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Growth rate of basemoney(%)

26,0%

53,4%

Growth rate of M2 (%)

20,96%

54,7%

US dollar exchange rate(Rbs/$)

20,65

33,0

Real money stock M2 (per cent of GDP, period end)

13,8%

13,0%

Scenario 2


Inflation (per cent)

84,4%

81%

GDP (in blns of Rbs)

2685

4476

Growth rate of base money(percent)

26,0%

99,8%

Growth rate of M2 (per cent)

20,96%

96,8%

US dollar exchange rate(Rbs/$)

20,65

40,0

Real money stock M2 (per cent of GDP, period end )

13,8%

12,9%

The second scenario implies that as fromMay 1999, there will be a rise in expenditure on financial support for theregions totaling 1.0 per cent of the yearly GDP as envisaged by the Law on theBudget, that is, by about 40 billion. The losses of the Pension Fund willrequire another 1.4 per cent of annual GDP, or about Rb56 billion. Theseexpenditures can be financed by printing money; in this case, the overallvolume of money issue during the year would be approximately Rb205 billion(doubling of base money). The other assumptions of this scenario coincide withthe first one.

The figures presented in Table 18show that real non-interest budget expenditure was reduced withoutaccount of increased expenditures on financial support for the regions andPension Fund receipts (an attempt to raise expenditure by 2.4 per cent of GDPin 1999 caused its real growth by 1.8 per cent of GDP2

266). Prices rose 1.8 times. The realincomes of persons whose wages are paid from the budget will fall by 25-30 percent over the year (by 60 per cent as compared to July 1998).

Figures describing the volume of financingof the principal federal budget items in conformity with the law and the firsttwo scenarios for 1999, as well as the actual execution of the budget in 1997,the first half of 1998 and 1998 can be found in Table 19. Table 20 shows thechange of the level of the federal budget expenditure in 1999 under the Law onthe Budget, the first and the second scenarios as compared to 1997, the firsthalf of 1998 and 1998. The need for several comparison bases is determined bythe distinctions in the economic and political situation over those periods.The 1997 budget was being executed in a situation of relative economic andpolitical stability, and 1998 can be divided into pre- and post-crisisperiods.

As shown by Tables 1.19 and 1.20, the mostconsiderable reduction of federal budget expenditure in real terms is revealedby a comparison with 1997, and the least considerable, with 1998. The executionof the federal budget under the second scenario leads to a more significantreduction of expenditure as compared to the first scenario on all line itemswith the exception of social expenditure. The latter's significant rise underthe first scenario as compared to all the base periods is determined by theirincorporating the subsidies to the Pension Fund (Rb56 billion or 1.3 per centof GDP). Overall, it is due to the growth of social expenditure that the secondscenario envisages a lower reduction of expenditure than the first.

It should be noted that the federal budgetexpenditure on financial support for the regions, which includes the Fund forthe Regions' Financial Support, would go down under practically all scenariosand in comparison with all periods. The greatest reduction in expenditure forthis purpose would occur if the situation evolved in conformity with the firstscenario, under which this expenditure would decline by almost one third (inper cent of GDP) even in comparison with 1997.

We see that in 1999, an aggravation of thesocial crisis and public discontent are highly likely. In a situation likethis, the government may succumb to the temptation to take rash steps, e.g.,start the printing press, especially in the year of State Duma elections. Inthe future, indexation of budget expenditure, a higher volume of money issue,further reduction of budget revenues and payments in real terms, and moremonetary financing become unavoidable.

To show what can happen if an attempt ismade to solve the problem of reducing real expenditure by using the printingpress, we quote the results of our estimates for one of the versions of suchpolicy. It should be noted that the results presented below are not anotherprognostic scenario but are only an illustration which confirms the obviousfact that currency issue cannot solve real economic problems.

Let us assume that as in the secondscenario, additional support for the regions and transfers to the Pension Fund(all in all, 2.4 per cent of GDP) will take place. Also, as from May 1999, thebudget's expenditure side will be indexed on a quarterly basis. In ourcalculations, indexation to the 1997 level (13.9 per cent of GDP) is based onthe inflation indices for the past two months of the preceding quarter. Theincreased fiscal deficit is financed by direct loans from the Central Bank(overall volume of issue will reach Rb430 billion).

In doing this, we assume that a higherinflation rate and a high volume of money issue would increaseinflationary expectations and a rapid rise in money velocity, which, in turn,would accelerate the price growth and the decline of the nominal and effectiveruble rates (the latter implies a growth of expenditure on RF foreign debtservicing as a share of GDP). High inflation rates also lead to a reduction intax revenues in real terms because of their inflationary devaluation in theperiod between tax assessment and tax receipts by the budget.

Table 1.19

Key expenditure items of the federal budget
(per cent of GDP)

1997

First half of1998

1998

Law n the 1999

Budget

Scenario 1

Scenario 2

Governmentadministration

0,4

0,3

0,4

0,3

0,3

0,3

Law enforcement andjustice

1,7

1,2

1,3

1,4

1,3

1,3

Defense

3,1

1,8

2,1

2,3

2,2

2,1

Science

0,4

0,2

0,2

0,3

0,3

0,3

Services to the nationaleconomy

2,0

0,8

0,9

0,9

0,8

0,8

Social expenditure

1,9

2,0

2,1

2,0

1,8

3,0

Government debt service

4,5

5,4

4,0

4,2

4,0

4,0

Domestic debt


11,7


1,7

1,5

1,5

External debt




2,5

2,5

2,5

Other expenditure,of which:

4,6

2,9

3,6

3,0

2,6

3,4

Financial aid to Russian regions,of which:

1,9

1,6

1,6

1,1

1,0

1,8

Federal RestructuringFund

1,3

1,4

1,1

0,8

0,8

1,6

TOTAL EXPENDITURE

18,4

14,7

14,5

14,4

13,3

15,1

Source: RF Ministry of Finance, estimatesby the book’sauthors.

In this case, by the end of 1999, we wouldhave extremely high inflation rates. In November-December prices would grow byover 25 per cent a month. For the year as a whole, the consumer price indexwould reach 3.52, and money supply would increase 2.7 times. By December 199,the economy's level of monetization would fall to 11 per cent ofGDP.

Table 1.20

Change in key expenditure items of thefederal budget

Law n the Budget

Scenario 1

Scenario 2

1997

First half of 1998

1998

1997

First half of 1998

1998

1997

First half of 1998

1998

Governmentadministration

-8%

5%

-5%

-15%

-4%

-12%

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