Russian Federation-Concluding Statement for the December 2011 Staff Visit
December 8, 2011
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.
The Russian economy has broadly recovered from the 2008-09 crisis, but spillovers from the euro area crisis cloud Russia’s growth prospects. This calls for mitigation of risks and contingency planning. Taking steps to restore buffers while oil prices are high would put Russia in a stronger position to handle downside risks. At the same time, Russia should stand ready to take timely and well-targeted measures to support the economy if the euro area crisis deepens. Beyond managing near-term risks, lifting growth onto a higher path requires strengthening policy frameworks and reinvigorating structural reforms.
1. Aided by high oil prices, the Russian economy has broadly recovered from the 2008-09 crisis. Despite the relatively modest economic growth since the crisis, the output gap appears to be closed and unemployment has come down close to its pre-crisis level. In 2011, economic performance has been bumpy, with growth slowing considerably in the second quarter before picking up again in the third quarter. Short-term indicators point to continuing improvements in economic activity and employment supported by high oil prices and a good harvest, despite continued capital outflows.
2. However, the global outlook has darkened because of the euro area crisis. Short-term economic indicators point to a slowing of growth, especially in Europe. At the same time, financial market turbulence has intensified on growing concerns about public debt sustainability and the health of banks in the euro area. Adverse feedback loops between the real economy and the financial sector contribute further to uncertainty about the economic forecast and could result in a deep and protracted recession in Europe with negative knock-on effects for global growth.
3. Against this backdrop, Russia’s growth is likely to remain subdued. Spillovers from the euro area have been manageable so far, but capital outflows have intensified, likely reflecting a global flight to safety in recent months, rather than Russia-specific factors. We project growth to slow from 4.1 percent in 2011 to 3.5 percent in 2012, with significant downside risks.
4. An escalation of the euro area crisis would pose considerable risks to Russia. A worsening of the crisis could precipitate a global downturn, which could translate into lower commodity prices and nonoil exports and drag Russia’s growth down. Russia could also be impacted through the financial channel, especially if banking distress in core euro area countries causes an abrupt freezing of bank funding and liquidity as in 2008.
5. In some ways Russia is now better positioned to manage crises than it was in 2008. Since the crisis, Russian banks have reduced their external exposure. At the same time, the CBR has allowed more exchange-rate flexibility, enabling the ruble to better absorb external shocks. Moreover, the economy is not overheating this time, implying a less severe correction in growth in response to an external shock. Last but not least, the authorities have strengthened their institutional capacity to manage crises, including by extending for two years the powers of the Deposit Insurance Agency (DIA) to rehabilitate banks, by merging the financial markets and insurance supervisors into one stronger agency, and through the experience gained in extending emergency liquidity support to banks in the 2008 crisis.
6. However, important vulnerabilities remain. In particular, the room for a fiscal policy response has been substantially reduced. Russia’s public finances have become more vulnerable to a decline in oil prices: at some 10 percent of GDP, the nonoil deficit—the overall balance excluding oil revenue—has more than tripled compared to the pre-crisis period, while the rainy-day oil Reserve Fund stands at about one-fifth its 2008 level relative to GDP. And banks’ balance sheets have been weakened by a considerable stock of nonperforming assets—a legacy of the crisis.
7. Taking steps to reduce vulnerabilities should be given the highest priority. Action is needed on multiple fronts:
- Addressing fiscal risks by reducing the nonoil deficit. Oil prices are still high and the window of opportunity is still open to reduce fiscal vulnerabilities from a position of strength. This would require saving any budget surplus this year in the oil Reserve Fund and reducing the federal government nonoil deficit further in 2012—including by curtailing subsidies, transfers, and tax exemptions—rather than increasing it as planned in the 2012-14 budget. Frontloading the consolidation—for example by reducing the nonoil deficit by 2 percent of GDP in 2012 from its 2011 level—would enhance the credibility of fiscal policy and allow further rebuilding of buffers in the oil Reserve Fund. For the medium term, fiscal policy should be re-anchored on the authorities’ currently suspended nonoil deficit target of 4.7 percent of GDP—which we still see as appropriate—while putting in place a credible and growth-friendly plan to reach this target by 2015. These efforts will need to be underpinned by structural reforms, including in pensions and healthcare.
- Keeping inflation on a downward path by preserving the current tighter liquidity conditions. Liquidity conditions have recently tightened and market interest rates have risen, while the repo policy rate of the Central Bank of Russia (CBR) has become binding. These are welcome developments that should help curb inflation and improve the effectiveness of monetary policy going forward. While headline inflation has been coming down, core inflation on our estimates remains high at over 7 percent. This suggests that absent a renewed economic downturn or further monetary policy action the headline inflation rate is unlikely to continue declining toward the 4-5 percent medium-term target stated in the CBR’s Monetary Policy Guidelines. On balance, and given unusually high uncertainties globally and in Russia, we support the CBR’s cautious approach regarding policy rate increases at this time. However, the CBR should stand ready to tighten policies further if the downside risks from an intensification of the euro area crisis do not materialize. Looking ahead, we support the CBR’s planned move to formal inflation targeting by 2014. Achieving this objective will require continued exchange rate flexibility and improvements to the monetary operations framework.
- Safeguarding financial system stability by strengthening bank oversight. In light of heightened external risks and supervisory deficiencies—highlighted by the costly failure of the Bank of Moscow—it is crucial that the CBR’s ability to conduct more intensive and intrusive supervision is brought up to international standards, as recommended in the recent IMF Financial Stability Module FSAP. In this regard, it is critical to approve without delay the pending legislation on connected lending and consolidated supervision and grant the CBR greater supervisory discretion to use professional judgment in applying laws and regulations to individual banks, and strengthen the accountability of bank managers and owners. We welcome the recent extension of the DIA powers in bank rehabilitation, and look forward to the broader reform of the framework for banking resolution currently under legislative consideration.
8. Were the euro area crisis to deepen, policies should be geared toward mitigating the impact on the economy and maintaining economic stability. The more flexible exchange rate should act as a shock absorber as the ruble adjusts to new economic fundamentals, while international reserves could be used to smooth the transition. Drawing on its successful experience in 2008-09, the CBR should stand ready to utilize emergency liquidity facilities as needed to mitigate the impact on banks. Meanwhile, monetary policy could become more accommodative, provided inflation is in check. For fiscal policy, since the nonoil deficit is already high, another massive stimulus would be imprudent. Instead, fiscal consolidation should be postponed to 2013 and automatic stabilizers allowed to operate to dampen effects on growth by letting unemployment benefits rise and the tax burden fall in response to lower growth.
9. Beyond managing short-term risks, lifting growth onto a sustained higher trajectory continues to require reinvigorating long-stalled reforms. We welcome the recent progress made toward WTO accession, which should strengthen Russia’s business climate by making it more rules-based and predictable. But broader reforms will be needed to support economic diversification and underpin growth. The Strategy 2020 now being formulated provides an opportunity to strengthen policy frameworks and advance the much-needed structural reforms to improve the investment climate.