The 1998 monetary crisis and Kaliningrad’s dependence on Russian economic

Short and medium-term consequences of the 1998 rouble devaluation

The financial and monetary crisis of August 1998 hit the whole of Russia hard. Kaliningrad’s specific reaction to the crisis is connected to the exclavity factor. It fully corresponds with the notion of enclave-specific vulnerability. Since Kaliningrad’s economy was already highly dependent on foreign trade flows (as the SEZ began to unfold), it was also highly sensitive to the exchange rate of the rouble. That is why it overreacted to the financial crisis of 1998 in four ways:

1) Prices jumped twice as much as in most Russian regions (Samson, 2000a, pp. 8-9).

2) Production decreased by 9.5%, which was much greater than in Russia on average (-1.9%).

3) Foreign trade flows fell by 25% in one year. The total foreign trade turnover decreased from $1,617 mn to $1,207 (Table 2.6). In parallel, the foreign trade gap grew owing to diminishing imports.

4) Also, foreign investment dropped because of overall economic instability and a general decrease in economic activities, declining from $39.4 mn in 1998 to $18.3 mn in 1999, i.e. by more than half.

Table 2.6 Impact of the 1998 crisis on foreign trade

Year X+M

($ mn)

X ($ mn)

M ($ mn)

X-M ($ mn)

1998 1,617.2 429.3 1,187.9 -758.6

1999 1,207.7 383.6 824.1 -440.5

2000 1,403.2 519.0 884.2 -365.2

Note: X = export, M = import, (X+M) = total foreign trade turnover, (Х-М) = foreign trade balance Source of primary data: KRCS (2001).

Exports did not take off – and even slightly decreased – because of the unfavourable climate on world commodities markets, in particular low oil prices. Imports decreased drastically, falling from $1,188 mn in 1998 to $824 mn in 1999, or by 30.4%. Although the foreign trade balance benefited because of this, it can hardly be judged a positive consequence of the 1998 economic shock.

The fourfold reaction described above took place in a small period of time (1998–99), or within one year following the crisis. In the medium term, the strong economic recovery followed, triggered by the rouble’s devaluation. The devaluation of the rouble served as the foundation of the strong rise of import substitution, which has become Kaliningrad’s primary economic engine in the 2000s. In other words, the 1998 crisis had short- as well as medium-term effects.

In the short term, the most noticeable effect was on prices, since the cost of imported goods rose steeply. The effect was stronger than Russia’s average, since, owing to the SEZ regime, the local market was saturated with the complete range of imported products, from foodstuffs to consumer electronics.

Over the long term, according to the economic theory of the ‘J curve’, the effects might have been twofold:

• Exports might have been promoted thanks to the new competitiveness gained by the depreciation of the exchange rate of the rouble. That being stated, this had not been the case following the 1998 crisis, which calls for a more comprehensive explanation.

• Opportunities would have arisen for import substitution.

As the situation has evolved, the design of the SEZ regime explains why the regional economy used the second opportunity and completely ignored the first one. The SEZ had promoted import substitution implicitly but very strongly. In addition, the strong rise of the domestic Russian economy on the whole and the expansion of domestic consumer demand reinforced opportunities for Kaliningrad-based businesses. On the other hand, the resource-oriented nature of Kaliningrad exports held only a limited growth potential. The development of the new export industries was depressed owing to the abundant business opportunities in import substitution.

By the end of 2003, five and a half years after the rouble devaluation in August 1998, the annual, real effective rouble appreciation was about 6.5%. The Moscow-based Institute for the Economy in Transition (IET) argues:

[T]he observed rates of appreciation of the Russian national currency do not pose a serious threat to the competitiveness of Russia’s producers, while at the same time diminishing the real costs of attraction of foreign capital, imported machinery, equipment and technologies necessary for technical and technological modernization of the Russian economy and improvement of its products (2004, p. 34).

A heavy dependency on Russian economic trends

It is necessary to dwell on one more external factor of general economic nature, which is of increasing importance to the special conditions of the Kaliningrad region. It is the strong dependency of the Kaliningrad economy on the growth rates of the Russian economy overall.

As noted in section 2.1, a comparison of dynamics in Russia and Kaliningrad reveals a clear correlation (Table 2.7). While following the all-Russia economic trends, the fluctuations in Kaliningrad’s GRP are more intense in their volatility.

Table 2.7 Russia’s GDP and Kaliningrad region’s GRP in 1995–2004, annual changes (in %) 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Russia -4.1 -3.4 0.9 -1.9 5.4 9.0 5.0 5.6 7.3 7.1 6.4 Kaliningrad -16.2 -14.2 -4.5 -9.5 6.8 14.4 6.0 9.5 11.5 12.3 13.0 Sources: KRCS (2001 and 2004) and Kaliningrad Regional Government data.

The authors of the 5^th Economic Bulletin of the TACIS project on trade and economic development in the Kaliningrad region¹ observe that the growth of import substitution in the region during the last few years was largely conditioned by general economic growth in the country and by the upswing of demand, particularly on the part of Russian consumers. This view is confirmed by the obvious dependence of the parameters describing the development rates of Kaliningrad’s import-substituting sector on the rates of growth of basic Russian macroeconomic parameters. They provide two figures that illustrate a dependency on the rates of development of the Russian economy (the index of basic industries’ growth rate and a real rouble exchange rate). While the first figure shows a positive correlation of Kaliningrad’s exports to the mainland with Russian industrial growth, the second figure shows an inverse

1 See EU–Russia Cooperation Programme (2004d, p. 21).

negative relation of Kaliningrad’s imports with the real rouble exchange rate. Yet it can be argued that it is incorrect to compare the growth of the SEZ exports with Russian industrial growth. There is no correlation between them, taking into account the commodity structure of Kaliningrad’s outflows (consumer goods). It makes more sense to look for a correlation with Russian consumption figures, especially with household consumption figures given in US$.

Figure 2.4 shows the existence of a positive correlation between consumption in Russia, in particular household consumption, with the volume of exports to Russia under Kaliningrad’s SEZ regime. The SEZ outflows to the Russian mainland correlate better with the total consumption expenditure for households because of the specific nature of outflows to the mainland – consumer goods.

Figure 2.4 Consumption figures in Russia and the volume of goods delivered from Kaliningrad to mainland Russia, growth (in %)

0

Final and household final consum expenditures in Russia

0

The volumes of the outflows to the mainland also correlate closely with total Russian imports (Figure 2.5). That is not surprising when one takes into consideration that the cost of imports determines 70-90% of the cost price in Kaliningrad’s import-substitution industries. Hence, the same factors determine the mainland’s demand for imported goods and for goods produced in Kaliningrad (Usanov & Kharin, 2005, p. 17).

Figure 2.5 Correlation of Kaliningrad’s outflows to mainland Russia and total Russian imports, 2000–04

40,000 50,000 60,000 70,000 80,000 90,000 100,000 Total Russian imports