Russian Federation—Concluding Statement- 2013 Article IV Consultation Mission
June 17, 2013
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.
While growth has slowed, the economy continues to operate at full capacity and inflation remains high. As a result, monetary and fiscal stimuli may prove ineffective. Reinvigorating growth potential requires bold supply-side reforms, improvements in the investment climate and financial intermediation, diversification, and a smaller role for the state in the economy. The fiscal rule should be strengthened and efficiency in the public sector and public enterprises improved. The shift to inflation targeting should be completed on schedule.
Economic activity: Structural bottlenecks limiting growth
1. Economic activity has been slowing, but inflation remains high. Growth was 3.4 percent in 2012 and slowed further in the first quarter of 2013 amidst weak investment and external demand. At the same time, the economy remains at full capacity, with unemployment at historic lows and capacity utilization at pre-crisis highs.
2. Near-term prospects are modest. Russia’s growth could reach 2½ percent in 2013 and 3¼ percent in 2014, well below the authorities’ medium-term growth target of 5 percent. Headline inflation is projected to decline modestly to the upper end of the Central Bank of the Russian Federation’s (CBR) target range for end 2013 of 5 to 6 percent and, without policy action, would remain above the CBR’s target range of 4-5 percent in 2014.
3. The Russian economy remains vulnerable to shocks. Calls for near-term policy stimulus threaten newly minted macroeconomic anchors, and rapid unsecured consumer credit growth has increased financial stability risks. Russia could be affected by a sharp decline in oil prices or an acceleration of capital outflows if global economic and financial conditions or the domestic business environment worsen. At the same time, Russia is better equipped to handle such shocks than previously, given a more flexible exchange rate, improving crisis management capacity, and narrower balance sheet mismatches. However, the current level of the Reserve Fund is not sufficient to counter revenue shortfalls in the event of large and lasting oil price decline. Rebuilding the Reserve Fund to no less than 7 percent of GDP, as envisaged in the fiscal rule, would help support the near-term policy response to revenue shortfalls.
4. Russia needs deep structural reforms to increase its medium-term growth potential and reduce its vulnerabilities. The growth model of the pre-crisis years, which was based on increasing oil prices and rising use of spare capacity, is not replicable. Growth in the next decade will need to rely on more efficient use of resources and generating investment. This will require maintaining stable macro-economic conditions, further strengthening institutions, and implementing structural reforms.
Fiscal policy: gradual consolidation and rebuilding buffers
5. The fiscal stance in 2013 is appropriate and temptations to increase spending should be resisted. The general government headline fiscal balance is expected to swing back into deficit this year as oil prices are down, while the non-oil fiscal stance is roughly neutral. Rising spending pressures notwithstanding, temptations to circumvent the fiscal rule should be resisted. Additional stimulus would likely be ineffective and merely intensify inflationary pressures, given a closed output gap.
6. More ambitious medium-term fiscal adjustment is needed to generate sufficient saving of oil revenues. The new oil price-based fiscal rule is welcome because it helps to smooth spending volatility and contain spending pressures. Yet, under current policies, the overall general government deficit will continue to widen, the Reserve Fund will remain below the target of 7 percent of GDP, and the National Welfare Fund will be eroded. The authorities should tighten the fiscal rule to rebuild fiscal buffers, save more of the exhaustible oil income, and help counter Dutch disease effects. Adjustment should focus on expenditure reductions and improving the mix and efficiency of spending, including preserving space for growth-friendly infrastructure programs. A lower benchmark oil price and reduced net borrowing would help to lock in savings under the fiscal rule. Such adjustment would also strengthen policy credibility and help anchor inflation expectations.
7. Structural fiscal reforms should support fiscal adjustment. The government is facing significant medium-term current spending pressures that risk crowding out investment spending. Negative demographics will steadily increase long-term pension and health care costs, while studies suggest significant inefficiencies in spending on infrastructure, health, education, and social expenditures. To reconcile competing demands, the government will need to free up fiscal space and rebalance the mix of spending and enhance its efficiency. This will require bold decisions, including parametric pension reform and improvement in the efficiency of publicly-owned enterprises.
Monetary policy: lowering inflation
8. Monetary policy should remain geared towards achieving inflation objectives. The CBR has kept its main policy rate unchanged since September 2012. Interbank rates have edged up close to the upper end of the interest rate corridor. With 2013 inflation projections close to the CBR target range and uncertainty about the near-term economic outlook, the current monetary policy stance is appropriate, but sustainably reducing inflation to the lower 2014 target calls for a tightening bias.
9. Adoption of formal inflation targeting will help anchor inflation expectations. The CBR has made considerable progress in improving the monetary policy framework in preparation for adopting full-fledged IT by end-2014. Foundations for the IT framework should be completed, including through conduct of regular inflation expectation surveys, publication of inflation forecasts and policy meeting minutes, further consolidation of CBR liquidity instruments, strengthening the CBR’s capacity to forecast system liquidity, and better coordination with Treasury in liquidity management. The CBR’s proposal to move from an inflation-target range to a point target to guide inflation expectations more precisely is appropriate.
Financial sector policies: supporting growth and stability
10. Financial stability risks are moderate but rising. Retail lending growth in 2012–13 has been rapid, largely driven by unsecured consumer loans. Some financial soundness indicators have worsened, and declining capital adequacy and liquidity positions are weakening banks’ ability to absorb shocks. At the same time, the debt burden of households has been increasing. The CBR has appropriately responded with prudential measures, including higher provisioning requirements and increased risk weighting for high-interest loans. The authorities should also consider introducing a formal ceiling on the debt-service-to-income ratio and higher capital requirements for high credit concentration risks.
11. Recent steps to improve the supervisory framework are welcome. Legislative amendments recently adopted by Duma will expand CBR supervisory authority over bank holding companies and related parties and allow the CBR to sanction individual directors and managers; raise capital requirements; and use professional judgment in applying laws and regulations to individual banks. The CBR should adopt Basel 2.5 and 3 capital frameworks as planned, which will require some banks to raise capital. The planned creation of a mega-supervisor could enhance the capacity to monitor systemic risks, but the current weaknesses in supervision of nonbanks need to be addressed, including power to apply fit and proper criteria to directors and managers.
12. Improving corporate governance, borrower information, creditor rights, and competition will strengthen the financial sector’s efficiency and contribution to growth. The recent slowdown in corporate lending is largely demand-driven. High lending rates reflect weaknesses in corporate governance, collateral registry and foreclosure, borrower opacity, and still high inflation expectations. Expediting envisaged amendments to legislation regarding credit bureaus and collateral registries would reduce information asymmetries and improve access to financing, in particular for SMEs. Further divestiture of state-owned banks—consistent with the Development Strategy for the Banking Sector through 2015— should also be pursued.
Structural Policies: unleashing growth potential
13. Raising potential growth will require further supply-side structural measures. Russia’s weak business climate remains an obstacle to investment, diversification, and higher growth. The authorities have made improving the investment climate a priority, but progress remains uneven. Corporate governance, including full disclosure of affiliated parties, should be strengthened to increase transparency and improve the investment climate. Deregulation should continue. Inefficiencies at customs and other “red tape”—two areas often cited in surveys—should be addressed. The government’s goal to reduce its footprint in the economy through privatization is welcome; transparency and swift implementation of plans in this area are of the essence. WTO accession in 2012 was an important step to further integrate Russia into the world economy and support reforms. The OECD accession process provides an appropriate venue for furthering and broadening the reform process.
14. Russia should leverage its comparative advantages to boost growth. Russia has a clear potential for growth in the energy sector but investment has lagged, weakened by a revenue-based taxation scheme that inhibits investment in more-difficult-to-reach energy projects. Tax regime changes, together with strengthened property rights and distribution access, are needed to attract foreign technical expertise and nimble domestic players. Improvement in the efficiency of publicly-owned companies is also necessary. Without such reforms, oil and gas production will decline soon. Economic diversification is also necessary to lift potential growth and reduce vulnerability to shocks. In pursuing regional development initiatives, the authorities should rely on market-based mechanisms and carefully consider the costs and benefits and remove impediments to labor mobility. Given adverse demographics, it will be especially important to adopt measures to enhance the participation rate and efficiency of the labor force through measures such as encouraging later retirement in the context of the pension system, and reforming education and training to facilitate better matching of skills with market demands.