Regional

Foreign direct investment in the former communist world topped $46 billion in mid-1996, up 60 percent from a year earlier, with countries that are reforming faster getting the lion’s share. Hungary ranked number one in foreign direct investment in transition economies with a cumulative $13.9 billion, followed by Poland with $9.1 billion, a report by the U.N. Economic Commission for Europe (ECE) said. Hungary now accounts for 30 percent of total foreign direct investment in the ex-communist world, followed by Poland with a 17 percent share. Russia is third with a 13 percent share, pushing the Czech Republic into fourth place with 12 percent. Overall, Hungary, the Czech Republic, Poland, the Slovak Republic, and Slovenia receive nearly 70 percent of the total.

Although tiny by Western standards, the per capita foreign direct investment in transition economies more than doubled to $135 at the start of 1996 from $60 at the start of 1994, the ECE said. This is way below the $1,800 or so in per capita foreign direct investment in the United States but is more than Brazil’s $130 and China’s some $110. At the bottom of the heap, per capita foreign investment in 1996 was just $17 in Ukraine and $20 in Moldova.

In the former Soviet Union, Russia led in foreign direct investment with $6.6 billion, according to the report. In contrast, Moldova and Belarus received just $104 million and $350 million, respectively. Western Europe accounted for the bulk of foreign direct investment in the former Soviet Union, with a share of 80 percent in Belarus, 70 percent in Russia, and up to 60 percent in Estonia, Latvia, and Ukraine, but reaching only 17 percent in oil-rich Kazakstan.

Central and Eastern Europe

The European Investment Bank (EIB), the European Union’s (EU) main financing arm, posted record results in 1996 with total lending of $27.26 billion, EIB President Brian Unwin announced. Lending to Central and Eastern Europe reached an all-time high.

The EU invited Central and East European leaders to a special summit in June to discuss the EU’s preparations to admit new members from among the former communist countries. The meeting, scheduled for June 27 in Amsterdam, will follow EU approval of a package of reforms designed to prepare for an eastward expansion over the coming years. The Czech Republic, Hungary, and Poland are seen as the leading contenders for early EU membership, with Bulgaria, Estonia, Latvia, Lithuania, Romania, and Slovenia also hoping to join.

The European Commission is completely revamping its multibillion dollar Phare program aimed at getting the ten former communist countries ready for EU membership. Commission officials said the program to date has been driven by requests from the countries, resulting in a plethora of small projects, many run by outside consultants and not all run efficiently. Under the new system the fragmented aid programs will be merged into a superfund, and decisionmaking on development spending will be shifted from the region to Brussels. The EU will draw up national programs with the countries being offered membership, and the money will be targeted directly at preparing the countries to join the EU.

Albania

Albania needs at least $300 million to prevent economic collapse, Albania’s new finance minister, Arben Malaj, told an EU fact-finding mission in mid-March. The country faces a food crisis because looters have stolen government food reserves. The EU should act in Albania by sending an elite brigade of accountants and economists, according to a recent Times of London editorial.

Bulgaria

Caretaker Prime Minister Stefan Sofiyansky on March 17 presented on national television the main features of the stabilization program, admitting it could cost as many as 58,000 people their jobs. (Unemployment reached 13.4 percent in January, the highest level since July 1994.) All prices would be fully liberalized except for temporary continuation of subsidies for bread, milk, white cheese, and chicken. Earlier the government announced a 257 percent increase in the prices for heating, electricity, and coal. Services offered by the Bulgarian Telecommunications Company are to be raised eightfold.

Wages would be increased by 70 percent starting April 1, and a new social security system would be created by the end of June. The average monthly wage is to reach $72 in April and $112 in December, the average pension $22.5 in April and $34 in December. The government will try to find ways to compensate the country’s poorest citizens. Some 20 million ECU provided by the EU will be distributed among 150,000 families. Eighty-nine percent of Bulgarians say that they are poorer than they were last year. The number of those who are living off their savings has doubled since 1995. Almost every fourth Bulgarian has run up debts reported the National Statistics Institute (NSI).

Harvard Institute for International Development Director and Bulgarian presidential adviser Jeffrey Sachs said the Bulgarian government should seek ways to restructure its heavy debt burden over both the short and the long term. He told a news conference in early March that a country with hyperinflation could not be expected to make net payments to the outside world to any significant extent. Sachs also warned Bulgaria against long-term implementation of a currency board, as proposed by the IMF, to help stabilize the economy. The country’s small foreign reserves (about $400 million) cast doubt on the efficacy of a currency board, he claimed. Noting that annual debt service is about 10 percent of GDP, he lambasted the West for being more concerned about the welfare of Western creditors than about that of the Bulgarian people.

Meanwhile, Steve Hanke, the world’s best-known advocate of currency boards, has become an adviser to Bulgarian President Petar Stoyanov. (See Steve Hanke’s article on new currency boards, Transition, February 1997, p. 8.)

Czech Republic

An economic slowdown—and the consequent shrinkage of the tax base—was largely responsible for the deficit in the state budget after only two months of 1997. In January-February the budget deficit reached 6.7 billion crowns ($231 million). The finance ministry attributes much of the current year’s deficit to a fall of 3.3 billion crowns in revenues from taxes. In addition to the economic downturn, Czech firms have become smarter at avoiding taxes, according to Evzen Kocenda, deputy director of research at Charles University’s Center for Economic Research and Graduate Education.

Economists blame the slowdown on three factors: the incomplete privatization of large companies, the growing trade deficit, and the Czech National Bank’s inflation-conscious and restrictive monetary policy.

Finance Minister Ivan Kocsrník has announced an across-the-board cut in state spending of 2 percent, (that is, 11 billion crowns). Proposed government measures also include increasing consumption taxes (for example, on gasoline, cigarettes, and beer) and lowering the corporate tax rate from the current 39 percent to 35 percent.

The strong crown, as well as Czech industry’s failing export performance, is driving the country’s trade deficit—$5.9 billion in 1996, compared with $3.7 billion the previous year. The national bank reported that the current account deficit for all of 1996 was $4.5 billion, compared with $1.4 billion in 1995. This year’s trade deficit could top 200 billion crowns (about $7 billion). The trade deficit in January was 13.6 billion crowns ($477 million), compared with 7.9 billion crowns in January 1996.

Hungary

The foreign trade balance is expected to deteriorate by $500 million in 1997 compared with last year, because of a 10 to 12 percent projected increase in imports, Hungarian officials predict. To preserve the balance of payments the tourism sector must produce a surplus of $1billion to $1.2 billion. Industrial production must grow by 4 percent and investments by 8 to 10 percent, along with stagnant export and domestic consumption levels, in order to achieve GDP growth of 2 to 3 percent. In accordance with the EU association agreement, Hungary will lift import quotas on EU goods. Hungary must also abolish import duties by the turn of the century, with only temporary duties to be imposed on products important to the Hungarian economy.

The gap between the rich and the poor in Hungary continues to widen: the 20 percent of people with the highest incomes earn four times as much as the poorest 20 percent, according to a recent report by the Central Statistical Office. About 25 to 30 percent of the nation lives under the poverty line, defined last year at earnings of 15,172 forints (Ft), or $87, a month. A typical family of four spends 45.3 percent of its income on food. Hungary’s 3 million pensioners received an average Ft 17,300 (about $100) a month last year.

The Budapest-based Economic Research Institute (GKI) forecasts a 2.5 percent rise in real GDP in 1997 with 6 percent growth in industrial production and a 1 percent increase in agricultural output. Capital investment is expected to grow by 10 percent next year. GKI forecasts 8 percent growth in exports and a 10 percent increase in imports next year. This will result in a $2.8 billion $3 billion trade deficit, including the turnover of duty-free zones, but GKI expects the current account deficit to remain at $1.8 billion in 1997. The conditions for economic growth are expected to emerge in the next few months, and falling inflation and higher wages are likely to boost domestic demand.

Hungary on April 1 reduced the monthly crawling-peg depreciation of the forint to 1.1 percent from 1.2 percent. The government is to reduce Hungary’s special surcharge on imports to 3 percent effective May 15. The country’s improving economic fundamentals have allowed the government to take these steps as part of an effort to force down inflation in 1997.

Poland

According to estimates by the economy ministry, the foreign trade deficit reached $12.6 billion in 1996, almost double the figure for the previous year. Export revenues totaled $24.35 billion (a 6.3 percent increase over 1995) and import revenues $36.94 billion (27.2 percent). Economy ministry official Janusz Kaczurba said the shortfall was caused mainly by the limited export capacity of the Polish economy and the slowing down of global foreign trade. He added that the improvement of the German economy (Germany is the biggest importer of Polish goods) and the increase in foreign investment in Poland should mean that the foreign trade deficit will be lower this year. Exports are projected to grow by 15 percent and imports by 22 percent.

Polish authorities are weighing controls on some foreign investment as part of their effort to reduce inflation by reining in money supply growth. The national bank wants foreign investors who buy Polish government bonds and corporate debt securities to deposit a portion of their investments in non-interest-bearing accounts. Critics are concerned that the national bank’s intended measure would slow down investments by foreigners, who have already invested an estimated $1 billion in Polish government debt.

Romania

Prime Minister Victor Ciorbea presented the government’s long-awaited shock therapy program. About 3,600 state companies will be privatized in 1997; unprofitable companies will be closed or auctioned off, exchange controls are to be lifted, tariffs and price controls cut, and an inflated exchange rate abandoned. (The price of fuel, electricity, public transport, and telecommunications already surged in February following the government’s decision to withdraw subsidies for them. As a result, consumer prices rose 18.8 percent in February, after a 16.2 percent rise in January.)

The government expects a rise in unemployment to about 8 percent from the current 6 percent. A social program will compensate those most affected by the measures—over 10 percent of GDP will be channeled into this program. The average monthly wage will increase by more than 30 percent, from 329,000 lei ($53) to 430,000 lei ($70). The government hopes that the wage increase will compensate for some 75 percent of the price hikes. The minimum taxable salary will double from the present 97,000 lei (about $16).

Within the next two months the government will introduce or revise up to eighty laws in order to attract direct and portfolio investments from the West, Prime Minister Ciorbea said. Bureaucratic procedures are to be cut back. Romanian authorities plan to allow foreign banks to acquire up to about 95 percent of state banks’ capital and to develop capital markets. All five state-controlled commercial banks will be included in the bill. Mr. Ciorbea also invited foreign companies to buy stakes in state utilities, communications groups, and oil companies that are to be privatized. Foreign investors in Romania, whether their interest is in partially or entirely foreign-owned businesses, will be entitled to own the land required for their activities.

Romania’s GDP will contract by 1 to 2 percent this year amid sweeping free market reforms. Romania’s annual foreign debt servicing will total about $900 million this year but will grow to $1.6 billion between 1999 and 2001 due to recent short-term borrowing, IMF Resident Representative John Hill told an investors conference in Bucharest in early March. Most of the country’s resources for debt servicing in 1997 will come from foreign loans. The budget and current account deficits should steadily improve, and the state could pay for the higher debt servicing in the near future with little borrowing. Modest GDP growth is expected in 1998 following the free market reforms.

The leu has stabilized at rates of 8,500 to 9,000 to the dollar after a six-week depreciation of 46 percent. The National Bank of Romania has set an official reference rate of 6,822 lei to the dollar in order to hold the leu’s depreciation to 39 percent so far this year. The bank will set minimum and maximum rates for the leu by the end of this year if foreign reserves total at least $2.5 billion and inflation drops to an annualized rate of 30 percent, national bank officials predicted.

Federal Republic of Yugoslavia

The Yugoslav economy is on the verge of collapse and the government is facing stark economic options—recession or rampant inflation—the Belgrade-based Institute for Market Research (IZIT) said on March 4. IZIT director Jovan Todorovic said Yugoslavia urgently needs to rejoin international financial institutions but must also embark on privatization, economic restructuring, and reform of the expensive state apparatus. The West has made any recourse to such bodies as the IMF conditional on political as well as economic change by the government.

Baltics

The Baltic states of Estonia, Latvia, and Lithuania are all moving ahead with legislation to introduce private pensions, which experts say will provide a major boost to both local markets and the economy. "This is really important for economic growth," said Louise Fox of the World Bank, who is advising the Latvian and Lithuanian authorities on pension fund legislation. Fox said that once private pension are introduced, around 1 percent of Latvia’s 2.7 million population will likely take part in some form of private pension scheme in the first year, with participation rising to around 20 percent after ten years. An underground pipeline to smuggle vodka between Estonia and Latvia has been discovered by the countries’ customs officials. The 300-meter pipeline ran between two border villages alongside the main Riga-Tallinn road. The pipeline was discovered before it began operating. The price of vodka in Estonia is 60 percent higher than in Latvia.

In February monthly inflation in Estonia was 0.9 percent, in Latvia 0.4 percent, and in Lithuania 0.6 percent, in each case sharply down from January levels. The combined rates for the first two months (2.3 percent in both Estonia and Latvia and 3.4 percent in Lithuania) are considerably lower than for the same period over the past six years.

Russia

In January Russians purchased $5.2 billion worth of foreign currency, a recent Russian State Statistical Committee report said. This amounts to 18.5 percent of total earned income. The monthly flight of Russian capital abroad totals between $1.5 billion and $2 billion, according to the Russian Academy of Sciences’ Institute of Economics. The most widespread scheme is to sell raw materials at lower than world prices and then share the difference between the participants in the deal.

Russia’s 17 million jobless constitute 22 percent of the labor force, the International Labor Organization claims. The ministry of labor in Moscow, however, cites data that put unemployment at just 7.5 million (9.7 percent) at the end of 1996: 2.5 million registered unemployed, plus 3 million engaged in part-time work and 2 million on unpaid leave. Arrears of unemployment benefits total 1.2 trillion rubles ($210 million). Currently, an unemployed worker receives 75 percent of the last earned wage. A new law would cap the benefit at the subsistence minimum for the region in which the applicant resides.

Only six of Russia’s eighty-nine regions met their 1996 tax obligations to the federal budget, according to Deputy General Procurator Vladimir Davidov. The main reasons for tax arrears are falling industrial output and the inefficient fiscal system, he admitted. Barter deals and the mass issuance of bills of exchange (vekselya) represent major channels for tax evasion. Russian commercial banks alone issued 114 trillion rubles (some $20 billion) worth of vekselya, according to the central bank. At any one time 11 trillion rubles in tax payments are being held by commercial banks, which delay passing the funds on to the federal authorities. (On March 14 the Duma imposed higher fines for each day that commercial banks delay transferring tax payments to the budget.)

The 1997 budget, signed into law, plans expenditure of 530 trillion rubles ($76 billion), including 104 trillion on defense, 47 trillion on internal security, 18.5 trillion on education, and 10 trillion on social policy. With income of 434 trillion rubles and a deficit of 95 trillion (3.5 percent of GDP), the budget formally complies with the deficit guidelines agreed with the IMF. Prime Minister Viktor Chernomyrdin admitted that 40 trillion rubles of expenditure carried over from 1996 are not covered by revenues at present.

The volume of domestic investment in the Russian economy in January totaled 18 trillion rubles, a 9 percent decline over the same period a year earlier. The fall is largely due to drastic cuts in federal investment programs, high interest rates for banking credits, and the higher returns possible from state short-term securities.

In the fuel and energy sector investment in 1996 fell 16 percent compared with the previous year, amounting to 104 trillion rubles ($18.4 billion). Investment in the gas industry fell 5.5 percent, and in the oil sector the decline was 25.7 percent. Oil production dropped 2 percent in 1996, and has fallen 40 percent overall since its peak in 1987. Major foreign investors are staying away pending the approval of a list of sites authorized under the production-sharing law. Half of the oil pipelines are more than twenty years old, and 2 percent of the oil is lost through leaks due to corrosion and accidents.

The average monthly salary in Russia was 870,000 rubles ($155) in January, 10 percent higher than a year earlier after adjustment for inflation. As of January 27, Russian workers were owed 48.6 trillion rubles in delayed wages, up 3 percent from 47.2 trillion in December 1996; late payments from the budget accounted for about 20 percent of the arrears.

Russia’s population will decline by up to 25 million people during the next three decades if current demographic trends continue, Carl Haub of the Washington-based Population Reference Bureau predicts in a recent study. The population will decrease from the present 148 million to 123 million by 2030, and after that the decline will be even faster. The drop in population is related to the low birth rate (in 1996 the rate was just 9 births per 1,000 population) and the high death rate among Russian males, which now equals that of war-ravaged Liberia. This high mortality rate is attributed primarily to cardiovascular diseases, industrial accidents, and alcoholism. Soon, almost one-third of Russia’s population will be people who are dependent on pensions.

Ukraine

Ukraine owes 1.36 billion hryvnyas ($750 million) in wage arrears and 1.2 billion (more than $700 million) in unpaid pensions, Prime Minister Pavlo Lazarenko told the parliament on March 11. He said the debts have accrued because budget revenues were smaller than predicted, unforeseen wage increases were being financed from the budget, and local budgets were higher than envisaged. He hoped that 35 percent of all wage arrears would be paid by May and all pensions dating from December 1996 by the end of March.

Ukraine wants to promote foreign investment: Prime Minister Lazarenko announced in mid-February that the tax burden will be reduced, and the state’s share in privatized enterprises will not exceed 26 percent (except for strategic facilities, in which the government will retain 51 percent ownership). Ukraine has so far attracted only $1.5 billion in foreign direct investment.

Ukrainian lawmakers have voted to increase the minimum monthly wage from 15 hryvnyas ($8) to 70.9 hryvnyas. Labor Minister Mykola Biloblotsky warned that the move would cost the state budget 32 billion hryvnyas this year. The average monthly wage for Ukraine’s industrial workers is now 157 hryvnyas.

Central Asia

The presidents of the Kyrgyz Republic, Tajikistan, and Turkmenistan have pledged aid totaling 0.3 percent of their annual fiscal budgets to the International Fund for Saving the Aral Sea.

Under a major government reorganization in Kazakstan, two new state agencies directly responsible to the president have been created to control strategic resources and planning. The economy ministry, the trade and industry ministry, and the antimonopoly committee have been merged into a new economy superministry. The state property and state privatization committees have been abolished, and their powers transferred to the finance ministry and the state investment committee. The energy sector ministries were amalgamated into a new energy and natural resources ministry. The changes seem likely to concentrate more power in the hands of the president and to strengthen the hand of the oil and gas lobby.

U.S. investors at the start of 1996 had a 66 percent share, worth $1.8 billion, in Kazakstan’s foreign direct investments, mainly in the oil industry. More than 27,000 Kazaks now work for foreign companies or joint ventures, compared with around 6,400 in early 1993. (A U.S. firm, CCL, has recently invested in Kazakstan, having a three-year concession to run the Pavoldar oil refinery. The plant previously produced more than half of Kazakstan’s gasoline needs.)

Kyrgyzstan’s GNP increased by 5.6 percent, industrial output by 10.8 percent, and agricultural output by 13.1 percent in 1996, President Askar Akayev announced to parliament on March 26. One of the country’s goals for 1997 is to reduce the trade deficit. In 1996 Kyrgyzstan imported 1.7 times more than it exported. Another goal is to bring inflation down to 17 percent and to cut unemployment, which is running at 20 percent.

Uzbek President Islam Karimov called 1996 the year of economic and financial stabilization. The budget deficit did not exceed 3.5 percent, inflation was cut in half, the national currency was strengthened, and foreign trade was more than $9.3 billion. Mr. Karimov called for 1997 to be a year of social security for all. (The EBRD has granted a credit line of $120 million to develop the Uzbek banking sector, and OPIC has provided $200 million worth of political risk insurance and financing for U.S. projects in the country.)

In Turkmenistan inflation in 1996 was 100.1 percent. Some 4.4 million metric tons of oil and 35.2 billion cubic meters of gas were extracted during the year. Over 90 percent of industrial production came from state enterprises but some 66 percent of retail trade is reportedly outside state control. GDP exceeded 6.6 billion manats ($1.6 billion) in 1996.

Turkmen President Saparmurat Niyazov signed a $580 million agreement with three Japanese concerns—Itochi, JGC, and Nissho Iwai—to build Turkmenistan’s first polypropylene plant in Turkmenbashy (formerly Krasnovodsk). The Japanese government will extend a $400 million credit to the plant, which will produce 90,000 tons of polypropylene annually.

Cambodia

Cambodia is laying plans to set up its first stock market, and finance ministry officials are aiming for a 1998 start-up. Capital market laws have already been drafted and are awaiting submission to the National Assembly for approval. The government also needs to pass company laws and legislation affecting withholding tax and foreign exchange. Cambodia’s economic growth for 1996 has been revised upward to 6.5 percent from an original 6 percent, Finance Minister Keat Chhon said in early March.

Vietnam

Vietnam is expected to record a $945 million trade deficit for the first three months of this year. That level would represent a 6.5 percent decline from the shortfall in the same period in 1996, and would signal that government efforts to tame the deficit were paying off.

Nearly one-fifth of Vietnamese state-owned enterprises (SOEs) are operating at a loss, a Vietnamese newspaper reported. However, experts say that given the nature of accounting at most state-owned enterprises, the figure could be much higher.