1. SUMMARY. 1995 WAS A YEAR OF DRAMATIC VICTORIES IN THE RUSSIAN GOVERNMENT'S ON-GOING BATTLE TO STABILIZE THE RUSSIAN ECONOMY. AT THE CORE OF THE GOVERNMENT'S SUCCESS WAS A BOLD ECONOMIC STABILIZATION PROGRAM CONSISTING OF A TIGHT BUDGET, GRADUAL LOWERING OF INFLATION THROUGH RESTRICTIVE MONETARY POLICY, AND TRADE AND ENERGY SECTOR LIBERALIZATION. THIS PROGRAM FORMED THE BASIS FOR A USD 6.5 BILLION STANDBY CREDIT FROM TNE IMF AND CONTRIBUTED POSITIVELY TO SUCCESSFUL DEBT RESCHEDULING NEGOTIATIONS WITH BOTH PARIS AND LONDON CLUB CREDITORS. THE RUSSIAN GOVERNMENT WORKED TO FURTHER DAMPEN INFLATIONARY EXPECTATIONS AND SUBSTANTIALLY STABILIZE THE RUBLE THROUGH INTRODUCTION IN EARLY JULY OF A CURRENCY CORRIDOR. THE 1996 BUDGET IS SIMILARLY TIGHT, AND IT WILL BE A CHALLENGE FOR THE RUSSIAN GOVERNMENT TO STAY THE COURSE OF FINANCIAL STABILIZATION IN THE FACE OF PRESIDENTIAL ELECTIONS IN JUWE.
2. THE REAL ECONOMY ALSO SHOWED SIGNS OF PROGRESS IN 1995. THE FALL IN GROSS
DOMESTIC PRODUCT AND INDUSTRIAL PRODUCTION LARGELY STOPPED, AND SOME SECTORS
OF THE ECONOMY -- ESPECIALLY IN THE EXPORT ORIENTED RAW MATERIALS AND PRIMARY
COMMODITIES SECTOR -- RECORDED SOLID GROWTH. SECONDARY INDICATORS SUPPORT
THE NOTION THAT OUTPUT CONTINUES TO BE UNDERSTATED DUE TO ENTERPRISE ATTEMPTS
TO LOWER THEIR TAX EXPOSURE AND WEAKNESSES IN DATA COLLECTION ON THE PART
OF THE CENTRAL STATISTICAL AGENCIES. DESPITE A TIGHTENING MONETARY
ENVIRONMENT, UNEMPLOYMENT DID NOT EXPLODE AS IT HAS IN OTHER ECONOMIES IN
TRANSITION, IN PART BECAUSE LABOR WAS WILLING TO ACCEPT MUCH LOWER REAL WAGES.
AND IN PART BECAUSE OF DISTORTIONS CAUSED BY THE TAX REGIME.
3. FINANCIAL STABILIZATION HAD ITS ROUGH EDGES IN 1995 AS WELL. TIGHT MONEY
KEPT INTEREST RATES HIGH EVEN AS MONTHLY INFLATION FELL -- RAISING THE COST
OF GOVERNMENT BORROWING AND CLOSING OFF
OPPORTUNITIES FOR CAPITAL INVESTMENT. MOREOVER, LOWER INFLATION AND A STABLE
RUBLE CREATED HARD BUDGET CONSTRAINTS WHERE NONE HAD EXISTED BEFORE: COMMERCIAL
BANKS WERE SLOW TO ADJUST AND EXPERIENCED A SHOCK WITH THE AUGUST INTERBANK
LIQUIDITY SCARE. ENTERPRISES, ALSO ACCUSTOMED TO EASY PROFITS FROM PAPER TRANSACTIONS,
REACTED TO STABILIZATION BY ACCUMULATING TAX ARREARS, ARREARS TO WORKERS,
AND ARREARS ON CONTRIBUTIONS TO THE FEDERAL PENSION FUND. END SUMMARY.
-------------------------------- -
FINANCIAL STABILIZATION TAKES HOLD
----------------------------------
4. FINANCIAL STABILIZATION ESTABLISHED A STRONG FOOTHOLD IN RUSSIA IN 1995
WITH A REDUCTION IN THE FEDERAL BUDGET DEFICIT, A LOWERING OF INFLATION, AND
THE STABILIZATION OF THE RUBLE. TNE
CENTERPIECE OF THE 1995 FEDERAL BUDGET WAS A GOVERNMENT PLEDGE TO HOLD THE
DEFICIT TO 4.1 PERCENT OF GDP, AND TO FINANCE IT WITHOUT RESORT TO INFLATIONARY
CENTRAL BANK CREDITS. THE GOVERNMENT MET ITS DEFICIT TARGET FOR THE YEAR,
AND FINANCED THE DEFICIT VIRTUALLY WITHOUT RESORT TO CENTRAL BANK LENDING.
IN 1996, THE GOVERNMENT PLANS TO MAINTAIN REVENUES AT 1995 LEVELS WHILE DECREASING
EXPENDITURES SLIGHTLY (IN PERCENT OF GDP TERMS) AND THEREBY LOWER THE DEFICIT
TO 3.85 PERCENT OF GDP.
5. INFLATION FELL SHARPLY OVER THE COURSE OF 1995, IN LINE WITH THE GOVERNMENT'S COMMITMENT TO FISCAL DISCIPLINE AND TIGHT MONETARY POLICY. MONTHLY NFLATION AVERAGED 7.3 PERCENT FOR THE YEAR, FALLING FROM A PEAK OF 18 PERCENT IN JANUARY TO 4-5 PERCENT A MONTH IN THE SECOND HALF OF THE YEAR, AND FURTHER TO A POST-TRANSITION LOW OF 3.2 PERCENT IN DECEMBER. ON AN ANNUAL BASIS, INFLATION IN 1995 WAS 131 PERCENT, DOWN FROM THE 215 PERCENT REGISTERED IN 1994, AMD THE 840 PERCENT REGISTERED IN 1993. THE PACE OF RUBLE MONEY SUPPLY (M2) GROWTH ALSO SLOWED, FALLING FROM 195 PERCENT IN 1994 TO 110 PERCENT IN 1995.
6. THE RUBLE HAS COME A LONG WAY SINCE ITS 22 PERCENT ONE-DAY DROP AGAINST
THE DOLLAR IN OCTOBER 1994. IN 1995, THE RUBLE DEPRECIATED IN LINE WITH INFLATION
UNTIL APRIL 29, WHEN IT HIT AN ALL-TIME LOW OF 5,130 RUBLES TO THE DOLLAR.
THROUGH MAY AND JUNE, THE RUBLE REVERSED COURSE AND APPRECIATED 13 PERCENT
AGAINST THE DOLLAR, WITN THE CENTRAL BANK INTERVENING TO SLOW THE RUBLE'S
APPRECIATION. IN EARLY JULY, THE GOVERNMENT INTRODUCED A CURRENCY CORRIDOR
(A BAND IN WHICH THE CURRENCY WOULD BE ALLOWED TO FLUCTUATE) TO FURTHER DAMPEN
INFLATIONARY EXPECTATIONS. (THE CORRIDOR WAS EXTENDED INTO THE FIRST SIX MONTHS
OF 1996, WITH ITS PARAMETERS REVISED FROM R4300-R4900 TO R4550- R5150 TO THE
U.S. DOLLAR.) FOLLOWING THE INTRODUCTION OF THE RUBLE CORRIDOR, THE RUBLE
DEPRECIATED SLOWLY IN NOMINAL TERMS, REACHING R4640 BY THE END OF DECEMBER.
DESPITE THE SHARP REDUCTION IN INFLATION THIS PAST YEAR, THE REAL RUBLE APPRECIATED
BY 65 PERCENT (DECEMBER 1995 OVER DECEMBER 1994).
7. INTEREST RATES REMAINED HIGH FOR MOST OF 1995, REFLECTING THE TIGHT MONETARY SITUATION. AT ITS WORST POINT, THE RUSSIAN BANKING SYSTEM SUFFERED A TEMPORARY LIQUIDITY CRISIS ON AUGUST 24, 1995. THE CENTRAL BANK MOVED QUICKLY TO PROVIDE LIQUIDITY, AND THE CRISIS PASSED WITHIN ONE DAY. THE LEVEL OF ACTIVITY ON THE INTERBANK LENDING AND FOREIGN EXCHANGE MARKETS SUBSTANTIALLY CONTRACTED FOLLOWING THE CRISIS, BUT PICKED UP SOMEWHAT BY YEAR'S END. THE LIQUIDITY PINCH CAN BE SEEN AS AN INEVITABLE REACTION TO THE SUCCESS OF THE RUSSIAN GOVERNMENT'S STABILIZATION EFFORTS, WHICH HAVE TENDED TO REDUCE OPPORTUNITIES FOR SPECULATIVE BEHAVIOR ON THE PART OF COMMERCIAL BANKS. IN THE AFTERMATH OF THE LIQUIDITY CRISIS, MUCH-NEEDED BANK CONSOLIDATION HAS BEGUN.
8. THE DISCOUNT RATE WAS STABLE BUT HIGH IN 1995, AND COMMERCIAL BANKS RARELY TURNED TO THE CENTRAL BANK FOR SHORT-TERM LIQUIDITY REQUIREMENTS. INTERBANK LENDING WAS ALSO EXPENSIVE, ALTHOUGH IN THE FIRST SIX MONTHS OF THE YEAR, THREE-MONTH INTERBANK MARKET RATES FELL DRAMATICALLY, FROM 175 TO 108 PERCENT IN SIMPLE ANNUAL TERMS. IN THE RUN UP TO AND FOLLOWING THE AUGUST INTERBANK CRISIS, THREE-MONTH INTERBANK RATES ROSE SHARPLY AND THE NUMBER OF TRADES AT THAT MATURITY DECLINED IN FAVOR OF 21-DAY OR SHORTER PAPER. THE DISCOUNT RATE AND THREE-MONTH INTERBANK RATES ENDED 1995 RESPECTIVELY AT 160 AND 140 PERCENT (IN SIMPLE ANNUAL TERMS).
-----------------------------
PRODUCTION DECLINE STALLS OUT
-----------------------------
9. AFTER FOUR YEARS OF LARGE ANNUAL DECLINES IN GROSS DOMESTIC PRODUCT (GDP) AND INDUSTRIAL PRODUCTION, THE RUSSIAN ECONOMY SHOWED EARLY SIGNS OF STABILIZING IN 1995. BOTH REAL GDP AND REAL INDUSTRIAL PRODUCTION STRONGLY OUTPERFORMED EVEN THE MOST OPTIMISTIC GOVERNMENT FORECASTS. BY THE SECOND HALF OF 1995, THE FALL IN REAL GDP HAD VIRTUALLY STOPPED. PRELIMINARY DATA FOR THE YEAR INDICATES THAT REAL GDP DECLINED JUST 4 PERCENT IN 1995 OVER 1994 (COMPARED TO THE 13 PERCENT DROP IN 1994 OVER 1993). SECONDARY INDICATORS OF ECONOMIC ACTIVITY SUGGEST THAT THE RUSSIAN ECONOMY MAY HAVE BEGUN TO RECOVER SLIGHTLY, WITH ELECTRICITY OUTPUT UP SLIGHTLY IN 1995 OVER 1994. OFFICIAL STATISTICS ALSO SHOWED FREIGHT HAULAGE (MEASURED IN MILLIONS OF TONS PER KILOMETER) DOWN LESS THAN 2 PERCENT IN 1995 OVER 1994, AND UNDER-REPORTING TRENDS SUGGEST HAULAGE LEVELS MAY HAVE INCREASED IN 1995.
10. IN 1995, THE RUSSIAN ECONOMY CONTINUED TO ADJUST AWAY FROM IMBALANCES FOUND IN THE HEAVILY INDUSTRIAL-BASED SOVIET ECONOMY. OFFICIAL STATISTICS INDICATE THAT SERVICES, ONLY 43 PERCENT OF GDP IN 1993, GREW TO 51.5 PERCENT IN 1995, REFLECTING ONE OF THE MOST PALPABLE ASPECTS OF CHANGE IN RUSSIA. GIVEN UNDER REPORTING OF SMALL AND MEDIUM-SIZED BUSINESSES TO THE OFFICIAL STATISTICAL AGENCIES, IT IS LIKELY THAT THE OVERALL SIZE OF THE SERVICE SECTOR IN THE ECONOMY IS LARGER THAN OFFICIAL FIGURES SUGGEST. INDUSTRIAL PRODUCTION OVER THE SAME PERIOD SLIPPED FROM 50 TO 41 PERCENT OF GDP.
11. THE STABILIZATION OF REAL INDUSTRIAL OUTPUT, BEGUN IN AUGUST 1994, CONTINUED IN 1995. REAL SEASONALLY ADJUSTED INDUSTRIAL PRODUCTION DEMONSTRATED POSITIVE GROWTH RATES IN MONTH-OVER- MONTH STATISTICS IN THE LAST FOUR MONTHS OF 1994, AND THEN FELL OFF SLIGHTLY IN THE FIRST QUARTER OF 1995, HITTING ITS ALL-TIME LOW IN APRIL. FROM MAY, REAL SEASONALLY ADJUSTED INDUSTRIAL PRODUCTION REMAINED ESSENTIALLY FLAT FOR THE REST OF 1995, DIPPING SLIGHTLY IN DECEMBER, AND ENDING THE YEAR DOWN 3 PERCENT OVER 1994.
12. THERE ARE EARLY INDICATIONS THAT BOTH RAW MATERIALS PROCESSING AND MAMUFACTURING INDUSTRIES ARE BEGINNING TO RECOVER, ALTHOUGH GROWTH IS UNEVEN AMONG SECTORS AND REGIONS. SOME SECTORS, IN PARTICULAR THE FERROUS AND NON-FERROUS METAL, CHEMICAL AND PETROCHEMICAL, PARTS OF THE PAPER AND CELLULOSE INDUSTRY, AND TNE BUILDING MATERIALS INDUSTRY, SHOWED MARKED GROWTH IN 1995. MOST SURPRISINGLY, OUTPUT IN SOME SECTORS OF LIGNT INDUSTRY ALSO GREW FOR THE FIRST TIME SINCE THE BEGINNING OF THE TRANSITION TO A MARKET ECONOMY. OUTPUT OF CONSUMER DURABLES, INCLUDING MOST CONSUMER ELECTRONICS, CONTINUED TO DECLINE IN 1995.
---------------------------------
REAL WAGES CONTRACT BY 13 PERCENT
---------------------------------
13. PRELIMINARY ESTIMATES SHOW THAT AVERAGE WAGES REACHED 710,000 RUBLES PER MONTH IN 1995 (ABOUT USD 153 A MONTH AT THE END-YEAR EXCHANGE RATE). IN THE FIRST QUARTER OF 1995, REAL AVERAGE WAGES (ADJUSTED FOR INFLATION) FELL TO THEIR LOWEST LEVEL SINCE THE BEGINNING OF THE TRANSITION. WHILE RECOVERING SOMEWHAT OVER THE REMAINDER OF THE YEAR, REAL WAGES REMAIN QUITE DEPRESSED, AND ENDED 1995 DOWN 13 PERCENT OVER DECEMBER 1994. METHODOLOGICAL WEAKNESSES IN THE OFFICIAL REAL INCOME FIGURES MEAN THAT MOST ANALYSTS USE REAL CONSUMPTION AS A PROXY FOR REAL INCOME. AVERAGE ANNUAL REAL CONSUMPTION DECLINED 5.3 PERCENT IN 1995 OVER 1994.
14. MUCH OF THE FALL IN REAL WAGES CAN BE ATTRIBUTED TO ENTERPRISES SUCCESSFULLY AVOIDING THE EXCESS WAGE TAX, A 38 PERCENT TAX ON WAGES EXCEEDING SIX TIMES THE MINIMUM WAGE (ROUGHLY USD 74/MONTH). THE TAX, WHICH WAS ABOLISHED AT BEGINNING IN 1996, ENCOURAGED A FIRM TO DEPRESS ARTIFICIALLY ITS AVERAGE WAGE BILL BELOW THE USD 74/MONTN THRESHOLD BY EMPLOYING EXCESS WORKERS AT MINIMUM WAGE. THE TAX ALSO ENCOURAGED FIRMS TO DIVERT WAGES INTO NON-WAGE RENUMERATION FOR EMPLOYEES, SUCH AS SHORT-TERM INSURANCE POLICIES OR THE WESTERN EQUIVALENT OF A THREE-MONTH CERTIFICATE OF DEPOSIT.
------------------------------------------------- - UNEMPLOYMENT RISES SLOWLY AS LABOR COSTS REMAIN LOW ---------------------------------------------------
15. UNEMPLOYMENT INCREASED SLOWLY IN 1995, AND REMAINS LOWER IN RUSSIA THAN
IN MOST OF EASTERN EUROPE. ACCORDING TO THE FEDERAL EMPLOYMENT SERVICE, UNEMPLOYMENT
(BY ILO STANDARDS) REACHED 8.2 PERCENT OF THE LABOR FORCE BY THE END OF 1995,
ALTHOUGH UNEMPLOYMENT RATES VARY GREATLY BY REGION. IN OTHER TRANSITION ECONOMIES,
PROGRESS TOWARDS FINANCIAL STABILIZATION OF THE ECONOMY HAS MEANT HIGHER UNEMPLOYMENT
LEVELS. IN RUSSIA,
UNEMPLOYMENT IN 1995 REMAINED LOW COMPARED TO OTHER TRANSITION ECONOMIES PRIMARILY
BECAUSE OF GREAT DOWNWARD FLEXIBILITY IN WAGES. RUSSIAN WORKERS IN DECLINING
INDUSTRIES ACCEPTED DEEP REAL WAGE CUTS IN ORDER TO KEEP THEIR JOBS IN 1995.
16. EXPERTS ESTIMATE THAT THE NUMBER OF UNEMPLOYED AND UNDEREMPLOYED, WHEN TAKEN TOGETHER, REMAINED CONSTANT LAST YEAR AT 12 PERCENT OF THE LABOR FORCE. MANY UNDEREMPLOYED WORKERS KEPT THEIR WAGE POSITIONS IN ORDER TO RECEIVE SOCIAL BENEFITS, WHILE SUPPORTING THEIR INCOME THROUGH SECOND OR THIRD JOBS, SMALL SCALE START-UP BUSINESSES, GROWING FOOD AT HOME OR WORKING IN THE INFORMAL ECONOMY. IN ADDITION, THE EXCESS WAGE TAX (DESCRIBED ABOVE) ENCOURAGED FIRMS TO MAINTAIN EXCESS LABOR AT RELATIVELY LOW COST TO THE FIRM. IN 1996, THE ABOLITION OF THE EXCESS WAGE TAX IS LIKELY TO PUT PRESSURE ON FIRMS TO LET EXCESS LABOR GO, ADDING TO THE PRESSURE ON TNE OPEN UNEMPLOYMENT RATE.
------------------------------------------------ TRADE SURPLUS STRONG, CURRENT ACCOUNT IN SURPLUS ------------------------------------------------
17. RUSSIA HAS BEEN RUNNING A GROWING TRADE SURPLUS FOR THE LAST THREE YEARS, REACHING USD 12 BILLION IN 1994 AND USD 23 BILLION IN 1995, ACCORDING TO PRELIMINARY ESTIMATES (AND BEFORE RECONCILIATION WITH PARTNER DATA). BALANCE OF PAYMENTS DATA FOR THE FULL YEAR IS NOT YET AVAILABLE, BUT DATA FROM THE FIRST SIX MONTHS OF 1995 SHOWS RUSSIA'S CURRENT ACCOUNT IN SURPLUS BY AS MUCH AS USD 9 BILLION. IN JUNE 1995, THE PARIS CLUB OF OFFICIAL CREDITORS AGREED TO RESCHEDULE ROUGHLY $6.3 BILLION IN DEBT REPAYMENTS FALLING DUE IN 1995 ON DEBT INHERITED FROM THE FORMER SOVIET UNION. THE U.S. AND RUSSIA IMPLEMENTED THE 1995 PARIS CLUB RESCHEDULING ACCORD IN OCTOBER BY SIGNING A BILATERAL DEBT RESCHEDULING AGREEMENT COVERING $64 MILLION. IN 1994, THE PARIS CLUB AGREED TO RESCHEDULE $7 BILLION IN SOVIET-ERA DEBT. PRELIMINARY DISCUSSION OF REMAINING SOVIET ERA OBLIGATIONS TO PARIS CLUB CREDITORS BEGAN IN NOVEMBER. THE LONDON CLUB OF COMMERCIAL BANK CREDITORS REACHED AGREEMENT WITH THE RUSSIAN GOVERNMENT IN NOVEMBER TO RESCHEDULE $32.5 BILLION IN DEBT. THE AGREEMENT, WHICH IS EXPECTED TO BE FINALIZED IN EARLY 1996, CALLS FOR PRINCIPAL TO BE REPAID OVER 25 YEARS, WITH A SEVEN-YEAR GRACE PERIOD.
18. UNDER THE GOVERNMENT'S 1995 ECONOMIC STABILIZATION PROGRAM, RUSSIA'S TRADE REGIME UNDERWENT SOME LIBERALIZATION. ON JANUARY 1, 1995, PRESIDENT YELTSIN ABOLISHED THE OIL EXPORT QUOTA REGIME. IN MARCH 1995, THE GOVERNMENT BEGAN THE PROCESS OF ELIMINATING WIDE-SPREAD EXEMPTIONS FROM TAXES AND DUTIES, AND ABOLISHED THE SPECIAL EXPORTER REGIME FOR PETROLEUM. THE GOVERNMENT ALSO MADE CMANGES TO THE TARIFF REGIME -- LOWERING PEAK TARIFFS TO 30 PERCENT, AWD (FOR REVENUE REASONS) RAISING SOME NULL TARIFFS, THEREBY INCREASING THE AVERAGE TARIFF RATE FROM 11 TO 15 PERCENT.
19. IN 1995, A LAW ON FOREIGN ECONOMIC ACTIVITY, WHICH INCLUDED PROVISIONS ON TRADE DEFENSIVE MEASURES, WAS ENACTED. BY LATE IN THE YEAR, THE GOR HAD COMPLETED ITS CONSIDERATION OF IMPLEMENTING DECREES AND MADE PRELIMINARY ANNOUNCEMENTS OF SAFEGUARD AND ANTI-DUMPING INVESTIGATIONS' OUTCOMES. RUSSIA'S INTEREST IN PROTECTING IT INDUSTRIES FROM UNFAIR FOREIGN TRADE PRACTICES AND STRONG INDUSTRY LOBBYING FOR PROTECTION MAY LIMIT OR REVERSE TRADE LIBERALIZATION MOVES IN 1996. THE RUSSIANS CONTINUE TO SHOW A STRONG INTEREST IN ACCESSION TO THE WORLD TRADE ORGANIZATION (WTO), A GOAL THE U.S. AND OTHER TRADING PARTNERS STRONGLY SUPPORT.