Economic Health Check
New Growth Model Can Unlock Russia’s Growth Potential
October 22, 2013
- Policy stimulus may not deliver desired results in current economic conditions
- Russia faces supply-side constraints and needs new growth model
- Ambitious investment climate reforms could unleash Russia’s growth potential
Russia needs to embrace a new growth model, complemented by more diversification, higher investment, and a more efficient use of resources, to raise its growth potential, says the IMF in its regular assessment of the Russian economy.
Russia faces a growth challenge. The years preceding the global financial crisis saw rapid increases in per capita income, declines in unemployment, strengthened fiscal and external buffers, and considerable improvements in institutional frameworks. However, after a swift post-crisis rebound, growth has begun to slow and medium-term prospects are increasingly dampened—the previous model of high growth on the back of rising oil prices and utilization of spare capacity cannot be replicated.
These considerations provided the backdrop to the IMF’s latest annual review of the Russian economy, also known as the Article IV report. “Achieving higher sustainable growth is clearly possible,” says Antonio Spilimbergo, the IMF’s mission chief for Russia, “but that would require a new growth model, relying on a more diversified economic structure, strengthened institutions, and structural reforms.”
The IMF economists project growth in Russia to slow to 1½ percent in 2013—down from 3½ percent seen last year, and even higher rates earlier. Weak investment, industrial production, and external demand account for much of the observed slowdown.
A pickup to 3 percent is expected in 2014, with growth remaining in that range over the medium term in the staff baseline scenario.
Despite this slowdown, however, there appears to be little slack in the economy: inflation—though declining—is projected to remain above the central bank target; unemployment remains close to historic lows; and available measures indicate high utilization of existing capacity.
In this environment, policy stimulus may not pay much dividend. “Expansionary monetary and fiscal policies can certainly provide some temporary support,” said Spilimbergo, “but this may come at the expense of generating policy uncertainty and may not provide a long-lasting boost.”
Fiscal stimulus measures may jeopardize the credibility of the new fiscal rule that links expenditure to oil revenues. In fact, IMF economists advise that the rule should be strengthened to save more of the exhaustible oil income and rebuild the fiscal buffers that served Russia well in the last crisis.
Monetary policy has been appropriately focused on securing low and stable inflation, said the IMF economists. Welcome moves toward putting in place a rigorous inflation-targeting framework and allowing increased exchange rate flexibility should continue, given their roles in providing firm anchors for inflation expectations and absorbing external shocks, respectively, reducing uncertainty and volatility.
The IMF report notes that the Russian authorities broadly agree with the structural agenda set out to restart Russia’s growth engine over the medium term; an ambitious set of reforms could deliver this desired outcome.
Going forward, the Russian economy will have to rely on a more efficient use of resources and higher investment, rather than increasing oil prices. This calls for measures to boost productivity and improve the investment climate, governance, and transparency.
The financial sector remains a lynchpin of the growth agenda, intermediating available resources to productive ends. In their report, the IMF economists recommend that in order to level the playing field and encourage competition, the role of the state in dominant banks should be reduced. Further, improvements in corporate governance and consolidation of the fragmented banking system would encourage a more efficient allocation of investment capital that could provide the needed boost to the Russian economy.
The obvious comparative advantage that Russia has in the energy sector should be exploited. Changes in the tax regime—as well as improvements in property rights protection and access to distribution infrastructure—would help attract foreign technical expertise and nimble domestic players, underpinning Russia’s natural source of growth.
The report also notes the importance of further improving the efficiency of public expenditure. Stronger implementation of the government’s privatization agenda and pension reform can support better public finances and catalyze growth by facilitating better labor force participation and private sector involvement.
More generally, implementation of commitments already made in Russia’s WTO accession, as well as items being discussed for joining the Organization for Economic Cooperation and Development, provide important means for advancing this structural agenda to unleash Russia’s growth potential.
The current economic environment not only poses a challenge to policymakers, but also provides a timely opportunity for reform. Improvements in the macroeconomic policy framework in recent years placed Russia in a strong position in a global environment buffeted by crises. A focused reform agenda would further strengthen this armor, while delivering higher growth—and better living standards for its population—for years to come.