Mission Concluding Statements
Russian Federation and the IMF
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INTERNATIONAL MONETARY FUND
of the IMF Mission to Moscow February 10-16, 2005
February 16, 2005
The mission has reviewed macroeconomic developments and changes to the short-term outlook since the Article IV Consultation discussions in mid-2004. In the mission's view, recent developments have confirmed the need to: (i) continue to fully save additional oil revenue windfalls in the stabilization fund; (ii) allow more exchange rate flexibility; and (iii) accelerate structural reform and take steps to improve the business climate. The mission also believes that downside risks have increased, in particular due to a weakening of the investment climate, increasing budgetary reliance on oil and other temporary revenues, and inconsistencies between macroeconomic policies. The main findings are briefly summarized as follows.
1. Economic activity has softened and inflation has remained entrenched. While the data are still not fully conclusive, real GDP growth has slowed since mid-2004, owing to reduced investment growth and lower oil export volumes, high oil prices notwithstanding. This is widely being attributed to supply disruptions in the oil sector and a weakened business climate, as well as to a reduced credit growth in the wake of last summer's banking sector turmoil. Consumption growth, meanwhile, has remained very strong, reflecting fast rising wages. Despite the slowing of real GDP growth, inflation is running well above target and the ruble is appreciating apace in real terms.
2. Oil revenue windfalls should continue to be saved. The policy of saving revenues arising from oil prices above $20 per barrel has served Russia well as it has moderated real ruble appreciation, inflation, and interest rates, underpinning steady economic growth. However, this policy is being gradually relaxed. Although the headline government surplus has surged in recent years as oil prices have continued to rise, a significant and growing part of the oil revenue windfall is being spent, as reflected in a gradual increase in the deficit on a constant oil price basis. This has added to inflation.
3. The current fiscal stance is not supportive of the inflation objectives. The 2005 budget entails a relaxation on a constant oil price basis of about 1 percent of GDP, which will intensify demand pressures. The recent proposed increase in pension and other recurrent expenditures by over ¾ percent of GDP will further raise such pressures. This permanent increase in expenditures is in effect financed by one-time revenues from the sale of Yuganskneftegaz, which will reduce the headline surplus next year, and further shift the composition of aggregate spending towards consumption. It is therefore becoming a matter of urgency to resist new initiatives to spend more of the oil revenue windfall, and no further amendments to the 2005 budget should be considered. In line with this, the floor on the amount of resources in the stabilization fund that cannot be spent should be lifted to facilitate saving in full the oil windfall, except for that part that is allocated to the prepayment of external debt.
4. VAT reform should be revenue-neutral. In this way, it would not add further to aggregate demand in 2006, when its implementation is planned. The revenue loss from lowering the top rate could be offset with rate unification or elimination of exemptions. International experience shows that improvements in compliance following a rate reduction are at best very small. The mission believes that the primary objective of tax reforms should now be to improve tax administration, not to reduce the tax rates.
5. More exchange rate flexibility is needed. Core inflation remains entrenched at 10½-11 percent—it has been in this range for almost three years—because the CBR, when there is tension between real exchange rate and inflation targets, has tended to give priority to the former. Unless the CBR stands ready to reduce its foreign exchange interventions and allow faster ruble appreciation if inflation deviates from the targeted downward path, inflation in 2005 is unlikely to decrease. In this connection, the trade-off between reducing inflation and resisting ruble appreciation is likely to sharpen this year, as the balance of payments is set to improve further, provided there is no repeat of the negative jolts to confidence that caused a sharp rise in capital outflows in 2004.
6. Demand management policies aside, the overriding challenge facing the government is to shore up the investment climate. Recent developments have fueled doubts about the government's commitment to market-oriented reforms and, rightly or wrongly, raised the specter of increased state interventionism. In the mission's view, boldly launching long-delayed structural reforms—not least administrative and civil service reform—and ensuring that the tax administration and other state agencies act in a transparent and even-handed manner are crucial for reassuring investors and restoring growth momentum. More generally, the softening of growth in the face of record high oil prices is a timely reminder that high economic growth cannot be sustained without a more determined pursuit of structural reform.
7. The CBR is making good progress in determining eligibility of banks for the deposit insurance system. It appears to have generally followed strict criteria to ensure that only sound banks are enrolled into this system. It is also taking steps to strengthen supervision. However, some gaps in prudential supervision and the legislative framework—such as fit and proper requirements for bank owners, greater powers to intervene preemptively in banks, and rules on mergers and acquisitions—remain to be addressed, in order to bring these areas closer to best international practices.
IMF EXTERNAL RELATIONS DEPARTMENT