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Part 2
Monetary and budget spheres

2.1 Monetarypolicy

Monetary policy outlook for 1997

In 1997 the government continued to implementa consistent tight monetary policy initiated in 1995. Main reasons whichexplained the significant reduction in the inflation rate in 1996-1997 were:control over the money supply in the framework of the co-ordinated with IMFmonetary programme and some reduction in the budget deficit at the expense ofcuts in the budget outlays.

During the first half of 1997, the growth ofthe money supply amounted to 27.6 per cent, of the money stock M2 – 24per cent. By the beginning of July, the volume of money stock reached Rb 364trillion or more than 15 per cent of the annual GDP. The ratio of thehigh-powered money to M2somewhat declined compared with its 1996 level and came to 37.6 per cent by themiddle of 1997. The ratio of the monetary base M2 went up reaching 45.9 per cent by thebeginning of July.

Increment of the monetary base for the wholeof 1997 constituted 25.7 per cent which corresponds to a monthly averageincrement of 1.92 per cent, the high-powered money in circulation M0 – 32.0 per cent (2.34 per cent on average per month),the money stock M2– 28.6 per cent (2.12per cent on average per month) (Table 1). This reflects a reduction in themoney multiplier from 2.4 by the end of January 1997 down to 2.31 by the end ofDecember 1997 (Fig. 1). Increment in the real money stock amounted to 15.8 percent (Fig.а2).

Table 1.

1996 –1997	М0 (by end of month)		Money stockМ2 (by end of month)		Monetary base (by end of month)		Moneymultiplier
	Rb trillion	change in per cent	Rb trillion	Change in per cent	Rb trillion	change in per cent	М2/ДБ
Dec.	103,8	8,35	295,2	4,57	130,9	4,72	2,26
Jan.	96,3	-7,23	297,4	0,75	123,9	-5,35	2,40
Feb.	102,0	5,92	307,6	3,43	130,2	5,08	2,36
March	105,2	3,14	315,0	2,41	136,3	4,69	2,31
April	115,2	9,51	328,4	4,25	145,7	6,90	2,25
May	120,4	4,51	339,4	3,35	148,2	1,72	2,29
June	136,8	13,62	363,8	7,19	167,0	12,69	2,18
July	140,3	2,56	375,5	3,22	171,4	2,63	2,19
Aug.	141,6	0,93	377,7	0,59	174,7	1,93	2,16
Sept.	134,8	-4,80	376,2	-0,40	169,8	-2,80	2,22
Oct.	135,7	0,67	382,3	1,62	170,4	0,35	2,24
Nov.	128,7	-5,16	371,1	-2,93	163,8	-3,87	2,27
Dec.	137,0	6,45	379,5	2,26	164,5	0,43	2,31

In 1997 the monetary base was growing mainlyat the expense of an increase in the official external reserves (Fig. 3). Forthe first half of 1997, the CBR’s gross assets grew from Rb 130.9 trillion up to Rb 167 trillion,i.e. by 27.6 per cent. In the second half-year, they have practically remainedunchanged (reduction constituted 1.5 per cent). Net internal assets (NIA)of the monetary authorities were changing unevenly during that period. From thebeginning of the year their value declined by 0.6 per cent, reaching by thebeginning of May Rb 122.2 trillion worth. For the first nine months of 1997,the value of NIA have not practically changed (reduction constituted 1.6 percent). However, at the end of the year, in the circumstances of the financialmarkets crisis, the Central Bank carried out a massive acquisition of the statebonds. For the second half-year, they have grown by 33.08 per cent. The growthof the monetary base in the first half-year occurred mostly at the expense ofan increase of the official internal assets in the second quarter-year. Netexternal reserves of the CBR in the first half of 1997 grew from US$1.7 bn upto US$10.6 bn, i.e. by 517 per cent. From June to December they declined byabout 62 per cent.

Figure 1

Accumulation of the external reserves in thefirst half of 1997 and increasing pressure on the rouble by buying a bull wascaused not so much by a positive Russia’s trade balance (precisely in1997 there appeared a trend toward its decline. In the circumstances of thelargest positive 1996 balance, NIR never reached such record volumes), but byan inflow of foreign capital to Russian financial markets, first of all, to theGKO market and by the process of de-dollarisation, i.e. substitution of thepart of assets in foreign currency with the assets nominated inroubles.

Figure 2

Figure 3

A massive inflow of the foreign capital tothe market of state debt obligations becomes a contradictory (thatcontradiction became evident during the autumn financial crisis whennon-residents started to withdraw their assets from the GKO market) factor ofthe financial stabilisation. According to the data of the balance of payments,investment of non-residents in the Federal government bonds in 1996 increasedby more than US$7 bn worth. Such a dramatic increase in supply have contributedto a fast decline in interest rates, slowing down increasing expenditure on thestate debt service. However, in the circumstances of instability in theinternational financial markets, exodus of cautious investors from the marketsof the developing countries, from Russia in particular, can result in seriouscrisis in the circumstances of once-only sale of packets of state bonds andattack on the national currency.

Figure 4

Inflation in 1997 consistently declined. Ifin January 1997, the rate of consumer prices constituted 2.3 per cent permonth, then in the second-quarter, it declined to about one per cent permonth and to the end of the year practically, it did not surpass that level(Fig. 4). In the first half-year, the price increment constituted 8.6 per centwhich was somewhat above the targets enshrined in the monetary programme forthe year 1997. In the second half-year, inflation declined to 2.3 per cent (4.6per cent annual). During the year, the consumer prices increased by 11 percent.

Figure 5

Constant lagging of the inflation rate behindthe stock of money growth which corresponds to the growth of remonetisation ofthe economy, has been taking place since 1995, when as a result of thestabilisation measures, the demand for money went upwards. In 1996 the volumeof the real money stock increased by 9.6 per cent and in 1997--already by 15.8per cent. Decline in the inflation rate in 1997 has also resulted in the growthof the real exchange rate of the national currency. For the first six months of1997, the real exchange rate of the rouble with relation to the dollarincreased by 4.14 per cent (Fig. 5). During the second half-year, the realexchange rate of the rouble declined by about one percentage point of its Junelevel and for the whole of 1997 in went up by 3.0 per cent1.

By July 1997, it became obvious that thesecurities market has been overheating. That was caused by the fact that theinvestors have overestimated the stability of the political situation and theability of the government to push forward the economic reforms and overcome thefiscal crisis. However, by the middle of the year, the crisis of the reformpolicy became evident. It manifested itself in the fact that the State Duma hadrejected a set of proposed social draft laws, in the growth of the oppositionto the reforms inside the executive power. In particular, it was noted in thelatent confrontation between the government and the president’s administration, inconsistencyof the government policy (refusal to adopt strict measures to the budgetdebtors, lack of real enforcing measures for the debtors, lack of real measuresdesigned to restructure the budget outlays, etc.). Among the reasons for thatcrisis are: the interest of the opposition majority in the Duma to preserve theeconomic crisis, readiness of some groups in the executive power to colludewith the opposition, УquietФ opposition to the reforms by a number of electedgovernors of the Federation subjects in relation to whom the centralauthorities have no adequate means of influence2

, attempts of the influential interest groupsto place the government under their control.

Increasing pressure exerted on the reformistwing of the government, weakening of its position as a result of large-scalepolitical scandals which have brought about a change in investors estimates,first of all, foreign ones, of the prospects about the future economicdevelopment. That has brought about a decline in demand for the Russiancorporate equity which resulted in a sharp adjustment of the stock market. Thefirst round took place at the end of August, i.e. before the autumn financialcrisis occurred. Simultaneously, there started a growth of demand on currencyassets and the growth of CBR’s currency reserves sharply slowed down. Reduction of net externalreserves at the end of 1997 forced a wide circle of investors to apprehend forthe stability of the currency policy and macroeconomic course of the Russiangovernment as a whole. These fears have strengthened aspirations of the foreigninvestors acting in the Russian stock market and GKO-OFZ market to obtain theirprofit at a stable dollar exchange rate.

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