1. The Global Economy and Financial Markets

1.1. Outlook, Risks, and Economic Policy Responses

Following a certain recovery in the second and third quarters, in late 2002 economic activity in industrial countries slowed down, and it has remained subdued to this date. As a consequence the growth rate projections for 2003 were revised down in the latest World Economic Outlook. Intensification of geopolitical tensions and the war in Iraq certainly had a negative impact on the world economy. Moreover, it continues to suffer from adverse effects from the bursting of the stock market bubble.

It should be underscored, however, that so far the economic consequences of the stock market collapse turned out to be rather mild: for example, a significant economic recession did not occur. This is evidence that in many industrial countries the fundamentals remain sound, and that the adopted policy measures did have a stabilizing effect. In particular, monetary easing strengthened cash balances in the corporate sector of industrial countries, which in turn created favorable conditions for future investment growth.

Still, major downside risks to the outlook remain. Prolonged geopolitical tension in the Middle East can lead to sizable fluctuations in world oil prices. Besides that, in times of uncertainty we cannot rule out the possibility of a further drop in stock prices. In a number of industrial countries there is a possibility of a downward adjustment in housing prices. Finally, the recent fall of the dollar notwithstanding, there remain considerable imbalances in current accounts between the U.S. on one hand and Europe and Japan on the other. This can lead to further significant depreciation of the dollar.

These conditions require concerted actions by the international community to boost investor and consumer confidence and to generally improve the business climate. In particular, progress in multilateral trade negotiations under the Doha Round is acquiring special importance. Unfortunately, no such progress has been observed recently, and the Doha Round itself is now jeopardized by deep differences regarding trade in agricultural products.

As before, global growth remains dependent on the developments in the U.S. economy. Despite some recent slowdown, the U.S. economy continues to be the most dynamic compared to other industrial countries' economies. Recently, however, there was a significant fiscal weakening, which carries no small risk, especially when combined with the large current account deficit and uncertainty regarding future expenditures on the operations in Iraq. Against this backdrop, the tax cuts envisaged by the U.S. Administration, should they materialize, may lead to serious deterioration of the U.S. fiscal position over the medium term.

The situation in the world economy could improve significantly if solid economic growth resumes in euro area countries and Japan. Unfortunately, as it follows from the latest WEO projections, the situation in both regions continues to change for the worse. In particular, the 2003 growth projection for the euro area was lowered by one percentage point. As a result of weak growth, the 3 percent budget deficit limit imposed by the Stability and Growth Pact (SGP) has become a problem in a number of large European economies. It would seem that under these conditions maximum advantage should be taken of the flexibility of the SGP, which is foreseen for exceptional circumstances. This would allow to preserve the credibility of the SGP and simultaneously avoid negative consequences of the pro-cyclical budget policy.

We know full well that major structural reforms, especially in regard to employment, are needed to boost medium- and long-term growth in euro area countries. In those of them that have already undertaken such reforms, there has been a sizable decline in structural unemployment. In this connection we welcome the reform program recently put forward by the German government. We trust that consistent implementation of this program will allow Germany to regain the role of the engine of economic growth in Europe. We also attach great importance to successful implementation of the European Union's Lisbon Strategy.

We read with interest the WEO section devoted to asset price bubbles. It is noted in this section that the recent boom and subsequent bust in equity markets have been quite similar to earlier episodes of this kind in terms of the lengths, magnitudes, and cross-country synchronization of price declines. Unfortunately the monetary authorities of industrial countries have not yet been able to prevent such bubbles from swelling. Taking into account that the bursting of a typical equity price bubble leads to losses of close to 4 percent of GDP on the average, it would be desirable to extract some lessons from the accumulated experience on possible ways to identify the bubbles sooner and, to the extent possible, mitigate their negative consequences for the economy.

The economic situation in emerging market economies has generally remained relatively stable, even despite the slowdown of global growth. Large differences are observed, however, in respect to certain countries and regions. Experience has shown that countries maintaining disciplined fiscal and monetary policies and undertaking energetic structural reforms exhibit greater resilience to external shocks.

Risks arising in emerging market economies because of the level of their external debt have been attracting particular attention recently. The experience of the latest financial crises shows that in an environment of floating exchange rates and relatively free access to financial markets, the "safe" level of external debt turns out to be far lower than previously estimated. Rapid accumulation of external debt is especially dangerous to countries in which foreign trade remains a small share of GDP. In the event of a financial crisis, such countries are not always able to count on resolving it through the growth of exports brought about by real depreciation of the national currency.

1.2. Economic Developments in Russia

While growth projections for the global economy have been revised downward, we recently made an upward revision of the projected growth of the Russian economy. According to our most recent conservative estimates, GDP growth should be at least 4.5 percent in 2003. It should be noted that GDP growth was already about 6 percent in the first quarter of 2003, as opposed to 3.7 percent in the first quarter of 2002. To some degree such acceleration of growth is explained by a significant increase in world oil prices compared to the first quarter of 2002. Still, GDP growth in the first quarter of 2003 was accompanied both by acceleration of growth in net exports and also by higher growth in domestic demand. We are especially encouraged by acceleration of growth in investments into the Russian economy, which was around 9 percent in the first quarter of 2003. We believe that this is evidence of gradual improvement of the investment climate in Russia.

Given the high world oil prices, the Russian federal budget is receiving sizable additional revenues. We intend to use these windfall revenues to further replenish the financial reserve. Such a fiscal policy will allow us not only to service external debt without resorting to new borrowing, but also to significantly facilitate the conduct of monetary policy. We also anticipate that beginning from 2004, all of the windfall revenues from oil exports will be channeled into a special stabilization fund, and the use of these resources will be governed by a special law.

The conduct of monetary policy is still complicated by large foreign exchange inflows. This is explained not only by high oil prices but also by a reduction in net outflow of capital from Russia, including growth of borrowing by Russian companies on international capital markets. In this environment the Central Bank of Russia is continuing to build up foreign exchange reserves, which have reached the level of about US$55 billion. In recent months the Central Bank began pursuing a more flexible exchange rate policy, attaching priority to containing inflation. Beginning from February 2003 we have observed strengthening of the nominal exchange rate of the ruble against the dollar.

The overall improvement of the situation in the Russian economy in the last three years is reflected in the favorable developments in the financial markets. Thus, in all of these years we have observed an increase in prices for Russian sovereign bonds. A number of large Russian companies have already managed to take advantage of this by placing their corporate bonds abroad under good terms. Also, growth of the domestic corporate bond market has continued.

Contrary to widespread opinion, we are continuing to work actively on major structural reforms. To be sure, approach of the parliamentary and presidential elections is having a certain impact. Even so, we have already been able to move forward in a number of important areas this year. Thus, the Russian parliament is now considering a package of amendments to the law on foreign exchange regulation and foreign exchange control. In the near future the lawmakers will begin discussing the draft of a new law on deposit insurance system. Efforts are continuing in other important areas such as administrative reform, reform of infrastructure monopolies, and reform of the banking system.

As for our approaches to the banking system reform, we intend to carefully study the recommendations of the Fund and the Bank experts prepared within the framework of the Financial Sector Assessment Program.

2. Strengthening Crisis Prevention

In an environment of increasing trade and financial integration, surveillance of the global economy and developments in financial markets remains one of the Fund's main objectives. In recent years the Fund has done a great deal of work to strengthen the tools of surveillance, and now the main task is to apply them consistently. In particular, greater attention should be paid to the analysis of vulnerability and debt sustainability indicators of individual countries. In conducting debt sustainability analysis there is a tendency in the Fund to expect the materialization of the most optimistic macroeconomic scenarios. We think that it is necessary to move away from this optimistic bias towards more realistic estimates.

We agree with the proposal to devote more attention to surveillance of countries that are systemically important at the global or regional level, and to use more extensively cross-country experiences.

We deem it unlikely that further modifications of Contingent Credit Lines (CCL) can make this financial facility genuinely attractive to potential users. In this connection we have no objection to letting the facility expire in November 2003.

We support the Fund's activity on the Financial Sector Assessment Program (FSAP) and on assessing observance of international standards and codes (ROSCs). Work in this area is progressing well, as demonstrated by the great increase in the number of ROSCs and FSAP reports. The increase in quantitative indicators should not, however, occur to the detriment of the quality of the reports. We share the opinion that to increase the effectiveness of this work a more rational use of existing resources is needed. In particular, there should be greater selectivity in the choice of countries for assessments, which will help reduce their number initiated in each year. Within the framework of individual assessments and reports, it would be useful to demonstrate greater flexibility and concentrate on sectors that are most important for a given country.

We would like to thank the Fund and Bank staff for their work on the FSAP in Russia undertaken in 2002. On the whole we were satisfied with the results of that effort and we believe that the exchange of views that took place on the status of Russia's financial sector and needed reforms was useful.

3. Improving the Capacity to Resolve Financial Crises

First and foremost we would like to note that the Fund has done a great deal of work on development of a concrete proposal for the establishment of an SDRM. We believe that currently we already have at our disposal just such a detailed, concrete proposal. We also wish to note that a high degree of accord has been achieved with regard to a majority of the methodological, organizational, and technical details of the SDRM.

At the same time, we observe that currently there is no sufficient support for adoption of the necessary amendment to the Fund's Articles of Agreement. We also observe a sharply negative attitude to the idea of the establishment of the SDRM on the part of private investors and some countries that are large borrowers on international financial markets. Perhaps, such an attitude could be explained by their opinion that neither the problem of collective action nor the problem of creditors' litigation are important obstacles to a successful restructuring of sovereign debt. We believe that only practical experience with restructuring a sovereign debt, inter alia the practical experience of restructuring Argentina's debt, will allow us to obtain convincing answers to these questions.

Recently—apparently, as a consequence of discussions on the establishment of the SDRM—we have observed increased interest on the part of private investors in the inclusion of collective action clauses in the sovereign bonds. We welcome the efforts of the G-10 countries and organizations of private investors to develop model clauses, but we believe that in this area there should be sufficient flexibility to allow the circumstances of the individual sovereign borrowers to be taken into consideration. We also welcome the successful placement of Mexican sovereign bonds with collective action clauses in New York.

We support the idea of developing a code of conduct for sovereign borrowers and private creditors in sovereign debt restructuring process. We believe that such code of conduct, although it will not have any legal power, may, nevertheless, allow to enhance predictability of the restructuring process.

At the same time, it may well turn out that neither the inclusion of collective action clauses, nor the development of a code of conduct will allow to remove all the obstacles. If we see in the near future that the absence of a proper legal environment significantly hinders the restructuring of sovereign debt, it will be necessary to return to the idea of establishing the SDRM and adopting an amendment to the Fund's Articles of Agreement. The existence of a detailed, concrete proposal for the establishment of the SDRM means that we will not have to once again start from the very beginning. We believe that it would make sense for the Fund to continue the work on the SDRM with the aim of achieving its full readiness.

We believe that among all the issues pertaining to crisis resolution, the issue of access to Fund resources is a key one. Given its limited resources, the Fund cannot act as a lender of last resort for sovereign states. At the same time, all efforts to establish any norms for access to Fund resources in exceptional cases have not thus far been very successful. Thus each new crisis leads to strong pressure on the Fund to cover the financing gap that has appeared. In this context it seems advisable to return again to the question of establishing some quantitative guidelines for exceptional access. In addition to protecting the Fund's capital, the existence of such guidelines would help ensure greater predictability of Fund policy, which is important for both sovereign borrowers and private investors.

For a number of reasons, exceptional access norms can hardly be linked to country quotas. Other approaches, however, could be examined, such as linking the amount of Fund resources to be provided with the efforts of the country itself to cover part of the financing gap. A good indicator in this respect could be the scale of fiscal correction implemented by the country. We do not propose to establish a rigid relationship between the scale of fiscal correction and the amount of Fund financing. We propose to establish some quantitative guidelines that would allow the Fund to have, at least, some rules for exceptional access. Also, such an approach would correspond to the traditional requirement of the Fund that the level of Fund financing should be commensurate with the strength of the program.

4. Initiatives to Support Low-Income Countries

Development of the PRSP/PRGF approach, despite the existing difficulties, is increasingly contributing to improvements in economic policy in the low-income countries. Among the primary objectives on the agenda in this area, we would especially emphasize the need for greater realism of PRSPs and also better alignment and coordination between the PRSPs, PRGF programs, and the budgetary process. Efforts should be made to ensure that further development of the PRSP/PRGF process will contribute to the achievement of the main goals stipulated in the United Nations' Millennium Declaration.

We continue to support implementation of the HIPC Initiative, inter alia in bilateral relations with those countries that are our debtors. Debt relief may indeed contribute to poverty reduction and sustainable economic growth in the poorest countries. We continue to believe, however, that debt relief alone, without implementing sound economic policies and strengthening institutions and governance, will not yield the desired results. In this connection, we are especially concerned with the fact that many of the HIPC countries are moving off-track with their PRGF programs, especially in the period between the decision and completion points, which threatens the very goals of the Initiative.

For various reasons some HIPC countries may approach their completion points with deteriorated debt burden indicators. We would like to emphasize that debt relief topping-up for such countries should be considered only in those cases where the deterioration in the debt burden indicators is a result of exclusively exogenous shocks, as the rules of the Initiative stipulate. Moreover, the debt relief topping-up procedure should also be performed in strict compliance with the rules approved under the Initiative.

We consider the participation of all creditors of the poorest countries (both bilateral and commercial) to be of fundamental importance in the implementation of the HIPC Initiative, and we support the actions of the management of the Fund and the Bank to this end.