Public Information Notice: IMF Concludes Article IV Consultation with the Russian Federation
November 9, 2000
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On September 15, 2000, the Executive Board concluded the Article IV consultation with the Russian Federation.1
Recent macroeconomic performance has been strong. Driven by a combination of a large real ruble depreciation following the August 1998 crisis, a sharp improvement in the terms of trade, and strengthened monetary and fiscal policies, the external current account has moved into a substantial surplus while output has rebounded sharply and is now above its level immediately before the crisis. The fiscal balance has improved significantly reflecting policy adjustments and the windfall gains from high world oil prices. Monetary policy has focused on bringing down inflation while preserving relative stability of the exchange rate. However, the liquidity injections resulting from large foreign exchange market interventions (to prevent an excessive appreciation of the ruble) have been associated with some uptick in inflation in the last few months.
After declining by 4.9 percent in 1998, output grew by 3.2 percent in 1999 and is on course to grow by around 7 percent in 2000. The recovery was initially based on import substitution in response to the 40 percent real depreciation of the ruble, but has subsequently broadened as domestic consumption and investment have begun to recover and non-energy exports have grown strongly. A recovery in enterprise profitability coupled with the stronger fiscal position and an insistence by the federal government on payment of taxes in cash have resulted in a reduction in barter and domestic arrears accumulation.
The external current account has swung from a deficit of 3 percent of GDP in the first half of 1998 to an estimated surplus of 18 percent of GDP in the first half of 2000. This sharp turnaround largely reflects the compression of imports following the ruble depreciation, as well as the increase in world energy prices. Despite continuing high levels of capital flight and a small deficit for the public sector capital account, the overall balance of payments has moved into significant surplus with gross reserves increasing by $8.6 bn in the first half of 2000 to over $21 bn (equivalent to 4.7 months of imports) compared to a stock of $10.9 bn (2.5 months of imports) at end-1998. The balance of payments position has also benefited from debt restructuring provided by both Paris Club and London Club creditors.
The fiscal position of all levels of government has improved sharply. At the federal level, the primary balance has moved from a deficit of about 1½ percent of GDP in 1998 to a surplus of 1½ percent of GDP in 1999 and a surplus of about 6½ percent of GDP in the first half of 2000. The improvement has been driven by a large increase in revenues from the growing tax base, discretionary tax changes including the reintroduction of export taxes that have captured a portion of the windfall revenue gains in the energy sector, and a more determined effort to improve compliance. Balances of the local governments and extrabudgetary funds have also improved, in this case due to expenditure reductions.
Monetary policy has sought to bring down inflation while resisting pressures for a sharp nominal appreciation arising from the balance of payments surplus. During 1999, inflation was kept on a downward path, falling to less than 1 percent per month (seasonally adjusted) at the end of the year. Liquidity injected through CBR purchases of foreign exchange was partly absorbed by an increase in the demand for money, on account of the output recovery and the decreased use of barter, as well as an increase in commercial bank deposits at the CBR. The expanding balance of payments surplus in the first part of 2000 has resulted in the CBR making substantial purchases of foreign exchange in the market which has placed great pressure on the CBR’s ability to sterilize the liquidity injected. While the demand for money has continued to grow and the CBR has been helped by a large build-up in balances by all levels of government, base money grew by almost 25 percent in the second quarter of 2000. After remaining at less than 1 percent per month (seasonally adjusted) through the first four months of 2000, there has been a notable uptick in inflation since May. While this coincided with an increase in utility tariffs, it is also likely that underlying inflation has increased.
Progress with structural reforms has been mixed, though it has received new impetus in the post-election period. Reforms in a number of areas, such as privatization, accounting reform, and bank restructuring, have been delayed, in some cases due to delays in securing passage through the Duma of key legislation. There has been backtracking in the energy sector through the reintroduction of export restrictions to ensure domestic supplies of oil and oil products to certain sectors and regions and to restrain domestic price increases. Progress was made in fiscal reform during 1999 with measures to strengthen tax administration and enhance expenditure control. In July 2000, the government adopted a comprehensive and ambitious plan for the development of the Russian economy over the next 10 years. One key component of this plan, a major tax reform designed to streamline the tax system and lower the tax burden, has already been approved in large part by the parliament and will come into effect in 2001.
Executive Board Assessment
Executive Directors commended the authorities for Russia’s impressive recent macroeconomic performance, with a strong output recovery and the achievement of a considerable measure of financial stability.
Directors noted that the favorable external environment had contributed to the recent success, and welcomed the improved macroeconomic policies, particularly the strengthening of the fiscal position, which has helped to preserve and extend the initial gains from the ruble depreciation and the high price of oil. However, Directors cautioned that many of the deep-seated structural problems that were present before the 1998 crisis still remain to be tackled, making recent achievements—particularly on growth—more vulnerable to a major deterioration in the environment. Thus, Directors believed that the main challenge facing the authorities remains the need to implement a broad-based acceleration of structural reform, to ensure that the recovery and the stabilization gains will be sustained over the medium term.
Given the massive external current account surplus, most Directors believed that real appreciation would be both desirable and unavoidable, and that it would be preferable for this to take place through a nominal appreciation rather than through inflation. However, Directors noted that an excessive real appreciation could threaten the recovery and generally regarded continuation of the current policy of sterilized intervention to slow the rate of appreciation as appropriate. A few Directors recommended that the authorities should consider instituting an inflation-targeting monetary regime.
In this regard, several Directors expressed concern that the issue of whether the cost of sterilization should be borne by the Central Bank of Russia (CBR) or by the government risked deflecting monetary policy from focusing on inflation. They stressed that the responsibility for controlling liquidity and inflation in the short term rests with the CBR. Directors noted that fiscal policy has been conducted in a very responsible manner during this episode of rapid foreign exchange purchases, and considered that the CBR should be more determined in using its market-based instruments to keep control over reserve money. Directors called on the government to regularize its relations with the CBR, including by paying a market-related interest rate on CBR credits. The financial position of the CBR should be reviewed, and the CBR should, if necessary, be recapitalized. However, any such recapitalization should be accompanied by increased transparency and accountability on the part of the central bank, including the termination of functions not normally performed by a central bank, such as ownership of subsidiaries engaged in commercial banking activities and operations in precious metals.
As to fiscal policy, Directors commended the authorities for their restraint in limiting new expenditure commitments despite the strong revenue performance. They encouraged the authorities to continue this cautious approach, given the uncertainties over the medium-term outlook and in the absence of a fuller assessment of the costs of planned reforms. Directors noted that, while revenues had been boosted by the windfall gain accruing to the energy sector, collections from the energy sector had also improved due to more determined efforts to enforce compliance with statutory tax obligations. Directors welcomed other policy improvements including the strengthening of Treasury expenditure control, downsizing of the civil service, reform in tax administration, an increased federal share of tax receipts, and determined efforts to collect revenues in cash.
Looking to 2001, Directors believed that the authorities’ target of a zero deficit for the overall balance of the federal government is broadly appropriate given the current macroeconomic outlook. They noted that this target is likely to entail a significant increase in federal expenditures and cautioned that the increased expenditures should be directed primarily toward reform-related expenditures, or the clearance of arrears, rather than increasing recurrent expenditures, which would significantly curtail the room for maneuver in the future. A few Directors considered that the overall fiscal objective should be more ambitious in light of the large external debt and the uncertainties about the outcome of the tax reform.
Directors generally agreed that the current strength of the balance of payments could not be expected to be sustained over the medium term as imports recover from their compressed levels and oil prices subside from recent highs. Most Directors also acknowledged that the fiscal outlook was particularly uncertain, partly due to questions pertaining to the sustainability of expenditure reductions and the cost of reform. These uncertainties notwithstanding, several Directors felt that the current strength of the balance of payments meant that the case for exceptional balance of payments support is not apparent at this stage. Directors considered that, given Russia’s healthy external position, emphasis should be placed on normalizing relations with creditors, improving market confidence and attracting foreign investment. In this regard, a few Directors felt that the time was ripe for the removal of remaining restrictions on current transactions.
Directors were of the view that the overall progress in advancing market-oriented structural reforms had been disappointing to date. The government’s stated determination to accelerate reforms was therefore encouraging. In this regard, Directors welcomed the long-term reform program recently adopted by the government, especially the emphasis on market liberalization, enterprise restructuring, and measures to tackle deep-seated problems of corruption and governance. They judged the objectives of the government’s program to be appropriately ambitious. Directors urged the authorities to move resolutely ahead with the implementation of the envisaged reforms, taking advantage of the opportunity provided by the strong macroeconomic environment and by what appeared to be strengthened political support for reforms following the recent elections.
Several Directors noted, however, that most of the policies envisaged in the government’s program had been part of Fund and World Bank supported programs in the past, and that previous governments had failed to implement these policies because of fierce resistance from vested interests. In this regard, Directors noted that any new program that could be supported by the Fund would have to include strong up-front measures in those areas of structural reform that would be key to macroeconomic stability, notably tax reform, bank restructuring, including the completion of financial and strategic reviews of Sberbank, measures to reduce the incidence of barter and arrears accumulation, and steps to strengthen governance and transparency in policy-making institutions. A few Directors were of the view that, given Russia’s stronger external position, any future Fund program support should be of a precautionary nature to help catalyze private investment activity. There was also a call for post-program monitoring of the evolution of the economy in the period ahead.
Directors were encouraged by the authorities’ efforts to further strengthen the statistical data base including through the design of proper safeguards to ensure data quality. In this regard, the Report on the Observance of Standards and Codes (ROSC) modules on fiscal policy, monetary and financial policies, and on data dissemination provided a generally favorable evaluation of the existing framework, though these also highlighted a number of areas in which further progress is necessary. Directors welcomed the authorities’ intention to subscribe to the Special Data Dissemination Standard (SDDS) and encouraged them to address as a matter of priority the weaknesses identified in the ROSC modules.
Directors took note of the authorities’ disappointment at their inclusion on the Financial Action Task Force on Money Laundering (FATF) list of countries not cooperating in the fight against money laundering. They welcomed the authorities’ intention to introduce measures to correct the shortcomings identified in the FATF report.