Temporarily tight in Tbilisi

The countries of the former Soviet Union seem to have made remarkable cuts in their budget deficits. Or have they?

CAST an eye over the public finances of the countries of the former Soviet Union and it seems that fiscal discipline has become de rigueur from Tbilisi to Tashkent. Egged on by, among others, the IMF, policymakers in the 15 countries have slashed their average fiscal deficit from 13% of GDP in 1992 to below 5% last year. For countries such as Georgia, whose deficit had reached 37% of GDP back in 1992, the transformation has been breathtaking. But is this performance as brilliant as it seems?
     It may sound churlish to complain at such apparent prudence. The cost of profligacy is often high: in poor countries without domestic bond markets, governments usually pay for high deficits by forcing central banks to print money, thus causing galloping inflation. In the early 1990s inflation rates of hundreds of percent a year were commonplace. These days, although inflation is still high by western standards, the days of near-hyperinflation seem to be over--thanks in no small part to thinner deficits.
     Nevertheless, the figures conceal plenty. For a start, the definition of a budget deficit in a once centrally planned economy is rather arbitrary. Under the previous regime, state-owned companies produced goods at prices fixed by the plan; usually, they also provided health clinics, kindergartens and other social benefits. During the transition to a market economy, a government's apparent fiscal health depends partly on which of these activities are incorporated into the budget. Small deficits mean little if spending on schools, say, is left out.
     Worse, a fixation with the deficit can slow down restructuring. Many of the governments in question, determined to cut their deficits, still support ailing state firms with cheap credit, which does not show up in the budget.
     Even so, these countries had little choice but to slash their deficits in order to conquer inflation. So far, they seem to have been successful. But will their fiscal discipline last? That depends in part on politicians' mettle. But it also depends on what lies behind today's smaller deficits. In a new paper* Adrienne Cheasty and Jeffrey Davis (both, as it happens, IMF economists writing in a personal capacity) argue that behind the figures lies a complex and troubling tale.
     Strikingly, deficits have been cut despite a huge drop in government revenues. On average, these were about 33% of GDP in 1992. Last year's average was closer to 20%, with Georgia putting a minuscule 5% of GDP into its public purse (see chart). There are several reasons for this: the poorer countries stopped receiving liberal hand-outs from Moscow; state firms, the traditional tax base, were hit hard by deep recessions; the new private sector proved difficult to tax; and endless tax exemptions for politically powerful firms made things worse.

Fiddling the figures
Given this, how did these countries manage to bring their fiscal deficits down so fast? In short, through apparently swingeing cuts in spending. Government spending fell from an average of 45% of GDP in 1992 to 29% in 1995. But, say Ms Cheasty and Mr Davis, many of these cuts are neither politically sustainable nor economically sensible.
     One approach is deliberately to set aside too little cash to meet spending promises, by basing the budget on artificially low forecasts of inflation. In 1995, for instance, the Russian budget assumed an inflation rate that was one-third lower than the official inflation target. A similar tactic is to write conflicting legislation. In Ukraine laws on raising social benefits were passed by the parliament at the same time as a tough budget law which strictly limited the government's ability to finance them.
     When the cash runs out, a common tool has been "sequestration", a fancy name for cash rationing. In some countries (such as Russia) there are rules governing who gets the money; in others (such as Ukraine) government spending depends on the decisions of individual bureaucrats. Either way, the result is that wages, pensions and so forth are simply not paid, and the government goes into arrears. In 1995 the Russians "saved" at least 3% of GDP this way.
     The trouble is that this cannot last. Withholding wages and pensions is no way to win elections. Nor does running up arrears reduce fiscal deficits for good. It merely postpones the day on which governments must either print money to pay for them or, better but less popular, make permanent spending cuts.
     From a macroeconomic point of view, that is bad enough. Even worse, the strategy may ruin the government's control of economic policy. As government agencies learn that their access to cash is erratic, they begin to hoard money whenever they get hold of it. This means that the central government can no longer predict its own spending patterns. Also, local governments are more reluctant to pass on tax revenue to the centre.
     Ms Cheasty and Mr Davis also point out that there has been surprisingly little reorganisation of spending priorities by governments. In many former Soviet countries, much public money is still spent on state intervention in the economy through, say, subsidies for agriculture or energy rather than on economic restructuring. The authors argue that a successful transition to the market will require much deeper changes in the structure of public spending.
     All this makes the region's fiscal success less dramatic than it appears. So far, it is true, small deficits have helped to bring inflation down. But if this is to prove permanent, governments will have to use intelligent, longer-term fiscal policies, and not rely on short-term fixes.