(Archived Content)
Good evening. It is a pleasure to be here in this historic hall to address a group that has played such an important role in Russia's progress.
Over the years, the council's invitations to me to speak have often coincided with turning points in Russia's progress. Tonight is no exception. Last week, at the G-7 meetings in Washington, I had the privilege of meeting Russia's new economic team who underscored the commitment made by Russia's leadership following the Gore-Chernomyrdin meetings in July to making investment its top priority.
This enthusiasm reflects what I believe is a new stage in Russia's progress, a stage in which growth, rather than stabilization, is emerging as the central priority.
All too often in the early 1990s, hope for Russia's reform in spring gave way to despair by autumn as spending pressures increased. This year, for the second fall in a row, that is not the case.
In my view, there is an excellent chance that we will look back on this period as the point at which Russia consolidated its progress toward stabilization and began serious, sustainable growth.
Prospects for Russia
There are those on both sides of the Atlantic, who are inclined to see the present situation in crisis terms. According to this view, while temporarily stabilized, Russia remains a dangerous place to do business. Proponents of this interpretation argue that Russia is at best a high risk country, and at worst, an explosive powder keg, where fortunes are lost more easily than made. In this view, the damage done by Communism was so profound that any timeframe for Russia's convergence with the West should be measured in decades rather than years.
I do not share these views. While Russia, in many respects, lies at a critical juncture, if there is one lesson to be learned from the past several years of reform, it is that Russia is no different from any other country. Russians respond to the same incentives as other economic actors; and Markets work in Russia as surely as they do anywhere else.
Already, we can point to signs of real progress:
Russia's government budget deficit last year was smaller as a share of GDP (4.8 percent) than many European countries (including Spain, Italy, Sweden and Austria), and near the EU average of 4.5 percent of GDP. With the largest transfer of assets in history, nearly 70 percent of Russian production is now in the private sector. Wages in dollar terms have increased fivefold in the last four years; and Inflation has been less than 1% per month for the last three months.
With stabilization at hand, Russia is no longer trying to build a house in a hurricane which is what reform in a high inflationary environment means. Having reduced inflation, the central objective now must be to bring back growth. Growth is central because it is only through growth...
That people can enjoy rising living standards; That a society can attain the political stability that comes from parents seeing their children enjoying a better life than they did; and that Russia can generate the resources necessary to address vast social needs as manifested in life expectancies below those of India and Brazil.
Moreover, growth drives international integration because businesses want to go into growing markets more than shrinking ones.
Just as the central challenge of the early years of reform was stabilization and the devolution of state functions to the private economy, so the challenge ahead is to pursue structural reform which can create the foundation for growth.
Indeed, I would go so far as to say that the prospects for continued stabilization and liberalization are dependent on growth.
Growth raises tax revenues and reduces the deficit which promotes stability. Moreover, it creates the confidence needed to generate investments that, in turn, beget more growth.
What I want to speak about today are some of the key pre-requisites for reform to promote growth. They fall into two broad areas. First, the role of the state in creating an economic environment in which business can flourish; and
Second, the development of a modern, sophisticated financial system that can channel capital to the most productive uses and ensure that it is well used.
What the State Must Do
There are two principle things that the state can do to promote a favorable business environment. The state must strengthen the rule of law; and it must insure that its tax system, while meeting revenue needs, does not stifle business.
The Rule of Law and Liberalization
The Russian government has a critical role to play in bringing to life the rule of law, without tangling private enterprise in a web of regulation. Legal and judicial reform is needed to ensure that contracts, when made, are kept, and property rights are recognized and protected. And the economy must be further liberalized so that there's a presumption of permission, not prohibition. Progress on this front will be key to making Russia an attractive outlet for investors -- and to protect those investors from crime and corruption.
As you all know, business operations in Russia are not for the fainthearted. Our objective must be twofold: First, through privatization and liberalization, to reduce the role of the state in the economy, thereby reducing the opportunities for corruption; As one Russian trade official recently said, We no longer have any corruption, because we have nothing left to sell.
Second, through legal and judicial reform, to establish rights and insure they are enforced by...
Developing clear contract and property rights; Putting in place bankruptcy procedures to work out arrangements among creditors and debtors; and Reforming enforcement and judicial institutions to provide a legal alternative to the dispute resolution services provided by organized crime.
Taxes
I do not need to convince this audience of the need for tax reform. Firms face as many as 34 different taxes, at times adding up to more than 100 percent of profits, imposed by multiple tax authorities, often in a discriminatory manner. Russia needs to do the following three things:
First, it needs to break the vicious cycle in which inadequate enforcement leads to shortfall in revenues which drives an increase in rates and a further fall-off in enforcement. Instead, Russia needs to put in place a virtuous circle in which the government lowers rates, resists constant adjustments and enforces them equitably -- not just on foreigners.
Second, Russia's market economy requires a tax system based on market principles, not Soviet accounting techniques. Taxes should be levied not on revenues, but on profits, calculated in the normal way in which legitimate business expenses are fully deductible.
Third, since the energy sector is so central to Russia's development, special attention should be paid to rationalizing taxes in this sector so that the burden of taxes falls more on those who are getting the rents than those whose activities lead to greater production.
Developing a Modern Financial System
The second broad requirement of growth is a modern financial system.
Capital Markets
Just today, Russia's foreign currency debt was rated by Standard & Poor's, Moody's and IBCA, and a Eurobond issue is expected soon. This is a very positive development.
Nevertheless, it is equally clear that no economy can be built on foreign investment alone. To maximize growth, Russia must also draw on domestic savings.
Russians save an estimated 20-22 percent of GDP, but the institutions for channeling those savings into productive investments have yet to be fully developed.
The development of capital markets will be key to the mobilization and deployment of these savings. Here, Russia has great potential. Today, only about 25 companies' shares trade actively, and market capitalization of the top 200 firms is less than $30 billion -- smaller than many Fortune 500 companies.
If the ratio of market capitalization to GDP in Russia was comparable to that of other emerging markets, market capitalization would run at a level 10-15 times higher.
Let me be clear from the outset. There is no lack of creativity in this area; Russians have shown they can introduce the most complex financial instruments. The problem is the lack of basic infrastructure, protection of investor rights, the development of attractive investment instruments, and use of accepted accounting standards which we so take for granted.
Take, for example, central share registries. Because firms resist central share registries, it is not unusual for investors to have to fly across 11 time zones to the company's headquarters to register their shares.
Until investors can rely on the basic underpinnings of a capital market registries and depositories, recognition and enforceability of basic ownership rights, transparent and informative accounting standards, and a clearance and settlement system that functions promptly and accurately Russia will not be able to mobilize the large amounts of capital it needs to grow its economy.
This is why Secretary Rubin and SEC Chairman Levitt have agreed to co-chair the U.S.-Russia Capital Markets Forum -- to marshall the expertise of the U.S. private sector to help support and guide the development of Russia's capital markets. Drawing on the extensive experience of U.S. financial institutions, we will convene over the next several month four working groups to prepare recommendations on capital markets infrastructure, investor protection, mutual funds, and accounting and tax issues.
Today the high level of Russian interest rates stand as an almost impenetrable obstacle to investment and growth. The development of broader and more liquid financial markets would do much to reduce interest rates. But the Russian government could take an immediate step to reduce interest rates by fully opening the government securities market to foreign investors.
Banking
Second, Russia needs a strong banking system which can perform the critical function of financial intermediation and in which Russians have confidence. With 2,100 banks, Russia is overbanked; still Russia's banking sector is small relative to size of the overall economy.
With one-third of commercial loans estimated to be non-performing, there are likely to be more bank closures. One lesson that we can draw from the scores of countries which have faced difficulties in their banking sector is that one cannot simply grow out of a banking sector problem. Russia's Central Bank should be aggressive in its efforts to manage Russia's banking problems, bank by bank.
In addition, Russian banks must develop the skills necessary to evolve from government securities traders to true financial mediators. They must learn how to attract deposits, assess credit and develop clients. One Russian bank described how their competitors were astounded to learn that they were trying to develop commercial clients. Why bother, they were asked, given the high yields on government securities. But this is exactly what banks in Russia need to do to prosper in the future and to help Russia's economy grow.
The Road Ahead
Russia's ultimate success in economic reform will depend on the energy of its people and the quality of its government’s decisions. But the international community continues to have a major role.
I have no doubt that the IMF's $20 billion in financing, first under a Systemic Transformation Facility, then under a one-year Stand-By Arrangement, and now under the three-year Extended Arrangement, has made a major contribution to the stabilization of the Russian economy.
The financing has reduced the need for recourse to the monetary printing press, and the conditionality of the IMF loans has spurred reform.
Large-scale debt rescheduling by the Paris and London Clubs have made financial stability possible and reduced the near-term burden of debt service. And a huge international technical assistance effort has contributed to the institutional development that underpins a market economy.
Assistance has come in every area from taxation to the clean-up of lakes to reform of universities, a truly remarkable outpouring of public and private efforts.
Now, as we go into the next stage of reform, the priorities for international assistance will differ.
External finance will still support stabilization efforts, but stabilization will no longer be the principal preoccupation of the international institutions; and Technical assistance, in all its manifestations, will continue, but increasingly in conjunction with market investments.
The crucial need for external finance will be in support of the structural changes necessary as Russia becomes a market economy.
It is time to pass the baton across 19th St. from the IMF to the World Bank and to shift the focus to structural reform.
I am encouraged by reports of greater cooperation between Russia and the World Bank, due in great part to the efforts of Jim Wolfensohn and his system of country portfolio performance review.
I look forward to an energized World Bank presence which will permit a substantial increase over the $1.7B disbursed to date. These will include actions to: disburse committed funds offer new fast-disbursing assistance to support structural reforms in crucial areas such as the banking sector; and provide support for private investment.
The EBRD will play a crucial role as well in stimulating investment and growth in the private sector. The EBRD has committed more than 20% of its resources to support private sector development in Russia; still it needs to deepen its commitment if it is to support Russia's growth in a serious way. In particular:
The regional venture funds are well positioned in Russia's regions to play an important role in catalyzing private sector investment, but they need to accelerate efforts to find suitable investment projects and put their dollars to work.
While I have emphasized finance, let no one forget that trade is better than aid. Much can be done to help Russia develop sensible trading relationships with its neighbors, ensuring that the region's products -- and especially its rich natural resources -- make their way to market. Russia's effort to join the World Trade Organization (WTO) and to conduct its trade relations consistent with WTO rules is a constructive step toward Russia's integration with the international economy.
Conclusion
Let me conclude where I began. Over the last few years, Russia has seen many turning points, perhaps too many. With stabilization taking hold, Russia is now poised to enter a new stage of reform that represents a new opportunity for growth and all that growth brings with it.
I look forward to returning to see you on the occasion, not of another turning point on the path to reform but rather at the completion of what I believe can represent a new milestone in Russia's development.