Russian Federation--Concluding Statement for the 2012 Article IV Consultation Mission
June 15, 2012
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 recovered from the 2008-09 crisis and is now running close to its potential. While demand pressures risk overheating the economy in the short run, medium-term growth prospects are constrained. To address these challenges Russia should continue to strengthen the conduct of macroeconomic policy and tackle long-standing structural bottlenecks. An ambitious fiscal adjustment is needed to ensure that economic growth is balanced, fiscal policy is not pro-cyclical, and oil wealth is spent equitably across generations. Meanwhile, monetary policy should be tightened to keep underlying inflation on a declining path. The increased exchange rate flexibility has been a major policy advancement and is helping the Russian economy absorb external shocks, including spillovers from the international financial turbulence. A stronger supervisory framework is key to promote sound financial intermediation. Critically, the new government should deliver promptly on long-awaited structural reforms, including to improve the investment climate.
1. Russia has recovered from the 2008–09 crisis. The economy grew 4.3 percent in 2011 and accelerated in the first quarter of 2012, helped by high oil prices. Strong real wage and consumption growth have supported demand. Meanwhile, the unemployment rate has fallen to below 6 percent and the capacity utilization of the manufacturing sector has risen to its pre-crisis peak. These factors suggest that the remaining slack in the economy is small, and that on current trends there is a risk of overheating. While headline inflation has slowed to 3.6 percent in May 2012, this owes mostly to a delay in administrative price increases and favorable food price developments, and the IMF staff team’s measure of underlying inflation remains above 6 percent.
2. The baseline outlook is for continued moderate growth and a rebound in inflation. Under unchanged policies, we project growth of about 4 percent in 2012 and in 2013. With the economy moving above potential, the factors temporarily muting prices reversing, and the exchange rate recently depreciating, inflation is projected to bounce back to around 6½ percent by end 2012 and to remain at that level in 2013. The external current account surplus is projected to decline as the drop in oil prices will reduce exports.
3. Ongoing turbulence in the international markets is affecting Russia mostly through oil prices. The reliance on oil exports exposes Russia to declining oil prices, especially if accompanied by large capital outflows. While the more flexible exchange rate and the private sector’s reduced external exposure have improved the economy’s resilience to external shocks, significant weaknesses persist.
4. Strong policy actions are needed to reduce Russia’s vulnerability to external shocks. Large government nonoil deficits expose the economy to abrupt drops in oil prices. Also, shocks can easily push inflation higher in a context of not-yet-well-anchored inflation expectations. A weak business climate makes investors very sensitive to uncertainty, resulting in large swings in capital flows.
5. The new government has the opportunity to change course and put Russia on a sustainable growth path. An ambitious fiscal adjustment would help contain demand pressures in the short run, while over time laying the basis for balanced economic growth and equitable spending of oil wealth across generations. Adopting a firm medium-term anchor for fiscal policy should be an integral part of the fiscal strategy. Monetary policy should aim for stable and low inflation, with further monetary tightening needed to keep inflation on a declining path. Exchange rate flexibility should help absorb external macroeconomic shocks. Critically, the new government should deliver quickly on long-awaited structural reforms.
Government Budget Policy: Avoiding Boom-Bust Cycles and Saving for Future Generations
6. The current budget risks overheating the economy and is depleting the wealth of future generations. Government spending is adding to already strong domestic demand. At some 10 percent of GDP in 2011, the federal nonoil deficit, which is the relevant fiscal indicator for oil-producing economies, remained double the long-term level of about 5 percent of GDP consistent with intergenerational equity. The 2012 budget implies an increase in the nonoil deficit of about 1 percent of GDP. Meanwhile, the current 2012–14 medium-term budget envisages a retrenchment only in the outer years, with a consolidation of less than 1 percent of GDP by 2014.
7. An ambitious fiscal consolidation is needed. Cutting the nonoil deficit by some 1½ percent of GDP in 2012 to 9 percent of GDP, with further consolidation of about 1½ percent per year through 2015, would limit demand pressures and help ensure inter-generational equity. The immediate priority should be to withdraw the 2009 crisis-related subsidies to enterprises and reduce tax exemptions. However, in case of a severe downside shock, fiscal consolidation should be delayed by letting automatic stabilizers operate. In the medium term, there is ample scope for high-quality fiscal adjustment with predominantly expenditure-based consolidation.
8. Pension reform is indispensible for fiscal adjustment but other measures will also be needed. Russia is facing significant population aging in coming years. The staff team projects that, absent reforms, public pension spending would almost double to 16 percent of GDP by 2050. To stabilize pension spending at its 2010 level, the retirement age should be raised for both men and women to 63 years by 2030 and to 65 years by 2050 in line with increases in life expectancy. Raising retirement ages would also increase the labor force, bolstering potential output. In addition, the generous eligibility criteria for early retirement should be tightened, while strengthening disability and welfare programs to protect the vulnerable. Other measures, such as better targeting social transfers and improving the efficiency of government expenditures, will also be needed to ensure fiscal sustainability.
9. A fiscal anchor should be promptly reinstated. A fiscal anchor should be enshrined in a rule that decouples the fiscal stance from short-term variations in oil prices, ensures intergenerational equity, and is transparent. While reinstatement of the currently-suspended nonoil deficit target combined with a medium-term plan to reach this target would be the first-best option, an oil price-based rule, if well designed, could broadly achieve the same objectives. The oil-price rule currently under discussion, however, would leave the nonoil deficit in excess of the level consistent with intergenerational equity and a more conservative base oil price would be appropriate. A strong political commitment to the chosen rule is also important; international experience suggests that the steady implementation of a fiscal rule is as important as its design. In this respect, continuing the long-standing practice of adopting multiple supplemental budgets during the year would undermine the rule and should be discontinued.
Monetary Policy: Tightening the Stance and Anchoring Inflation Expectations
10. A further tightening of monetary policy is necessary to keep underlying inflation on a downward path. Despite the currently low level of headline inflation, without policy action, inflation is likely to bounce back to around 6½ percent by the end of 2012 and to remain at that level in 2013. Credit growth has started to decelerate after growing by more than 20 percent last year, but it remains brisk. Given the lags in the transmission mechanism, timely policy action is necessary to contain the expected rebound in inflation and anchor medium-term inflation expectations. At the same time, the Central Bank of Russia (CBR) should stand ready to provide emergency liquidity as needed if global financial conditions worsen.
11. Greater exchange rate flexibility is a welcome development and will help absorb external shocks. The CBR’s intention to continue on the path of gradual further widening of the ruble trading band and reductions in intervention amounts will allow monetary policy to focus squarely on inflation. Exchange rate flexibility also provides an automatic buffer against external shocks. This is facilitated by reduced balance sheet exposure in the private sector.
12. The increasing clarity of the monetary framework is improving the transmission of monetary policy. Helped by reduced exchange rate interventions, over the past year the CBR has moved from an effective floor system to a more symmetric interest rate corridor system that provides a clearer signal with regard to the stance of monetary policy. It has also taken several steps to narrow the corridor so as to limit interest rate volatility.
13. Further steps are necessary for the successful adoption of inflation targeting. The completion of the transition to a narrower policy interest rate corridor—defined as the spread between the refinancing and deposit standing facility rates—to 200bp would further reduce interest rate volatility, while a reduction of the number of central bank liquidity instruments and interest rates would simplify the operational framework and encourage interbank lending. In addition, further improvements in communication policies, including the publication of inflation forecasts, will be important to improve transparency and explain the rationale for monetary policy measures to the public. In the interest of transparency, it is also recommended that the repo rate is formally made the primary policy interest rate.
14. Russia’s current level of international reserves provides an adequate cushion against external shocks. While further reserve building is not needed for precautionary purposes, the accumulation of fiscal savings in the oil funds should continue as a way of rebuilding fiscal buffers while oil prices are high. Over time it would be appropriate to invest oil reserve fund assets in higher-yielding instruments, subject to appropriate safeguards.
The Financial Sector: Promoting Sound Financial Intermediation by Strengthening Supervision
15. Official liquidity support to the banking sector has shielded the economy from the international financial turmoil. Banks managed ruble and foreign exchange liquidity risks broadly well, supported by solid deposit growth and their net foreign creditor position. However, tight global liquidity conditions and capital outflows from Russia have reduced external funding for the corporate sector, while the fiscal position and the change in exchange rate policy affected liquidity conditions in the domestic money market. However, stepped-up official liquidity support operations helped maintain broadly adequate levels of liquidity in the system, ensuring the continued availability of financing to the private sector.
16. The financial system is improving, but concerns remain about asset quality in the context of rapid credit growth and volatile oil prices. Banks’ overall performance has improved, as indicated by higher profitability and lower nonperforming loan (NPL) ratios. At the same time, credit growth has picked up, reducing the overall capital adequacy ratio and raising the loan-to-deposit ratio. Maintaining credit quality could be a challenge, as the stock of legacy NPLs remains high and the recent fall in oil prices may reduce borrowers’ repayment capacity.
17. A stronger supervisory framework is a key safeguard of a sound financial system, but progress has been slow. Russia continues to improve its financial stability analysis and macroprudential oversight framework. However, progress to fill the important gaps in the supervisory framework vis-à-vis international standards, as identified by the IMF’s 2011 assessment of Russia’s financial sector, has been slow. Crucially, the CBR still lacks adequate authority to effectively supervise bank holding companies and related entities and address connected lending. The CBR also continues to lack sufficient power to exercise discretion based on their professional judgment in applying regulations to individual banks, which is an integral component of the Basel framework. In this context, the prompt passing of the pending legislation on consolidated supervision and connected lending and the expansion of the CBR’s powers to use professional judgment remains a priority.
The Investment Environment: Delivering on Structural Reforms to Promote Growth
18. Addressing the weak investment climate is essential to increase Russia’s growth potential. Between 2000 and 2007, the economy grew at a brisk rate due to an unprecedented increase in oil prices, an increase in capacity utilization, technological catch-up, and a broadening of the labor force. This combination of factors is unlikely to be repeated in the future. Therefore, improving the business climate so as to create a positive investment environment is critical to achieving sustained growth.
19. Despite many proposals to strengthen the investment climate, implementation has been lagging. Persistent institutional weaknesses and large state involvement in the economy make Russia’s business environment compare unfavorably with peers. Structural reforms are crucial to increase investment, diversify the economy, and raise potential growth.
20. Russia’s accession to the WTO should be a catalyst for reforms. WTO membership should be seized upon to strengthen the momentum for domestic reforms to make the business environment more predictable and rules-based, and thereby help boost Russia’s growth potential. International experience suggests that the development of sound domestic institutions is an essential determinant of the benefits gained from WTO accession in terms of medium-term development and growth. Efforts to reduce corruption, strengthen the rule of law, and scale back state involvement in the economy (including through transparent and more decisive privatization of state owned companies) are priorities.