Russia Economic Reform in the 1990s

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Russia - Economic Reform in the 1990s

Economic reform in the 1990s

Two fundamental and interdependent goals--macroeconomic stabilization and economic restructuring--mark the transition from central planning to a market-based economy. The former entails implementing fiscal and monetary policies that promote economic growth in an environment of stable prices and exchange rates. The latter requires establishing the commercial, legal, and institutional entities--banks, private property, and commercial legal codes--that permit the economy to operate efficiently. Opening domestic markets to foreign trade and investment, thus linking the economy with the rest of the world, is an important aid in reaching these goals. Under Gorbachev, the regime failed to address these fundamental goals. At the time of the Soviet Union's demise, the Yeltsin government of the Russian Republic had begun to attack the problems of macroeconomic stabilization and economic restructuring. As of mid-1996, the results were mixed.

The sharp increase in the money supply was influenced by large foreign currency deposits that state-run enterprises and individuals had built up and by the depreciation of the ruble. Enterprises drew on these deposits to pay wages and other expenses after the Government had tightened restrictions on monetary emissions. Commercial banks monetized enterprise debts by drawing down accounts in foreign banks and drawing on privileged access to accounts in the RCB (see Banking and Finance, this ch.).

The Government also began to address the interenterprise debt that had been feeding inflation. The 1995 budget draft, which was proposed in September 1994, included a commitment to reducing inflation and the budget deficit to levels acceptable to the IMF, with the aim of qualifying for additional international funding. In this budget proposal, the Chernomyrdin government sent a signal that it no longer would tolerate soft credits and loose budget constraints, and that stabiliza-tion must be a top government priority.

The Government also failed to constrain its own expenditures in this period, partially under the influence of the conservative Supreme Soviet, which encouraged the Soviet-style financing of favored industries. By the end of 1992, the Russian budget deficit was 20 percent of GDP, much higher than the 5 percent projected under the economic program and stipulated under the International Monetary Fund (IMF--see Glossary) conditions for international funding. This budget deficit was financed largely by expanding the money supply. These ill-advised monetary and fiscal policies resulted in an inflation rate of over 2,000 percent in 1992.

Exchange Rates

An important symptom of Russian macroeconomic instability has been severe fluctuations in the exchange rate of the ruble. From July 1992, when the ruble first could be legally exchanged for United States dollars, to October 1995, the rate of exchange between the ruble and the dollar declined from 144 rubles per US$1 to around 5,000 per US$1. Prior to July 1992, the ruble's rate was set artificially at a highly overvalued level. But rapid changes in the nominal rate (the rate that does not account for inflation) reflected the overall macroeconomic instability. The most drastic example of such fluctuation was the Black Tuesday (1994) 27 percent reduction in the ruble's value.

The next phase of the privatization program called for direct cash sales of shares in remaining state enterprises. That phase would complete the transfer of state enterprises and would add to government revenues. After that procedure met stiff opposition in the State Duma, Yeltsin implemented it by decree in July 1994. But the president's commitment to privatization soon came into question. In response to the monetary crisis of October 1994, Yeltsin removed Chubays from his position as head of the State Committee for the Management of State Property, replacing him with little-known official Vladimir Polevanov. Polevanov stunned Russian and Western privatization advocates by suggesting renationalization of some critical enterprises. Yeltsin reacted by replacing Polevanov with Petr Mostovoy, a Chubays ally. In the ensuing eighteen months, Yeltsin made two more changes in the chairmanship position.

Inflation

In 1992, the first year of economic reform, retail prices in Russia increased by 2,520 percent. A major cause of the increase was the decontrol of most prices in January 1992, a step that prompted an average price increase of 245 percent in that month alone. By 1993 the annual rate had declined to 840 percent, still a very high figure. In 1994 the inflation rate had improved to 224 percent.

By mid-1996 many Duma deputies raised concerns about the Government's failure to meet its tax revenue targets. Revenue shortages were blamed on a number of factors, including a heavy tax burden that encourages noncompliance and an inefficient and corrupt tax collection system. A variety of tax collection reforms were proposed in the parliament and the Government, but by 1996 Russian enterprises and regional authorities had established a strong pattern of noncompliance with national tax regulations, and the Federal Tax Police Service was ineffectual in apprehending violators (see Ministry of Internal Affairs (MVD), ch. 10).

Economic Restructuring Measures

Immediately after the dissolution of the Soviet Union was announced, the Government lifted price controls on 90 percent of consumer goods and 80 percent of intermediate goods. It raised, but still controlled, prices on energy and food staples such as bread, sugar, vodka, and dairy products. These measures were to establish a realistic relationship between production and consumption that had been lacking in the central planning system.

Because the faults of the Yeltsin privatization program were an important plank in the 1996 presidential election platform of the Communist Party of the Russian Federation (Kommunisticheskaya partiya Rossiyskoy Federatsii--KPRF), the strongest opposition party, Yeltsin's campaign strategy was to reduce privatization as far as possible as a campaign issue (see The Executive Branch, ch. 7). Part of that strategy was to shift the privatization process from Moscow to the regions. In February 1996, a presidential decree simply granted shares in about 6,000 state-controlled firms to regional governments, which could auction the shares and keep the profits.

After Yeltsin's reelection in July 1996, his financial representatives announced continuation of the privatization program, with a new focus on selling ten to fifteen large state enterprises, including the joint-stock company of the Unified Electric Power System of Russia (YeES Rossii), the Russian State Insurance Company (Rosgosstrakh), and the St. Petersburg Maritime Port. The Communications Investment Joint-Stock Company (Svyazinvest), sale of which had failed in 1995, was to be offered to Western telecommunications companies in 1996.

On October 1, 1992, vouchers, each with a nominal value of 10,000 rubles (about US$63), were distributed to 144 million Russian citizens for purchase of shares in medium-sized and large enterprises that officials had designated and reorganized for this type of privatization. However, voucher holders also could sell the vouchers, whose cash value varied according to the economic and political conditions in the country, or they could invest them in voucher funds.

The Yeltsin Economic Program

In October 1991, two months before the official collapse of the Soviet regime and two months after the August 1991 coup against the Gorbachev regime, Yeltsin and his advisers, including reform economist Yegor Gaydar, established a program of radical economic reforms. The Russian parliament, the Supreme Soviet, also extended decree powers to the president for one year to implement the program. The program was ambitious, and the record to date indicates that the goals for macroeconomic stabilization and economic restructuring programs may have been unrealistically high. Another complication in the Yeltsin reform program is that since 1991 both political and economic authority have devolved significantly from the national to the regional level; in a series of agreements with the majority of Russia's twenty-one republics and several other subnational jurisdictions, Moscow has granted a variety of special rights and powers having important economic overtones.

Privatization

The essence of economic restructuring, and a critical consideration for foreign loans and investment in Russia's economy, is the privatization program. In most respects, between 1992 and 1995 Russia kept pace with or exceeded the rate established in the original privatization program of October 1991. As deputy prime minister for economic policy, the reformist Chubays was an effective advocate of privatization during its important early stages. In 1992 privatization of small enterprises began through employee buyouts and public auctions. By the end of 1993, more than 85 percent of Russian small enterprises and more than 82,000 Russian state enterprises, or about one-third of the total in existence, had been privatized.

In late 1994, Yeltsin reasserted his commitment to macroeconomic stabilization by firing Viktor Gerashchenko, head of the RCB, and nominating Tat'yana Paramonova as his replacement. Although reformers in the Russian government and the IMF and other Western supporters greeted the appointment with skepticism, Paramonova was able to implement a tight monetary policy that ended cheap credits and restrained interest rates (although the money supply fluctuated in 1995). Furthermore, the parliament passed restrictions on the use of monetary policy to finance the state debt, and the Ministry of Finance began to issue government bonds at market rates to finance the deficits.

Government efforts to control credit expansion also proved ephemeral in the early years of the transition. Domestic credit increased about nine times between the end of 1991 and 1992. The credit expansion was caused in part by the buildup of interenterprise arrears and the RCB's subsequent financing of those arrears. The Government restricted financing to state enterprises after it lifted controls on prices in January 1992, but enterprises faced cash shortages because the decontrol of prices cut demand for their products. Instead of curtailing production, most firms chose to build up inventories. To support continued production under these circumstances, enterprises relied on loans from other enterprises. By mid-1992, when the amount of unpaid interenterprise loans had reached 3.2 trillion rubles (about US$20 billion), the government froze interenterprise debts. Shortly thereafter, the government provided 181 billion rubles (about US$1.1 billion) in credits to enterprises that were still holding debt.

The new, postelection privatization stage also was to reduce the role of enterprise workers in shareholding. Within the first years of such ownership, most worker shares had been sold at depressed prices, devaluing all shares and cutting state profits from enterprise sales. Therefore, to reach the budget target of 12.4 trillion rubles (about US$2.4 billion) of profit from privatization sales in 1996, distribution was to target recipients who would hold shares rather than sell them immediately.

In late 1992, deteriorating economic conditions and a sharp conflict with the parliament led Yeltsin to dismiss economic reform advocate Yegor Gaydar as prime minister. Gaydar's successor was Viktor Chernomyrdin, a former head of the State Natural Gas Company (Gazprom), who was considered less favorable to economic reform.

By October 1994, inflation, which had been reduced by tighter fiscal and monetary policies early in 1994, began to soar once again to dangerous levels. On October 11, a day that became known as Black Tuesday, the value of the ruble on interbank exchange markets plunged by 27 percent. Although experts presented a number of theories to explain the drop, including the existence of a conspiracy, the loosening of credit and monetary controls clearly was a significant cause of declining confidence in the Russian economy and its currency.

In 1995 and 1996, political conditions continued to hamper the privatization program, and corruption scandals tarnished the program's public image. By 1995 privatization had gained a negative reputation with ordinary Russians, who coined the slang word prikhvatizatsiya , a combination of the Russian word for "grab" and the Russianized English word "privatize," producing the equivalent of "grabification." The term reflects the belief that the privatization process most often shifted control of enterprises from state agencies to groups of individuals with inside connections in the Government, the mafiya , or both. Distrust of the privatization process was part of an increasing public cynicism about the country's political and economic leaders, fueled by the seeming failure of Yeltsin's highly touted reform to improve the lot of the average Russian (see Social Stratification, ch. 5).

Chernomyrdin formed a new government with Boris Fedorov, an economic reformer, as deputy prime minister and finance minister. Fedorov considered macroeconomic stabilization a primary goal of Russian economic policy. In January 1993, Fedorov announced a so-called anticrisis program to control inflation through tight monetary and fiscal policies. Under the program, the Government would control money and credit emissions by requiring the RCB to increase interest rates on credits by issuing government bonds, by partially financing budget deficits, and by starting to close inefficient state enterprises. Budget deficits were to be brought under control by limiting wage increases for state enterprises, by establishing quarterly budget deficit targets, and by providing a more efficient social safety net for the unemployed and pensioners.

Monetary and Fiscal Policies

In 1992 and 1993, the Government expanded the money supply and credits at explosive rates that led directly to high inflation and to a deterioration in the exchange rate of the ruble. In January 1992, the Government clamped down on money and credit creation at the same time that it lifted price controls. However, beginning in February the RCB loosened the reins on the money supply. In the second and third quarters of 1992, the money supply had increased at especially sharp rates of 34 and 30 percent, respectively, and by the end of 1992, the Russian money supply had increased by eighteen times.

Another sign of currency stabilization was the announcement that effective June 1996, the ruble would become fully convertible on a current-account basis. This meant that Russian citizens and foreigners would be able to convert rubles to other currencies for trade transactions.

In June 1994, Chernomyrdin presented a set of moderate reforms calculated to accommodate the more conservative elements of the Government and parliament while placating reformers and Western creditors. The prime minister pledged to move ahead with restructuring the economy and pursuing fiscal and monetary policies conducive to macroeconomic stabilization. But stabilization was undermined by the RCB, which issued credits to enterprises at subsidized rates, and by strong pressure from industrial and agricultural lobbies seeking additional credits.

Macroeconomic Stabilization Measures

The program laid out a number of macroeconomic policy measures to achieve stabilization. It called for sharp reductions in government spending, targeting outlays for public investment projects, defense, and producer and consumer subsidies. The program aimed at reducing the government budget deficit from its 1991 level of 20 percent of GDP to 9 percent of GDP by the second half of 1992 and to 3 percent by 1993. The government imposed new taxes, and tax collection was to be upgraded to increase state revenues. In the monetary sphere, the economic program required the Russian Central Bank (RCB) to cut subsidized credits to enterprises and to restrict money supply growth. The program called for the shrinkage of inflation from 12 percent per month in 1991 to 3 percent per month in mid-1993.

The printing of money and domestic credit expansion moderated somewhat in 1993. In a public confrontation with the parliament, Yeltsin won a referendum on his economic reform policies that may have given the reformers some political clout to curb state expenditures. In May 1993, the Ministry of Finance and the RCB agreed to macroeconomic measures, such as reducing subsidies and increasing revenues, to stabilize the economy. The RCB was to raise the discount lending rate to reflect inflation. Based on positive early results from this policy, the IMF extended the first payment of US$1.5 billion to Russia from a special Systemic Transformation Facility (STF) the following July.

In addition, late in 1995 Yeltsin dismissed Anatoliy Chubays, one of the last economic reform advocates remaining in a top Government position, as deputy prime minister in charge of economic policy. In place of Chubays, Yeltsin named Vladimir Kadannikov, a former automobile plant manager whose views were antireform. This move raised concerns in Russia and the West about Yeltsin's commitment to economic reform. Another casualty of the political atmosphere was RCB chairman Paramonova, whose nomination had remained a source of controversy between the State Duma and the Government. In November 1995, Yeltsin was forced to replace her with Sergey Dubinin, a Chernomyrdin protégé who continued the tight-money policy that Paramonova had established.

Fedorov's anticrisis program and the Government's accord with the RCB had some effect. In the first three quarters of 1993, the RCB held money expansion to a monthly rate of 19 percent. It also substantially moderated the expansion of credits during that period. The 1993 annual inflation rate was around 1,000 percent, a sharp improvement over 1992, but still very high. The improvement figures were exaggerated, however, because state expenditures had been delayed from the last quarter of 1993 to the first quarter of 1994. State enterprise arrears, for example, had built up in 1993 to about 15 trillion rubles (about US$13 billion, according to the mid-1993 exchange rate).

More about the Economy of Russia.

The second phase of the privatization program went ahead with the sale of state-held shares for cash. Although the process was virtually complete by the end of the first quarter of 1996, the Government failed to garner expected revenues. Meanwhile, Yeltsin's June 1996 bid for reelection brought a virtual halt in privatization of state enterprises during the campaign period. In February 1996, the Procuracy announced a full-scale investigation into privatization practices, in particular a 1995 transaction in which state banks awarded loans to state firms in return for "privatization" shares in those enterprises (see The Procuracy, ch. 10). This loans-for-shares type of transaction characterized the second phase of privatization; banks provided the government badly needed cash based on the collateral of enterprise shares that banks presumably would be able to sell later. But most of the twenty-nine state enterprises originally slated to participate withdrew, and the banks that received shares appeared to have a conflict of interest based on their role in setting the rules of the bidding procedure. In the most widely publicized deal, the Uneximbank of Moscow received a 38 percent interest in the giant Noril'sk Nickel Joint-Stock Company at about half of a competing bid. Other banks and commercial organizations joined the traditional opponents of privatization in attacking the loans-for-shares program, and in 1996 the Government admitted that the program had been handled badly. As a result of corruption allegations, the State Duma formed a committee to review the privatization program. And Prime Minister Chernomyrdin requested off-budget funds to buy back shares from the banks.

Despite periodic delays, the inept administration of the program's more recent phases, and allegations of favoritism and corrupt transactions in the enterprise and financial structures, in 1996 international experts judged Russia's privatization effort a qualified success. The movement of capital assets from state to private hands has progressed without serious reversal of direction--despite periodic calls for reestablishing state control of certain assets. And the process has contributed to the creation of a new class of private entrepreneur.

Trends in annual inflation rates mask variations in monthly rates, however. In 1994, for example, the Government managed to reduce monthly rates from 21 percent in January to 4 percent in August, but rates climbed once again, to 16.4 percent by December and 18 percent by January 1995. Instability in Russian monetary policy caused the variations. After tightening the flow of money early in 1994, the Government loosened its restrictions in response to demands for credits by agriculture, industries in the Far North, and some favored large enterprises. In 1995 the pattern was avoided more successfully by maintaining the tight monetary policy adopted early in the year and by passing a relatively stringent budget. Thus, the monthly inflation rate held virtually steady below 5 percent in the last quarter of the year. For the first half of 1996, the inflation rate was 16.5 percent. However, experts noted that control of inflation was aided substantially by the failure to pay wages to workers in state enterprises, a policy that kept prices low by depressing demand.

During most of 1995, the government maintained its commitment to tight fiscal constraints, and budget deficits remained within prescribed parameters. However, in 1995 pressures mounted to increase government spending to alleviate wage arrearages, which were becoming a chronic problem within state enterprises, and to improve the increasingly tattered social safety net. In fact, in 1995 and 1996 the state's failure to pay many such obligations (as well as the wages of most state workers) was a major factor in keeping Russia's budget deficit at a moderate level (see Social Welfare, ch. 5). Conditions changed by the second half of 1995. The members of the State Duma (beginning in 1994, the lower house of the Federal Assembly, Russia's parliament) faced elections in December, and Yeltsin faced dim prospects in his 1996 presidential reelection bid. Therefore, political conditions caused both Duma deputies and the president to make promises to increase spending.

By the end of June 1994, the voucher privatization program had completed its first phase. It succeeded in transferring ownership of 70 percent of Russia's large and medium-sized enterprises to private hands and in privatizing about 90 percent of small enterprises. By that time, 96 percent of the vouchers issued in 1992 had been used by their owners to buy shares in firms directly, invest in investment funds, or sell on the secondary markets. According to the organizers of the voucher system, some 14,000 firms employing about two-thirds of the industrial labor force had moved into private hands.

In July 1995, the RCB announced its intention to maintain the ruble within a band of 4,300 to 4,900 per US$1 through October 1995, but it later extended the period to June 1996. The announcement reflected strengthened fiscal and monetary policies and the buildup of reserves with which the Government could defend the ruble. By the end of October 1995, the ruble had stabilized and actually appreciated in inflation-adjusted terms. It remained stable during the first half of 1996. In May 1996, a "crawling band" exchange rate was introduced to allow the ruble to depreciate gradually through the end of 1996, beginning between 5,000 and 5,600 per US$1 and ending between 5,500 and 6,100.

To encourage the development of the private sector, fundamental changes were made in the tax system, including introduction of a value-added tax (VAT--see Glossary) of 28 percent on most transactions, a progressive income tax, and a tax on business income; revisions in the system of import tariffs and export taxes; new taxes on domestic energy use to encourage conservation (a necessary step because energy prices were still controlled); and new taxes on oil and natural gas exports to narrow the gap between subsidized domestic prices and world prices and to prevent domestic energy shortages (see Taxation, this ch.). A fixed exchange rate was to be established for the ruble, which then would become convertible. Many restrictions on foreign trade and investment also were to be lifted to expose Russia to the discipline of world prices.

 
You can read more regarding this subject on the following websites:

Economic history of the Russian Federation - Wikipedia
AllRefer.com - Russia - Economic Reform in the 1990s - The
Economy of Russia - Wikipedia
Stabilization and Economic Reform in Russia - Brookings
The IMF and Russia in the 1990s, by John Odling-Smee (WP


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