Inflation and stabilization in Yugoslavia

Policy, Research, and External Affairs WORKING-PAPERS Macroeconomic Adjustment and Growth Country Economics Department The World Bank August 1991 WPS 752 Inflation and Stabilization in Yugoslavia Roberto de Rezende Rocha A successful stabilization program in Yugoslavia requires more political resolve about wage indiscipline and loss-making enter- prises than was observed in 1990. But the ultimate question is whether stabilization can succeed without a comprehenisive privatization program. The Policy. Research, and Extemal Affairs Complex distnhutes l'RI' Working ladprs to disseniiniat the findings of work in progrcss and to cnoourage the cxchange of idcas among lanik stafl' and all others ...erested in development issucs. These papers carry the names of the authors, rflect only theie views, and should be used and cited accordingly. 'Ithe findduigs, interpretations, and conclusions arc the authors own. They should not be atibuted to the World liank, its Board of l)irectors, its managmncnL, or any of its member countries.  Policy, Research, and External Affairs Macroeconomic Adjustment and Growth WPS 752 This paper -a product of the Macroeconomic Adjustment and Growth Division, Country Economics Department- is part of a larger effort in PRE to examine the problems of transition faced by reforming socialist countries and to contribute to the Bank's policy dialogue with these countries. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Lanha Ly, room N9- 083, extension 37352 (35 pages). Rocha exarnines the main reasons inflation was initially successful in fighting inflation. But accelerated in Yugoslavia in the 1980s and it became clear in the course of the program that reviews past and current attempts at stabilization. other losses had not been removed. Pressures to finance enterprises and avoid a liquidity crisis in He shows that inflation in Yugoslavia shares the financial system resulted in a relaxation of common elements with inflation in other highly monetary policy in mid- 1990 and a revival of indebted countries, despite appearances other- inilationary pressures. Attempts to reimpose wise. These common elements include a large monetary control met considerable difficulty at transfer of resources abroad unmatched by an the end of tlhe year, includinlg a bizarre episode internai adjustment, resulting in a large internal of expansion of central bank credits without the redistribution of real resources through inflation. board of governors' approval. Yugoslavia differs from other countries in It also became clear that the fiscal compo- that these internal conditions are not transparent. nent was not consistent with other elements of Instead of an open fiscal deficit, there were the program. It was clearly not enough to complex interactions among enterprises, com- finance a social program of the magnitude mercial banks, and the central bank, involving, required had loss-making enterprises really been among otner things, the absorption and servicing lorced into bankruptcy and also to cover the of a large stock of foreign exchange liabilities by needs of the bank restructuring program. Seen the central bank. from this angle, the Yugoslav program of 1990 resembles other heterodox programs that had Other factors contributed to the sharp initial success in reducing inflation but later acceleration of inflation at the end of the eighties faltered because of the insufficiency of the fiscal - especially a large real devaluation in mid- adjustment. 1988, when an indexed economy drove inflation to a much higher level. In 1989, a preemptive At the same time, the events in the second explosion of real wages added fuel to inflation's half of' 1990 also indicate that, for a stabilization fire. program to succeed in Yugoslavia, there must be much greater political resolve to cope with wage Rocha argues that the failure to correct indiscipline and loss-making enterprises than hidden losses in the economy was the main was observed in 1990. And the question reason various stabilization attempts failed in the remains whether financial discipline can be 1980s. The 1990 program was the first to imposed in the system only at the macroeco- recognize the existence of those hidden losses nomic level and without introducing private and the need for fiscal correction - although it ownership of capital. The ultimate question may also introduced other elements to cope with be whetlher stabilization can succeed without a inflationary inertia. The program succeeded in comprehlensive privatization program. eliminating the central bank's own deficit and The PRE Working Paper Serics disseminates thc findings of work under way in the Bank's Policy, Research, and Extemal I Affairs Complex. An objective ofthc scrics is to get thesc fin(ings ot qu(luickly, even itprcsentalions arc Icss than fully polished. The findings, interpretations, and conclusions in thesc papers do not necessarily rcprcsent official Bank policy. Produced by the PRE Dissemination Center  Inflation and Stabilization in Yugoslavia by Roberto de Rezende Rocha* Table of Contents 1. Introduction 2 2. Enterprise Losses, Central Bank Deficits, and Inflation 5 3. Exchange Rate, Wages, and Prices 17 4. Past Stabilization Attempts and the 1990 Program 25 5. Conclusions so References 33 * I am grateful to Barry Bosworth, Simon Commander, Vittorio Corbo, Wei Ding, Rudiger Dornbusch, Manuel Hinds, Mitja Gaspari, Miguel Kiguel, Neven Mates, Branko Milanovic, Jeffrey Sachs, Boris Skapin, William Tyler, Milan Vodopivec, and Steve Webb for useful comments on earlier drafts. Conversations with Valimir Bole were also very helpful.  2 1. Introduction. The reversal of external financing flows during the 19808 forced Yugoslavia to undertake drastic measures to balance its external accounts. The external adjustment consisted primarily of large real exchange rate devaluations and, initially, quantitative restrictions on imports. Although these measures were able to generate increasing current account surpluses, economic activity stagnated and inflation accelerated almost continuously (figure 1 and table 1). Moreover, the absence of fiscal imbalances in the economy (figure 1) might suggest that the nature of inflation in Yugoslavia is entirely non fiscal. Table 1 Annual Rates of Inflation (CPI) in Yugoslavia, 1980-90 (in S) 80 81 82 83 84 85 86 87 88 89 90 Dec. 37 36 33 60 53 75 92 169 245 2685 120 Aver. 31 39 31 40 54 72 90 120 194 1240 588 Sources IFS While it is true that many hyperinflation episodes are triggered by balance of payments difficulties and large exchange rate devaluations, the complete absence of fiscal imbalances from the overall picture in the case of Yugoslavia is intriguing. Indeed, even the "balance of payments view of inflation" recognizes the role of fiscal deficits in the determination of inflation, although such a role is assumed to be less central than under the "fiscal view of inflation". In the former, the exchange rate assumes the central role, while fiscal deficits contribute to inflation mostly through endogenous interactions with the exchange rate and the inflation rate itself (Dornbusch 1987; Dornbusch and Fischer 1986; Liviatan and Piterman 1986; and Montiel 1989).  Figure 1 Selected Macroeconomic Variables For Yugoslavia, 1977-89 Exporto and Imports, 1977-89 Real Exohange Rate, 1977-1989 (BiIllons of US$) (1980 a 100, 1 70 14 . . ........ , ..................... ........... . .e ..... . ........ ..... .- .... tc It4 _ .... "I. ........ .......... ........... ........ 1'- ......... .~ ...... .................... ...........''. tg, .. . ............. .. . ............ ..........'''-t40 ..,_,,_,_,-I_._. .... ............ _.._... .. .................. f~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~o ...... ... .. . .. . ...... . ... . .............. ...... IC *-*tOC _ ,, r ne Sr O 19at IM =I8 '"M nt4 w08 tf Ss MeB INSf .. r- . {10 .___ _ _ _ ______bs........... - EOlDrtto +- Im9orto K S _~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 __ . . . ......... .... ._... ,-... ... . . . . . . . . 1l77 tore 1970 98 198 198l 2 198 1984 t08980I1987 198