During 1992–97, most of the Baltics, Russia, and other countries of the former Soviet Union have made significant progress toward macroeconomic stabilization. While average inflation has declined steadily since 1992, output fell significantly for many of these countries during this period, and it was not until 1996–97 that as a group they experienced positive growth. Throughout this period, these countries have relied heavily on foreign savings to supplement their relatively low domestic savings. The composition of net external financing has gradually started shifting away from official external sources toward private capital flows, attracted by high rewards. This signaled an important change in the perception of sovereign risk in response to the progress achieved in implementing sound domestic financial policies and structural reform.

Progress in macroeconomic stabilization has not been uniform across the Baltics, Russia, and other countries of the former Soviet Union. Differences in performance can be attributed in part to diverging initial conditions: uneven productive factor endowments; various degrees of financial policy restraint; and, equally important, differences in the pace of implementation of comprehensive structural reforms. There is growing evidence¹ that those countries that have succeeded in lowering inflation by decisively reducing their domestic financial imbalances and have proceeded rapidly to implement comprehensive structural reforms have benefited the most in terms of output growth, exchange rate stability, and access to private international capital markets. By contrast, those countries where financial policy restraint has been pursued inconsistently and structural reforms have been embraced apprehensively seem to have experienced short-lived episodes of stability and only sporadic or no revivals in economic activity. If sound macroeconomic policies are not adequately supported by comprehensive structural reforms, the sustainability of the stability achieved is put at risk, and vulnerability to external and domestic shocks increases.

The efforts to achieve macroeconomic stability have generally been framed in the context of IMF-supported programs. During 1992–97, of the 15 countries comprising the Baltics, Russia, and the other countries of the former Soviet Union, 14 had adopted IMF-supported programs, with cumulative commitments close to SDR 20 billion--the equivalent of about $28 billion (Appendix, Table 1).² Russia, Estonia, and Latvia were the first to obtain access to IMF resources starting as early as 1992, while financial support to Tajikistan only materialized in 1996. During the period under study, Turkmenistan was the only country in the region that had not had an IMF-supported program, mainly because there was not a clear initial need for balance of payments financing, and, subsequently, there was no internal consensus on the reform approach to be pursued. Increasingly, IMF support has been provided through multiyear arrangements, either under the Extended Fund Facility (EFF), as for Azerbaijan, Kazakhstan, Lithuania, Moldova, and Russia, or the Enhanced Structural Adjustment Facility (ESAF), as for Armenia, Georgia, the Kyrgyz Republic, and, more recently, Tajikistan.³ The Stand-By Arrangement has been used to support programs in countries that were not ready for an EFF, such as Ukraine, or for those that have preferred precautionary arrangements, such as Estonia and Latvia. In Lithuania, following the successful completion of an EFF, the authorities have so far chosen not to embark on a successor arrangement. Belarus and Uzbekistan, while in need of a broad-ranging stabilization and reform drive, do not have IMF-supported programs but maintain a policy dialogue with the IMF (Appendix, Table 2).

Although progress has been achieved, many sources of vulnerability remain, which, if left unattended, may complicate macroeconomic management. First, the Baltics, Russia, and other countries of the former Soviet Union face for the most part considerable fragility in their public finances. There is a need for further fiscal consolidation to achieve not only reasonable fiscal balances, but also to address severe revenue collection problems, contain overall expenditure levels (mainly by increasing the cost-effectiveness of social spending), improve the institutional framework of the budgetary process, and increase the transparency of the fiscal accounts.⁴ Second, despite noticeable improvements, many of these countries still need to bolster their banking systems. The weaknesses in this sector have contributed to fiscal imbalances and excessive foreign borrowing and, at times, have significantly constrained monetary policy. Financial intermediaries need to be subjected to stricter prudential and regulatory requirements, and efforts at developing further the supervisory framework and enforcing prudential requirements must continue.⁵ Finally, there are increasing concerns about the sustainability of the sizable external current account deficits, particularly in countries where these deficits have been financed through borrowing rather than through foreign direct investment.⁶ The experience of some of these countries in addressing the initial spillover effects of the Asian crisis (see Chapter VI) illustrates how external shocks can magnify the potential adverse impact of the remaining sources of vulnerability, even with timely and adequate short-term financial policy responses.

This paper does not review the progress achieved in the areas of structural reform. Given that the achievement and sustainability of macroeconomic stability cannot be seen in isolation from the progress in implementing structural reforms, however, the macroeconomic indicators for individual countries⁷ are presented in a way that permits inferences to be made on how their current stages in the transition may be correlated with their macroeconomic performance. Countries are classified into four categories: advanced, intermediate, and slow reformers, and a special group of countries that have been significantly affected by military conflict, whether internal or external, sometime during the first six years of transition.⁸