Russian Federation: Concluding Statement for the December 2009 Staff Visit
December 14, 2009
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Our assessment of the economic situation and the policy response is broadly similar to that provided at the time of the Article IV mission in May 2009.1 This statement provides a brief update, focusing on our concerns regarding: (i) the highly unsustainable fiscal deficit; (ii) the need to adopt a more ambitious inflation target; (iii) the large-scale monetization of fiscal deficits; and (iv) unresolved problems in the banking system.
1. Compared to six months ago, economic and financial conditions in both the global economy and Russia have improved, but recovery is expected to be sluggish.
• The global economy has returned to positive growth. Nonetheless, the pace of recovery is likely to be gradual, particularly in the advanced economies where balance sheet adjustment presents a continuing drag on growth.
• In Russia, growth is expected to stage a modest recovery in 2010, reaching 3½ percent. However, this largely reflects base effects and a turn in the inventory cycle. Despite relatively high oil prices, underlying domestic demand is likely to be subdued as bad loans in the banking system are expected to weigh on credit growth.
2. The Russian authorities have continued to manage the fallout of the global financial crisis well. The Central Bank of Russia (CBR) has maintained a more flexible exchange rate policy and has appropriately taken advantage of the notably lower inflationary pressures to reduce policy interest rates. The fiscal authorities have rightly undertaken a countercyclical fiscal expansion, but concerns remain about the size and reversibility of expenditures. Financial sector policies have not been as forceful as needed, but the expansion of deposit guarantees and other confidence-building measures undertaken last year were successful in stabilizing the financial system and preventing a full-scale banking crisis.
3. The task now is to develop exit strategies that appropriately balance Russia’s short- and medium-term objectives.
• On fiscal policy, our main concern is that the higher spending contained in the 2009 and 2010 budgets will become entrenched. Expenditures are set to rise by 7 percentage points of GDP compared with 2007 levels—half of which represent increased statutory obligations. This points to the risk that the sizeable fiscal expansion will not be reversed, eventually leading to a highly procyclical fiscal stance, inflation, rapid real ruble appreciation and increased dependence on oil. Given these concerns, fiscal policy should strike a better balance between short- and medium-term fiscal considerations by further reducing spending in 2010. Expenditure on items deemed to have low fiscal multipliers—particularly subsidies to enterprises and inefficient projects suffering from significant waste—should be scaled back first. Indeed, cross-country comparisons suggest that Russia has scope to achieve significant budgetary savings by improving expenditure efficiency. Over the medium term, a sustainable reduction in the non-oil deficit would require a reinvigoration of much-needed structural reforms, including in the health and education sectors as well as public administration.
• The CBR should be more ambitious in reducing inflation. With inflation already running at 6 percent at an annualized rate, the CBR’s current objective for 2010 is unambitious, especially as it entails no further decline compared to current levels. We believe that the CBR should take advantage of the current disinflationary environment to reduce inflation to below 5 percent by end-2010. In this regard, the increased exchange rate flexibility represents a welcome strengthening of policies.
• In the near term, the monetization of large fiscal deficits will significantly circumscribe monetary policy. Monetization raises risks that, with banks still reluctant to extend credits on a substantial scale, significant excess liquidity will build up, eventually putting pressure on the ruble to depreciate and pushing up inflation. While Russia’s ample foreign reserves would provide scope to cushion sharp movements in the exchange rate, liquidity conditions would need to gradually be tightened through the placement of CBR paper or other means. Given this, we believe that the recent upward pressures on the ruble associated with capital inflows are likely to be temporary. Thus, further cuts in policy interest rates should be put on hold until the monetary implications of the very large end-year liquidity injection associated with the fiscal deficit become clear.
• The situation in the banking system has stabilized, but generous liquidity support—alongside regulatory forbearance and flexible accounting and reporting standards—is likely to be masking more severe underlying problems. We are concerned that, absent more forceful policy action, significant problems in the banking system could emerge once a normalization of cyclical conditions forces the CBR to tighten monetary policy. Given these concerns, the CBR should take advantage of the current stable environment to restore more stringent regulatory requirements by not extending the forbearance framework that is due to expire at the end of the year. A complementary action would be to develop plans for unwinding the forbearance already granted. The authorities could then determine the appropriate means for dealing with undercapitalized or insolvent banks—be it through merger, recapitalization, restructuring, or closure. Over the medium term, accounting and reporting standards should be tightened and the authority of the CBR enhanced to conduct consolidated supervision.
1 This assessment can be found in the Concluding Statement for that mission (http://www.imf.org/external/np/ms/2009/060109.htm) and in the 2009 Article IV Staff Report (http://www.imf.org/external/pubs/cat/longres.cfm?sk=23176.0).