N 8  1998

The deterioration of Russia’s 1998 trade balance (caused mainly by a decrease in Russian exports) will reduce the current account surplus. This in turn will have a negative effect on Russia’s investment climate. The country’s creditworthiness will suffer and foreign financial institutions may revise their investment strategies downward with respect to Russia.

Tax collection has not improved since the beginning of 1998, which will make it impossible to implement the approved budget. According to official estimates, federal budget revenues will amount to no more than 85 percent of the planned target. The Ministry of Finance plans to reduce budgetary expenditures by 62 billion rubles. Russia’s payment crisis continues, and the government’s debt to state-run organizations continues to grow.

At the beginning of the year, the State Statistics Committee (Goskomstat) recalculated Russia’s 1997 nominal GDP and produced a new, lower figure. Accordingly, Russia’s first-quarter 1998 GDP amounted to 569 billion rubles in current prices. In real terms it remained unchanged from 1997.
 

         Source: Goskomstat RF
 

Fixed investment amounted to 63.5 billion rubles in the first quarter of 1998. In real terms, it decreased by 7.1% compared with the same period last year. One of the main reasons for this decline is that in 1998, Russia’s largest oil and gas companies (which account for up to 60% of total investment) reduced investment spending on investment projects. Leading companies such as Gazprom and LUKoil plan further reductions later this year.
 

 Source: Goskomstat RF
 

* - In this survey, figures representing percentage of GDP are different from those cited in previous surveys due to the recalculation of Russia’s 1997 GDP by Goskomstat

According to estimates based on data provided by the Federal Treasury, consolidated budget expenditures from January through February 1998 (including local non-monetary offsetts) amounted to 82.9 billion rubles, or 21.1% of GDP. According to the Treasury’s report, consolidated budget revenues grew by 15% in real terms in the first two months of 1998, compared to last year’s figure of 65.3 billion rubles. This growth occurred due to an increase in tax revenues. In February, they increased by 11% in real terms and amounted to 35.1 billion rubles.
 

 
    Source: Goskomstat RF
 

According to the Treasury’s report, from January through February the consolidated budget deficit amounted to 9.0 billion rubles, or 2.3% of GDP.

Expenditures on public debt service were 28.5 billion rubles (or 5.0% of GDP) in the first quarter of 1998. March payments of coupon interest to OFZ-PD holders amounted to about 8 billion rubles, while 5 billion rubles in new securities were issued. In the first quarter of the year, debt service costs decreased by 21% compared to the previous year due to a decrease in yields on GKOs during 1997. However these costs will rise in the second half of the year due to high yields at the end of 1997.

According to the State Tax Service, federal tax arrears (budgetary funds excluded) amounted to 102.6 billion rubles as of April 1. Despite a significant volume of off-sets in January through February (18.4 billion rubles), federal tax arrears grew by 8.7 billion rubles in the first quarter of the year. Most of this growth was the result of 7.2 billion rubles in VAT arrears and 1.1 billion rubles in gas excise tax arrears.
 

RF Ministry of Finance
 

According to the Treasury’s operative report, the federal budget deficit calculated on a cash basis amounted to 22.3 billion rubles (3.9% of GDP) in the first three months of 1998. Such a deficit is much smaller than that planned for the first quarter (30.8 billion rubles).

Budget Deficit Financing According to IMF Standards. According to preliminary estimates, the budget deficit calculated on a cash basis in accordance with IMF standards amounted to 26.2 billion rubles (4.6% of GDP) in the first quarter of the year. As a result, the IMF’s target (35 billion rubles), which henceforth will be calculated on the basis of governmental commitments, was met (mutual debts accumulated in the first quarter excluded).

In late March, Russia placed the first of this year’s Eurobond issue, denominated in DM. Revenues from this placement amounted to 4.2 billion rubles. The largest part of the budget deficit was financed through the issue of GKOs and OFZs (22.1 billion rubles). Nearly all funds raised through the issue of these securities were used to redeem previous issues (21.1 billion rubles). Annual interest payments to OFZ-PD holders took place in March, amounting to 8 billion rubles. Of this amount, 5 billion was raised through the issue of new securities.
 

 
RF Ministry of Finance
 

Cash accounted for 53.9% of tax payments in 1997. However cash accounted for more than 70% of tax payments in only six subjects of the Russian Federation [Moscow (93%), the Krasnoyarsk Territory (97%), the Taimyr autonomous district (90%), the Republic of Ingushetia (73%), the Tula Region (72%) and St. Petersburg (80%)]. This group includes both rich regions (Moscow, St. Petersburg) and poor (Ingushetia) and medium-wealth regions (Tula region). The regions where cash payments account for less than 30% of tax payments include those with both large and minimum tax revenues. For instance, cash payments accounted for less than 18% of tax payments in the Khanty-Mansi autonomous region (relatively rich) and in the Republic of Chuvashia (relatively poor). This shows that the share of non-monetary instruments is determined by fiscal policies pursued by local governments rather then by the wealth or poverty of particular regions.

Changes in the share of revenues collected within a region in the total revenue of the region are different in different regions. This indicator grew by more than 5 percentage points in 19 regions and by between 0 and 5 percentage points in 22 regions. It declined by less than 5 percentage points in 24 regions and by more than 5 percentage points in 23 regions. The distribution of territory between these groups is an indicator of internal resources. Moreover, a process of regional redistribution between groups of donors and recipients of federal budget transfers is currently taking place.

In 1997, the share of transfers from the Fund for Financial Support of Subjects of the Russian Federation as a percentage of the total amount of local budget revenue decreased by more than 5% in only 4 regions, including the Bryansk, Astrakhan and Penza regions and the Taimyr autonomous region. This share decreased by less than 5% in 24 regions. An increase in the share of transfers in total revenues by less than 5 percentage points was registered in 32 regions, while an increase by more than 5 percentage points was registered in 19 regions. In other words, financial support from Russia’s regions began to play a more important role in 1997.

Local budget deficits increased significantly last year. The aggregate local budget deficit grew from 5.8% of revenues in 1996 to 7.3% in 1997, or from 0.9% to 1.2% of GDP. In 1997, the greatest deficit as a percentage of expenditures was registered in the Koryak autonomous district (54.5%) and the Aginsk Buryat autonomous district (54.4%). The greatest budget surplus as a percentage of expenditures was registered in Moscow (3.6%) and the Irkutsk region (3.4%).

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In the first quarter of 1998 the Central Bank’s monetary policy was characterized by further tightening of the money supply. At the end of the first quarter of 1998, after a signifcant decrease in January and stability in February and March, the monetary base was 7.2% smaller than at the end of December 1997. At the end of February, Russia’s money supply was 2.1% smaller than in December 1997.

This goal-oriented tightening of the money supply, which began in November 1997 and continued in 1998, was prompted by instability on domestic financial markets. An increase in the amount of ruble funds had an immediate effect on the foreign exchange market and increased pressure on the ruble exchange rate. As a result, the money supply decreased on average by 1% every month since the beginning of the year, while planned montly growth was 1.7-2.2%. Loosening of monetary policy can be expected in the second quarter on the condition of foreign capital inflows and financial market stability.

From January through March 1998, Russia’s gross foreign currency reserves decreased by more than $2 billion. This decrease was prompted by instability on the foreign exchange market at the beginning of the year and subsequent foreign currency sales by the Central Bank. In March, gross international reserves increased by more than $1.8 billion due to Central Bank intervention on the foreign exchange market and foreign borrowing which had not yet been converted as of April 1. Russia’s net international reserves also decreased in January (by $2.5 billion) and grew in March (by more than $1.8 billion) to total about $2.4 billion by the beginning of April. The share of net international reserves in the monetary base grew to 9% by the end of the first quarter. However, an increase in reserves in March could not compensate for their decrease over the previous two months. As a result, net international reserves were smaller at the end of the first quarter than in December 1997.
 

 
Source: Goskomstat RF, Central Bank of Russia
 

In February, Russian and foreign investors resumed purchases of government securities and as a result, yields decreased from 46 to 30% per year. This made it possible for the Central Bank to reduce the refinancing rate to 39%. The inflow of non-resident funds into the GKO/OFZ market continued in early March, predetermining a decrease in yields to 25%. The refinancing rate was reduced to 36% in March and then to 30%. However, a political crisis provoked by the dismissal of the government on March 23 prompted a new rise in yields on government securities to 32%.

Inflation. This year, the rate of consumer price growth decreased from 1.5% in January to 0.9% in February and 0.6% in March. In the first quarter of 1998, inflation amounted to 3.0% and was lower than in the first half of 1997 (5.3%). Inflation decreased due to a low ruble devaluation rate (prices for manufactured goods increased by only 1% from January through March) and a decrease in consumer demand associated with a decline in personal income and a growth in deposits.

Producer prices increased by 0.9% in January and 0.8% in February. In March, they decreased by 0.1%. In the first quarter of 1998, manufacturers’ prices grew by 1.6% compared with 4.1% in the same period last year. Factors that slowed growth in manufacturers’ prices included a decline in international (and consequently export) prices for primary fuels, a large amount of barter transactions, and growing of enterprises arrears.
 

 
          Source: EU VEDI, Goskomstat RF
 

 
      Source: Goskomstat RF
 

The share of individuals’ funds used in payment for goods and services as a percentage of total expenditures increased, which occurs naturally under conditions of declining real income. The pattern of personal savings also changed. According to Goskomstat, spending on foreign currency purchases decreased from 21.9% of aggregate income from January through March 1997 to 14.4% during the same period for 1998. Meanwhile, private individuals’ commercial bank deposits grew (from January through March 1998 by 8.4%). If data confirming a decrease in households’ demand for foreign currency prove to be correct, one can assume that deposits grew as a result of an increase in interest rates. Commercial banks, including the Savings Bank of the Russian Federation (Sberbank), now attract money with promises of 18% to 22% annualized interest on three-month deposits.
 

 

 
        Source: Goskomstat RF
 

Trade Balance. From January through February 1998, Russia’s trade balance was positive ($1.2 billion) with exports amounting to $11.5 billion and imports amounting to $10.3 billion.

In money terms, Russia’s exports continued to decrease from January through February due to a decline in international prices. In January 1998, Russia’s exports decreased by 17.5% compared to the same period last year. In February, they decreasd by 14.1%. Meanwhile, the growth of exports to CIS countries observed in the second half of 1997 resumed in February. This was largely due to the abolishment on February 1 of VAT on goods imported as part of Russian-Ukrainian trade. In February, exports to CIS countries grew by 4.9%, while exports to the “far abroad” decreased by 8.2%.

Russia’s imports continued to grow rapidly in the first two months of 1998 due to an increase in imports from countries outside the CIS. Russia’s imports grew by 17.3% in January compared to the same period last year, and by 11.5% in February.

1997 Balance of Payments. Last year, the current account surplus amounted to $3.3 billion, nearly a 75-percent decrease compared to 1996 ($12.0 billion). This was due to a worsening trade balance and an increase in payments on investment income.

In money terms, the export of Russian goods decreased by $1.8 billion, or 2% in 1997, with export of goods to the “far abroad” decreasing by 3% and export to CIS countries increasing by 4%. Russia’s imports increased by $3.9 billion, or 6%. Russia’s trade balance decreased by $5.8 billion, or 25%.

In 1997, the balance of services changed marginally compared to the previous year. Interest payments to non-residents grew by 33%, from $9.1 billion in 1996 to $12.1 billion in 1997. This was due to interest payments on investment in the government sector (interest payments grew by $2.7 billion, or 39%).

According to the Russian Central Bank, last year the outflow of capital from Russia was practically equal to its inflow. In 1997, the net outflow of capital from Russia amounted to only $0.7 billion, compared to $14.3 billion in 1996.

The inflow of non-resident funds increased from $25.4 billion in 1996 to $44.2 billion in 1997. This was due to an increase in the inflow of capital into the state administrative sector from $14.8 to $20.0 billion. Last year, non-resident investment in GKOs and OFZs amounted to $10.9 billion, while investment in municipal and MinFin bonds amounted to $4.8 billion. Direct investment grew nearly three times in 1997 and amounted to $7.1 billion compared to $2.4 billion in 1996. At the same time, the volume of new loans raised during that period decreased from $8.7 billion in 1996 to $7.5 billion in 1997. Russia’s debt to the London Club of creditors was rescheduled in the fourth quarter of 1997. This made possible the resumption of large overdue loan repayments ($24.7 billion) through the raising of new loans.

In 1997, the net inflow of capital into the government sector amounted to $19.1 billion, compared to $14.4 billion in 1996. Net foreign banking liabilities grew by $7.9 billion in 1997, compared to growth in 1996 of $1.3 billion.

In 1997, the export of private capital from Russia grew to $44.1 billion, from $39.3 billion in 1996. Foreign assets of the non-financial private sector grew by $35.2 billion, compared to growth of $28.5 billion in 1996. According to data based on Russia’s balance of payments, households purchased $13.4 billion in foreign currency in 1997, or $4.3 billion more than in 1996. During the same period, trade credits and advances amounted to $7.0 billion, compared to $9.5 billion in 1996. Overdue export revenues grew by $4.6 billion ($5.5 billion), while unrepaid import advances grew by $6.9 billion ($4.3 billion). In 1997, unaccounted capital outflows (errors and ommissions) were estimated at $8.2 billion. During that period, total capital exports from Russia amounted to $44.9 billion, compared to $39.7 billion in 1996.

Exchange Rate. In the first quarter of 1998, the nominal exchange rate grew by 2.5%, from 5.960 to 6.106 rubles/dollar. This growth was smaller than that of the consumer price index during the same period (3.0%). On the Moscow Interbank Currency Exchange (MICEX), the exchange rate grew by only 1.9% during the first quarter of the year. The exchange rate grew most rapidly in March, while the ruble devaluated by 0.3%. Thus the real strengthening of the ruble which occurred in January and February (the ruble appreciated by 0.1 and 0.8% respectively) as a result of the Central Bank’s anti-crisis measures was slightly offset. In real terms, the ruble appreciated by 0.6% in the first quarter of 1998.

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Foreign investment in the non-financial sector amounted to $10.5 billion in 1997, having grown 1.6 times compared to 1996 (in 1996 they grew 2.3 times). Foreign investment in the non-financial sector amounted to $6.5 billion in 1996 and $2.3 billion in 1995.

Direct investment grew 1.9 times in 1997 compared with the previous year (in 1996 it grew by 11% compared with 1995). Direct investment accounted for 37.1% of total investment in 1997, compared with 32.2% in 1996. Other investment (trade credits, bank deposits, etc.) grew by 43.2% and accounted for 59.6% of total investment. In 1996, it grew 5 times and accounted for 67.2% of total investment.

In 1997, $3.3 billion in foreign investment was channelled toward Russian industry. Of this amount, 30.2% was direct investment, compared to 57.2% in 1996. Direct foreign investment was mainly directed toward the food and fuel industries, non-ferrous metallurgy, and the machine-building and metal-working industries (85.2% of total direct investment in industry). There was practically no foreign investment in agriculture - $5.2 million, or almost 0.0% of total foreign investment. Most foreign investment was directed toward the financial sector and commerce.

As of January 1, 1998, gross foreign investment in Russia amounted to $21.8 billion (monetary authorites and the banking sector excluded). According to estimates, direct per-capita foreign investment in Russia amount to $47. This is significantly less than the similar figure for Poland of $300.

In terms of the distribution of inter-regional foreign investment in 1997, most was channeled into the Central Economic Region and Moscow (81.4% of total foreign investment, with the exception of monetary authorities and the banking sector), raw material producing regions in Western Siberia (6.7%), large machine-building centers in the Volga region (3.2%), and regions bordering those of foreign investors.

Many local governments in the Russian Federation implement measures to support foreign investors. The legal base for foreign investors includes measures such as guaranteed tax incentives. Such legislation exists in the Primorski Territory, on Sakhalin Island, in the Pskov Region, and in the Republic of Tatarstan.

Foreign ruble investment is actually investment by foreign companies already operating in the Russian Federation. Such investment is comprised of reinvested company profits. Ruble investment from abroad thus shows the level of foreign investor confidence in the stability of the Russian economy. In 1997, the ruble component of foreign investment amounted to 10.4 trillion rubles (about $1.7 billion), some 4.4 times greater than in 1996 (in 1996, it grew 2.8 times compared to 1995). Of this amount, 8.3 trillion rubles, or 79.9% of total foreign ruble investment, was direct investment (compared to 75.3% in 1996). In 1997, direct investment grew 4.6 times (compared with 2.7 times in 1996).
 

 
        Source: Goskomstat RF  

In 1997, large foreign investment was made in Central Russia (81.1% of total investment), North-Western Russia (7.1%), the Russian Far East (3.1%) and Western Siberia (2.1%).

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Under present economic conditions, real GDP is not likely to grow by more than 1% in 1998. In terms of changes in GDP components, one may expect that consumption will increase by 2% under favorable conditions, investment will remain at the existing level and net exports will decrease by 1.4%.

In 1998, industrial output will increase by 1.5%, while output by large and medium-sized enterprises will decrease by 0-1%. The greatest increase in production is expected in non-ferrous metallurgy (7-9%), light industry (4-5%) and machine-building (2-2.5%). A decline in production is expected in the construction materials (-3 to -6%) and fuel industries (-3 to -6%). Fixed capital investment will continue to decline, by 2-3%.

According to Goskomstat data, inflation will not exceed 8% in 1998, while money supply growth (M2) will not exceed 24%. The reduction of yields on government securities to 22-24% by the end of 1998 is considered a target for 1998.
 
According to expert estimates, the current account surplus will decrease from $3.3 billion in 1997 to $0-0.5 billion in 1998. The exchange rate will increase by 6.2-7.0% in 1998. By the end of the year, it will amount to 6.4 rubles to the dollar.