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Russia

Author(s):
International Monetary Fund
Published Date:
September 1999
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Russian Federation: Basic Data

Social and demographic indicators 1/
Area17,075,200 sq. km
Population (in millions)146.7
Urban (As a percent of total population)73
Rate of population growth (Percent per annum)-5.2
Life expectancy at birth (Years)66.6
Infant mortality rate (Per 1,000 live births)17.2
Literacy (Percent of population)99.1
199319941995199619971998
Share of gross domestic product(In percent of GDP)
Agriculture7.76.27.57.16.9
Industry33.032.029.328.326.9
Services
GDP
Nominal GDP (in billions of rubles)171.5610.71,540.52,1462,5222,685
Real GDP (percentage change)-8.7-12.6-4.1-3.60.9-4.6
Consumer prices (percentage change, period average)875307197481528
Enlarged government finances(In trillions of rubles)
Total Revenue62.1211.5515.8708.2917.8850.2
(in percent of GDP)36.234.633.533.036.431.7
Total expenditure74.7275.2610.3898.51,116.71,065.5
(in percent of GDP)43.645.139.641.944.339.7
Fiscal balance-12.6-63.6-94.4-190.4-198.8-215.2
(in percent of GDP)-7.3-10.4-6.1-8.9-7.9-8.0
Money and credit (end-period)
Ruble broad money (in billions of rubles)28.992.4220.5287.9374452
Ruble money velocity (level)11.111.09.18.97.98.5
Balance of payments(In billions of U.S. dollars)
Total exports44.367.882.790.689.074.8
Total imports32.848.564.072.877.456.8
Current account balance2.68.44.83.9-3.02.3
Official reserves (in months of imports of goods and nonfactor services)1.21.22.42.02.22.0
Exchange rate, rubles per U.S. dollar, end-period1.253.554.645.565.9620.65
Sources: Russian authorities; and Fund staff estimates.

Data for 1997 or latest available.

Sources: Russian authorities; and Fund staff estimates.

Data for 1997 or latest available.

I. Overview

1. The period since the last Article IV consultation with the Russian Federation has witnessed perhaps the greatest contrast in the fortunes of the economy since Russia became an independent state in 1992. This swing in economic performance and prospects was most emphatically marked by the financial and economic crisis that erupted with the events of August 17, 1998. Expectations reached a high-point in mid-1997, when aggregate output was at last growing, interest rates on treasury bills had fallen below 20 percent, the Central Bank of Russia (CBR) was accumulating about $1½ billion a month in reserves, the Moscow Stock Exchange was the best-performing equity market in the world, and inflation had virtually ceased. By September 1998, in contrast, the economy had descended to a point of collapsing output and trade volumes, disorderly disruption of relations with domestic and external creditors, paralysis of the banking system, decimated financial asset prices, and surging inflation.

2. Beneath these sharp swings in key economic indicators, however, there were steadier processes at work which, when not reversed, made a crisis such as that of August 1998 virtually inevitable. Most fundamentally, the erosion of federal government revenues, particularly cash payments, made a robust fiscal consolidation and durable macroeconomic stabilization impossible (Figure 1). The inability to collect adequate revenues in turn owed much to the lack of progress in structural reform—notably the failure to impose hard budget constraints throughout the economy—which was manifest most clearly in an inadequate restructuring of the economy and the steady growth of economy-wide nonpayments (see Annex II, “Nonmonetary Transactions and Arrears Accumulation”). The causation was not, however, unidirectional: the government’s fiscal policy itself contributed to the lack of financial discipline. In particular, recourse to tax offsets—mutual cancellation of tax and budgetary arrears—both reduced incentives for tax compliance and contributed to nonpayments more generally.

Figure 1.Russian Federation: Enlarged Government Revenues, 1992-98

(In percent of GDP)

Source: Russian authorities; and Fund staff estimates.

3. Despite the limited fiscal adjustment, the stabilization gains earned in 1993–95 were prolonged through mid-1998 by the maintenance of a fixed exchange rate regime supported by heavy external borrowing, much of it short term.1 However, the government’s decision to allow foreign currency-denominated and short-term obligations to account for a growing proportion of total government debt (Figure 2) made budget financing increasingly vulnerable to shifts in market sentiment.

Figure 2.Russian Federation: Composition of Sovereign Debt, 1993-98

Sources: Data provided by the Russian authorities; and Fund staff estimates.

4. While the authorities’ inability to come to grips with the underlying fiscal problems made the financial stability that prevailed from 1996 through mid-1998 inherently tenuous, the timing of the shattering of that stability undoubtedly owed much to the souring of the external environment from late-1997 onward. Most importantly, there were significant spillover effects from the economic crisis that swept across Asia from mid-1997. That crisis led to a rise in interest rate spreads on debt issued by borrowers in emerging market economies (Figure 3). At the same time, Russia’s terms of trade deteriorated by about 37 percent between January 1997 and December 1998, led by steep declines in the price of oil, natural gas, and base metals. Compared to end-1996, the fall in the terms of trade by mid-1998 implied an annualized deterioration in the balance of payments of about $25 billion.

Figure 3.Emerging Market and Russian Bond Indices, 1995-99

(Inverse of total return index, end-1996=100)

Source: J.P. Morgan Emerging Market and Russian bond indices, and Fund staff estimates.

5. Clear though it is that these adverse exogenous developments played a key role in triggering the 1998 crisis, it is also evident that the external environment had previously been unusually positive. From 1995 through 1997 U.S. long-term interest rates were stable at relatively low levels, while spreads over U.S. government bond yields for emerging market borrowers (as measured by the benchmark Emerging Market Bond Index) fell rapidly from above 12 percent in late-1995 to a record-low of about 3 percent in the fall of 1997. Corresponding to that narrowing of spreads was a large increase in volumes of capital flows to emerging markets. The growth in emerging markets’ gross primary market financing on all instruments (equities, bonds, loans, and other fixed income) quickened from annual rates of about 15 percent in 1994–95 to about 40 percent in 1996 and the first three quarters of 1997. Apart from this positive global capital market environment, which prevailed until late-1997, Russia’s terms of trade also saw an improvement of 16½ percent from a trough in October 1995 to their January 1997 peak. Although the terms of trade index then began the fall that was to extend through 1998, in August 1997 it was still 11½ percent above its October 1995 level.

6. Although the undermining of financial stability by persistent fiscal imbalances was the salient feature of the 1992–98 period, slow progress in creating a favorable business environment also contributed to a stagnating economy throughout the period. The lack of decisive structural reform in areas such as corporate governance, bankruptcy procedures, property rights enforcement, labor mobility, and accounting standards was bound up with the continued failure of aggregate output to rebound, the slow pace of foreign direct investment, and the low and falling level of overall investment as a percentage of GDP (Figure 4). In addition, this meant that the very large upward move in the real effective exchange rate from 1992 to mid-1998 was not underpinned by a corresponding increase in labor productivity.

Figure 4.Russian Federation: Investment Activity, 1992-98

Source: Russian authorities; Fund database; Fund staff estimates.

A. 1992–96: The First Five Years of Transition

7. The authorities’ reform efforts in 1992–94 were focussed on reducing macroeconomic imbalances that had widened in the final years of the Soviet Union, allowing markets to begin performing their allocative function, and developing the basic institutional and legislative frameworks required by a market economy. Although the authorities made some progress in these areas, stabilization was only partial, and many of the goals of the reform process were not met, particularly in terms of institutional reforms and enterprise restructuring. Inflation fell, but remained high, and federal revenues declined precipitously as a percentage of GDP. Moreover, there was a systematic tendency to relax fiscal and monetary policies in the second half of each year, damaging the credibility of the authorities and adding to uncertainty about the policy environment.

8. Against that background, the authorities resolved in 1995 to achieve a decisive reduction in inflation via a tight monetary policy supported by a halving of the federal budget deficit to under 6 percent of GDP. Also, chastened by the exchange crisis of October 1994 which saw a one-day drop of 20 percent in the ruble’s value against the U.S. dollar (on “Black Tuesday”), they sought to bolster confidence in their determination to achieve macroeconomic stabilization by legislating a prohibition on direct lending from the CBR to the budget. Finally, to foster stability of the ruble, they adopted an exchange rate band system from July 1995. Despite political pressures, the authorities stuck to their program, and their main goals were achieved: the federal budget deficit (on a cash basis) was contained to about 5 percent of GDP, inflation fell to 131 percent (December to December) from 215 percent in 1994, and economic activity in some sectors stabilized. However, continuing revenue shortfalls made the fiscal situation increasingly vulnerable. In response, noninterest cash expenditures were compressed well below the levels of previous years, but a lack of control of expenditure commitments led to an accumulation of arrears, and spending pressures built up late in the year. Also, inertial inflation combined with the exchange rate band led the ruble to appreciate in real terms by 65 percent in 1995 (December to December), creating increasing difficulties for the tradeables sector.

9. The pressures evident at the end of 1995 continued into the following year, when the run-up to the June 1996 presidential elections saw an easing of financial rigor. Tax collection efforts slackened and large tax offsets were permitted. Adding to the fiscal problems, the Chechen war is estimated to have cost at least 1 percent of GDP. While the federal (cash) deficit widened to 8 percent of GDP in 1996, inflation continued to decline, supported by the exchange rate anchor and reliance on nonmonetary government financing. At the same time a number of important structural reforms—such as land reform, the creation of an adequate legal framework for the capital market, and privatization—continued to lag.

10. The erosion of federal revenue and the lack of institutional reform during the first five years of transition were partly a function of the lack of the necessary political consensus. Such a large part of the economy was economically nonviable on the basis of normal market relations—and barriers to the reallocation of resources, especially labor, were such—that there was a powerful constituency against the hardening of budget constraints. The major appreciation of the ruble in real effective terms that characterized the period since 1992, and which was unusually marked compared to the experience of more successful transition economies (see Figure 5), tended to increase the number of nonviable enterprises, and may have swelled the constituency opposing necessary reforms. The result was that, despite a number of economic policy successes in the period through 1996—including taming hyperinflation, and progressively opening the economy to trade and investment—the inability to break the culture of nonpayment (Annex II) and reverse the revenue decline meant that fiscal deficits remained stubbornly high, while growing budgetary arrears led to further nonpayments throughout the economy (Figure 6).

Figure 5.Real Effective Exchange Rate Movements, Selected Transition Economies

(Index, first year of transition = 100)

Source: IMF database.

Figure 6.Russian Federation: Measures of Nonpayments, 1994-98 1/

(In percent of GDP)

Sources: Goskomstat.

1/ For 1998 November data.

B. The Zenith of Expectations, January–September 1997

11. The policy mix of 1996, with high fiscal deficits and declining inflation reconciled by an exchange rate anchor and heavy government borrowing, continued through 1997. By early 1997 the fragility of this policy mix was well recognized, both by outside observers and within the government. There was, however, renewed optimism that the fiscal problems could be overcome. To begin with, the presidential elections were over, President Yeltsin’s health was less in doubt than it had been, and the position of market-oriented reformers in the government was seemingly strengthened. Further, the authorities had publicly recognized the seriousness of the problem of insufficient federal revenues, and had launched successive waves of measures designed to raise compliance and enhance collections. In addition, the completion of a rescheduling accord with Russia’s Paris Club creditors (and the nearing of final agreement with the London Club) removed concern about the government’s near-term debt service burden, while an apparent incipient turnaround in the output decline in Russia and through much of the former Soviet Union gave rise to widespread expectations of a resumption of growth in the region. Finally, Russia benefitted from an improvement in investor perceptions of emerging markets in general: private capital flows to emerging markets were again surging after the brief retrenchment following the Mexico crisis of 1995.

12. Thus, from late-1996 through much of 1997 there was a considerable appetite for Russian government securities, both domestically and abroad. Between November 1996 and December 1997 the federal government was able to issue $4½ billion in Eurobonds at spreads over comparable U.S. government securities of between 330 and 375 basis points. At the same time, GKO yields declined from around 100 percent in September 1996 to 18½ percent in July 1997. Net GKO/OFZ issues in 1997 amounted to 4.2 percent of GDP, with nonresidents making net purchases equivalent to $11 billion, and raising their share of outstanding GKOs from under 20 percent in December 1996 to about 33 percent by the end of 1997.

13. The resort to extensive foreign budgetary finance through Eurobond and GKO/OFZ sales from late-1996 through 1997 is understandable, as the government was able to borrow via the GKO market at relatively low real interest rates for much of this period (Figure 7). Also, the virtually uninterrupted real appreciation of the ruble against the U.S. dollar made dollar yields of around 10 percent on Russian government Eurobonds look very reasonable. It should be emphasized, however, that the decision of the government to open the GKO market to nonresidents in 1996 was premised on the ability of the government to overcome its fiscal problems which, in the end, it was unable to do.

Figure 7.Russian Federation: Interest Rates, 1995-98

(In percent, annualized)

Sources: Bloomberg, Reuters, SKATE Agency, Goskomstat, and Fund staff estimates.

1/ Corrected by annualized monthly price change.

14. For much of 1997, the balance of macroeconomic news was positive, sustaining market optimism. In the third quarter, aided by a good grain harvest, Russia experienced its first positive real GDP growth since independence. At the same time, inflation fell to 2 percent at an annualized rate, with the CPI actually falling in August and September (Figure 8). In addition, until September 1997, the terms of trade were more favorable than in the corresponding period of 1996 (Figure 9). This positive environment helped propel the stock market to new highs: in the first nine months of 1997 the main index more than doubled in U.S. dollar terms. Also, the improvement in market sentiment allowed the authorities to reverse the shortening of the maturity profile of domestic government debt.2

Figure 8.Russian Federation: Consumer Price Inflation, January 1996-June 1999

(percent changes)

1/ Adjusted with X11 multiplicative procedure from index data.

Figure 9.Russian Federation: Terms of Trade, January 1995 - March 1999

(Index, 1995=100)

Source: Fund staff estimates.

C. Rising Pressure and Policy Responses, October 1997–July 1998

15. By late 1997, however, the economic and financial environment was deteriorating. The realization that 1997 was not bringing the hoped-for rebound in federal revenues and associated fiscal consolidation, combined with the deterioration in market sentiment towards emerging markets following the onset of crisis in Thailand in July 1997 (and even more so following the turmoil in Hong Kong’s financial markets in October), meant that in November 1997 the authorities were forced—for the first of what was to be several times—to raise interest rates sharply to defend the exchange rate band and roll over maturing GKOs. At the same time, the CBR intervened heavily in the foreign exchange market: reserves declined by $6 billion in November 1997 alone.

16. From late-1997 onward, other developments also turned negative. Russia’s export prices declined by more than 20 percent between August 1997 and July 1998, driven in large part by the fall in oil and gas prices. Real GDP began to fall again, led by a sharp contraction in investment. With a more difficult external environment and a renewed downturn in domestic economic activity, combined inward foreign direct and portfolio investment—excluding purchases of government debt—shrank from some $8 billion in 1997 to an annual rate of only about $2½ billion in the first half of 1998. The Moscow Times U.S. dollar equity index retreated rapidly from its peak of August 1997, falling by 43 percent by end-November, and a further 31 percent by end-June 1998 (Figure 10). By August 13, even before the devaluation of the ruble, equities had lost nearly 80 percent of their value in U.S. dollar terms compared to their August 1997 peak.

Figure 10.Russian Federation: Moscow Times U.S. Dollar Equity Index, 1996-99

(September 1994=100)

Source: Moscow Times.

17. There was also a growing awareness of the fragility of the Russian banking system, as many large banks had become reliant on GKOs and other securities whose prices were falling rapidly. From early-1998, this exposed some banks to margin calls, forcing sales of assets which further depressed financial markets and added to the pressure on bank balance sheets. Also, the banking system as a whole had become vulnerable to devaluation; foreign investors holding GKOs had hedged their ruble exposure by buying dollar forward contracts from Russian banks. As a result, the banking system was caught in the downward spiral of Russia’s fiscal fortunes, as a failure to solve the fiscal problem was leading to higher interest rates, lower financial asset prices, and an ever-higher probability of devaluation.

18. At the same time, deep-seated fiscal problems remained, while political uncertainty became an increasingly important factor. Federal government revenue as a percentage of GDP had fallen again in 1997, and the deficit remained close to 7 percent of GDP. Moreover, further government reshuffles and a standoff between the President and the Duma in March–April 1998 over the President’s choice for Prime Minister, Mr. Kiriyenko, weakened market confidence in the government’s ability to overcome parliamentary resistance to a reform agenda. The heightened risks were reflected in successive warnings and downgradings of Russia’s credit ratings by one or more of the main agencies in December 1997 and March, May, June, and August 1998.

19. A financing crisis ensued as interest rates rose sharply. After large, though short-lived, upward moves in GKO yields in late 1997 and January 1998, the pressure intensified in May–June 1998, when yields were briefly driven above 100 percent, and averaged about 60 percent. Faced with this crisis, the Russian authorities attempted to restore confidence by strengthening their efforts to correct the fiscal imbalance and accelerate structural reforms. In support of these efforts, the authorities sought the help of the international financial institutions in assembling an official financing package large enough to bolster confidence in the adequacy of reserves. At the same time, a voluntary swap of about $4.4 billion in GKOs into Eurobonds was arranged.

20. In mid-July 1998, after the announcement of new fiscal and structural policy measures and agreement with the IMF on a package of additional official assistance (the total value of which, including contributions from the World Bank and Japan, was to be about $17 billion), pressure on interest rates and reserves temporarily eased. GKO yields declined from nearly 200 percent on July 10 to 54 percent by July 15. However, when the Duma balked at passing certain key promised measures, the credibility of the program was crippled. By mid-August GKO yields had reached a new high of nearly 300 percent and reserves had fallen by some $3½ billion from late-July.

D. The August 1998 Crisis

21. Faced with dwindling international reserves despite the massive spike in interest rates, on August 17, 1998 the authorities announced a series of emergency measures. These included a de facto devaluation of the ruble (with an upward shift and widening of the exchange rate band), a unilateral restructuring of ruble-denominated government debt falling due between August 19, 1998 and December 31, 1999, and a 90-day moratorium on private sector payments on external liabilities. The measures, announced without supporting macroeconomic policies, only aggravated the decline in investor confidence and the associated outflow of private capital. Moreover, a new wave of political uncertainty was unleashed with the dissolution of the Kiriyenko government on August 23. Thus, despite continued heavy intervention by the CBR, the ruble rapidly reached the new ceiling of Rub 9.5 per U.S. dollar established on August 17, forcing the authorities to abandon the exchange rate band on September 2. The exchange rate quickly jumped beyond Rub 20 per U.S. dollar, before settling back to Rub 16 per U.S. dollar by the end of September. Driven by the depreciation of the ruble, monthly inflation hit 38 percent in September.

22. The most immediate and dramatic result of the August 17 measures was the virtual collapse of the banking system. Banks’ portfolios were generally heavily skewed towards government securities, and the effective default on GKOs had a powerful negative effect on the balance sheets of many banks. A large number of banks were also wrong-footed by the abandonment of the quasi-fixed exchange rate, holding major short-dollar positions in the forward market which they were unable to square after the devaluation. Interbank transactions virtually ceased, and the payments system was paralyzed for over a month. Also, in the chaotic post-August 17 environment, even nonmonetary transactions were temporarily disrupted. As a result, there was a severe contraction in output and trade. By October 1998 industrial production, which had been up year-on-year in the first half of the year, was down 15 percent relative to October 1997. Imports, affected also by the massive change in relative prices, fell to about $2 billion a month in the last four months of 1998, roughly half the level during the same period of 1997.

E. The Post-Crisis Period

23. After the initial aftershock of August 17, economic policy was initially passive, but the worst post-August fears concerning macroeconomic stability were not realized in the following months. Inflation remained higher than before the crisis, averaging about 7 percent a month from October 1998 through February 1999, but declined steadily, reaching 2 percent per month by May–June. Further, after the initial sharp depreciation, the exchange rate stabilized in the range of Rub 24–25 per U.S. dollar from March through mid-July 1999. A relatively tight fiscal policy, aided by efforts to restrain cash expenditures, allowed CBR ruble credit to the federal government to be contained to about 2 percent of GDP in the fourth quarter of 1998 and the first quarter of 1999. (The CBR also provided U.S. dollar credit for the payment of external debt service equal to about 5 percent of GDP over this period). Also, while the CBR was slow to begin withdrawing the licenses of insolvent banks, central bank liquidity support for ailing banks was moderate. Output, after declining sharply immediately after the onset of the crisis, stabilized in late 1998. By March-April 1999, owing to the depreciation of the ruble, there were incipient signs of an economic recovery led by import substitution and exports, as industrial output exceeded its level of the same period of 1998. Also, since mid-March 1999 real incomes and dollar exports have been boosted by the strong rebound in world oil prices.

24. It remained clear, however, that without strong measures to improve federal government revenue collection and advance structural reforms, this period of stability would represent only an interlude between crises. While cash revenues improved significantly in the first quarter of 1999 relative to the immediate post-crisis months, they remained at the pre-crisis level of about 10 percent of GDP, despite the positive impact on revenues of the large depreciation of the ruble. Further, the fiscal adjustment for 1999 outlined in the budget was initially based on a severe compression of real noninterest expenditures, including wages and pensions, which would likely not have been sustainable over the medium term.

25. Meanwhile, the effect of the ruble’s depreciation on the ruble value of the government’s debt service obligations was immediate. The federal government’s total foreign currency-denominated debt service stands at $17.5 billion in 1999, equivalent to about 80 percent of budgeted revenue. The government has initiated negotiations with its external creditors on a rescheduling of its Soviet-era debts, but even a full rescheduling of those obligations would leave foreign currency debt service at over 40 percent of budgeted revenue. The price of the government’s traded debt clearly reflected the perception of significant default risk; by early March, 1999, the interest rate spread on Russia’s Eurobonds had increased to about 6,000 basis points, although it subsequently declined to about 2,500 by end-May. Further, in February 1999 Russia’s sovereign credit ratings were again downgraded by two of the major agencies.

26. Moreover, until April 1999, structural reforms largely stalled, with reversals in some areas. Access to the oil pipeline was used as a lever to force energy companies to supply nonpaying customers. Privatization came to a virtual halt. Slow progress on bank restructuring facilitated asset stripping and capital flight. State initiation of bankruptcy proceedings against tax debtors was suspended. Interbank currency exchanges were first closed, then (from early October 1998) regulated to provide for a segmented exchange market. Also, as from the beginning of 1999 surrender requirements on export receipts were raised from 50 to 75 percent. At the same time, the trade regime became less liberal with, for instance, the introduction of a ban on alcohol imports and restrictions on food exports.

27. From April 1999 onward, however, there were signs that these trends were being reversed and the causes of the August 1998 crisis belatedly being addressed. In order to address the underlying fiscal imbalance, the authorities introduced several new revenue-enhancing tax measures and took action to force oil companies with tax arrears to move toward full compliance with statutory tax obligations. There was also a sharp change in direction in the structural policy area: in June, the authorities unified the interbank currency markets, passed legislation to facilitate bank restructuring and began to withdraw the licenses of major insolvent banks, canceled the state directives to oil companies to supply nonpaying refineries, and rescinded the decision to suspend new bankruptcy proceedings. After the trough of macroeconomic performance and sentiment in late-1998, by mid-1999 there were signs—on the basis of the relative macroeconomic stability in the last several months and the output recovery driven by the depreciation of the ruble—that the crisis was over.

II. Domestic Economy

A. Output and Expenditure

Overview

28. Output fell precipitously in 1992–94 in response to the withdrawal of subsidies and the disruption in traditional economic relations, but the decline then began to taper off, and real GDP registered a small increase in 1997.3 However, the recovery proved short-lived, and GDP was already on a downward trend by the first half of 1998. This contraction was severely aggravated by the economic crisis that erupted in mid-1998 (Table 1, Figure 11). A significant erosion of real income, a loss of trade financing, and a temporary disruption of the payments system contributed to a seasonally-adjusted real output decline of 6 percent in the third quarter of 1998.

Table 1.Russian Federation: Selected Indicators of Economic Activity, 1991-98(Annual percentage change)
19911992199319941995199619971998
Gross domestic product-5.0-14.5-8.7-12.6-4.1-3.60.9-4.6
Industrial output-8.0-18.5-13.3-20.9-3.3-4.01.9-5.2
Extraction industries-4.0-11.0-10.0-10.0-1.0-2.03.0
Processing industries-8.0-19.0-15.0-24.0-4.0-5.02.0
Agricultural output-4.5-9.4-4.0-12.0-8.0-5.11.3-12.3
Crops-23.619.9-7.3-18.0-22.09.427.7
Livestock-4.1-4.5-6.3-11.5-8.3-11.6-10.2
Freight transport-7.0-14.0-12.0-14.0-1.0-5.0-3.6-3.5
Source: Goskomstat.
Source: Goskomstat.

Figure 11.Russian Federation: Output and Income, 1995-98

Source: Goskomstat.

29. Recent developments have, however, proved more positive than had initially been expected. Seasonally-adjusted real GDP fell by less than 1 percent in the last quarter of 1998, and preliminary data indicate that it grew by 4 percent in the first quarter of 1999. Seasonally-adjusted industrial output grew by 12 percent over the last quarter of 1998 and the first quarter of 1999 combined, and in April–May it stood 4 percent higher than its level one year earlier. The recovery initially appears to have been led primarily by import substitution in response to the real depreciation of the ruble. However, with recent improvements in the prices of Russia’s key exports, there is now some evidence of a pickup in exports as well.

30. The fact that sustained growth has not materialized until now reflects, in part, the failure to advance reforms following the initial price liberalization, and in particular the failure to secure property rights, generate economic restructuring, and create a stable business environment (see Chapter VI for further details). Widespread corporate governance problems have prevented viable enterprises from improving efficiency and making the needed investments to enhance competitiveness. These problems have also dissuaded entry by new businesses, while the failure to impose hard budget constraints throughout the economy has allowed many non-viable firms to survive (see Annex II, “Nonmonetary Transactions and Arrears Accumulation”). The persistent fiscal imbalances have furthermore limited the channeling of resources for investment to the private sector. The lack of adequate investment has, in turn, resulted in the deterioration of the economic infrastructure, potentially affecting the long-term prospects for the economy as well.

The main components of demand: 1996–98

31. During 1996–97, movements in real output were dominated by domestic demand, which fell by over 7 percent before registering a small turn-around (Table 2). Changes in net exports were relatively less important. In contrast, in 1998 net exports exercised a significant positive influence: while the collapse in domestic demand acted to reduce GDP by almost 8 percent, the increase in net exports (occurring mainly in the last quarter) offset about half of this amount.

Table 2.Russian Federation: GDP by Expenditure, 1991-98
199119921993199419951996199719981995-98
Cumulative ChangeChange in GDP: Decomposition
(Annual percentage change at constant prices)
Gross domestic product-5.5-19.4-10.4-11.6-4.8-6.71.0-3.8-11.6-11.6
Consumption-4.9-5.5-1.0-2.5-3.1-3.13.0-2.8-5.9-4.2
Households-4.6-3.01.21.2-2.8-4.75.4-4.0-6.2-3.0
General government-11.3-11.8-6.4-2.91.10.8-2.40.1-0.4-0.1
Non-profit institutions34.5-1.00.2-35.9-30.5-0.5-1.8-3.5-34.5-1.1
Gross Investment-3.1-39.5-28.1-29.6-10.4-20.6-3.6-27.6-45.6-11.5
Capital formation-15.5-41.5-25.8-26.0-7.5-19.3-5.7-8.6-34.5-7.6
Changes in inventory264.1-29.2-37.4-47.1-30.4-27.38.9-128.3-128.2-4.1
Net exports of goods and services171.4-159.766.2-18.11.121.2-8.898.3129.54.2
Memorandum Items
GDP at production basis-5.0-14.5-8.7-12.6-4.1-3.40.9-4.6-10.9n/a
(In percent of GDP at current prices)
Consumption63506470717174765n/a
Households41344144494951567n/a
General government1714182319202118-1n/a
Non-profit institutions425322220n/a
Gross Investment3736282625242316-9n/a
Capital formation2425212221211917-4n/a
Changes in inventory131174434-1-5n/a
Net exports of goods and services0158534384n/a
Exports goods and services (fob)14643928282523324n/a
Imports of goods and services (fob)13503123242021240n/a
Source: Goskomstat and Fund staff estimates.
Source: Goskomstat and Fund staff estimates.

32. The decline in output over the transition period has been accompanied by an even sharper contraction in investment whereas consumption, in particular by households, has seen relatively little decline. The shift of expenditure towards consumption partly reflects a correction of policies in the Soviet planned economy, which heavily encouraged capital accumulation above all else. In this context, the decline in investment can partly be seen as a positive outcome of the transition process that reduced inefficient areas of investment. However, much-needed investment has not been forthcoming, and where it has occurred, it has not been broad-based, having increasingly concentrated in a few areas, including the energy sector.

33. From 1996 until late 1998, the growth in consumption continued to outpace GDP, fueled by rising real wages and income, and the lack of public sector adjustment. In the wake of the crisis, however, this relationship has been reversed. Real consumption growth outstripped GDP growth by at least 2 percentage points 1996–97, and seasonally-adjusted real household consumption grew by a further 1 percent during the first half of 1998. In the second half of 1998, however, the crisis reduced seasonally-adjusted real per capita income by over 14 percent. In response, household consumption was initially financed by a drawdown of personal savings and by nonpayment, but then contracted sharply, by about 21 percent during September 1998–March 1999. As for government consumption, it rose in each of the years 1995–97, and was largely unchanged in 1998 (Table 2).

34. With economic prospects still uncertain and the business climate remaining largely unfavorable, investment in capital goods continued to decrease in 1996 and 1997. After a fall of 19 percent in 1996, the decline moderated in 1997, reflecting a sharp one-time rise in imports of machinery and equipment prompted by the government’s plan to eliminate tax exemptions for imports of investment goods, and by an increase in inventories. In 1998, the investment decline accelerated, as economic prospects deteriorated. For the year as a whole, capital formation fell by 9 percent. Further contributing to the decline in investment, inventories dwindled rapidly as consumption shifted to domestically produced goods following the sharp depreciation of the real exchange rate.

35. Performance of net exports swung dramatically over 1996–98. In 1997, as the terms of trade deteriorated, exports decreased and imports increased by 10 percent each in dollar terms. In 1998, however, despite the continued worsening of the terms of trade, net exports rose by 5 percentage points of GDP, reflecting developments in the second half of the year. While export revenues continued to decline with commodity prices, imports were compressed, owing to the decline in incomes, the depreciation of the ruble, and the short-run impact of the breakdown in the payments system. In the last quarter of 1998, imports were less than half their level one year earlier.

36. The import compression has continued in 1999. In the first quarter, imports remained about half their level one year earlier. The limited available data suggests that this compression has been broad-based, with a particularly large reduction in imports of consumer goods. In contrast, there is only very recent evidence of a pickup in exports; in April 1999, the dollar value of exports was higher than its level one year earlier, the first such rise since 1997. One reason for the delayed response of exports to the devaluation is that the oil and gas sector, which accounts for 40 percent of exports, faces severe extraction and transportation constraints.

Sectoral developments

37. Despite the generally slow progress on structural reforms, the Russian economy has nevertheless undergone a significant transformation since 1991, with a sizable shift in resources from industry and agriculture to the services sector taking place alongside the secular decline in output (Table 3). By 1997, industrial activity accounted for less than 30 percent of GDP, compared with 39 percent in 1991. After a dramatic decline of about 45 percent in 1991–94, the contraction of the industrial sector slowed, as exports to new markets began to mitigate the impact of the earlier drop of demand in traditional markets and of the reduction in government subsidies, and as domestic income gradually recovered. Although industry has experienced an across-the-board decline, the sectors hit most severely have been light industry, construction materials, and machinery building. In contrast, those sectors which have managed to expand exports (such as fuels and metallurgy), and nontradeables (in particular electricity generation), have been able to cushion the decline (Table 4). The agricultural sector has also seen a decline, falling from 14 to 7 percent of GDP during 1991–97. This decline largely reflected the gradual reduction of government financial support to the sector, but was exacerbated by slow progress in land reform and farm restructuring. Over the same period, the services sector has been expanding, increasing its share of output from 36 percent to about 50 percent.

Table 3.Russian Federation: GDP by Sector, 1991-98
19911992199319941995199619971998
Total GDP100.0100.0100.0100.0100.0100.0100.0100.0
Agriculture14.07.28.26.57.27.36.76.0
Industry38.233.734.432.829.029.528.429.1
of which:
processing industry31.228.627.124.723.722.5
Construction9.46.37.99.18.58.47.97.2
Wholesale, retail, foreign trade, public catering, procurement12.229.119.018.319.618.317.820.3
Transportation and communications7.57.48.69.911.912.412.711.5
Finance, credit, insurance, real estate operations, science and research, housing, geology, subsoil resources, exploration, meteorology, computer services, others9.29.412.011.011.310.912.212.7
State administration and defense2.52.13.14.75.25.26.05.5
Education, culture and art, health care, physical education & social security, utilities, non-production activities services to households, people’s associations7.04.86.87.77.38.08.37.7
Source: Goskomstat and Fund staff estimates.
Source: Goskomstat and Fund staff estimates.
Table 4.Russian Federation: Gross Industrial Output by Sector, 1991-98
19911992199319941995199619971998
(Annual average percentage changes)
Total-8.0-18.0-14.1-20.9-3.3-4.02.0-5.2
Electric power generation0.3-4.7-4.7-8.8-3.2-1.6-2.1-2.5
Fuel-6.0-7.0-11.6-10.2-0.8-1.50.3-2.5
Ferrous metallurgy-7.0-16.4-16.6-17.39.6-2.51.2-8.1
Nonferrous metallurgy-9.0-25.4-14.1-8.92.8-3.66.0-5.0
Chemicals and petrochemicals-6.0-21.7-21.5-24.57.6-7.12.0-7.5
Machinery-10.0-14.9-15.6-30.8-9.1-4.63.5-7.5
Forestry, timber processing, paper and pulp-9.0-14.6-18.7-30.5-0.7-16.50.9-0.4
Construction materials-2.0-20.4-16.0-27.3-8.0-16.3-4.0-5.8
Light industry-9.0-30.0-23.0-46.0-30.2-22.5-2.4-11.5
Food processing-9.016.4-9.0-17.5-8.2-4.2-0.8-1.9
(In percent of 1991 level)
Total100.082.070.455.753.951.752.850.0
Electric power generation100.095.390.882.880.278.977.275.3
Fuel100.093.082.273.873.272.172.470.5
Ferrous metallurgy100.083.669.757.763.261.662.457.3
Nonferrous metallurgy100.074.664.158.460.057.961.358.3
Chemicals and petrochemicals100.078.361.546.449.946.447.343.8
Machinery100.085.171.849.745.243.144.641.3
Forestry, timber processing, paper and pulp100.085.469.448.347.940.040.440.2
Construction materials100.079.666.948.644.737.435.933.9
Light industry100.070.053.929.120.315.715.413.6
Food processing100.0116.4105.987.480.276.976.274.8
Source: Goskomstat.
Source: Goskomstat.

38. In 1997, domestic demand contributed to a brief recovery in industrial output, but the momentum stalled quickly and the output decline resumed in 1998. As real incomes increased and the real exchange rate stabilized in 1997 (following a sharp appreciation beginning in 1995), demand shifted toward domestic products, eliciting strong growth in the automobile industry. This in turn underlay a 3.5 percent growth in the machine building industry, and stimulated ferrous metallurgy output. Robust activity in the nonferrous metal industry in 1997, owing to a continued expansion of exports, also contributed to overall growth. However, the decline in oil and gas prices and constrained external demand for steel products in late 1997 hit the export sectors hard, and their impact was felt quickly throughout the economy. In 1998, the decline in industrial output was aggravated across the board by the August crisis; industrial output ended the year 5 percent lower than in 1997. However, toward the end of 1998, output began to recover from low levels in September as demand for domestically-produced goods increased in the wake of the depreciation of the ruble.

39. While a bumper grain harvest allowed total agricultural output to increase slightly in 1997, a severe drought led to a 12 percent reduction in output in 1998. The drought affected almost a quarter of the sown area, and stocks accumulated in 1997 were significantly reduced. Livestock production has declined steadily, and is estimated to have fallen by 9 percent in 1998.

40. The services sector’s contribution to economic output has continued to increase. In 1997, activity in market services and trade rose by 4 percent, reflecting the generally buoyant consumer demand, before slowing significantly in 1998 as the economic crisis took its toll. Activity in nonmarket services (including publicly-provided goods such as defense, administration, education, health care, and culture) rose by more than 1 percent in 1997, and is expected to remain largely unchanged in 1998.

B. Labor Market Trends

41. The transition has seen a sizeable reallocation of labor within the economy. The share of total employment in industry was reduced by 7 percent during 1991–97, while the share of employment in commerce-related and non-market services increased. These trends were particularly marked in the period 1995–97.4 Within the industrial sector, a few sectors such as food processing, forestry, and machine building have seen productivity recover to 90 percent of the 1991 level, after falling sharply in the early years of transition (Table 5). Further, labor turnover statistics indicate a relatively active labor market, with an average annual separation rate of above one quarter of total employment during the period 1991–97, and annual rates of new hires of approximately 20 percent of total employment (Table 6).

Table 5.Russian Federation: Employment and Labor Productivity in Industry by Sector, 1991-98
19911992199319941995199619971998 1/
(In thousands of people)
Employment
Total20,11720,02018,86417,44016,00614,93414,00911,856
Electric power generation563626666710750790810949
Fuel8158708868608468568211,017
Ferrous metallurguy772795788738727727683736
Nonferrous metallurgy502532542517549537508492
Chemicals and petrochemicals1,1151,1431,1091,011968923891793
Machinery9,0938,7677,9337,0296,1905,6285,2624,189
Forestry, timber processing, paper and pulp1,7251,8131,6411,5351,3831,2611,138763
Construction materials1,0671,1361,0951,040973868783538
Light industry2,1451,8451,6991,6001,3321,1331,006687
Food processing1,5331,5541,5561,5541,5061,4871,4541,179
(In percent of 1991 levels)
Labor Productivity 2/
Total10082756468707685
Electric power generation10086776660565445
Fuel10087767071697257
Ferrous metallurguy10081686067657060
Nonferrous metallurgy10070595755546160
Chemicals and petrochemicals10076625158565962
Machinery10088826466707790
Forestry, timber processing, paper and pulp10081735460556191
Construction materials10075655049464967
Light industry10081683933303342
Food processing1001151048682798097
Source: Goskomstat and Fund staff calculation.

As of November 1998.

Calculated as the ratio of output to employment.

Source: Goskomstat and Fund staff calculation.

As of November 1998.

Calculated as the ratio of output to employment.

Table 6.Russian Federation: Labor Force Turnover, 1993-98 1/
199319941995199619971998
(In thousands)
Total number of separations14,28414,59713,06911,37211,01710,650
of which: in industry5,3815,3054,2843,6973,3853,333
Number of newly hired11,96311,07911,4808,9828,9818,984
of which: in industry3,7703,0393,1922,3112,4262,387
(As percent of total employment)
Total number of separations25.127.425.723.924.524.9
of which: in industry28.832.828.427.026.827.7
Number of newly hired21.120.822.618.919.921.0
of which: in industry20.118.821.116.919.219.8
Sources: Goskomstat.

Data for large and medium enterprises.

Sources: Goskomstat.

Data for large and medium enterprises.

42. Despite the significant reallocation of labor, the pace of labor shedding has in most cases lagged well behind the output decline. Compared with the major losses in output since 1992, formal employment has declined much more slowly, falling by just 12 percent during 1992–97, and by a further 2 percent between end-1997 and April 1999 (Table 7). This pattern is most pronounced in public administration and the social sector; employment has increased by 63 percent for the former and declined by only 3 percent for the latter in 1992–98, reflecting slow progress in public sector reform. There are several reasons why enterprises continue to hoard labor in the face of continued output declines, including legal restrictions on severing labor contracts,5 and potential bargaining advantages vis-à-vis regional and local government loath to see unemployment increase. While formally laying-off workers is considered to be difficult, managers resort to hidden unemployment—putting employees on administrative leave or part-time schedules—and to wage arrears to contain wage costs.6 Some 4–6 percent of workers work shortened workdays, and forced-leave days averaged about 30 days per person in 1997–98 (Table 8). Workers are often willing to tolerate wage arrears and lower wages because of the relative importance of non-wage social benefits provided by firms, an inadequate social safety net, and the limited opportunities for geographic mobility resulting from the high costs of moving and of housing, relative to workers’ cash incomes.

Table 7.Russian Federation: Employment by Sector, 1991-98 1/
19911992199319941995199619971998

estimate
(In percent of 1991 level)
Total100.097.695.992.790.089.387.586.2
Industry100.095.292.982.976.773.066.563.1
Agriculture and forestry100.0103.7103.8105.6100.395.488.683.1
Construction100.092.984.180.073.169.266.663.7
Transportation and communication100.097.994.193.191.490.889.087.7
Commerce, food service, material and technical supply, marketing and procurement100.0100.9113.3115.3118.7120.8154.7158.2
Public health, physical training, social security, education, art, culture and science100.098.095.694.993.793.190.591.1
Administrative staff, lending and state insurance100.094.2106.0115.5137.6175.2170.4168.9
Other sectors (housing, pub. utilities, nonproduction types of gen. services to the public)100.0100.294.092.093.6101.696.2103.2
(In percent of total employment)
Total100.0100.0100.0100.0100.0100.0100.0100
Industry30.329.629.427.125.924.823.022.2
Agriculture and forestry13.514.314.615.415.114.413.713
Construction11.510.910.19.99.38.98.78.5
Transportation and communication7.87.87.67.87.97.97.97.9
Commerce, food service, material and technical supply, marketing and procurement7.67.99.09.510.110.313.514
Public health, physical training, social security, education, art, culture and science19.419.519.419.920.220.320.120.6
Administrative staff, lending and state insurance2.72.62.93.34.15.25.25.2
Other sectors (housing, public utilities, nonproduction types of general services to the public)7.27.47.07.17.48.27.98.6
Source: Goskomstat.

Average for the year; does not include students.

Source: Goskomstat.

Average for the year; does not include students.

Table 8.Russian Federation: Indicators of Hidden Unemployment, 1993-98 1/
Shortened Workday 2/Forced Leave 3/
Thousands

of persons
In percent

of workforce
Thousands

of persons
Avg. leave days per

person per quarter
1993
Q19502.8190814.0
Q29242.8281918.0
Q310743.3368223.6
Q415584.9487628.9
1994
Q1327410.6463219.0
Q2434814.2678225.0
Q3485816.0727435.0
Q4504816.7772742.0
1995
Q122444.42466 4/14.7 5/
Q219913.91868 4/11.1 5/
Q319003.81621 4/9.6 5/
Q420514.12401 4/14.4 5/
1996
Q129526.1292511.0
Q232926.8329210.0
Q331846.6318412.0
Q434097.7340910.0
1997
Q123825.21708 4/32.3 5/
Q225525.61688 4/27.3 5/
Q324825.51223 4/33.0 5/
Q425965.81494 4/27.8 5/
1998
Q117314.01284 4/32.3 5/
Q218044.21285 4/30.7 5/
Q320374.81630 4/33.3 5/
Q420064.81429 4/30.3 5/
Source: Goskomstat.

In industry, construction, transportation, communication, services, science, and scientific support.

For 1993, 1995-98 data include number of people on shortened workday at the end of each quarter; for 1994 data show those on shortened workdays over the course of the period.

Without pay or with partial pay.

Data for last month of the quarter.

Full-quarter estimate based on data for last month of the quarter.

Source: Goskomstat.

In industry, construction, transportation, communication, services, science, and scientific support.

For 1993, 1995-98 data include number of people on shortened workday at the end of each quarter; for 1994 data show those on shortened workdays over the course of the period.

Without pay or with partial pay.

Data for last month of the quarter.

Full-quarter estimate based on data for last month of the quarter.

43. Open unemployment is increasing, while differences in regional unemployment rates remain large. By ILO definitions, the unemployment rate increased from 9.4 percent in 1996 to 13.3 percent at end-1998, and to 14.2 percent at end-April 1999 (Table 9). However, because of the low unemployment benefits and strict eligibility requirements, registered unemployment is much lower, and actually showed a decline from 3.1 percent in 1996 to 2.2 percent in 1998 (Table 9).7 Regional variation in unemployment rates, and more generally in economic activity, is extremely high, reflecting limited labor mobility (see Annex I, “Regional Developments”). For example, in October 1997, unemployment rates of 3–5 percent in the Evenkiyski Autonomous District and in Moscow contrasted with the rate of 58 percent in the Republic of Ingushetia (Table 10). Survey results indicate that unemployment spells have become slightly longer, with the average duration of job search increasing from 8.2 months in 1996 to 9.1 months in 1998 (Table 11). Accordingly, persistent unemployment has become increasingly significant, as the share of long-term unemployed has increased, in particular for those approaching retirement age. This suggests that there is a sizable group of Russians who lack the skills to find employment in an increasingly market-oriented economy.

Table 9.Russian Federation: Selected Labor Market Indicators, 1992-98
Registered UnemploymentUnemployment

According to

ILO Definition
Total

Employment 1/
Registered VacanciesRegistered JobseekersTotalReceiving

Benefits
(In percent of labor force)
End-year 1992-2.40.41.30.80.54.8
End-year 1993-1.70.51.51.10.75.9
End-year 1994-3.30.42.62.21.97.3
End-year 1995-3.00.43.53.22.88.4
End-year 1996-0.70.43.83.43.19.4
End-year 1997-2.00.53.02.82.411.1
End-year 1998-2.10.53.02.72.213.3
Source: Goskomstat.

Annual percentage change.

Source: Goskomstat.

Annual percentage change.

Table 10.Russian Federation: Unemployment Rate by Regions (ILO methodology), 1993-97(In percent; for 1993-95 and 1997, data are for October; for 1996, data are for March)
19931994199519961997
Northern Region
Karelian Republic6.97.711.611.312.1
Komi Republic5.19.011.711.214.1
Arkhangel’sk Oblast6.110.111.312.813.7
Nenets Autonomous Okrug13.4
Vologodsk Oblast3.87.28.18.010.1
Murmansk Oblast7.410.312.915.919.5
North-western region
Saint Petersburg7.49.19.89.59.0
Leningrad Oblast7.010.111.010.713.6
Novgorod Oblast5.77.89.38.613.3
Pskov Oblast7.411.511.713.814.1
Central region
Bryansk Oblast4.28.09.38.612.9
Vladimir Oblast5.69.612.311.511.5
Ivanovo Oblast8.213.214.916.816.8
Kaluzhska Oblast4.45.18.38.011.1
Kostromska Oblast7.08.58.79.89.2
Moscow5.26.15.24.93.7
Moscow Oblast5.88.29.59.911.0
Orlov Oblast3.95.87.29.39.1
Ryazan Oblast4.86.26.46.510.1
Smolensk Oblast5.56.69.611.612.5
Tver Oblast3.86.68.05.89.9
Tula Oblast3.96.25.96.69.3
Yaroslavl Oblast5.07.911.510.38.5
Volga region
Marii-El Republic4.58.511.210.016.0
Mordoviya Republic5.57.410.312.811.1
Chuvash Republic6.19.19.611.013.6
Kirov Oblast6.09.69.29.111.4
Nizhegorod Oblast4.86.07.88.79.2
Central-Chernozem region
Belgorod Oblast3.44.75.56.39.9
Voronezh Oblast4.15.17.48.87.6
Kursk Oblast3.35.75.97.27.5
Lipetsk Oblast4.65.26.36.79.8
Tambov Oblast5.27.010.011.112.2
Povolgski region
Kalmykiya Republic9.010.919.712.622.5
Tatarstan Republic3.25.86.46.67.7
Astrakhan Oblast6.58.813.112.414.0
Volgograd Oblast5.16.610.310.413.0
Penzensk Oblast5.47.812.513.911.4
Samara Oblast4.15.87.38.49.3
Saratov Oblast4.87.89.610.014.5
Ulyanov Oblast4.15.77.88.210.0
North-Kaukaz region
Adygeya Republic7.312.711.811.011.8
Dagestan Republic14.914.722.323.521.6
Ingush Republic45.231.852.0
Kabardino-Balkar Republic10.014.814.716.617.1
Karachaev-Circassian Republic9.311.924.019.918.7
North Ossetian-Alaniya Republic2.83.824.030.322.7
Chechen Republic
Krasnodarsk Krai6.37.88.810.715.6
Stavropol Krai5.55.79.29.413.2
Rostov Oblast4.77.18.28.111.1
Ural
Bashkortostan Republic3.76.07.37.910.8
Udmurt Republic5.78.311.212.911.8
Kurgan Oblast5.09.08.59.912.4
Orenburg Oblast3.05.66.95.68.9
Perm Oblast5.48.38.68.510.7
Komi-Permyatsk Autonomous Okrug17.5
Sverdlovsk Oblast6.08.08.58.910.6
Chelyabinsk Oblast6.07.88.39.29.7
West-Siberia
Altai Republic8.311.611.312.317.7
Altai Krai5.97.510.810.613.7
Kemerovo Oblast4.76.86.66.911.5
Novosibirsk Oblast6.38.09.59.211.0
Omsk Oblast5.06.85.26.812.2
Tomsk Oblast6.89.38.58.011.9
Tyumen Oblast4.26.86.18.010.8
Khanti-Mansi Autonomous Okrug12.6
Yamalo-Nenetsk Autonomous Okrug10.7
East Siberia
Buryat Republic5.89.813.713.319.1
Tyva Republic6.49.814.713.518.9
Khakasian Republic4.76.59.611.613.3
Krasnoyarsk Krai4.68.09.08.212.8
Taimyrsk Autonomous Okrug7.1
Evenkisk Autonomous Okrug3.5
Irkutsk Oblast6.18.69.211.913.9
Ust-Ordinsk Buryat Autonomous Okrug7.7
Chitinsk Oblast6.07.710.215.619.0
Aginsk Buryat A. Okrug28.2
Far East region
Sakha republic (Yakutiya)4.25.86.46.311.4
Jewish Autonomous Oblast6.512.715.913.025.1
Chukotsk A. Oblast1.83.65.210.8
Primorye Krai5.47.810.710.713.5
Khabarovsk Krai7.110.111.612.912.8
Amur Oblast5.49.012.510.915.5
Kamchatka Oblast6.310.08.57.612.6
Koryak Autonomous Okrug6.9
Magadan Oblast6.110.210.410.513.3
Sakhalin Oblast6.98.912.712.215.3
Kaliningrad Oblast6.29.19.414.811.5
Source: Goskomstat.
Source: Goskomstat.
Table 11.Russia Federation: Unemployment Composition by Duration of Job Search and Age Group, 1996-98
Job search time (months)
Under 11-33-66-99-1212+Average
(In percent of total)
Total unemployed, October 19967.410.326.812.310.732.58.2
of which: ages
Under 2010.413.129.215.112.719.66.8
20-247.111.628.013.311.128.87.8
25-298.18.427.410.39.336.68.5
30-347.110.125.512.88.136.38.5
35-396.89.627.011.910.434.38.4
40-445.910.325.812.312.233.58.4
45-496.88.924.911.511.536.48.7
50-545.510.324.812.612.434.48.6
55-596.79.126.710.511.235.78.6
60-6411.712.722.612.33.936.98.0
65-7216.314.335.86.55.521.76.0
Total unemployed, October 19977.815.915.810.711.638.18.8
of which: ages
Under 2011.723.224.110.110.820.16.5
20-249.119.119.910.110.731.17.9
25-298.616.015.110.211.039.18.8
30-347.814.913.910.912.440.19.1
35-396.614.913.211.411.842.29.3
40-446.614.014.311.912.540.69.3
45-495.712.213.211.112.445.49.8
50-545.911.111.712.512.945.910.0
55-597.111.713.78.712.845.99.8
60-646.015.915.36.65.450.79.7
65-725.312.713.34.910.253.610.4
Total unemployed, October 19986.116.015.910.310.840.99.1
of which: ages
Under 207.624.627.49.28.822.46.7
20-247.718.918.510.210.334.48.3
25-296.315.316.512.610.438.99.0
30-345.215.113.310.512.543.49.5
35-395.814.112.910.011.046.29.7
40-445.213.114.49.510.847.19.8
45-495.513.713.410.111.445.99.7
50-544.615.413.98.39.248.69.8
55-596.416.012.59.310.545.39.5
60-644.613.915.913.413.139.19.3
65-726.612.711.37.415.047.010.0
Source: Goskomstat Statistical Bulletin No.9 (48), 1998.
Source: Goskomstat Statistical Bulletin No.9 (48), 1998.

44. Unemployment is increasingly the result of enterprise restructuring, but voluntary resignation remains almost as important in accounting for unemployment. Survey results indicate that an increasing share of the unemployed are involuntarily laid off. In 1998, about 37 percent of the unemployed lost their jobs because of redundancy or enterprise liquidation (compared to 34 percent in 1997), while 22 percent resigned voluntarily (compare to 25 percent in 1997) (Table 12). Only about 37 percent of the unemployed contacted employment agencies for job search assistance in 1998, a drop from the 1996–97 levels, while over half of the unemployed relied on information from friends, relatives and acquaintances in job search. Since the number of registered vacancies has hovered around 0.5 percent of the number of workers employed since 1992, it appears that little job market activity takes place in government-sponsored job agencies (Table 13).

Table 12.Russia Federation: Unemployment by Reason of Being Unemployed, 1992-98(In percent of total unemployed)
1992199319941995199619971998
Total unemployed
Those who had a previous job
of which: left the previous employment because of:79.981.383.684.983.788.085.9
release, redundancy, liquidation21.022.928.931.629.834.037.1
resignation34.840.439.338.538.425.022.2
completion of term of temporary, seasonal or contract work7.05.84.94.64.04.45.3
discharge from military1.91.71.31.41.10.91.2
other reasons15.310.59.28.910.623.720.2
Those who have not had a job before20.118.716.415.116.312.014.1
Total unemployed: male
Those who had a previous job80.782.185.485.485.689.086.8
of which: left the previous employment because of:
release, redundancy, liquidation14.317.223.827.026.031.134.4
resignation40.045.744.542.642.429.525.7
completion of term of temporary, seasonal or contract work7.65.44.64.33.75.25.8
discharge from military3.43.02.42.41.81.62.1
other reasons15.410.810.19.211.721.718.9
Those who have not had a job before19.317.914.614.614.411.013.2
Total unemployed: female
Those who had a previous job79.180.481.684.381.586.884.8
of which: left the previous employment because of:
release, redundancy, liquidation28.329.234.837.234.237.540.3
resignation29.134.533.333.533.619.718.0
completion of term of temporary, seasonal or contract work6.46.35.15.04.33.64.7
discharge from military0.20.10.20.10.20.10.1
other reasons15.210.28.28.49.225.921.6
Those who have not had a job before20.919.618.415.718.513.215.2
Source: Goskomstat.

As of end October 1997.

Source: Goskomstat.

As of end October 1997.

Table 13.Russia Federation: Distribution of the Unemployed by Job Search Methods, 1992-98(In percent of total)
1992199319941995199619971998
Oct.Oct.Oct.Oct.MayOct.Oct.
Application to the state employment service28.128.334.437.639.039.937.2
Application to a commercial employment service1.03.13.74.04.22.42.4
Placing ads in papers, responding to ads8.713.615.615.717.616.318.6
Contacting friends, relatives, acquaintances29.936.737.836.737.055.057.8
Directly contacting the management/employer26.330.929.028.125.628.829.5
Search for land, machines and equipment, raw materials, financial resources for starting
own business, applying for licenses, etc.1.81.91.41.20.91.11.0
Other methods9.012.912.014.014.314.715.6
Source: Goskomstat.
Source: Goskomstat.

45. Geographic mobility is limited, but appears to reflect regional differences in economic conditions. During 1992–98, most regions experienced net in and out migration of about 3–4 percent of 1991 populations (Table 14). However, the Far East region as a whole has experienced an outflow of 9 percent, and several individual sub-regions have experienced outflows of 20–45 percent. Regression analysis indicates that annual migration into or out of a region is determined primarily by the region’s per capita income and by the region’s unemployment rate.

Table 14.Russian Federation: Migration Between the Regions of Russia, 1989-98(In thousands)
19891990199119921993199419951996199719981992-98
TotalTotal as percent Total of population 1/
Northern Region-9.5-13.2-39.2-45.6-37.5-40.8-25.3-24.3-30.4-31.7-235.6-3.9
Karelian Republic0.50.80.40.9-0.71.61.800.2-0.23.60.5
Komi Republic-5.6-7.8-15.7-11.9-15.1-22.3-12.1-9.1-11.1-10.6-92.2-7.4
Arkhangel’sk Oblast-4.8-3.4-9.2-7.6-5.4-3.5-4.8-6-7.6-7.7-42.6-2.8
Vologodsk Oblast0-0.21.54.16.34.35.54.232.630.02.3
Murmansk Oblast0.4-2.6-16.2-31.1-22.6-20.9-15.7-13.4-14.9-15.7-134.3-11.7
North-western region12.419.1-6.6-3.97.447.840.341.528.234.3195.62.5
Central region91.17.8961.5113.2216.2166.2138.5139.313.9848.83.0
Volga region-8.6-1.54.322.22650.831.621.719.918.7190.92.3
Central-Chernozem region12.423.226.380.191.8102.462.653.238.837.6466.56.3
Povolgskl region20.740.133.4104.4131.2167.2104.762.967.359.3697.04.3
North-Kaukaz region19.778.6149.5103.1143167.386.435.236.526.7598.23.5
Ural-39.4-23.1-4.136.641.3123.674.44966.854.5446.22.2
West Siberia6.1-2.2-32-8.226.3112.249.730.464.334.3309.02.1
East Siberia-25-24.5-28.6-36.2-22.6-7.33.9-7.7-21.4-20.6-111.9-1.2
Far East region-0.2-9.6-66.1-150.4-101.1-147.8-102.8-65-69.7-64.6-701.4-8.8
Sakha republic (Yakutiya)1.6-4.5-28.4-27.9-20.4-30.9-18.7-12-17.2-19.7-146.8-12.8
Jewish Autonomous Oblast0.30.1-0.1-2.6-1.4-5.5-1.4-1.8-1.8-1.9-16.4-7.5
Chukotsk A. Oblast-3.6-3.7-9.3-22.2-11.5-13.6-9.3-5.2-4.7-4.0-70.5-45.8
Primorye Krai7.661.9-7.9-7-5.4-9.4-9.4-11-4.2-54.3-2.4
Khabarovsk Krai1.2-0.3-2.9-13.7-8.3-14.8-10.9-7.5-5.3-6.3-66.8-4.2
Amur Oblast-0.4-0.7-4.1-15.2-4-13.6-1.1-3.9-5.7-6.2-49.7-4.7
Kamchatka Oblast0.10.1-3.6-16.6-16.5-15-11.7-7-7-6.4-80.2-16.8
Koryak Autonomous Okrug-0.30-0.5-1.9-2.3-1.6-0.9-0.6-1-1.0-9.3-23.2
Magadan Oblast-5.2-6.7-18.7-38.1-18.9-26.8-20.4-6.6-5.4-6.0-122.2-33.2
Sakhalin Oblast-1.80.1-0.9-6.2-13.1-22.2-19.9-11.6-11.6-10.0-94.6-13.5
Kaliningrad Oblast3.26.35.712.511.118.410.58.21313.086.710.0
Source: Goskomstat.

Total as percent of regional population at end-1991.

Source: Goskomstat.

Total as percent of regional population at end-1991.

C. Prices and Wages

46. Inflation in both consumer and producer prices declined sharply after the adoption of the exchange-rate based stabilization strategy in 1995 (Tables 15 and 16). In 1997, annual consumer price inflation fell to 11 percent. Due to a significant decline in fuel prices, producer prices inflation fell even faster, to 7 percent in 1997, reversing the historical relationship between consumer and producer prices.8 This trend has persisted and inflation as measured by the PPI has been consistently lower than CPI inflation.

Table 15.Russian Federation: Consumer Price Inflation, 1992-98 1/
Overall

CPI
Food 2/Nonfood 3/Paid

Services 4/
(Percentage changes from December to December)
19922508.82526.22573.42120.5
1993839.9804.9641.82311.2
1994215.1214.1169.0522.4
1995131.3123.4116.3232.2
199621.817.717.848.4
199711.09.18.122.5
199884.496.999.518.3
(Monthly percentage changes)
1997Jan2.33.11.02.3
Feb1.51.40.63.6
Mar1.41.40.82.5
Apr1.01.00.51.6
May0.90.80.62.0
June1.11.50.51.0
July0.90.80.42.3
Aug-0.1-0.90.61.1
Sep-0.3-1.40.81.2
Oct0.2-0.50.91.2
Nov0.60.40.71.1
Dec1.01.20.60.7
1998Jan1.52.10.51.7
Feb0.91.20.31.0
Mar0.60.70.21.2
Apr0.40.30.21.0
May0.50.60.11.1
June0.10.00.00.6
July0.2-0.10.11.2
Aug3.72.47.11.2
Sep38.439.554.33.4
Oct4.53.97.41.6
Nov5.77.64.31.3
Dec11.617.16.31.8
1999Jan8.510.46.44.1
Feb4.14.43.93.1
Mar2.82.83.21.9
Apr3.02.64.03.1
May2.22.02.72.1
June1.9
Source: Goskomstat.

The Russian authorities have discontinued the practice of publishing average monthly inflation rates since November 1994. Data reported in this table, since December 1994, are on an end of period basis.

Includes food, beverages, and tobacco.

Includes clothing and footwear, household goods, medicines, recreation, education, and culture, and personal care and effects.

Includes rent, water, fuel and power, transport, and communication.

Source: Goskomstat.

The Russian authorities have discontinued the practice of publishing average monthly inflation rates since November 1994. Data reported in this table, since December 1994, are on an end of period basis.

Includes food, beverages, and tobacco.

Includes clothing and footwear, household goods, medicines, recreation, education, and culture, and personal care and effects.

Includes rent, water, fuel and power, transport, and communication.

Table 16.Russian Federation: Industrial Producer Prices, 1991-98
Overal PPI IndexElectricityFuelFerrous MetallurgyChemicalsMachineryConstruction MaterialsLight IndustryFood Industry
(Percentage changes from December to December)
1991236110129237165212215371314
19923,2785,4099,1663,5253,7912,6212,7141,1582,628
19938951,2586341,0868489491,1696811,229
1994233229201242262230212241208
1995175199187185168178171163156
19961263540161824342022
1997791115991012
19982331122629134453
(Monthly percent changes)
1997Jan1.11.41.60.01.20.80.81.11.8
Feb1.62.52.30.21.71.51.91.42.0
Mar1.31.32.60.70.80.70.80.71.3
Apr0.80.61.3-0.10.61.00.81.41.1
May0.5-0.20.80.20.40.50.90.81.0
Jun0.81.40.60.92.70.80.30.40.4
Jul0.21.4-0.7-0.40.30.40.50.40.1
Aug0.5-0.90.70.12.80.60.40.50.4
Sep0.1-0.10.7-0.60.10.20.30.70.8
Oct0.11.3-0.30.3-0.21.20.41.30.7
Nov0.2-1.00.61.4-3.00.50.40.60.7
Dec0.00.60.5-1.4-2.40.20.70.50.8
1998Jan0.91.21.10.41.10.91.01.00.9
Feb0.50.50.00.5-0.81.20.60.90.3
Mar-0.1-0.3-0.70.8-1.20.40.40.60.4
Apr0.01.7-1.90.5-1.00.40.60.3-0.1
May-0.9-1.8-3.4-1.00.80.70.00.1-0.2
Jun0.01.0-1.60.10.50.40.10.1-0.5
Jul-0.80.1-4.91.00.6-0.10.3-0.2-0.2
Aug-1.2-2.1-5.6-1.7-0.30.10.30.2-0.2
Sep7.41.21.82.48.38.63.610.521.1
Oct5.91.45.32.97.53.82.79.25.1
Nov5.1-0.97.31.94.55.91.08.27.6
Dec4.8-0.54.23.23.94.11.67.311.3
1999Jan6.91.35.36.24.98.53.17.89.2
Feb5.53.82.94.93.55.81.68.38.7
Mar3.90.33.67.63.73.31.95.46.3
Apr3.60.93.64.44.03.61.62.64.2
May3.5
Source: Goskomstat.
Source: Goskomstat.

47. With the onset of the financial crisis in August 1998 and the consequent sharp depreciation of the ruble, inflation accelerated dramatically. Cumulative inflation for September through December 1998 stood at close to 70 percent for the CPI and 25 percent for the PPI. Within the CPI basket, prices for goods increased significantly, while the prices of services rose much more gradually for two reasons. First, the approximately 60–70 percent of service prices that are administered were not fully adjusted. Second, services are relatively labor-intensive, and real wages declined substantially over the period.

48. The rate of inflation has slowed in 1999, to 25 percent on a cumulative basis through June. This was achieved partly as a result of a fairly tight fiscal policy, which has allowed for only moderate Central Bank financing of the government. In addition, a significant improvement in the external current account has reduced pressures on the exchange rate and therefore on domestic prices.

Wage developments

49. Average real monthly wages showed significant increases in 1996–97, after the continuous large declines in earlier years (Table 17).9 For the first eight months of 1998, real wages continued to increase, rising by over 6 percent compared to the same period in 1997. However, in the wake of the August crisis and the sharp depreciation that followed, real wages plummeted: during September–December, they were two-thirds of the level during the same period in 1997. As of April 1999, real wages stood at 59 percent of the level a year earlier, but the decline appears to have bottomed out.

Table 17.Russian Federation: Wages, Pension and Per Capita Income, 1991-98 1/
19911992199319941995199619971998
(In new rubles)
Average wages16592204727909501,095
Minimum wages01152161737683
Pensions22079188302328399
Income per capita6485382,4766,3659,33811,06411,682
(Annual percentage change 2/)
Real wages-400-8-28135-10
Minimum wages-7367-66-1-19-9-14
Pensions28-3-199-5-5
Real income per capita-531613-14-13-17
Source: Goskomstat and staff calculations

Wages and pensions are monthly figures. Income refers to annual figure.

Nominal numbers deflated by CPI.

Source: Goskomstat and staff calculations

Wages and pensions are monthly figures. Income refers to annual figure.

Nominal numbers deflated by CPI.

50. The implications for Russia’s competitiveness of the trends in wages have been mixed. Although real wages as measured against the CPI from 1995 onward have generally been lower than in the 1992–94 period, U.S. dollar wages—which are more relevant from the point of view of competitiveness—have increased from very low levels since the beginning of 1992, reflecting the real appreciation of the ruble. On the other hand, the ULC-based real effective exchange rate remained broadly unchanged from 1995 until the August crisis (Figure 12). The crisis has led to dramatic declines in all three indicators, as well as in the real effective exchange rate based on relative CPIs. (For further discussion of competitiveness, see Chapter V.)

Figure 12.Russian Federation: Competitiveness Indicators, 1992-99

Source: Goskomstat, IMF staff calculations.

51. Wage arrears in industry, agriculture and construction have increased dramatically in real terms since 1992, with a particularly large rise in 1996 (see Table 18 and Annex II, “Nonmonetary Transactions and Arrears Accumulation”). Wage arrears continued to increase, albeit more slowly, in 1997 and 1998. In the face of chronic wage arrears, many workers have increasingly relied on a second job or other activities to supplement their income.

Table 18.Russian Federation: Wage Arrears in Industry, Agriculture, and Construction, 1992-98
IndustryAgricultureConstruction
Nominal 1/Real 2/Nominal 1/Real 2/Nominal 1/Real 2/
End year 1992153.661.492.2
End year 19933649.22877.21684.2
End year 19942,17017.41,30110.48687.0
End year 19957,73426.82,5728.91,9416.7
End year 199622,14963.15,91316.86,18317.6
End year 199726,60768.37,96520.47,06918.1
End year 199830,82679.19,23423.78,99223.1
1997Jan22,93063.86,08816.96,69618.6
Feb24,01365.96,15916.96,55418.0
Mar24,94168.46,24017.16,84018.8
Apr25,36767.96,11016.46,77418.1
May25,90268.76,16516.36,67417.7
Jun26,50869.56,58317.36,71017.6
Jul27,07770.36,94218.06,76017.6
Aug27,46371.47,26818.96,76517.6
Sep27,56571.97,74220.27,05618.4
Oct27,49171.68,14921.27,25318.9
Nov27,75871.98,19321.27,33319.0
Dec26,60768.37,96520.47,06918.1
1998Jan26,72567.58,28520.97,59719.2
Feb28,21370.78,39321.07,40318.5
Mar29,33173.08,38820.97,49918.7
Apr30,44275.58,33120.77,66819.0
May32,07379.18,50421.07,98519.7
Jun33,47382.58,84821.87,55018.6
Jul34,93686.09,24022.78,36320.6
Aug37,43688.89,64522.98,99321.3
Sep39,264102.59,90925.910,09526.3
Oct35,10391.59,84825.79,71225.3
Nov34,06788.29,56124.89,57124.8
Dec30,82679.19,23423.78,99223.1
Source: Goskomstat.

In millions of rubles.

In constant March 1992 prices, deflated by CPI.

Source: Goskomstat.

In millions of rubles.

In constant March 1992 prices, deflated by CPI.

52. Real income recovered in 1996 and 1997 as general economic conditions began to improve somewhat.10 In 1997, real per capita income increased by 3 percent, reflecting relatively buoyant economic activity (Table 17). However, it fell sharply because of the economic crisis and, during the first quarter of 1999, was 32 percent below its value a year before. Over the whole period since reform started, living standards broadly measured have deteriorated significantly (see Box 1).

Box 1.Living Standards in Russia: The Picture After Reform

Indicators of living standards suggest that social conditions have worsened during transition:

Selected Indicators of Leaving Standards 1/
19911992199319941995199619971998
Life expectancy at birth69.067.965.164.064.665.966.6
of which: male63.562.058.957.658.359.860.8
GDP per capita (in thousand rubles, in 1990 prices)4.13.53.22.82.62.62.52.4
Distribution of income (GINI coefficient)0.260.290.400.410.380.380.380.38
Population below subsistence level (in percent)33.531.522.424.721.020.823.8
Number of divorces (per 1000 people)4.04.34.54.64.53.83.83.4
Deaths for psychiatric reasons (per 100000 people)2.83.66.39.610.27.15.1
Source: Goskomstat Yearbook 1998; “Poverty Policy in Russia: Targeting & the Longer-Term Poor”, World Bank (1998).

For 1998, data is for November only.

Source: Goskomstat Yearbook 1998; “Poverty Policy in Russia: Targeting & the Longer-Term Poor”, World Bank (1998).

For 1998, data is for November only.

Almost all social indicators show significant worsening in 1992–1994, including increasing human mortality, declining real income, increasing income inequality, rising social stress, and increasing poverty. While most indicators have subsequently recovered, the deterioration over the entire period remains sizable.

GDP Per Capita Index

(10 PPPS, USA=100)

Based on 1995 data, the United Nations Human Development Index placed Russia in the “Medium Human Development” category, 72nd among 173 countries. Compared to the 1991 figures, based on data for 1985–90, which placed the USSR 31st out of 160 countries—about midway among the list of “High Human Development” countries—the reduction is significant. Countries judged to have overtaken Russia includes Bulgaria, Poland, Brazil, Mexico and Turkey. The most recent official estimate of per capita income at PPP$ (at $6,744) is about ¼ lower than the level in 1990, and ranks Russia similar to Poland and Estonia (see chart). UN estimates suggest a similar drop in per capita income.

III. Public Finances

53. Since 1995, Russia has had only limited success in achieving its main fiscal policy objectives, which have been a reduction in the unsustainably high deficit, a reversal of the prolonged decline in revenues, and a reduction in the size of government and in unproductive expenditures. The enlarged government primary deficit rose from 2½ percent of GDP in 1995 to 3 percent in 1996 and to 3½ percent in 1998, and the overall deficit increased from 6 to 8 percent of GDP during the same period (Table 19).1112 At the same time, revenues of the enlarged government declined from 33 percent of GDP in 1996 to 31.7 percent of GDP in 1998, while expenditures remained relatively constant at about 40 percent of GDP. At the federal level, the primary deficit rose from 2.2 to 2.4 percent of GDP between 1995 and 1997, but decreased to 1.3 percent of GDP in 1998, as revenues declined from almost 13 percent of GDP in 1995 and 1996 to 10.7 percent in 1998 (Table 20). While the size of the enlarged government (as measured by the share of government expenditures in GDP) has remained relatively stable since 1995, there has been a notable shift in government expenditures from the federal level to local and regional governments. Thus although federal noninterest spending has declined significantly as a share of GDP, only minimal success has been achieved in reducing unproductive spending and controlling expenditure commitments, with the result that attempts to reduce cash spending have generated sizable expenditure arrears.

Table 19.Russian Federation: Summary Operations of the Enlarged Government, 1992-98
19921993199419951996199719981998
Q1Q2Q3Q4
(In billions of rubles)
Enlarged government balance (deficit -) 1/-3.5-12.6-63.6-94.4-190.4-198.8-56.2-67.2-70.4-21.4-215.2
Revenues 2/7.562.1211.5515.8708.2917.8169.7201.3184.2294.9850.2
Expenditures 2/11.174.7275.2610.3898.51,116.7226.0268.6254.7316.31,065.5
Federal government balance-2.0-11.2-69.7-88.5-179.6-179.8-31.9-42.8-51.9-31.9-158.5
Revenues3.223.572.1198.1268.1310.459.064.853.8110.3287.9
Expenditures5.234.7141.8286.7447.7490.290.9107.6105.7142.2446.3
Interest0.13.412.054.7126.8118.027.634.431.828.6122.4
Transfers to local govt.0.34.425.129.251.149.98.011.44.221.745.2
Local government balance0.31.13.1-4.9-8.1-21.9-18.5-11.9-5.22.9-32.7
Revenues2.628.6110.0231.8326.7429.867.297.183.4145.0392.7
of which: Federal transfers0.34.425.129.251.149.98.011.44.221.745.2
Expenditures2.327.5106.8236.7334.9451.785.8109.088.6142.1425.3
Extrabudgetary funds balance0.51.12.90.1-2.72.9-5.9-12.6-14.99.3-24.1
Revenues2.114.855.3123.6174.2250.954.252.750.369.4226.6
of which: Federal transfers0.40.77.49.923.42.81.90.66.611.9
of which: Intra-EBF transfers1.10.00.0
Expenditures1.613.752.3123.5176.9248.060.165.365.260.1250.6
Unbudgeted import subsidies2.33.6
Financing of the enlarged government3.512.663.794.4190.4198.856.267.270.421.3215.2
Net foreign financing2.13.30.2-3.214.540.36.826.731.3-9.755.1
Foreign disbursements2.34.55.411.028.850.710.233.240.79.793.9
Principal repayment-0.2-1.2-5.3-14.2-14.3-10.4-3.4-6.5-9.5-19.4-38.8
Domestic financing1.49.363.597.6175.8158.649.440.639.231.0160.2
Domestic Banking system1.08.754.379.4157.643.924.91.0-5.737.257.4
Monetary Authorities1.710.149.425.648.830.47.15.062.610.284.9
Rest of the banking system-0.7-1.44.953.8108.713.517.9-4.1-68.326.9-27.5
Net credit from commercial banks-2.0-6.1-0.2170.7-9.17.53.3-1.933.642.4
Securities held by commercial banks0.611.051.1-61.922.610.4-7.3-66.3-6.7-69.9
Other financing0.30.69.218.218.3114.624.539.644.8-6.1102.7
Privatisation proceeds0.10.40.74.72.723.51.01.50.714.617.8
Net proceeds from sale of gold, gems and precious metals0.21.03.910.418.3-2.20.11.33.01.86.2
Securities held by nonbank sector-0.65.5-1.1-5.078.012.711.5-10.5-5.68.2
Domestic principal repayment0.0-0.4-0.9-0.6-0.61.60.00.2-0.20.00.0
Other0.10.24.92.913.710.725.151.7-16.970.6
(In percent of GDP)
Federal govt overall balance-10.4-6.5-11.4-5.7-8.4-7.0-5.8-7.1-7.4-3.8-5.9
Federal govt primary balance-9.7-4.6-9.4-2.2-2.5-2.4-0.8-1.4-2.9-0.4-1.3
Revenue16.613.711.812.912.512.010.810.77.713.210.7
Expenditure27.020.223.218.620.919.016.717.715.117.116.6
Local govt overall balance1.50.60.5-0.3-0.4-0.8-3.4-2.0-0.70.3-1.2
Revenue (including transfers)13.516.718.015.015.216.612.316.011.917.414.6
Revenue (net of transfers)11.914.113.913.212.814.710.914.111.314.812.9
Expenditure12.016.117.515.415.617.515.718.012.717.015.8
Extrabudgetary funds overall balance2.50.60.50.0-0.10.1-1.1-2.1-2.11.1-0.9
Revenue (including transfers)10.98.69.08.08.19.79.98.77.28.38.4
Revenue (net of transfers)10.98.48.97.57.78.89.48.47.17.58.0
Expenditure8.48.08.68.08.29.611.010.89.37.29.3
Enlarged govt overall balance-18.4-7.4-10.4-6.1-8.9-7.7-10.3-11.1-10.1-2.6-8.0
Enlarged govt primary balance-17.7-5.4-8.4-2.6-3.0-3.1-5.3-5.4-5.50.9-3.5
Revenue39.336.234.633.533.035.531.133.226.435.431.7
Expenditure57.743.645.039.641.943.241.544.336.437.939.7
GDP (In billions of rubles)19.2171.5611.01,540.52,145.72,586.4545.2606.6698.9833.92,684.5
Source: Ministry of Finance, CBR, Goskomstat, and IMF staff calculations.

On a cash basis before 1996, includes wage and arrears in transfers to the Pension Fund in 1997, and accumulation of all federal spending arrears and local wage and pension arrears in 1998.

Consolidated revenues and expenditures (excluding intragovernmental transfers) and including both cash and noncash items.

Source: Ministry of Finance, CBR, Goskomstat, and IMF staff calculations.

On a cash basis before 1996, includes wage and arrears in transfers to the Pension Fund in 1997, and accumulation of all federal spending arrears and local wage and pension arrears in 1998.

Consolidated revenues and expenditures (excluding intragovernmental transfers) and including both cash and noncash items.

Table 20.Russian Federation: Federal Government Budget Execution, 1994-99
1994199519961997199819981999
Q1Q2Q3Q4Q1
(In billions of rubles)
Revenue 1/72.1198.1268.1310.459.064.853.8110.3287.989.5
Cash revenue69.6168.9198.1252.059.064.848.670.5242.989.5
Noncash revenue 2/2.529.370.058.50.00.05.239.845.00.0
VAT31.478.0115.4117.923.423.621.136.7104.733.9
Other taxes on goods and services4.517.751.453.411.811.612.118.554.021.5
Nonenergy excise taxes2.45.011.73.33.64.44.615.93.3
Energy excise taxes:15.244.038.77.06.26.312.832.317.0
Profit taxes17.141.034.833.14.911.07.311.734.98.4
Personal income taxes0.13.35.11.70.00.00.00.00.10.0
Natural resources taxes1.03.04.57.00.90.50.71.13.21.3
Taxes on trade9.629.727.630.17.310.38.415.341.317.6
Export taxes3.215.78.00.10.00.00.00.00.02.2
Import tariffs2.78.514.826.66.57.15.78.127.49.7
Other (excl. gold transactions)3.65.54.83.40.83.22.77.113.95.7
Budgetary funds3.015.422.938.37.45.94.55.923.74.4
Other5.410.06.428.83.31.81.219.626.01.5
Expenditure 1/141.8286.7447.7490.290.9107.6105.7142.2446.3156.7
Non-interest expenditure129.8231.9320.9372.263.373.173.9113.6323.999.0
Government administration 3/14.44.55.49.71.92.11.74.09.72.4
International activity21.520.64.30.0-0.8-0.59.98.54.9
Defense28.047.663.979.710.911.311.423.156.716.3
Law enforcement and public order10.819.228.543.77.36.76.913.134.07.9
Science4.86.69.51.81.00.42.05.21.5
Education5.58.611.414.42.52.82.74.912.92.3
Health and emergency management2.35.98.315.52.32.22.25.312.02.6
Social policy1.03.89.922.77.57.35.516.236.510.9
Housing and municipal services1.32.02.50.40.40.40.82.10.3
Culture and mass media1.72.82.02.50.40.40.50.82.10.4
Industry, energy and construction18.225.726.226.61.33.31.94.911.31.9
Agriculture and fishing6.28.512.10.21.20.81.03.30.3
Transportation and communication0.50.73.80.9-0.70.50.31.00.1
Net lending14.022.819.618.32.03.15.6-1.29.59.6
Intergovernment Transfers25.129.251.149.98.011.44.221.745.210.8
Budgetary funds3.014.116.529.14.95.75.18.023.64.7
Other 4/5.813.539.827.811.115.824.7-1.250.422.1
o/w accumulation of arrears10.42.58.022.0-20.412.10.0
Interest Payments12.054.7126.8118.027.634.431.828.6122.457.7
External debt 5/3.116.922.823.85.59.216.125.956.747.1
Treasury bills (GKO/OFZ)1.428.589.786.221.222.617.10.060.90.0
Other domestic debt7.59.314.38.00.92.7-1.42.64.810.6
Overall Balance (deficit -)-69.7-88.5-179.6-179.8-31.9-42.8-51.9-31.9-158.5-67.2
(In percent of GDP)
Revenue11.812.912.512.010.810.77.713.210.710.3
Cash11.411.09.29.710.810.77.08.59.010.3
Noncash0.41.93.32.30.00.00.74.81.70.0
Expenditure23.218.620.919.016.717.715.117.116.618.1
Interest2.03.65.94.65.15.74.63.44.66.7
Noninterest21.215.115.014.411.612.110.613.612.111.4
Overall balance-11.4-5.7-8.4-7.0-5.8-7.1-7.4-3.8-5.9-7.8
Primary balance-9.4-2.2-2.5-2.4-0.8-1.4-2.9-0.4-1.3-1.1
Source: Ministry of Finance; and IMF staff estimates.

Excludes budgetary funds (road and ecology funds) before 1994.

Includes ruble off sets (decree 71) and tax offset in 1996, ruble offsets (decree 20) reverse monetary offsets in 1997, and targeted financing in 1998.

From 1992-94 includes science and international activity.

Includes unallocated noncash expenditures in 1996, accumulation of wage and arrears in transfers to the Pension Fund in 1997, and accumulation of all expenditure arrears in 1998.

Measured on a commitments basis.

Source: Ministry of Finance; and IMF staff estimates.

Excludes budgetary funds (road and ecology funds) before 1994.

Includes ruble off sets (decree 71) and tax offset in 1996, ruble offsets (decree 20) reverse monetary offsets in 1997, and targeted financing in 1998.

From 1992-94 includes science and international activity.

Includes unallocated noncash expenditures in 1996, accumulation of wage and arrears in transfers to the Pension Fund in 1997, and accumulation of all expenditure arrears in 1998.

Measured on a commitments basis.

A. Overview 1996–99

54. The government’s economic program for 1996 envisaged a consolidation of the fiscal position, but the actual outcome fell short of expectations. Spending pressures were carried over from the previous year, there was a further marked decline in cash revenues, and interest rates surged in the second quarter due to uncertainty surrounding the approaching Presidential election. Although the federal government primary balance was contained to approximately its 1995 levels on a cash basis, the overall federal deficit grew by 2.7 percent of GDP, to 8.4 percent of GDP, as a result of increased interest payments. The enlarged government deficit was slightly higher due to a small deficit at other levels of government. Further, tight control over cash spending led to an accumulation of federal arrears on wages, obligations to the Pension Fund and goods and services expenditures, including for energy consumption.

55. In 1997, plans to address the underlying fiscal imbalance were again not fulfilled. Despite the first signs of recovery in the real economy, revenues continued to languish, and in October 1997, the budget began to suffer from the fallout of the Asia crisis, in particular owing to increasing interest rates. By diverting financing to cover the growing interest bill, the government incurred new arrears, reversing gains made earlier in the year. Cash revenues fell in the fourth quarter, in anticipation of a year-end offset operation (see below) while noninterest spending jumped. The federal government primary deficit for 1997 as a whole remained largely unchanged compared to the previous year, while the overall deficit declined to 7 percent of GDP. The reduction in interest payments as a share of GDP for that year reflected a large decline in the beginning of the year before the onset of the Asia crisis. As in 1996, the enlarged government deficit was slightly higher than that of the federal government due to a small deficit on local budgets.

56. During the first half of 1998, government interest payments rose sharply and revenues continued to fall short of expectations. There was, however, some success in reducing noninterest expenditure commitments. For the second half of 1998, events were largely shaped by the August crisis. Federal government cash revenues plummeted to unprecedented levels in the third quarter, reaching 7 percent of GDP. While cash revenues recovered slightly in the fourth quarter, as the payments system began functioning again, compliance remained low. Despite the economic crisis, the primary balance of the federal government (on a commitments basis) was reduced from 2.4 percent of GDP in 1997 to 1.3 percent of GDP, reflecting the improved expenditure control as well as a continued shift of expenditures from the federal level to the regions (see below). Due to this latter development, local wage arrears increased by ½ percent of GDP, while pension arrears rose by about 1 percent of GDP. The enlarged government’s overall deficit ended the year at 8 percent of GDP, a slight increase over the previous year.

57. Fiscal policy has been reasonably tight through the first quarter of 1999. Federal cash revenues rebounded to over 10 percent of GDP compared to 8.4 percent in the fourth quarter of 1998, partly due to a determined effort to improve tax compliance. A number of endogenous factors have also contributed to the improved revenue performance. These include the output recovery in the wake of the large ruble depreciation, which has also boosted tax revenues. The revenue situation has also been helped by the improvements in the external terms of trade occasioned by higher oil prices on world markets, which increased the tax base of the energy sector. Expenditures were restrained in the first two months of 1999—largely reflecting the fact that spending was limited to 1/12 of the previous year’s nominal levels prior to the passage of the 1999 budget—but spending increased significantly in March. The primary deficit was 1.1 percent of GDP, allowing CBR financing to be limited primarily to covering debt service. The overall federal deficit was 7.8 percent (commitments basis), while the enlarged government deficit was somewhat lower, at 6.5 percent of GDP, reflecting a surplus for the Pension Fund.

B. Key Features of 1996–99 Developments

Federal government revenue performance

58. The revenue problem in Russia is deeply entrenched. The authorities did not succeed in reversing the sharp reduction in revenues that had taken place since the beginning of transition. Cash revenues of the federal government, in fact, declined by a further 0.2 percent of GDP during 1996–98 (Figure 13). This decline reflects a number of fundamental factors, but perhaps most importantly, continued recourse to nonmonetary fiscal operations or tax offset schemes (see Box 2). These operations arose in the context of the need to settle mutual claims between the budget and taxpayers, but have evolved over the years into various arrangements that have generally exacerbated the government’s problems of collecting tax revenues in cash and meeting budgetary obligations in a timely manner. Often arrears are accumulated as a means of forcing the government to purchase the goods and services supplied by tax delinquent enterprises, thereby contributing to nontransparent and inefficient expenditures as well as the overpricing of goods and services sold to government. Given the implicit discount that inevitably accompanies these arrangements, they have also effectively operated as a rolling partial tax amnesty that has had an adverse impact on tax payment discipline. These schemes have also presented opportunities for corruption, and engender a general belief among taxpayers that the central government is incapable of enforcing statutory tax obligations.

Figure 13.Russian Federation: Cash and Noncash Federal Revenues, January 1996-March 1999

(In billions of constant December 1995 rubles)

59. Other factors have contributed to weak tax administration in Russia. Large taxpayers routinely negotiate their tax payments, essentially independent of the statutory tax liability, and the audit and investigation functions of the tax authorities are weak. Taxpayer compliance has also been eroded by complex and contradictory tax laws, high marginal tax rates (particularly on labor income), the growing problem of nonpayments throughout the economy, and endemic corruption among both taxpayers and tax collectors.

60. A number of reforms have been attempted to address weaknesses in tax administration capacity. In 1996, several measures were put in place, including the introduction of large taxpayer inspection units, limits on tax deferrals, and the elimination of import exemptions. However, these measures have had little impact on tax collections, owing to inadequate implementation as well as the more fundamental problems noted above. In the absence of improved taxpayer compliance, the elimination of a number of taxes—in an effort to simplify and enhance the efficiency of the tax system—contributed to a reduction in revenue as a share of GDP in 1996.13 In response to these developments, in October 1996, the government established the Emergency Tax Commission headed by the Prime Minister, which was intended to tackle the problem of large tax debtors, including by initiation of bankruptcy proceedings against the worst offenders. The Tax Commission again had only a limited effect on overall tax compliance, in part because actions against several large tax debtors, including bankruptcy and seizure of assets, did not have sufficient political support. More recently, additional steps have been taken to enhance tax administration, including improving collection enforcement of the VAT through the mandatory use of tax invoices; enhancing the effectiveness of tax audit operations by modernizing audit selection criteria and audit techniques; and increasing the effectiveness of alcohol excise taxation by improving legislation to strengthen licensing controls.

Box 2.Nonmonetary and Offset Arrangements in the Russian Federation

Nonmonetary or offset fiscal operations arose in Russia in the context of the need to settle mutual claims between the budget and taxpayers. Various offset or nonmonetary arrangements have evolved since 1994, with new forms typically following on commitments to cease previously existing mechanisms. In general, these schemes have (i) provided for discounts which effectively operate as a rolling partial tax amnesty that, in turn has had a serious adverse impact on taxpayer discipline, (ii) exacerbated the government’s problems of meeting cash obligations in a timely manner, while distorting expenditure patterns, and (iii) led to overpricing of goods and services delivered to the government.

1994—The use of nonmonetary fiscal operations began in the fourth quarter of 1994 when the authorities attempted to close the budget year and clear large mutual tax and spending arrears with Treasury obligations—kaznacheskie obyazatel’stva or KOs. The instruments carried below-market interest rates, and the holder knew from the outset that they would be allowed to use them to pay taxes on maturity. On maturity, the holder was offered the choice of receiving cash or a treasury tax offset (KNO) which could be presented to the tax authorities to extinguish tax obligations. Two features encouraged holders of maturing KOs to accept KNOs: (i) cash was not always available; and (ii) the prospects of early redemption of KOs allowed for an implicit tax liability discount.

1995—KOs were slowly phased out in 1995. For the year as a whole, 1¼ percent of GDP in KOs were issued. Of the Rub 22 billion of KOs maturing during the year, Rub 15 billion in KNOs were issued to cover taxes.

1996—The government began to issue KNOs directly to pay for budgetary arrears. During 1996 Rub 44 billion in KNOs were issued and although the original intention was to use the KNOs to settle mutual arrears, firms were allowed to acquire tax arrears needed to participate in offset chains. The transaction costs of acquiring these tax arrears by firms which had a claim on the budget inevitably led to an overpricing of goods and services delivered to the budget. The use of KNOs was discontinued in September 1996, but in October, monetary offsets (MOs) were introduced whereby a commercial bank would lend money to a tax debtor who would use the funds to pay their tax arrears into a Treasury account held at that same bank. This money would be precommitted to make payments, through the same bank, for a budgetary arrear and the same money would then be used by the budget recipient to clear a chain of interenterprise arrears ending finally in payment to the tax debtor and repayment of the bank loan. Because this arrangement depended on a predetermined chain of offsets it had the effect of distorting government expenditure patterns, and limiting the ability of the government to meet other cash expenditures, such as wages. In the fourth quarter of the year Rub 26 billion of MOs were conducted to clear budgetary and tax arrears.

1997—During the first eight months of 1997 MOs continued. The low revenues of the third quarter led to the introduction of a new offset scheme in the fourth quarter—the so-called reverse monetary offsets (RMOs)—which were similar to the MOs except that the initiating transaction was a payment from the budget for its spending arrears rather than from the tax debtor. The government would establish a chain from budget arrears through a number of enterprises (each with arrears to the other) and finally to a tax debtor. From the end of 1997 to January 1998 Rub 58 billion of RMOs were conducted.

1998—Offset operations were resisted for the first half of 1998, bolstered by a Presidential Decree prohibiting all such noncash arrangements. In September “targeted financing” (TF) was introduced. In much the same way as RMOs, accounts were opened for all participants in an offset chain and monies were credited and debited from their accounts eliminating arrears as they went. The only difference, was that the accounts were opened under the auspices of the Federal Treasury. By year-end, Rub 25 billion in offsets were conducted, with the practice continuing in the first few months of 1999.

61. An adequate commitment from the highest levels of government will play a critical role in any future undertaking to improve tax collections. To demonstrate this commitment the Duma, in July 1999, passed a number of key amendments to Part I of the Tax Code. Among the changes are the following: increasing the powers of the tax authorities by eliminating the need for the Ministry of Taxation to use the already over-burdened court system and giving the authorities the ability to issue liens on bank accounts of delinquent taxpayers; introducing legal sanctions against tax agents who fail to deposit withheld taxes in a timely fashion; eliminating the ceiling on interest accruals on overdue taxes, as well as the ceiling on the interest rate; extending deadlines for collection orders; and introducing stronger penalties and sanctions for failures to file tax invoices, filing of false invoices or bookkeeping practices in violation of the law. Nevertheless, there is still a need to improve the management and organization of the tax authorities, strengthen the capacity to monitor and enforce collections from large taxpayers, and implement an appropriate tax identification system.

Federal government expenditures

62. Federal government spending has declined dramatically from the high levels of the Soviet era.14 Reductions in noninterest expenditures have been particularly striking, with a decline from 26 percent of GDP in 1992 to 15 percent of GDP in 1996, and to 12 percent by 1998. These reductions were concentrated in spending on defense, subsidies to industry and agriculture, and net lending (mainly to Northern regions, agriculture and industry). A further rationalization of the structure of the federal government would require a comprehensive public expenditure review, which would allow for a prioritizing of spending and a reduction in the large number of federal employees. This would help prevent unplanned in-year expenditure cuts via sequestration and across-the-board spending reductions. In recent times such practices have contributed to large expenditure arrears. While the expenditure reduction program begun in 1998 has gone some way toward addressing these shortcomings, implementation appears to have been far from complete.

63. The lack of action in further rationalizing federal expenditures has been compounded by shortcomings in the Treasury system. While the Federal Treasury has made progress in the past year in expanding its control over an increasing share of government activity, it still does not encompass the military (which accounts for ¼ of expenditures in the 1999 budget) and the Ministry of Finance does not yet have in place an effective mechanism for controlling (or even measuring) expenditure commitments.15 Further, these problems have been exacerbated by the fact that suppliers, particularly in the energy sector, have not denied goods to those spending units that do not pay, and by the proliferation of nontransparent off-budget practices.16

64. Less progress has been made in reducing government absorption than is suggested by cash spending estimates. In 1996, arrears in federal transfers to the Pension Fund increased to ¾ percent of GDP, and significant delays on payments for goods and services were experienced. In addition, throughout the year, off-budget activities were conducted that were not captured by the Treasury reports on cash spending.17 At the same time, interest payments increased rapidly from 2 percent of GDP in 1994 to an average of 5 percent of GDP in 1996–98.

65. Attempts to reduce arrears and control expenditure commitments in 1997 met with mixed results. The government was successful in early 1997, virtually eliminating federal wage and pensions arrears in the first half of the year. However, due to insufficient action in reducing government programs and in downsizing the defense and security ministries, arrears were building in these areas. Towards the end of the year, the government did begin taking significant steps to control expenditure commitments, and publicly announced Rub 40 billion in expenditure reductions to take place in 1998, including a reduction in civil service employment, and physical limits on energy consumption.

66. Building on this plan, there were continued efforts in 1998 to reduce domestic absorption through an intensified focus on reducing spending commitments rather than on simply limiting cash expenditures. In April, limits were placed on ministerial expenditures and each ministry was required to submit a plan to achieve these limits. To bolster the Ministry’s control over spending units, the Treasury was expanded to cover all spending by nondefense ministries. For the first half of the year, some effect was felt from the expenditure reduction plan, as commitments declined.

67. Immediately following the August crisis in 1998, the lack of financing caused a sharp decline in cash spending, which fell from an average of Rub 21 billion per month in the first half of the year to Rub 12 billion in August. Consequently, federal spending arrears began to grow rapidly, increasing by Rub 22 billion or 3¼ percent of period GDP in the third quarter alone. In the final quarter of the year, civilian arrears stabilized and wage and defense arrears actually fell, financed primarily by recourse to borrowing from the CBR as well as with funds from the sale of Gazprom shares. The year ended with federal noninterest spending reaching 11½ percent of GDP. In the first quarter of 1999, federal noninterest spending was initially limited by the lack of an approved budget, but accelerated in March, ending the quarter at 11.4 percent of GDP, slightly lower than the same period of 1998.

The regional and local budgets

68. The period since the transition process began has been characterized by a gradual shift of expenditure responsibilities to local and regional governments. These included the shifting from the federal government of the payment of child allowances and some education expenditures, as well as a transfer from enterprises of the responsibility for the provision of housing and utilities and other divested “social assets.” Increased expenditure assignments were initially accompanied by increased transfers, but later were shifted as unfunded mandates.

69. The fiscal position of the regional and local budgets has slowly deteriorated along with the federal budget finances. The consolidated fiscal balance of local and regional budgets, on a cash basis, gradually moved from a surplus of ½ percent of GDP in 1994 to a deficit of ¾ percent of GDP in 1997 and 1 percent of GDP in 1998 (Table 21).18 These deficits were financed largely from the issuance of promissory notes (“veksels”) and other local debt instruments although, in 1997, the deficit was also partially financed by loans extended to the regions from the federal budget. In the second quarter of 1997 some of the more fiscally sound regions began to gain access to foreign capital markets and proceeded to issue Eurobonds to finance their budget expenditures.19

Table 21.Russian Federation: Regional and Local Government Operations, 1994-98
199419951996199719981998
Q1Q2Q3Q4
(In billions of rubles)
Revenue110.0231.8326.7429.867.297.183.4145.0392.7
VAT11.628.239.754.79.711.410.320.451.8
Profits taxes31.775.864.169.010.616.812.421.761.5
Excises3.06.58.212.40.00.00.00.00.0
Personal Income taxes17.433.251.473.414.215.915.825.371.1
Natural resource payments2.09.316.828.63.63.44.87.219.0
Property taxes4.816.036.646.94.314.612.015.746.5
Federal transfers25.126.960.278.69.412.35.220.647.4
Other14.335.949.666.115.522.923.034.195.4
Expenditure106.8236.7334.9451.785.8109.088.6142.0425.4
Education22.047.872.494.514.724.117.028.384.1
Health17.437.452.567.010.614.612.222.159.5
Housing & municipal services33.961.389.5107.515.922.019.838.095.6
Social security6.516.926.932.45.67.35.69.628.0
Other 1/27.073.293.6150.438.940.934.144.1158.1
Overall balance (- deficit)3.1-4.9-8.1-21.9-18.5-11.9-5.23.0-32.7
Financing-3.14.98.121.918.511.95.2-3.232.4
Foreign financing0.00.05.20.63.40.00.04.0
Banking system-3.8-0.11.93.110.12.10.3-3.29.3
of which: monetary authorities-2.41.20.0-1.51.20.10.7-0.51.5
Nonbank0.65.16.313.67.86.44.90.219.3
Privatisation0.61.31.94.70.50.90.40.72.6
Other3.84.48.97.35.54.4-0.516.7
(In percent of GDP)
Revenue18.015.015.216.612.316.011.917.414.6
VAT1.91.81.82.11.81.91.52.41.9
Profits taxes5.24.93.02.72.02.81.82.62.3
Excises0.50.40.40.50.00.00.00.00.0
Personal Income taxes2.82.22.42.82.62.62.33.02.6
Natural resource payments0.30.60.81.10.70.60.70.90.7
Property taxes0.81.01.71.80.82.41.71.91.7
Federal transfers4.11.72.83.01.72.00.72.51.8
Other2.32.32.32.62.83.83.34.13.6
Expenditure17.515.415.617.515.718.012.717.015.8
Education3.63.13.43.72.74.02.43.43.1
Health2.82.42.42.61.92.41.72.62.2
Housing & municipal services5.64.04.24.22.93.62.84.63.6
Social security1.11.11.31.31.01.20.81.11.0
Other 1/4.44.84.45.87.16.84.95.35.9
Overall balance (- deficit)0.5-0.3-0.4-0.8-3.4-2.0-0.70.4-1.2
Financing-0.50.30.40.83.42.00.7-0.41.2
Foreign financing0.00.00.00.20.10.60.00.00.1
Banking system-0.60.00.10.11.80.30.0-0.40.3
of which: monetary authorities-0.40.10.0-0.10.20.00.1-0.10.1
Nonbank0.10.30.30.51.41.10.70.00.7
Privatisation0.10.10.10.20.10.10.10.10.1
Other0.20.20.31.30.90.6-0.10.6
Sources: Ministry of Finance, CBR and staff estimates.

Including, in 1998, local wage arrears.

Sources: Ministry of Finance, CBR and staff estimates.

Including, in 1998, local wage arrears.

70. This loosening of the financial constraints on some regional budgets, along with a substantial rise in regional and local revenues, allowed regional spending to rise in 1997.20 By the end of the year, however, access to foreign financing had dried up and regions were again constrained by the limited domestic financing that was available. However, the federal government made available Rub 19 billion (¾ percent of GDP) in loans to regions in order to clear local wage arrears which had become a sensitive political issue. By end-year, government wage arrears at both local and regional levels fell to almost zero although arrears on non-wage spending amounted to around 1 percent of GDP.

71. The improvement in local and regional revenue was short-lived, however, and with a decline in federal transfers and in the absence of financing sources, cash spending fell across-the-board in 1998. Cash sequestration caused an increase in arrears both on local government wages (which ended 1998 at 0.6 percent of GDP) and on goods and services (which totaled 2¾ percent of GDP by December 1998). This accumulation of arrears also reflected further shifting by the federal government of expenditure items to the local level without provision of commensurate revenues.21

Social extrabudgetary funds

72. The four main social extrabudgetary funds have seen a deterioration in their financial position since 1992. Revenues of these social funds, including transfers from the federal budget, declined from 11 percent of GDP in 1992 to a low of 8 percent of GDP in 1995–96 before rebounding somewhat; in 1998, revenues stood at 8.4 percent of GDP. (Table 22). Over the same period, the combined balance of the social funds fell from a financial surplus of 2½ percent of GDP to a deficit of 1 percent of GDP. This has left a benefit system that is nontransparent, poorly targeted, and increasingly unable to provide basic social support for the most exposed segments of Russian society. Moreover, despite real benefits being significantly reduced during the period, the dramatic decline in revenues has resulted in continued accumulation of arrears on pension payments.

Table 22.Russian Federation: Extrabudgetary Fund Operations, 1994-98
199419951996199719981998
Q1Q2Q3Q4
(In billions of rubles)
Revenue55.3123.6174.2250.954.252.750.369.4226.6
Pension Fund38.385.2127.3181.038.435.734.353.1161.6
Employment Fund3.06.26.98.81.92.21.92.18.0
Social Insurance Fund7.517.625.431.57.57.77.47.430.0
Fed. Medical Insurance Fund6.614.614.629.66.47.26.66.827.0
Expenditure52.3123.5176.9248.060.165.365.260.1250.6
Pension Fund 1/37.385.8127.1176.643.148.448.849.8190.2
Employment Fund2.46.47.18.81.92.01.92.18.0
Social Insurance Fund6.616.624.830.46.67.77.78.030.0
Fed. Medical Insurance Fund6.014.614.628.96.57.46.86.327.0
Float0.00.23.33.31.8-0.2-0.1-6.1-4.5
Balance, total extrabudgetary funds2.90.1-2.72.9-5.9-12.6-14.99.3-24.1
Financing-2.9-0.12.6-2.95.912.614.9-9.324.1
of which: Monetary authorities-1.60.3-0.2-2.21.70.5-0.3-2.5-0.6
of which: pension arrears1.211.917.4-6.826.3
(In percent of GDP)
Revenue9.08.08.19.79.98.77.28.38.4
Pension Fund6.35.55.97.07.05.94.96.46.0
Employment Fund0.50.40.30.30.30.40.30.20.3
Social Insurance Fund1.21.11.21.21.41.31.10.91.1
Fed. Medical Insurance Fund1.10.90.71.11.21.20.90.81.0
Expenditure8.68.08.29.611.010.89.37.29.3
Pension Fund 1/6.15.65.96.87.98.07.06.07.1
Employment Fund0.40.40.30.30.40.30.30.30.3
Social Insurance Fund1.11.11.21.21.21.31.11.01.1
Fed. Medical Insurance Fund1.00.90.71.11.21.21.00.81.0
Float0.00.00.20.10.30.00.0-0.7-0.2
Balance, total extrabudgetary funds0.50.0-0.10.1-1.1-2.1-2.11.1-0.9
Financing-0.50.00.1-0.11.12.12.1-1.10.9
of which: Monetary authorities-0.30.00.0-0.10.30.10.0-0.30.0
of which: pension arrears0.22.02.5-0.81.0
Source: Extrabudgetary funds and CBR.

Measured on a cash basis 1992-7 and a commitment basis in 1998.

Source: Extrabudgetary funds and CBR.

Measured on a cash basis 1992-7 and a commitment basis in 1998.

73. The Pension Fund suffers from a number of structural problems that have contributed to a worsening financial situation over 1996–98.22 These factors include a shrinking payroll tax base (as employers move toward non-wage forms of payment) and a steady decline in payroll tax compliance; an increase in the dependency ratio from 50 percent in 1993 to 58 percent in 1998; and insufficient transfers from the Federal budget to cover the costs of social pensions. Moreover, problems have been exacerbated by occasional Duma-mandated increases in pensions (for example in July 1997) that have not been accompanied by measures to improve the financial position of the Pension Fund.

74. These financial difficulties have been manifested in the form of pension arrears rather than in a cash deficit, as the Pension Fund has been constrained in its ability to borrow from the banking system. By end-1996, these arrears stood at Rub 16 billion (around 1½ months of benefits or ¾ percent of GDP). Arrears varied greatly by region, with those in some wealthier regions near zero while other regions had not been paid benefits for several months. During 1997, social pressures became acute and the federal budget transferred Rub 23 billion (0.9 percent of GDP) to the Pension Fund to clear arrears. This effort was successful and by mid-year the stock of arrears was eliminated. The Pension Fund ended the year with a small surplus on a cash basis and a ¾ percent of GDP surplus on a commitments basis.

75. In 1998, the finances of the Pension Fund were adversely affected by benefit increases early in the year, and the economic crisis in August.23 In February 1998, a new formula was introduced for calculating pensions whereby pensioners could choose to either receive benefits based upon a statutory formula or have their benefits calculated on the basis of an “individual pension coefficient” that links their pension to their wage history and the increase in the economy-wide average wage. This change proved more costly than anticipated, despite a modification limiting indexation to the average wage implicit in the level of payroll tax collections.24 In the first half of the year, payroll tax collections averaged a little over Rub 11 billion per month while, at the same time, pension benefits were nearer Rub 15 billion per month; by July, the Pension Fund had exhausted all its financing options (such as the drawdown of commercial bank deposits) and pension arrears rose to Rub 16 billion. In August and September, following the onset of the economic crisis, payroll taxes fell further to about Rub 10 billion and arrears doubled to over Rub 30 billion (or two months of benefits). This stock of arrears was reduced to Rub 26½ billion (or 1 percent of GDP) by year-end, in part due to Rub 6½ billion in transfers from the federal budget.

76. In the first quarter of 1999, the Pension Fund ran a small surplus. This was primarily due to the nonindexation of entitlements since the August 1998 crisis. As a result, the Pension Fund was able to reduce pension arrears from the end-December 1998 stock of Rub 26½ billion to Rub 18 billion at end-March 1999.

77. The Social Insurance Fund, which provides birth, maternity, sickness and other benefits and some child allowances, appears to be a source of significant inefficiencies. The Fund is financed by a payroll tax contribution of 5.4 percent, but its resources are highly decentralized, with the majority of the payroll taxes collected remaining within the enterprise to pay for benefits for those workers in the enterprise. As a result there is little transparency in the activities of this Fund—despite its accounting for resources in excess of 1 percent of GDP. A significant portion of the benefits paid by this Fund are not targeted to needy groups and amount to little more than non-wage benefits for workers.25

78. The Employment Fund is limited in its ability to provide an effective social safety net for unemployed workers. It is the smallest of the social extrabudgetary funds with spending and revenues of only ⅓ percent of GDP in 1997–98. The nature of the Employment Fund has changed markedly since the early 1990s with fewer of its resources devoted to labor subsidies to enterprises and more used to pay cash benefits to the unemployed. However, as noted (in Chapter II), only about one quarter of the unemployed (by ILO standards) are actually receiving benefits. In addition, benefit levels remain quite modest (only about 25 percent of the average wage), and are highly differentiated across region. Currently, 80 percent of Employment Fund revenues are retained in the regions; as a result, some regions do not have resources to pay benefits, while others have sufficient resources to engage in capital construction. The Employment Fund is entirely funded by a 1.5 percent payroll tax.

79. In general, the social extrabudgetary funds do not meet the objectives for which they were designed. The Pension Fund is continually forced to run pension arrears which results in inequities between regions and individuals. Further, while some pensioners receive relatively large benefits, others, particularly those retiring before 1992, receive only a minimum pension that covered about 35 percent of the subsistence level of consumption in early 1999. It is not clear to what extent the Social Insurance Fund and Employment Fund are meeting social needs and providing benefits that are sufficiently well-targeted to protect the most vulnerable of the population. In addition, the overall payroll tax of 36 percent, in particular when combined with the top marginal rate of personal income tax of 45 percent, leads to large distortions in the labor market and incentives for employers and employees to collaborate to evade taxes.

IV. monetary developments

A. Overview

80. Starting in early 1995 and leading up to the period preceding the crisis in mid-1998, monetary policy was geared, first and foremost, at maintaining exchange rate stability. This resolute policy stance of the CBR brought annual inflation down sharply, from over 215 percent in 1994 to about 6.5 percent by mid-1998. In maintaining the stability of the ruble, the CBR often intervened heavily in the foreign exchange market and showed a willingness to accept high real interest rates when necessary.

81. Success at reigning in inflation in the presence of large fiscal imbalances was made possible by two crucial developments: the liberalization of the domestic treasury bill market and large external capital inflows during 1996–97.26 These enabled the government to reduce its reliance on central bank financing of the deficit and enabled the CBR to bear down on inflation without incurring unsustainable losses in external reserves.

82. The sustained decline in inflation had a favorable impact on the monetization of the economy, although it remained at a very low level by international standards. The increased scope for extension of credits resulting from the remonetization benefited, however, mainly the public sector; growth in ruble credit to the economy remained anemic as banking activity became very narrowly focused on the treasury bill market which expanded rapidly due to the large financing needs of the government. Credit extension to the real sector was further limited by structural problems, including insecure property rights and poor accounting standards, which made commercial lending inherently more risky.

83. Following the decision in August 1998 to unilaterally restructure domestic government debt and allow the ruble to depreciate, much of the commercial banking system was left in a state of insolvency. Further, the sharp depreciation of the ruble contributed to rapid inflation in the months immediately following the crisis. The authorities have subsequently succeeded in reigning in monetary expansion, and, as a result, inflation has begun to level off and the ruble to stabilize. (See Chapter I for a detailed discussion of events leading up to, and following, the August crisis.)

B. Institutional and Legal Structures

84. The banking sector in Russia includes the CBR and about 1,400 banks at present. The CBR is responsible for the exercise of monetary policy and conducts banking supervision. The majority of the foreign reserves of Russia are held by the CBR; however, the government also holds some reserves and reserve-related liabilities.27 There are a number of state-owned banks, notably Sberbank which holds the majority of household deposits, Vneshtorgbank (the Russian foreign trade bank) and Vnesheckonombank (which handles the external debt operations of the federal government). In addition, the CBR owns a number of commercial banks abroad.

85. Until the crisis in mid-1998, treasury bills, spot and forward foreign exchange, and commodities were traded on numerous exchanges in Russia. Interbank markets were active and the debt market—dominated by federal government debt instruments, including treasury bills, floating rate Federal savings bonds, and medium-term foreign-currency bonds—was highly liquid. Short-term debt instruments, including promissory notes (veksels) issued by banks, companies, and local governments were also widely issued and actively traded. The Russian equity market was one of the best emerging market performers in 1997.

86. The financial crisis has led to a substantial downturn in financial market activities. The organized interbank auctions for foreign exchange was segmented into two sessions—a restricted morning session and an open afternoon session.28 Following the collapse of the banking sector, trading in the interbank market for ruble liquidity became very thin. As a result of the restructuring of treasury bills and a temporary freeze on secondary market trading (which has since been revoked), activity in the government debt market came to a complete halt during the second half of 1998. More recently, activity in this market has remained minimal, due in part to an administrative floor on prices. An informal market in the trading of commercial bank assets and liabilities has also recently sprung-up, in conjunction with the widespread spontaneous restructuring of banks’ balance sheets.

C. Trends in Monetary and Exchange Rate Policies, 1995–99

The pre-crisis period

87. The groundwork for the adoption of an exchange rate-based monetary policy was laid in 1995. Early that year, the CBR significantly tightened its policy stance and monthly inflation declined to 8.5 percent by March, compared to over 16 percent in December 1994. In addition, the Central Bank Law passed in April 1995 provided independence in the formulation of monetary policy to the CBR and prohibited direct lending to the government. Finally, the CBR stopped providing directed credit to the banking system. These developments facilitated the adoption of an exchange rate band in July 1995.

88. Until mid-1998, despite occasional policy slippages, the CBR adhered to the monetary policy requirements of maintaining the ruble within some form of an exchange rate band (See Box 3). During periods when demand for ruble assets increased substantially, market interest rates were allowed to fall and CBR gross reserves increased (Figure 14). In contrast, during periods when confidence ebbed, market interest rates soared and the CBR intervened heavily in the foreign exchange market to defend the ruble. Some remonetization of the economy occurred as velocity declined. Nevertheless, the impact on base money growth of the continued large external capital inflows, particularly to finance the budget, were in large part offset by sales of foreign exchange by the CBR. The exchange rate policy was, therefore, used to bear down on the inflationary impact of the persistent fiscal deficits (for a description of monetary policy instruments and procedures, see Box 4).

Figure 14.Russian Federation: Monetary Developments, December 1994-May 1999

Sources: Russian authorities and Fund staff estimates.

89. Daily movements in the exchange rate remained very predictable as the ruble was, for the most part, maintained in the appreciated portion of the band. The CBR also announced a more narrow daily intervention band each day within which it was prepared to let the ruble trade. This daily intervention band was actively managed to enhance the predictability of the exchange rate. For example, during the first half of 1998, a smooth depreciation of the midpoint of the daily band was maintained even while the ruble was under pressure and had been trading in the depreciated end of the band. Furthermore, the size of the daily band was often narrowed in the face of intensified foreign exchange market pressures in an attempt to influence market expectations regarding the stability of the exchange rate.

90. The extension of domestic credit by the CBR was restrained and therefore did not exert significant pressures on the exchange rate. The prohibition on direct lending to the government starting in 1995 implied that any increases in net credit to government from the monetary authorities; came about through either the use of government holdings of NIR, which did not directly affect base money, or CBR purchases of treasury bills in the secondary market.29 Recourse to the latter was limited, however, as other sources of credit were tapped by the government. The flow of net credit to the federal government from the CBR declined from about 350 percent of the stock of beginning-period base money in 1994 to about 20 percent in 1997. Meanwhile, commercial banks also increasingly relied on foreign sources of credit and the build-up in private sector deposits to finance lending activities, including to the government, so that net CBR credit to commercial banks also declined steadily during 1995–97.

91. The decrease in central bank financing of the government budget occurred in tandem with the growth of the treasury bill market. This market, which had its inception in 1993, took off in 1995. The stock of outstanding bills increased from about 1.2 percent of GDP at end-1994 to over 12 percent of GDP at end-1997 (Figure 15). Nominal yields on treasury bills fell during 1995–97, despite considerable volatility, as success was achieved in reducing inflation. However, yields adjusted for inflation and the depreciation of the ruble remained high, reflecting the risk premium on lending to the Russian government (Figure 15).

Figure 15.Russian Federation: Treasury Bill Market, 1993-August 1998

Sources: Russian authorities, Bloomberg and Fund staff estimates.

1/ Using exchange rate and inflation developments from the preceding 6 months and the following six months.

2/ Non-residents were legally allowed participation only in early 1996.

Box 3.Exchange Rate Bands

In July 1995, with the aim of stabilizing market expectations about the exchange rate, the CBR introduced an exchange rate band—ranging from Rub 4,300 to 4,900 per US dollar—for the period until end-1995. Following a successful experience with this band, a new band of Rub 4,550–5,150 per U.S. dollar was set for the period January 1–July 1, 1996.

The corridor system was extended into the period July-December 1996, but with a sliding band in contrast to a flat corridor in previous periods, starting at Rub 5,000 to Rub 5,600 and ending at Rub 5,500 to Rub 6,100 per dollar at end-December, with an implied monthly depreciation of 1.5 percent. Within the wide band, the CBR announced a narrower daily band at which it would transact with market participants. In the event, the Ruble depreciated by less than the mid-point of the band, ending 1996 at Rub 5,560 per dollar.

For 1997, the CBR retained a sliding band, beginning at Rub 5,500 to 6,100 and ending at Rub 5,750 to 6,350 at end-1997, implying a depreciation of 4 percent for the center of the band. The ruble, which began the year in the appreciated end of the band, depreciated by 6.7 percent over the course of the year.

In November of 1997, the authorities announced a new exchange rate regime for the period 1998–2000. The exchange rate of the rouble would be centered at 6.2 re-denominated rubles per U.S. dollar, with a margin of +/-15 percent. At the same time, a narrower daily intervention band would remain in effect around an official mid-point rate for the day. In practice, the size of the daily intervention band varied substantially from day to day. Beginning with an average of +/- 0.5 percent around the mid-point rate in January, the band had narrowed to +/- 0.3 percent by April. The narrow daily band was progressively expanded over the course of the summer to +/- 0.7 percent before narrowing it down again to +/- 0.3 percent by August 14, 1998.

As part of the set of emergency measures announced on August 17, 1998, the wide exchange rate band was expanded, from the previous Rub 5.3–7.1 per US dollar to 6.0–9.5, and the announcement of the daily narrow band was eliminated.

On September 2, 1998 the authorities abolished the band system and let the exchange rate float.

Nominal Exchange Rate

(In rubles per U.S. dollar)

Box 4.Monetary Policy Instruments and Procedures

Until mid-1998, the primary instrument that the CBR used for regulating monetary conditions was the open market purchase and sale of treasury bills in the secondary market. In addition to open market operations and foreign exchange market interventions, the CBR used a number of instruments for liquidity management.

The Lombard facility was introduced in April 1996 through which the CBR provides refinance credit (collateralized by government securities) for periods of up to one month. Credit was initially available in weekly auctions subject to minimum interest rates, but subsequently provided on a continuous basis for banks in good standing with prudential requirements. As of mid-1998, the CBR extended Lombard credits through both a fixed-rate window and through credit auctions. Beginning in July 1998, however, Lombard credits were only extended through auctions, which are held twice a week. Lombard interest rates were lowered during 1996 and most of 1997, but were raised towards year-end. The CBR also has a facility for repurchase agreements (repos) with primary dealers (large banks that have undertaken to make markets in government securities). There is also an end-of-day overnight settlement facility for selected banks to ensure the smooth functioning of the payments system.

Following the banking crisis in 1998, the CBR created a special facility to extend rehabilitation loans to commercial banks. While not created with liquidity management in mind, significant resources have been provided to commercial banks through this facility. Loans are extended for periods upto one year at 20 percent interest per annum (compared to annualized inflation of over 100 percent at end-1998-early 1999) and in return the CBR retains 75 percent plus one share of the bank as collateral. Loans extended through this facility are subject to individual agreements with commercial banks and the full terms are not transparent. These loans are purportedly provided to banks to help in restructuring plans approved by the CBR.

Following the halt in trading of treasury bills in mid-1998, the CBR issued its own short-term paper. The amounts of these CBR bills issued remained small, and as their legal status was the subject of debate with the Securities Commission, the issuance of new bills was halted in late 1998. Amendments were recently enacted to the law, however, which will enable the CBR to resume their issuance. CBR bills are also expected to act as collateral in a new interbank repo market being set-up by the CBR and MICEX. The CBR also has a deposit facility available. Historically, there was little use of this instrument; deposits with maturities of only 1-2 days were offered; and, this facility was primarily used for very short-term liquidity management. Towards the end of 1998, however, this facility increased in importance; maturities were significantly lengthened and the deposit facility is actively used by commercial banks given the build-up in liquidity that has occurred recently.

Reserve requirements have also been used as a front-line instrument of monetary policy. Starting in August 1998, the CBR reduced reserve requirements on a number of occasions. First, following the devaluation of the ruble, the exchange rate used for the calculation of reserve requirements on foreign currency deposits was frozen. Second, reserve requirements were uniformly reduced by 1 percentage point on August 24, 1998. Third, required reserves were reduced for selected banks—depending on the share of treasury bills in their portfolios—to between 5 and 7.5 percent on September 1, 1998. Fourth, banks’ required reserves were reduced in connection with the CBR’s attempts to clear the payments system on a number of occasions during September–November 1998, with the reduction in required reserves depending on individual banks’ obligations with regard to outstanding payments on behalf of clients. By late 1998, the required reserve ratio, therefore, varied considerably between different banks. Effective, December 31, 1998 the CBR unified reserve requirements on both ruble deposits and foreign currency deposits at 5 percent and required that current exchange rates be used for calculating reserves on foreign currency deposits. In 1999, reserve requirements have been increased twice to mop up liquidity and a differentiation of rates, depending on currency and type of deposits, has been reintroduced.

92. Changes in legislation governing treasury bill purchases by nonresidents, coupled with a growing appetite for emerging market issues in international financial markets ensured that market demand for these instruments remained high (see Box 5). The fixed exchange rate policy conferred an implicit exchange rate risk guarantee on these investments, further encouraging purchases by nonresidents. Domestic commercial banks also found investment in treasury bills more lucrative than other forms of credit extension, and the increase in ruble deposits was diverted to the treasury bill market. The large need for government financing, however, ensured an ever-increasing supply of treasury bills.

93. Base money growth remained moderate over the period without excessive losses of external reserves. (For a review of CBR management of international reserves, see Box 6.) The CBR’s restrained credit policy stance, large capital inflows, and a willingness to sell significant amounts of foreign exchange in the market contributed to a slowing in the growth of base money from over 225 percent in 1994 to 26 percent in 1996–97 (Table 23), and a steady decline in inflation despite the persistence of large fiscal deficits. Owing to these developments, the CBR was able to successfully weather temporary reversals in market sentiments, for example against the backdrop of political uncertainties associated with the Presidential election in 1996, and in the process further bolster public confidence in the stability of the ruble.

Table 23.Russian Federation: Monetary Authorities’Accounts, 1995-99

(In billions of new rubles, unless otherwise indicated) 1/

19951996199719981999
DecDecDecMarJunSepDecDec revalued.Mar
Base money103.7130.9164.5152.9163.2175.2210.4210.4205.9
Currency issued83.4108.6137.0127.2137.7161.8197.9197.9186.5
Required reserves on ruble deposits20.422.327.525.725.513.412.512.519.4
Net international reserves (NIR) 2/35.79.622.314.49.5-107.4-134.0-148.6-188.8
(US$)7.71.73.72.41.5-6.7-6.5-7.2-7.8
Net domestic assets (NDA)68.0121.3142.2138.5153.8282.6344.4359.0394.7
Net credit to enlarged government99.8157.2191.1192.4183.1228.1238.3238.3233.7
Net credit to federal government104.1161.5199.2197.9187.9232.5245.7245.7245.0
CBR net credit to the federal government 3/4/73.4107.1134.0131.7122.3155.8179.9179.9197.0
o/w securities32.560.0146.9148.8138.0163.6208.7208.7215.6
Ruble counterpart 5/30.854.465.266.265.676.765.865.848.0
CBR net credit to local government 4/-2.1-2.1-3.6-3.2-2.9-2.0-2.9-2.9-5.6
CBR net credit to extrabudgetary funds 4/-2.2-2.3-4.5-2.3-1.9-2.4-4.5-4.5-5.7
Net credit to banks-6.1-17.8-20.7-13.8-2.2-5.529.929.966.5
Gross credit to banks 6/17.511.411.15.812.017.975.075.0134.7
Gross liabilities to banks and deposits23.629.231.819.614.223.445.145.168.2
OIN-25.7-18.1-28.2-40.1-27.060.076.290.894.6
o/w required reserves on foreign currency deposits-1.2-3.6-8.9-12.7-12.6-6.8-8.3-8.3-15.7
o/w other items-24.5-14.5-19.3-27.4-14.466.884.599.0110.2
Demand deposits at CBR-1.1-1.3-5.2-4.2-3.7-3.4-5.5-5.5-6.8
Time and forex deposits at CBR0.00.0-0.2-0.8-2.3-1.1-1.8-1.8-2.2
Memorandum:
Exchange rate (official, end-period)4.645.565.966.116.2016.0620.6520.6524.18
Gross reserves (US$) 7/17.315.417.817.016.212.612.112.210.9
o/w gold2.94.14.94.95.03.94.44.44.1
CBR15.014.817.216.015.012.412.012.110.6
MinFin2.30.50.61.01.20.10.20.20.3
Reserve Liabilities (US$)9.613.614.014.614.719.218.619.418.7
CBR0.01.10.00.00.03.83.84.04.1
MinFin9.612.514.014.614.715.414.815.414.7

Data (except for external reserves and the ruble counterpart) are compiled according to IFS definitions, which differ from program definitions. Due to the adoption of a new chart of accounts in 1998, data not strictly comparable to earlier periods.

At end-of-period Ruble/US$ exchange rates. US$ amounts based on end-1997 cross rates for 1998 and end-1998 cross rates for Dec 1998 revalued onwards.

Includes valuation losses in government securities portfolio which, in 1998 amounted to about Rub 35 billion, Excludes US$ 2.3 billion in U.S. dollar directed credit to the federal government in 1998 and US$ 2 billion during Q1, 1999 through Vneshekonombank for external debt service of the federal government.

Definitions of “federal government”, “local government” and “extrabudgetary funds” do not fully coincide with program definitions.

Represents the government’s use of NIR resources and calculated in flow Ruble terms using the exchange rate in effect at the time of the transaction.

Includes US$ 2.3 billion in U.S. dollar directed credit to the federal government in 1998 and US$ 2 billion during Q1, 1999 through Vneshekonombank for external debt service.

Include amounts held with domestic banks and by CBR-owned banks abroad. Change in gross reserves during the first quarter of 1999 differs from the BOP presentation as the latter excludes.

Data (except for external reserves and the ruble counterpart) are compiled according to IFS definitions, which differ from program definitions. Due to the adoption of a new chart of accounts in 1998, data not strictly comparable to earlier periods.

At end-of-period Ruble/US$ exchange rates. US$ amounts based on end-1997 cross rates for 1998 and end-1998 cross rates for Dec 1998 revalued onwards.

Includes valuation losses in government securities portfolio which, in 1998 amounted to about Rub 35 billion, Excludes US$ 2.3 billion in U.S. dollar directed credit to the federal government in 1998 and US$ 2 billion during Q1, 1999 through Vneshekonombank for external debt service of the federal government.

Definitions of “federal government”, “local government” and “extrabudgetary funds” do not fully coincide with program definitions.

Represents the government’s use of NIR resources and calculated in flow Ruble terms using the exchange rate in effect at the time of the transaction.

Includes US$ 2.3 billion in U.S. dollar directed credit to the federal government in 1998 and US$ 2 billion during Q1, 1999 through Vneshekonombank for external debt service.

Include amounts held with domestic banks and by CBR-owned banks abroad. Change in gross reserves during the first quarter of 1999 differs from the BOP presentation as the latter excludes.

94. Following the presidential election and through late 1997, a surge in capital inflows and a favorable external environment masked the continued inconsistencies between fiscal policy and monetary and exchange rate policies. Eurobond placements by the federal government began with the issuance of $1 billion in late 1996 and amounted to an additional $3.5 billion during the course of 1997. Increasingly, regional and local governments as well as Russian commercial banks made successful placements of Eurobonds (see Chapter V for further details). As a result, the need for monetary financing of the government budget was further reduced, gross reserves increased by about $9 billion between mid-1996 and mid-1997, and average monthly inflation came down to about 1 percent.

95. Russia had, however, become increasingly vulnerable to a sudden and sustained turnaround in investor confidence. A major vulnerability arose from the government’s accumulation of short-term ruble-denominated debt. Increased participation by nonresidents in the treasury bill market explained, in large measure, the ever-increasing outstanding stock of treasury bills. Nevertheless, by early 1997, demands on the government to issue new treasury bills simply to keep pace with maturing issues and meet interest payments had become severe due to the short-term nature of the bonds and the high interest costs. As a result, while issuance of new bills continued unabated, net financing (after debt-service costs) declined continuously, from more than 85 percent of new issuance in 1993 to less than 10 percent in 1997 (Figure 15).

Box 5.Nonresidents and the Treasury Bill Market

Nonresident access to the GKO market was not officially permitted until early 1996, when a scheme was introduced to allow nonresidents to purchase securities in primary auctions and hold them to maturity. The investor received a predetermined dollar yield of 25 percent through an effective CBR foreign exchange forward contract, which was subsequently reduced to 19 percent in April 1996.

A modified scheme introduced in August 1996 allowed nonresidents to participate in the primary and secondary markets in the same way as residents and to keep all the ruble proceeds, except that repatriation of the balances held in “S” accounts at commercial banks could not occur until the investor had purchased and held until maturity a three- to six-month forward foreign exchange contract on the balance in these accounts. These forward contracts were provided by commercial banks which were required to enter into contracts with the CBR for 90 percent of the amount to be repatriated; the contracts continued to yield a 19 percent return on the CBR component, with the banks covering the remainder of the contract. The effective dollar yield for nonresident investors was cut in stages to 9 percent by September1997, by which time the proportion of the forward contract provided by the CBR had been reduced to 25 percent.

The CBR announced in February 1997 that all restrictions on capital outflows would be removed by end-1997. Starting in 1998, the CBR withdrew completely from the forward contracts market. Nonresidents, however, continued to hedge their exposures through forward contracts with large Russian commercial banks. These banks, in turn, hedged with other domestic banks. It was widely perceived, however, that the quality of the hedges by Russian banks was questionable and that some of these were engaged in purely to meet prudential requirements, which in turn were lax.

Box 6.The CBR Management of International Reserves

There has been public controversy surrounding the international reserves management practices employed by the CBR during 1993 to 1996—in particular, as it involved the use of an off-shore company, the Financial Management Company (FIMACO) Limited. With the development of its own capacity to manage reserves, however, CBR reserve management has been following best international practice in recent years.

Foreign currency reserves. The operations in managing and placing foreign currency reserves are regulated by the CBR board-approved guidelines of reserves management which became effective in mid-1996. The guidelines set out definitions for eligible assets, the methods of evaluating various risks, the calculation of yields, the currency and maturity structure, asset quality, and counterpart quality. They also prescribe the delegation of authority within the CBR with regard to decision making on reserves and provide that the performance of investments be evaluated against benchmark portfolios. The CBR maintains some foreign currency reserves at CBR-owned banks abroad which are not actively managed and not covered by the general guidelines.

The CBR distinguishes between two different types of portfolios, the operational portfolio and the investment portfolio. The operational portfolio is intended to provide ready-funds for day-to-day interventions in the domestic foreign currency market. The portfolio has no fixed currency structure, but assets are mostly invested in highly liquid U.S. dollar instruments, as most turnover in Russia’s currency markets is in U.S. dollars. The investment portfolio has a fixed currency structure. Until mid-1998, assets were to be invested in U.S. dollar and DEM assets only. However, following the purchase of SDRs from the IMF in July 1998, the revised benchmark portfolio now resembles the SDR basket of currencies for the size of the tranche. For assets in excess of the Fund tranche, the original benchmark portfolio continues to be applicable.

Any assets in which the CBR invests must be highly rated by the major rating agencies. Counterparties need to be of high-quality and explicit limits are assigned. For unsecured transactions, for example foreign currency transactions and deposits, there is a specific list of permissible counterparties, with specific counterparty limits and country limits. These limits apply combined for foreign currency and gold transactions and placements. For secured, i.e., collateralized transactions, for example repos, more generous limits apply. And for delivery-versus-payments transactions with primary dealers in the United States and Germany, no quantitative limits are set. As a general rule, the CBR does not take any speculative positions nor can positions be leveraged.

Gold reserves. The practices employed are conservative and only three different instruments are currently being used for placing gold reserves: gold placement in CBR vaults, deposits in allocated gold accounts, and deposits in unallocated gold accounts. The CBR only places gold on deposit and does not perform any swaps or other transactions with gold.

The onset of the crisis

96. The underlying tensions in economic fundamentals abruptly came to the fore in late 1997 in the aftermath of the financial crisis in Asia and in the context of a precipitous decline in export prices. The CBR successfully weathered the first bout of instability in late 1997, but at a cost that indicated the extent to which the exchange regime had become vulnerable to a turn-around in investor confidence. Sales of foreign exchange in November alone amounted to $6 billion (over one quarter of gross reserves), while the rise in interest rates necessary to defend the exchange rate weakened commercial banks, in whose portfolios the share of federal government securities had increased to almost three quarters of ruble deposit liabilities at end-1997.

97. Large scale capital outflows resumed in May 1998 as investors became increasingly unwilling to roll over maturing short-term treasury bills while the CBR continued to defend the exchange rate. Market turbulence intensified in the face of political uncertainties associated with the dismissal of the government of Prime Minister Chernomyrdhin and the prolonged stalemate over the formation of a new cabinet. The growing perception that the fiscal position was unsustainable encouraged larger outflows, necessitating further foreign exchange market intervention by the CBR and increases in interest rates; the latter crippled commercial banks which relied on their portfolios of treasury bills to manage liquidity. Finally, large-scale support by the CBR to both banks and the government intensified pressure on the ruble, completing the vicious cycle.30 Yields on short-term treasury bills at one point exceeded 300 percent and CBR intervention from April to mid-August amounted to $10.5 billion, or 40 percent of end-July base money.

98. Faced with an unsustainable financial regime, the government on August 17 announced a set of emergency measures. These included, in particular, a change in the wide exchange rate band and the elimination of the daily narrow band, and the unilateral conversion of all ruble treasury bills maturing before end-1999 into longer-term paper (see Chapter I). In the wake of the announcement, financial turmoil intensified and the ruble depreciated sharply despite large-scale intervention by the CBR. Foreign exchange trading was brought to a virtual halt on August 26 when the CBR terminated the fixing of the exchange rate in the MICEX auctions. On September 2, the authorities abolished the exchange rate band and let the ruble float.

Developments since the crisis

99. Following the events of August 17, financial market activity ceased completely and the payment system came to a virtual halt due to a breakdown in trust between banks, while a run on deposits ensued. In the first instance, the authorities responded to the banking crisis by injecting liquidity into the system, including through a freeing-up of commercial banks’ required reserves. While these liquidity injections and a shift in household deposits to Sberbank brought about some return to banking and payments system activity, commercial banks’ free reserves at the CBR increased rapidly as a flight to quality ensued.

100. Monetary policy was largely reactive to the crisis through end-1998. The CBR’s credit policy became circumscribed by the financing needs of the government and the decision to provide credit to ailing individual commercial banks on a case-by-case basis. Together, CBR net credit to the government and gross credit to banks amounted to Rub 81 billion, or 46 percent of base money during the fourth quarter of 1998. However, the effects of this expansionary credit policy on inflation and the exchange rate were, to some extent, neutralized by the deflationary impact of the banking crisis and the introduction of foreign exchange market restrictions such as a prohibition on the increase of commercial banks’ net long foreign currency positions. Nevertheless, monthly inflation at year-end had picked up to 11½ percent compared to 4½ percent in October.

101. Monetary policy was significantly tightened during the first few months of 1999, monthly inflation declined to about 2 percent and the rate of depreciation of the ruble decelerated. Ruble credit to the government and banks was reduced while the external debt service payments of the government were financed largely through draw-downs of reserves. The CBR also increased reserve requirements for commercial banks, partly offsetting the relaxation in the immediate aftermath of the crisis. Nevertheless, the stability achieved remains precarious as even small injections of liquidity have required immediate sterilizations to eliminate the emergence of renewed pressures in the foreign exchange market.

D. Commercial Banking and Broad Money Developments, 1995–99

Broad money and credit developments

102. The success until mid-1998 in reducing inflation had a significant positive impact on monetization and the demand for money. Ruble broad money velocity steadily declined for the most part during 1996–97 and ruble broad money increased by almost 23 percent, in real terms, between end-1994 and June 1998. In addition, real ruble deposits increased by 27 percent compared with a rise of 16 percent in currency in circulation, suggesting an enhanced financial intermediation function of commercial banks. This function, however, became increasingly directed towards channeling private sector deposits to finance the budget deficit (Figures 16 and 17). The stability of the ruble also decreased the dollarization of banking services; the ratio of foreign currency deposits to ruble deposits declined by 56 percent, from a high of 0.74 in March 1995 to 0.33 in June 1998 (Figure 16), while the share of banking sector credit denominated in foreign currency declined by 14 percent.31 The smaller change in currency composition of credits reflects the fact that the favorable external environment enabled commercial banks to obtain foreign loans, which were on-lent to domestic clients. Reflecting this, the net foreign asset position of commercial banks deteriorated markedly during 1997 as on-balance sheet foreign liabilities almost doubled to $18.4 billion by year-end.

Figure 16.Russian Federation: Monetary and Credit Developments, December 1994-March 1999

Sources: Russian authorities and Fund staff estimates.

1/ Seasonal adjustment normalized to equal actual velocity during the second quarter.

Figure 17.Russian Federation: Commercial Banks: Credit and Interest Rates, January 1995- March 1999

Sources: Russian authorities and Fund staff estimates.

1/ Including amounts on-lent from the CBR.

103. Despite gains in remonetizing the economy and the access to foreign capital by Russian banks, commercial banks did not play a major role in meeting the credit needs of the real economy. The real stock of credit to the nongovernment sector declined sharply in 1995 and by and large remained at that level until mid-1997 when a rise in foreign-currency denominated credit occurred in conjunction with increases in commercial banks’ foreign liabilities. Nevertheless, the real stock of credit to the economy at end-1997 stood substantially below the level at end-1994. Commercial bank credit to the private sector declined further in 1998, reflecting the lackluster growth in monetary aggregates during the first half of the year and the wholesale collapse of the banking system after August; credit denominated in rubles declined by 11.5 percent during the second half of the year. In the aftermath of the banking crisis, loans in foreign currency were also either called in or not rolled-over and consequently declined by one-third during August-December to $10 billion by year-end and a further $9.3 billion by March 1999.32

104. Commercial bank deposit and lending rates on credit to the private sector fell steadily from January 1995 to end-1997, although effective real rates initially remained very high as inflationary expectations adjusted slowly (Figure 17). Nominal deposit rates were substantially below lending rates in early 1995 and the spread, while narrowing markedly, still averaged about 14 percent during 1997. The persistence of a large spread can be attributed, in part, to the low penetration of banks in the economy, particularly at the regional level, leading to a lack of competition in attracting household deposits, while the high lending rates reflected the attractive yields offered by investment in government debt and the real risks of lending in an environment with unclear property rights, poor accounting, and lax regulations. Deposit and lending rates, as well as the spread, started to move upwards again toward the end of 1997, preceded by a rise in the interbank rate, as commercial banks began to feel the credit squeeze associated with the CBR’s efforts to defend the ruble.

105. From the first quarter of 1994 through 1997, credit to government from commercial banks increasingly crowded out credit to the economy. While at end-1993 commercial banks had a net liability position vis-à-vis government, the stock of government securities started increasing steadily in commercial banks’ portfolios thereafter. By August 1998, the nominal value of government securities in banks’ portfolios had increased by about 250 times while the real value had experienced a staggering twenty three-fold increase over end-1993.

106. The growing concentration of commercial banks’ activities increased the risks to the stability of the banking system from any volatility in the price of government debt or the exchange rate. By mid-1998 the balance sheet positions of a number of large banks were already critical due to the persistently high interest rates needed to defend the ruble and the poor quality of their foreign-currency-denominated credit to the private sector. Money demand remained stagnant during the first half of 1998, reflecting decreased confidence in the ruble as well as perceived weaknesses of the banking system. Ruble deposits had, by mid-1998 declined in nominal terms compared to end-1997, as broad money velocity was already on an increasing path; velocity declined in June 1998 by less than 6 percent compared to a year earlier whereas the comparable figure for end-1997 had been 12 percent.

107. The liquidity crisis during the first half of 1998 associated with skyrocketing interest rates and falling prices of government debt quickly turned into a system-wide insolvency problem with the devaluation and unilateral restructuring of treasury bills. The payments system collapsed, activity in the interbank market came to a virtual halt, and banks froze their clients’ deposits in the wake of a bank run; by end-August ruble deposits in the banking system had fallen by over 12 percent from levels two months earlier while foreign currency deposits declined by over 18 percent in dollar terms during the third quarter.

108. In response to the crisis the authorities transferred household deposits from a number of large private banks to Sberbank—where deposits were guaranteed by the government. In addition, the CBR freed up commercial banks’ required reserves in the context of a mutual clearing of interbank settlements; extended liquidity and longer-term stabilization credit to banks, often in an ad-hoc manner; and purchased frozen treasury bills from banks. The use of required reserves to clear the payments system had a stabilizing effect as payments transactions, which had declined by about 40 percent following the devaluation, subsequently recovered—albeit to a point below the pre-crisis level, reflecting the decline in economic activity.

109. The large liquidity injections resulted in a sharp rise in currency and in banks’ free reserves during the fourth quarter of 1998, while ruble broad money velocity increased further. The rise in base money accommodated, to some extent, the need for currency for transactions following the sharp decline in the real value of ruble balances after the devaluation and the increase in the price of imports, and offset some of the impact of the freezing of household deposits. Deposits transferred to Sberbank were, for the most part, not made available for withdrawal until year-end and numerous banks either did not allow withdrawals or placed restrictions on amounts or required advance notices. The frozen deposits in the banking system also help to explain the relatively small increase in measured velocity, which at year-end had increased by only about 8½ percent compared to a year earlier despite the scale of the financial crisis.33 The contraction in effective money supply resulting from the nonavailability of deposits for withdrawals, coupled with restrictions in the foreign exchange market, also contributed to a slowing of inflation during October–November, 1998.

110. The collapse of the interbank market, the halt in trading of government securities and restrictions on increasing foreign currency positions, led to a large build-up in commercial banks’ free reserves at the CBR during the final months of 1998.34 While this liquidity reflected, to some extent, a change in liquidity management practices by banks who could no longer rely on liquid government paper, on other banks, or on foreign sources for raising funds, it also reflected a genuine breakdown of all credit market activity and the flight to security by commercial banks. Banks were even less willing than earlier to extend new loans to the private sector and the market for government debt was nonexistent.35 The breakdown of financial markets resulted in a segmentation of the banking sector, with some banks highly liquid following the CBR’s extension of support in the aftermath of the crisis and others starved for liquidity. In the aggregate, however, commercial banks’ correspondent accounts at the CBR had, by year-end, quadrupled compared to end-August.

111. In early 1999, a lack of progress in bank restructuring ensured a continuation of the trends evident at end-1998. Velocity continued to increase and real credit declined while banks’ free reserves at the CBR increased further. The net foreign asset position of the commercial banking sector improved, however, as some banks successfully made payments on their external debt obligations while new foreign credit to the banking sector had virtually dried up.

Developments in the commercial banking sector

112. Despite an explosive growth in the number of commercial banks, from fewer than 100 in 1988 to about 1,500 a decade later, the Russian banking sector is highly concentrated. At end-1997, the top five banks accounted for 36 percent of total assets and the top 50 for 71 percent.36 Private sector deposits were similarly concentrated; at end-1997 about three-quarters of all household deposits were maintained with Sberbank and the figure has since increased substantially. Including enterprise deposits, at end-1997 five banks accounted for 58 percent of ruble deposits and 50 banks for 65 percent.37 The number of banks has been reduced from a high of about 2,400 in 1994, including through license withdrawals of nonviable banks. Most banks remain small in terms of the size of operations, with only a quarter of them authorized to have capital above Rub 20 million ($1 million) at end-1998.

113. Despite the large number of banks, Russia’s banking sector accounts for a small portion of economic activity by international standards. In mid-1998, total commercial bank assets amounted to about 30 percent of GDP while nongovernment deposits accounted for some 12 percent of GDP. This compares, for example, to a deposit base of 33 percent of GDP in Poland and 64 percent of GDP in the Czech Republic at end-1997.

114. The banking system is dominated by Sberbank, which accounted for almost a quarter of all assets at end-1997. The remainder of the banking system can be grouped into four broad categories: (i) large banks with extensive branch networks and significant retail-banking based businesses; (ii) large banks with limited retail banking activities; (iii) subsidiaries of foreign banks licensed to operate in Russia; and (iv) small and primarily regional banks. Banks of types (i)–(iii) are primarily based in Moscow; at end-1997 all but four of the top 50 banks (in terms of assets) were based in Moscow and three in St. Petersburg. Very few banks, outside of Sberbank, can be characterized as having a significant retail banking business; at end-1998, despite the sheer geographical size of Russia, there were only about 4,500 bank branches in the country, with Sberbank alone accounting for close to half and SBS-Agro Bank for another third.38 Most of the large Moscow banks’ client base derives from enterprises within the financial-industrial group (FIG) that also includes the bank. Apart from servicing the banking needs of these clients, these banks’ activities primarily focused on trading in government securities and conducting trade-related and other financial transactions.

115. The pattern of holdings and cross-holdings between industrial enterprises and commercial banks within a financial industrial group make the ownership structure of the Russian banking sector extremely opaque. The lack of consolidated information about FIGs poses difficulties in assessing risk from the point of view of creditors and regulators and renders any analysis of exposure from connected lending difficult to assess. The CBR has recently required consolidated reporting of accounts, including of banking subsidiaries, for bank supervision purposes; however, legal impediments still stand in the way of requiring consolidation of all subsidiaries. Russian accounting standards differ from international standards and calculations of prudential norms, such as capital adequacy, vary considerably, further complicating the task of assessing banking sector soundness.

116. Nevertheless, by 1997 it was already evident that the Russian banking system was significantly exposed to exchange rate and interest rate risks. Due to the concentration of government securities in the assets of the large Moscow based banks, any decline in the values of these portfolios threatened the solvency of the banks. Furthermore, banks relied on government securities with short maturities to manage their day-to-day liquidity needs. The tight liquidity conditions necessary to defend the ruble in late 1997 and early 1998 and the persistence of high interest rates forced many banks to realize losses by unloading government paper to meet liquidity needs.

117. Russian banks were also significantly exposed to external and foreign-currency risks. Data from early 1998 indicated that the maturity structure of foreign assets and liabilities was mismatched, with liabilities to nonresidents denominated in foreign exchange of under one year of $11.8 billion offset by similar assets of only $5.9 billion.39 This reflected, in part, the use of short-term foreign loans from nonresidents to extend credit denominated in foreign currency to resident enterprises. In terms of currency exposure, although balance sheet assets of the commercial banking sector denominated in foreign currency exceeded liabilities, the quality of the assets was extremely poor due in large part to loans of dubious quality extended in foreign currency to domestic enterprises. Furthermore, the gross foreign currency exposure of the banking system as a whole was substantial, with assets and liabilities denominated in foreign currency exceeding $40 billion. The short-run position of the commercial banking system appeared particularly vulnerable to any deterioration of asset quality, as about 26 percent of foreign-currency liabilities had maturities of under one month.

118. Commercial banks in Russia also had an extensive off-balance sheet exposure to foreign currency risks. Following changes in the rules governing nonresidents’ access to the treasury bill market and in conjunction with the inflow of foreign capital into the Russian stock market, commercial banks engaged in heavy trading of foreign currency derivatives. Given the stability of the ruble and weak prudential supervision, banks did not, however, ensure that their own exposures were adequately hedged. While the volume of forward foreign currency operations declined somewhat in early 1998, commercial banks’ off-balance sheet forward foreign currency claims on residents and nonresidents still stood at a staggering $93 billion at end-May 1998, with such obligations amounting to $83 billion.40 Furthermore, reflecting the volume of contracts with nonresident investors participating in the market for short-term government debt paper, the short-term gross position of the banking sector was very vulnerable, as forward operations of under 90 days accounted for 38 percent of the total and the quality of Russian banks’ own claims on smaller banks and enterprises for delivery of foreign exchange was highly questionable.

119. Given the exposure of the Russian banking system, three sources of risk arising from a devaluation of the currency existed. First, a substantial portion of lending was denominated in foreign currency and made to clients without foreign currency earnings, while on-balance sheet liabilities had short maturities requiring rollovers of existing credit lines or the continuation of access to foreign capital markets. Second, there was a danger of an unfolding chain of defaults in off-balance sheet contracts, as nonresidents typically purchased forward foreign currency contracts and options from larger banks, which in turn did their hedging with smaller, weaker banks. This risk was exacerbated by the difficulty of enforcing off-balance sheet contracts under Russian law. Third, prudential requirements for coverage of foreign currency positions were inadequate, and the quality of banks’ hedges of foreign currency risk was highly questionable.

120. The August crisis dealt two death-blows to a large number of commercial banks—particularly the large Moscow-based banks. First, banks’ substantial foreign currency loans, which were already of extremely poor quality, became uncollectible as often such loans represented claims on parties without foreign currency earnings. While some commercial banks reached bilateral agreements with their counterparts for settling forward claims at rates substantially below the new value of the ruble, many of the forward claims in the banking system still have not been settled. Exacerbating the problem, external credit lines were curtailed or withdrawn and some banks subsequently defaulted on their external debt while others initiated negotiations with their creditors for restructuring their debts.41 Second, given the short-term nature of treasury bills, most of the commercial banks’ portfolios of government paper became subject to the restructuring—effectively at a fraction of the face value of the instruments. The bulk of the Russian banking system in terms of asset size became insolvent, reflecting the relative size and nature of banking activities of the Moscow-based banks. Regional banks, however, fared significantly better given their lower exposure to external and currency risks and the lower share of their assets invested in government paper.

121. The Russian banking system lay in a state of semi-paralysis. In the aftermath of the crisis, the authorities delayed moving decisively to close the large insolvent banks and extended ad hoc support to a number of banks in the form of “rehabilitation credits” While this support enabled banks to continue functioning in some fashion, the fundamental problems remained to be addressed. There were wide-spread reports of asset-stripping, of banks shifting assets to shell entities, and the initiation of unilateral restructuring of their own balance sheets. Legal impediments had, to some extent, prevented the authorities from intervening; however, in the case of banks receiving rehabilitation credits—where the CBR held 75 percent of shares as collateral—the lack of legal intervention powers can not fully explain the lack of early decisive actions.

122. More recently, the authorities have begun to accelerate the process of bank restructuring. The strategy is aimed at rehabilitating a core group of banks while liquidating a large number of nonviable banks. The first priority was to lay the legal and technical groundwork necessary for a program of bank restructuring. The Bank Bankruptcy Law, which, inter alia, strengthens the CBR’s intervention powers, was ratified by parliament in early 1999. The authorities also conducted a due diligence analysis of the soundness of a number of individual large Moscow-based banks and identified the size of the capital hole in the system and set-up a bank restructuring agency (ARCO). The adoption of a stand-alone Bank Restructuring Law in June 1999 gives sole responsibility for restructuring banks to ARCO, allows for the transfer of banks to ARCO only by CBR directive issued on the basis of specific criteria, provides for an equitable and transparent mechanism for shareholder writedowns, and empowers ARCO to undo transactions made with intent to defraud depositors and creditors of insolvent banks. The CBR has decided to adopt a policy of limiting liquidity support to solvent banks or those implementing ARCO-approved restructuring plans, and only though regular facilities with full collateralization. The CBR revoked the licenses of four large Moscow banks in late June, bringing the total number of such banks who have had their licenses revoked to six. Nevertheless, much remains to be done and the large scale restructuring of the banking sector, aimed at setting up a sound and competitive system that can engage in effective financial intermediation and in allocating credit efficiently while providing banking services to households, remains a key priority.

V. External Sector Developments

123. The balance of payments has been heavily influenced by the pattern of Russia’s access to international capital markets, which peaked in 1997 before a progressive decline and eventually abrupt shutoff in 1998. (See text table, below and Table 26). In 1997, heavy net government borrowing from private and official external sources more than offset continued net private outflows and Russia’s first annual current account deficit since the breakup of the Soviet Union, permitting a buildup of $1½ billion in net international reserves (NIR) without compromising exchange rate stability. In 1998, by contrast, the curtailment of government borrowing from private external sources, accompanied by an acceleration of capital flight, resulted in a swing in the capital account of some $16 billion. This was reflected in the forced abandonment of the exchange rate band, a sharp import compression that brought the current account back into surplus, a rundown in NIR of about $10 billion, and an accumulation of external official and private sector arrears. The post-August 1998 pattern of capital outflows driving an overall balance of payments deficit and forcing reserve losses and an accumulation of official external arrears continued until the first quarter of 1999, when the tightening of monetary policy, possibly reinforced by the imposition of a number of capital controls, was reflected in a reduction in net private capital outflows and a stabilization in reserves.42

Table 24.Russian Federation: Monetary Survey, 1995-99 1/(In billions of new rubles, unless otherwise indicated)
19951996199719981999
DecDecDecMarJunSepDecDec revalued.Mar
Net foreign assets 2/51.923.6-19.1-21.2-23.3-151.8-112.4-126.9-130.2
NIR of monetary authorities35.79.622.314.49.5-107.4-134.0-148.6-188.8
NFA of commercial banks16.214.0-41.4-35.6-32.7-44.421.721.758.6
NDA223.8333.7478.3457.5469.4681.2752.8767.4818.0
Domestic credit349.5523.3655.5660.4660.6800.3859.2859.2959.1
Net credit to general government152.7296.3365.3385.0375.7417.6478.8478.8532.8
Net credit to federal government 3/163.2301.8369.7375.1363.7405.7474.5474.5532.6
Net credit from the monetary authorities 4/104.1161.5199.2197.9187.9232.5245.7245.7245.0
Net credit from com. Banks 4/59.1140.3170.5177.2175.7173.2228.9228.9287.6
Ruble credit124.1147.8156.6150.883.876.776.764.5
Forex credit16.222.720.624.989.4152.2152.2223.1
Net credit to local government and EBFs 4/-10.5-5.5-4.49.912.012.04.34.30.2
Net credit from monetary authorities-4.3-4.3-8.1-5.5-4.9-4.4-7.4-7.4-11.3
Net credit from com. banks-6.2-1.13.715.416.916.411.711.711.6
Credit to the economy196.8227.0290.2275.3284.9382.6380.3380.3426.3
Loans in foreign currency 2/71.377.997.478.790.3204.8207.9207.9224.1
(in U.S. dollar)15.414.016.312.914.612.710.110.19.3
Other loans125.5149.1192.8196.7194.6177.8172.4172.4202.2
Other items (net)-125.6-189.6-177.2-202.8-191.2-119.1-106.3-91.7-141.1
Broad money275.8357.3459.2436.3446.1529.4640.5640.5687.8
Ruble broad money220.5287.9374.2360.4368.6365.8452.5452.5473.7
Currency in circulation80.8103.8130.5119.1129.8154.2187.8187.8174.2
Ruble deposits 5/139.7184.0243.7241.3238.8211.6264.7264.7299.5
Forex deposits 2/55.369.485.075.977.5163.6188.0188.0214.0
(in U.S. dollar)11.912.514.312.412.510.29.19.18.9

Data largely presented according to IFS definitions and methodologies, which differ from program definitions. Due to the adoption of a new chart of accounts in 1998, data not strictly comparable to earlier periods.

At end-period Ruble/US$ exchange rates. NIR of the monetary authorities in US dollars calculated using end-1997 cross rates for 1998 and end-1998 cross rates from Dec 1998 revalued onwards.

Inclusive of valuation gains and losses on holdings of government securities. Directed credit in foreign exchange from the CBR to the government through Vneshekonombank included as credit from commercial banks and not from the monetary authorities.

Definitions of “federal government”, “local governments” and “extrabudgetary funds” do not fully coincide program definitions.

Data largely presented according to IFS definitions and methodologies, which differ from program definitions. Due to the adoption of a new chart of accounts in 1998, data not strictly comparable to earlier periods.

At end-period Ruble/US$ exchange rates. NIR of the monetary authorities in US dollars calculated using end-1997 cross rates for 1998 and end-1998 cross rates from Dec 1998 revalued onwards.

Inclusive of valuation gains and losses on holdings of government securities. Directed credit in foreign exchange from the CBR to the government through Vneshekonombank included as credit from commercial banks and not from the monetary authorities.

Definitions of “federal government”, “local governments” and “extrabudgetary funds” do not fully coincide program definitions.

Table 25.Russian Federation: Key Monetary Indicators, 1995-99
19951996199719981999
DecDecDecMarJunSepDecDec

rev.
Mar
Velocity
Ruble broad money velocity (seasonally adj.) 1/7.97.76.86.36.67.37.47.47.7
Ruble money multiplier2.132.202.272.362.262.092.152.152.30
Currency-to-deposit0.580.560.540.490.540.730.710.710.58
Reserves -to-deposits0.150.120.110.110.110.060.050.050.06
Currency held by banks to deposits0.020.030.030.030.030.040.040.040.04
Currency ratios
Forex deposits/ruble deposits0.400.380.360.320.330.790.730.730.73
Forex credit/ruble credit0.570.520.510.400.461.151.211.211.11
Real measures of monetary aggregates
Real currency in circulation 2/1.031.091.241.101.180.980.960.960.77
Real ruble deposits 2/1.061.141.361.311.280.790.800.800.78
Real ruble broad money 2/1.051.121.321.231.250.860.860.860.78
Real forex deposits 2/0.630.650.720.620.630.920.860.860.84
Real credit (incl. Forex) to the economy 2/0.750.710.820.760.780.730.580.580.56
Real ruble credit to the economy 2/0.560.550.640.630.620.390.310.310.31
Contributions to monetary growth
1. Monetary authorities 3/
Base money growth123.926.225.7-7.16.87.320.1-2.2
NDA64.351.416.0-2.310.078.935.317.0
Credit to government84.855.325.90.8-6.127.65.8-2.2
NIR59.6-25.29.7-4.8-3.2-71.6-15.2-19.1
2. Banking system 4/
Broad money112.629.628.5-5.02.318.721.07.4
NDA105.739.840.5-4.52.747.513.57.9
Credit to government68.252.119.34.3-2.29.411.68.4
NFA6.9-10.3-12.0-0.5-0.5-28.87.5-0.5
Growth in credit 5/
Total credit to the economy4.81.42.5-2.71.614.0-0.3-0.35.3
Ruble-denominated credit to the economy2.61.11.70.7-0.3-2.4-0.7-0.73.5
Credit to government from commercial banks3.24.01.43.40.0-0.46.16.16.8
Prices
Inflation from end of previous year131.321.811.08.56.452.284.484.416.1

Based on annualized end-period monthly GDP. Seasonal adjustment normalized to June level.

End-1993 = 1.00. Deflated by the CPI, stocks of foreign currency-denominated items converted into rubles at prevailing exchange rates.

Change as a percent of the previous period stock of base money. Changes in NIR include valuation effects arising from exchange rate movements

Change as a percent of the previous period stock of broad money (including foreign exchange deposits). Changes in NFA include valuation changes arising from exchange rate movements.

Change as a percent of period GDP (annual 1994-97 and quarterly thereafter). Includes valuation effects in banks’ portfolios of government debt.

Based on annualized end-period monthly GDP. Seasonal adjustment normalized to June level.

End-1993 = 1.00. Deflated by the CPI, stocks of foreign currency-denominated items converted into rubles at prevailing exchange rates.

Change as a percent of the previous period stock of base money. Changes in NIR include valuation effects arising from exchange rate movements

Change as a percent of the previous period stock of broad money (including foreign exchange deposits). Changes in NFA include valuation changes arising from exchange rate movements.

Change as a percent of period GDP (annual 1994-97 and quarterly thereafter). Includes valuation effects in banks’ portfolios of government debt.

Table 26.Russian Federation: Balance of Payments, 1994-98(In billions of U.S. dollars, unless otherwise indicated)
19941995199619971998
Current account8.44.83.9-3.02.3
Trade balance19.318.717.811.617.9
Exports67.882.790.689.074.8
of which: Oil14.618.323.422.014.2
Natural gas10.612.114.716.413.3
Imports48.564.072.877.456.8
Services and income, net-10.6-13.9-14.0-14.3-15.3
Services, net-6.5-8.1-6.4-4.7-3.2
Net income-4.1-5.8-7.6-9.6-12.2
Interest, net-4.3-5.6-7.1-8.7-11.3
Receipts0.50.91.11.20.9
Payments-4.8-6.5-8.2-10.0-12.2
of which: Official-4.8-6.5-6.4-9.5-11.0
Dividends, net0.0-0.10.0-0.2-0.4
Other income, net0.2-0.1-0.5-0.7-0.5
Current Transfers, net-0.30.10.1-0.3-0.4
Capital account-27.1-4.2-10.96.3-9.7
Capital flows relating to the federal government-11.2-9.71.715.17.7
Disbursements2.72.55.58.89.5
Amortization, net-14.0-12.6-10.9-4.6-4.1
Payments-14.0-12.7-11.2-5.3-4.8
Receipts0.00.00.30.70.7
Purchases of government securities, net (includes GKOs/OFZs)0.00.05.910.92.8
Other 1/0.00.51.20.0-0.4
Medium- and long-term capital to other sectors0.41.63.85.82.2
Foreign direct investment, net0.51.71.73.61.2
Reinvested earnings0.00.00.00.0-0.1
Other-0.1-0.12.12.21.2
Other, including short term 2/-16.43.9-16.4-14.5-19.6
Errors and omissions, net-0.3-7.9-8.6-7.8-7.9
Overall balance-19.1-7.3-15.6-4.5-15.3
Financing19.17.315.64.515.3
Net international reserves3.9-5.44.6-1.410.2
Gross reserves (- increase)2.4-10.81.7-2.55.6
Net Fund liabilities1.55.42.91.55.3
Other liabilities0.00.00.0-0.4-0.7
Arrears/debt under negotiation 3/2.80.72.62.82.3
Deferral/rescheduling 4/12.412.18.43.12.8
Memorandum items:
Trade balance (percent of GDP)7.15.54.32.75.7
Current account (percent of GDP)3.11.40.9-0.70.7
Gross reserves6.517.215.317.812.2
(months of imports of goods and nonfactor services)1.22.42.02.22.0
External debt service payments 5/19.019.420.115.517.5
(percent of exports of goods and nonfactor services)24.720.419.615.020.0
Sources: Data provided by the Russian authorities, and staff estimates.

Receipts and payments on debts denominated in non-convertible currencies net of reschedulings deferrals, including debts to COMECON countries (payable almost entirely in kind), and short-term banking sector flows.

Includes cash-related transactions, enterprise credits, inter-FSU trade arrears, unrepatriated export proceeds, and short-term banking sector flows.

In 1998, includes accumulation of arrears of $1.2 billion to London and Paris Club creditors.

Includes arrears, debt rescheduling, and debt deferrals. Consists of interest capitalization by commercial banks, according to the London Club agreement, and debt reschedulings from uninsured suppliers and non-Paris Club creditors.

Excludes payments on short-term debt.

Sources: Data provided by the Russian authorities, and staff estimates.

Receipts and payments on debts denominated in non-convertible currencies net of reschedulings deferrals, including debts to COMECON countries (payable almost entirely in kind), and short-term banking sector flows.

Includes cash-related transactions, enterprise credits, inter-FSU trade arrears, unrepatriated export proceeds, and short-term banking sector flows.

In 1998, includes accumulation of arrears of $1.2 billion to London and Paris Club creditors.

Includes arrears, debt rescheduling, and debt deferrals. Consists of interest capitalization by commercial banks, according to the London Club agreement, and debt reschedulings from uninsured suppliers and non-Paris Club creditors.

Excludes payments on short-term debt.

124. These dramatic developments overshadowed the government’s efforts, until the August crisis, to liberalize the exchange and trade regimes. After accepting the obligations of Article VIII of the IMF’s Articles in June 1996, Russia had progressed toward an exchange system that was largely free of restrictions on both current and capital transactions. In the wake of the August crisis, however, a number of measures—some short-lived, others still in place—were taken to bolster reserves and stem capital outflows. Similarly, while Russia continued to advance the development of the regional customs union and to seek accession to the WTO, a number of trade-hindering measures were taken after August 1998.

Summary Balance of Payments, 1995–99
19981999
1995199619971st

half
2nd

half
Year1st

quarter
(In billions of U.S. dollars)
Current account4.83.9-3.0-6.99.22.33.3
Trade balance18.717.811.61.816.117.96.5
Exports82.790.689.037.537.374.815.3
Imports-64.0-72.8-77.4-35.7-21.2-56.8-8.8
Other current account transactions-13.8-13.8-14.6-8.7-6.9-15.7-3.3
Capital account-4.2-10.96.37.4-17.1-9.7-3.5
Capital flows relating to the federal government-9.71.715.17.30.47.7-0.4
Inflows 1/2.511.419.79.33.012.20.4
Amortization-12.6-10.9-4.6-1.8-2.3-4.1-0.7
Other capital flows5.4-12.6-8.70.2-17.5-17.4-3.0
of which: foreign direct investment, net1.71.73.61.10.11.20.2
Errors and omissions, net-7.9-8.6-7.8-4.4-3.5-7.9-1.6
Overall balance-7.3-15.6-4.5-3.9-11.4-15.3-1.8
Net international reserves (- = increase) 2/-5.44.6-1.42.37.810.20.2
Exceptional financing12.811.05.91.63.65.21.6
Sources: Data provided by the Russian authorities, and Fund staff estimates.

Loan disbursements and net purchases of government securities.

The definition of NIR differs from that used in the monetary accounts due to differences in cross exchange rates and treatment of gold.

Sources: Data provided by the Russian authorities, and Fund staff estimates.

Loan disbursements and net purchases of government securities.

The definition of NIR differs from that used in the monetary accounts due to differences in cross exchange rates and treatment of gold.

A. Current Account

125. Beginning in 1994, and continuing through mid-1998, Russia’s current account position showed a trend deterioration, driven by a decline in the merchandise trade surplus. (Table 26, Figure 18). Despite the still-depressed level of domestic demand, by the second quarter of 1997 the current account had swung into deficit, and did not move decisively back into surplus until after the August 1998 crisis. This trend, although masked for a time by an improvement in the terms of trade, was broadly coincident with the continuing appreciation of the ruble in real effective terms through July 1998 (Figure 19). From the point in 1997 when the terms of trade began to deteriorate, until the collapse of the ruble in August 1998, the shrinkage of the trade surplus accelerated, reversing itself only when the sudden plunge in the real effective exchange rate (and the disruption of the payments system in August–September 1998) resulted in a severe compression of imports. Exports were also initially hit in the chaotic economic and financial environment after August 17, delaying the response to the sharp depreciation of the ruble. On a seasonally adjusted basis, however, export volumes did begin to improve from December 1998 onwards, and dollar export values picked up markedly from the beginning of the second quarter of 1999 in tandem with the strong recovery in oil prices. With the gradual return of stability, imports have been rising in 1999, although from very depressed levels: for the first four months of the year they remained at just over half the level of the corresponding period of 1998.

Figure 18.Russian Federation: Quarterly Merchandise Trade, 1994-98

Sources: Data provided by the Russian authorities; and Fund staff estimates.

Figure 19.Russian Federation: Merchandise Trade Balance, Terms of Trade, and Real Effective Exchange Rate, 1994-98

Merchandise trade

126. The erosion of the trade surplus in the four years through mid-1998 was a function of the continued rapid growth in imports, despite a large decline in real GDP over that period, combined with sluggish and slowing increases in export volumes (Figure 19). Fluctuations of the trade surplus around that declining trend were driven largely by oscillations in export prices, especially oil and gas prices. The trends in the trade account, as well as the sharp exchange rate correction in which they culminated, appear to have reflected an increasing degree of overvaluation of the ruble (see Box 7).

Exports

127. After the marked shift in the destination of exports toward non-CIS countries in the first two years of transition, driven by the dismantling of the Soviet economic system and the removal of barriers to trade with the West, there has been relatively little change in the ratio of total exports going to non-CIS countries since 1994 (Table 27).43 Within the CIS, the 1997–98 period showed some evidence of a shift in exports toward Russia’s customs union partners (Belarus, Kazakhstan, and the Kyrgyz Republic). Among non-CIS trading partners, the most marked change in the destination of Russian exports was the fall in the share of Asian countries, from 14 percent in 1996 to under 12 percent in 1998, reflecting the slowdown in demand in that region arising from the economic crises in mid-1997.

Table 27.Russian Federation: Destination of Exports, 1994-98 1/(In percent of total exports)
1998
1994199519961997Q1Q2Q3Q4Year
Exports to:
CIS21.518.518.419.523.219.120.422.821.5
Belarus4.93.83.65.47.16.97.17.37.1
Kazakstan2.63.43.02.92.93.33.53.33.3
Ukraine10.68.99.08.510.66.86.59.18.3
Other3.32.42.72.62.62.13.23.12.8
Non-CIS78.581.581.680.576.880.979.677.278.5
Europe55.554.254.555.755.053.650.451.552.4
Czech Republic2.22.72.12.12.12.02.11.82.0
Finland3.23.13.13.33.13.02.12.02.5
France2.02.01.91.91.92.13.22.32.4
Germany8.77.88.07.77.98.39.67.18.2
Hungary1.92.12.12.22.42.22.31.62.1
Ireland1.93.33.42.91.50.90.02.41.3
Italy4.34.23.34.25.54.33.44.64.4
Netherlands3.84.13.95.45.15.31.86.24.7
Poland1.82.12.53.03.12.93.22.62.9
Slovak Republic1.21.52.22.02.31.92.01.61.9
Switzerland6.04.84.74.43.64.11.01.92.5
UK5.84.03.83.32.94.13.12.53.1
Other12.712.513.413.313.612.616.514.814.5
Asia12.314.714.012.39.511.112.512.811.7
China4.54.45.64.73.85.55.44.74.8
Japan3.64.13.53.42.72.92.93.12.9
Other4.26.35.04.23.02.74.25.03.9
Western Hemisphere7.59.49.08.08.011.510.57.89.3
US5.96.67.65.85.48.26.75.06.2
Other1.62.81.42.22.63.33.82.83.1
Middle East and Africa2.32.52.62.52.92.93.83.33.3
Other0.90.71.42.01.41.82.41.71.8
Source: IMF Direction of Trade Statistics.

Based on exports according to the Direction of Trade Statistics, which differ somewhat from those compiled by the Central Bank of Russia and shown in Table 26.

Source: IMF Direction of Trade Statistics.

Based on exports according to the Direction of Trade Statistics, which differ somewhat from those compiled by the Central Bank of Russia and shown in Table 26.

128. Through the first half of 1998, Russia’s exports showed a tendency to become increasingly dominated by primary commodities. Exports of fuel products, base and precious metals, forest products and precious stones accounted for about 77 percent of total exports in the period January 1997–June 1998, up from slightly over 70 percent in 1995 (Table 28). Over the same period, exports of other commodity groups like textiles and clothing stagnated or declined in dollar terms. The pronounced natural-resource orientation of Russian exports has tended to make overall exports sensitive to changes in world demand and the attendant swings in commodity prices.

Table 28.Russian Federation: Composition of Merchandise Exports, 1994-98
19971998
199419951996Q1Q2Q3Q4YearQ1Q2Q3Q4Year
(In millions of U.S. dollars)
Total exports (f.o.b.) 1/63,28578,29084,38719,28818,53119,61622,93080,36515,92915,92815,91917,21164,987
Food, beverage, tobacco and agricultural products1,4101,3321,6542852803365071,4072672332644141,177
Stone and ore641943750156170201257784175226232165798
Fuel products27,28830,44038,36510,6048,9848,45110,02338,0628,0116,4036,0056,78927,208
Oil and oil products15,53017,29122,0565,3825,0795,1925,08320,7363,5703,4583,2143,04113,283
Crude11,33512,40314,8603,5233,3183,5233,45613,8212,619.42,5582,3232,0479,546
Oil products4,1954,8887,1961,8591,7611,6681,6276,915950.89018919943,737
Gas10,35511,41013,9884,8883,5272,8714,50215,7884,1452,6682,5003,45812,771
Coal7521,012978188177202218786156155157147615
Other6517271,343145201186220752140122134143539
Chemicals (incl. pharmaceuticals and rubber)5,4767,4536,8991,4901,4411,6541,9936,5781,1701,2901,6071,3765,443
Leather3733073551078369125383978268114361
Wood and paper products2,6234,3203,4518518738769023,5027948308359093,367
Textiles and clothing1,3101,071951189208213217826170193177163702
Gems and precious metals6,4585,3563,6251973418331,7743,1452009491,3451,5694,062
Metals11,24215,28016,1073,8004,1564,3924,36716,7153,5363,7373,7933,38614,451
Non-ferrous4,8957,5227,9742,0052,1382,3022,2678,7131,8961,9762,1831,406.77,462
Ferrous6,3477,7588,1331,7952,0182,0892,1008,0021,6401,7611,6101,978.86,990
Machines, equipment (including cars) and instruments6,2138,3338,6201,4601,8012,3482,5678,1761,4091,8771,4512,1476,884
Other, including ceramics and glass2513,4563,610151193243199786101110145179534
(In percent of total exports)
Total exports (f.o.b.) 1/100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
Food, beverage, tobacco and agricultural products2.21.72.01.51.51.72.21.81.71.51.72.41.8
Stone and ore1.01.20.90.80.91.01.11.01.11.41.51.01.2
Fuel products43.138.945.555.048.543.143.747.450.340.237.739.441.9
Oil and oil products24.522.126.127.927.426.522.225.822.421.720.217.720.4
Gas16.414.616.625.319.014.619.619.626.016.715.720.119.7
Coal1.21.31.21.01.01.01.01.01.01.01.00.90.9
Other1.00.91.60.81.10.91.00.90.90.80.80.80.8
Chemicals (incl. pharmaceuticals and rubber)8.79.58.27.77.88.48.78.27.38.110.18.08.4
Leather0.60.40.40.60.40.40.50.50.60.50.40.70.6
Wood and paper products4.15.54.14.44.74.53.94.45.05.25.25.35.2
Textiles and clothing2.11.41.11.01.11.10.91.01.11.21.10.91.1
Gems and precious metals10.26.84.31.01.84.27.73.91.36.08.49.16.3
Metals17.819.519.119.722.422.419.020.822.223.523.819.722.2
Non-ferrous7.79.69.410.411.511.79.910.811.912.413.78.211.5
Ferrous10.09.99.69.310.910.79.210.010.311.110.111.510.8
Machines, equipment (including cars) and instruments9.810.610.27.69.712.011.210.28.811.89.112.510.6
Other, including ceramics and glass0.44.44.30.81.01.20.91.00.60.70.91.00.8
Source: State Customs Committee.

Excludes shuttle trade and other adjustments to the customs data that appear in estimates in Table 26.

Source: State Customs Committee.

Excludes shuttle trade and other adjustments to the customs data that appear in estimates in Table 26.

Box 7.Real Exchange Rate Trends

Since the collapse of the Soviet Union, the ruble has seen huge swings in its purchasing power vis-à-vis the US dollar and other major world currencies. Given the major structural change inherent in the process of transition to a market economy and the large associated shifts in relative prices, the path of the fundamental equilibrium exchange rate has been particularly hard to identify. Nonetheless, by early 1998 a number of signs suggested that the ruble had become overvalued:

  • The real effective (CPI-based) exchange rate index rose seven-fold from its low point just after the collapse of the Soviet Union at the end of 1991 to a high that was broadly maintained from July 1997 to July 1998. Qualitatively, this was not atypical: most transition economies have experienced a pattern of sharp initial real depreciation of the currency followed by steady real appreciation (especially of CPI-based real exchange rate indices), reflecting initial dislocation and a subsequent catchup in labor productivity vis-à-vis advanced non-transition economies, and corrective changes in the relative price of nontradeables. The pace and degree of appreciation of the ruble in real effective terms, however, were unusual even by the standards of other transition economies, including other former Soviet republics (see Figure 5).
  • The path of average monthly dollar wages tell a similar story. In 1990 dollar wages in the Soviet Union were about $100 a month, although the existence of numerous trade and exchange barriers make it difficult to infer what their equilibrium level would have been in the absence of such controls. From an obviously distorted level of only about $10 a month in early 1992, dollar wages rose to $50 a month by mid-1993, and $100 a month by mid-1994. At that point, monthly dollar wages in Russia were broadly in line with other newly independent transition economies. With the nominal exchange rate stability that was imposed from early 1995 onward combined with inertial wage inflation, however, monthly dollar wages continued to rise rapidly, reaching $150 at the end of 1995. They continued to climb, to over $200 a month, by December 1997.
  • The rise in dollar wages was not matched by increases in labor productivity or in the dollar prices of traded goods, so that the profitability of firms in the tradeables sector was increasingly under stress. Over the period 1995 to mid-1998 the unit labor cost-based measure of the real exchange rate rose even more rapidly than the CPI-based measure, while the dollar price of exports and the producer price index in dollar terms showed little cumulative change.
  • Although for much of the period 1993-96 the terms of trade were relatively stable, they registered a substantial deterioration from early 1997 through 1998.
  • From 1994 through mid-1998, imports continued to rise despite a cumulative fall in real incomes over the same period, while exports stagnated and the trade and current account balances deteriorated by about 7 percentage points of GDP.
  • There was a growing awareness in pre-crisis months of the difficulties in the banking system and public finances, which led international capital markets to lower their assessment of Russia’s creditworthiness and raise the risk premium on Russian financial assets, worsening the underlying balance of payments position.

The stability of the nominal exchange rate was ended, suddenly and dramatically, in August 1998. By January 1999 the ruble had declined in real effective terms by more than 45 percent from its July 1998 level, reversing all of the rise since early 1995. Over the same period, average monthly dollar wages are estimated to have fallen even more, by some 70 percent. The response was an immediate and sharp improvement in the current account balance, mainly on account of import compression. The nominal effective exchange rate broadly stabilized between January and June 1999, while gross reserve losses slowed and then were reversed.

Imports

129. As with exports, there was no marked trend in the share of CIS countries in Russia’s total imports, at least until the fourth quarter of 1998 (Table 29 and Figure 18). After the August crisis, there were signs that imports from other CIS countries—whose currencies had appreciated against the ruble by less than had the U.S. dollar44—were holding up better than imports from non-CIS countries.

Table 29.Russian Federation: Origin of Imports, 1994-98 1/(In percent of total imports)
1998
1994199519961997Q1Q2Q3Q4Year
Imports from:
CIS26.729.031.826.924.926.427.432.228.0
Belarus5.44.26.18.89.010.111.113.611.1
Kazakstan5.25.96.85.25.04.15.64.74.9
Ukraine11.414.314.17.67.48.05.67.27.0
Other4.74.64.95.23.64.15.16.85.0
Non-CIS73.371.068.273.175.173.672.667.872.0
Europe53.353.247.550.450.747.350.849.149.6
Czech Republic1.10.91.21.11.21.30.91.51.2
Finland4.24.43.73.63.13.44.23.13.5
France2.62.32.83.03.63.62.51.92.8
Germany14.714.111.612.713.111.713.79.411.9
Hungary1.91.81.51.81.81.62.32.22.0
Ireland0.60.70.70.80.70.80.40.50.6
Italy4.14.05.25.14.84.04.74.94.6
Netherlands4.23.52.32.32.12.22.22.52.3
Poland2.52.82.12.02.82.53.03.93.1
Slovak Republic0.50.60.60.50.50.50.60.80.6
Switzerland1.51.51.11.00.90.90.50.40.7
UK2.32.42.52.83.52.62.51.22.3
Other13.014.012.213.712.812.313.416.914.0
Asia10.17.69.59.39.69.410.210.810.1
China2.51.92.22.42.72.62.83.73.0
Japan2.91.62.21.92.21.71.60.91.5
Other4.74.15.15.14.85.15.86.25.5
Western Hemisphere7.98.59.611.212.814.69.45.910.3
US5.45.76.57.88.28.55.34.26.3
Other2.52.83.13.54.56.24.11.74.0
Middle East and Africa1.31.21.01.51.21.61.71.51.5
Other0.80.50.50.60.80.60.40.50.5
Source: IMF Direction of Trade Statistics.

Based on imports according to the Direction of Trade Statistics, which differ somewhat from those compiled by the Central Bank of Russia and shown in Table 26.

Source: IMF Direction of Trade Statistics.

Based on imports according to the Direction of Trade Statistics, which differ somewhat from those compiled by the Central Bank of Russia and shown in Table 26.

130. Through mid-1998, much of the growth of imports was attributable to unregistered or “shuttle” imports.45 These imports peaked in late 1996 at about 35 percent of total imports, remaining high until the onset of the full-blown crisis; in the fourth quarter of 1998 they had fallen to about 20 proportion of total imports (Figure 19 shows the proportion of total imports accounted for by all adjustments to customs data, including for shuttle trade.) There are indications that demand for consumer goods, which is the essence of shuttle trade, was particularly hard-hit by the sharp depreciation of the ruble.

131. During 1997–98, the composition of Russia’s imports remained broadly unchanged (Table 30). The most notable shift was the substantial drop in the relative share of food and agricultural commodities in total imports in the aftermath of the August crisis.

Table 30.Russian Federation: Composition of Merchandise Imports, 1994-98
19971998
199419951996Q1Q2Q3Q4YearQ1Q2Q3Q4Year
(In millions of U.S. dollars)
Total imports (c.i.f) 1/38,61646,61445,4389,75811,35812,79814,34448,25811,66411,3929,1205,88538,061
Food, beverage, tobacco and agricultural products10,70013,04111,0282,5353,2123,4943,47412,7153,1903,4132,2361,1189,957
Stone and ore1,1301,02873315513923123876419719712084598
Fuel products1,3891,5841,7033934374965441,8704804022682461,397
Chemicals (incl. Pharmaceuticals and rubber)3,8024,8576,1401,4161,6421,8642,0977,0191,7131,8511,3549095,827
Leather197144144242746581552722252093
Wood and paper products5661,0661,4273654104455181,7384534573502391,499
Textiles and clothing2,9632,3451,9483994414696271,9363723702532401,234
Gems and precious metals8742655535412091058118431
Metals2,5243,3963,7188007778398943,3107967676124342,609
Non-ferrous562779813189224259280952219243170110742
Ferrous1,9622,6172,9056115535806142,3585775244423241,866
Machines, equipment (including cars) and instruments14,82418,22217,4343,2933,8634,4355,34816,9394,0803,5363,5802,38713,583
Other, including ceramics and glass4345056083423694595391,7083483673152031,234
(In percent of total imports)
Total imports (c.i.f) 1/100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
Food, beverage, tobacco and agricultural products27.728.024.326.028.327.324.226.327.330.024.519.026.2
Stone and ore2.92.21.61.61.21.81.71.61.71.71.31.41.6
Fuel products3.63.43.74.03.83.93.83.94.13.52.94.23.7
Chemicals (incl. Pharmaceuticals and rubber)9.810.413.514.514.514.614.614.514.716.214.815.415.3
Leather0.50.30.30.20.20.40.40.30.20.20.30.30.2
Wood and paper products1.52.33.13.73.63.53.63.63.94.03.84.13.9
Textiles and clothing7.75.04.34.13.93.74.44.03.23.22.84.13.2
Gems and precious metals0.20.91.20.40.40.20.10.20.10.10.10.10.1
Metals6.57.38.28.26.86.66.26.96.86.76.77.46.9
Machines, equipment (including cars) and instruments38.439.138.433.834.034.737.335.135.031.039.240.635.7
Other, including ceramics and glass1.11.11.33.53.23.63.83.53.03.23.53.53.2
Source: State Customs Committee.

Excludes shuttle trade and other adjustments to the customs data that appear in estimates in Table 26.

Source: State Customs Committee.

Excludes shuttle trade and other adjustments to the customs data that appear in estimates in Table 26.

Services, net income and transfers

132. Russia has traditionally had a deficit in services, owing mainly to sizable interest payments on Federal government debt. This pattern continued through 1997–98, with the services account registering deficits averaging about $15 billion (4 percent of GDP). With the growing interest payments on government debt, the deficit on income rose from $7.6 billion in 1996 to close to $12 billion in 1998. Nonfactor services (net), on the other hand, have been improving during the same period, due in part to falling outflows related to travel and tourism. There continued to be a small net inflow of transfers, reflecting primarily funds remitted to Russia by nonresident nationals.

B. Capital Account

133. The developments in Russia’s capital account since the last Article IV consultation closely mirror the country’s economic and financial fortunes. Overall, Russia’s capital account balance swung from a deficit of $10.9 billion to a surplus of $6.3 billion in 1997 and back to a deficit of $9.7 billion in 1998 (Table 26). Improvements in Russia’s economic policy environment and financial position, together with successful rescheduling agreements with Paris and London Club creditors, in 1996 and 1997 respectively, encouraged sharp improvements in Russia’s access to global capital markets, which were reflected in large inflows. In the first half of 1997, these inflows induced the CBR to purchase foreign exchange, while slowing the pace of the crawl of the ruble within its “sliding corridor.” However, as much of these inflows were directed to short-term investments in government securities and equities, Russia became increasingly vulnerable to shifts in market sentiment, a weakness that manifested itself forcefully in the form of large capital outflows after the onset of the Asian crisis in the third quarter of 1997. The decline in investor confidence in emerging markets, adverse terms-of-trade developments, and unresolved structural and fiscal weaknesses encouraged a revision of investors’ assessments of Russia’s financial position and prospects, thereby inducing accumulating financial pressures that culminated in the crisis of August 1998.

Capital flows to the federal government

134. The federal government was a major beneficiary of the improved financial environment from 1996 through late-1997, as it gained extensive access to the global capital markets. Net inflows to the federal government soared from less than $2 billion in 1996 to a peak of $15 billion in 1997, before declining to $7.7 billion in 1998 (Table 26). After an initial $1 billion Eurobond placement in November 1996, the Russian government successfully issued another three bonds for $3.6 billion in 1997.46 With the relaxation of restrictions on nonresidents’ holdings of short-term zero-coupon GKOs and longer-term OFZs that occurred in 1996, foreign investors in 1997 purchased, on a net basis, about $11 billion of the government’s local-currency instruments, up from $6 billion in 1996. In addition to market borrowing, the government received close to $6 billion in loans from official bilateral and multilateral sources. In 1998, however, excluding disbursements from the Fund, inflows to the budget fell from $19.7 billion in 1997 to $12.2 billion (Tables 26 and 31, Figure 20).47

Table 31.Russian Federation: Foreign Currency Disbursements to the Federal Government, 1994-98(In millions of U.S. dollars)
Creditors19941995199619971998
Multilateral1,9316,3194,9404,7767,519
IMF 1/1,5445,4503,7582,0196,240
World Bank2808261,1072,6991,219
EBRD643755960
Other1010000
Bilateral2,0571,5543,2801,3752,110
Tied2,0571,5541,0901,3752,110
Untied002,19000
Bonds 2/001,0003,5499,615
Suppliers/other commercial5079301,136156
Total4,4967,9669,22010,83619,399
(excluding IMF)2,9522,5155,4628,81713,160
Memorandum item:
Minfin bonds 3/003,50000
Nonresident purchases of GKOs/OFZs (net)005,93410,8822,767
Total including Minfins and nonresident GKOs/OFZs4,4967,96618,65421,71822,166
(excluding IMF)2,9522,51514,89619,69915,927
Total disbursements from nonresidents,
including GKOs/OFZs, excluding Minfins4,4967,96615,15421,71818,466
Source: The Russian authorities.

Full amount of Fund purchases. In 1998 part of this amount was disbursed directly to the CBR.

Figure for 1998 includes $3,700 of Eurobonds purchased by residents. Data on resident purchases in other years were not available.

Only Minfin bonds VI and VII, issued in 1996, are included here. Prior Minfin bond issues did not entail any new inflows to the government but were in exchange for foreign currency deposits of enterprises held at the Vnesheconombank. These bonds are recorded at face value; information on discounted amounts were not available.

Source: The Russian authorities.

Full amount of Fund purchases. In 1998 part of this amount was disbursed directly to the CBR.

Figure for 1998 includes $3,700 of Eurobonds purchased by residents. Data on resident purchases in other years were not available.

Only Minfin bonds VI and VII, issued in 1996, are included here. Prior Minfin bond issues did not entail any new inflows to the government but were in exchange for foreign currency deposits of enterprises held at the Vnesheconombank. These bonds are recorded at face value; information on discounted amounts were not available.

Figure 20.Russian Federation: Disbursements from Non-residents to the Federal Government, 1994-98 1/

(In billions of U.S. dollars)

Source: Russian authorities.

1/ Excludes MinFin bonds issued in 1996.

135. The fall in inflows in 1998 primarily reflects the experience in the second half of the year; in the year to mid-1998, despite adverse developments in emerging markets, Russia continued to receive substantial inflows from abroad, albeit on increasingly expensive terms. From total inflows of $12.2 billion in 1998, all but $0.9 billion came during January-August, as access to capital markets virtually dried up after the August crisis.

136. The large Eurobond-related inflows in 1998 included a sizable voluntary exchange of GKOs for Eurobonds undertaken by the government in July. With increasing uncertainties in capital markets, starting in the latter part of 1997, there was a decline in demand for GKOs. This reflected in part net sales of such instruments by investors in a number of other emerging markets, including Brazil and Korea, who were rebalancing portfolios in the context of the overall emerging market downturn.48 To lengthen the maturity structure of its ruble-denominated debt, the government sought not only to move budgetary financing away from short-term GKOs to longer-term OFZs, but also to exchange some of the outstanding GKOs for Eurobonds. To this end, in July 1998, the authorities undertook a debt exchange under which about $4.4 billion of GKOs, including some of Sberbank’s holdings, were converted into 7- and 20-year Eurobonds. Both bonds were issued at very high spreads (940 basis points above U.S. Treasuries).49

Capital flows to other sectors

137. The improved access to global capital markets in 1997 extended beyond the federal government. The deficit in the nonsovereign capital account declined from $19.1 billion in 1996 to $13.5 billion in 1997, before widening again to $14.7 billion in 1998 (Table 32).50 There was increased investor interest in equities and bonds issued by the Russian private sector, as well as in bonds issued by Russian regional governments. However, such access diminished with the intensification of the crisis in emerging markets and concerns about Russia’s financial position.

Table 32.Russian Federation: Nonsovereign Sector Capital Account, 1994-98(In millions of U.S. dollars)
19941995199619971998
Direct investment5391658170836401155
Abroad-101-358-771-2603-1027
In Russia6402016247962432182
Portfolio investment81-1,6112,1402,223842
Assets114-1,705-172-156-256
Equity-145-144-7532-10
Debt securities259-1,561-97-188-246
Liabilities-33942,3122,3791,098
Equity45592,1521,265714
Banks4547509333
Nonfinancial enterprises0122,1021,172681
Debt securities-78351601,114384
Local governments000897500
Banks-78776110-266
Nonfinancial enterprises02884107150
Other investments-13,6151,874-22,934-19,342-16,700
Assets-14,4186,292-28,686-34,009-14,559
Cash foreign currency and deposits-4,4114,167-9,596-13,1222,021
Trade credit-3,7218,040-9,500-6,948-6,810
Loans-1,085-360360-2,639-334
Banks-1,085-356443-2,16439
Nonfinancial enterprises0-4-83-475-373
Arrears-29-4-2822-291
Banks-29-4-2822-151
Nonfinancial enterprises0000-140
Changes in the stock of nonrepatriated
Export proceeds and nonrepatriated
Import advances-3,860-4,928-9,773-11,458-8,625
Other-1,312-623-149136-520
Liabilities803-4,4185,75214,667-2,141
Cash foreign currency and deposits4741,7791,4274,240-2,759
Trade credit-978-8,090-759-64322
Loans9849714,2039,977300
Banks4266611,7053,840-3,395
Nonbank financial organizations001,516-1,5163,695
Nonfinancial enterprises5583109827,6530
Arrears2003693
Banks2003693
Nonfinancial enterprises00000
Other321922881511-697
Total (net)-12,9951,921-19,086-13,479-14,703
Source: Central Bank of Russia.
Source: Central Bank of Russia.

138. Foreign direct investment (FDI) inflows surged to $6.2 billion in 1997, from $2.5 billion in the year before, but fell to about $2.2 billion in 1998. While the pickup in 1997 was substantial, compared with FDI in other transition countries and Russia’s vast potential, the magnitude of inward FDI remained small. A host of factors continued to hinder inward investment, including uncertainty about the robustness of macroeconomic stability, shortcomings in the protection of property rights and the enforcement of contracts, and inadequacies in bankruptcy laws. In 1997, food and retail trade and catering services remained a major recipient of FDI, and there was a sharp pickup in investment in the financial sector. In 1998, the food industry regained its position as the leading recipient of investment. FDI outflows from Russia amounted to $2.6 billion in 1997, but fell to $1 billion in 1998.

139. At $2.4 billion, portfolio investment inflows—other than to the federal government—remained high in 1997, but, as with FDI, fell back significantly in 1998 to $1.1 billion. In 1997, reflecting the overall concerns about emerging market equity markets, there was a shift in the composition of portfolio inflows away from equities and toward bonds, especially those of local governments, who succeeded in issuing Eurobonds for the first time.51 Russian banks and corporations were also able to issue bonds abroad and attracted interest to their issues in the form of American Depository Receipts (ADRs). In 1998, local governments remained the largest recipients of portfolio investment ($0.5 billion). During 1997–98, portfolio outflows were small, averaging about $200 million a year.

140. The balance on other investments—which consist of changes in holdings of foreign currency cash and deposits, trade credit, loans, arrears, and changes in the stock of nonrepatriated export earnings and import payments—improved significantly in 1997–98. However, there are shortcomings in the quality of the official data on some of these transactions, particularly in the estimation of nonrepatriated export proceeds and nonrepatriated import advances (which amounted to $11.5 billion in 1997 and $8.6 billion in 1998), and other forms of capital flight. Loans to banks and to nonfinancial enterprises picked up sharply, before falling dramatically in 1998; loans to nonbank financial enterprises rose rapidly in the first three quarters of 1998, but stopped in the fourth quarter. The rise in external borrowings by nonfinancial enterprises was particularly large in 1997, rising to $7.7 billion, compared with less than $1 billion in the previous year, but came to a halt in 1998.52

141. Capital flight, especially through misinvoicing of trade transactions, remained a significant factor in Russia’s balance of payments, and containing it has been a major component of the authorities’ recent policies. There has been extensive debate on the nature and size of capital flight from Russia (Box 8). The Russian authorities have tentatively estimated that capital flight averaged about $11 billion during 1994–98. While there is little doubt that there have indeed been outflows, the estimates are subject to a great deal of uncertainty.

142. The Russian authorities have been seeking to limit capital flight, especially since August 1998, through the intensification of exchange controls.53 In the past, they had tightened tax administration and financial sector supervision, and had introduced the so-called “passport system” (which was intended to monitor closely residents’ trade-related transactions) and other current and capital account restrictions. More recently, the intensification of controls has included an increase in the surrender requirement on exports from 50 percent to 75 percent; a 100 percent deposit requirement on advance payments for imports; more rigorous monitoring of trade-related transactions undertaken through the banking system (e.g., CBR Directive 500-U, requiring more detailed reporting by banks to CBR on suspicious trade transactions); suspension of conversion operations through nonresidents’ S-accounts (special nonresident bank accounts used for GKO-OFZ transactions) limiting investors’ ability to effect moderate amounts of amortization from proceeds of bond transactions; and the imposition of a $10,000 limit on transfers of cash abroad without CBR approval.

Box 8.Capital Flight From Russia

Capital flight from Russia has been the subject of a controversial debate in academic and policy circles. As in other countries, there is considerable debate on its definition and measurement, and policy implications. In Russia, capital flight has been done through misinvoicing of barter and cash external trade, and illegal financial transactions. As noted by Tikhomirov (1997), using different definitions and data sources, a number of studies have arrived at estimates of capital flight from Russia flight during 1990-95 in the range of $35 billion (Russian government) and $400 billion (Russian Security Ministry). More recently, a project on capital flight from Russia by Moscow Institute of Economics and the Center for the Study of Economic Relations at the University of Western Ontario, using balance of payments data, has estimated capital flight during 1994 through September 1997 at $17 billion per annum. Recently, the CBR has provided highly tentative estimates of capital flight (defined as the sum of nonreceipt of export earnings, unredeemed import advances, nonequivalent barter, and 50 percent of errors and omission) from Russia to have amounted to $54.2 billion during 1994–98, or an average of more than $10.8 billion per annum (including the entire errors and omissions would yield an average annual figure of $14.1 billion instead).

Channel19941995199619971998Total
Nonreceipt of export earnings3.94.94.23.73.219.9
Unredeemed import advances0.00.04.36.94.315.5
Nonequivalent barter0.00.01.30.80.42.5
50 percent of errors and omissions0.23.94.33.94.016.3
Total capital flight4.18.814.115.311.954.2
Source: CBR.
Source: CBR.

These estimates are subject to very great uncertainty due to the continuing shortcomings in balance of payments data. The existence of a persistent negative entry for “errors and omissions” does not necessarily imply persistent capital outflows, but could reflect a persistent underrecording of current accounts outflows, in particular imports.

The impact of the August crisis on Russia’s relations with external creditors

143. The measures announced on August 17, especially the unilateral restructuring of OFZs/GKOs and the moratorium on private external debt payments, had wide-ranging implications for Russia’s financial relations with external creditors. The GKO/OFZ conversion—which entailed prolonged and difficult negotiations with nonresident holders of these instruments—led to a freezing of the government securities market, cutting off the government from a major source of financing, and a deep and protracted banking crisis (Box 9). At the same time, the imposition of the moratorium on private debt payments—especially the legal and payment uncertainties surrounding the treatment of Russian banks’ foreign exchange forward contracts and the asset stripping done by the Russian banks under cover of the moratorium—adversely affected its relations with external creditors (Box 10). Financial and market uncertainties and sentiment also deteriorated on account of the intensification of exchange restrictions. While a number of Russian banks and nonbank corporations managed to service some of their external debt under the moratorium, relations with foreign creditors have been harmed by actual and potential litigation.

C. External Debt and Claims

Sovereign debt

144. Prior to the August crisis, the Russian government had made important progress in regularizing its relations with external creditors. It had reached key rescheduling agreements with Paris and London Club creditors, which were finalized in April 1996 and October 1997, respectively, and allowed a substantial lengthening of the maturity structure of sovereign debt and reduced debt service pressures. In December 1996, the government had also reached an agreement in principle on a rescheduling of its debt to uninsured suppliers.

Box 9.The GKO/OFZ Novation

As a part of their policies to overcome pressures on public finances, on August 17 the Russian authorities announced their decision to restructure all GKOs/OFZs (except for holdings by the CBR and individuals) with maturity dates through end-December 1999 and suspended all trading in the GKO/OFZ market indefinitely. About Rub 190 billion in GKOs/OFZs, of which about ruble 83 billion was held by nonresidents, were affected by the restructuring. In addition, nonresident investors were faced with new restrictions, imposed under the private debt moratorium, on payments by Russian banks to nonresidents toward settlement of forward foreign exchange contracts that investors had written to hedge their GKO/OFZ holdings against a ruble devaluation.

It took several months for an agreement to be reached between the Russian government and external creditors on restructuring. An offer made by the authorities on August 25—which some market participants have argued was more attractive than the final terms of the agreement reached in March—included cash payments and new OFZs, with a partial Eurobond option, but was declined by nonresident holders who would have incurred significant losses on their holdings. In a further round of negotiations, the authorities sought to improve their offer by including in the restructuring negotiations nonresidents’ claims on Russian commercial banks. This was also rejected by creditors. Russian domestic law provided little legal recourse for creditors, either resident and nonresident. Domestic banks were allowed to exchange collateral held in frozen GKOs against CBR credit for CBR debt securities. To accelerate discussions, the authorities announced the formation of a steering committee of nonresident creditors in October, and published substantially modified terms for the restructuring in December. Finally, after months of often difficult negotiations with nonresident creditors—who displayed deep disagreements among themselves—an agreement was reached that has since been accepted by the overwhelming majority of holders. Under the terms of the novation scheme, finalized in March, most resident and nonresident holders had the amount of their original GKOs/OFZs adjusted by discounting the stream of payments on such GKOs/OFZs from their scheduled payment date to August 19, 1998 at a rate of 50 percent per annum. Subsequently, they received a package including cash, GKOs and OFZs, as follows:

Type of payment/securityPercentage of adjusted holdingsCoupon (in percent)Comments
Cash payment3 1/3NoneFunds must be deposited in “restricted” ruble account
3-month GKO (Maturity March 1999)3 1/3NoneFunds must be deposited in “restricted” ruble account
6-month GKO (Maturity June 1999)3 1/3NoneFunds must be deposited in “restricted” ruble account
Cash-value OFZ20NoneCan be used, at par, to pay tax obligations that were in arrears as of July 1, 1998; purchase newly issued shares of Russian banks. Any sales receipts must be deposited in “restricted ” ruble accounts.
OFZs with maturities ranging from 4 to 5 years7030, 25, 20, 15 and 10 each year, respectivelyFunds must be deposited in “restricted” ruble account

The rubles that are received by nonresidents under the novation (up-front cash payment, coupon, or principal, as well as proceeds from secondary market trading in GKOs/OFZs) must be deposited in their S-account. These “restricted rubles” could then be used for purchases of permitted Russian corporate bonds and equity securities. Nonresidents electing to convert and repatriate “restricted rubles” would need to deposit the funds in noninterest bearing transit accounts for one year, after which repatriation would be allowed. In addition, the CBR has agreed to hold at least four sales of foreign currency of at least $50 million each in 1999, through which nonresidents could purchase and repatriate foreign currency at an exchange rate that is at most 20 percent more depreciated than the market rate by offering either ruble balances in S-accounts or securities government securities held in S-accounts to the CBR. The first two sales were based on an exchange rate which was depreciated by 10 percent from the market exchange rate. In view of the complexity of the package, it has been difficult to obtain a reliable estimate of the loss suffered by investors. Some have indicated that, under the restructuring, returns to investors would amount to only 5 cents on the dollar. It should be noted, however, much of the losses suffered by the GKO/OFZ investors would be related to the depreciation of the ruble. Accordingly, the loss to investor due purely to the restructuring would be much smaller.

Russian institutional holders which were required by law to hold GKO/OFZs received slightly better terms (10 percent cash, 10 percent 3 -month GKOs, 10 percent 6-month GKOs, 20 percent cash-value OFZ, 50 percent OFZs with maturities ranging from 4 to 5 years). Some Russian institutional investors and individuals, as well as those holders who did not agree to the novation offer, would be paid according to the original terms of their holdings. Nonresidents, however, would not be allowed to repatriate their funds for a period of five years.

Box 10.The Moratorium on Private External Debt

As part of the set of measures to address Russia’s financial crisis, the authorities announced a 90-day moratorium, effective from August 17 to November 14, 1998, on the repayment of private external debt. The moratorium was adopted primarily to protect official reserves in the face of an acute balance of payments crisis and to aid the domestic banking sector whose liquidity position was sharply diminished on account of the unilateral conversion of GKOs/OFZs and the suspension of trade in these instruments.

The moratorium suspended payments by residents to nonresidents of principal on loans with maturity exceeding 180 days, margin payments on loans collateralized with securities (including repo transactions), and foreign currency forward contracts. The moratorium did not cover payments on debt of the Russian government (directly or through Vnesheconombank), CBR, or local governments. Also excluded were payments on loans from the EBRD. In principle, the moratorium did not affect payments in foreign currency from and to Russia by nonresidents. In practice, however, nonresidents faced restrictions on transfers of funds from their S-accounts, containing the proceeds of nonresidents’ transactions in GKOs/OFZs, as these transfers required a forward transaction of three days, which was covered by the moratorium. To work out relations with external creditors, the authorities encouraged residents whose payments were affected by the moratorium to seek, individually or in groups, from their foreign creditors a rescheduling of their obligations.

According to the authorities, payments that fell due to nonresidents during the moratorium (excluding payments against forward contracts) amounted to $3.1 billion, of which $2.7 billion were liabilities of commercial banks. Despite restrictions imposed under the moratorium, commercial banks actually settled $1.8 billion of their obligations (excluding forwards), leaving only $0.9 billion in unsettled arrears when the moratorium expired. Reportedly, Russian commercial banks (and nonbank corporations) circumvented the moratorium and settled some of their external obligations by utilizing their foreign assets held abroad or foreign currency earnings outside Russia or by making deposits with the Russian branches of foreign creditor banks, which was not prohibited under the moratorium.

Regarding forward contracts, CBR data indicate that prior to the declaration of the moratorium, the banking system’s net forward position was close to neutral (-$0.2 billion) (Table A). With the sharp movement in the dollar/rubble exchange rate, however, this net position had moved to -$2.9 billion by November 1, 1998.

Table A.Claims and Obligations of Banks on Forward Contracts with Nonresidents(Notional values, in billions of U.S. dollars)
August 1Sept. 1Oct. 1Nov. 1Dec. 1
1Claims in FX10.37.53.21.81.2
2Obligations in FX15.112.18.37.86.6
3Net obligations in FX (2-1)4.74.65.16.05.4
4Claims in rubles13.510.13.93.83.3
5Obligations in rubles8.95.61.30.70.5
6Net claims in rubles (4-5)4.64.52.63.12.8
7Net position (6-3)-0.2-0.1-2.5-2.9-2.6
Source: CBR.
Source: CBR.

As noted in Box B3, the authorities originally intended to solve jointly the issues of nonresidents’ holdings of GKOs/OFZs and the nonresidents’ forward claims on Russian banks. However, in the course of negotiations, this approach was abandoned and the GKO/OFZ exchange and the settlement of forward claims were delinked. As a result, foreign creditors have been free to seek bilateral agreements with Russian debtors, or pursue their claims through litigation. As some of the forward contracts between Russian banks and foreign creditors were written under English law, some Russian banks are now vulnerable to litigation abroad. Several foreign creditors have been able to pursue Russian banks in courts abroad. For example, Lehman Brothers was able to obtain injunctions from U.K. courts to freeze the assets of Inkombank and Uneximbank. Thus far, however, there have been fewer instances of litigation abroad against Russian banks than had been anticipated. In recent months, some foreign and Russian banks have reached agreements with regard to the forward contracts. The ability of foreign creditors to pursue Russian banks in Russian courts has been undermined by ambiguities over the legal status of forward contracts under Russian laws.

In retrospect, while it provided some breathing space for Russian banks and nonbank corporations in meeting their external obligations, there is evidence that the moratorium was a costly undertaking. Reportedly, some Russian debtors circumvented the moratorium and serviced their external obligations. Second, there is anecdotal evidence that a number of other Russian bank and nonbank corporations used the debt moratorium as a cover for asset stripping and as an excuse for not settling their domestic obligations to other Russian creditors, with the attendant adverse implications especially for the banking and payments systems.

145. At end-1998, Russia’s sovereign foreign currency debt stood at $158 billion (48 percent of GDP),54 up from $135 billion in the previous year (Table 33). Two thirds of this debt was inherited from the Soviet era (prior to 1/1/1992).555657 Except for some arrears on Soviet-era debt, nearly all of Russia’s sovereign foreign-currency debt is of medium- and long-term maturity. About 60 percent is owed to official creditors. Russia’s debt to private creditors includes $16 billion in Eurobonds. Comprehensive debt data by residency are not available. However, Russia’s sovereign debt to nonresidents is estimated at $152 billion (46 percent of GDP) at end-1998.58

Table 33.Russian Federation: External Debt, 1994-98 1/(In billions of U.S. dollars)
19941995199619971998
I. SOVEREIGN DEBT
A. Russian-era foreign currency debt (post 1/1/1992)11.317.427.735.655.4
Medium and long term55.4
Multilateral Creditors5.411.415.318.726.0
IMF4.29.612.513.219.4
World Bank0.61.52.65.36.4
Other0.60.30.20.20.2
Official creditors 2/5.96.07.97.69.7
Eurobonds0.00.01.04.516.0
Minfin bonds (Minfins VI and VII)0.00.03.53.53.5
Commercial creditors (includes financial institutions)0.00.00.01.30.2
Short term0.0
B. Soviet-era foreign currency debt (pre 1/1/1992)116.2110.6108.499.0102.8
Medium and lone term102.8
Multilateral Creditors0.00.00.00.00.0
Official creditors 2/69.962.661.956.959.5
Paris Club39.641.642.337.640.0
of which: arrears0.8
COMECON25.716.615.414.914.7
of which: arrears0.0
Other, including non-Paris Club bilateral4.64.44.24.44.7
of which: arrears4.0
Commercial creditors36.038.337.833.935.2
Financial institutions31.133.032.529.731.2
of which: arrears2.1
Other 3/4.95.35.34.24.1
of which: arrears4.1
Eurobonds1.71.10.10.10.0
Credits contracted by entities other than VEB1.01.01.00.50.5
Minfin bonds (Minfins III, IV and V)7.67.67.67.67.6
of which: arrears0.00.00.00.00.0
Short term0.0
C. Total sovereign foreign currency debt (= A + B)127.5128.0136.1134.6158.2
(In percent of GDP)45.836.831.630.248.1
D. Total sovereign debt to nonresidents (= C - E - F + G)152.4
(In percent of GDP)46.3
E. Residents’ Minfin bonds 5/7.3
F. Residents’ eurobonds 6/3.7
G. Nonresidents’ GKOs/OFZs (ruble denominated) 7/5.2
II. NONSOVEREIGN DEBT
Local governments1.12.2
Medium and long term1.11.9
of which: Euorobonds0.00.00.00.91.4
Short term0.3
Banks 9/2.65.29.219.29.9
Medium and long term2.8
Short term7.1
Nonbank corporations (including arrears)13.619.6
H. Total31.7
(In percent of GDP)9.6
III. TOTAL EXTERNAL DEBT (to nonresidents) (= D + H)184.0
(In percent of GDP)55.9
Memorandum items:
Sovereign arrears10.9
Sources: Russian Federation authorities and Fund staff estimates.

Foreign currency values of outstanding external debt have been converted into U.S. dollars at the relevant market exchange rate prevailing at the respective dates indicated.

Includes government to government creditors and official export credits.

Subject to reconciliation.

Arrears on principal are included in the debt figures.

Estimated by the authorities at 60 percent of outstanding issues.

Applies only to Eurobonds issued in July 1998, in the context of the GKO-Eurobond exchange. Data on nonresident holdings of other Eurobond issues are not available to Fund staff.

Equivalent to Rub. 76 billion, valued at the end-1998 exchange rate. The ruble amount is the discounted amount that resulted after the GKO/OFZ conversion. Also includes Rub 75 billion of OFZs not covered by the GKO/OFZ conversion.

Includes interest on arrears.

Figures for 1994-97 include equity. At end-1998 such equity amounted to about $0.5 billion.

Sources: Russian Federation authorities and Fund staff estimates.

Foreign currency values of outstanding external debt have been converted into U.S. dollars at the relevant market exchange rate prevailing at the respective dates indicated.

Includes government to government creditors and official export credits.

Subject to reconciliation.

Arrears on principal are included in the debt figures.

Estimated by the authorities at 60 percent of outstanding issues.

Applies only to Eurobonds issued in July 1998, in the context of the GKO-Eurobond exchange. Data on nonresident holdings of other Eurobond issues are not available to Fund staff.

Equivalent to Rub. 76 billion, valued at the end-1998 exchange rate. The ruble amount is the discounted amount that resulted after the GKO/OFZ conversion. Also includes Rub 75 billion of OFZs not covered by the GKO/OFZ conversion.

Includes interest on arrears.

Figures for 1994-97 include equity. At end-1998 such equity amounted to about $0.5 billion.

146. In the aftermath of the August financial crisis and the subsequent loss of access to global capital markets, the Russian government was not able to meet all of its external obligations and has been accumulating arrears on its Soviet-era debt. By end-December 1998, Russia’s overdue obligations to Paris and London club creditors stood at $851 million and $364 million, respectively, up from zero on the eve of the crisis (Table 33). In addition, Russia has been accumulating arrears on its Soviet-era debt vis-à-vis some of its other creditors. Following the 1996 agreement with the Paris Club, agreements in principle on rescheduling terms were reached with a number of non-Paris Club official bilateral creditors, the International Investment Bank (IIB), the International Bank for Economic Cooperation (IBEC), and uninsured suppliers. The Russian authorities, however, were not able to finalize these agreements and make the payments necessary to regularize those obligations. At end-1998, the Russian government’s total overdue obligations, including new (1998) arrears to Paris and London Club creditors and amounts outstanding on debts that were never formally rescheduled by non-Paris Club official bilateral creditors, IIB/IBEC, and uninsured suppliers, amounted to $10.9 billion (including penalty interest). Of that amount, about $2 billion were accumulated during 1998.59

Nonsovereign debt

147. In late 1998 nonsovereign debt, consisting of external obligations of local governments, banks, and nonbank corporations, is estimated at $31.7 billion (10 percent of GDP). Reflecting improved access to global capital markets, local governments were able to raise funds abroad during 1997–98. At end-1998, their external obligations amounted to $2.2 billion, of which about $1.4 billion were in the form of Eurobonds. The financial crisis in August also affected the ability of local governments to service their external debt; the Republic of Tatarstan was unable to pay its $100 million bond falling due in October 1998, but was able to reach agreement with its creditors on a rescheduling.

148. The external debt of banks, which more than doubled to $19 billion in 1997, fell sharply after the August crisis to $9.9 billion at end-1998 (including about $1 billion in arrears), of which $7 billion was short term.60 In addition to the above, Russian banks had off-balance sheet obligations to nonresidents on account of forward foreign exchange contracts amounting to $7 billion (notional value) on December 1, 1998.61 The authorities have attributed the decline in bank debt in the second half of 1998 to the repayments of loans, valuation effects, and accounting issues. With the near-collapse of the banking system after August 17, Russian banks have been increasingly facing difficulties servicing their external obligations; for example, in January 1999, Uneximbank indicated that it would not be able to service its external obligations, including on a Eurobond, the first such default for a Russian bank.

149. Recently improved CBR data suggest that at end-1998 nonbank corporate debt, mainly of the energy sector, stood at $19.6 billion (of which $1.6 billion was in Eurobonds), up from $13.6 billion in 1997.62 Corporate overdue obligations amounted to $330 million. According to market sources, external creditors have been effectively rolling over the distressed debt of Russian corporations. However, corporate creditors have also been facing increasing difficulties meeting their external obligations, including Eurobonds.

Russia’s external claims

150. Russia is a major creditor to a number of developing countries. As of December 1, 1998, Russia’s claims on former socialist and developing countries amounted to $114 billion in nominal terms. In September 1997, an agreement was finalized between Russia and Paris Club creditors on the terms of Russia’s participation in reschedulings as a creditor. That agreement provided for up-front discounts on Russia’s claims on rescheduling countries, with larger discounts for the poorest countries. The post-discount claims would then be subject to the same terms granted by the Paris Club. This agreement has facilitated the regularization of Russian claims on developing countries, and the implementation of the HIPC Initiative. While Russia participated as a creditor in the Paris Club rescheduling meetings for Bosnia, the Central African Republic, and Yemen, and is negotiating bilateral agreements with a number of countries that had Paris Club reschedulings in the past, progress in signing bilateral reschedulings has been slow. After debt relief to be provided pursuant to the terms of Russia’s accession to the Paris Club, Russia’s claims would amount to about $33 billion.

D. Trade Policy, Regional and CIS Trade Relations, and WTO Accession

Overall trade policy

151. Before the August 1998 crisis, the authorities were pursuing a strategy of progressively liberalizing the trade system.63 The weighted average tariff rate rose slightly from 13.6 percent in 1996 to 13.9 percent in 1997, and is estimated to have remained broadly unchanged in 1998 (Table 35).64 After the onset of full-blown financial and economic crisis in August, however, the authorities felt compelled to take a number of steps in the opposite direction. To bolster revenues, export taxes were reintroduced in January 1999, applying to crude oil, natural gas, and a variety of other products including nonferrous metals. Food exports were banned to ensure that food aid from the West was not re-exported. And, also effective as from January 1999, a ban on private imports of ethyl alcohol was imposed. At the same time, other measures continued the earlier trend toward a more open trade regime. To attenuate the impact of the crisis on consumers, in October the authorities lowered import duties on several essential items, and, in November 1998, removed the 3 percent import surcharge (originally adopted in July 1998) on foodstuffs, medicines, and several other priority items. With the increased use of restrictive trade and exchange measures (including the increase in the export surrender requirement from 50 percent to 75 percent), on the Fund’s index of trade restrictiveness, Russia’s ranking has changed from 2 to 5. That index ranges from 1 to 5, with 1 indicating the most open trade regime.

Table 34.Russian Federation: Foreign Currency Debt Service, 1994-98 1/(In billions of U.S. dollars)
19941995199619971998
Debt Service Due18.7819.1517.9411.7613.01
Principal13.9912.6511.685.845.76
Interest4.796.506.265.927.25
Principal13.9912.6511.685.845.76
Russian-era debt2.092.281.601.543.27
Multilateral0.210.430.740.521.03
Bonds0.000.000.000.000.00
Official bilateral1.881.850.860.921.10
Commercial0.000.000.000.101.14
Soviet-era debt11.9010.3710.084.302.49
Multilateral0.000.000.000.000.00
Bonds0.060.800.980.000.07
Official bilateral and
other commercial11.849.579.104.302.42
Interest4.796.506.265.927.25
Russian-era debt0.650.940.961.422.29
Multilateral0.280.400.610.771.10
Bonds0.000.000.000.210.66
Official bilateral0.370.540.350.430.47
Commercial0.000.000.000.010.06
Soviet-era debt4.145.565.304.504.96
Multilateral0.000.000.000.000.00
Bonds0.120.140.080.000.00
Official bilateral and
other commercial2.203.072.792.624.44
Interest on arrrears1.822.352.431.880.52
Debt Service Paid3.666.406.925.897.77
Principal2.273.322.861.683.49
Interest1.393.084.064.214.28
Principal2.273.322.861.683.49
Russian-era debt2.092.281.591.543.27
Multilateral0.210.430.740.521.03
Bonds0.000.000.000.000.00
Official bilateral1.881.850.850.921.10
Other commercial0.000.000.000.101.14
Soviet-era debt0.181.041.270.140.22
Multilateral0.000.000.000.000.00
Bonds0.060.800.980.000.07
Official bilateral0.120.240.290.140.14
Other commercial0.000.000.000.000.01
Interest1.393.084.064.214.28
Russian-era debt0.650.940.961.422.22
Multilateral0.280.400.610.771.03
Bonds0.000.000.000.210.66
Official bilateral0.370.540.350.430.47
Other commercial0.000.00