KEY ISSUES Context. Growth has slowed amidst weak investment and external demand, while the output gap appears to be at or near zero and inflation is elevated. Activity is currently weak, but is expected to accelerate somewhat later this year. However, structural factors constrain medium-term prospects. The introduction of a new oil price-based fiscal rule, a more flexible exchange rate, and operational improvements in monetary policy have strengthened the macroeconomic policy framework. Financial sector reform has progressed, though sector indicators are mixed and rapid growth in unsecured retail credit is of some concern. Risks remain tilted to the downside, including on account of possible external (e.g., oil price) and domestic (e.g., investor sentiment) shocks. Near-term macroeconomic policy mix. Calls for policy stimulus are testing Russia’s newly strengthened macroeconomic anchors. But absent a widening output gap, expansionary fiscal and monetary policies would at best provide only a modest and unsustainable increase in GDP, while generating overheating and greater policy uncertainty. So far, the Central Bank of the Russian Federation (CBR) has kept its main policy interest rate on hold. Fiscal policy is appropriately neutral this year but is under threat from off-budget spending plans. To contain inflation and reduce risks, the authorities should keep monetary policy on hold with a tightening bias, resist additional fiscal stimulus, and consider further measures to dampen excessive retail credit growth. Medium-term policy challenges. To reach higher sustainable growth, Russia needs to further strengthen the macroeconomic policy framework and implement supply-side reforms. The authorities should gradually tighten the fiscal rule to rebuild fiscal buffers and save more of the nation’s exhaustible oil income. The CBR should complete its transition to a flexible exchange rate and inflation targeting (IT) by end-2014 as planned, which, combined with fiscal policy changes, would help anchor inflation expectations. To mitigate supply-side growth constraints, Russia should reduce the regulatory burden to facilitate more private sector activity in key sectors, strengthen the financial sector to improve its ability to channel savings into productive investment projects, increase transparency, and enhance the business climate. Further global integration, including completing OECD accession, would support and broaden these efforts.