IMF Conditionality and Objections: The Russian Case

American Journal of Economics and Sociology, The, April, 2001 by Jorge Martinez-Vazquez, Felix Rioja, Samuel Skogstad, Neven Valev

NEVEN VALEV [*]

ABSTRACT. Emerging economies in crisis typically request assistance from the International Monetary Fund (IMF). After evaluating the situation, the IMF makes a loan available to the country, conditional on certain policy reforms. Governments usually resist many of these measures and negotiation ensues. This paper analyzes the most contentious measures of IMF coditionality in the context of Russia after the August 1998 crisis. The most discussed measures include the budget deficit, structural reforms, and exchange rate policy. Our analysis suggests that to some extent the disagreement arose because the IMF is focused on changing steady states somewhat ignoring the transition path, wile the Russian government is preoccupied with transitional dynamics without a clearly defined steady state concept.

I

Introduction

EVENTS FOLLOWING financial crises in developing countries resemble a well-rehearsed screenplay. Often, the first actors on the scene are an International Monetary Fund (IMF) team who assess the size and causes of the foreign exchange crisis and draft stabilization plans. Invariably, there is a domestic government that has an un-financed gap between foreign exchange payments and inflows expected in the near term. The government typically is reluctant to adopt the conditions attached to the IMF's financial assistance. The IMF team is confronted by indignant government officials who claim that the IMF plan is not specific to the features of the country, is unnecessarily painful, is unreasonable, etc. This recurrent sequence of events has become so familiar to observers that few pay close attention to the specifics of the argument. What does the IMF want to accomplish in that country by way of its proposed policy adjustments? Why does the home government so often disagree? Are the government officials simply self -interested? Are there problems in the IMF's plan?

This paper analyzes the basis of IMF conditionality as well as the typical objections of emerging countries' governments. These are difficult issues to analyze in a general context. Hence, we concentrate on negotiations between the IMF and the Russian government following the ruble devaluation and implicit debt default of August 1998. While this paper focuses on Russia's case, many aspects of the Fund's conditionality and the home government's objections are common to negotiations with emerging economies worldwide.

Transition has been turbulent in Russia, with periods of extreme volatility taking turns with periods of macroeconomic stability. The one persistent theme throughout the last decade has been a budget deficit as the Russian government inherited a significant mismatch between revenue potential and expenditure needs. The prolonged economic stagnation has not allowed much improvement in this respect. Hence, most of what happened and is happening in Russia circles around the budget. In the early 1990s, the deficit was financed by money creation, leading to high inflation. In the late 1990s, inflation was contained as the government filled the budget gap by borrowing, but, as a result, private investment was crowded out.

By 1998, the budget and the banking system were deeply entangled. The government needed the banks to channel domestic and foreign savings to the state, and banks were profitable because of the high interest rates on government bonds. It took some external pressures (i.e., the Asian crisis and the collapse in world energy prices) to reveal the vulnerability in the system. Russians and foreigners lost confidence in the government's ability to service its obligations and staged a run on the ruble and the banks, Unable to attract fresh funds, the government announced a de facto default on its obligations in August 1998.

This paper proceeds as follows. In Section II, we briefly discuss the philosophy of IMF programs and how this philosophy materializes into specific conditions. Sections III through V discuss the main issues of disagreement: tightening the budget, structural reforms in banking and bankruptcy, and monetary and exchange rate policy, respectively. Section VI makes concluding remarks.

II

Philosophy and Implementation of IMF Plans

IN THE 1970s and 1980s, IMF conditionality concentrated on restoring stability in countries with balance of payments problems. Conversely, recent IMF plans place greater emphasis on reforms that will lay the foundations for future growth. In the words of IMF Managing Director Michel Camdessus: "Our primary objective is growth. In my view, there is no longer ambiguity about this. It is towards growth that our programs and their conditionality are aimed." [1]

Therefore private investment is a key element in the IMF's programs. According to standard growth theory, higher capital accumulation today pays off in the future by increased production capacity. To promote investment, the IMF insists On:

A. A stable macroeconomic environment. Low inflation and predictable exchange rates lead to low interest rates and make long-term investment decisions possible. Because large budget deficits lead to either inflation or high interest rates and crowding out of private investment, the IMF insists on reducing the deficit. Fixing the exchange rate along with tightening the budget provides for stable exchange rates.