RUSSIA ECONOMIC HEALTH CHECK
Russia Should Leverage Commodity Boom to Boost Growth
IMF Survey online
September 27, 2011
- Russian growth of 4.3 percent projected for 2011
- Lower world growth and euro area crisis are main risks to outlook
- Stronger policies would leverage commodity boom and lift growth rate
Russia’s economy grew by 4 percent in 2010, aided by the boom in commodity prices, in particular oil.
For 2011, the IMF is projecting growth of 4.3 percent. But Russia could do much better. Before the global financial crisis, the economy was growing at more than 7 percent per year, and it could take off again if economic policies and the supporting policy institutions are strengthened.
Russia also remains overly reliant on oil revenues, which makes it vulnerable to a slowdown in economic growth and a sudden drop in commodity prices.
In an interview, IMF mission chief for Russia Juha Kähkönen and deputy mission chief Daria Zakharova discuss the outlook for Russia’s economy, and weigh risks such as continued crisis in the euro area or a pronounced slowdown in the global economy.
IMF Survey online: What is the outlook for Russia’s economy?
Kähkönen: Russia is still benefiting from high oil prices, but its post-crisis economic performance has been disappointing, with only moderate growth and high inflation.
Russia saw a major decline in output of about 8 percent of GDP during the global crisis, and is still catching up. The economy grew by 4 percent in 2010 and is projected to grow by 4.3 percent this year. Growth has suffered as a result of a bad harvest in 2010 brought on by drought. The economy is also slowing down now because of the ongoing turmoil in advanced countries.
Going forward, Russia’s outlook will depend not just on the external environment but also on economic policies.
If current policies—a high nonoil fiscal deficit and no clear medium-term anchor for fiscal policy, monetary policy that is insufficiently focused on reducing inflation, a financial sector lacking adequate oversight, and stalled structural reforms—are maintained, the result will be muddling through, with growth tapering off to below 4 percent in the medium term. But if there is a major strengthening of the economic policies, Russia’s potential is huge. The country could easily grow by an annual rate of 6 percent or more on a sustained basis if the right policies are put in place.
IMF Survey online: How vulnerable is the economy to ongoing turmoil in Europe and the slowdown in global growth?
Zakharova: If the crisis in the euro area intensifies and leads to another global downturn and a precipitous fall in oil prices, Russia’s economy could be severely affected.
Russia could also be impacted through the financial channel. Although Russia’s direct exposure to European sovereign debt is limited, a severe distress in a large bank in a core euro area country could have serious repercussions for Russia’s banking system.
IMF Survey online: What are your main recommendations to the Russian authorities on the macroeconomic policy mix?
Kähkönen: High oil prices give Russia a window of opportunity to put the economy on a higher growth path. Policies should be strengthened in four main policy areas: monetary policy, fiscal policy, structural reforms to improve the business climate, and banking sector supervision. We think it would be most beneficial to have action simultaneously in all of these areas because the reforms would be mutually reinforcing.
Russia’s macroeconomic policies would also benefit from more stable and predictable frameworks. Right now, there are too many ad hoc policy decisions. In terms of monetary policy, we think the central bank should focus squarely on inflation. In the past, the bank has had multiple targets, which has diluted the emphasis on price stability. Russia’s underlying inflation currently is high at about 8 percent.
Zakharova: The fiscal policy framework should also be strengthened. Right now, policy focus is on the overall fiscal balance. But because Russia is an oil producer, it is more appropriate to look at the nonoil deficit—the size of the deficit before taking oil revenues into account. This deficit increased by 9 percent of GDP during the crisis, with Russia implementing one of the largest fiscal stimuli in the Group of 20 (G-20) leading industrial and emerging market countries.
Our advice is to refocus fiscal policy on the nonoil balance and introduce an ambitious, credible, and growth-friendly fiscal consolidation that aims at reaching a nonoil deficit of 4.7 percent, the current long-term fiscal target of the government.
We also recommend that Russia refrain from enacting further supplementary budgets, which in the past have been used to spend excess oil revenues. Supplementary budgets make fiscal policy pro-cyclical, thus undermining macroeconomic stability.
IMF Survey online: Russia has been riding high on the commodity boom, but what will happen if prices start to falter?
Zakharova: Russia has been rescued from the recent financial crisis by a strong recovery in oil prices, but in the process the economy has become much more vulnerable to a sudden drop in commodity prices.
Russia’s nonoil deficit has almost tripled following the crisis. Just to put this in perspective, if oil prices were to fall to $40 per barrel as they did during the most recent financial crisis, Russia would be running deficits in the order of 8 percent of GDP.
At the same time, the Oil Reserve Fund, which Russia successfully used to cushion the economy in the most recent downturn, has been almost exhausted. This means that the government would have to borrow from the markets—and possibly at high rates—if there is a precipitous drop in oil prices.
The external current account would also be severely affected by a decline in oil prices. We would expect that the current high surplus would turn into a deficit fairly quickly, putting pressure on the exchange rate.
The good news is that Russia’s central bank today is much better prepared to handle a crisis It has introduced more exchange-rate flexibility. It has also developed more tools to cushion the effect of the crisis on banks by providing emergency liquidity support and recapitalizing systemically important banks and resolving smaller banks.
The bad news is that the room for fiscal action is now much smaller because of the high deficits.
IMF Survey online: Are you optimistic that Russia will succeed in improving its investment climate?
Kähkönen: There is general agreement that Russia’s investment climate is very poor. International surveys that cover the BRICs [the four major emerging market countries] and emerging European countries rank Russia last in terms of government effectiveness, regulatory quality, the rule of law, and control of corruption.
The authorities openly acknowledge the problems and there are plans to address them. President Medvedev has announced a Ten-Point Plan that includes a number of initiatives to tackle corruption, reduce state interference in the economy, and improve services for businesses.
However, implementation is key and it remains to be seen how fast the reforms proceed, especially with presidential elections scheduled for 2012. Also, these reforms alone would not be sufficient. More would need to be done, including finalizing accession to the World Trade Organization and implementing an ambitious privatization agenda.
IMF Survey online: What measures are needed to strengthen the banks?
Zakharova: Russia’s financial system has weathered the crisis relatively well, but banks are still burdened by nonperforming loans, and there are still deficiencies in accounting standards and regulatory and supervisory frameworks. This means the banking system remains vulnerable to shocks.
The IMF’s recent assessment of Russia’s financial sector found that the quality of bank loans may be overestimated, and that capital provisions are lower than they should be.
Continued regulatory weaknesses were illustrated by the recent failure of Bank of Moscow, Russia’s fifth largest bank. In our report, conducted as part of the IMF’s Financial Sector Assessment Program, we recommend giving the central bank more supervisory authority and adopting legislation on consolidated supervision and connected lending. Effective implementation of these recommendations should help promote sustainable and strong credit, which in turn would boost growth and create jobs.