Hoover Daily Report

Review of the World Bank's "Russian Economic Report, October 2001"

via russianeconomy.org
Tuesday, December 4, 2001

The World Bank is an important international organization with a substantial budget. As part of its global operations, it maintains a large office in Russia. It underwrites various Russian economic projects running in the hundreds of millions of dollars. In October 2001, the Moscow office of the World Bank issued the first of a new series of quarterly economic reports on Russia, which are intended to describe major economic trends and issues facing the economy. The inaugural issue also contains a special focus on the efficiency of public investment in Russia, based on work carried out by the World Bank as part of its assistance program to the Russian Federation.

Along with the International Monetary Fund, the U.S. Treasury, the European Bank for Research and Development, and numerous centers for the study of transition economies in universities and central banks, the World Bank is an important indicator of current thinking on the problems and prospects of the Russian economy, and a guide to policies that are under consideration in international and Russian economic and political circles.

We begin with our conclusion. The report presents no coherent framework or analysis of recent economic developments in Russia. The report is purely descriptive of current trends. Its authors make no attempt to develop or offer an analytical framework to explain Russia's sustained contraction during 1992–1998, or put current growth in the context of past contraction. Insofar as Russia's recent growth in 1999–2001 is concerned, the authors point to high oil prices and the devaluation of the ruble, which accompanied the default of August 17, 1998. Devaluation, in the Bank's view, gave a temporary boost to the competitiveness of domestic industry. The Bank is worried that a continued rise in the real effective exchange rate (REER), or real appreciation of the ruble (RAR), and/or lower oil prices threaten to slow future growth.

Here are the main points in the World Bank's inaugural "Russian Economic Report":

  • The sustainability of current high growth appears fragile. The average growth rate of capital investment at 7.3% during the first seven months of 2001 is sharply lower than the 16.9% during the same period in 2000.

  • As a share of GDP, investment decreased from 17% in 2001 to 13.5% in 2001.

  • The share of credits extended to the private sector with maturity exceeding one year decreased from 25.7% in 2000 to 7.4% in 2001.

  • Commercial banks continue to refrain from long-term lending to the real sector, even though they have accumulated over R250 billion in their accounts with the Central Bank of Russia, which currently yield negative real interest rates.

  • The share of loss-making companies remains high at 38.6% through June 2001, although down slightly from 41.6% in December 2000.

  • Enterprises continue to use their suppliers (arrears to suppliers increased 11.9% in nominal terms) and state budgets at all levels (arrears increased by 9.8%) as their main sources of implicit subsidies to acquire working capital.

  • Inflation remains moderate (13.9% for the first three quarters of 2001). The reasons are large fiscal surpluses held at the Central Bank, increase in money demand caused by a recovery in domestic industrial output and real appreciation of the ruble (RAR rose 7.1% during January-May 2001), and the reduction in non-cash settlements and barter. However, the growth of the money supply absorbed by the demand for cash balances (real M2 grew 113% in 1999, 84% in 2000, and only 27% during January-August 2001) has slowed drastically.

  • Capital outflows remain at the same levels as in the past, amounting to over $10 billion in the first half of 2001.

  • The budget is in surplus, the first in the history of the Russian Federation.

  • Moody's has raised Russia's sovereign risk from B3 to B2 and changed the outlook from "stable" to "positive."

What, in the view of the World Bank, is the implication of these trends? Sadly, the report is almost totally lacking in projecting future trends. It has, as we said at the outset, no framework within which to assess current data and place them in the context of past trends or future prospects. All that it can do is report the numbers.

The Bank wants to see the growth of a real banking sector, but offers no ideas on how to create one.

The Bank wants to see diversification away from heavy reliance on natural resources, but offers no ideas on how to convert loss-making industrial companies into profitable ones.

The Bank is concerned that future growth is overly dependent on volatile natural resource prices, and is worried about high capital outflows, but praises, as one element in the government's reform agenda, a reduction in the mandatory repatriation of export earnings from 75% to 50% that became effective in July 2001.

The Bank is concerned that productivity growth lags behind exchange rate appreciation, yet offers no ideas about closing inefficient enterprises.

The Bank is concerned about the continued growth in arrears, but offers no explanation of their origin and nature, their increase or how to reverse the trend.

The Bank is concerned about a slowdown in growth, but offers no ideas about how to reverse the trend.

We have in Chapter 1 of From Predation to Prosperity and in numerous "Comments and Articles" (e.g., "Bush and Putin at the Ranch"and "Can More Liberal Subsidies Spur Growth and Reduce Inflation?") put forth a coherent framework that accounts for the sustained contraction of 1992–1998 and the high, albeit now slowing, growth of 1999–2001. The explanation is really quite simple. An increase or decrease in receivables (arrears) either congests or eases the payment jam between enterprises, concurrently increasing or decreasing tax remittance to the government. As we have repeatedly explained, the Central Bank's policy of mandatory repatriation of 75% (now only 50%) of export earnings eased the payment jam through an increased supply of rubles (which people are willing to hold) thereby making it possible for the government to enforce tax remittance, without running the risk of bankrupting enterprises by seizing the cash flow they require to remain in business.

We have shown that high oil prices coupled with the Central Bank's mandatory repatriation policy are the main sources of recent growth. We have forecast that the reduction in mandatory repatriation of export earnings from 75% to 50%, coupled with a fall in oil prices, will slow growth. If oil prices remain low for an extended period of time, the Russian economy will shift from growth to contraction. We have shown that the "Dutch disease," or concern about REER (RAR) is misguided. Russia exports almost no industrial products. The Russian ruble remains substantially undervalued.

To summarize, the World Bank's inaugural "Russian Economic Report" is a compendium of recent figures, held together by an framework of traditional IMF/WB descriptive economic categories, but without any theory of contraction and growth, especially as it relates to the Russian economy.