MAJOR INDUSTRIAL COUNTRIES

The world's major industrial countries continued to display a modest economic growth in 1996. Therefore, both inflation and interest rates remained low, despite the increase in the price of oil on the world market. The major economic indicators characterizing different regions and countries in 1996 have been given in Table 1 (The major economic indicators characterizing different regions and leading industrial countries in 1996 and prognosis for the 1997).

Table 1. The major economic indicators characterizing different regions and leading industrial countries in 1996 and prognosis for the 1997

 

GDP (%)

CPI (%)

Unemployment (%)

Budget (% of GDP)(1)

Balance of payments
(% of GDP)(1)

1996

1997 (2)

1996

1997 (2)

1996

1997 (2)

1996

1997 (2)

1996

1997 (2)

World

2.8

2.6

 

 

 

 

 

 

 

 

USA

2.5

2.4-3.0

3.3

3.2

5.4

5.2

-1.4

-1.6

-2.1

-1.7

Canada

1.5

3.0-4.3

2.0

1.7

9.4

8.5

-4.0

-2.5

0.0

+0.5

Australia

4.0

3.0-3.1

2.8

2.5

8.6

8.3

+0.4

+0.6

-4.0

-3.9

Asia (excl. Japan)

7.5

6.2-7.0

 

 

 

 

 

 

 

 

Japan

3.4

0.3-1.9

0.5

1.2

3.4

3.4

-4.6

-4.4

+1.5

+1.5

Europe

1.7

3.0-3.1

 

 

 

 

 

 

 

 

Germany

1.4

2.2-2.4

1.5

1.8

10.4

10.9

-3.9

-3.0

-0.7

-0.4

Great Britain

2.4

3.5-3.8

2.6

3.2

7.5

6.3

-3.4

-2.6

-0.1

-0.9

France

1.2

2.1-2.2

1.7

1.7

12.4

12.7

-4.1

-3.1

+1.5

+1.2

(1) "+" shows surplus. "-" deficit
(2) prognosis by Deutsche Morgan Grenfell

As can be seen from the table, economic development in different regions was uneven. While the gross domestic product (GDP) of Asian developing countries increased rapidly, growth in the industrial countries of Europe was well below expectations. The unemployment indicators improved considerably in the USA. For 1997, too, low inflation and relatively low interest rates can be expected.

On financial markets, 1996 was for a long time the first year without major crises (in 1995 negative developments had been connected with the foreign exchange markets and Mexico and Argentina; in 1994 with the bond market, Brazil and Turkey; in 1992 and 1993 with the European exchange rate mechanism; in 1988-1992 with shocks at the real estate market and in 1987 in the stock market, etc.). Still, there were problems on the level of individual financial institutions (Daiwa, Sumitomo). The latter led to a significant shift in the improvement of risk management and supervision of banks.

Fluctuations on the foreign exchange markets were smaller than in 1995. The German mark weakened over the year against both the US dollar, the British pound as well as the currencies of peripheral European countries (see Table 2. Changes in exchange rates of major currencies within a year and developments on the stock and bond markets in 1995 and 1996).

Table 2. Changes in exchange rates of major currencies within a year and developments on the stock and bond markets in 1995 and 1996 (shot-down value on 31 December)

 

1995

1996

Change (%)

Foreign currency markets

DEM/USD

1.438

1.555

8.2

JPY/USD

103.4

115.9

12.1

DEM/GBP

2.228

2.638

18.4

Stock markets

DJI

5,117.12

6,448.27

26.0

Nikkei

19,868.2

19,361.4

-2.6

DAX

2,230.35

2,888.69

29.5

FT-SE

3,689.3

4,118.5

11.6

Bond markets(*)

World

280.30

301.13

7.4

USA

309.59

318.29

2.8

Japan

213.60

224.84

5.3

Germany

227.53

244.12

7.3

Great Britain

333.15

357.82

7.4

Sweden

185.50

219.36

18.3

Finland

119.57

134.74

12.7

(*) According to the Salomon Brothers Inc.

Prices increased on the majority of stock markets, with the increase on the US market exceeding 20% for the second consecutive year. The price increase on the bond markets was moderate and although prices in the USA dropped marginally over the year, European markets were dominated by the upward trend. The price increase can be contributed to the expectations of the common European currency that led to the decline in interest rates and boosted bond prices in peripheral European countries (the price of bonds increased by 21.9% in Italy and by 22.1% in Spain).

Regardless of the return of the Iranian oil to the market, oil prices increased by 35% over the past year and the price of gold dropped to the lowest level in recent years.

USA

In the USA a moderate, 2.5% economic growth continued for the fifth year running, coinciding with the potential trend. Despite the low unemployment level (the December figure of 5.3% points rather to the shortage of labour than unemployment) inflation remained low. In the near future there is no reason to expect the increase in inflation because the strong dollar will compensate for the pressure arising from the increasing wages. For 1997, consumer prices are predicted to increase by 3.2%. On the domestic policy level such a tendency is welcome but low and, according to forecasts, lowering unemployment will become a source of inflational pressure in future.

The current account deficit increased by 10 billion dollars last year, reaching 158 billion dollars. In 1997, the current account deficit is expected to decrease to 135 billion dollars. Although trade deficit with Japan decreased considerably, the deficit in trade with China increased.

Japan

The Japanese economy increased exceptionally rapidly in 1996 (3.4%) while growth in the first quarter was particularly remarkable - 8.4%. If development had followed, the prevailing trend growth should have been 2.2% in Japan.

The increase in the consumer price index was near zero (0.5%) and this too was caused by the weakening of the yen - otherwise the consumer price index would have decreased. Due to the increase in the tax burden, a 2% inflation is forecast for 1997. Unemployment was at a traditionally low level (3.3-3.5%) and will obviously remain at that level also in the near future.

The surplus of the current account decreased by 29% in 1996 and trade surplus dropped by 31%. Such major shifts can mainly be attributed to the so-called trade war with the USA which has made some sectors of the Japanese economy more open. The openness is expected to increase even further in 1997, spreading to the financial sector. This points to the continuation of the trend.

Throughout 1996 the Japanese central bank kept interest rates low. In view of the declining demand and strict financial policy, monetary policy will, in the near future, remain the only factor favourable to economic growth and there are no grounds to expect that interest rates would be increased, at least not in the first half of 1997.

European Countries

In continental Europe, economic growth in 1996 was below the predicted level which created problems with budget revenues and kept unemployment rate high. Interest rates dropped considerably over the past year, particularly in peripheral countries. At the moment all members of the European Union (EU), with the exception of Italy and Greece, have reached the level required for membership in the European Monetary Union. At the EU Council of Ministers meeting in Dublin an accord was reached on the fiscal policy principles of the third stage of the European Economic and Monetary Union (EMU).

For the majority of EU countries, with the exception of Luxembourg, meeting the Maastricht treaty criteria 100% by the deadline still seems unlikely (see Table 3. Economic indicators of EU member countries in 1995 and 1996 and prognosis for 1997). The two possible alternatives - changing the time schedule or adopting a broader approach to meeting the convergence criteria - would apparently have a negative impact on bond prices and would strengthen the German mark. The increase in interest rates in continental Europe would probably slow down the already modest economic growth and increase unemployment.

Table 3. Economic indicators of EU member countries in 1995 and 1996 and prognosis for 1997

 

Inflation rate

Budget (% of GDP)(1)

Total state debt (% of GDP)(1)

1995

1996

1997(2)

1995

1996

1997(2)

1995

1996

1997(2)

Criterium for the EU members

2.9

2.4

2.9

-3.0

60.0

Germany

1.8

1.5

1.4

-3.5

-3.9

-3.0

58.1

60.4

61.5

France

1.8

2.0

1.6

-4.9

-4.1

-3.1

53.0

56.0

58.0

Italy

5.4

3.9

2.7

-7.1

-7.4

-4.0

125.0

124.8

124.3

Great Britain

2.8

2.7

2.3

-5.6

-4.1

-3.2

54.1

54.6

53.9

Spain

4.7

3.5

2.8

-6.6

-4.4

-3.4

65.7

67.7

67.5

Netherlands

1.9

2.0

2.4

-4.0

-2.6

-2.3

79.7

78.6

76.0

Belgium

1.5

2.0

2.5

-4.1

-3.4

-2.9

133.8

130.6

127.0

Sweden

2.9

0.7

1.5

-8.1

-3.8

-3.0

78.7

78.7

78.7

Austria

2.2

1.8

2.0

-5.9

-4.5

-3.4

69.0

71.3

69.5

Denmark

2.1

2.1

2.3

-1.6

-1.6

-0.4

72.1

71.0

68.8

Finland

1.0

0.6

1.4

-5.2

-2.6

-2.0

59.4

58.0

62.1

Portugal

4.1

3.1

2.8

-4.9

-4.0

-3.2

71.5

70.4

69.0

Greece

9.3

8.5

6.7

-9.1

-8.0

-5.7

111.8

110.7

108.2

Ireland

2.5

1.7

2.4

-2.3

-1.1

-1.8

84.8

76.7

72.2

Luxemburg

1.9

2.0

2.2

0.3

0.9

0.5

5.9

7.8

8.8

(1) "+" shows surplus. "-" deficit
(2) prognosis by Deutsche Morgan Grenfell

  indicator meets the Maastricht criterium

Germany

Economic growth (approximately 1.4%) remained smaller than expected. Since nearly half of the GDP increase came from exports, the declining demand of trade partners set considerable constraints to the actual potential of the economy. The relatively high long-term interest rates and cold winter reduced construction activities and had a negative impact on the GDP and unemployment. The level of spending increased at the same rate as the GDP. The decline in the retail trade volume reduced orders from industries. In 1997, economic growth is expected to quicken to 2.2-2.4%, mostly due to the predicted boom in world trade (+7%) but also due to a more favourable exchange rate of the German mark.

Last year, the increase in the consumer price index was on the lowest level in post-reunification years, i.e. at 1.5%. This can be attributed to high unemployment, moderate wage agreements, decreasing producer prices and economic growth that was below the general trend. Most of these factors will also be there in 1997 and thus the CPI is not expected to increase notably in the near future.

Unemployment increased in 1996 and the December figure of 11.8% (4 million unemployed) is by no means the peak. The main reason for high unemployment is insufficient economic growth and structural problems at the labour market. The situation at the labour market will worsen still in 1997: due to the austerity measures less funds have been allocated to the Labour Ministry which will reduce its possibilities for creating new jobs.

Despite a positive trade balance, Germany's current account had a deficit of 25 billion German marks. If economic growth picks up in 1997, the deficit is expected to decrease.

Sweden

Economic growth was modest in Sweden in 1996 - only 1.4%. This year, too, stocks are high and outlook for industry is rather bleak. For 1998, economic growth is expected to reach 2.5%.

In December, disinflation was recorded in Sweden - consumer prices decreased by 0.8%. However, the annual average CPI increase was 0.7% but even this is unprecedentedly low for Sweden. The low CPI level was caused mainly by the considerably decreased interest rates and the reduction of the VAT in January 1996. Inflation is expected to remain low (approximately 1.5%) also in 1997 and this is below the central bank's goal of 2%.

The annual average unemployment level was 7.9%, but if we take into account also those people who have found employment in the framework of the government's employment programme, the summary unemployment figure would be 13.4%. In the European context this is a relatively average figure. Since there are few vacancies, no immediate improvement is forecast for the unemployment situation.

In 1996, both trade balance and current account were positive in Sweden, and the surplus increased as compared to 1995. The same trend is expected to continue in 1997.

Being a new member of the European Union, Sweden's fiscal and monetary policy is mainly aimed at meeting the provisions of the Maastricht treaty. Since Sweden's tax revenue in 1996 was larger than expected, it is possible that the budget deficit meets the requirements. But as far as total state debt is concerned, the target figure will probably not be reached in the coming years. There may emerge additional problems in connection with the 1998 elections which force the government to increase spending. Joining the European exchange rate mechanism is still open due to strong public opposition.

Finland

Economic growth was close to 3% in Finland in 1996 and covered all sectors of the economy. A 3.5% growth is predicted for this year, mainly due to increasing consumption (taxes are reduced and consumer confidence growing). Although much depends on the developments in the price of pulp, Finland is expected to display one of the most rapid economic growths in Europe and this should also be reflected in increasing trade.

Inflation has remained low in recent years (below 1% a year) and is lower than the target set by the central bank (2%). Producer prices are falling. Unemployment is high (approximately 18%) and wage agreements concluded for 1997 are moderate (approximately 2-3% increase), which means there will be no inflationary pressure from the labour. The unemployment, which is one of the highest in Europe (the highest unemployment (22%) was registered in Spain), has been a problem for Finland since 1992. There has been no significant shift to the better despite the relatively high economic growth of the two last years (4.2% in 1995). However, as of recent, the number of vacancies has been going up and this indicates that unemployment may start going down in the near future.

On the political level, meeting the Maastricht criteria is one of the priorities for Finland. At the end of 1996, the country's total debt was below 60% of the GDP, which has been set as the upper limit for joining the EMU.

Another priority has been the reduction of unemployment level in which there has been no clear progress. In the short run, spending more money on boosting employment is prevented by the tight budget policy adopted in order to qualify for the EMU.

In 1996 Finland's current account and trade balance were both positive. Although both were marginally smaller than in 1995, the surplus helped to maintain the exchange rate of the Finnish markka. In 1997, both surpluses are expected to increase.

TRANSITION ECONOMIES OF CENTRAL AND EASTERN EUROPE

Poland, Slovakia, the Czech Republic and Hungary

The real GDP increased slightly less in 1996 than in 1995 in Poland, Slovakia and the Czech Republic (see Table 4. Economic indicators of some Central and Eastern European countries in 1995 and 1996). However, economic growth in Poland exceeded 5% for the third consecutive year. Hungary's economy was still under the influence of the stabilization programme begun in the spring of 1995 and thus its growth remained below 1%.

Table 4. Economic indicators of some Central and Eastern European countries in 1995 and 1996

 

Poland

Slovakia

Czech Republic

Hungary

Latvia

Lithuania

Russia

1995

1996

1995

1996

1995

1996

1995

1996

1995

1996

1995

1996

1995

1996

Change over previous year (%)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross domestic product (GDP)

7.0

6.0

7.4

7.0

4.8

4.1

1.5

0.3

1.6

2.5

2.7

3.5

-4.2

-6.0

Industrial production

9.4

8.5

8.3

2.5

9.2

6.8

4.8

2.3

-6.3

0.0

2.0

3.0

-2.9

-5.0

Central government budget
deficit (-) / surplus (+)
(% of GDP)

-2.6

-2.5

-1.6

-4.4

0.6

-0.1

-2.4

-2.0

-3.8

-0.8

-2.1

-3.6

-3.0

-3.8

Consumer prices (%)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compared to the end of previous
year

21.6

18.5

7.2

5.3

7.9

8.6

28.3

20.1 (1)

23.1

13.1

35.7

13.1

131.4

21.8

Annual average

27.8

19.9

9.9

5.8

9.1

8.8

28.2

23.6

25.0

17.6

38.8

24.4

197.5

47.7

Unemployment rate (proportion
of unemployed to the total
number of employed and
unemployed, %)

14.9

13.6

13.1

12.8

2.9

3.5

10.9

10.5

6.6

7.2

7.3

6.2

8.8

9.3

Real effective exchange rate
(change over previous year,
vis-a-vis 21 industrial
countries, according to the
proportion of foreign trade, %)(2)

6.4

9.2

4.8

4.1

4.6

8.1

-4.7

2.9

17.2

13.1

21.1

 

28.7

34.0

Foreign trade (USD mn)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exports

22,878

24,420

8,578

8,830

21,639

21,922

12,861

13,145

1,305

1,422

2,706

3,145

81,100

87,700

Imports

24,705

32,574

8,769

10,935

25,253

27,829

15,466

16,209

1,749

2,137

3,404

3,991

60,900

59,700

Balance

-1,827

-8,154

-191

-2,105

-3,614

-5,907

-2,605

-3,064

-444

-715

-698

-846

-20,200

28,000

Current account (USD mn)

-2,299

-8,505

649

-1,409

-1,362

-3,430

-2,480

-1,678

-19

-364

-614

-809

11,300

7,000

Current account deficit (-) /
surplus (+) (% of GDP)

-1.9

-6.3

3.7

-10.3

-3.1

-6.5

-5.7

-3.8

-0.4

-6.8

-10.3

-10.5

3.5

2.2

Net foreign direct investments
(USD mn)

1,171

447(3)

157

62(3)

2,526

434(3)

4,410

735(3)

245

145(3)

72

46(3)

1,711

483(3)

Foreign exchange reserves
(USD mn)

14,961

18,033

3,418

3,498

13,900

12,297

11,968

9,714

504

652

682

702

17,300

11,700

Ratio of foreign exchange
reserves to the average monthly
imports

7.3

6.6

4.9

3.8

6.6

5.3

9.3

7.2

3.5

3.7

2.4

2.1

4.5

2.4

(1) Data of November 1996
(2) Lithuania vis-a-vis 5 industrial countries, main trading partners   
(3) Data of the 1st half of 1996

Sources:
International Financial Statistics (IMF)
Transition Report 1995, EBRD, 1995
Economic Indicators for Eastern Europe, Bank for International Settlements; February 1996, January 1997
United Nations Economic Bulletin for Europe; Vol. 47, 48
Publication of central banks and national statistics offices

The GDP growth of the Czech Republic and Poland still rested on the rapid increase in industrial production which was over 6% in both countries. In Poland, the production of investment and consumer goods increased at a more rapid rate. The increase of the subcontracting related production, however, slowed down, reflecting the halt in the increase in exports. In Slovakia, the increase in industrial production was considerably smaller than it had been in previous years. This was mainly caused by the decline in demand for Slovakia's low value-added industrial production on the markets of Western Europe, but also the slowness of structural changes in the economy. The small real increase in industrial production in Hungary was mainly due to the continuing low domestic demand, while the production of the export-oriented and mainly foreign investments financed machine building industry increased notably.

The increase in the GDP was based on the increase in domestic demand, that is, consumption and investments. The share of external demand in the GDP was negative in Poland, Slovakia and the Czech Republic, that is, the import of goods and services by those countries exceeded export and their current account showed a deficit. In Hungary, the increase in domestic demand came to a halt due to the stabilization programme and strict fiscal policy, but it was compensated for by the decrease in the current account deficit.

In Poland and the Czech Republic the growth in domestic demand was based on increasing private consumption, and in particular, increasing investments. The real growth of fixed investments amounted to 20% in Poland and nearly 15% in the Czech Republic. In both countries the increase in investments reflected the general optimism about the further development of the economy. The decline of real interest rates also contributed to the growth of investments. In Slovakia the rapid growth of investments continued mostly owing to state investments while in Hungary the increase in investments remained low due to the decrease in the public sector investments because of the stabilization programme and high real interest rates. Investments into the private sector increased though.

The rapid growth of exports by Central and Eastern European countries that began in 1994 slowed down considerably in 1996. In Poland, export of goods (measured in US dollars) increased approximately 6%, the increase in exports from Hungary, Slovakia and the Czech Republic was around 1-3%. There are at least three reasons for the slow-down of exports:

  1. due to the smaller than expected real growth in economies of the EU countries, and particularly Germany, demand for the production of Central and Eastern European countries declined;
  2. with domestic demand increasing, part of the export sector resources and goods were channelled to the domestic market;
  3. after the shock of the initial stage of economic reforms the prices of countries in transition are nearing the medium-term equilibrium prices and hence the small growth in the value of exports.

The growth of imports, on the contrary, continued at a high rate in all countries. This was mainly caused by the increasing demand for investment goods and the growing real income of the consumers.

Poland, the Czech Republic and Hungary continued a relatively strict fiscal policy in 1996. In Poland and Hungary this was reflected in the decrease of the budget deficit and the government's total debt. Budget deficit increased only in Slovakia. The indices characterizing the fiscal policy of the above countries, particularly as far as foreign debt is concerned, are better than the respective indices of the majority of the EU countries. However, we have to take into account that the primary deficit (the difference between revenue and spending, without loan interests) is larger in Central and Eastern Europe than in the majority of the EU countries. In the majority of the transition economies the public sector reform has been relatively slow and major changes in the health care and social insurance system are still to be carried out. The obligations related to the future payment of pensions and the increase in the sums needed for maintaining the systems of education and health care place the financial position of the countries in transition under a serious pressure in the years to come.

Inflation remained relatively high in Central and Eastern Europe in 1996 although its rate of increase was lower than in 1995. In Poland and Hungary consumer prices increased by nearly 20%, in the Czech Republic the price increase remained around 10%. In Hungary and Poland the relatively high inflation can partly be put down to the crawling peg system, while in the Czech Republic and Slovakia the increase in consumer prices has for several years remained between 5% and 10% despite the fixed exchange rate. First of all, this reflects the continuing change in relative prices and the real strengthening of the local currency stemming from the increasing efficiency of the economic system.

The higher foreign trade deficit of Poland, Slovakia and the Czech Republic in 1996 was only partially compensated for by the surplus of the services account and income transfers. Therefore, the current account deficit increased considerably in those countries in 1996, amounting to 6-10% of the GDP. In Hungary, the current account deficit decreased just like the trade deficit.

Owing to the relatively high capital productivity, investment propensity is quite high in the most developed Central and Eastern European transition countries, reaching as high as 28% of the GDP in the Czech Republic, for example. This level cannot be achieved through domestic savings alone. Thus, the inflow of foreign capital continued also in 1996, but unlike in 1995 the share of short-term capital flow decreased significantly. Hungary continued to attract the biggest amount of foreign direct investments. The total volume of investments made into Slovakia was still small, reflecting the government's relatively high involvement in the economy. The lack of foreign investments in Slovakia was compensated for by the public sector investments which in turn increased the budget deficit.

In 1996 the monetary policy environment in the countries of Central and Eastern Europe was considerably affected by the rapid inflow of short-term capital the year before. The rapid increase in domestic money supply resulting in a possible inflationary pressure and the high cost of the central banks' open market operations (carried out to reduce the impact of capital flows on the money supply) forced the central banks to change the use of monetary policy instruments in 1996. The Czech central bank extended the scope of fluctuation for the koruna's exchange rate, thus trying to increase potential risks and make the instruments denominated in the koruna less attractive. The Czech Republic and Poland both liberalized the rules of capital movement. These measures managed to curb the inflow of short-term capital as compared to 1995. Hungary continued to maintain the crawling peg based exchange rate policy, while the monetary policy of Slovakia was still based on the fixed exchange rate of the koruna.

The reform of the banking system developed most rapidly in Hungary where all large state-owned banks were privatized in 1996. In Poland and the Czech Republic the state's share in commercial banking remained considerable.

Latvia and Lithuania

The economic indices of Latvia improved considerably in 1996 as compared with the budget and banking crises of the previous year. The real GDP growth was 2.5%. Although the economic development of Lithuania was influenced by the weakness of the banking system and the political instability of the election year, the GDP growth was registered at 3.5%. Although the increase in exports slowed down last year in both Latvia and Lithuania, the respective growth of approximately 9% and 16% (measured in dollar terms) was still higher than in the majority of Central and Eastern European countries. Growing investments in their turn led to increasing demand for imports and thus imports exceeded exports in both countries.

After the fiscal crisis of 1995, Latvia's fiscal policy strengthened considerably. Curbing government spending and improved tax collection reduced the central government budget deficit below 1% of the GDP. The parliamentary elections had little impact on the fiscal policy of Lithuania. The central government budget deficit remained on the level of the previous year, amounting slightly over 3% of the GDP. The budget deficit was financed from the government loans from the local money market where a significant role was played by foreign investors. The decline of interest rates that reflected the favourable development of the macroeconomic environment reduced considerably the cost of servicing the government loans.

The increasing foreign trade deficit was only partially compensated for by the surplus of the services account in both Latvia and Lithuania and the deficit of the current account increased to over 6% of the GDP in Latvia and to over 10% of the GDP in Lithuania. The availability and price of foreign financing was positively influenced by the good credit rating given to both Latvia and Lithuania.

The monetary policy principles remained unchanged in 1996 in both Latvia and Lithuania. Latvia followed de facto the policy of a fixed exchange rate against the SDR, while Lithuania relied on the currency board system. Despite the real strengthening of national currencies the pressure on revising the exchange rate has not been significant. The constantly decreasing interest rates also testify to the increasing trust in the preservation of the external value of the national currency. Although demands for abandoning the currency board system have gained ground in Lithuania, the policy based on the fixed exchange rate has not been questioned.

The banking system in Latvia became stronger last year. The increased reliability and efficiency of financial intermediation is proven by the 15% increase in deposits and the decreasing difference between the interest rates of loans and deposits. At the same time the share of loans granted to residents is still small in the consolidated balance sheet of the banking system, amounting to 20% at the end of 1996. The Lithuanian banking system was overshadowed by the crises that hit several commercial banks at the end of 1995. The continuing high state involvement in commercial banking also played an important role there.

Russia

Despite the emergence of the first signs of stabilization in 1995, Russia's real GDP dropped by 6% in 1996. Industrial production decreased by 5% and the decline of the production volume continued particularly in the branches with higher added value. In the energy sector, metal industry and partially also in the chemical industry the output remained stable or even increased.

The decline in private consumption, caused by the decreasing real income, continuously low investment activity and problems with budget revenue were the main reasons behind the drop in the GDP. Economic growth was also affected by political instability and the resulting slow-down of structural reforms and high real interest rates. The decline in domestic consumption and investments was not fully compensated for by the foreign trade surplus. Nearly half of the total volume of Russian exports was made up of the energy sector commodities, metals and chemical products.

After the reduction of the budget deficit in 1995, the deficit of the public sector increased in 1996. The budget deficit of the federal government amounted to nearly 4% of the GDP, considerably exceeding the predictions made at the beginning of the year. The main reasons for the worsening of the fiscal situation were the political instability caused by the presidential elections and the sharp decline in tax collection that can partially be attributed to political instability. Problems with revenue flow and the government's great need for financing kept the interest rates of government bonds high despite the downward tendency that emerged during the year. The cost of servicing the state debts was also increased by the continuing division of the bond market into segments meant for foreign and domestic investors. Due to high real interests the banks' lending to the real economy was modest. Throughout the year the government was forced to finance the budget deficit through tax delays and accumulation of arrears.

The year 1996 was successful for Russia in the restructuring of the foreign debt - an agreement was reached with the so-called Paris Club uniting the major creditor countries of the former Soviet Union. In 1997 a similar agreement is expected to be reached with the so-called London Club uniting commercial creditors. Russia's access to international financial markets was made considerably easier by the credit rating given to the country in 1996. This helped Russia to float its first bond emission in European financial markets since 1917.

Despite the sometimes critical situation of the state budget and political instability, the Russian central bank managed to keep inflation under control throughout the year. Consumer prices increased by 22%, which is a considerable improvement as compared to the 130% increase in 1995. The external value of the ruble linked to the US dollar through the crawling peg system served as one of the basic nominal anchors in the monetary policy. It was complemented by the high domestic real interests sustained by the central bank and control over the domestic money supply through curbing the movement of capital.

Like in 1995, exports still outstripped imports. But as the increase in the volume of exports was slow, the low demand for imports was caused by the small domestic demand due to the decline of the GDP, and low investment activity. The surplus of the foreign trade served to compensate for the deficit of other subbalances of the current account.