Economic Performance and Trade in the CIS¹
John Odling-Smee
Director, European II Department
International Monetary Fund
May 10, 2003

It is a pleasure for me to address this conference. I will begin my presentation with a brief overview of the main recent macroeconomic developments in the Commonwealth of Independent States (CIS). In the second part of my presentation, I will address some of the key policy challenges that need to be addressed for the recovery to continue, focusing on the importance of trade.

I. Overview

Economic performance in the countries of the CIS has generally been much better in the period since the 1998 financial crisis in Russia than in the early part of the 1990s.² This has in particular been the case in the oil-exporting countries and in countries that had made headway in implementing market reforms. Economic growth has been impressive; inflation has come down, in most countries to single-digit levels; the balance of payments has strengthened; and international reserves have increased significantly. In addition, budget deficits have been brought down and the process of remonetization has gained momentum.

Real GDP growth in the CIS picked up strongly in 1999-2001 and held up well in most countries of the region in 2002. Average real growth had reached 7½ percent in 2001, but fell to a somewhat lower level in 2002, except for the countries in the Caucasus (Figure 1).

• In Russia, the impetus to growth in 2002 continued to come mainly from higher energy exports and consumption. The latter reflected the rebound in real wages from the depressed levels in the wake of the 1998 financial crisis, and a rapid increase in government expenditures. However, it is worrying that investment growth slowed considerably, especially in the non-oil sector.
  
  
• In Kazakhstan and Azerbaijan, in addition to higher oil exports, activity was spurred by increased investment in the oil and related sectors.
  
  
• While the other countries in the region benefited from the economic expansion in the oil-exporters, growth in Ukraine, Georgia, Armenia, and Tajikistan in 2002 was also driven by strong domestic demand.
  
  
• In Uzbekistan, growth suffered from heavy restrictions on external and domestic trade, and a drop in non-traditional exports and foreign direct investment due to the very difficult business environment.
  
  
• Real GDP in the Kyrgyz Republic declined in 2002 largely because of temporary supply-side disruptions, notably the landslide at the Kumtor gold mine and the impact of the weather on hydroelectricity production. With these factors being reversed, growth is expected to return this year to pre-2002 rates.

Regional inflation continued to decline in 2002 from the very high levels that had wreaked havoc in the early 1990s (Figure 2). In particular, the pace of consumer price increases in Ukraine, Moldova, and Kazakhstan came down further in 2002, and inflation in the Kyrgyz Republic has now reached the low level attained for some time already by the countries in the Caucasus, where it averages 3 percent. While inflation in Tajikistan was much lower in 2002 then in previous years, an upsurge in the second half of the year indicates the need to strengthen monetary discipline. Inflationary pressures in Russia also remain a cause for concern. Inflation continues to run high in the slow-reforming countries, Belarus and Uzbekistan, but came down in Uzbekistan in 2002.

Assessing the size of the government sector, as measured by the tax-to-GDP ratio, there are large differences between countries (Figure 3). In Russia, the tax ratio has been at the level of 35 percent for some years. In most other CIS countries, the tax ratio is much lower, despite improvements in tax collection in Georgia, Kazakhstan, the Kyrgyz Republic, and Tajikistan. In Uzbekistan the tax ratio has fallen sharply since the mid-1990s.

The tax ratio is a measure of the size of the government sector that the country can afford. A very low tax ratio prevents the government from providing public goods, such as education, health care, a social safety net, and the infrastructure that is needed for economic growth, on the scale that people would like. There is a serious need in the Kyrgyz Republic and many other CIS countries to explain to the public why more public goods cannot be provided. At the same time efforts should be made to rationalize public services so as to increase value for money, and to remove tax exemptions and strengthen tax administration. Only once all this has been done does it make sense to cut tax rates.

The process of monetary deepening in the region, which had been interrupted in
1998- 99, continued steadily in 2002 (Figure 4). The increasing share of monetary transactions and liquidity in the economy is an important enabling factor for economic growth. In the Caucasus and Central Asia, the degree of monetization has increased in recent years but remains low, except in Kazakhstan. This reflects in particular the still weak confidence in domestic currencies.

We expect remonetization to continue in CIS countries. This will allow a substantial rise in money and credit in the economy without threatening inflation. However, policy makers, especially in central banks, must monitor the situation carefully, because the pace of remonetization is unpredictable. It will be important not to overestimate it and as a result allow excessive monetary growth and inflation.

II. Trade and growth

In the rest of my presentation I want to focus on external trade and its importance for strengthening growth. Of course, trade is not the only factor enabling growth. Structural and institutional reforms aimed at reducing undue government interference and strengthening competition on a level playing field are the most important components of a strategy to improve the business climate and hence growth. Monetary and fiscal policies to maintain macroeconomic stability are also essential. But the relatively low level of trade of CIS countries restricts the opportunities for growth. This is most obvious in the case of small countries like the Kyrgyz Republic, which large investors avoid because the domestic market is small and the larger regional market is not fully accessible.

Across countries of all types, there is a strong association of higher trade ratios with higher per capita income (Figure 5). Some researchers question the direction of causality and there are many econometric debates. But there has not been a single case of a country that has achieved sustained prosperity under autarky or restricted trade. On the other hand, we have many examples of countries that have become rich while trading.

Trade openness in the CIS remains relatively low (Figure 6). In 2002, the openness ratio³ reached only 12 percent, compared to 32 percent for other transition countries and 49 percent for the EU. The ratio for the Kyrgyz Republic was only 7 ½ percent, well below the CIS average.

The European II Department of the IMF has tried to quantify how much more trade CIS countries could engage in under alternative policy regimes. We have simulated the level of trade that would occur if the CIS economies were at the same stage of transition as those in Central and Eastern Europe, after controlling for differences in population and per capita income (Figure 7).

• Based on this simulation, additional CIS trade would amount to $117 billion, equivalent to 59 percent of actual trade.
  
  
• The additional trade for the Kyrgyz Republic would be $3.7 billion, almost four times as much as its current total trade.

These numbers look very high and we do not want to suggest that the Kyrgyz Republic or other countries could easily achieve them. However, they are indicative of how much potential still remains unrealized.

The difference between actual and potential trade can be explained by both country-specific and regional factors. Major country-specific reasons include trade blockades in the Caucasus, infrastructure problems (e.g., pipelines), and governance and corruption problems in customs and transport services. For the entire group, however, the key factors are distance from major world markets and the landlocked character of many countries, restrictions on trade, slower progress in transition, and exchange rate developments.

The lower trade openness ratio of the CIS economies is partly explained by formal and informal trade barriers, established in spite of numerous regional trade agreements. These barriers are captured by the IMF trade restrictiveness index, which takes into account trade taxes and nontariff barriers.⁴ The average trade restrictiveness index in the CIS reached 3.8 in 2002, significantly higher than the average of 2.0 for the Central and East European countries and the Baltics (Figure 8). The Kyrgyz Republic and Tajikistan are very open economies, but the benefits for them are limited by the restrictions imposed by their neighbors, especially Uzbekistan and Kazakhstan.

The depreciation of the real effective exchange rate of several CIS countries following the 1998 Russian crisis improved their competitiveness (Figure 9). As a consequence, market-driven import substitution increased and imports declined by one third between 1997 and 1999. However, the recovery of exports helped by a lower real exchange rate was initially not large enough to compensate for the fall in imports. Total trade recovered from the impact of the Russian crisis only in 2002. The effect of the crisis on trade was strongest for Russia, but also significant for other CIS countries, including the Kyrgyz Republic.

Conclusion

In my presentation I have summarized the main recent macroeconomic developments in the CIS and highlighted some key policy challenges, mainly in the area of trade. The CIS countries have lower external trade than one would expect given their size and level of income; the Kyrgyz Republic has an especially low level of trade.

Trade is an important generator of growth through attracting investors who are unwilling to operate in small markets but would be willing to exploit larger markets. Accordingly, governments should give priority to reducing barriers to trade. This is partly a matter of reducing tariffs and non-tariff barriers imposed by the central government. It is also necessary to stop all the harassment and corruption by officials at the border and those controlling transit trade. In Central Asia, centrally placed Uzbekistan plays a crucial role. It is the most closed economy in Central Asia, and its growth potential, as well as the potential of neighboring countries, would be greatly enhanced by major trade liberalization. All countries benefit from more trade, and all should contribute to reducing the barriers.

1The Figure shows real per capita growth for 96 countries, divided into three groups. The category "rich countries" refers to the 24 OECD economies before recent expansions plus Chile, Hong Kong, Korea, Taiwan, and Singapore. The group of "globalizers" refers to 24 countries constituting the top one-third in terms of their growth in trade relative to GDP between 1975-79 and 1995-97 of a group of 72 developing countries for which data on trade as a share of GDP in constant local currency units since the mid-1970s are available. "Non-globalizers" comprise the remaining 48 developing countries in this group. Averages are population-weighted and calculated per decade.