FROM THE OFFICE OF PUBLIC AFFAIRS

It is a privilege to be here to discuss Russia's economic future with a group that will do so much to shape it.

These are momentous times. In the past year Russia has emerged as a significant player in the market for global capital -- and the opportunities, and risks, of this closer integration have been brought out in stark relief. The bad news --that Russia, along with other major emerging markets, has been hit by contagion effects from the crises in Asia --is also the good news. Three years ago, during the Mexico crisis, Russia was little affected by declining investor confidence in other markets --because back then, foreign investors had very little confidence in Russia left to lose. That Russia no longer sits in not-so-splendid isolation from turbulence elsewhere also reflects its recent dramatic progress --toward stabilizing its economy and integrating it more closely with the global economy.

The United States' strong stake in Russian economic success is a bedrock of our evolving bilateral partnership --a partnership that took another major step forward in the security sphere last year in the NATO-Russia founding act. Make no mistake: America and Russia do, and will, disagree on some issues. But these are the subject of negotiation, not confrontation. We are perhaps in greatest harmony in our desire to see Russia achieve rapid growth as an open and competitive market economy --and claim its rightful position in global institutions and markets.

I would like to focus my remarks today on the progress we have seen in Russia this past year toward that shared vision --and critical tasks that remain if Russia is finally to translate these achievements into sustained growth. Running through all of these remarks is a central irony --that, after years of shrinking the state, in many important respects the challenge Russia faces today is to strengthen it. It is now clear that markets can work in Russia as surely as they do in every other country. The question today is whether government can work effectively in Russia in support of free and fair markets.

Let me start by discussing Russia's macroeconomic environment. Then I will touch on the financial system, the climate for investment and Russia's integration with the global economy.

I. Locking in macroeconomic stability

1. Monetary policy successes

Effective control of macroeconomic policy is a vital job of government --vital for achieving growth and, in this new era of global markets, vital for building and maintaining investor confidence. Here the reformers appointed to the Russian cabinet last spring have helped make possible some notable achievements. Russia's tight monetary policy has delivered a stable exchange rate and cut the average inflation rate from 35 percent in 1996 to just 11 percent last year --somewhat lower than Mexico's.

This strong policy was rewarded in the first half of the year in the form of dramatic inflows of capital and a surging stock market --and in the second half was severely tested as East Asian turmoil began to cross Eurasian borders. After some initial delay, the Central Bank of Russia rose to the challenge. Its willingness to raise interest rates to defend the currency helped boost market confidence. And, since mid-December, the money that was flowing out of Russia appears to have started to flow back in.

The experience of the recent ruble redenomination is further testament to the new era of monetary stability in Russia. Rather than causing the crisis of confidence that some observers expected, introduction of the new currency has so far been a virtual non-event. The Russian authorities deserve congratulations for devising a sensible plan to capitalize on this success in managing the country's monetary policy, announcing it well in advance, and bolstering it with an extensive public relations effort to ease uncertainty about the reform.

2. The fiscal hole

The resolute monetary policy of the past year, including the response to the Asian crisis, was an important factor in yesterday's decision to reactivate Russia's program with the International Monetary Fund, a decision the United States supported. Another major factor was the clear indication that Russia is redoubling its fiscal reform efforts. Indeed, to be effective and meaningful, the program depends on immediate, substantial improvements in tax administration and budget control and accountability. As all now recognize, Russia's hard-won monetary stability will rest on shaky ground as long as the government fails to deliver on its fiscal policy aims.

Oliver Wendell Holmes famously said that taxes are the price we pay for civilization. In that regard, Russia is surely living on borrowed time. At 9 percent of GDP, the level of tax revenues the federal government was able to collect last year is at odds with the role both the government and its electorate envision for the state --indeed, it cannot credibly sustain the operations of the most minimal state.

Russia's inability to collect taxes efficiently and balance its books carries heavy costs for the entire transition process:

1. high public borrowing puts an excessive burden on monetary policy and stifles domestic and foreign direct investment

2. consistently large deficits also leave the government highly dependent on foreign lending, thereby increasing its vulnerability to external shocks

3. the failings of the tax system also stymie the development of small businesses, a sector that has played a vital role in successful transitions elsewhere. Anders Aslund has noted that Russia has only one officially registered enterprise for every 60 citizens, as compared with one in 10 in Poland and Hungary. When polled on the reasons for this, entrepreneurs cite the tax system and general uncertainty about government as the two leading concerns (indeed, these rank higher than crime --because crime, they say, is usually more predictable.)

4. more broadly, poor fiscal management undermines faith in government and the rule of law and risks, creating a culture in which only the weak or the uninformed pay their bills.

Russia knows a great deal more now than it did even at the start of 1997 about the steps needed to put its fiscal house in order. A year ago, increasing revenue collection was the focus. But now it is clear that improving mechanisms for tax collection is only part of the story.

The path to more sustainable fiscal accounts lies not only in basic and wide-ranging tax reform but, still more fundamentally, in a sea-change of attitudes on the part of government and taxpayer alike. Indeed, it is in the very nature of any market-based democracy that its conceptions --and its practice --of good citizenship and governance should improve over time. This has been America's experience too.

The action plan adopted by the Russian government last month represents a good start at systemic fiscal change --but its success will depend on full and rapid implementation.

Briefly, there are six main priorities:

1. reforming the tax laws remains perhaps the most important hurdle facing the authorities this year. Introduction of a comprehensive code this year now appears in doubt. But it remains critical that a proposal for a strong code be submitted to the Duma and passed as quickly as possible. I would hope that key elements may still be implemented this year.

2. eliminating offsets (swapping debts for taxes payments) is also key: offsets are a powerful disincentive for taxpayers to meet their obligations in cash and must be abolished. Many of Russia's tax debtors stopped making cash payments in the second half of last year precisely because they anticipated a massive year-end offsetting operation.

3. adjusting penalties and interest on tax debts: the current structure of penalties for non-compliance is overly punitive, and firms which have dug a deep tax hole for themselves need transparent, predictable guidelines for making good on overdue obligations.

4. increasing compliance by large taxpayers: cracking down on the large tax arrears of Russia's dominant firms sends the strongest possible signal that no one is above the law. In this context the recent high-profile efforts to ensure compliance of two major tax debtors were an important step.

5. more realistic budgeting: Russia's budget process to date has consistently committed the government to more spending than it is able to meet through current revenues. The resort to stringent sequestration of funds has undermined transparency and added to the nations's mass of overlapping public and private sector debt.

6. increasing expenditure control: until recently, budget-funded entities funded their programs from individual accounts maintained with a variety of Russian banks, making it impossible for the Ministry of Finance to track spending with certainty. Consolidation of these accounts within a functioning Treasury is now underway and should be completed as fast as possible.

II. Strengthening the financial system

The Asian crises have amply demonstrated that, while the right mix of monetary and fiscal policies is fundamental, governments must also ensure the safety and soundness of their financial systems.

Although Russia lacks the high levels of foreign debt and other weaknesses we have seen in Thailand and some other countries, it shares with them the problem of a weak banking sector. By any reckoning, in its first years of reform Russia has been overbanked and under regulated.

We know from experience elsewhere that building the effective supervisory and regulatory regime and the financial infrastructure needed for a strong domestic financial system takes time and determination. As the unfolding events in Asia remind us, this is utterly indispensable for safeguarding stability and restoring growth. I would note that Russia's central bank has been taking several important steps:

1. its special regulatory division for close monitoring of large banks that could pose systemic risk was fully operational during the fall and is an important confidence-builder.

2. the central bank continues to make progress on shutting down weak banks, revealing this week that it had closed 270 small and medium banks and withdrawn operating licenses from another 316 last year --reducing their total number by more than 15 percent.

3. a new bankruptcy law for banks is due to be adopted early this year, which should ease the way for creditors to take bankrupt banks to court.

4. the central bank has also announced and made progress implementing its schedule for gradually tightening prudential norms for risk and liquidity, with the overall goal of reaching most Basle standards by the end of the century.

All of these measures will help promote mergers and weed out many of the remaining small and poorly capitalized Russian banks --and also provide for overall healthy evolution of banking sector as a whole.

Clearly, much work remains. Effective and transparent supervision will be critical. Russia can help itself by following through on its commitment to introduce international accounting standards by year-end. This will provide a better sense of the scale of the banking sector problems. In addition, credible mechanisms are needed for the organized liquidation of insolvent banks. Equally vital will be the evolution of a modern credit culture within banks and other financial institutions themselves. In short, Russian banks must develop the skills to evolve from government securities traders to true financial mediators.

III. Creating the Environment for Investment and Competition

This point leads us to the vital link with the real economy. If the financial sector provides the lifeblood of a market economy, then the heart and nerves and sinew are to be found in the structures and institutions that make investment possible and attractive. Russia will not attain sustainable growth without a major upturn in both domestic and foreign investment, primarily the former. And this will not occur without a wide range of important structural and regulatory reforms in support of the macroeconomic policies and financial sector reforms I have already mentioned. The agenda for structural change includes reforming the pension system, completing the privatization program, rationalizing and further developing regulatory systems (including in the spheres of capital markets and antitrust), introducing pro-market land reform, defining and protecting property rights (including shareholder rights) and strengthening the rule of law generally --all these areas continue to be key priorities if Russia is to develop a dynamic environment to foster and attract investment.

To take just one example, it is clear that the quality of privatization is as important as its quantitative results. As we have seen in the response to many past privatizations, it matters, for the building of public trust in government, not just that actions are fair and even-handed, but that they are widely seen to be so. To put it bluntly: the public must be shown that Proudhon and Marx were wrong --that property is not theft. They must be shown convincingly that property will not be stolen or highjacked by "insiders".

The problem is not intractable. President Yeltsin has taken the first step by firmly signaling that corruption must not be tolerated. The lesson of other countries is that only when a nation's leadership shows that the government will apply and enforce the law evenhandedly --even to the rich and powerful --only then will lasting progress be made.

IV. Closer Integration with Global Institutions and Markets

Both the US and Russia agree on the importance of Russia's ongoing integration into international economic organizations. It is immensely gratifying for the Administration to witness the great strides that have occurred in 1997. In twelve short months we have seen:

• Russia successfully join the Paris Club official creditors (something, incidentally, that will greatly improve coordination of international efforts to reduce foreign debt stocks in some of the poorest nations in Africa.)
• the completion, early last month, of the restructuring of Russian commercial debt with London Club creditors, which the government coolly and sensibly kept on schedule despite the surrounding market furor.
• the members of APEC welcome Russia's application for membership.
• and, most prominently, the first Summit of the Eight in Denver, where the G-7 countries signaled their commitment, not only to Russian integration, but to a global leadership role for Russia. This important new relationship will be developed further at the Summit of the Eight in Birmingham this year.

There has also been increased Russian engagement with the OECD, aimed at eventual membership. It is still too soon to be talking dates, but President Yeltsin has clearly recognized the benefits for Russia --and for its partners --that would flow from Russia's undertaking the binding obligations on freedom of capital movements and investment and other core OECD conditions.

The challenge for Russia now is to apply itself with equal vigor to its process of WTO accession . This could produce major positive dividends for Russia. And Russia alone holds the key to how quickly the accession talks can move.

V. The Governing Challenge: Making Less Government Do More

Russia's success in laying the foundations for democracy and a market economy these past six years has put its destiny squarely in its own hands. The United States is committed to doing all we can to nurture these achievements and assist Russia in advancing them.

It was Napoleon (of all people) who said that "men are powerless to secure the future: institutions alone fix the destinies of nations". In my remarks today I have highlighted some of the core institutions that we believe will be essential to building an open free market economy in Russia --one that can deliver the rapid and broad-based growth in living standards the Russian people deserve. President Yeltsin sounded many of the same themes in his March State of the Union address and speech to the Duma last fall.

Effective macroeconomic management, a sturdy financial infrastructure, the rule of law, transparent and evenhanded regulation, and open, competitive markets --all will be critical to realizing the vision both our countries share --of Russia as a leading, prosperous member of the global economy. But none of these things will come automatically, and none will come without resistance. In this election-free period Russian leaders have a rare opportunity to make good on this agenda.

It is in Russia's interest, it is in the United States' interest, and it is in the world's interest that 1998 be the year this opportunity is finally seized. Thank you.