1. Global Economy and Financial Markets

1.1. Outlook, Risks, and Economic Policy Responses

Since the second quarter of this year we have seen a slowdown in economic activity in developed countries, which led to a downward revision in the projections of global economic growth. The list of major vulnerabilities in the world economy now includes a synchronized slowdown in growth in the major advanced economies, continuing current account imbalances, financial markets volatility, and the possibility of a further rise in oil prices.

It is already clear by now that there was a bubble in the equity markets of developed countries in the late 1990s, when a large gap emerged between actual stock valuations and their economically justified levels. The build-up of the bubble was triggered by euphoria about the IT revolution that occurred in the 1990s, which led to inflated expectations of corporate profits. In addition, the manipulations of financial statements by major corporations that have recently come to light also led to an overstatement of companies' profitability, thus contributing to the formation of the bubble.

We welcome the recent measures undertaken in the United States and a number of other countries to strengthen controls on corporate accounting. They have made it possible to stabilize the situation in equity markets somewhat, although there is still a possibility that stock prices will continue to decline even further. At the same time, the way in which financial regulatory authorities should react to the formation of bubbles, which lead to extremely negative consequences for both the financial and real sectors of the economy, is open to question. We are closely following the discussion in this area, and we trust that an appropriate strategy to prevent financial excesses will ultimately be devised.

1.2. Global Current Account Imbalances

We read with interest the essay of the World Economic Outlook that contains an analysis of global current account imbalances, and on the whole we share the views expressed there. Indeed, as shown in the WEO, current account imbalances have reached an unprecedented scale and could lead to significant disruptions in the event of a disorderly adjustment. One of the main factors contributing to the increase in these imbalances was faster growth in investment over savings in deficit countries. To a significant extent, this occurred as a result of overly optimistic expectations about investment returns related to the IT revolution. Thus, the accumulation of external imbalances is partly connected with the emergence of asset price bubbles.

Current account imbalances will be adjusted through a depreciation of the real exchange rates and, possibly, a fall in output growth in deficit countries. The question is whether this will be a relatively orderly process or one that is accompanied by severe disruptions in trade flows and financial markets. It is impossible to predict in advance how events will unfold. At the same time, as shown in the WEO, some measures can increase the likelihood that the imbalances will subside in a benign fashion. Medium-term fiscal consolidation, which allows for an increase in national savings, is such a measure for deficit countries. Surplus countries should implement structural reforms to boost growth potential and support domestic demand. This would promote a smoother redistribution of global demand between deficit and surplus countries without threatening the growth of the world economy as a whole.

1.3. Economic Developments in Russia

The slowdown in global economic growth has not yet had a visible negative impact on the situation in Russia. While in the first quarter of this year there was some slowdown in economic growth, in the second and third quarters growth, on the contrary, has strengthened. This led to an upward revision in projected growth for 2002, albeit by a slight margin. We currently expect that GDP growth in 2002 will be around 4 percent. The main factor in economic growth is consumer demand, while net exports are gradually shrinking. In 2003 we expect growth to continue at the present rate of around 4 percent, with the latter figure serving as the basis for the 2003 budget parameters.

In order to sustain economic growth in 2003, we are planning to loosen fiscal policy somewhat, which will be reflected in a small reduction of the federal budget surplus. For a number of years the pursuit of responsible fiscal policy has enabled us to service our external debt almost without resorting to external borrowing, and to achieve a substantial improvement in debt sustainability indicators. In 2003 external debt payments will reach a peak of approximately US$17 billion. We do not anticipate any major difficulties in servicing this debt, although we intend to borrow in both domestic and foreign markets.

The conduct of monetary policy in Russia is still complicated by large foreign exchange inflows. On the one hand, in 2002 there has been some reduction in the current account surplus, primarily as a result of an increase in imports. On the other hand, this year there has been a significant reduction in net capital outflows from Russia. Under these circumstances, the Central Bank of Russia is continuing to accumulate foreign exchange reserves, which are close to US$45 billion, and to carry out sterilization of excess liquidity together with the Government. We still expect that by the end of 2002 inflation will not exceed 14 percent, which was the assumption for the 2002 budget. Next year, despite the need for a further increase in regulated tariffs, we expect inflation to drop to 10-12 percent.

Deep structural reforms are needed in order to achieve sustainable growth in the medium to long-term. This year we managed to make significant progress in this direction. In particular, a new land code has been adopted, which will promote the development of a land market and agriculture as a whole. The Russian government has prepared and sent to Parliament legislative proposals that need to be adopted for the reform of monopolies in electricity and rail transport. The Central Bank of Russia is making considerable efforts to speed up the process of banking sector reform. In addition, the draft budget for 2003 provides for the allocation of significant funding for judicial and military reforms.

We would like to say a few words about the evolution of our cooperation with the IMF. Even with the forthcoming peak in external debt payments, we do not anticipate a need for new loans from the IMF. At the same time, we still highly appreciate the professionalism of Fund staff and we continue to consult with them in many areas of economic policy. Experts of the Fund and the Bank, together with Russian agencies, are presently completing their work under the Financial Sector Assessment Program (FSAP) for Russia. In the future, we are going to continue our active dialogue with the Fund.

1.4. Economic Developments in CIS Countries

The high level of external debt in a number of the poorest CIS countries continues to be a matter of concern. It is well known that more than half of the external debt of these countries is owed to international financial institutions. We anticipate that the Fund and the Bank will continue to provide effective assistance, both technical and financial, to these countries. At the same time, one cannot ignore the fact that the level of budget revenue in these countries remains extremely low--substantially lower than the average for the CIS. Under these conditions, when providing financial assistance to these countries, the international community has all the right to expect them to take very decisive actions directed at increasing budget revenues. In addition, the collection of payments from domestic consumers for energy deliveries should be substantially increased, given that slow progress in this very area has become one of the main reasons for economic difficulties experienced by these countries.

2. The Fund and the International Financial System in the Process of Reform

2.1. Strengthening Surveillance, Crisis Prevention, and Crisis Resolution

In an environment of increasing trade and financial integration, surveillance of the global economy and developments in financial markets remains one of the IMF's main tasks. Over the last several years the IMF has done a great deal of work to strengthen surveillance. We should mention in particular that the Fund has begun to pay more attention to surveillance at the regional level. Fund initiatives such as the introduction of the Special Data Dissemination Standard, the preparation of Reports on Observance of Standards and Codes, and the conduct of Financial Sector Assessment Programs play an important role in strengthening surveillance. Ultimately, all this work is aimed at preventing financial crises, because timely identification of weaknesses and vulnerabilities and well-timed provision of technical assistance to correct them are of great significance. We would also like to mention a substantial improvement in the transparency of Fund's activities, which manifests itself primarily in the increased number of its publications. Nonetheless, the increased transparency should not be at the expense of the candor of the analysis.

Unfortunately, it is hardly realistic to expect preventive measures to be 100 percent effective—crises will occur. It is interesting to trace the evolution of our understanding of the nature of crises. Initially we noticed that countries with fixed exchange rate regimes turned out to be particularly prone to crises. Today we see that crises may occur even with floating exchange rates, when a sharp devaluation of a national currency resulting from an abrupt capital outflow leads to a significant increase in the debt-to-GDP ratio. As a result, we now witness some countries encountering great difficulties with debt servicing even though just a short time ago their level of external debt was not a cause for particular concern. Given this situation, debt sustainability should be analyzed in more depth, and we welcome the Fund's efforts in this area.

Inevitably, in some instances crisis resolution will require sovereign debt restructuring. The Fund is currently working on two complementary approaches—a contractual approach and a statutory one. With regard to the contractual approach, the introduction of collective action clauses into the bulk of sovereign debt contracts will require prolonged effort. In this connection we welcome the intention of the EU countries to make the use of collective action clauses a standard practice as part of their sovereign bond issues.

At the same time, the contractual approach does not fully address the problem of creditors' collective actions insofar as it remains possible for a minority of creditors to block the decision of the majority. In order to eliminate this possibility it is necessary to adopt an international treaty that makes the decision of the majority binding on all creditors in all jurisdictions. Perhaps, this could be done on the basis of a corresponding amendment to the IMF Articles of Agreement.

2.2. The IMF's Role in Low-Income Countries

We have closely followed the efforts of the international community to provide effective assistance to low-income countries. We welcome the substantial progress achieved within the framework of the HIPC Initiative, including on the issue of its financing, and we support an extension of the sunset clause under the Initiative to end-2004. Our own contribution to the implementation of the Initiative consists, in part, of debt relief granted to those HIPC countries that are our debtors. We continue to believe, however, that debt relief alone will not yield the desired results without the implementation of sound economic policies and the strengthening of governance in the poorest countries themselves. In this connection, we are concerned with the fact that many of the HIPC countries are performing poorly under their PRGF programs, especially in the period between the decision and completion points. We believe that creditor countries should adopt a stricter and more coordinated position in relation to those HIPC countries that pursue irresponsible economic policies and do not implement their PRGF programs.

For various reasons, many HIPC countries may approach the completion point of the Initiative with deteriorating debt indicators. The enhanced framework of the Initiative includes the possibility of additional debt relief at the completion point. We would like to emphasize that this provision should be invoked only in those instances when the deterioration of the country's economic situation, including its debt indicators, is exclusively the result of exogenous shocks, as the rules of the Initiative stipulate.

2.3. Combating Money Laundering and the Financing of Terrorism

We support the efforts of the international community to combat money laundering and the financing of terrorism, including efforts in this area made by the Fund and the Bank. In this connection, we welcome the completion of work on the single comprehensive methodology for assessing compliance with all 40+8 recommendations. This will complement the eleven standards for which Reports on the Observance of Standards and Codes (ROSCs) are already being prepared by the Fund and the Bank with a standard on anti-money laundering and combating the financing of terrorism. We also support the intention of the Fund and the Bank to initiate a pilot program for the preparation of such reports. At the same time, we have substantial doubts about the procedure that is being proposed, whereby the FATF and FATF-style regional bodies prepare their own reports on compliance with the standard independently of the Fund and the Bank but under the same title. This will, in essence, lead to the establishment of two autonomous processes for assessing compliance with the standard, even though in both instances the final report will be called a ROSC. And this is despite the fact that the Fund and the Bank, on the one hand, and the FATF and FATF-style regional bodies on the other, have not yet managed to agree on mutual recognition of respective assessments. In addition, we remain to be persuaded that the FATF and FATF-style regional bodies are going to respect the principles of the uniform, voluntary, and cooperative approach adopted by the Fund and the Bank. It is common knowledge that the FATF does not currently adhere to these principles.