IMF Executive Board Concludes 2010 Article IV Consultation with Russian FederationPublic Information Notice (PIN) No. 10/105
August 2, 2010
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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2010 Article IV Consultation with Russian Federation is also available.
On July 23, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Russian Federation.1
Following a deep recession, the Russian economy has improved, but the recovery remains fragile. In 2009, GDP fell by 7.9 percent, as domestic demand contracted sharply in the first half of the year, following plunging oil prices and an abrupt reversal of capital flows that brought a multi-year credit boom to an end. The economy began to recover in the second half of 2009 amid a pick-up in exports and inventory accumulation. After some temporary softness in the first quarter of 2010, short-term indicators point to a strengthening of the recovery. While all components of demand now appear to be expanding, growth is becoming increasingly driven by consumption, reflecting to a large extent the recent 45 percent cumulative increase in pensions and other policy support. Inflation has come down rapidly in the context of a large output gap. Labor market conditions have improved, with the unemployment rate declining and real wages strengthening modestly. The overall balance of payments has remained in surplus, and the ruble has appreciated considerably since its trough in February 2009.
The banking system is still under strain and credit is likely to recover only gradually. Until recently, bank lending remained subdued, amid weak demand for credit and the continuing efforts by banks to restructure their balance sheets. There are signs, however, that the accumulation of overdue loans is now decelerating, and that banks are scaling back efforts to boost provisions and capital. In this context, credit growth picked up modestly in March and April, reflecting an improvement in credit demand and moderating credit supply constraints. The authorities have been exiting from extraordinary banking sector support extended during the crisis.
Significant fiscal stimulus was provided in 2009, and the relaxation is set to continue in 2010. The general government nonoil deficit increased from 8¼ percent of GDP in 2008 to 15 percent of GDP, almost entirely on account of higher spending. However, much of the expansion was targeted at low-multiplier areas, such as strategic sectors and defense and security. By end-2009, the underlying federal government nonoil balance was some 9 percent of GDP above both its pre-crisis level and the government’s own medium-term target. In June, the government passed a supplementary budget, entailing a further slight increase in the federal nonoil deficit in 2010.
Monetary policy has been accommodative amid a more flexible exchange rate. Against the backdrop of a more stable external outlook and falling inflation, the Central Bank of Russia (CBR) cut its refinancing rate by 525 bps to 7¾ percent from its peak in April 2009. However, given the uncertain economic outlook and increased risk aversion that persisted in 2009, deposit and lending rates remained relatively high until recently. At the same time, the exchange rate has become more flexible. This has, however, occurred in the context of a weaker balance of payments and a sizeable output gap, which has reduced the tradeoff between inflation and exchange rate objectives.
Against this backdrop, the near-term economic outlook is for a moderate recovery. GDP growth is projected to reach 4¼ percent in 2010, reflecting a turn in the inventory cycle and a boost to consumption from rising real wages and a gradual resumption of bank lending. However, absent sustained increases in oil prices, underlying growth momentum is expected to recover only slowly, causing annual growth to fall back to around 4 percent in 2011. Reflecting the output gap, still-weak demand, and continued ruble appreciation, inflation is projected to remain subdued, reaching 6 percent (y-o-y) at end-2010 and 5½ percent at end-2011. The current account is expected to improve in 2010 before deteriorating modestly in 2011 as import growth picks up.
Executive Board Assessment
Executive Directors commended the authorities’ forceful response to the recession, noting that the pre-crisis policy of taxing and saving much of the oil windfall in a stabilization fund had created significant space for fiscal expansion, monetary easing, and extraordinary liquidity support to the banking system, while also helping to prevent an abrupt ruble depreciation. Given the near-term prospect of a recovery with lower potential growth, Directors agreed that the main challenges will be to implement medium-term fiscal consolidation, mitigate pressures for real appreciation and inflation, restore the health of the banking system, and improve the investment climate through ambitious structural reforms.
Most Directors considered that, given the scale of the required fiscal adjustment, the authorities should begin now to gradually withdraw the stimulus and step up the process in 2011–12. Directors regretted the recently passed supplementary budget and cautioned against another supplement in the fall. They emphasized that—with most of the stimulus having taken the form of permanent measures, notably higher pensions—advancing long-stalled public sector reforms will be critical to preventing renewed overheating and rapid real appreciation. Directors encouraged the authorities to strengthen the fiscal framework. To ensure an effective countercyclical fiscal stance and anchor fiscal policy over the medium term, they advised the authorities to avoid the use of supplementary budgets and firmly focus annual and medium-term budgets on the nonoil deficit.
Most Directors stressed that monetary policy should focus on controlling inflation, and advised the authorities that the next move should begin a tightening cycle. A few other Directors cautioned that a tightening at this stage would be premature and could lead to a resurgence of capital inflows and greater exchange rate volatility. Directors noted the staff’s assessment that the exchange rate is broadly in line with fundamentals. They welcomed the recent increase in exchange rate flexibility. Most Directors considered that greater exchange rate flexibility could help limit speculative capital flows and strengthen incentives for domestic borrowing. A few Directors, however, thought that the economy is not yet ready to cope with the increased exchange rate volatility that could accompany greater flexibility, in particular given the country’s reliance on global commodity prices and the foreign exchange exposure of the financial sector.
Directors welcomed the progress achieved on banking supervision, and recommended that loan risk assessment be strengthened and provisioning made more forward-looking. They recommended that the CBR be given greater supervisory powers, particularly regarding consolidated supervision and connected lending, which remains a potential risk. Given the high level of reserves, the authorities remain well-positioned to safeguard financial stability. However, Directors stressed the importance of dealing decisively with the overhang of nonperforming and restructured loans, which could deter economic growth by hampering sustained credit expansion.
Directors emphasized that reinvigorating structural reforms remains a key priority, given the likely lower potential output growth going forward. They stressed the need to improve the investment climate for private sector activity and boost the potential for productivity gains. Directors welcomed the recent progress toward WTO accession. They underscored that such reforms, alongside the policy of taxing and saving oil revenues, remain key to the modernization and diversification of the Russian economy.