IMF Executive Board Concludes 2011 Article IV Consultation with the Russian FederationPublic Information Notice (PIN) No. 11/120
September 14, 2011
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 9, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Russian Federation.1
The Russian economy has improved, but the recovery has been uneven, high commodity prices notwithstanding. Growth picked up to 4 percent in 2010, intermittently carried by consumption—supported by large pension hikes—and investment, while the contribution of net exports turned sharply negative as imports surged. Following strong growth in the fourth quarter of 2010, fueled by a temporary rebuilding of inventories following a severe drought in the summer, short-term economic indicators suggest a notable slowdown in the first half of 2011. Meanwhile, inflation remains stubbornly high, pointing to second-round effects of last year’s spike in food prices. Unemployment has declined, while real wages remain volatile. The current account has strengthened aided by high oil prices, but net capital outflows persist likely owing to political uncertainty in the run-up to the 2012 Presidential elections and the poor business climate.
The financial system is still in a process of balance sheet repair. Banks are liquid and official data suggest nonperforming loans have come down from a peak of 10 percent during the crisis to just over 8 percent of loans in April, while profitability has bounced back from crisis lows. However, banks remain burdened by a high stock of nonperforming assets and this continues to weigh on the outlook for credit growth. Also, remaining weaknesses in reporting and banking supervision pose risks, as was pertinently illustrated by the discovery in June 2011 of a large capital deficiency in the Bank of Moscow, which prompted a US$14.2 billion rescue operation.
The large crisis-related fiscal stimulus, much of it in the form of permanent measures, is being only partially withdrawn. Following a massive fiscal expansion of some 9 percent of GDP during the crisis, the general government nonoil deficit—the relevant measure of the fiscal stance in oil exporters, given oil price volatility and the nonrenewable nature of oil reserves—fell by 1¾ percent of GDP in 2010. This reduction was achieved mainly on account of the recovering economy and expenditure under-execution. The 2011–13 budget plans only a modest further reduction in the federal nonoil deficit of some 2¼ percent of GDP by 2013. Over half of this adjustment stems from an increase in the payroll tax rate in 2011—which is likely to be partially reversed in 2012—and the remainder from lower investment and transfers and a reduction in civil service employment, policy plans for which are still being elaborated. The recently published preliminary 2012–14 budget further scales down the planned fiscal retrenchment. The budget leaves the nonoil deficit in double-digits by 2014 and some 5½ percent of GDP above the government’s own long-term target of 4.7 percent of GDP (suspended during the crisis).
With inflation increasing since the summer of 2010, the Central Bank of Russia (CBR) initiated a policy tightening at the end of the year. Following an initial hike in the CBR’s overnight deposit rate in December 2010, policy rates were increased more comprehensively during February-May 2011. In addition, reserve requirements were raised and differentiated by residency. Meanwhile, the CBR has continued to increase exchange rate flexibility as the floating band for the ruble was widened and intervention amounts scaled back.
The short-term outlook is for only moderate growth. Real growth is projected at 4.8 percent in 2011—compared to over 7 percent during 2000-07—even as the output gap is still negative and oil prices are high. The muted outlook reflects expectations that the combination of soaring oil prices and large capital inflows—which, together with procyclical economic policies, propelled credit and powered the boom in the run-up to the crisis—is unlikely to return amid political uncertainty, a still fragile banking system, and increased risk aversion by investors. Inflation is projected to edge down to 8 percent by end-2011, assuming food prices continue to moderate.
Executive Board Assessment
Executive Directors observed that while Russia’s post-crisis rebound is underway, growth has been moderate and inflation high. Downside risks have increased against the backdrop of a worsened external environment. Directors underscored that high commodity prices create a window of opportunity to embark on bold and decisive reforms to strengthen growth prospects over the medium term. The focus should be on reducing fiscal vulnerabilities, lowering inflation, promoting a stronger and more competitive banking system, and creating a favorable environment for investment and economic diversification. Directors observed that the 2020 strategy, currently under preparation, provides an occasion to introduce the reforms to support stronger growth.
Directors encouraged the authorities to undertake a growth-friendly, credible, and ambitious fiscal consolidation. They recommended re-anchoring fiscal policy on the long-term nonoil deficit target of 4.7 percent of GDP. This would also help rebuild fiscal buffers in the oil funds, thereby reducing fiscal vulnerabilities. Directors underscored that durable adjustment would require fundamental fiscal reforms, including to pensions, social protection, and healthcare. Most Directors noted that front-loading the consolidation while strengthening fiscal institutions, would enhance its credibility and help realize growth benefits sooner, and, in this regard, recommended reconsideration of the 2012–14 preliminary budget.
Most Directors saw a need for a continued tightening of monetary policy this year to bring inflation down towards a medium-term rate of 3–5 percent. A few Directors, however, saw merit in a more cautious approach to further tightening given the still negative output gap and easing food prices. Directors noted that the effectiveness of monetary policy would be bolstered by improvements to the monetary operations framework and a consistent communications policy. They welcomed the ongoing steps to enhance exchange rate flexibility, which will allow monetary policy to focus on inflation and could help dampen current inflationary pressures.
Directors encouraged the authorities to address remaining gaps in the framework for financial regulation and supervision to help safeguard the financial system. They supported the Financial Sector Assessment Program recommendations to strengthen financial sector policies, including by granting the CBR greater supervisory powers and adopting the pending legislation on consolidated supervision and connected lending. Directors noted that effective implementation of these recommendations would reduce banking sector risks and bring supervision in line with international best practice.
Directors underscored the importance of improving the business climate to bolster private investor activity and diversify the economy. They noted that the President’s action plan, if effectively implemented, would make progress in this direction. At the same time, they called for broader reforms, including WTO accession, reducing the role of the state in the economy, and improving governance, to reap the plan’s growth benefits fully.