## cr17197 ## Source details **Canonical URL:** [cr17197](https://www.imf.org/-/media/files/publications/cr/2017/cr17197.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17197.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17197.pdf.json) --- ### Context and recent developments - After two years of recession, the economy is recovering due to higher oil prices and improved sentiment, amid tight fiscal and monetary policies. - Real GDP growth: - 2014: 0.7 - 2015: -2.8 - 2016: -0.2 - 2017 (forecast): 1.4 - 2018 (forecast): 1.4 - Inflation and prices: - Consumer prices, period average: 2014: 7.8; 2015: 15.5; 2016: 7.0; 2017 (proj): 4.2; 2018 (proj): 4.0 - Consumer prices, end of period: 2014: 11.4; 2015: 12.9; 2016: 5.4; 2017 (proj): 4.0; 2018 (proj): 4.0 - GDP deflator: 2014: 10.7; 2015: 8.2; 2016: 3.6; 2017 (proj): 5.7; 2018 (proj): 3.8 - Key drivers of recent improvement: - Doubling of oil prices from a low of US$26 pb in January 2016 to over US$50 pb in May 2017. - 100 bps cut in the policy rate. - Improvements in consumption and investment; credit growth reached 2.5 percent y-o-y in March 2017. - Inflation declined to 4.1 percent in April 2017, down from 7.2 percent a year earlier. ### Outlook and key projections - Near term: - GDP forecast: 2017: 1.4 percent. - Domestic demand expected to support GDP growth; net exports’ contribution will diminish as imports recover. - Inflation expected to continue declining, driven by ruble appreciation and falling inflation expectations in the context of a small negative output gap of about ½ percent. - Medium term: - Oil price assumption: US$55pb on average over the medium-term. - Potential growth likely to stay at about 1½ percent over the medium term absent significant structural reforms. - Risks and buffers: - Main risk: fall in oil prices. - Additional downside risks: flare up in geopolitical tensions; a significant slowdown in China; continued drop in investment due to lack of structural reforms; slower than expected banking system recovery. - Buffers: reserves stood at 206 percent of the Fund’s adequacy metric adjusted for the impact of commodities at end-2016; public debt is low; current account is in surplus. ### Fiscal policy assessment and recommendations - Past/current stance: - Authorities reinstated the three-year fiscal framework in the 2017 budget to reduce policy uncertainty. - Fiscal consolidation pace judged appropriate given the recovery and persistently lower oil prices compared to the recent past. - Key fiscal figures (percent of GDP unless indicated): - General government net lending/borrowing (overall balance): 2014: -1.1; 2015: -3.4; 2016: -3.7; 2017 (proj): -1.9; 2018 (proj): -1.2 - General government revenue: 2014: 33.8; 2015: 31.8; 2016: 32.8; 2017 (proj): 32.6; 2018 (proj): 31.9 - General government expenditures: 2014: 34.9; 2015: 35.2; 2016: 36.4; 2017 (proj): 34.5; 2018 (proj): 33.1 - Primary balance: 2014: -0.4; 2015: -2.6; 2016: -2.6; 2017 (proj): -1.0; 2018 (proj): -0.2 - Nonoil balance (general government): 2014: -11.4; 2015: -11.4; 2016: -9.8; 2017 (proj): -8.4; 2018 (proj): -7.6 - Federal government net lending/borrowing (overall balance): 2014: -0.4; 2015: -2.3; 2016: -3.4; 2017 (proj): -1.7; 2018 (proj): -1.0 - Federal government nonoil balance: 2014: -9.9; 2015: -9.5; 2016: -9.0; 2017 (proj): -7.5; 2018 (proj): -6.8 - Staff and Directors’ recommendations: - Support fiscal consolidation with durable, well-targeted, growth-enhancing spending. - Adopt a credible fiscal rule to anchor adjustment, allow smoother response to oil price changes, build adequate savings, and contain Dutch disease. - Consider parametric reform of the pension system to deliver fiscal savings over time. - Reinstate and sustain the three-year fiscal framework to reduce policy uncertainty. ### Fiscal rule, authorities’ actions, and simulation evidence - 2017–19 federal budget assumptions/targets: - assumes an oil price of US$ 40 pb; - targets about a 1 percentage point of GDP yearly reduction in the overall budget deficit; - relies mostly on a nominal spending freeze and temporary revenue measures. - 2017 budget amendment (May): - budget deficit revised to 2.1 percent of GDP from 3.2 percent in the original budget; - non-oil revenue collections in 2017Q1 were well ahead of budget projections; - three-quarters of the additional non-oil revenues will be spent in 2017; - authorities aim to keep unchanged the annual reduction in the non-oil primary structural deficit over 2017–2019 at around 1 percentage point of GDP. - New mechanism to save oil revenues (implemented February): - MoF saves the difference between actual oil revenues and those that would have accrued at the budgeted price (symmetric around US$40 pb); - MoF purchases/sells corresponding FX amount on the market and deposits/withdraws it in/from the Reserve Fund (RF); - daily purchases amounted to US$70–100 million in February and March; - average daily FX turnover in the spot market is US$3–5 billion. - Simulation evidence (Box 1): - Authorities’ proposed new rule builds up the nearly depleted reserve fund under baseline and persistently higher oil price scenarios relative to a US$40 pb benchmark. - If oil prices are persistently lower than US$40 pb, the new rule results in lower savings compared to Staff’s proposed rule. - Simulations show savings can be achieved through a more stringent fiscal target (Staff’s proposal) rather than an inflexible benchmark. - Both staff and authorities’ proposed rules perform equally well in shielding the economy from volatile oil prices with no discernible difference in impact on growth and the real effective exchange rate. - The old rule would have led to the lowest savings and highest spending during high oil prices and to a large fiscal stimulus under persistently low oil prices. ### Monetary policy assessment and recommendations - Current stance: - Monetary policy easing has begun, with a 100 bps policy rate cut noted in 2017 context; CBR resumed easing in March, cutting policy rate by a cumulative 75bps to 9.25 percent. - Inflation objective: 4 percent at end–2017. - Money and credit indicators (annual percent change): - Base money: 2014: 6.3; 2015: -4.3; 2016: 3.8; 2017 (proj): 6.3; 2018 (proj): 6.4 - Ruble broad money: 2014: 1.5; 2015: 11.3; 2016: 9.2; 2017 (proj): 9.4; 2018 (proj): 9.6 - Staff and Directors’ recommendations: - Monetary policy easing should continue, but at a gradual pace given the uncertain size of the output gap and the potential for disinflation reversal. - Shift communication strategy to cover a longer horizon and clarify acceptable departures from the inflation target. - Staff estimates the current stance is tight, with the gap between current policy rate and the estimated neutral rate around 2–3.5 percentage points. - Conditions for further disinflation: negative, albeit small, output gap; slowly recovering consumption amid a tight fiscal stance; sequential deceleration in core inflation. - Risks to gradual easing: inflation expectations above target; uncertain recovery pace amid volatile oil prices; tightening labor market; potential reversal of ruble overvaluation. ### Financial sector and macro-financial policies - Progress and issues: - Steps taken to increase financial system resilience, including an improved bank resolution mechanism. - Banking system liquidity support and capital injections helped stabilize the sector during the downturn. - Financial soundness and external metrics: - Gross international reserves (billions of U.S. dollars): 2014: 385.5; 2015: 368.4; 2016: 377.7; 2017 (proj): 395.3; 2018 (proj): 412.6 - Reserves in months of imports of goods and non-factor services: 2014: 10.8; 2015: 15.7; 2016: 17.0; 2017 (proj): 16.8; 2018 (proj): 16.7 - Percent of short-term debt: 2014: 302; 2015: 450; 2016: 419; 2017 (proj): 391; 2018 (proj): 417 - Staff and Directors’ recommendations: - Continue implementing FSAP recommendations to enhance the institutional framework. - Remove obstacles that discourage investors from effectively acquiring assets and liabilities in bank resolutions. - Replace central bank funding with federal funds and increase recourse to banking industry capital. - Revamp statutory bail-in legislation while considering financial stability implications. - Further tighten limits on related-party lending and accelerate introduction of explicit early bank intervention procedures. ### Banking sector performance, resolution reform, and macroprudential actions - Banking sector metrics and developments: - Lending activity: loan volume growth averaged 2 percent annually since early 2016. - NPLs after rising for two years have settled at around 9.5 percent. - Capital Adequacy Ratio increased moderately to around 13 percent; CET1 ratio of 9.2 percent in relation to a phased-in Basel III capital requirement of 4.5 percent. - CBR closed 110 credit institutions in 2016, compared to 101 in 2015; number of total credit institutions declined to 616 from 923 at end-2013. - Bank resolution law (effective mid-June): - Replaces DIA-operated open bank resolution framework with one operated by the CBR. - Allows the CBR to provide an equity capital injection but only after wiping out shareholders’ equity capital. - Permits a limited amount of bail-in for subordinated liabilities held by individuals who are managers and/or exercise control over the bank. - Creates a Bank Consolidation Fund (BCF), financed and managed by the CBR; BCF does not carry an explicit arrangement for federal government funding. - CBR will take majority control of the DIA’s board of directors to oversee restructuring of the 27 banks currently undergoing open bank resolutions. - Staff assessment of reform shortfalls: - Reform falls short of implementing the FSB Key Attributes. - Shortcomings include: no explicit replacement of CBR funding by federal government funds; modified procedure has no provision for statutory bail-in; P&A transactions likely remain unattractive due to asset transfer at book value. - Staff argued to remove impediments to P&A: allow bridge bank transactions, market valuation for asset transfers, and a run-off entity for bad assets. - CBR macroprudential and supervisory actions: - Initiated Asset Quality Review elements via Risk Assessment Department; review expected to be completed by end-2018. - Tightened macroprudential requirements to reduce dollarization by setting higher capital risk weights for FX lending to unhedged borrowers. - Strengthened stress-testing and established a tiered supervisory framework with capital surcharge for ten domestic systemically important banks. - Incorporated elements of FSAP recommendations, including on AML/CFT; AML/CFT framework needs further strengthening (e.g., definition of politically exposed persons, beneficial ownership transparency). ### Structural policies and medium-term growth - Assessment: - Medium-term prospects subdued; fiscal policy expected to provide little impetus to domestic demand compared to past oil price recoveries. - Lingering effects of sanctions and adverse demographics weigh on investment and potential growth. - Need for a new growth model: slow capital accumulation since 2009, adverse demographics, and weak TFP growth lowered potential growth prior to the 2014 crisis. - Weak property rights, poor infrastructure, and governance issues remain constraints despite Doing Business improvements. - Staff and Directors’ recommendations: - Accelerate structural reforms to reduce dependency on oil and diversify the export mix. - Strengthen property rights, advance privatization, improve governance, and invest in innovation and infrastructure to raise potential growth and accelerate convergence in per capita income to advanced economies. - Continue banking sector cleanup to support financial deepening and confidence. - Fiscal measures to support non-commodity exports and medium-term growth: - An appropriately designed fiscal-oil price rule would lessen the impact of oil prices on the REER and protect competitiveness. - Tax policy changes suggested: reduce social security contributions from 30 percent to 22 percent and increase the VAT rate from 18 to 22 percent. - Rebalance fiscal federal–regional interaction to ensure transfers do not disincentivize regional tax base development. ### External sector and trade - External indicators (billions of U.S. dollars unless indicated): - Total merchandise exports, fob: 2014: 496.8; 2015: 341.5; 2016: 281.7; 2017 (proj): 330.4; 2018 (proj): 339.1 - Total merchandise imports, fob: 2014: -307.9; 2015: -193.0; 2016: -191.7; 2017 (proj): -203.1; 2018 (proj): -213.7 - External current account: 2014: 57.5; 2015: 68.9; 2016: 25.0; 2017 (proj): 44.0; 2018 (proj): 48.9 - External current account (in percent of GDP): 2014: 2.8; 2015: 5.0; 2016: 1.9; 2017 (proj): 2.9; 2018 (proj): 3.2 - World oil price (U.S.D. per barrel): 2014: 96.2; 2015: 50.8; 2016: 42.8; 2017 (WEO assumption shown figure): 51.9; 2018 (proj): 52.0 - Staff assessment: - The average REER over 2016 appreciated by 24 percent as of February 2017 and is estimated by staff to be moderately overvalued, implying an external position in 2016 that was moderately weaker than suggested by medium-term fundamentals. - Medium-term external projections (selected, Table 1 & Table 2): - Current account (billions of U.S. dollars): 2017: 44.0; 2018: 48.9; 2019: 56.6; 2020: 63.8; 2021: 67.9; 2022: 72.2 - Current account (percent of GDP): 2017: 2.9; 2018: 3.2; 2019: 3.5; 2020: 3.8; 2021: 3.9; 2022: 4.0 - Exports (f.o.b, billions USD): 2017: 330.4; 2018: 339.1; 2019: 349.7; 2020: 366.3; 2021: 385.2; 2022: 412.6 - Imports (f.o.b, billions USD): 2017: -203.1; 2018: -213.7; 2019: -221.9; 2020: -229.4; 2021: -241.6; 2022: -257.6 - Gross international reserves (billions USD): 2017: 395.3; 2018: 412.6; 2019: 427.9; 2020: 442.1; 2021: 456.4; 2022: 469.6 - Months of prospective GNFS imports (reserves): 2017: 16.8; 2018: 16.7; 2019: 16.7; 2020: 16.7; 2021: 16.3; 2022: 15.8 ### Authorities’ assessment and views - Growth expectations: - Authorities (Ministry of Finance and Ministry of Economic Development) expect growth to reach 2 percent in 2017; the Central Bank expected growth in the range of 1-1½ percent. - Authorities agreed with staff’s estimate of a small negative output gap of about ½ percent, noting large uncertainty in measuring slack. - Authorities judged risks to the economy have diminished due to: - flexible exchange rate cushioning the economy against volatile oil prices; - recent banking sector external deleveraging; - gradual de-dollarization reducing the impact of future external shocks on households and corporates. - On the fiscal rule: - Authorities plan to introduce a new fiscal rule effective in 2019 when the budget will be close to balance. - Discussions center on a fixed (real) oil price benchmark of US$40 pb and a zero-primary balance target at the benchmark oil price. - Authorities view such a rule as simpler, more transparent and easier to communicate and are considering escape clauses to cap withdrawals from the reserve fund when savings reach a threshold. - On pensions and regional policy: - Authorities discussed pension reform options to be considered sometime after presidential elections: (i) increasing and equalizing statutory retirement ages; (ii) reducing early retirement benefits; (iii) curtailing pension benefits for pensioners below the mandatory retirement age. - Authorities agree federal fiscal policy should support development of regional tax bases and have started developing incentives for regions to generate higher own revenues. ### Banking sector stress, metrics, and projections - Key banking statistics and indicators: - NPLs to total loans: 2013: 6.0; 2014: 6.7; 2015: 8.3; 2016: 9.4; 2017 (April): 9.8 - Loan loss provisions to total loans: 2013: 5.9; 2014: 6.5; 2015: 7.8; 2016: 8.5; 2017 (April): 8.5 - Capital to risk-weighted assets: 2013: 13.5; 2014: 12.5; 2015: 12.7; 2016: 13.1; 2017 (April): 13.3 - Return on assets: 2013: 1.9; 2014: 0.9; 2015: 0.3; 2016: 1.2; 2017 (April): 1.7 - Return on equity: 2013: 15.2; 2014: 7.9; 2015: 2.3; 2016: 10.3; 2017 (April): 14.3 - Macro-financial linkages: - Profitability increasing across tradable and non-tradable sectors; overdue loans in ruble and FX are falling across sectors, with FX overdue loans falling faster in construction and retail. - FX maturity risks for corporates and banks remain low given their long positions. ### Debt sustainability and stress tests (selected) - Public DSA (selected figures): - Nominal gross public debt (percent of GDP): 2015: 10.8; 2016: 15.9; 2017: 15.6; 2018: 17.4; 2019: 17.8; 2020: 18.3; 2021: 18.3; 2022: 18.1; projection 2022: 18.0 - Public gross financing needs (percent of GDP): 2015: 0.8; 2016: 7.4; 2017: 6.5; 2018: 3.6; 2019: 2.7; 2020: 2.1; 2021: 0.8; 2022: 0.2 - External debt sustainability: - External debt (percent of GDP): 2014: 29.1; 2015: 38.0; 2016: 40.0; 2017: 35.9; 2018: 35.0; 2019: 34.6; 2020: 34.3; 2021: 34.1; 2022: 34.1 - Gross external financing need (in billions of U.S. dollars): 2017: 73.5; projection 2022: 82.4 ### Implementation of past IMF and FSAP recommendations (Annex I & Annex IV highlights) - Fiscal policy: - The three-year budgeting framework was reintroduced with measures of about 1 percent of GDP per year over 2017-2019. - New mechanism to save excess oil revenues implemented; authorities plan a fiscal rule effective in 2019. - Parametric pension reform discussion ongoing; no roadmap finalized. - Monetary policy: - Policy rates decreased gradually: cumulative 100bps in summer 2016 and cumulative 75bps in March-April 2017, bringing the key rate to 9.25 percent. - Financial sector: - Risk Assessment Department created; an asset quality review of the entire banking system is expected by end-2018. - Stress testing practices enhanced; tighter macroprudential measures to reduce dollarization implemented. - New bank resolution mechanism introduced but does not yet fully align with FSB Key Attributes; several FSAP recommendations remain in progress (e.g., P&A enhancements, funding mechanisms for resolution, broader implementation of AML/CFT improvements). - FSAP implementation status (selected): - Asset quality review: In progress; expected completion by end-2018. - Strengthen related-party framework: Done (effective January 2017, broader definition and exposure limit set at 20 percent of a bank’s equity capital). - Re-establish T-bill program and coordinate sterilization of excess liquidity: Not done. - Establish funding mechanism to recover temporary public financing costs through levies on the financial industry: Not done. ### Policy implications and recommended priorities (as reflected in source material) - Maintain vigilance on fiscal consolidation to reduce the non-oil deficit and rebuild buffers (Reserve Fund and NWF) gradually. - Continue cautious monetary easing as inflation moves toward the 4 percent CBR target, monitoring inflation expectations and exchange rate developments. - Continue banking-sector cleanup by the CBR to support stability: monitor NPLs, provisioning, capital adequacy, and concentration of profitability in top banks. - Accelerate structural reforms to raise potential growth: property rights, governance, labor market policies, innovation, infrastructure, and privatization where appropriate. - Rebalance tax policy and fiscal composition toward investment to support competitiveness and non-commodity export growth. - Strengthen AML/CFT framework, beneficial ownership transparency, and the legal basis for effective bank resolution and P&A transactions. *Source: IMF staff report for the 2017 Article IV consultation with the Russian Federation (June 15, 2017).* ### 1.4 percent in 2018. The still negative output gap, weak consumption demand, strengthening of ### RUSSIAN FEDERATION: STAFF REPORT FOR THE 2017 ARTICLE IV CONSULTATION ### Context and recent developments - After two years of recession, the economy is recovering due to higher oil prices and improved sentiment, amid tight fiscal and monetary policies. - Output: Real GDP growth - 2014: 0.7 - 2015: -2.8 - 2016: -0.2 - 2017 (forecast): 1.4 - 2018 (forecast): 1.4 - Inflation and prices - Consumer prices, period average: 2014: 7.8; 2015: 15.5; 2016: 7.0; 2017 (proj): 4.2; 2018 (proj): 4.0 - Consumer prices, end of period: 2014: 11.4; 2015: 12.9; 2016: 5.4; 2017 (proj): 4.0; 2018 (proj): 4.0 - GDP deflator: 2014: 10.7; 2015: 8.2; 2016: 3.6; 2017 (proj): 5.7; 2018 (proj): 3.8 - Key drivers of recent improvement: - Doubling of oil prices from a low of US$26 pb in January 2016 to over US$50 pb in May 2017. - 100 bps cut in the policy rate. - Improvements in consumption and investment; credit growth reached 2.5 percent y-o-y in March 2017. - Inflation declined to 4.1 percent in April 2017, down from 7.2 percent a year earlier, supported by a negative output gap, ruble appreciation, and declining food prices from a strong harvest. ### Outlook and key projections - Near term: - GDP is forecast to grow by 1.4 percent in 2017. - Domestic demand expected to support GDP growth; net exports’ contribution will diminish as imports recover. - Inflation expected to continue declining, driven by ruble appreciation and falling inflation expectations in the context of a small negative output gap of about ½ percent. - Medium term: - Oil price assumption: US$55pb on average over the medium-term. - With adverse demographics and barring significant structural reforms to lift productivity, potential growth is likely to stay at about 1½ percent over the medium term. - Risks: - Main risk remains a fall in oil prices. - Additional downside risks: flare up in geopolitical tensions, a significant slowdown in China, continued drop in investment due to lack of structural reforms, or a slower than expected banking system recovery. - Short-term risks have declined as production cuts by OPEC and other major oil producers seem sustained. - Buffers: reserves stood at 206 percent of the Fund’s adequacy metric adjusted for the impact of commodities at end-2016; public debt is low; current account is in surplus. ### Fiscal policy assessment and recommendations - Past and current stance: - Authorities reinstated the three-year fiscal framework in the 2017 budget to reduce policy uncertainty. - Fiscal consolidation pace judged appropriate given the recovery and persistently lower oil prices compared to the recent past. - Key fiscal figures (percent of GDP unless indicated): - General government net lending/borrowing (overall balance): 2014: -1.1; 2015: -3.4; 2016: -3.7; 2017 (proj): -1.9; 2018 (proj): -1.2 - General government revenue: 2014: 33.8; 2015: 31.8; 2016: 32.8; 2017 (proj): 32.6; 2018 (proj): 31.9 - General government expenditures: 2014: 34.9; 2015: 35.2; 2016: 36.4; 2017 (proj): 34.5; 2018 (proj): 33.1 - Primary balance: 2014: -0.4; 2015: -2.6; 2016: -2.6; 2017 (proj): -1.0; 2018 (proj): -0.2 - Nonoil balance (general government): 2014: -11.4; 2015: -11.4; 2016: -9.8; 2017 (proj): -8.4; 2018 (proj): -7.6 - Federal government net lending/borrowing (overall balance): 2014: -0.4; 2015: -2.3; 2016: -3.4; 2017 (proj): -1.7; 2018 (proj): -1.0 - Federal government nonoil balance: 2014: -9.9; 2015: -9.5; 2016: -9.0; 2017 (proj): -7.5; 2018 (proj): -6.8 - Staff and Directors’ recommendations: - Support fiscal consolidation with durable, well-targeted, growth-enhancing spending. - Adopt a credible fiscal rule to anchor adjustment, allow smoother response to oil price changes, build adequate savings, and contain Dutch disease. - Consider parametric reform of the pension system to deliver fiscal savings over time. - Reinstate and sustain the three-year fiscal framework to reduce policy uncertainty. ### Monetary policy assessment and recommendations - Current stance: - Monetary policy easing has begun, with a 100 bps policy rate cut noted in 2017 context. - Inflation objective (4 percent at end–2017) is being approached, supported by a strengthening ruble and lower food prices from a bumper harvest. - Staff and Directors’ recommendations: - Monetary policy easing should continue, but at a gradual pace given the uncertain size of the output gap and the potential for disinflation reversal. - Shift communication strategy to cover a longer horizon and clarify acceptable departures from the inflation target. - Money and credit indicators (annual percent change): - Base money: 2014: 6.3; 2015: -4.3; 2016: 3.8; 2017 (proj): 6.3; 2018 (proj): 6.4 - Ruble broad money: 2014: 1.5; 2015: 11.3; 2016: 9.2; 2017 (proj): 9.4; 2018 (proj): 9.6 ### Financial sector and macro-financial policies - Progress and issues: - Steps taken to increase financial system resilience, including an improved bank resolution mechanism. - Banking system liquidity support and capital injections helped stabilize the sector during the downturn. - Staff and Directors’ recommendations: - Continue implementing Financial Sector Assessment Program (FSAP) recommendations to enhance the institutional framework. - Remove obstacles that discourage investors from effectively acquiring assets and liabilities in bank resolutions. - Replace central bank funding with federal funds and increase recourse to banking industry capital. - Revamp statutory bail-in legislation while considering financial stability implications. - Further tighten limits on related-party lending and accelerate introduction of explicit early bank intervention procedures. - Financial soundness and external metrics: - Gross international reserves (billions of U.S. dollars): 2014: 385.5; 2015: 368.4; 2016: 377.7; 2017 (proj): 395.3; 2018 (proj): 412.6 - Reserves in months of imports of goods and non-factor services: 2014: 10.8; 2015: 15.7; 2016: 17.0; 2017 (proj): 16.8; 2018 (proj): 16.7 - Percent of short-term debt: 2014: 302; 2015: 450; 2016: 419; 2017 (proj): 391; 2018 (proj): 417 ### Structural policies and medium-term growth - Assessment: - Medium-term prospects are subdued; fiscal policy expected to provide little impetus to domestic demand compared to past oil price recoveries. - Lingering effects of sanctions and adverse demographics weigh on investment and potential growth. - Need for a new growth model: slow capital accumulation since 2009, adverse demographics, and weak TFP growth lowered potential growth prior to the 2014 crisis. - Weak property rights, poor infrastructure, and governance issues remain constraints despite Doing Business improvements. - Staff and Directors’ recommendations: - Accelerate structural reforms to reduce dependency on oil and diversify the export mix. - Strengthen property rights, advance privatization, improve governance, and invest in innovation and infrastructure to raise potential growth and accelerate convergence in per capita income to advanced economies. - Continue banking sector cleanup to support financial deepening and confidence. ### External sector - External indicators (billions of U.S. dollars unless indicated): - Total merchandise exports, fob: 2014: 496.8; 2015: 341.5; 2016: 281.7; 2017 (proj): 330.4; 2018 (proj): 339.1 - Total merchandise imports, fob: 2014: -307.9; 2015: -193.0; 2016: -191.7; 2017 (proj): -203.1; 2018 (proj): -213.7 - External current account: 2014: 57.5; 2015: 68.9; 2016: 25.0; 2017 (proj): 44.0; 2018 (proj): 48.9 - External current account (in percent of GDP): 2014: 2.8; 2015: 5.0; 2016: 1.9; 2017 (proj): 2.9; 2018 (proj): 3.2 - World oil price (U.S.D. per barrel): 2014: 96.2; 2015: 50.8; 2016: 42.8; 2017 (WEO assumption shown figure): 51.9; 2018 (proj): 52.0 - Staff assessment: - The average REER over 2016 appreciated by 24 percent as of February 2017 and is estimated by staff to be moderately overvalued, implying an external position in 2016 that was moderately weaker than suggested by medium-term fundamentals. ### Executive Board assessment (summary of Directors’ views) - Commended authorities for effective policy response drawing on robust buffers that helped exit a two-year recession. - Emphasized need to reduce dependence on oil and rekindle structural reforms to support new sources of growth, accelerate per capita income convergence to advanced economies, and overcome demographic challenges. - Urged fiscal adjustment to be underpinned by durable, well-targeted, growth-enhancing measures and a credible fiscal rule. - Recommended gradual monetary easing with clearer, longer-horizon communication on the inflation target. - Encouraged further financial sector reforms: improve bank resolution mechanisms, remove obstacles to asset/liability acquisition in resolutions, replace central bank funding with federal funds, increase reliance on banking capital, revamp bail-in legislation, tighten related-party lending limits, and accelerate early intervention procedures. - Called for reforms to strengthen property rights, advance privatization, improve governance, and invest in innovation and infrastructure. *Source: IMF staff report for the 2017 Article IV consultation with the Russian Federation (June 15, 2017).* ### 9. The authorities agreed with staff that 2017 will be a recovery year and that risks have ### 9. The authorities agreed with staff that 2017 will be a recovery year and that risks have ### Authorities’ assessment and macro outlook - Authorities (Ministry of Finance and Ministry of Economic Development) expect growth to reach 2 percent in 2017; the Central Bank expected growth in the range of 1-1½ percent. - Investment likely grew in Q1 despite contracting construction activity. - Recovery in consumption expected to be driven by falling inflation, easing financial conditions and improved confidence. - Authorities agreed with staff’s estimate of a small negative output gap of about ½ percent, noting large uncertainty in measuring slack. - Authorities judged risks to the economy have diminished due to: - flexible exchange rate cushioning the economy against volatile oil prices; - recent banking sector external deleveraging; - gradual de-dollarization reducing the impact of future external shocks on households and corporates. - The Central Bank estimates that the ruble is overvalued by 5 to 9 percent. ### Fiscal policy: medium-term adjustment and 2017 budget - 2017–19 federal budget (approved November 2016) assumptions and targets: - assumes an oil price of US$ 40 pb; - targets about a 1 percentage point of GDP yearly reduction in the overall budget deficit; - relies mostly on a nominal spending freeze and temporary revenue measures. - Spending adjustments: - cuts to defense and other spending items of 6 and 9 percent, respectively, per year; - rising pensions and social payments are indexed to inflation and higher debt service are assumed offset by those cuts. - Revenue measures: - increasing dividend payouts of state owned enterprises to 50 percent of their profits; - higher excise and mineral extraction taxes, yielding up to 1 percent of GDP per year. - 2017 budget amendment (May): - budget deficit revised to 2.1 percent of GDP from 3.2 percent in the original budget; - non-oil revenue collections in 2017Q1 were well ahead of budget projections with higher VAT collections and higher one-off revenues; - three-quarters of the additional non-oil revenues will be spent in 2017; - authorities aim to keep unchanged the annual reduction in the non-oil primary structural deficit over 2017–2019 at around 1 percentage point of GDP. - New mechanism to save oil revenues (implemented February): - MoF saves the difference between actual oil revenues and those that would have accrued at the budgeted price (symmetric around US$40 pb); - MoF purchases/sells corresponding FX amount on the market and deposits/withdraws it in/from the Reserve Fund (RF); - daily purchases amounted to US$70–100 million in February and March; - average daily FX turnover in the spot market is US$3–5 billion. ### Fiscal rule: proposals, staff views, and authorities’ views - Authorities plan to introduce a new fiscal rule effective in 2019 when the budget will be close to balance; discussions center on: - fixed (real) oil price benchmark of US$40 pb (instead of a backward-looking price formula); - a zero-primary balance target at the benchmark oil price (versus a 1 percent overall deficit under the old rule). - Staff views and recommendations: - agreed with the pace of adjustment but advocated for better quality fiscal measures to protect growth-enhancing spending; - recommended comprehensive review of spending priorities, focusing on subsidies, social programs, pension payments and regional transfers (more than half of budget spending is dedicated to these items); - fiscal adjustment should be based on more permanent and better targeted measures (e.g., improving targeting of social assistance programs) with low short-term multipliers (e.g., reductions in energy subsidies); - parametric reform of the pension system could deliver increased fiscal savings over time; - supported reinstatement of a fiscal rule but encouraged a higher level of savings and an oil benchmark that would adjust to persistent oil price changes (e.g., including oil future prices); - suggested increasing savings generated by the proposed fiscal rule because Russia's projected non-oil primary deficits by 2019 will be about 1–2 percent of GDP short of meeting the fiscal benchmark suggested by intergenerational equity; - proposed an additional target on expenditure growth or adjusting non-oil revenues to the economic cycle once more data are available. - Authorities’ views on the rule and consolidation: - committed to fiscal consolidation and see the amended 2017 budget as a signal consolidation will continue even with higher oil prices; - noted efforts to increase tax collection by reducing informality; - are considering means-testing of social benefits; - view a fiscal rule with a fixed real oil price as simpler, more transparent and easier to communicate; - considering escape clauses in the event of persistently low oil prices—capping withdrawals from the reserve fund when savings reach a certain threshold—to prevent depletion, though this may not be strictly binding as it does not constrain borrowing; - discussed pension reform options to be considered sometime after presidential elections: (i) increasing and equalizing statutory retirement ages; (ii) reducing early retirement benefits; (iii) curtailing pension benefits for pensioners below the mandatory retirement age; - agree federal fiscal policy should support development of regional tax bases and have started developing incentives for regions to generate higher own revenues. ### Evaluations and simulation evidence (Box 1 highlights) - Comparison of fiscal rules using IMF Flexible System of Global Models: - Authorities’ proposed new rule builds up the nearly depleted reserve fund under baseline and persistently higher oil price scenarios relative to a US$40 pb benchmark. - Should oil prices be persistently lower than US$40 pb, the new rule results in lower savings compared to Staff’s proposed rule. - Simulations show savings can be achieved through a more stringent fiscal target (Staff’s proposal) rather than an inflexible benchmark. - Both staff and authorities’ proposed rules perform equally well in shielding the economy from volatile oil prices with no discernible difference in impact on growth and the real effective exchange rate. - The old rule would have led to the lowest savings and highest spending during high oil prices and to a large fiscal stimulus under persistently low oil prices. ### Fiscal federalism and regional performance (Box 2 highlights) - Russia’s fiscal federalism features a relatively centralized tax authority and a complex system of federal transfers aimed at reducing cross-regional fiscal revenue dispersion. - Findings: - Transfers have been effective in supporting factor accumulation in lower per capita income regions and in reducing cross-regional disparities in real per capita spending in education and health. - Regions receiving higher transfers generally showed larger investment-to-Gross Regional Product (GRP) ratios. - Transfers have been less effective in supporting self-sustaining GRP growth and productivity increases: transfers pushed up regional growth through expansion of public sector services but resulted in lower real per capita growth and lower TFP growth. - Large cross-regional differences in the ratio of own fiscal revenues-to-expenditures persist, as does dependence on federal transfers. - Policy considerations: - Regional dependence on transfers will likely continue; sudden decreases or reallocation of transfers would create disruptions. - Fiscal policy at the federal level should support development of regional tax bases; expanding use of personal property taxes (currently 0.4 percent of consolidated revenues of regions) would strengthen regional tax bases and accountability. - A well-designed fiscal rule would dampen volatility of oil prices on the real exchange rate with positive spillovers for lower per-capita income regions. - Rebalancing domestic taxes in favor of lower labor taxes should support decreases in informality predominant in low per-capita income regions. ### Monetary policy: gradual easing and communication - Recent monetary actions and inflation: - CBR resumed easing in March, cutting policy rate by a cumulative 75bps to 9.25 percent. - Inflation fell to 4.1 percent in April. - Inflation target is 4 percent. - Drivers of lower inflation cited: - weak consumption demand; - strengthening of the ruble; - lower food prices from a bumper harvest. - Central Bank concerns: - disinflation could unwind quickly, jeopardizing attainment of the 4 percent inflation target by end-year, especially given a moderately overvalued exchange rate. - need to keep inflation expectations anchored. - Staff recommendations on monetary policy: - further monetary easing should continue at a gradual pace given risks to the inflation outlook; - staff estimates the current stance is tight, with the gap between current policy rate and the estimated neutral rate around 2–3.5 percentage points; - conditions for further disinflation remain due to a negative, albeit small, output gap, slowly recovering consumption amid a tight fiscal stance, and sequential deceleration in core inflation; - advised gradual easing given risks: inflation expectations above target, uncertain recovery pace amid volatile oil prices, tightening labor market (slope of core inflation Phillips curve expected to increase with recovery), and potential reversal of ruble overvaluation which may be driven in part by the current tight monetary stance. - Communication: - staff recommended CBR shift communication strategy to a horizon beyond end-year and provide clarity on what keeping inflation at 4 percent implies afterward; - suggested defining a horizon over which it plans to hit the target, or referring to the inflation horizon objective as an average over the medium-term. - Research note (Box 3): - A hybrid New Keynesian Phillips curve with time-varying coefficients for Russia (2000Q1–2016Q3) indicates the slope of the Phillips curve tends to increase during normal times and decrease after a crisis; - weight on inflation expectations in the Phillips curve has increased recently, likely due to introduction of a credible IT regime; - coefficient of REER small and stable over time; importance of import price inflation increased until recently, but elasticity of core inflation response to import price inflation has declined since onset of sanctions. *International Monetary Fund — Policy Discussions: Sowing the Seeds of a Strong, Durable Recovery (excerpt).* ### 20. The authorities agreed with the need for a gradual easing of monetary policy. They ### 20. The authorities agreed with the need for a gradual easing of monetary policy. They ### Monetary policy stance and communication - Authorities endorsed a gradual easing of monetary policy to continue anchoring inflation expectations while moderately tightening was being relaxed. - Faster disinflation than originally forecast was driven by: - ruble appreciation, - a bumper harvest, - still weak consumer demand. - Authorities judged the ruble vulnerable to volatile capital flows and oil prices, including uncertainty over the renewal of the OPEC production agreement; these unpredictable factors justified a cautious approach even if it meant undershooting slightly the end-year target. - The CBR indicated it aims to lower interest rate volatility by allowing inflation to deviate slightly from target and is working on defining acceptable deviation parameters together with a horizon to meet the inflation target. - The CBR plans to release these deviation and horizon details in September. ### Banking sector performance and key financial metrics - Lending and deposits: - Lending activity stopped contracting in Q4 for the retail segment and remained positive, albeit weak and stagnating, for the overall economy. - Loan volume growth averaged 2 percent annually since early 2016. - Banks’ deposit funding experienced healthy growth and the banking system is now in a structural liquidity surplus. - Asset quality and provisioning: - NPLs after rising for two years have settled at around 9.5 percent. - Lower provisioning on stabilized NPLs contributed to rising profitability. - Capital metrics: - Capital Adequacy Ratio remained stable overall and increased moderately in the past few months to around 13 percent, against a regulatory minimum of 8 percent. - Common Equity Tier 1 (CET1) ratio of 9.2 percent in relation to a phased-in Basel III capital requirement of 4.5 percent. - Banking sector restructuring and closures: - The CBR closed 110 credit institutions in 2016, compared to 101 in 2015. - Number of total credit institutions declined to 616, from 923 at end-2013. - Corporate sector vulnerabilities: - Corporate and bank FX risks in the short-term remain low as short-term liabilities are sufficiently covered by liquid external assets. - Corporate deleveraging over the past two years improved balance sheets, though as much as 10 percent of corporates may have less than full coverage of interest servicing costs with earnings. ### Macro-financial risk management and regulatory actions - Macro-financial risks declined as the economy adjusted to lower oil prices; profitability of tradable and non-tradable sectors picked up with improving activity and higher oil prices. - CBR actions to support financial stability: - Initiated elements of an Asset Quality Review through the newly created Risk Assessment Department for the entire banking system; review expected to be completed by end-2018. - Tightened macroprudential requirements to reduce dollarization by setting higher capital risk weights for FX lending to unhedged borrowers. - Strengthened stress-testing by adjusting for potential misclassification of loans and linking stress-test results to supervisory action. - Established a tiered supervisory framework for banks and defined a capital surcharge for ten domestic systemically important banks. - Incorporated elements of FSAP recommendations, including on AML/CFT. - AML/CFT: framework needs further strengthening by upgrading the definition of politically exposed persons in line with international standards and improving transparency of legal persons by making beneficial ownership information available. ### Bank resolution framework reform and assessment - New law (effective mid-June) amends the bank resolution framework: - Replaces the DIA-operated open bank resolution framework with one operated by the CBR. - Allows the CBR to provide an equity capital injection but only after wiping out shareholders’ equity capital, rather than extending a below-market rate loan via the DIA. - Permits a limited amount of bail-in for subordinated liabilities held by individuals who are managers and/or exercise control over the bank. - Creates a Bank Consolidation Fund (BCF), financed and managed by the CBR, to provide resolution funding; the BCF does not carry an explicit arrangement for federal government funding and its size would be determined on a case-by-case basis. - CBR will take majority control of the DIA’s board of directors to oversee restructuring of the 27 banks currently undergoing open bank resolutions. - Staff assessment and remaining shortcomings: - Replacing below-market loans with direct capital injections should reduce balance sheet encumbrance and shorten open bank resolution processes. - The reform falls short of Russia’s G20 commitment to implement the Financial Stability Board’s Key Attributes. - Shortcomings include: - The law does not replace CBR funding by federal government funds; the budget would incur indirect cost through lower CBR profits (not recognized explicitly). - The modified procedure has no provision for statutory bail-in, increasing the cost of intervention for the state. - Purchase and assumption (P&A) transactions likely remain unattractive because the new law requires asset transfers at book value—all assets must be acquired (good and bad). - Staff argued that removing impediments to P&A (e.g., allowing bridge bank transactions, market valuation for asset transfers, and a run-off entity for bad assets) would increase chances of P&A transactions. - Authorities’ views: - New mechanism is an improvement; previous mechanism was discontinued because it became expensive as market interest rates declined and created opportunities for fraud in P&A transactions. - Authorities consider P&A transactions unlikely soon due to difficulty finding buyers domestically; large banks are absorbing failed institutions. - Authorities prefer continued use of CBR funds for faster intervention and insist asset transfers remain at book value due to concerns about abuse in market valuation assessments. - Authorities agreed that enhancing AML/CFT framework will help deter financial crimes and noted legislative amendments have been prepared to upgrade the framework in line with international standards. ### Structural policies, exports, and reform priorities - Structural reform progress and state footprint: - Some measures taken: passing a PPP law, purging weak banks for a third year, privatizing a 19.5 percent stake in Rosneft and in other mostly small SOEs. - Privatization agenda for 2017–2019 has been scaled back; initial plans to partially privatize VTB and an extra 10 percent of Rosneft postponed. - Large state role persists: a large network of corporations (about 64,000 at end-2016) in multiple sectors; more than half of total banking system assets are held by state-owned banks. - Data constraints limit comprehensive analysis of state involvement impacts, but regional analysis suggests a larger footprint of the state is associated with lower productivity increases and negatively associated with real per capita regional income. - Limited export rebalancing and REER effects: - Significant REER depreciation during 2014-2015 has not led to a strong rebalancing towards non-energy tradable sectors. - Since Q3 2016, only "machinery and equipment" and "other goods" non-energy export sectors experienced large jumps, but a consistent trend is not yet evident. - Structural constraints—poor property rights and business regulation—and a non-diversified export basket weigh on export response; manufactured exports have become on average less sophisticated over the past 15 years. - Russia’s RTAs provide access to a very low share of global GDP; non-commodity exports are concentrated in immediate neighbors (over a quarter to CIS countries representing only 0.6 percent of global GDP). - Reasons for muted non-commodity export response (staff analysis): - For commodity exporters, the medium-term elasticity of manufactured exports to the REER decreases during periods of falling commodity prices (proxy: Export Commodity Price Index (ECPI) falling by over 2.5 percent a year), even controlling for external demand. - Slower response may reflect overall economic stress during terms-of-trade shocks: reduced corporate investment appetite and banking system adjustment that hinders financing of tradable sector projects. - Improved price competitiveness often coincides with lower external demand; Russia’s export partners’ weak performance limits demand. - Staff reform priorities and policy recommendations: - Rekindle structural reform agenda to address pre-existing structural causes of slowdown and to ensure depreciation-induced competitiveness attracts investment. - Priority areas: institutional improvements in property rights and governance, labor market policies, innovation, and infrastructure. - Sequencing: improve institutional and investment environment first to realize dividends from innovation. - Continue commitments to fight financial crimes (May 2016 London anti-corruption summit) and expand RTAs beyond neighboring countries to secure access to additional markets. - Fiscal measures to support non-commodity exports and medium-term growth: - An appropriately designed fiscal-oil price rule would lessen the impact of oil prices on the REER and protect competitiveness from oil price volatility. - Tax policy changes could help competitiveness, such as rebalancing from labor taxes to consumption taxation: - reducing social security contributions from 30 percent to 22 percent and increasing the VAT rate from 18 to 22 percent. - Design of fiscal federal–regional interaction should ensure transfers do not disincentivize development of regional tax bases or discourage private sector development. - Refocus fiscal policy to increase non-oil revenues and to improve the balance between current and capital spending; shift composition toward public investments to raise productivity and investment growth. - Parametric pension reform, such as increasing the statutory retirement age, could help offset negative demographic trends on labor markets. *International Monetary Fund staff summary (excerpt).* ### 32. The authorities are still designing a comprehensive structural transformation strategy. ### 32. The authorities are still designing a comprehensive structural transformation strategy. ### Authorities’ planned reforms and recent actions - Authorities are designing a comprehensive structural transformation strategy to address staff-identified bottlenecks to higher potential growth. - Considered reforms aim to improve the investment climate and support technological progress and productivity gains. - Specific measures highlighted by authorities: - Reforming customs administration, including automating clearance of goods and modernizing the risk management framework to speed up customs procedures. - Approval of the 2030 economic security strategy. - Noted that a comprehensive reform agenda will likely be implemented after the upcoming presidential elections. - Authorities observe early signs of reorientation toward the tradable sector, driven by a weaker ruble, with particular activity in: - the chemical industry, - food processing, - agricultural sectors. - Authorities acknowledge these "green shoots" will take time to translate into a meaningful contribution to growth, including for reasons identified by staff. ### Staff appraisal — near-term outlook - The economy is exiting a two-year recession that proved shallower than past downturns. - The authorities’ effective policy response, enabled by the economy’s robust buffers, cushioned the shocks. - Growth is expected to resume in 2017, supported by higher oil prices and improved sentiment. - Short-term risks from volatile financial markets and oil prices have diminished. ### Staff appraisal — medium-term prospects - Medium-term prospects are subdued due to: - expected stability of oil prices at lower levels than historical highs, - a structurally weak economy (adverse demographics, lingering effects of sanctions on productivity and investment, and structural constraints). - The depreciation of the exchange rate has so far not ignited a robust response of non-traditional industries; a new growth model less dependent on commodities is yet to emerge. - The external position in 2016 was moderately weaker than suggested by medium-term fundamentals and desirable policy settings. ### Fiscal policy and recommendations - Fiscal adjustment should be underpinned by quality measures. - Positive step: reinstatement of the three-year budget framework in the 2017–2019 federal budget to reduce policy uncertainty. - The envisaged pace of fiscal consolidation is appropriate as it allows a steady adjustment to permanently lower oil prices in the context of a recovering economy. - Concerns and recommendations: - The consolidation relies on spending reductions that are not targeted; more permanent and better targeted measures should be envisaged to safeguard growth-enhancing fiscal spending and sustain the significant adjustment. - A parametric reform of the pension system could deliver substantial fiscal savings over time and help ease the negative demographic trend on labor markets. ### Fiscal rule - A credible fiscal rule is paramount to support medium-term sustainability and mitigate the effect of oil price volatility. - The FX purchase program functions as a short-term tool to replenish fiscal buffers but is short of a fiscal rule. - A credible fiscal rule that anchors the deficit at an appropriate level would reduce fiscal policy uncertainty. - The authorities’ current fiscal rule proposal, while broadly appropriate, could be improved by: - modifying the rule to allow for a smoother adjustment of fiscal policy to persistent oil price changes; - generating more savings, since Russia’s current and projected non-oil primary deficits are larger than suggested by long-term fiscal benchmarks. ### Monetary policy and CBR communication - Staff commends the CBR for having largely met its inflation target. - The monetary policy easing initiated in March was appropriate considering the inflation outlook and the decline in inflation expectations. - Monetary policy remains tight; interest rate cuts should continue but at a gradual pace given the uncertain size of the output gap and the potential reversal of the exchange rate-driven disinflation. - Recommendation on communication: - The CBR should shift its communication strategy to a horizon beyond end-2017. - The CBR should elaborate on its medium-term inflation targeting framework by providing clarity as to what constitutes acceptable departures from the 4 percent inflation target and over what horizon. - The CBR could consider either defining a horizon over which it plans to hit its target or refer to its inflation horizon objective as an average over the medium-term. ### Banking sector and financial stability - The banking system’s performance is improving; authorities should continue implementing last year’s FSAP recommendations. - Actions taken to increase resilience: - setting limits on related-party lending, - gradually reducing dollarization through macroprudential measures, - introducing a tiered supervisory framework. - Further steps recommended: - scope for further tightening the limit on related party lending over time; - accelerate the introduction of explicit early bank intervention procedures; - the new resolution mechanism should shorten the process of open bank resolution and reduce balance sheet encumbrance. - remove obstacles for effective use of P&A transactions, replace central bank funding by federal funds, and increase recourse to banking industry capital. - continue work on statutory bail-in legislation that factors in financial stability implications. - further strengthen the effectiveness of the AML/CFT framework, including measures related to politically exposed persons and entity transparency, to address financial crimes related to tax evasion and corruption. ### Structural reform priorities - Structural reforms are needed to lift potential output and accelerate per capita income convergence with advanced economies. - Steps already taken: passing a PPP law, privatizing some companies, and purging weak banks from the financial system. - A wider reform agenda is needed to jump start investment, leverage the impact of the more competitive exchange rate, and increase productivity. - Policy priorities identified: - property rights, - governance, - labor market policies, - innovation, - infrastructure. - Urgent need to better understand and measure channels through which the large size of the state may be hampering economic performance to: - focus state activity in areas with positive spillovers for productivity and competition, including at the regional level. - Strengthening regional and multilateral trade relations could allow greater penetration of foreign markets by Russian entities. - Pension reform, such as increasing the statutory retirement age, could help offset the impact of negative demographic trends on labor markets. *RUSSIAN FEDERATION — INTERNATIONAL MONETARY FUND (excerpt).* ### 41. The next Article IV consultation should be held on the standard 12-month cycle. ### cr17197 - 41. The next Article IV consultation should be held on the standard 12-month cycle. ### Overall recommendation - The next Article IV consultation should be held on the standard 12-month cycle. ### Real sector: recent developments and outlook - The economy is recovering from a two-year recession with high-frequency indicators pointing to a recovery in Q3-Q4. - Key projections and indicators (Table 1): - Real GDP: 2014: 0.7; 2015: -2.8; 2016: -0.2; 2017: 1.4; 2018: 1.4; 2019: 1.5; 2020: 1.5; 2021: 1.5; 2022: 1.5. - Real domestic demand: 2017: 1.0; 2018: 1.0; 2019: 1.1; 2020: 1.2; 2021: 1.2; 2022: 1.2. - Investment (annual percent change): 2014: -4.4; 2015: -13.4; 2016: 1.5; 2017: 2.5; projection 2018–2022: 1.0 each year. - Consumer prices (period average): 2014: 7.8; 2015: 15.5; 2016: 7.0; 2017: 4.2; 2018–2022: 4.0 each year. - CPI end of period: 2014: 11.4; 2015: 12.9; 2016: 5.4; 2017: 4.0; 2018–2022: 4.0 each year. - Unemployment rate: 2014: 5.2; 2015: 5.6; 2016: 5.5; 2017–2022: 5.5 each year. ### External sector: trade, current account, capital flows - Recent dynamics: - Imports leveled off before exports stopped contracting, leading to a deterioration of the current account; trade balance is supporting headline CA improvement while non-energy current account has stopped improving. - Net private capital outflows have declined, supported by inflows into local sovereign public debt. - Key projections and indicators (Table 1 & Table 2): - Current account (billions of U.S. dollars): 2014: 57.5; 2015: 68.9; 2016: 25.0; 2017: 44.0; 2018: 48.9; 2019: 56.6; 2020: 63.8; 2021: 67.9; 2022: 72.2. - Current account (percent of GDP): 2014: 2.8; 2015: 5.0; 2016: 1.9; 2017: 2.9; 2018: 3.2; 2019: 3.5; 2020: 3.8; 2021: 3.9; 2022: 4.0. - Trade balance (billions of U.S. dollars): 2014: 188.9; 2015: 148.5; 2016: 90.0; 2017: 127.3; 2018: 125.4; 2019: 127.8; 2020: 136.9; 2021: 143.6; 2022: 155.0. - Exports (f.o.b, billions USD): 2014: 496.8; 2015: 341.5; 2016: 281.7; 2017: 330.4; 2018: 339.1; 2019: 349.7; 2020: 366.3; 2021: 385.2; 2022: 412.6. - Imports (f.o.b, billions USD): 2014: -307.9; 2015: -193.0; 2016: -191.7; 2017: -203.1; 2018: -213.7; 2019: -221.9; 2020: -229.4; 2021: -241.6; 2022: -257.6. - Non-energy exports (billions USD): 2014: 172.4; 2015: 142.6; 2016: 130.6; 2017: 151.3; 2018: 158.5; 2019: 170.3; 2020: 184.6; 2021: 199.7; 2022: 215.3. - Energy exports (billions USD): 2014: 324.4; 2015: 198.9; 2016: 151.1; 2017: 179.0; 2018: 180.6; 2019: 179.3; 2020: 181.7; 2021: 185.5; 2022: 197.3. - Gross international reserves (billions USD): 2014: 385.5; 2015: 368.4; 2016: 377.7; 2017: 395.3; 2018: 412.6; 2019: 427.9; 2020: 442.1; 2021: 456.4; 2022: 469.6. - Months of prospective GNFS imports (reserves): 2014: 10.8; 2015: 15.7; 2016: 17.0; 2017: 16.8; 2018: 16.7; 2019: 16.7; 2020: 16.7; 2021: 16.3; 2022: 15.8. - Net private capital flows (percent of exports of GNFS): 2014: -28.2; 2015: -15.7; 2016: -5.2; 2017: -8.7; 2018: -8.8; 2019: -11.2; 2020: -12.3; 2021: -13.3; 2022: -13.1. ### Fiscal policy: revenue, deficits, and buffers - The decline in oil prices led to a large drop in oil revenues, widening the deficit amid an elevated non-oil deficit; fiscal consolidation is expected to be achieved through lower expenditures. - Key fiscal indicators (Table 1, Table 4): - General government revenue (percent of GDP): 2014: 33.8; 2015: 31.8; 2016: 32.8; 2017: 32.6; 2018: 31.9; 2019: 31.7; 2020: 31.9; 2021: 32.2; 2022: 32.3. - General government expenditures (percent of GDP): 2014: 34.9; 2015: 35.2; 2016: 36.4; 2017: 34.5; 2018: 33.1; 2019: 32.3; 2020: 31.8; 2021: 31.7; 2022: 31.7. - Net lending/borrowing (overall balance, percent of GDP): 2014: -1.1; 2015: -3.4; 2016: -3.7; 2017: -1.9; 2018: -1.2; 2019: -0.7; 2020: 0.1; 2021: 0.5; 2022: 0.6. - Primary balance (percent of GDP): 2014: -0.4; 2015: -2.6; 2016: -2.6; 2017: -1.0; 2018: -0.2; 2019: 0.3; 2020: 1.1; 2021: 1.5; 2022: 1.7. - Non-oil balance (percent of GDP): 2014: -11.4; 2015: -11.4; 2016: -9.8; 2017: -8.4; 2018: -7.6; 2019: -6.9; 2020: -6.0; 2021: -5.5; 2022: -5.4. - Reserve Fund (percent of GDP): 2008–2017 shown and projected: 2014: 1.1; 2015: 0.6; 2016: 0.6; 2017: 0.6; projected increases to 3.5 by 2022 (Table 4, memorandum). - General government debt (percent of GDP): 2014: 15.6; 2015: 15.9; 2016: 15.6; 2017: 17.4; 2018: 17.8; 2019: 18.3; 2020: 18.3; 2021: 18.1; 2022: 18.0. ### Monetary policy and inflation - The ruble rebound since February 2016 (linked to oil prices) is supporting the decline in inflation toward the CBR target of 4 percent. - CBR started cutting rates in March by 25 bps. - Key indicators (Figure captions and Table 5/6): - Household one-year ahead inflation expectations are falling towards the 4 percent target. - Policy and interbank rates shown declining; consensus forecasts expect gradual easing. - CPI inflation (12-month change, eop): 2014: 11.4; 2015: 12.9; 2016: 5.4; 2017: 4.0; 2018–2022: 4.0 each year. - Accounting exchange rate (ruble per U.S. dollar, eop) listed as 56.3 for 2014, 72.9 for 2015, 60.7 for 2016 (Table 5). ### Banking sector and financial stability - Banking developments: - Consumer credit growth continues to recover; NPLs have started falling. - Banks’ profitability continues to increase, driven by top-5 banks, supporting a slight uptick in capital ratios while the CBR continues cleaning up the banking system. - Key banking statistics (Figure 5, Table 7): - NPLs to total loans: 2013: 6.0; 2014: 6.7; 2015: 8.3; 2016: 9.4; 2017 (April): 9.8. - Loan loss provisions to total loans: 2013: 5.9; 2014: 6.5; 2015: 7.8; 2016: 8.5; 2017 (April): 8.5. - Capital to risk-weighted assets: 2013: 13.5; 2014: 12.5; 2015: 12.7; 2016: 13.1; 2017 (April): 13.3. - Return on assets: 2013: 1.9; 2014: 0.9; 2015: 0.3; 2016: 1.2; 2017 (April): 1.7. - Return on equity: 2013: 15.2; 2014: 7.9; 2015: 2.3; 2016: 10.3; 2017 (April): 14.3. ### Macro-financial linkages - Profitability increasing across tradable and non-tradable sectors; overdue loans in ruble and FX are falling across sectors, with FX overdue loans falling faster in construction and retail, supporting higher portfolio shares for these sectors. - FX maturity risks for corporates and banks remain low given their long positions; borrowing has remained relatively stable. ### Selected medium-term framework and projections - Medium-term projections (Table 6): - GDP growth at constant prices: 2017: 1.4; 2018: 1.4; 2019: 1.5; 2020: 1.5; 2021: 1.5; 2022: 1.5. - Consumer prices (end of period): 2017: 4.0; 2018–2022: 4.0 each year. - External current account balance (percent of GDP): 2017: 2.9; 2018: 3.2; 2019: 3.5; 2020: 3.8; 2021: 3.9; 2022: 4.0. - Gross reserves (end of period, billions USD): 2017: 395.3; 2018: 412.6; 2019: 427.9; 2020: 442.1; 2021: 456.4; 2022: 469.6. ### Debt sustainability and stress tests - Public DSA (Table 8, Table 9, Table 10): - Nominal gross public debt (percent of GDP): 2015: 10.8; 2016: 15.9; 2017: 15.6; 2018: 17.4; 2019: 17.8; 2020: 18.3; 2021: 18.3; 2022: 18.1; projection 2022: 18.0. - Public gross financing needs (percent of GDP): 2015: 0.8; 2016: 7.4; 2017: 6.5; 2018: 3.6; 2019: 2.7; 2020: 2.1; 2021: 0.8; 2022: 0.2. - Baseline primary balance and alternative scenarios provided, including Historical and Constant Primary Balance scenarios with associated assumptions for real GDP growth, inflation, and effective interest rates (Table 9). - Stress tests presented: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Macro-Fiscal Shock (Table 10). Specific scenario values include, for example, Real GDP growth under the Real GDP Growth Shock scenario: 2017: 1.4; 2018: -3.2; 2019: -3.1; 2020: 1.5; 2021: 1.5; 2022: 1.5. - External debt sustainability (Table 11): - External debt (percent of GDP): 2014: 29.1; 2015: 38.0; 2016: 40.0; 2017: 35.9; 2018: 35.0; 2019: 34.6; 2020: 34.3; 2021: 34.1; 2022: 34.1. - External debt-to-exports ratio (percent): 2012–2022 series shown with baseline value 2017: 138.5 (from table’s row labelled external debt-to-exports ratio and corresponding periods). - Gross external financing need (in billions of U.S. dollars): 2017: 73.5 (Table 11 shows a sequence including 2017: 73.5 and subsequent projections up to 2022: 82.4). ### Policy implications and considerations (as reflected in source material) - Maintain vigilance on fiscal consolidation to reduce the non-oil deficit and rebuild buffers (Reserve Fund and NWF) gradually, while recognizing that the Reserve Fund would only gradually increase and provide a limited buffer against volatile oil prices. - Continue cautious monetary easing as inflation moves toward the 4 percent CBR target, monitoring inflation expectations and exchange rate developments. - Continue banking-sector cleanup by the CBR to support stability: monitor NPLs, provisioning, capital adequacy, and concentration of profitability in top banks. - Monitor external financing needs and private capital flow dynamics given their contributions to balance of payments adjustments and reserve adequacy. *Source: IMF staff report (cr17197) — Russian Federation: Figures, tables, and projections as presented in the provided content.* ### Annex I. Implementation of Past IMF Recommendations ### Annex I. Implementation of Past IMF Recommendations ### Key recommendations — Fiscal Policy - Recommendation: Medium-term fiscal consolidation is required to adjust to lower oil prices and rebuild buffers. - Implemented policies: - The three-year budgeting framework was reintroduced with measures of about 1 percent of GDP per year over 2017-2019 to adjust to lower oil prices. - The fiscal adjustment should be smooth and based on quality and permanent measures while safeguarding growth-enhancing expenditures. - The three-year budget assumes a balanced adjustment path and is predicated on a nominal freeze of most categories of spending, irrespective of their contributions to growth, while relying on some temporary revenue measures. - Recommendation: A parametric pension reform has become urgent to help support the fiscal adjustment in a timely manner. - Implemented policies: - The current debate over pension reform has yet to lead to a roadmap of measures. - Recommendation: The reinstatement of the fiscal rule will help anchor the fiscal adjustment over the medium-term. - Implemented policies: - The new mechanism to save oil revenues helps improve the predictability of fiscal policy by ensuring that excess oil revenues are saved rather than spent. - The authorities plan to introduce a new fiscal rule that would be effective in 2019. ### Key recommendations — Monetary Policy - Recommendation: Monetary policy normalization could resume cautiously as inflation is on a declining path and inflation expectations continue to fall. - Implemented policies: - Policy rates were decreased gradually, first in the summer of 2016 by a cumulative 100bps, and then in March-April 2017 by a cumulative 75bps, bringing the key rate to 9.25 percent. ### Key recommendations — Financial Sector Policy - Recommendation: Enhanced stress tests and an Asset Quality Review (AQR) would be important steps towards putting the banking system on a sounder footing. - Implemented policies: - Stress tests of banks have led to supervisory actions with some banks. - A Risk Assessment Department was created to focus on asset quality review, supported by a new system-wide database on corporate credit and collaterals and recently acquired legal powers to challenge collateral valuations. - Recommendation: The authorities should prepare an action plan to address deficiencies in supervision. - Implemented policies: - Regulations on supervision are being amended with draft laws to improve CBR interaction with external auditors and requirements for CBR approval for major acquisition of financial companies. - Recommendation: Improvements in the bank resolution framework are critical to minimize the use of public funds. - Implemented policies: - The authorities introduced a new resolution framework that would provide solvency support in open bank resolution by purchasing bank shares at above fair price value. ### Key recommendations — Structural Policies - Recommendation: Reduce unwarranted administrative pressures while strengthening contract enforcement and property rights, increase mobility and reduce skills mismatches, support innovation for higher value added sectors, and reduce the footprint of the state in the economy. - Implemented policies: - The authorities have successfully privatized a 19.5 percent stake in Rosneft together with other, mostly small, divestures from SOEs. - Various support programs for SMEs are being implemented to foster competition in the domestic market, improve quality of production and facilitate the increase of localization of manufacturing. - Trade integration initiatives are continuing. ### External sector assessment — Overall Assessment and Policy Implications - Background and key statistics: - The net international investment position (NIIP) at end-September 2016 was at 18 percent GDP (up from 10 percent in 2013), with gross assets of 96 percent of GDP and liabilities of 78 percent of GDP. - Total external debt was at 41.6 percent of GDP at end-2016. - Assessment: - The projected current account surpluses suggest that Russia will continue to maintain a positive IIP, which minimizes risks to external stability. - Reserve assets should increase further, as accumulation of fiscal savings in the oil funds is resuming. - External deleveraging by the private sector since 2014 reduces risks further. - Overall Assessment statement: - The external position in 2016 was moderately weaker than suggested by medium-term fundamentals and desirable policy settings. - Since 2016 the REER has appreciated, sharply as oil prices bottomed out, economic uncertainty declined, and appetite for Russian assets resumed. - The structural implications of sanctions create exceptional uncertainty when assessing the external position, although on balance they would suggest the equilibrium REER should be lower. - Potential policy responses: - The weaker external position calls for greater diversification. - The non-oil fiscal deficit remains significantly higher than its long-term desirable level and needs to adjust to facilitate a rebalancing from public to private activity, and a re-allocation of government expenditure from current to capital spending. - This rebalancing—coupled with a renewed emphasis on structural reforms to invigorate the private sector—would help increase on a net basis savings, and yet create some room for somewhat higher private and public sector investment over the medium-term. ### Current account - Background and key statistics: - From 2000 to 2013, the current account (CA) surplus fell from 16 to 1.5 percent of GDP. - The 2014 oil price shock triggered a brief correction: the CA rose to 5 percent of GDP in 2015, as reduced oil export revenues (approximately 7 percent of GDP) were more than offset by falling absorption. - In 2016, the CA surplus shrunk to 1.7 percent of GDP, although the non-oil current account deficit remained stable. - Assessment: - The EBA CA model yields a norm for 2016 of 6.3 percent of GDP, compared to a cyclically adjusted CA surplus of 4.2 of GDP, thus yielding a CA gap of -2 percent of GDP. - Staff assesses the 2016 CA gap to have been between -2 to 0 percent of GDP. - The identified fiscal gap accounts for almost all of the CA gap. - Policy implication: In the medium term, fiscal policy should be tightened to rebuild buffers and save more of the oil wealth for future generations. ### Real exchange rate (REER) - Background and key statistics: - Following the dual shocks of oil prices and sanctions, and the floating of the ruble in November 2014, the REER depreciated over 35 percent between mid-2014 and February 2016. - In 2016, the average REER remained largely unchanged compared to 2015. - From the fourth quarter of 2016, the exchange rate sustained a significant appreciation, and as of February 2017 the REER was 26.2 percent above the 2016 average due largely to oil price increases. - Assessment: - Staff assess that the 2016 REER was between 0 and 10 percent, above its equilibrium, and therefore moderately overvalued. - Note: The EBA Level REER model suggests an undervaluation of 18.1 percent, and the EBA Index REER regression model an undervaluation of 23.6 percent; for commodities exporters, the fit of the REER models tends to be relatively poor, hence staff puts more weight on the results implied by the CA model. ### Capital and financial accounts; FX intervention and reserves - Capital and financial accounts — background and assessment: - Net private capital outflows continued in 2016 though the pace significantly slowed relative to 2014 and 2015, as confidence resumed. - Private sector external deleveraging has continued in the face of limited access to international capital markets. - Assessment: While Russia is exposed to risks of accelerated capital outflows because of the uncertain geopolitical context, the floating exchange rate regime and large international reserves provide substantial buffers. - FX intervention and reserves — background and assessment: - Since adopting a free floating exchange rate regime in November 2014, FX interventions have been limited. - International reserves rose to US$378 billion in 2016, up from U$368 billion in 2015, due mostly to valuation effects. - International reserves at end-2016 were equivalent to 235 percent of the Fund’s basic reserve adequacy metric, considerably above the adequacy range of 100–150 percent. - Taking into account Russia’s vulnerability to commodity shocks, the adjusted adequacy metric falls to 206 percent of the metric, still above the adequacy level. - Policy implication: Small regular purchases to replenish reserves could be justified by the high level of uncertainty related to sanctions and oil prices. Large FX interventions should be limited to episodes of market distress. *Source: Annex I. Implementation of Past IMF Recommendations (cr17197).* ### Annex IV. Implementation of FSAP Recommendations ### Annex IV. Implementation of FSAP Recommendations ### Banking Stability - Conduct an asset quality review (AQR) to ensure adequate bank capitalization (CBR). Timing: ST/MT. Progress: In progress. The authorities expect to complete an asset quality review of the entire banking system by end-2018. Stress tests of banks make supervisory adjustments for assets and capital for certain banks. - Enhance stress testing practices, including on a consolidated basis and by currency (CBR). Timing: ST/MT. Progress: In progress. CBR is developing methodologies for stress testing on a consolidated basis, with the help of an external consultant, and by currency, for individual banks. ### Liquidity Management - Review FX repo framework, and formalize lender of last resort (CBR). Timing: ST. Progress: Done. The FX repo framework takes account of banks’ access to FX funding from the interbank market. The CBR strengthened its framework for emergency liquidity assistance (ELA) during 2016 and is in the process of receiving IMF TA in this area. - Re-establish T-bill program and coordinate sterilization of excess liquidity (Ministry of Finance—MoF, CBR). Timing: ST. Progress: Not done. ### Financial Sector Oversight and Regulation - Require prior approval for banks’ domestic investments in nonbank institutions (CBR). Timing: ST. Progress: In progress. A draft law requires banks to coordinate with the CBR on acquisition of shares representing more than 10 percent ownership in nonbank credit institutions. The draft law has passed public discussion and is at the stage of inter-agency examination. - Issue specific requirements for management of banks’ country and transfer risks (CBR). Timing: ST. Progress: In progress. Under review. - Upgrade framework for relations with and use of banks’ external auditors (CBR). Timing: ST. Progress: In progress. A draft law allows the CBR to regulate and supervise audit activities. The draft is being prepared for a second reading in parliament. - Strengthen further the legal framework applicable to related parties (CBR). Timing: ST. Progress: Done. Effective from January 2017, the definition of related parties has been broadened and a limit set on such exposure at 20 percent of a bank’s equity capital. - Upgrade framework for prudential oversight of banks’ operational risk (CBR). Timing: ST. Progress: In progress. - Bring securities and insurance regulation and supervision in line with international standards (CBR). Timing: MT. Progress: In progress. The CBR is preparing a road map to bring legislation in line with the Core Principles, Standards, Guidance and Assessment Methodology of the International Association of Insurance Supervisors and IOSCO Objectives and Principles of Securities Regulation. - Ensure the effective implementation of the AML/CFT framework (CBR, MoF monitoring). Timing: ST. Progress: In progress. Work is at an early stage. ### Macroprudential Policy - Adopt legal changes to provide a comprehensive policy toolkit (CBR, MoF). Timing: ST/MT. Progress: In progress. The CBR is drafting a regulation to consolidate existing macroprudential tools. The authorities have taken measures to reduce dollarization by requiring higher capital risk weights on banks’ FX lending not matched by FX earnings. ### Crisis Management and Resolution - Review the framework for the use of public funds to finance the DIA for resolution purposes to be provided by the federal government. If necessary to use CBR funds, the federal government should provide an indemnity (CBR, MoF). Timing: MT. Progress: Not done. The authorities have identified a new mechanism to finance the costs of banking resolution but it does not explicitly provide for use of public funds. - Establish a funding mechanism for recovery of the costs of providing temporary public financing through levies on the financial industry (CBR, MoF). Timing: MT. Progress: Not done. The resolution mechanism does not envisage levies on banks other than the premia already collected by the DIA. - Introduce the full range of resolution powers and safeguards recommended by the FSB Key Attributes, including by implementing legal and operational changes needed to make purchase and assumption (P&A) an effective resolution tool (CBR, MoF). Timing: ST. Progress: In progress. The authorities have introduced a new resolution mechanism. However, there is no provision as yet for asset transfer at market prices to an acquiring institution as part of a P&A transaction. ### Banking Sector Development - Promote legal reforms to increase state-owned commercial banks (SOB’s) Board effectiveness (MoF, CBR). Timing: MT. Progress: Not done. - Continue gradual privatization of SOBs (MoF, CBR) as conditions permit. Timing: MT. Progress: Not done. *cr17197 - Annex IV. Implementation of FSAP Recommendations* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17197.pdf_