |
1995 |
1996 |
1997 | |
|
||||||
Current account balance |
-0.621 |
-0.854 |
-1.396 |
-1.515 |
-1.184 |
-1.335 |
Trade balance |
-0.622 |
-2.519 |
-2.361 |
-2.298 |
-4.296 |
-4.205 |
Exports (fob) |
11.308 |
12.796 |
12.111 |
13.647 |
15.547 |
15.418 |
Imports (fob) |
-11.930 |
-15.315 |
-14.471 |
-15.945 |
-19.843 |
-19.623 |
Non-factor services (net) |
0.016 |
1.614 |
1.028 |
1.091 |
3.174 |
2.669 |
Income (net) |
-0.015 |
-0.069 |
-0.264 |
-0.508 |
-0.571 |
-0.644 |
Current transfers (net) |
0.000 |
0.120 |
0.200 |
0.200 |
0.509 |
0.845 |
Capital and financial account |
-2.087 |
-0.317 |
0.059 |
-2.042 |
0.282 |
1.932 |
Direct investment |
0.170 |
0.200 |
0.091 |
0.266 |
0.526 |
0.581 |
Medium- and long-term loans |
0.415 |
0.709 |
-1.065 |
-0.347 |
-0.482 |
... |
Short-term capital |
-2.672 |
-1.226 |
1.033 |
-1.961 |
0.238 |
... |
Errors and omissions |
-0.029 |
0.014 |
0.000 |
0.000 |
0.265 |
-0.785 |
Overall balance |
-2.738 |
-1.157 |
-1.337 |
-3.557 |
-0.637 |
-0.188 |
Total financing |
2.738 |
1.157 |
1.337 |
3.557 |
0.637 |
0.188 |
Net International Reserves (-; increase) |
-0.096 |
-0.037 |
-0.513 |
-0.488 |
-0.860 |
-0.383 |
Use of IMF credits and loans |
0.000 |
0.000 |
0.373 |
1.217 |
0.778 |
... |
Exceptional financing |
0.000 |
2.528 |
1.477 |
2.828 |
0.720 |
... |
Other monetary liabilities (+; increase) |
2.834 |
-1.341 |
0.000 |
0.000 |
0.000 |
0.000 |
Source: NBU |
1 The GDP figure for 1997 has been revised upward from 0.4 per cent, not because of any underestimation of the 1997 figures, but because of an overestimation of the figures for 1996. Nevertheless, GDP data should be treated with caution, as official estimates of shadow economy output (around 25 per cent of GDP) are, in the opinion of many, too low. The frequent changes of most Russian statistics add to the confusion.
2 In 1997, the share of barter transactions in total sales was: 91 per cent for natural gas, 87 per cent for utilities, 79 per cent for steel, 69 per cent for oil and oil products, 59 per cent for cars, 37 per cent for alcoholic beverages, and 10 per cent for foodstuffs (according to Adamant Financial Corporation in Moscow).
3 According to rough estimates.
4 Private businesses hire unemployed workers, but due to the high (tax) costs of reporting the employment, the latter often remains unregistered (shadow economy).
5 The largest and leading FIGs are (in the following order: “barons”; banks; major enterprises; and controlling media): Vladimir Potanin – ONEKSIM Bank – Sidanko, Norilsk Nickel, Northwestern Shipping, Perm Motors, Svyazinvest – Interros, “Izvestia”, “Komsomolskaya Pravda; Boris Berezovskiy – Avtovaz Bank (USD 1.6 billion assets) – Logovaz, Sibneft – “Niezavismaya Gazeta”; Vladimir Gusinskiy – Most Bank (USD 0.8 billion assets) – Media Most, NTV, “Segodnya”, “Itogi”.
6 Monetisation of economy is defined as the ratio of domestic broad money to GDP.
7 There are anecdotal accounts of the dilution of shares acquired by foreign investors in the course of the long process of shareholder registration as carried out by managers. Additionally, time is required to get to remote areas of Russia (e.g., Siberia), where many resource or energy producing enterprises are located and keep their share registries.
8 The general government budget includes regional and local budgets, as well as all off-budget funds.
9 Primary deficit is total fiscal deficit less interest payments.
10 Data on trade and balance of payments in Russia, Ukraine, and Belarus must be treated with caution due to problems in the gathering of statistics.
11 In 1997, Russia exported 127 million tons of crude oil and 61 million tons of oil products, bringing in USD 14.8 billion and USD 7.2 billion in export revenues. Given these export volumes, and assuming that the prices of oil products closely follow crude prices, we may conclude that every USD per barrel change in the crude oil price changes Russian exports incomes by about USD 1.2 billion per year.
12 These were: reforming the tax system (e.g., a reduction in some taxes – VAT and income taxes – while broadening the tax base; an increase in excise and sale taxes; and the introduction of a land tax); diminishing non-payments and a reduction in budget expenditure; prompt payment of wages and pensions; clearing government debt to defence sector; supporting investment and structural reforms in production (including faster privatisation and bankruptcy procedures); lowering railway and energy tariffs for enterprises; intensifying administrative effectiveness; carrying out land reform; cutting subsidies and better targeting of social security expenditures; securing apartments for army employees and their families; having work place relations comply with market economy requirements; strengthening the legal protection of citizens and organisations.
13 In July 1998, the danger of economical and political crises in Russia raised the amount of financial support expected from international organisations (the IMF and the World Bank) and Japan to over USD 22 billion.
14 Prices of various energy resources exported by Russia to Ukraine and Belarus were either adjusted to the world level late when compared with the CMEA and other FSU countries; or they still remain subject to political considerations and are subsidised directly (Russian export of natural gas and oil to Belarus) or indirectly by allowing for arrears (payments for gas delivered to Ukraine).
15 According to a survey conducted by the Soros International Economic Advisory Group in
1997.
16 Calculations of specific values are based on forecasts by a team of experts from the Ukrainian government in co-operation with the Centre for Social and Economic Research and the Harvard Institute for International Development.
17 Studies of the social aspects of reforms can be found with various UN agencies, such as the UNDP, the IMF and the World Bank.
18 From co-operatives which took over shops and restaurants.
19 Using the official exchange rate.
20 No clear principles guided the sharing out of the nuclear forces. At first, only Russia, Ukraine, and Kazakhstan were in the possession of nuclear weapons. Subsequently, following trilateral agreements involving Russia, the United States, Ukraine and Kazakhstan, all nuclear warheads were deployed onto Russian territory in exchange for financial support and political guarantees among the signatories.
21 Representatives of Tajikistan and Turkmenistan were often invited to take part in UEZ meetings. Tajikistan joined the UEZ in 1997 and in 1998 declared its preparedness to join the CU.