Russian Federation -- Concluding Statement for the December 2010 Staff Visit
December 8, 2010
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 policies is broadly similar to that provided at the time of the Article IV consultation mission in June 2010. In particular, realizing Russia’s growth potential will require a decisive break with past policies, and failure to tighten fiscal and monetary policies and reinvigorate banking and structural reforms would likely result in continued low growth. This statement provides an update, focusing on (i) exit from crisis-related policies; (ii) the medium-term government budget; (iii) the central bank’s response to the recent surge in inflation; and (iv) banking supervision.
1. Following a disruption in the summer, the Russian economy’s recovery from the crisis has resumed, but growth is likely to remain subdued against the backdrop of an uneven global recovery and heightened macro-financial risks.
• The global recovery is proceeding at different speeds. The pace of recovery in most advanced economies remains slow, with the outlook clouded by high unemployment and sovereign and banking sector risks, especially in the Euro area. In contrast, a number of emerging economies are enjoying rapid growth, buoyed by strong capital inflows, raising concerns about overheating. Against this backdrop, Russia is faced with a weak and unusually uncertain external environment.
• Russia’s recovery was temporarily derailed by a heat wave and drought in the summer. Growth has since picked up and is projected to reach 3.7 percent in 2010 and 4.3 percent in 2011. Next year, growth is expected to be balanced, driven roughly equally by consumption and investment. Fundamental structural reforms and stronger macroeconomic policies, however, would be needed to boost growth in the medium term.
2. The Russian authorities have continued the exit from crisis-related policy support, but the exit strategy is not sufficiently bold and is undermined by weak policy frameworks, posing risks to a sustainable recovery. Planned fiscal consolidation in the 2011-13 budget unwinds only a part of the crisis-related stimulus, and is not fully supported by concrete policy plans. Monetary easing was paused in June and interest rates have since remained on hold, despite a surge in inflation. The extraordinary liquidity support extended to banks during the crisis has been withdrawn and regulatory forbearance is being unwound, but banks remain strained by bad loans, with weak balance sheets hindering a durable credit expansion. Delays in implementing consolidated supervision and connected lending regulations amplify financial sector risks.
3. Going forward, the challenge is to put in place a bold and convincing exit strategy to reduce risks to the recovery and bolster sustainable growth.
To support the government’s medium-term goals, a more ambitious, growth-friendly, and credible fiscal consolidation than currently planned is needed.
- The current large fiscal deficit is incompatible with the government’s goals of economic modernization, macroeconomic stability, and fiscal sustainability. At 13 percent of GDP, the federal government nonoil deficit—which should be the anchor for fiscal policy in oil exporting countries, given the volatility of oil prices and nonrenewable nature of oil—is some 8½ percent of GDP above the government’s long-term target of 4.7 percent of GDP, which remains appropriate. Most of the fiscal expansion in 2009-10 took the form of permanent measures, increasing the risk that the stimulus will not be reversed and that fiscal policy will become procyclical as the economy recovers. This would fuel inflation and real exchange-rate appreciation, undermining competitiveness. These risks are further exacerbated by ambitious infrastructure spending plans. Moreover, overall deficits over the past two years have all but depleted the oil reserve fund. The fund served Russia well during the crisis and its depletion makes Russia vulnerable to external shocks in a still uncertain and volatile global environment.
- Although the fiscal retrenchment planned in the 2011 budget is a step in the right direction, the medium-term fiscal plans fall well short of what is needed to ensure fiscal sustainability and foster strong and balanced growth. The 2011-13 budget envisages a reduction in the federal nonoil deficit of less than 3 percent of GDP in three years, with half of this in 2011, and entails a significant hike in the payroll tax, a reduction in the civil service—the supporting reforms for which still need to be articulated in policy plans—and cuts in investment. By 2013 the nonoil deficit will still be some 5½ percent of GDP above the government’s long-term target, putting into question the commitment to fiscal sustainability and intergenerational equity. At the same time, the composition of the adjustment is not supportive of long-term growth, as the adverse impact of a higher payroll tax on the labor market is likely to at least partially offset the positive effect of lower real interest rates from smaller deficits.
- Accordingly, a strong fiscal adjustment, supported by well-designed structural reforms, is needed. Cumulative consolidation should be stepped up to 4 percent of GDP by 2012 and 8½ percent by 2015 to ensure fiscal sustainability. Consolidation should be underpinned by a strong and credible fiscal framework that avoids excessive use of supplementary budgets and anchors policy on the nonoil balance to reduce expenditure volatility in response to oil price fluctuations. The oil reserve fund should be preserved and even replenished to reduce the vulnerability of government finances to large swings in oil prices. Consideration also should be given to gradually reducing the distortionary payroll tax, while offsetting lost revenue by increasing the retirement age, rationalizing early retirement schemes, and means-testing basic pensions. Besides pension reform, durable consolidation will require reforms in healthcare and social protection.
Monetary policy should focus squarely on reducing inflation. The increased inflationary pressures over the past few months argue for action to rein in inflation. Inflation picked up from a low of 5½ percent in July to over 8 percent in November. While the sharp increase in inflation has been largely driven by a drought-related spike in food prices, nonfood prices have also been steadily on the rise since July, which is a cause for concern. Accordingly, a hike in the policy interest rates would seem warranted to prevent the second-round effects of food-price increases from taking hold. Moreover, the Central Bank of Russia (CBR) should be more forceful in communicating its commitment to reducing inflation, including in its monthly policy statements.
The continued actions by the CBR to increase exchange-rate flexibility are welcome. The ruble is now fluctuating in a wider trading band, with more frequent adjustments of the band. This should reduce the scope for policy conflict between the exchange rate and inflation and help deter speculative capital flows. Indeed, a flexible exchange rate should be the first line of defense against volatile capital flows.
While the banking system has stabilized, considerable risks remain and strengthening of the supervisory and regulatory framework is vital.
- Lack of transparent and reliable financial information and disclosure continues to hinder assessment of the system. Nonperforming loans have peaked at a high level, leaving the banking system burdened by the large stock of problem assets. The system is liquid, but profits and credit growth remain weak, and existing provisions may be too low to cover potential losses.
- Significant further effort is needed to strengthen the supervisory framework and address banking risks. We support recent proposals to strengthen capital requirements and welcome the government strategy for the banking sector, which is comprehensive and candid in recognizing shortcomings in the banking supervision framework. The strategy proposes to strengthen the CBR’s legal supervisory powers, and improve transparency, asset valuation, and corporate governance in banks. Adopting the proposed agenda and pending legislation will enhance the CBR’s ability to conduct more intensive supervision, identify risks, and take timely corrective action. But implementation of legislation on consolidated supervision and connected lending should also be a priority. To ensure effective consolidated supervision, the bank-holding company definition in the draft law needs to be broadened to capture all significant banks, and the cumbersome requirement that the CBR work through other supervisors to take action on holding companies reconsidered.