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. Last Updated: 07/27/2016

Cause for Hope

At the end of 1995, there were several forecasts predicting that 1996 would be a year of economic growth. Indeed, many positive signs provided convincing grounds for such optimism: the slowing down of inflation; an almost complete stop to industrial decline; the growth of housing construction; and a considerable savings rate on the part of the population. The optimists' hopes, however, were betrayed. Production fell once again. Housing construction began to decline. Real income of the population also decreased. And the reduction of inflation in 1996 did not produce the main result that was hoped for: the renewal of investment activity.

Why did the optimistic predictions prove unwarranted?

In part, because they were premature. The main cause for optimism was a lowering of the pace of inflation at the end of 1995 to a level that was unprecedented during all the years of reform: 3.2 percent in December. This created favorable conditions for curtailing inflation further in 1996. The average monthly price increase of 1.9 percent was even a little lower than the government budget had foreseen, which in principle should have made profitable investment in real sectors rather than in currency speculation possible.

But what was not taken into account is that low inflation is a necessary but not sufficient condition for economic growth. Cheap credits are also needed. Moreover, interest rates do not decrease simultaneously with the lowering of inflation. Rather, there is a lag of several months.

The Central Bank's refinancing rate from a maximum level of 225 percent to 48 percent at the end of 1996 shows remarkable progress, but for long-term investment in industry, the real cost of credit should be no more than 15 to 20 percent. But under the 10 percent inflation rate that is projected for 1997, the nominal refinancing rate should be between 20 and 30 percent. Even this rate will take several months to achieve.

Together with low inflation and cheap credits, political stability is the third necessary condition for the revival of investment activity. It was hoped that the political problems would be behind the country after the presidential elections last summer. It was also believed that President Boris Yeltsin would stop the war in Chechnya at any price.

This is how things generally turned out, but the president's illness prolonged the political uncertainty in the country by several months. And the peacekeeping process turned out to be drawn out after the agreement between former National Security Council adviser Alexander Lebed and Chechen rebel leader Aslan Maskhadov was reached. The extremely personal activities of Lebed also did not promote political stabilization.

Thus the main factors on which optimistic forecasts for 1996 were based have been carried into 1997. Russia will enter the year with low inflation, good opportunities for reducing the cost of credit and growing political stability.

Is this enough for the hopes for a solution to the current crisis to finally come true?

The government believes it is. The 1997 federal draft budget is based on an expected 2 percent rate of economic growth. This is a very modest rate of growth or, in the words of Finance Minister Alexander Livshits, a rostik, a tiny growth. But it is a growth nonetheless and not a decline -- for the first time since 1989.

Economists such as the director of the Institute for Economic Analysis, Andrei Illarionov, however, are skeptical about the official forecasts. Illarionov's arguments deserve close attention. He believes that what is essential for economic growth is a radical lowering of the tax burden on industries and a decrease in federal budget outlays, above all in the form of subsidies and various privileges such as tax and customs exemptions. Since none of these are provided for in the 1997 federal budget, Illarionov does not see any possibility for a transition from recession to growth this year.

In principle Illarionov is right: The 1997 budget has not created the necessary conditions for growth. But there are still some other factors that give some hope for changes for the better.

The first is that Russia's federal troops were withdrawn from Chechnya during the final days of last year. Official figures on the cost of the war have never been published, but estimates come to 30 trillion rubles ($5.4 billion) a year -- significantly more than Russia received from the International Monetary Fund in 1996. The end of the war is thus a political event that has great economic significance.

There is also reason to hope that the federal budget will receive more revenues this year than it did last year. This is not only due to the activities of the emergency tax commission, which during the last two months of 1996 managed to improve tax collection. The miscalculations of the tax base that were made last year will probably not be repeated. In 1996, profits from industry, which make up a large part of tax revenues, were significantly lower than expected, for two reasons. First, inflation dropped faster than planned, and this unexpected success resulted in lowering the nominal degree of profit. Second, the unforeseen drop in production also narrowed the tax base.

Moreover, the strong penchant of the population over the past few years for savings will undoubtedly continue. In only 11 months of last year, Russian citizens spent 222 trillion rubles on the purchase of hard currency. Not less than half that sum was put away in savings -- unfortunately in the most irrational ways. Under intelligent government policies, these enormous savings could potentially be turned into a source of credit or investment.

Thus, despite significant problems in economic reform policies, modest growth in 1997 is not out of the question. Unless, of course, the government makes some enormous mistakes or there are very big, unexpected political events.

Otto Latsis is a senior political correspondent for Izvestia. He contributed this comment to The Moscow Times.