ECONOMIC
TRANSITION OF RUSSIA
Lecturer – Oleg Deev
oleg@mail.muni.cz
Contents
• Key factors of Russian economic development
• Conditions of the transformation
• Objectives and goals of the transformation
• Transformation procedures
• Macroeconomic situation during the transition
• Results of transformation
• The 1998 financial crisis
• Economic growth 1999-2008
• Russia during the global financial crisis
• Challenges for the future development
John Maynard Keynes in 1925
• “The economic system of Russia has
undergone such rapid changes that it
is impossible to obtain a precise and
accurate account of it… Almost
everything one can say about the
country is true and false at the same
time”
Key factors of Russian economic
development
• The largest country in the world - 17,075,400 square
kilomètres
Key factors of Russian economic
development
• The world’s largest reserves of mineral and energy
resources
Key factors of Russian economic
development
• Conflict between the center and the periphery (diversity of
population, nationality and religion)
• 160 different ethnic groups and indigenous people
• Religion groups – Russian Orthodox Christianity, Muslim,
Buddhism, Catholic, Protestant, Jewish, beliefs (shamanism,
pantheism, paganism, etc.)
• Induction into religion takes place primarily along ethnic lines
• Majority of ethnic groups are settled in certain areas
• In modern Russia several ethnic groups have a partial sovereignty
– 21 republics with its own constitution, president, and parliament
within the Russian Federation
• The public finances are generated in the regions, transferred to the
center, and only then re-allocated back to the regions
Key factors of Russian economic
development
• Conflict between the center and the periphery (diversity of
population, nationality and religion)
Key factors of Russian economic
development
• Lack of investment in infrastructure
• One of the world’s longest webs of railways, highways and subways
• the European part is more developed than the Asian part
Key factors of Russian economic
development
• Vast territory
• Natural resources
• Conflict between the center and the periphery
• Lack of investment in infrastructure
• Authoritarian nature of governance to control the territory
• Huge expanses on defense and military
• The origins of investments are mainly internal
Starting conditions of the transition
in late 1980s - social
• Low level of social inequality
• as low as in Scandinavian countries
• Relatively low level of corruption
• Relatively low crime and mortality rates
• Immense investments in the human capital
• Free high-quality education in every level
• One of the best education system in the world
• Free health care to all citizens
• Relatively high life expectancy level
• Highly developed theoretical science and innovation at the
theoretical level
Starting conditions of the transition
in late 1980s - economic
• Centralized bureaucratic allocation replaced market allocation
• Economic policy making was strictly hierarchical
• Macroeconomic situation – closed economy with the volume of
money exceeded the volume of goods;
• Microeconomic situation – people demanded other goods than
those supplied
• No initiative behavior among people and enterprises
• Economic distortion of prices
• Structural dysfunction of the economy (with prevailing heavyindustries
enterprises)
• Budget deficit – more than 6% of GDP
• Excessive foreign debt – 30 to 40% of GNP
• Falling oil prices
• Economic growth – 1 to 3%
USSR economic experiments of
systematic changes
• 1920s – NEP – New Economic Policy
• 1930s – Industrialization & Collective farming
• 1950s – Khrushchev’s reforms
• 1960s – Brezhnev’s reforms
• 1980s – Gorbachev’s reforms – transition to indicative
planning; introduction of some market mechanisms –
leased enterprises, family farming, joint ventures with
foreign capital
• ended up with political democratization
• Reforms did not change the planned nature of the
economy
Objectives
• Restructuring of the national economy
• Macroeconomic stabilization
Goals
• Deregulation and promotion of competition
• Prices and interest rates liberalization (if to let go the
prices, the output might be saved)
• Liberal foreign trade police (open market)
• Establishment of property rights
• Development of the market economy institutions
Starting the transition
Boris Yeltsin Yegor Gaidar
Price liberalization – early 1992
-9
-6
-3
0
3
6
5
10
15
20
25
30
1Q1992
2Q1992
3Q1992
4Q1992
1Q1993
2Q1993
3Q1993
4Q1993
1Q1994
2Q1994
3Q1994
4Q1994
Average monthly growth rates of money supply (M3),
prices and industrial output by quarters, %
M3 (left scale)
Prices (left
scale)*
Industrial
output (right
scale)*
*Lagged 4 months.
External liberalization - 1992
20
30
40
50
60
70
80
90
100
1993 1994 1995 1996 1997 1998
Russia's foreign trade, billion $
Export
Import
Trade surplus
Privatization – since 1988
• Spontaneous privatization (1988-1991)
• control over some industrial assets was acquired by their managers
• this accounted for only several thousand enterprises, a small part
of the Soviet industry
• Voucher privatization (1992 - 1994)
• each voucher were corresponding to a share in the national wealth
• vouchers were distributed equally among the population, including
minors
• vouchers could be exchanged for shares in the enterprises to be
privatized
• low price of vouchers $7-10 – less than an average monthly wage
• most shares were acquired by the management of the enterprises
Privatization – since 1988
• Loans for shares (1995)
• included most oil, gas and other natural resource-based
companies, which were highly profitable ones and were supposed
to be sold for cash
• industrial assets were leased through auctions for money lent by
commercial banks to the government
• the auctions lacked competition, as they were largely controlled by
favored insiders
• scheme that gave rise to the class of Russian business oligarchs,
who have concentrated enormous assets
• banks and enterprises involved in the scheme stopped seeing an
interest in maintaining high inflation
Macroeconomic instability
1
10
100
1000
10000
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Annual inflation rates in Russia
(December-to-December increase in CPI, log scale)
2510
Anti-inflation policy – 1992-1998
• First half of 1992 (Gaidar). Growth of money supply was
restricted; inflation fell to 10% a month in summer 1992;
as a consequence, massive non-payments emerged
• First half of 1994 (Chernomyrdin). Tightened monetary
policy allowed to bring down inflation to 5% a month in
summer 1994; again, non-payments increased
• mid 1995: exchange rate based stabilization; inflation
brought down to 6% a year (July 1998 to July 1997);
currency crisis in August 1998, acceleration of inflation
Why high inflation was so persistent?
• There was no consensus among major lobbying groups,
how to finance reforms, therefore it was impossible to
balance the budget
• Problems with tax collection: high level of tax evasion in
the 1990s. The government was willing, but not able to
increase tax revenues
• Attempts to tighten monetary policy caused non-payments
What was expected?
-0,3
-0,25
-0,2
-0,15
-0,1
-0,05
0
0,05
0,1
0,15
1985 1987 1989 1991 1993 1995
Government
CIA
Government, May 1990,
shock therapy
Government, May 1990,
gradual reform
Gosplan, March 1991
Pavlov, April 1991, if no
measures are taken
Pavlov, April 1991, shock
therapy
GNP growth rates,
%
Results (1991-1998)
• Free market
• Private business – 70% of GDP
• Huge fall in output
• High inflation
• Income redistribution
• Privatization – controversial results
• people’s disapproval & emergence of oligarchs
• Organized crime and corruption
• Capital flight – $20 billion a year
• The development of barter economic relations and dollarization
• Unemployment and poverty
• Deterioration of education system, health care, demographics
• Inadequate pension system
• Inefficient legal system
• Existence of shadow economy
GDP growth rates, %
-15
-10
-5
0
5
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Personal incomes - % of level in 1991
Human development
Human development
Human development
Russian financial crisis – August 1998
20
30
40
50
60
70
1992 1993 1994 1995 1996 1997 1998
Consolidated government revenues and expenditure,
% of GDP
Expenditures Revenues
Russian financial crisis – August 1998
0
2
4
6
8
10
12
14
16
18
20
1992 1993 1994 1995 1996 1997 1998 1999 2000
Budget Deficit, % of GDP
Russian financial crisis – August 1998
0
10
20
30
40
50
60
70
1994 1995 1996 1997 July 1,1998
Government debt, % of GDP
Short-term debt (GKO-OFZ) held by the banks
Short-term debt held by CBR
External debt
CBR credits to the government
Russian financial crisis – August 1998
• 1997 - Inflow of portfolio investment of $46 billion
or 10% of GDP
• High volatility of exchange rate – ruble/USD (high
valuation of ruble)
• Extremely high interest rates
• 1998 – world price for Russia’s oil – 10$ per
barrel
• The government was not able to refinance it’s
debt
Measures – August 1998
• Devaluation of the ruble
• At the moment the ruble/dollar trading band was expand
from 5.3-7.1 RUR/USD to 6.0-9.5 RUR/USD
• Later the RUR/USD rate was set to move freely within
the wider band
• Default on domestic debt
• To prevent mass Russian bank default Russia's rubledenominated
debt would be restructured
• A moratorium on payment to foreign creditors
• A temporary 90-day moratorium was imposed on the
payment of some bank obligations, including certain
debts and forward currency contracts
Russia's 1998 financial collapse
• In a matter of days the exchange rate lost over
60% of its value
• more than in all most Latin American and Southeast Asian
countries (except for Indonesia)
• Prices increased by nearly 50% in only 2 months
after the crisis
• as compared to less than 6% annual inflation July 1998 to July
1997 before the crisis
• Real output fell by about 6% in 1998
• after registering a small increase of 0.6% in 1997 for the first time
since 1989, it fell in January - September 1998, i.e. mostly
before the August 1998 crisis
Why was the drop so drastic?
• Some of the standard explanations
• Bad institutions
• Natural resource dependence
• Bad policies
• For a medium income level country, Russia is
trade wise open
• Financial dependence proved important
• Short-term debt was concentrated and fast growing
• Dependence of financial intermediation on foreign
funding
• The dual financial system: households and most
companies using domestic markets; some big
companies and banks dependent on foreign markets
Measures 1998-1999
• Budget reform
• Expenditures and arrears reduction
• Revision of expenditures
• Taxation reform
• The creation of efficient taxation system
• Changes in banking sector
• The worst half of the banks was closed
• Strengthening the governance of banks
• The payment system improvement
So why the talk of a safe haven?
• Politicians were not in the business of doom-saying
• Shifting blame to where it belonged: global
imbalances
• Good grounds why a pure financial crisis might
handle Russia softly
• Small financial sector with limeted role in investment
finance
• Strong public sector financial position – taxation reform
• Households with no financial wealth, little debt: no
wealth effect on consumption
• Labor markets expected to be very flexible
• Boom in industry
• After devaluation, domestic producers were
taking advantage of new export opportunities and
made shift from foreign to Russian made goods
• Devaluation of the previously overvalued
currency restored the previously lost
competitiveness
• Output was falling in the beginning of 1998, but
started to grow in October (unlike in East Asia,
where output fell after the currency crises)
After the crisis
Economic growth – 1999-2008
1
10
100
1000
10000
-15
-10
-5
0
5
10
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
GDP growth rates and inflation (right axis, log scale), %
GDP growth rates
Inflation (CPI, Dec. to Dec.)
Output is growing, inflation is under
control
Oil price grows, GDP does not accelerate
0
10
20
30
40
50
60
70
-15
-10
-5
0
5
10
15
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Oil prices ($ per barrel, right scale)
and GDP growth rates (%, left scale)
Oil price
GDP growth rates
Russia’s anti-crisis policies – 2008-2009
• Basically similar to those in other countries
• Package of tax reforms, reducing the tax burden
• Emphasis on monotowns, pensions, minimum wages crisis
fighting as a social policy measure
• Since 2005 - emphasis on social policy, with view on demography
(national priority programs). In practice - expenditure on health,
education and housing are stable as share of budget, increasing in line
with total expenditure
• Since 2007 - decisions to increase pensions, minimum wages, public
sector salaries were made
• Structure of the banking system left no alternative
to ”favoring” state-controlled banks as liquidity
channels
Challenges for the future
• Unpredictable export revenue
• Oil price
• Energy efficiency needed for maintaining export volumes
• Changes in gas markets
• Regaining budget surplus
• Re-accumulating reserve funds is a high priority
• Expenditure pressure due to recent hikes, long-term needs
• Revenue problem due to declining share of energy sector in GDP
• Exchange rate policy
• Increased flexibility of nominal rate, no pure inflation targeting
• Real exchange rate appreciation pressures as financial inflow resumes
• Financial system development
• Rolling back the state
• Need for long-term domestic funding
• Pension reform
• Increasing dependency ratio
• Previous failures to depart from pay-as-you-go
• Competitiveness of jobs