The re-emergence of financial instability in Russia could not have come at a worse moment for the global economy. Although the advanced western economies (except Japan) look robust, much of the rest of the international economy is looking increasingly vulnerable. The crisis in East Asia rolls on, with currencies and markets still weakening in countries like Indonesia, where political upheaval has been heaped upon economic difficulty.
The atmosphere of turmoil on international markets has not been assisted by the tit-for-tat round of nuclear detonations in the Indian sub-continent. The economic consequences are being felt already, as trade and economic sanctions are imposed on both nations and their currencies start to feel the downdraft.
Even Hong Kong, which has held its link to the US dollar so far, is now suffering, with gross domestic product down in the first quarter of 1998. China may be grateful that it has not followed the Russian and Asian route of opening up its financial markets to footloose western capital.
The current economic difficulties in Russia - which could easily spread to the other transition economies of the former Soviet Union and Eastern Europe - first began to emerge early this year when much of the world's attention was on the Far East. The rouble exchange rate, which has been seen by the Russian authorities and the International Monetary Fund as a barrier against inflation, has come under strong attack, as a result of Asian contagion. But more fundamental forces also have been at work. The sharp decline in the international price for oil, one of Moscow's main exports, has damaged exports. Deflation fears also have undermined the price of other Russian natural resources including gold and diamonds, both of which are trading at lower levels.
The Yeltsin administration, fearful of another period of hyperinflation like that seen in the early 1990s, has been aggressively defending the rouble by raising short-term interest rates as and when necessary. In early June short-term rates were tripled to 150 per cent in an effort to demonstrate to speculators a determination to maintain the value of rouble assets and to halt capital flight abroad. However, the high interest rates have had a catastrophic effect on stock markets, where values have come down by 40 per cent. This has damaged confidence, despite the assertion by investment houses like Brunswick Warburg that the problems are only temporary.
Among the keys to the loss of international credibility in Moscow have been President Yeltsin's constant political manoeuvrings and the difficulty the authorities have had in imposing fiscal discipline on the economy. The Latin American response to the Asian crisis was for governments in countries like Brazil and Chile to tighten policy so as to keep the faith of Western financiers. The converse has been true in Russia. There the fiscal situation has deteriorated, largely as a result of President Yeltsin's inability to address the fundamental issue of poor revenue collection, one of the main requirements for IMF funding to Russia.
However, the concern must now be that the long awaited recovery in the Russian economy will be stunted. Output shrunk rapidly over the last seven years as inefficient industries were rationalised and closed down. After shrinking by 2.8 per cent in 1996, the Russian economy was forecast to grow by 1.5 per cent in 1997 and more than 5 per cent this year. But the Asian problems and oil-price weakness have now changed those assessments. The latest IMF forecasts suggest that 1997 growth was less than 0.5 per cent and that this year - even before the most recent setbacks - the Russian economy will do well to achieve a 1 per cent lift in output.
As is always the case with Russia, because of its strategic importance, the US and the rest of the Group of Seven countries are anxious to prevent the crisis spinning out of control. President Yeltsin already has pledged to implement tax collection reforms immediately. He has charged former finance minister Boris Fyodorov, who is trusted in the West, with this task. The requirement is that the swelling budget deficit be held down to 5 per cent of gross domestic product. This should be enough to secure the release of the next $670 million tranche of the IMF's $9.2 billion three-year credit.
But it is not clear if this is enough. The deterioration in the trade balance has seen foreign exchange reserves drop from $14.5 billion last year to around $5 billion in June 1998. This will provide only the smallest of cushions against a new assault by speculators or further capital flight.
Like the Asian countries, Russia is experiencing the downside of open capital markets. Many emerging market economies have been encouraged to remove capital controls so they can enjoy the fruits of an increasingly open trading and financial system. But in lifting these controls the West has failed to point out firmly enough that economic security in the new system depends on keeping to the basics. This means controlling budget deficits, maintaining properly regulated banking and financial systems, and enforcing transparency in monetary policy and foreign exchange reserves. Instead, a new age of insecurity has been created for the emerging markets and the transitional economies.
The tendency under such circumstances is for countries to turn in on themselves, put up barriers and seek to impose rules on foreign capital. As has been seen in Indonesia and Malaysia, such tactics only make conditions worse. Yeltsin, who has always been Russia's leading reformer, appears to realise this, and is counting on an improved fiscal policy to deliver stability. The West clearly understands that Russia is too important, both economically and strategically, to be allowed to fail. Those who have placed their faith in Moscow may be in for a rough ride and a longer transition, but growth will eventually arrive. The journey will just be an unsettling one.
Source: Airline Business
