Russia's role in bringing about a deal on Kosovo and its subsequent participation in the peace-keeping force has already had a quid pro quo. This month, the IMF will most likely deliver on the first tranche of funding promised under the $4.5 billion stand-by arrangement agreed with the Russians under ousted prime minister Yevgeny Primakov.
Market sentiment on Russian financial assets has been dominated by the IMF decision. The IMF has said it will pay over the funds (or to be more accurate, write off existing debt obligations by Russia from its books) only if the Russian government implements further fiscal and banking reforms.
The duma passed a bankruptcy law last March. But proceedings against debtors in the courts still take too long. Courts often overrule creditors, who have difficulty liquidating collateral and recovering assets. The IMF wanted a strengthening of the law and for the government bank-restructuring agency, ARCO, to be sanctioned for action in restoring the health of the banking system.
The IMF target for the 1999 budget is a primary surplus of 2% of GDP. The duma had agreed only a 1.7% primary surplus. So the IMF wanted further revenue-raising measures worth 2% of GDP to cover slippage. They included an excise tax on gasoline and alcohol, export taxes on oil, a tax on luxury cars and the postponement of a planned VAT rate cut from 20% to 15% until 2000. Also there was a proposal for a federal income tax of 3%.
The fear was that the duma, hostile to a Yeltsin-appointed government containing reformists, would reject these measures. Then the IMF would refuse funding and other multilaterals would follow suit. That could force the government to default on all its foreign-currency debt, just as the Kiriyenko government did with rouble-denominated debt.
I've always reckoned those fears were overdone. First, the duma's surprisingly easy endorsement of new prime minister Sergei Stepashin after Yeltsin's sacking of their favourite, Primakov, suggested that it would eventually agree to the reforms. After all, it has been tamed by the easy defeat of the Communists' impeachment motion.
Second, duma members are gearing up for December elections and may need the support of provincial governors. Many of these are in Yeltsin's pocket.
What's more, the government does not want to cut off its remaining lifeline for raising international capital by defaulting on existing Eurobond obligations. The new pro-Yeltsin government of Stepashin is just as committed to paying post-1992 sovereign external debt as the pro-duma government of Primakov.
But here's the interesting side to the debate on whether Russia will honour its external obligations. Irrespective of whether Soviet-era debt is defaulted on, or whether IMF funding is forthcoming, enough hard currency will be available to service Russian Eurobonds this year. That's because of the improved external balance springing from rouble devaluation.
There are three drivers behind this transformation. First and foremost, imports are falling dramatically. They are unlikely to pick up this year, judging by the precedent set by the Asian countries during their crisis in 1998. It took them more than 12 months after their currencies devalued before import contraction bottomed out. Asian imports are still falling. That's because real incomes there have fallen 50%, making imports unaffordable. Most Russians have seen what little savings they have inflated away and are owed over 2% of GDP in wage arrears. That will take time to be paid and so keep imports contracting at a 30% to 40% rate through 1999.
Second, export revenue is improving. Unlike Asia, Russia is a massive net exporter of commodities (62% of exports). So, as global growth becomes more synchronized and commodity prices pick up further, Russian exports will recover much more quickly. That will further improve debt-servicing capability.
The Urals oil price is over $3 (or 35%) higher than last year's average. Each dollar increase in the oil price returns an extra $3.5 billion in revenues for the full year. With domestic costs slashed in US dollar terms, the oil and gas giants have stepped up production to take advantage of this. Most of the recent increase in the Urals oil price will be sustained in 1999. That should add between $8 billion and $10 billion in extra revenue to the current account. And the restrictive currency regime should ensure that more of these revenues are repatriated.
Third, non-servicing of Soviet-era debt has cut Russia's foreign-debt interest bill as more of that debt is restructured or defaulted on.
These factors mean that Russia will record a current-account surplus of over $30 billion this year. With the dollar value of nominal GDP down to $160 billion, that's equivalent to 19% of GDP. I reckon capital illegally fleeing Russia last year was around $18 billion. Even if this outflow accelerates, there will still be enough inflows coming through the current account to push forex reserves up to around $21 billion. So Russia should have no problem in servicing its Eurobonds, even if there is no official funding.
But investors also worry that the rouble will collapse under the weight of profligate central bank issue. Again, I'm more optimistic. There's been lower-than-expected inflation following last year's rouble devaluation. Monthly CPI inflation has slowed from 8.5% month-on-month in January to less than 2.2% a month in May, thanks to the central bank's restraint. The central bank has only printed as much money as forex inflows allow. As a result, the rouble has been fairly stable.
And with signs that the economy has bottomed out, the central bank will have less need to print money. Industrial output has already surpassed pre-crisis levels. Extra dollar revenues have enabled Russian enterprises to reduce their arrears. Even the construction sector seems to be picking up. Personal consumption will remain depressed in 1999. But that's unlikely to spell social turmoil.
Of course, there are still a few dark clouds. The government's primary balance swung into a deficit of 3.0% of GDP in March from balance at the start of the year, compared with a 2.0% of GDP surplus target for 1999. Non-interest expenditure has risen sharply this year, mainly to pay down government arrears.